Understanding the intent and application of these proposed regulations

1. PROPOSED
SECTION 965
REGULATIONS
A HIGHLIGHTED ANALYSIS OF

2. TODAY’S SPEAKERS
PAUL
DAILEY, CPA, MBA
Partner
2
JENNIFER
SKLAR-ROMANO, JD., LL.M, MBA
Principal

3. DEFINITION OF SPECIFIED FOREIGN CORPORATION
(“SFC”)
• A 10% corporation is a SFC with respect to a US SH even if the US SH is itself not
the 10% domestic C corp. owner of the foreign corporation. For example, FC is
owned 20% by A, a US individual, 20% by B, a US Corp., and 60% by foreign
persons. FC is a SFC with respect to both A and B even through it is not a CFC.
• Special downward attribution rule for partnerships – stock owned, directly or
indirectly, by or for a partner will only be treated as owned by a partnership
under the attribution rules if the partner owns at least 5% of the interests in the
partnership’s capital and profits.

4. ACCUMULATED POST-1986 DEFERRED FOREIGN INCOME
(“POST-1986 E&P”)
• SFC to SFC distributions: The amount by which the post-1986 E&P of a SFC is reduced as a result
of a distribution to another SFC in the inclusion year may not exceed the amount by which the
post-1986 E&P of the distributee SFC is increased.
• Accrued foreign taxes: Post-1986 E&P of a SFC on the November 2, 2017 measurement date is
reduced by the portion of applicable taxes attributable to the portion of taxable income (as
determined under foreign law) that accrued during the taxable year and on or before November
2, 2017.
• E&P Deficits: All deficits related to post-1986 E&P (including hovering deficits) are taken into
account in determining the post-1986 E&P (including a deficit) of a SFC.
• Non-US SHs: Post-1986 E&P is reduced by amounts that would be treated as PTI if non-US
shareholders were US shareholders. For example, if SFC is owned 80% by US SH and 20% by
Foreign SH and SFC has $100 of Subpart F PTI, the entire $100 (not just $80 attributable to US
SH) will reduce post-1986 E&P of SFC.

5. E&P DEFICIT FOREIGN CORPORATION (“E&P DEFICIT
CORP”)
• With respect to a SFC, it must first be determined whether the SFC is a DFIC. If so, the SFC is
classified solely as a DFIC and not also as an E&P deficit corp. For example, if SFC has positive E&P
on December 31, 2017 and an E&P deficit on November 2, 2017, SFC will be treated as a DFIC
only.
• PTI is not excluded in determining the existence or amount of a specified E&P deficit. PTI is only
taken into account in determining post-1986 E&P of a DFIC, and not in determining post-1986
E&P of a SFC.
• Section 965(b) PTI
o E&P of an E&P deficit foreign corp is increased in any tax year beginning with the inclusion
year by any E&P deficit reduction amount. The increase is not treated as current E&P.
o For Subpart F income purposes, a US SH’s pro rata share of E&P is increased by its pro rata
share of the E&P deficit reduction amount and such increase is treated as attributable to the
same activity to which the deficit taken into account was attributable.

6. ORDERING RULES IN INCLUSION YEAR
• Non-Section 965 Subpart F income is included in income and becomes PTI.
• Distributions from SFC to SFC reduce E&P – first reduce PTI and then other E&P.
• Section 965 Subpart F income is included in income, becomes PTI and reduces
other E&P. If PTI exceeds other E&P of a DFIC, this will create or increase an E&P
deficit.
• Distributions other than SFC to SFC first reduce PTI and then other E&P.
• Section 956 income is included in income and becomes PTI.

7. AGGREGATE FOREIGN CASH POSITION (“AFCP”)
• Greater of the aggregate of US SH’s pro rata share of cash position of each SFC
determined as of the close of the last tax year of the SFC beginning before
January 1, 2018 and ending on or after November 2, 2017, or one-half of the sum
of:
o The aggregate of US SH’s pro rata share of cash position of each SFC
determined as of the close of the last tax year of the SFC ending after
November 1, 2016 and before November 2, 2017 and
o The aggregate of US SH’s pro rata share of cash position of each SFC
determined as of the close of the last tax year of the SFC preceding the last
tax year of the SFC ending after November 1, 2015 and before November 2,
2016.

8. AGGREGATE FOREIGN CASH POSITION (“AFCP”)
• Examples of cash measurement dates (assuming foreign corporation was an SFC
on all dates)
o Calendar year SFC – December 2015, December 2016, December 2017
o FYE November 30 SFC – November 2015, November 2016, November 2018
(note: November 2017 is not a cash measurement date)
• A/P only includes payables related to the purchase of inventory or receipt of
services. Does not include royalties payable or payables to employees or with
respect to depreciable property.
• Demand loans are treated as S/T obligations even if they have a stated term.

9. AGGREGATE FOREIGN CASH POSITION (“AFCP”)
• A/R, A/P, S/T obligations, and derivative financial instruments between related
SFCs are disregarded to the extent of the smallest of the ownership percentages
of SFC stock owned by the US SH on the cash measurement date.
o Related SFCs = One SFC owns more than 50% of the vote or value of another
SFC or both SFCs are owned more than 50% by the same person(s).
o Example: US SH owns 100% of SFC1 and 60% of SFC2. SFC1 has an A/R from
SFC2 in the amount of $100. Because US SH’s ownership of SFC2 (60%) is
smaller than its ownership of SFC1 (100%), the amount of the A/R to be
disregarded is $60 ($100 x 60%).
o For A/R, A/P, and S/T obligations between SFCs that are not otherwise
explicitly disregarded under the Prop. Regs. (e.g., SFCs are not related), if the
US SH wants to treat such amounts as disregarded, the US SH must attach a
statement to its tax return which includes certain required information.

10. AGGREGATE FOREIGN CASH POSITION (“AFCP”)
• Treatment of Foreign Non-corporate Entities as SFCs – a foreign non-corporate entity is treated
as a SFC for purposes of determining the US SH’s AFCP if a SFC owns the foreign entity and the
foreign entity would be treated as a SFC if it were a foreign corporation. This would include
foreign partnerships, trusts and estates. This would not apply to foreign disregarded entities
(FDE), as the assets (and E&P) of a FDE are already treated as owned (and earned) by its owner.
• Multiple Inclusion Years
o Example: US SH has SFC1 with 12/31/17 year-end and SCF2 with 11/30/18 year-end.
o First tax year: AFCP equals the lesser of the US SH’s AFCP or aggregate §965(a) inclusion
amount for the tax year
o Succeeding tax year: AFCP equals the lesser of:
 The excess, if any, of the US SH’s AFCP over the amount of its AFCP taken into account in
preceding tax years, or
 The US SHS’s aggregate §965(a) inclusion amount for the tax year

11. AGGREGATE FOREIGN CASH POSITION (“AFCP”)
o If a SFC’s tax year beginning before January 1, 2018 ends after the US SH files its tax return
for the first inclusion year, the US SH may assume its pro rata share of the cash position of
the SFC will be zero as of the cash measurement date with which the year of the SFC ends.
For example, if SFC1 has a 12/31/2017 year-end and SFC2 has a 11/30/18 year-end, US SH
may assume that SFC2’s cash position at 11/30/18 will be zero when computing its AFCP for
its 12/31/17 inclusion year.
o If the final cash measurement date amount in fact exceeds the average of the first and
second cash measurement date amounts and the §965(a) inclusion amount in fact exceeds
the final cash measurement date amount, interest and penalties will not be imposed
provided the US SH files an amended tax return reflecting the correct AFCP by the due date
(including extensions) of the return for the year following the inclusion year for which the US
SH estimated the AFCP.

12. ANTI-AVOIDANCE RULES
• Looks at change in amount of “§965 element” rather than change in §965 tax
liability.
• Change in 965 element = reduction of §965(a) inclusion amount, reduction in
AFCP, or increase in deemed paid foreign taxes.

13. TRANSACTIONS BETWEEN E&P MEASUREMENT DATES
Amounts paid or incurred between related SFCs between November 2, 2017 and
December 31, 2017 that would otherwise reduce the post-1986 E&P as of
December 31, 2017 of the SFC that paid or incurred such amounts are disregarded
for purposes of determining the post-1986 E&P of both SFCs on December 31,
2017.

14. FOREIGN TAX CREDITS
• “Taxes paid or accrued” = foreign income taxes paid or accrued directly by the US
SH under §901 (e.g., withholding taxes).
o No credit under §901 or deduction may be taken for the applicable
percentage of any foreign income taxes paid or accrued with respect to any
amount for which a §965(c) deduction is allowed.
o No credit under §901 or deduction may be taken for the applicable
percentage of any foreign income taxes attributable to a distribution of
§965(a) or §965(b) PTI.
 Includes applicable percentage of any foreign withholding taxes.
 Includes applicable percentage of net basis taxes imposed on a US citizen
by its resident country.

15. FOREIGN TAX CREDITS
• “Taxes treated as paid or accrued” = foreign income taxes deemed paid by the US SH under §960,
foreign taxes allocated to a foreign partnership or disregarded entity, and a distributive share of
taxes paid by a partnership.
o FTC disallowance under §965(g) applies to foreign income taxes deemed paid
under §960(a)(3) (as in effect on December 21, 2017) with respect to distributions of §965(a)
or §965(b) PTI. For example, if a lower-tier SFC distributes §965(a) PTI to an upper-tier SFC
and the upper-tier SFC pays a withholding tax, such withholding tax would be creditable
under §960(a)(3) upon a distribution from the upper-tier SFC to an eligible domestic C Corp.
SH. The domestic C Corp., however, cannot claim a FTC for the applicable percentage of the
withholding tax.
o Credit permitted under §960(a)(3) only with respect to foreign income taxes imposed on an
upper-tier SFC on distributions of §965(a) or §965(b) PTI from a lower-tier SFC. No credits
allowed with respect to 10/50 SFCs below the third tier.

16. FOREIGN TAX CREDITS
o Credit not permitted under §960(a)(3) for foreign income taxes attributable to any E&P
deficit reduction amount as such taxes were not imposed on a distribution of PTI. Foreign
income taxes that would have been deemed paid with respect to §965(b) PTI under
§960(a)(1) had such amounts actually been included in income are treated as having been
deemed paid and, therefore, no credit is allowed under §960(a)(3) or any other Code
provision for such taxes.
o Application of FTC disallowance under §965(g) to foreign taxes deemed paid under new
§960(b) is reserved.
• Allocation and apportionment of expenses
o Sections 861-865 and the regs thereunder for allocating and apportioning deductions apply
for purposes of determining the FTCs permitted by reason of the §965(a) inclusion.
o The allowance of a §965(c) deduction against a §965(a) inclusion does not result in any
portion of the §965(a) inclusion being treated as exempt income and the assets to which the
§965(a) inclusion relates are not treated as exempt assets.

17. FOREIGN TAX CREDITS
• Computation of deemed paid foreign income taxes
o A DFIC’s post-1986 E&P (denominator of §902 fraction) is not reduced by specified E&P
deficits from an E&P deficit foreign corporation. This may result in trapped taxes in the DFIC
because the numerator of the §902 fraction is based on the §965(a) inclusion net of specified
E&P deficits.
o An E&P deficit foreign corporation’s post-1986 E&P (denominator of §902 fraction) is
increased by the E&P deficit reduction amount as of the first day of the first taxable year
following the E&P deficit foreign corporation’s last taxable year beginning before January 1,
2018.
o When the denominator of the §902 fraction is positive but less than the numerator, the §902
fraction is 1.
o When the denominator of the §902 fraction is zero or negative, no taxes are deemed paid
with respect to the §965(a) inclusion.

18. SECTION 965(H) INSTALLMENT ELECTION
• The election must be made no later than the due date, including extensions, or any additional
time that would have been granted if the US SH filed an extension, without regard to whether an
extension was actually filed.
• If a taxpayer is assessed a deficiency with respect to a §965(h) net tax liability or timely files a
return increasing the §965(h) net tax liability above the amount computed in determining the
first installment payment amount, or the taxpayer files an amended return increasing the
amount of the §965(h) net tax liability, the deficiency is prorated among the installment
payments (provided no negligence, intentional disregard, or fraud).
• If a taxpayer makes an election and does not pay the correct amount for the first installment
and the additional liability is prorated , the remaining installment payments due will not be
accelerated and the election will not be affected.
o This provision is essentially an indirect way of stating that to avoid acceleration of installment payments, an
amended return must be filed if the amount of the first installment paid was incorrect.
• The election may be revoked only by paying the full amount of the unpaid §965(h) net tax liability.

19. SECTION 965(H) INSTALLMENT ELECTION
• Acceleration events
o Any exchange or other disposition of substantially all assets of the taxpayer.
o Any event that results in a person no longer being a US person (e.g., resident
alien becomes nonresident alien).
o Person that was not a consolidated group member becoming a consolidated
group member.
o Consolidated group ceasing to exist or otherwise no longer filing a
consolidated return.
o “Eligible §965(h) transferee exception” – acceleration provisions would not
apply to certain eligible acceleration events if a “transfer agreement” is
executed.

20. SECTION 965(H) INSTALLMENT ELECTION
• Net tax liability
o The Prop. Regs define a new term – “total net tax liability”
o Total net tax liability reflects the definition of net tax liability under §965(h)(6) with respect to
a person as if the person were a US SH of all DFICs with respect to which it has §965(a)
inclusions.
 Net tax liability is the excess (if any) of the taxpayer’s net income tax for the §965(a)
inclusion year, over the taxpayer’s net income tax for that tax year determined without
regard to §965 and without regard to any income or deduction properly attributable to a
dividend received, directly or indirectly, from a DFIC.
o FTCs that are disregarded in determining net income tax include credits for foreign income
taxes deemed paid with respect to §965(a) inclusions or foreign income taxes deemed paid
with respect to a dividend, as well as credits for foreign income taxes imposed on
distributions of §965(a) or §965(b) PTI made in the taxable year in which the US SH has a
§965(a) inclusion amount.

21. SECTION 965(I) S CORP DEFERRAL ELECTION
• The election must be made no later than the due date, including extensions, for the S Corp. SH’s
return for the taxable year that includes the last day of the taxable year of the S Corp. in which
the S Corp. has a §965(a) inclusion to which the SH’s §965(i) net tax liability is attributable.
• The S Corp. SH must make the deferral election, however, the S Corp. remains jointly and severally
liable for the deferred payment including any additional amounts attributable to the payment.
• Triggering Events
• If an S Corp. SH (“eligible §965(i) transferor”) transfers its S Corp. stock to an “eligible §965(i)
transferee” (US person that is not a domestic pass-through entity) and they enter into a
“transfer agreement,” the transfer will not be treated as a triggering event.
• An S Corp. SH may obtain consent of the Secretary to make a §965(h) installment election in
the event of a triggering event that is a liquidation, sale, exchange, or other disposition of
substantially all assets of the S Corp., a cessation of business by the S Corp., or the S Corp.
ceasing to exist, by filing an agreement, the terms of which are set forth in the Prop. Regs.

22. SECTION 965(N) FORGO USE OF NOL ELECTION
The election applies to NOLs for the taxable year for which the election is made as
well as NOL carryovers or carrybacks to such taxable year, each in their entirety.

23. ELECTION TO USE OCTOBER 31, 2017 MEASUREMENT
DATE
• The US SH must make an election to compute post-1986 E&P using October 31,
2017 rather than November 2, 2017.
• The E&P amount at October 31, 2017 must be annualized to November 2, 2017.

24. FOREIGN CURRENCY TRANSLATION
• Spot rate at December 31, 2017 is used to determine §965(a) inclusion amount.
• Spot rate on each cash measurement date is used to determine cash position.
• In determining the amount of §965(a) PTI, §965(a) inclusion amount must be translated into
functional currency of DFIC using spot rate at December 31, 2017.
• In determining applicable §902 deemed paid credits, §965(a) inclusion amount must be
translated back into DFIC’s functional currency using spot rate at December 31, 2017.
• FX Gain/Loss
o FX gain or loss with respect to distributions of §965(a) PTI is determined based on
movements in the exchange rate between December 31, 2017 and the date of the actual
distribution of §965(a) PTI.
o Any FX gain or loss recognized with respect to a §965(a) PTI distribution is reduced in the
same proportion as the §965(a) inclusion was reduced by the §965(c) deduction.
o Because §965(b) PTI (i.e., E&P deficit reduction amount) is not included in income as Subpart
F, a §965(b) PTI distribution will not give rise to an FX gain or loss.

25. ADJUSTMENTS TO BASIS
• §965(a): US SH’s basis in its DFIC stock (or “applicable property”) is increased by
its §965(a) inclusion amount.
• §965(b): No adjustments to basis in stock (or “applicable property”) are made
with respect to the E&P deficit reduction amount. However, taxpayers are
permitted to elect to make the following basis adjustments with respect to all SFC
stock owned:
o Increase basis in DFIC stock (or “applicable property”) by an amount equal to
§965(b) PTI of DFIC, and
o Reduce basis in E&P deficit foreign corporation stock (or “applicable
property”) by an amount equal to the E&P deficit reduction amount.
• Rules relating to basis adjustments in the case of a §962 election are reserved.

26. GAIN-REDUCTION RULE
• Gain reduction: If a US SH received distributions through a chain of ownership
from a DFIC during an inclusion year that is attributable to §965(a) PTI, the
amount of the gain that would otherwise be recognized under §961(b)(2) (i.e.,
when PTI exceeds A/B of stock/property) is reduced (not below zero) by the
DFIC’s §965(a) PTI.
• Basis reduction: A US SH must reduce basis in stock (or “applicable property”) by
amount of gain that would have been recognized.

27. TREATMENT OF DOMESTIC PASS-THROUGH ENTITY (DPE)
SHAREHOLDERS
• If a DPE is a US shareholder of a SFC, the toll tax is determined at the DPE level; however, the DPE
owners are subject to the toll tax. Therefore, each DPE owner must take into account its share of
the toll tax liability, regardless of whether such DPE owner is also a US SH.
o The DPE owner must be allocated the §965(c) deduction in the same proportion that the
§965(a) inclusion amount was allocated.
• A DPE includes a partnership, LLC, S Corp. and trust. If there is a tiered pass-through structure,
you look through each DPE to determine the ultimate US owner’s toll tax liability. For example, if
A owns 5% of DPE and DPE owns 10% of SFC, A will have a toll tax liability even though A does
not own at least 10% of SFC.
• The §965(c) deduction is treated as exempt income for purposes of calculating the basis of
partners and S Corp. shareholders, however, not for purposes of computing AAA for an S Corp.
shareholder. This treatment preserves tax-free treatment for subsequent distributions.

28. TREATMENT OF CONSOLIDATED GROUPS
• All consolidated group members that are US SHs of a SFC are treated as a single
US SH for purposes of the specified E&P deficit offset rule under §965(b).
• All consolidated group members that are US SHs of a SFC are treated as a single
US SH for purposes of the installment election under §965(h), the extended SOL
under §965(k), and the election to forgo NOLs under §965(n).
• Single US SH treatment does not apply for purposes of determining the US SH’s
§965(a) inclusion or §965(c) deduction.
• A consolidated group member’s AFCP is generally determined by reference to its
pro rata share of the consolidated group’s AFCP as a whole (“group cash ratio”).

29. TREATMENT OF AFFILIATED GROUPS
• Prop. Regs apply when a US SH is both an E&P net surplus SH and a member of an
affiliated group in which not all members are members of the same consolidated
group.
• US SH’s pro rata share of the §965(a) E&P of a DFIC is reduced (not below zero) by
the DFIC’s allocable share of the US SH’s applicable share of the affiliated group’s
aggregate unused E&P deficit.

30. INDIVIDUAL TAX RATES ON SECTION 965(A) INCLUSIONS
The Explanation of Provisions section of the Prop. Regs confirms that the applicable
rates of tax for individuals may not be 8%/15.5% because the rate equivalents are
based off of the highest corporate tax rate. It states that this result was anticipated
by Congress to which it responded with the availability of the §962 election for
individuals to be taxed at corporate rates.

31. SECTION 1411 NET INVESTMENT INCOME TAX (NIIT)
• Section 1411 applies to actual distributions or if a taxpayer makes an election to
include the §965(a) inclusion as investment income (similar to existing treatment
for Subpart F income).
• The §965(c) deduction is not treated as a deduction properly allocable to a
corresponding §965(a) inclusion for NIIT purposes. Therefore, the NIIT applies to
the §965(a) inclusion amount without offset by the §965(c) deduction.
• The 8-year installment election under §965(h) does not apply to payment of the
NIIT.

32. THANK YOU
CONTACT US
PAUL DAILEY
(347) 505-6357
paul.dailey@citrincooperman.com
JENNIFER SKLAR-ROMANO
(646) 979-3954
jsklar-romano@citrincooperman.com