81_FR_5931 81 FR 5908 - Allocation of Creditable Foreign Taxes

81 FR 5908 - Allocation of Creditable Foreign Taxes

DEPARTMENT OF THE TREASURY
Internal Revenue Service

Federal Register Volume 81, Issue 23 (February 4, 2016)

Page Range5908-5916
FR Document2016-01949

This document contains temporary regulations that provide guidance relating to the allocation by a partnership of creditable foreign tax expenditures. These temporary regulations are necessary to improve the operation of an existing safe harbor rule that is used for determining whether allocations of creditable foreign tax expenditures are deemed to be in accordance with the partners' interests in the partnership. The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking (REG-100861-15) published in the Proposed Rules section in this issue of the Federal Register. These regulations affect partnerships that pay or accrue foreign income taxes, and their partners.

Federal Register, Volume 81 Issue 23 (Thursday, February 4, 2016) 
[Federal Register Volume 81, Number 23 (Thursday, February 4, 2016)]
[Rules and Regulations]
[Pages 5908-5916]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2016-01949]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9748]
RIN 1545-BM57


Allocation of Creditable Foreign Taxes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that provide 
guidance relating to the allocation by a partnership of creditable 
foreign tax expenditures. These temporary regulations are necessary to 
improve the operation of an existing safe harbor rule that is used for 
determining whether allocations of creditable foreign tax expenditures 
are deemed to be in accordance with the partners' interests in the 
partnership. The text of these temporary regulations also serves as the 
text of the proposed regulations set forth in the notice of proposed 
rulemaking (REG-100861-15) published in the Proposed Rules section in 
this issue of the Federal Register. These regulations affect 
partnerships that pay or accrue foreign income taxes, and their 
partners.

DATES: Effective Date: These regulations are effective on February 4, 
2016.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.704-1T(b)(1)(ii)(b)(1) and (b)(1)(ii)(b)(3)(B).

FOR FURTHER INFORMATION CONTACT: Suzanne M. Walsh, (202) 317-4908 (not 
a toll-free call).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

    Allocations of creditable foreign tax expenditures (``CFTEs'') do 
not have substantial economic effect, and accordingly a CFTE must be 
allocated in accordance with the partners' interests in the 
partnership. See Sec.  1.704-1(b)(4)(viii). Section 1.704-1(b)(4)(viii) 
provides a safe harbor under which CFTE allocations are deemed to be in 
accordance with the partners' interests in the partnership. In general, 
the purpose of the safe harbor is to match allocations of CFTEs with 
the income to which the CFTEs relate.
    In order to apply the safe harbor, a partnership must (1) determine 
the partnership's ``CFTE categories,'' (2) determine the partnership's 
net income in each CFTE category, and (3) allocate the partnership's 
CFTEs to each category. Section 1.704-1(b)(4)(viii)(c)(2) requires a 
partnership to assign its income to activities and provides for the 
grouping of a partnership's activities into one or more CFTE categories 
based generally on whether net income from the activities is allocated 
to partners in the same sharing ratios. Section 1.704-
1(b)(4)(viii)(c)(3) provides rules for determining the partnership's 
net income (for U.S. federal income tax purposes) in a CFTE category, 
including rules for allocating and apportioning expenses, losses, and 
other deductions to gross income. Section 1.704-1(b)(4)(viii)(d) 
assigns CFTEs to the CFTE category that includes the related income 
under the principles of Sec.  1.904-6, with certain modifications. In 
order to satisfy the safe harbor, partnership allocations of CFTEs in a 
CFTE category must be in proportion to the allocations of the 
partnership's net income in the CFTE category.

I. Effect of Section 743(b) Adjustments

    Section 1.704-1(b)(4)(viii)(c)(3)(i) of the current final 
regulations provides that a partnership determines its net income in a 
CFTE category by taking into account all partnership items attributable 
to the relevant activity or group of activities, including items of 
gross income, gain, loss, deduction, and expense, and items allocated 
pursuant to section 704(c). The current final regulations do not state 
whether an adjustment under section 743(b) is taken into account in 
computing the partnership's net income in a CFTE category.
    In the case of a transfer of a partnership interest that results in 
an adjustment under section 743(b) (because the partnership has a 
section 754 election in effect, or because there is a substantial 
built-in loss (as defined in section 743(d)) in the partnership), the 
partnership must adjust the basis of partnership property with respect 
to the transferee partner only (a section 743(b) adjustment). No 
adjustment is made to the common basis of partnership property, and the 
section 743(b) adjustment has no effect on the partnership's 
computation of any item under section 703. Sec.  1.743-1(j)(1).
    The Treasury Department and the IRS believe that a transferee 
partner's section 743(b) adjustment with respect to its interest in a 
partnership should not be taken into account in computing such 
partnership's net income in a CFTE category because the basis 
adjustment is unique to the transferee partner and because the basis 
adjustment ordinarily would not be taken into account by a foreign 
jurisdiction in computing its foreign

[[Page 5909]]

taxable base. As such, taking a transferee partner's section 743(b) 
adjustment into account for purposes of computing the partnership's net 
income in a CFTE category could change the partners' relative shares of 
net income in a CFTE category and their allocable shares of CFTEs under 
the safe harbor solely as a result of the transfer of the partnership 
interest and not as a result of a change to the allocation of any 
partnership items under the partnership agreement. Accordingly, Sec.  
1.704-1T(b)(4)(viii)(c)(3)(i) of these temporary regulations provides 
that, for purposes of computing a partnership's net income in a CFTE 
category, the partnership determines its items without regard to any 
section 743(b) adjustments that its partners may have to the basis of 
property of the partnership.
    A partnership that is a transferee partner may have a section 
743(b) adjustment in its capacity as a direct or indirect partner in a 
lower-tier partnership. Under Sec.  1.704-1T(b)(4)(viii)(c)(3)(i), such 
section 743(b) adjustment of the partnership is taken into account in 
determining the partnership's net income in a CFTE category. 
Nevertheless, in the case of a section 743(b) adjustment of a 
partnership that is a transferee partner, it may be appropriate to 
alter the way in which the section 743(b) adjustment is taken into 
account in determining the partnership's net income in a CFTE category 
when the section 743(b) adjustment gives rise to basis differences 
subject to section 901(m). The Treasury Department and the IRS intend 
to address section 901(m) in a separate guidance project.
    No inference is intended from Sec.  1.704-1T(b)(4)(viii)(c)(3)(i) 
as to how a section 743(b) adjustment is taken into account for other 
federal income tax purposes. The Treasury Department and the IRS 
request comments regarding whether final regulations should provide 
further guidance on how to compute a partnership's net income in a CFTE 
category, including how other types of items or adjustments to 
distributive shares that are specific to a partner should be taken into 
account in computing a partnership's net income in a CFTE category (for 
example, where property is contributed with a built-in loss and the 
built-in loss is taken into account only in determining the amount of 
items allocated to the contributing partner under section 
704(c)(1)(C)). The Treasury Department and the IRS also request 
comments on whether, and the extent to which, the application of the 
safe harbor should differ with respect to CFTEs that are determined by 
taking into account partner-specific adjustments that are similar to 
those that apply for U.S. tax purposes in computing the foreign taxable 
base of a partnership.

II. Special Rules for Deductible Allocations and Nondeductible 
Guaranteed Payments

    For purposes of the safe harbor, Sec.  1.704-
1(b)(4)(viii)(c)(3)(ii) provides, among other rules, a special rule 
that reduces the partnership's net income in a CFTE category to the 
extent foreign law allows a deduction for an allocation (or payment of 
an allocated amount) to a partner, for example, because foreign law 
characterizes a preferential allocation of gross income as deductible 
interest expense. The basis for this rule is that a CFTE category 
should not include income of the partnership that has not been included 
in a foreign taxable base due to the fact that an allocation (or 
payment of an allocated amount) to a partner of that income results in 
a foreign law deduction. Because the income out of which the allocation 
is made was not included in the taxable base of the foreign 
jurisdiction that allowed the deduction, no CFTEs are imposed on that 
income; therefore, the allocation of that income should not be taken 
into account in testing whether allocations of CFTEs of that 
jurisdiction match related income allocations for purposes of the safe 
harbor.
    Deductible guaranteed payments under section 707(c) reduce the 
partnership's net income in a CFTE category. Therefore, in the case of 
a guaranteed payment that results in a deduction under both U.S. and 
foreign law, no special rule reducing the partnership's net income in a 
CFTE category is necessary. However, to the extent that foreign law 
does not allow a deduction for a guaranteed payment that is deductible 
under U.S. law, Sec.  1.704-1(b)(4)(viii)(c)(3)(ii) provides another 
special rule that requires an upward adjustment to the partnership's 
net income in a CFTE category (this rule, together with the special 
rule described in the preceding paragraph, are referred to in this 
preamble as the ``special rules''). Adding the amount of a guaranteed 
payment that is not deductible under foreign law to the partnership's 
net income in a CFTE category results in CFTEs attributable to tax 
imposed on the income out of which the guaranteed payment is made 
following the payment for purposes of the safe harbor. An additional 
rule in Sec.  1.704-1(b)(4)(viii)(c)(4) treats the guaranteed payment 
as a distributive share of the partnership's net income in a CFTE 
category to the extent of the upward adjustment. Together, these rules 
for guaranteed payments provide a more appropriate matching under the 
safe harbor of CFTEs and the income to which they relate.
    However, the current final regulations do not expressly address 
situations in which an allocation or distribution of an allocated 
amount or guaranteed payment gives rise to a deduction for purposes of 
one foreign tax, but is made out of income subject to another tax 
imposed by the same or a different foreign jurisdiction. For example, a 
partnership may make a preferential allocation of gross income that is 
deductible in the foreign jurisdiction in which the partnership is a 
resident (foreign jurisdiction X) but that is made out of income earned 
by a disregarded entity or branch owned by the partnership that is 
subject to net basis tax in the jurisdiction in which the disregarded 
entity or branch is located (foreign jurisdiction Y). In this case, the 
Treasury Department and the IRS are aware that some taxpayers have 
suggested that Sec.  1.704-1(b)(4)(viii)(c)(3)(ii) may be interpreted 
to provide that the income related to the preferential allocation 
should not be included in a CFTE category because it is not included in 
the foreign jurisdiction X base, even though there are foreign 
jurisdiction Y CFTEs that clearly relate to the income out of which the 
preferential allocation is made. This interpretation is inconsistent 
with the purpose of the special rules to apply the safe harbor in a 
manner that matches income with the related CFTEs.
    The special rules were not intended to permit taxpayers to adjust 
or fail to adjust income in a CFTE category in a manner that distorts a 
partner's share of the income to which the CFTEs assigned to that 
category relate. Therefore, these temporary regulations revise the 
special rules to address situations in which allocations (or 
distributions of allocated amounts) and guaranteed payments that give 
rise to foreign law deductions are made out of income with related 
CFTEs. Specifically, Sec.  1.704-1T(b)(4)(viii)(c)(4)(ii) provides that 
a partnership's net income in a CFTE category from which a guaranteed 
payment that is not deductible in a foreign jurisdiction is made shall 
be increased by the amount of the guaranteed payment that is deductible 
for U.S. federal income tax purposes, and such amount shall be treated 
as an allocation to the recipient of the guaranteed payment for 
purposes of determining the partners' shares of income in the CFTE 
category, but only for purposes of testing allocations of CFTEs 
attributable to a foreign tax that

[[Page 5910]]

does not allow a deduction for the guaranteed payment. However, for 
purposes of testing allocations of CFTEs attributable to a foreign tax 
that does allow a deduction for the guaranteed payment, a partnership's 
net income in a CFTE category is increased only to the extent that the 
amount of the guaranteed payment that is deductible for U.S. federal 
income tax purposes exceeds the amount allowed as a deduction for 
purposes of that foreign tax, and such excess is treated as an 
allocation to the recipient of the guaranteed payment for purposes of 
determining the partners' shares of income in the CFTE category.
    Similarly, Sec.  1.704-1T(b)(4)(viii)(c)(4)(iii) provides that, to 
the extent that a foreign tax allows a deduction from its taxable base 
for an allocation (or distribution of an allocated amount) to a 
partner, then solely for purposes of testing allocations of CFTEs 
attributable to that foreign tax, the partnership's net income in the 
CFTE category from which the allocation is made is reduced by the 
amount of the foreign law deduction, and that amount is not treated as 
an allocation for purposes of determining the partners' shares of 
income in the CFTE category. For purposes of testing allocations of 
CFTEs attributable to a foreign tax that does not allow a deduction for 
an allocation (or distribution of an allocated amount) to a partner, 
the partnership's net income in a CFTE category is not reduced.
    Finally, the current final regulations provide that the adjustment 
to income attributable to an activity for a preferential allocation 
depends on whether the allocation of the item of income (or payment 
thereof) ``results'' in a deduction under foreign law. This rule was 
intended to apply even if the foreign law deduction occurred in a 
different taxable year (for example, because the foreign jurisdiction 
allowed a deduction only upon a subsequent payment of accrued 
interest). These temporary regulations at Sec.  1.704-
1T(b)(4)(viii)(c)(4)(ii) and (iii) clarify that a guaranteed payment or 
preferential allocation is considered deductible under foreign law for 
purposes of the special rules if the foreign jurisdiction allows a 
deduction from its taxable base either in the current year or in a 
different taxable year.

III. Inter-Branch Payments

    For taxable years beginning before January 1, 2012, the special 
rules under Sec.  1.704-1(b)(4)(viii)(c)(3)(ii) included a cross-
reference confirming that certain inter-branch payments that were 
described in Sec.  1.704-1(b)(4)(viii)(d)(3) (the ``inter-branch 
payment rule'') were not subject to the special rules. On February 14, 
2012, temporary regulations (TD 9577) were published in the Federal 
Register (77 FR 8127) addressing situations in which foreign income 
taxes have been separated from the related income. As part of those 
regulations, the inter-branch payment rule was removed because it 
allowed taxpayers to separate foreign income taxes and related income. 
In conjunction with the removal of the inter-branch payment rule, the 
cross-reference to the eliminated rule was removed from Sec.  1.704-
1(b)(4)(viii)(c)(3)(ii).
    The Treasury Department and the IRS have become aware that some 
taxpayers claim that the inclusion and subsequent removal of the cross-
reference created uncertainty regarding the application of the special 
rules under Sec.  1.704-1(b)(4)(viii)(c)(3)(ii) to disregarded payments 
among branches of a partnership. As explained above, the purpose of the 
special rules is to match preferential allocations and guaranteed 
payments to partners with CFTEs that relate to the income out of which 
the allocation or guaranteed payment is made, and also to ensure proper 
testing of CFTE allocations when no CFTEs relate to such income. The 
special rules accomplish this matching by treating preferential 
allocations and guaranteed payments as distributive shares of income, 
but only for purposes of allocating CFTEs attributable to taxes imposed 
by a foreign jurisdiction that does not allow deductions for such 
allocations and payments. Because an inter-branch payment is not made 
to a partner, it can never be treated as a distributive share, and is 
outside the scope of the special rules. By its terms, current Sec.  
1.704-1(b)(4)(viii)(c)(3)(ii) applies only to partnership allocations 
that are deductible under foreign law, guaranteed payments that are not 
deductible under foreign law, and (not discussed herein) income that is 
excluded from a foreign tax base as a result of the status of a 
partner. The inclusion and subsequent removal of the cross-reference 
did not change the purpose of current Sec.  1.704-
1(b)(4)(viii)(c)(3)(ii) or expand its scope to provide for reductions 
in income in a CFTE category if a partnership makes a disregarded 
payment that is deductible under foreign law. These regulations under 
Sec.  1.704-1T(b)(4)(viii)(c)(4)(iii) clarify that the special rule for 
preferential allocations applies only to allocations (or distributions 
of allocated amounts) to a partner that are deductible under foreign 
law, and not to other items that give rise to deductions under foreign 
law. For example, the special rule does not apply to reduce income in a 
CFTE category by reason of a disregarded inter-branch payment, even if 
the income out of which the inter-branch payment is made is not subject 
to tax in any foreign jurisdiction.
    In addition, the Treasury Department and the IRS are aware of 
transactions involving serial disregarded payments in which taxpayers 
take the position that withholding taxes assessed on the first payment 
in a series of back-to-back disregarded payments do not need to be 
apportioned among the CFTE categories that include the income out of 
which the payment is made. These regulations include new examples 
clarifying that under Sec.  1.704-1(b)(4)(viii)(d)(1) withholding taxes 
must be apportioned among the CFTE categories that include the related 
income. See Sec.  1.704-1T(b)(5) Example 36 and Example 37.

IV. Other Non-Substantive Clarifications

    These regulations make certain organizational and other non-
substantive changes that clarify how items of income under U.S. federal 
income tax law are assigned to an activity and how a partnership's net 
income in a CFTE category is determined.
    For the avoidance of doubt, Sec.  1.704-1(b)(4)(viii)(c)(2)(iii) is 
revised to more clearly describe when income from a divisible part of a 
single activity must be treated as income from a separate activity. 
Section 1.704-1(b)(4)(viii)(c)(2)(iii) provides that whether a 
partnership has one or more activities, and the scope of each activity, 
is determined in a reasonable manner taking into account all the facts 
and circumstances, with the principal consideration being whether the 
proposed determination has the effect of separating CFTEs from the 
related foreign income. The rule also provides that income from a 
divisible part of a single activity is treated as income from a 
separate activity if necessary to prevent separating CFTEs from the 
related foreign income. Example 24(iii) of Sec.  1.704-1(b)(5) 
illustrates that if a partnership agreement makes a special allocation 
of income earned by a disregarded entity (DE1) in order to reflect a 
disregarded inter-branch payment paid by DE1 to a second disregarded 
entity, then the payment is treated as a divisible part of an activity 
and treated as a separate activity. These regulations confirm this 
result by adding language in Sec.  1.704-1T(b)(4)(viii)(c)(2)(iii) 
clarifying that income from a divisible part of a single

[[Page 5911]]

activity is treated as income from a separate activity whenever the 
income is subject to different allocations.
    These regulations also confirm in Sec.  1.704-
1T(b)(4)(viii)(c)(2)(iii) that a guaranteed payment or preferential 
allocation of income that is determined by reference to all the income 
from a single activity generally will not result in dividing a single 
activity into separate activities. This clarification is consistent 
with the rule in Sec.  1.704-1(b)(4)(viii)(c)(2)(ii), which generally 
provides that a guaranteed payment, gross income allocation, or other 
preferential allocation that is determined by reference to income from 
all of the partnership's activities does not result in different 
allocations of income from separate activities. For an illustration of 
the application of Sec.  1.704-1(b)(4)(viii)(c)(2)(iii) prior to this 
clarification, see Sec.  1.704-1(b)(5) Example 22 and Example 25, the 
latter of which has also been updated as part of these temporary 
regulations.
    In order to more clearly explain how the rules for determining a 
partnership's net income in a CFTE category operate and to assist 
taxpayers in applying these rules, these temporary regulations 
reorganize Sec.  1.704-1(b)(4)(viii)(c)(3) and provide an introductory 
paragraph at Sec.  1.704-1T(b)(4)(viii)(c)(3)(i) that describes the 
steps for computing a partnership's net income in a CFTE category.
    The current final regulations provide that only items of gross 
income recognized by a branch for U.S. income tax purposes are taken 
into account to determine net income attributable to any activity of a 
branch. Example 24 in Sec.  1.704-1(b)(5) further illustrates that a 
disregarded inter-branch payment does not move income from one activity 
to another. These temporary regulations confirm at Sec.  1.704-
1T(b)(4)(viii)(c)(3)(iv) that disregarded payments are never taken into 
account in determining the amount of net income attributable to an 
activity (although, as noted above, a special allocation of income used 
to make a disregarded payment may result in that income being treated 
as a divisible part of the activity giving rise to the income), and 
that therefore an item of gross income is assigned to the activity that 
generates the item of income that is recognized for U.S. federal income 
tax purposes.
    In addition, the current final regulations use the term 
``distributive share of income,'' which has a general meaning under 
subchapter K but is used for a different purpose under Sec.  1.704-
1(b)(4)(viii)(c)(4). To avoid confusion, these temporary regulations at 
Sec.  1.704-1T(b)(4)(viii)(c)(4)(i) revise the term ``distributive 
share of income'' to ``CFTE category share of income.'' No difference 
in meaning or purpose is intended by the change in terminology. The 
Treasury Department and the IRS will update Examples 20, 21, 22, 23, 
24, 26, and 27 in Sec.  1.704-1(b)(5) (which are not revised under 
these temporary regulations) to reflect the new terminology when these 
temporary regulations are finalized. In the interim, any reference to 
``distributive share of income'' under the current final regulations 
should be treated as a reference to a ``CFTE category share of income'' 
as defined in Sec.  1.704-1T(b)(4)(viii)(c)(4)(i).

V. Effective Date

    These temporary regulations apply for partnership taxable years 
that both begin on or after January 1, 2016, and end after February 4, 
2016. The temporary regulations also modify an existing transition rule 
with respect to certain inter-branch payments for partnerships whose 
agreements were entered into prior to February 14, 2012. The current 
transition rule provides that if there has been no material 
modification to their partnership agreements on or after February 14, 
2012, then, for tax years beginning on or after January 1, 2012, these 
partnerships may apply the provisions of Sec. Sec.  1.704-
1(b)(4)(viii)(c)(3)(ii) and 1.704-1(b)(4)(viii)(d)(3) (revised as of 
April 1, 2011). That transition rule is modified to provide that for 
tax years that both begin on or after January 1, 2016, and end after 
February 4, 2016, these partnerships may continue to apply the 
provisions of Sec.  1.704-1(b)(4)(viii)(d)(3) (revised as of April 1, 
2011) but must apply the provisions of Sec.  1.704-
1T(b)(4)(viii)(c)(3)(ii). See Sec.  1.704-1T(b)(1)(ii)(b)(3)(B). For 
purposes of this transition rule, any change in ownership constitutes a 
material modification to the partnership agreement. This transition 
rule does not apply to any taxable year (and all subsequent taxable 
years) in which persons bearing a relationship to each other that is 
specified in section 267(b) or section 707(b) collectively have the 
power to amend the partnership agreement without the consent of any 
unrelated party.
    No inference is intended as to the application of the provisions 
amended by these temporary regulations under current law. The IRS may, 
where appropriate, challenge transactions, including those described in 
these temporary regulations and this preamble, under currently 
applicable Code or regulatory provisions or judicial doctrines.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It has also been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations, and because the regulations do not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of 
the Code, these regulations have been submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal author of these regulations is Suzanne M. Walsh of 
the Office of Chief Counsel (International). However, other personnel 
from the Treasury Department and the IRS participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 2. Section 1.704-1 is amended as follows:
0
1. In Paragraph (b)(0):
0
i. Add an entry for Sec.  1.704-1(b)(1)(ii)(b)(1).
0
ii. Revise the entries for Sec.  1.704-1(b)(4)(viii)(c)(1) through (4) 
and (b)(4)(viii)(d)(1).

0
2. Revise paragraphs (b)(1)(ii)(b)(1), (b)(1)(ii)(b)(3)(B), 
(b)(4)(viii)(a)(1), (b)(4)(viii)(c)(1), (b)(4)(viii)(c)(2)(ii) and 
(iii), (b)(4)(viii)(c)(3) and (4), (b)(4)(viii)(d)(1), and Example 25 
of paragraph (b)(5).

0
3. Add Examples 36 and 37 to paragraph (b)(5).
    The revisions and additions read as follows:


Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) Determination of partner's distributive share-(0) Cross-
references.

[[Page 5912]]



------------------------------------------------------------------------
                  Heading                              Section
------------------------------------------------------------------------
 
                                * * * * *
[Reserved]................................  1.704-1(b)(1)(ii)(b)(1)
 
                                * * * * *
[Reserved]................................  1.704-1(b)(4)(viii)(c)(1)
[Reserved]................................  1.704-1(b)(4)(viii)(c)(2)
[Reserved]................................  1.704-1(b)(4)(viii)(c)(3)
[Reserved]................................  1.704-1(b)(4)(viii)(c)(4)
 
                                * * * * *
[Reserved]................................   1.704-1(b)(4)(viii)(d)(1)
 
                                * * * * *
------------------------------------------------------------------------

    (1) * * *
    (ii) * * *
    (b) Rules relating to foreign tax expenditures. (1) [Reserved]. For 
further guidance, see Sec.  1.704-1T(b)(1)(ii)(b)(1).
* * * * *
    (3) * * *
    (B) [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(1)(ii)(b)(3)(B).
* * * * *
    (4) * * *
    (viii) * * *
    (a) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(4)(viii)(a)(1).
* * * * *
    (c) Income to which CFTEs relate. (1) [Reserved]. For further 
guidance, see Sec.  1.704-1T(b)(4)(viii)(c)(1).
    (2) * * *
    (ii) and (iii) [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(4)(viii)(c)(2)(ii) and (iii).
    (3) [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(4)(viii)(c)(3).
    (4) [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(4)(viii)(c)(4).
* * * * *
    (d) Allocation and apportionment of CFTEs to CFTE categories. (1) 
[Reserved]. For further guidance, see Sec.  1.704-1T(b)(4)(viii)(d)(1).
* * * * *
    (5) * * *
    Example 25.  [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(5) Example 25.
* * * * *
    Example 36.  [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(5) Example 36.
    Example 37.  [Reserved]. For further guidance, see Sec.  1.704-
1T(b)(5) Example 37.
* * * * *

0
Par. 3. Section 1.704-1T is added to read as follows:


Sec.  1.704-1T  Partner's distributive share (temporary).

    (a) through (b)(1)(ii)(a) [Reserved]. For further guidance, see 
Sec.  1.704-1(a) through (b)(1)(ii)(a).
    (b) Rules relating to foreign tax expenditures--(1) In general. 
Except as otherwise provided in this paragraph (b)(1)(ii)(b)(1), the 
provisions of paragraphs (b)(3)(iv) and (b)(4)(viii) of this section 
(regarding the allocation of creditable foreign taxes) apply for 
partnership taxable years beginning on or after October 19, 2006. The 
rules that apply to allocations of creditable foreign taxes made in 
partnership taxable years beginning before October 19, 2006 are 
contained in Sec.  1.704-1T(b)(1)(ii)(b)(1) and (b)(4)(xi) as in effect 
prior to October 19, 2006 (see 26 CFR part 1 revised as of April 1, 
2005). However, taxpayers may rely on the provisions of paragraphs 
(b)(3)(iv) and (b)(4)(viii) of this section for partnership taxable 
years beginning on or after April 21, 2004. The provisions of 
paragraphs (b)(4)(viii)(a)(1), (b)(4)(viii)(c)(1), 
(b)(4)(viii)(c)(2)(ii) and (iii), (b)(4)(viii)(c)(3) and (4), 
(b)(4)(viii)(d)(1), and Examples 25, 36, and 37 of paragraph (b)(5) of 
this section apply for partnership taxable years that both begin on or 
after January 1, 2016, and end after February 4, 2016. For the rules 
that apply to partnership taxable years beginning on or after October 
19, 2006, and before January 1, 2016, and to taxable years that both 
begin on or after January 1, 2016, and end on or before February 4, 
2016, see Sec.  1.704-1(b)(1)(ii)(b), (b)(4)(viii)(a)(1), 
(b)(4)(viii)(c)(1), (b)(4)(viii)(c)(2)(ii) and (iii), 
(b)(4)(viii)(c)(3) and (4), (b)(4)(viii)(d)(1), and (b)(5), Example 25 
(as contained in 26 CFR part 1 revised as of April 1, 2015).
    (b)(1)(ii)(b)(2) through (b)(1)(ii)(b)(3)(A) [Reserved]. For 
further guidance, see Sec.  1.704-1(b)(1)(ii)(b)(2) through 
(b)(1)(ii)(b)(3)(A).
    (B) Transition rule. Transition relief is provided herein to 
partnerships whose agreements were entered into prior to February 14, 
2012. In such cases, if there has been no material modification to the 
partnership agreement on or after February 14, 2012, then, for taxable 
years beginning on or after January 1, 2012, and before January 1, 
2016, and for taxable years that both begin on or after January 1, 
2012, and end on or before February 4, 2016, these partnerships may 
apply the provisions of Sec.  1.704-1(b)(4)(viii)(c)(3)(ii) (see 26 CFR 
part 1 revised as of April 1, 2011) and Sec.  1.704-1(b)(4)(viii)(d)(3) 
(see 26 CFR part 1 revised as of April 1, 2011). For taxable years that 
both begin on or after January 1, 2016, and end after February 4, 2016, 
these partnerships may apply the provisions of Sec.  1.704-
1(b)(4)(viii)(d)(3) (see 26 CFR part 1 revised as of April 1, 2011). 
For purposes of this paragraph (b)(1)(ii)(b)(3), any change in 
ownership constitutes a material modification to the partnership 
agreement. This transition rule does not apply to any taxable year in 
which persons bearing a relationship to each other that is specified in 
section 267(b) or section 707(b) collectively have the power to amend 
the partnership agreement without the consent of any unrelated party 
(and all subsequent taxable years).
    (b)(1)(iii) through (b)(4)(viii)(a) [Reserved]. For further 
guidance, see Sec.  1.704-1(b)(1)(iii) through (b)(4)(viii)(a).
    (1) The CFTE is allocated (whether or not pursuant to an express 
provision in the partnership agreement) to each partner and reported on 
the partnership return in proportion to the partners' CFTE category 
shares of income to which the CFTE relates; and
    (b)(4)(viii)(a)(2) through (b)(4)(viii)(b) [Reserved]. For further 
guidance, see Sec.  1.704-1(b)(4)(viii)(a)(2) through (b)(4)(viii)(b).
    (c) Income to which CFTEs relate--(1) In general. For purposes of 
paragraph (b)(4)(viii)(a) of this section, CFTEs are related to net 
income in the partnership's CFTE category or categories to which the 
CFTE is allocated and apportioned in accordance with the rules of 
paragraph (b)(4)(viii)(d) of this section. Paragraph (b)(4)(viii)(c)(2) 
of this section provides rules for determining a partnership's CFTE 
categories. Paragraph (b)(4)(viii)(c)(3) of this section provides rules 
for determining the net income in each CFTE category. Paragraph 
(b)(4)(viii)(c)(4) of this section provides rules for determining a 
partner's CFTE category share of income, including rules that require 
adjustments to net income in a CFTE category for purposes of 
determining the partners' CFTE category share of income with respect to 
certain CFTEs. Paragraph (b)(4)(viii)(c)(5) of this section provides a 
special rule for allocating CFTEs when a partnership has no net income 
in a CFTE category.
    (2)(i) [Reserved]. For further guidance, see Sec.  1.704-
1(b)(4)(viii)(c)(2)(i).
    (ii) Different allocations. Different allocations of net income (or 
loss) generally will result from provisions of the partnership 
agreement providing for different sharing ratios for net income (or 
loss) from separate activities. Different allocations of net income (or 
loss) from separate activities generally will also result if any 
partnership item is shared in a different ratio than any other 
partnership item. A guaranteed payment described in paragraph 
(b)(4)(viii)(c)(4)(ii) of this section, gross income allocation, or 
other preferential allocation will result in different allocations of 
net income (or loss) from

[[Page 5913]]

separate activities only if the amount of the payment or the allocation 
is determined by reference to income from less than all of the 
partnership's activities.
    (iii) Activity. Whether a partnership has one or more activities, 
and the scope of each activity, is determined in a reasonable manner 
taking into account all the facts and circumstances. In evaluating 
whether aggregating or disaggregating income from particular business 
or investment operations constitutes a reasonable method of determining 
the scope of an activity, the principal consideration is whether the 
proposed determination has the effect of separating CFTEs from the 
related foreign income. Relevant considerations include whether the 
partnership conducts business in more than one geographic location or 
through more than one entity or branch, and whether certain types of 
income are exempt from foreign tax or subject to preferential foreign 
tax treatment. In addition, income from a divisible part of a single 
activity is treated as income from a separate activity if necessary to 
prevent separating CFTEs from the related foreign income, such as when 
income from divisible parts of a single activity is subject to 
different allocations. A guaranteed payment, gross income allocation, 
or other preferential allocation of income that is determined by 
reference to all the income from a single activity generally will not 
result in the division of an activity into divisible parts. See 
Examples 22 and 25 of paragraph (b)(5) of this section. The 
partnership's activities must be determined consistently from year to 
year absent a material change in facts and circumstances.
    (3) Net income in a CFTE category--(i) In general. A partnership 
computes net income in a CFTE category as follows: First, the 
partnership determines for U.S. federal income tax purposes all of its 
partnership items, including items of gross income, gain, loss, 
deduction, and expense, and items allocated pursuant to section 704(c). 
For this purpose, the items of the partnership are determined without 
regard to any adjustments under section 743(b) that its partners may 
have to the basis of property of the partnership. However, if the 
partnership is a transferee partner that has a basis adjustment under 
section 743(b) in its capacity as a direct or indirect partner in a 
lower-tier partnership, the partnership does take such basis adjustment 
into account. Second, the partnership must assign those partnership 
items to its activities pursuant to paragraph (b)(4)(viii)(c)(3)(ii) of 
this section. Third, partnership items attributable to each activity 
are aggregated within the relevant CFTE category as determined under 
paragraph (b)(4)(viii)(c)(2) of this section in order to compute the 
net income in a CFTE category.
    (ii) Assignment of partnership items to activities. The items of 
gross income attributable to an activity must be determined in a 
consistent manner under any reasonable method taking into account all 
the facts and circumstances. Except as otherwise provided in paragraph 
(b)(4)(viii)(c)(3)(iii) of this section, expenses, losses, or other 
deductions must be allocated and apportioned to gross income 
attributable to an activity in accordance with the rules of Sec. Sec.  
1.861-8 and 1.861-8T. Under these rules, if an expense, loss, or other 
deduction is allocated to gross income from more than one activity, 
such expense, loss, or deduction must be apportioned among each such 
activity using a reasonable method that reflects to a reasonably close 
extent the factual relationship between the deduction and the gross 
income from such activities. See Sec.  1.861-8T(c). For the effect of 
disregarded payments in determining the amount of net income 
attributable to an activity, see paragraph (b)(4)(viii)(c)(3)(iv) of 
this section.
    (iii) Interest expense and research and experimental expenditures. 
The partnership's interest expense and research and experimental 
expenditures described in section 174 may be allocated and apportioned 
under any reasonable method, including but not limited to the methods 
prescribed in Sec. Sec.  1.861-9 through 1.861-13T (interest expense) 
and Sec.  1.861-17 (research and experimental expenditures).
    (iv) Disregarded payments. An item of gross income is assigned to 
the activity that generates the item of income that is recognized for 
U.S. federal income tax purposes. Consequently, disregarded payments 
are not taken into account in determining the amount of net income 
attributable to an activity, although a special allocation of income 
used to make a disregarded payment may result in the subdivision of an 
activity into divisible parts. See paragraph (b)(4)(viii)(c)(2)(iii) of 
this section and Examples 24, 36, and 37 of paragraph (b)(5) of this 
section (relating to inter-branch payments).
    (4) CFTE category share of income--(i) In general. CFTE category 
share of income means the portion of the net income in a CFTE category, 
determined in accordance with paragraph (b)(4)(viii)(c)(3) of this 
section as modified by paragraphs (b)(4)(viii)(c)(4)(ii) through (iv) 
of this section, that is allocated to a partner. To the extent provided 
in paragraph (b)(4)(viii)(c)(4)(ii) of this section, a guaranteed 
payment is treated as an allocation to the recipient of the guaranteed 
payment for this purpose. If more than one partner receives positive 
income allocations (income in excess of expenses) from a CFTE category, 
which in the aggregate exceed the total net income in the CFTE 
category, then such partner's CFTE category share of income equals the 
partner's positive income allocation from the CFTE category, divided by 
the aggregate positive income allocations from the CFTE category, 
multiplied by the net income in the CFTE category. Paragraphs 
(b)(4)(viii)(c)(4)(ii) through (iv) of this section require adjustments 
to the net income in a CFTE category for purposes of determining the 
partners' CFTE category share of income if one or more foreign 
jurisdictions impose a tax that provides for certain exclusions or 
deductions from the foreign taxable base. Such adjustments apply only 
with respect to CFTEs attributable to the taxes that allow such 
exclusions or deductions. Thus, net income in a CFTE category may vary 
for purposes of applying paragraph (b)(4)(viii)(a)(1) of this section 
to different CFTEs within that CFTE category.
    (ii) Guaranteed payments. Except as otherwise provided in this 
paragraph (b)(4)(viii)(c)(4)(ii), solely for purposes of applying the 
safe harbor provisions of paragraph (b)(4)(viii)(a)(1) of this section, 
net income in the CFTE category from which a guaranteed payment (within 
the meaning of section 707(c)) is made is increased by the amount of 
the guaranteed payment that is deductible for U.S. federal income tax 
purposes, and such amount is treated as an allocation to the recipient 
of such guaranteed payment for purposes of determining the partners' 
CFTE category shares of income. If a foreign tax allows (whether in the 
current or in a different taxable year) a deduction from its taxable 
base for a guaranteed payment, then solely for purposes of applying the 
safe harbor provisions of paragraph (b)(4)(viii)(a)(1) of this section 
to allocations of CFTEs that are attributable to that foreign tax, net 
income in the CFTE category is increased only to the extent that the 
amount of the guaranteed payment that is deductible for U.S. federal 
income tax purposes exceeds the amount allowed as a deduction for 
purposes of the foreign tax, and such excess is treated as an 
allocation to the recipient of the guaranteed payment for purposes of

[[Page 5914]]

determining the partners' CFTE category shares of income. See Example 
25 of paragraph (b)(5) of this section.
    (iii) Preferential allocations. To the extent that a foreign tax 
allows (whether in the current or in a different taxable year) a 
deduction from its taxable base for an allocation (or distribution of 
an allocated amount) to a partner, then solely for purposes of applying 
the safe harbor provisions of paragraph (b)(4)(viii)(a)(1) of this 
section to allocations of CFTEs that are attributable to that foreign 
tax, the net income in the CFTE category from which the allocation is 
made is reduced by the amount of the allocation, and that amount is not 
treated as an allocation for purposes of determining the partners' CFTE 
category shares of income. See Example 25 of paragraph (b)(5) of this 
section.
    (iv) Foreign law exclusions due to status of partner. If a foreign 
tax excludes an amount from its taxable base as a result of the status 
of a partner, then solely for purposes of applying the safe harbor 
provisions of paragraph (b)(4)(viii)(a)(1) of this section to 
allocations of CFTEs that are attributable to that foreign tax, the net 
income in the relevant CFTE category is reduced by the excluded amounts 
that are allocable to such partners. See Example 27 of paragraph (b)(5) 
of this section.
    (b)(4)(viii)(c)(5) [Reserved]. For further guidance, see Sec.  
1.704-1(b)(4)(viii)(c)(5).
    (d) Allocation and apportionment of CFTEs to CFTE categories--(1) 
In general. CFTEs are allocated and apportioned to CFTE categories in 
accordance with the principles of Sec.  1.904-6. Under these 
principles, a CFTE is related to income in a CFTE category if the 
income is included in the base upon which the foreign tax is imposed. 
See Examples 36 and 37 of paragraph (b)(5) of this section, which 
illustrate the application of this paragraph in the case of serial 
disregarded payments subject to withholding tax. In accordance with 
Sec.  1.904-6(a)(1)(ii) as modified by this paragraph (b)(4)(viii)(d), 
if the foreign tax base includes income in more than one CFTE category, 
the CFTEs are apportioned among the CFTE categories based on the 
relative amounts of taxable income computed under foreign law in each 
CFTE category. For purposes of this paragraph (b)(4)(viii)(d), 
references in Sec.  1.904-6 to a separate category or separate 
categories mean ``CFTE category'' or ``CFTE categories'' and the rules 
in Sec.  1.904-6(a)(1)(ii) are modified as follows:
    (b)(4)(viii)(d)(1)(i) through (b)(5) Example 24 [Reserved]. For 
further guidance, see Sec.  1.704-1(b)(4)(viii)(d)(1)(i) through (b)(5) 
Example 24.

    Example 25.  (i) A contributes $750,000 and B contributes 
$250,000 to form AB, a country X eligible entity (as defined in 
Sec.  301.7701-3(a) of this chapter) treated as a partnership for 
U.S. federal income tax purposes. AB operates business M in country 
X. Country X imposes a 20 percent tax on the net income from 
business M, which tax is a CFTE. In 2016, AB earns $300,000 of gross 
income, has deductible expenses of $100,000, and pays or accrues 
$40,000 of country X tax. Pursuant to the partnership agreement, the 
first $100,000 of gross income each year is specially allocated to A 
as a preferred return on excess capital contributed by A. All 
remaining partnership items, including CFTEs, are split evenly 
between A and B (50 percent each). The gross income allocation is 
not deductible in determining AB's taxable income under country X 
law. Assume that allocations of all items other than CFTEs are 
valid.
    (ii) AB has a single CFTE category because all of AB's net 
income is allocated in the same ratio. See paragraph 
(b)(4)(viii)(c)(2) of this section. Under paragraph 
(b)(4)(viii)(c)(3) of this section, the net income in the single 
CFTE category is $200,000. The $40,000 of taxes is allocated to the 
single CFTE category and, thus, is related to the $200,000 of net 
income in the single CFTE category. In 2016, AB's partnership 
agreement results in an allocation of $150,000 or 75 percent of the 
net income to A ($100,000 attributable to the gross income 
allocation plus $50,000 of the remaining $100,000 of net income) and 
$50,000 or 25 percent of the net income to B. AB's partnership 
agreement allocates the country X taxes in accordance with the 
partners' shares of partnership items remaining after the $100,000 
gross income allocation. Therefore, AB allocates the country X taxes 
50 percent to A ($20,000) and 50 percent to B ($20,000). AB's 
allocations of country X taxes are not deemed to be in accordance 
with the partners' interests in the partnership under paragraph 
(b)(4)(viii) of this section because they are not in proportion to 
the allocations of the CFTE category shares of income to which the 
country X taxes relate. Accordingly, the country X taxes will be 
reallocated according to the partners' interests in the partnership. 
Assuming that the partners do not reasonably expect to claim a 
deduction for the CFTEs in determining their U.S. federal income tax 
liabilities, a reallocation of the CFTEs under paragraph (b)(3) of 
this section would be 75 percent to A ($30,000) and 25 percent to B 
($10,000). If the reallocation of the CFTEs causes the partners' 
capital accounts not to reflect their contemplated economic 
arrangement, the partners may need to reallocate other partnership 
items to ensure that the tax consequences of the partnership's 
allocations are consistent with their contemplated economic 
arrangement over the term of the partnership.
    (iii) The facts are the same as in paragraph (i) of this Example 
25, except that country X allows a deduction for the $100,000 
allocation of gross income and, as a result, AB pays or accrues only 
$20,000 of foreign tax. Under paragraph (b)(4)(viii)(c)(4)(iii) of 
this section, the net income in the single CFTE category is 
$100,000, determined by reducing the net income in the CFTE category 
by the $100,000 of gross income that is allocated to A and for which 
country X allows a deduction in determining AB's taxable income. 
Pursuant to the partnership agreement, AB allocates the country X 
tax 50 percent to A ($10,000) and 50 percent to B ($10,000). This 
allocation is in proportion to the partners' CFTE category shares of 
the $100,000 net income. Accordingly, AB's allocations of country X 
taxes are deemed to be in accordance with the partners' interests in 
the partnership under paragraph (b)(4)(viii)(a) of this section.
    (iv) The facts are the same as in paragraph (iii) of this 
Example 25, except that, in addition to $20,000 of country X tax, AB 
is subject to $30,000 of country Y withholding tax with respect to 
the $300,000 of gross income that it earns in 2016. Country Y does 
not allow any deductions for purposes of determining the withholding 
tax. As described in paragraph (ii) of this Example 25, there is a 
single CFTE category with respect to AB's net income. Both the 
$20,000 of country X tax and the $30,000 of country Y withholding 
tax relate to that income and are therefore allocated to the single 
CFTE category. Under paragraph (b)(4)(viii)(c)(4)(iii) of this 
section, however, net income in a CFTE category is reduced by the 
amount of an allocation for which a deduction is allowed in 
determining a foreign taxable base, but only for purposes of 
applying paragraph (b)(4)(viii)(a) of this section to allocations of 
CFTEs that are attributable to that foreign tax. Accordingly, 
because the $100,000 allocation of gross income is deductible for 
country X tax purposes but not for country Y tax purposes, the 
allocations of the CFTEs attributable to country X tax and country Y 
tax are analyzed separately. For purposes of applying paragraph 
(b)(4)(viii)(a)(1) of this section to allocations of the CFTEs 
attributable to the $20,000 tax imposed by country X, the analysis 
described in paragraph (iii) of this Example 25 applies. For 
purposes of applying paragraph (b)(4)(viii)(a)(1) of this section to 
allocations of the CFTEs attributable to the $30,000 tax imposed by 
country Y, which did not allow a deduction for the $100,000 gross 
income allocation, the net income in the single CFTE category is 
$200,000. Pursuant to the partnership agreement, AB allocates the 
country Y tax 50 percent to A ($15,000) and 50 percent to B 
($15,000). These allocations are not deemed to be in accordance with 
the partners' interests in the partnership under paragraph 
(b)(4)(viii) of this section because they are not in proportion to 
the partners' CFTE category shares of the $200,000 of net income in 
the category, which is allocated 75 percent to A and 25 percent to B 
under the partnership agreement. Accordingly, the country Y taxes 
will be reallocated according to the partners' interests in the 
partnership as described in paragraph (ii) of this Example 25.
    (v) The amount of net income in the single CFTE category of AB 
for purposes of

[[Page 5915]]

applying paragraph (b)(4)(viii)(a)(1) of this section to allocations 
of CFTEs would be the same as in the fact patterns described in 
paragraphs (ii), (iii) and (iv) if, rather than being a preferential 
gross income allocation, the $100,000 was a guaranteed payment to A 
within the meaning of section 707(c). See paragraph 
(b)(4)(viii)(c)(4)(ii) of this section.

    (b)(5) Examples 26 through 35 [Reserved]. For further guidance, see 
Sec.  1.704-1(b)(5) Examples 26 through 35.

    Example 36. (i) A, B, and C form ABC, an eligible entity (as 
defined in Sec.  301.7701-3(a) of this chapter) treated as a 
partnership for U.S. federal income tax purposes. ABC owns three 
entities, DEX, DEY, and DEZ, which are organized in, and treated as 
corporations under the laws of, countries X, Y, and Z, respectively, 
and as disregarded entities for U.S. federal income tax purposes. 
DEX operates business X in country X, DEY operates business Y in 
country Y, and DEZ operates business Z in country Z. Businesses X, 
Y, and Z relate to the licensing and sublicensing of intellectual 
property owned by DEZ. During 2016, DEX earns $100,000 of royalty 
income from unrelated payors on which it pays no withholding taxes. 
Country X imposes a 30 percent tax on DEX's net income. DEX makes 
royalty payments of $90,000 during 2016 to DEY that are deductible 
by DEX for country X purposes and subject to a 10 percent 
withholding tax imposed by country X. DEY earns no other income in 
2016. Country Y does not impose income or withholding taxes. DEY 
makes royalty payments of $80,000 during 2016 to DEZ. DEZ earns no 
other income in 2016. Country Z does not impose income or 
withholding taxes. The royalty payments from DEX to DEY and from DEY 
to DEZ are disregarded for U.S. federal income tax purposes.
    As a result of these payments, DEX has taxable income of $10,000 
for country X purposes on which $3,000 of taxes are imposed, and DEY 
has $90,000 of income for country X withholding tax purposes on 
which $9,000 of withholding taxes are imposed. Pursuant to the 
partnership agreement, all partnership items from business X, 
excluding CFTEs paid or accrued by business X, are allocated 80 
percent to A and 10 percent each to B and C. All partnership items 
from business Y, excluding CFTEs paid or accrued by business Y, are 
allocated 80 percent to B and 10 percent each to A and C. All 
partnership items from business Z, excluding CFTEs paid or accrued 
by business Z, are allocated 80 percent to C and 10 percent each to 
A and B. Because only business X has items that are regarded for 
U.S. federal income tax purposes (the $100,000 of royalty income), 
only business X has partnership items. Accordingly A is allocated 80 
percent of the income from business X ($80,000) and B and C are each 
allocated 10 percent of the income from business X ($10,000 each). 
There are no partnership items of income from business Y or Z to 
allocate.
    (ii) Because the partnership agreement provides for different 
allocations of partnership net income attributable to businesses X, 
Y, and Z, the net income attributable to each of businesses X, Y, 
and Z is income in separate CFTE categories. See paragraph 
(b)(4)(viii)(c)(2) of this section. Under paragraph 
(b)(4)(viii)(c)(3)(iv) of this section, an item of gross income that 
is recognized for U.S. federal income tax purposes is assigned to 
the activity that generated the item, and disregarded inter-branch 
payments are not taken into account in determining net income 
attributable to an activity. Consequently, all $100,000 of ABC's 
income is attributable to the business X activity for U.S. federal 
income tax purposes, and no net income is in the business Y or Z 
CFTE category. Under paragraph (b)(4)(viii)(d)(1) of this section, 
the $3,000 of country X taxes imposed on DEX is allocated to the 
business X CFTE category. The additional $9,000 of country X 
withholding tax imposed with respect to the inter-branch payment to 
DEY is also allocated to the business X CFTE category because for 
U.S. federal income tax purposes the related $90,000 of income on 
which the country X withholding tax is imposed is in the business X 
CFTE category. Therefore, $12,000 of taxes ($3,000 of country X 
income taxes and $9,000 of the country X withholding taxes) is 
related to the $100,000 of net income in the business X CFTE. See 
paragraph (b)(4)(viii)(c)(1) of this section. The allocations of 
country X taxes will be in proportion to the CFTE category shares of 
income to which they relate and will be deemed to be in accordance 
with the partners' interests in the partnership if such taxes are 
allocated 80 percent to A and 10 percent each to B and C.
    Example 37.  (i) Assume that the facts are the same as in 
paragraph (i) of Example 36 of this section, except that in order to 
reflect the $90,000 payment from DEX to DEY and the $80,000 payment 
from DEY to DEZ, the partnership agreement treats only $10,000 of 
the gross income as attributable to the business X activity, which 
the partnership agreement allocates 80 percent to A and 10 percent 
each to B and C. Of the remaining $90,000 of gross income, the 
partnership agreement treats $10,000 of the gross income as 
attributable to the business Y activity, which the partnership 
agreement allocates 80 percent to B and 10 percent each to A and C; 
and the partnership agreement treats $80,000 of the gross income as 
attributable to the business Z activity, which the partnership 
agreement allocates 80 percent to C and 10 percent each to A and B. 
In addition, the partnership agreement allocates the country X taxes 
among A, B, and C in accordance with which disregarded entity is 
considered to have paid the taxes for country X purposes. The 
partnership agreement allocates the $3,000 of country X income taxes 
80 percent to A and 10 percent to each of B and C, and allocates the 
$9,000 of country X withholding taxes 80 percent to B and 10 percent 
to each of A and C. Thus, ABC allocates the country X taxes $3,300 
to A (80 percent of $3,000 plus 10 percent of $9,000), $7,500 to B 
(10 percent of $3,000 plus 80 percent of $9,000), and $1,200 to C 
(10 percent of $3,000 plus 10 percent of $9,000).
    (ii) In order to prevent separating the CFTEs from the related 
foreign income, the special allocations of the $10,000 and $80,000 
treated under the partnership agreement as attributable to the 
business Y and the business Z activities, respectively, which do not 
follow the allocation ratios that otherwise apply under the 
partnership agreement to items of income in the business X activity, 
are treated as divisible parts of the business X activity and, 
therefore, as separate activities. See paragraph 
(b)(4)(viii)(c)(2)(iii) of this section. Because the divisible part 
of the business X activity attributable to the portion of the 
disregarded payment received by DEY and not paid on to DEZ ($10,000) 
and the net income from the business Y activity ($0) are both shared 
80 percent to B and 10 percent each to A and C, that divisible part 
of the business X activity and the business Y activity are treated 
as a single CFTE category. Because the divisible part of the 
business X activity attributable to the disregarded payment paid to 
DEZ ($80,000) and the net income from the business Z activity ($0) 
are both shared 80 percent to C and 10 percent each to A and B, that 
divisible part of the business X activity and the business Z 
activity are also treated as a single CFTE category. See paragraph 
(b)(4)(viii)(c)(2)(i) of this section. Accordingly, $10,000 of net 
income attributable to business X is in the business X CFTE 
category, $10,000 of net income of business X attributable to the 
net disregarded payments of DEY is in the business Y CFTE category, 
and $80,000 of net income of business X attributable to the 
disregarded payment to DEZ is in the business Z CFTE category. Under 
paragraph (b)(4)(viii)(d)(1) of this section, the $3,000 of country 
X tax imposed on DEX's income is allocated to the business X CFTE 
category. Because the $90,000 on which the country X withholding tax 
is imposed is split between the business Y CFTE category and the 
business Z CFTE category, those withholding taxes are allocated on a 
pro rata basis, $1,000 [$9,000 x ($10,000/$90,000)] to the business 
Y CFTE category and $8,000 [$9,000 x ($80,000/$90,000)] to the 
business Z CFTE category. See paragraph (b)(4)(viii)(d)(1) of this 
section. To satisfy the safe harbor of paragraph (b)(4)(viii) of 
this section, the $3,000 of country X taxes allocated to the 
business X CFTE category must be allocated in proportion to the CFTE 
category shares of income to which they relate, and therefore would 
be deemed to be in accordance with the partners' interests in the 
partnership if such taxes were allocated 80 percent to A and 10 
percent each to B and C. The allocation of the $1,000 of country X 
withholding taxes allocated to the business Y CFTE category would be 
in proportion to the CFTE category shares of income to which they 
relate, and therefore would be deemed to be in accordance with the 
partners' interests in the partnership if such taxes were allocated 
80 percent to B and 10 percent each to A and C. The allocation of 
the $8,000 of country X withholding taxes allocated to the business 
Z CFTE category would be in proportion to the CFTE category shares 
of income to which they relate, and therefore would be deemed to be 
in accordance with the partners' interests in the partnership if 
such taxes were allocated 80 percent to C and

[[Page 5916]]

10 percent each to A and B. Thus, to satisfy the safe harbor, ABC 
must allocate the country X taxes $3,300 to A (80 percent of $3,000 
plus 10 percent of $1,000 plus 10 percent of $8,000), $1,900 to B 
(10 percent of $3,000 plus 80 percent of $1,000 plus 10 percent of 
$8,000), and $6,800 to C (10 percent of $3,000 plus 10 percent of 
$1,000 plus 80 percent of $8,000). ABC's allocations of country X 
taxes are not deemed to be in accordance with the partners' 
interests in the partnership under paragraph (b)(4)(viii) of this 
section because they are not in proportion to the partners' CFTE 
category shares of income to which the country X taxes relate. 
Accordingly, the country X taxes will be reallocated according to 
the partners' interests in the partnership.

    (c) through (e) [Reserved]. For further guidance, see Sec.  1.704-
1(c) through (e).
    (f) Expiration date. The applicability of this section expires on 
February 4, 2019.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: January 14, 2016.
 Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-01949 Filed 2-3-16; 8:45 am]
 BILLING CODE 4830-01-P

5908 Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations Paperwork Reduction Act DEPARTMENT OF THE TREASURY 1(b)(4)(viii)(c)(2) requires a partnership to assign its income to activities and This rule does not impose any new Internal Revenue Service provides for the grouping of a information collections subject to the partnership’s activities into one or more Paperwork Reduction Act, 44 U.S.C., 26 CFR Part 1 CFTE categories based generally on Chapter 35. The Department anticipates whether net income from the activities between 100 and 4,100 additional [TD 9748] is allocated to partners in the same nonimmigrant visa applicants per year RIN 1545–BM57 sharing ratios. Section 1.704– as a result of this rulemaking. The 1(b)(4)(viii)(c)(3) provides rules for current burden for this information Allocation of Creditable Foreign Taxes determining the partnership’s net collection (OMB Control No. 1405– income (for U.S. federal income tax AGENCY: Internal Revenue Service (IRS), 0182) is 13,875,345 hours, with purposes) in a CFTE category, including Treasury. 11,100,276 respondents. The burden per rules for allocating and apportioning response is 75 minutes. The top ACTION: Final and temporary regulations. expenses, losses, and other deductions estimate for the number of additional to gross income. Section 1.704– respondents would add approximately SUMMARY: This document contains 1(b)(4)(viii)(d) assigns CFTEs to the 5,000 hours to a burden that is almost temporary regulations that provide CFTE category that includes the related 14 million hours. Therefore, the guidance relating to the allocation by a income under the principles of § 1.904– addition of these respondents does not partnership of creditable foreign tax 6, with certain modifications. In order to significantly increase the burden expenditures. These temporary satisfy the safe harbor, partnership associated with this information regulations are necessary to improve the allocations of CFTEs in a CFTE category collection. operation of an existing safe harbor rule must be in proportion to the allocations List of Subjects in 22 CFR Part 41 that is used for determining whether of the partnership’s net income in the allocations of creditable foreign tax CFTE category. Aliens, Foreign officials, Immigration, expenditures are deemed to be in I. Effect of Section 743(b) Adjustments Nonimmigrants, Passports and visas. accordance with the partners’ interests in the partnership. The text of these Section 1.704–1(b)(4)(viii)(c)(3)(i) of For the reasons stated in the the current final regulations provides preamble, the Department of State is temporary regulations also serves as the text of the proposed regulations set forth that a partnership determines its net amending 22 CFR part 41 to read as income in a CFTE category by taking follows: in the notice of proposed rulemaking (REG–100861–15) published in the into account all partnership items Proposed Rules section in this issue of attributable to the relevant activity or PART 41—[AMENDED] group of activities, including items of the Federal Register. These regulations gross income, gain, loss, deduction, and ■ 1. The authority citation for part 41 is affect partnerships that pay or accrue expense, and items allocated pursuant revised to read as follows: foreign income taxes, and their partners. to section 704(c). The current final Authority: 22 U.S.C. 2651a; 8 U.S.C. 1104; DATES: Effective Date: These regulations regulations do not state whether an Pub. L. 105–277, 112 Stat. 2681–795 through are effective on February 4, 2016. adjustment under section 743(b) is taken 2681–801; 8 U.S.C. 1185 note (section 7209 Applicability Dates: For dates of into account in computing the of Pub. L. 108–458, as amended by section applicability, see §§ 1.704– partnership’s net income in a CFTE 546 of Pub. L. 109–295). 1T(b)(1)(ii)(b)(1) and (b)(1)(ii)(b)(3)(B). category. ■ 2. Amend § 41.2 as follows: FOR FURTHER INFORMATION CONTACT: In the case of a transfer of a Suzanne M. Walsh, (202) 317–4908 (not partnership interest that results in an ■ a. Remove paragraph (e). a toll-free call). adjustment under section 743(b) ■ b. Redesignate paragraphs (f) through SUPPLEMENTARY INFORMATION: (because the partnership has a section (m) as paragraphs (e) through (l). 754 election in effect, or because there ■ c. Revise redesignated paragraph Background and Explanation of is a substantial built-in loss (as defined (e)(2)(iv). Provisions in section 743(d)) in the partnership), The revisions read as follows: Allocations of creditable foreign tax the partnership must adjust the basis of expenditures (‘‘CFTEs’’) do not have partnership property with respect to the § 41.2 Exemption or waiver by Secretary of substantial economic effect, and transferee partner only (a section 743(b) State and Secretary of Homeland Security accordingly a CFTE must be allocated in adjustment). No adjustment is made to of passport and/or visa requirements for certain categories of nonimmigrants. accordance with the partners’ interests the common basis of partnership in the partnership. See § 1.704– property, and the section 743(b) * * * * * 1(b)(4)(viii). Section 1.704–1(b)(4)(viii) adjustment has no effect on the (e) * * * provides a safe harbor under which partnership’s computation of any item (2) * * * CFTE allocations are deemed to be in under section 703. § 1.743–1(j)(1). (iv) Presents a current certificate accordance with the partners’ interests The Treasury Department and the IRS issued by the Royal Virgin Islands in the partnership. In general, the believe that a transferee partner’s Police Force indicating that he or she purpose of the safe harbor is to match section 743(b) adjustment with respect has no criminal record. allocations of CFTEs with the income to to its interest in a partnership should asabaliauskas on DSK5VPTVN1PROD with RULES * * * * * which the CFTEs relate. not be taken into account in computing In order to apply the safe harbor, a such partnership’s net income in a Dated: January 22, 2016. partnership must (1) determine the CFTE category because the basis David T. Donahue, partnership’s ‘‘CFTE categories,’’ (2) adjustment is unique to the transferee Acting Assistant Secretary for Consular determine the partnership’s net income partner and because the basis Affairs, Department of State. in each CFTE category, and (3) allocate adjustment ordinarily would not be [FR Doc. 2016–02191 Filed 2–3–16; 8:45 am] the partnership’s CFTEs to each taken into account by a foreign BILLING CODE 4710–06–P category. Section 1.704– jurisdiction in computing its foreign VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00028 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations 5909 taxable base. As such, taking a adjustments that are similar to those upward adjustment. Together, these transferee partner’s section 743(b) that apply for U.S. tax purposes in rules for guaranteed payments provide a adjustment into account for purposes of computing the foreign taxable base of a more appropriate matching under the computing the partnership’s net income partnership. safe harbor of CFTEs and the income to in a CFTE category could change the which they relate. II. Special Rules for Deductible However, the current final regulations partners’ relative shares of net income Allocations and Nondeductible do not expressly address situations in in a CFTE category and their allocable Guaranteed Payments which an allocation or distribution of an shares of CFTEs under the safe harbor solely as a result of the transfer of the For purposes of the safe harbor, allocated amount or guaranteed partnership interest and not as a result § 1.704–1(b)(4)(viii)(c)(3)(ii) provides, payment gives rise to a deduction for of a change to the allocation of any among other rules, a special rule that purposes of one foreign tax, but is made partnership items under the partnership reduces the partnership’s net income in out of income subject to another tax agreement. Accordingly, § 1.704– a CFTE category to the extent foreign imposed by the same or a different 1T(b)(4)(viii)(c)(3)(i) of these temporary law allows a deduction for an allocation foreign jurisdiction. For example, a regulations provides that, for purposes (or payment of an allocated amount) to partnership may make a preferential of computing a partnership’s net income a partner, for example, because foreign allocation of gross income that is in a CFTE category, the partnership law characterizes a preferential deductible in the foreign jurisdiction in determines its items without regard to allocation of gross income as deductible which the partnership is a resident any section 743(b) adjustments that its interest expense. The basis for this rule (foreign jurisdiction X) but that is made partners may have to the basis of is that a CFTE category should not out of income earned by a disregarded property of the partnership. include income of the partnership that entity or branch owned by the A partnership that is a transferee has not been included in a foreign partnership that is subject to net basis partner may have a section 743(b) taxable base due to the fact that an tax in the jurisdiction in which the adjustment in its capacity as a direct or allocation (or payment of an allocated disregarded entity or branch is located indirect partner in a lower-tier amount) to a partner of that income (foreign jurisdiction Y). In this case, the partnership. Under § 1.704– results in a foreign law deduction. Treasury Department and the IRS are 1T(b)(4)(viii)(c)(3)(i), such section Because the income out of which the aware that some taxpayers have 743(b) adjustment of the partnership is allocation is made was not included in suggested that § 1.704– taken into account in determining the the taxable base of the foreign 1(b)(4)(viii)(c)(3)(ii) may be interpreted partnership’s net income in a CFTE jurisdiction that allowed the deduction, to provide that the income related to the category. Nevertheless, in the case of a no CFTEs are imposed on that income; preferential allocation should not be section 743(b) adjustment of a therefore, the allocation of that income included in a CFTE category because it partnership that is a transferee partner, should not be taken into account in is not included in the foreign it may be appropriate to alter the way testing whether allocations of CFTEs of jurisdiction X base, even though there in which the section 743(b) adjustment that jurisdiction match related income are foreign jurisdiction Y CFTEs that is taken into account in determining the allocations for purposes of the safe clearly relate to the income out of which partnership’s net income in a CFTE harbor. the preferential allocation is made. This category when the section 743(b) Deductible guaranteed payments interpretation is inconsistent with the adjustment gives rise to basis under section 707(c) reduce the purpose of the special rules to apply the differences subject to section 901(m). partnership’s net income in a CFTE safe harbor in a manner that matches The Treasury Department and the IRS category. Therefore, in the case of a income with the related CFTEs. intend to address section 901(m) in a guaranteed payment that results in a The special rules were not intended to separate guidance project. deduction under both U.S. and foreign permit taxpayers to adjust or fail to No inference is intended from law, no special rule reducing the adjust income in a CFTE category in a § 1.704–1T(b)(4)(viii)(c)(3)(i) as to how a partnership’s net income in a CFTE manner that distorts a partner’s share of section 743(b) adjustment is taken into category is necessary. However, to the the income to which the CFTEs assigned account for other federal income tax extent that foreign law does not allow a to that category relate. Therefore, these purposes. The Treasury Department and deduction for a guaranteed payment that temporary regulations revise the special the IRS request comments regarding is deductible under U.S. law, § 1.704– rules to address situations in which whether final regulations should 1(b)(4)(viii)(c)(3)(ii) provides another allocations (or distributions of allocated provide further guidance on how to special rule that requires an upward amounts) and guaranteed payments that compute a partnership’s net income in adjustment to the partnership’s net give rise to foreign law deductions are a CFTE category, including how other income in a CFTE category (this rule, made out of income with related CFTEs. types of items or adjustments to together with the special rule described Specifically, § 1.704– distributive shares that are specific to a in the preceding paragraph, are referred 1T(b)(4)(viii)(c)(4)(ii) provides that a partner should be taken into account in to in this preamble as the ‘‘special partnership’s net income in a CFTE computing a partnership’s net income in rules’’). Adding the amount of a category from which a guaranteed a CFTE category (for example, where guaranteed payment that is not payment that is not deductible in a property is contributed with a built-in deductible under foreign law to the foreign jurisdiction is made shall be loss and the built-in loss is taken into partnership’s net income in a CFTE increased by the amount of the account only in determining the amount category results in CFTEs attributable to guaranteed payment that is deductible asabaliauskas on DSK5VPTVN1PROD with RULES of items allocated to the contributing tax imposed on the income out of which for U.S. federal income tax purposes, partner under section 704(c)(1)(C)). The the guaranteed payment is made and such amount shall be treated as an Treasury Department and the IRS also following the payment for purposes of allocation to the recipient of the request comments on whether, and the the safe harbor. An additional rule in guaranteed payment for purposes of extent to which, the application of the § 1.704–1(b)(4)(viii)(c)(4) treats the determining the partners’ shares of safe harbor should differ with respect to guaranteed payment as a distributive income in the CFTE category, but only CFTEs that are determined by taking share of the partnership’s net income in for purposes of testing allocations of into account partner-specific a CFTE category to the extent of the CFTEs attributable to a foreign tax that VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00029 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

5910 Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations does not allow a deduction for the (the ‘‘inter-branch payment rule’’) were foreign law, and not to other items that guaranteed payment. However, for not subject to the special rules. On give rise to deductions under foreign purposes of testing allocations of CFTEs February 14, 2012, temporary law. For example, the special rule does attributable to a foreign tax that does regulations (TD 9577) were published in not apply to reduce income in a CFTE allow a deduction for the guaranteed the Federal Register (77 FR 8127) category by reason of a disregarded payment, a partnership’s net income in addressing situations in which foreign inter-branch payment, even if the a CFTE category is increased only to the income taxes have been separated from income out of which the inter-branch extent that the amount of the guaranteed the related income. As part of those payment is made is not subject to tax in payment that is deductible for U.S. regulations, the inter-branch payment any foreign jurisdiction. federal income tax purposes exceeds the rule was removed because it allowed In addition, the Treasury Department amount allowed as a deduction for taxpayers to separate foreign income and the IRS are aware of transactions purposes of that foreign tax, and such taxes and related income. In involving serial disregarded payments excess is treated as an allocation to the conjunction with the removal of the in which taxpayers take the position recipient of the guaranteed payment for inter-branch payment rule, the cross- that withholding taxes assessed on the purposes of determining the partners’ reference to the eliminated rule was first payment in a series of back-to-back shares of income in the CFTE category. removed from § 1.704– disregarded payments do not need to be Similarly, § 1.704– 1(b)(4)(viii)(c)(3)(ii). apportioned among the CFTE categories 1T(b)(4)(viii)(c)(4)(iii) provides that, to The Treasury Department and the IRS that include the income out of which the extent that a foreign tax allows a the payment is made. These regulations have become aware that some taxpayers deduction from its taxable base for an include new examples clarifying that claim that the inclusion and subsequent allocation (or distribution of an under § 1.704–1(b)(4)(viii)(d)(1) removal of the cross-reference created allocated amount) to a partner, then withholding taxes must be apportioned uncertainty regarding the application of solely for purposes of testing allocations among the CFTE categories that include the special rules under § 1.704– of CFTEs attributable to that foreign tax, the related income. See § 1.704–1T(b)(5) 1(b)(4)(viii)(c)(3)(ii) to disregarded the partnership’s net income in the Example 36 and Example 37. payments among branches of a CFTE category from which the partnership. As explained above, the IV. Other Non-Substantive Clarifications allocation is made is reduced by the purpose of the special rules is to match These regulations make certain amount of the foreign law deduction, preferential allocations and guaranteed organizational and other non- and that amount is not treated as an allocation for purposes of determining payments to partners with CFTEs that substantive changes that clarify how the partners’ shares of income in the relate to the income out of which the items of income under U.S. federal CFTE category. For purposes of testing allocation or guaranteed payment is income tax law are assigned to an allocations of CFTEs attributable to a made, and also to ensure proper testing activity and how a partnership’s net foreign tax that does not allow a of CFTE allocations when no CFTEs income in a CFTE category is deduction for an allocation (or relate to such income. The special rules determined. distribution of an allocated amount) to accomplish this matching by treating For the avoidance of doubt, § 1.704– a partner, the partnership’s net income preferential allocations and guaranteed 1(b)(4)(viii)(c)(2)(iii) is revised to more in a CFTE category is not reduced. payments as distributive shares of clearly describe when income from a Finally, the current final regulations income, but only for purposes of divisible part of a single activity must be provide that the adjustment to income allocating CFTEs attributable to taxes treated as income from a separate attributable to an activity for a imposed by a foreign jurisdiction that activity. Section 1.704– preferential allocation depends on does not allow deductions for such 1(b)(4)(viii)(c)(2)(iii) provides that whether the allocation of the item of allocations and payments. Because an whether a partnership has one or more income (or payment thereof) ‘‘results’’ inter-branch payment is not made to a activities, and the scope of each activity, in a deduction under foreign law. This partner, it can never be treated as a is determined in a reasonable manner rule was intended to apply even if the distributive share, and is outside the taking into account all the facts and foreign law deduction occurred in a scope of the special rules. By its terms, circumstances, with the principal different taxable year (for example, current § 1.704–1(b)(4)(viii)(c)(3)(ii) consideration being whether the because the foreign jurisdiction allowed applies only to partnership allocations proposed determination has the effect of a deduction only upon a subsequent that are deductible under foreign law, separating CFTEs from the related payment of accrued interest). These guaranteed payments that are not foreign income. The rule also provides temporary regulations at § 1.704– deductible under foreign law, and (not that income from a divisible part of a 1T(b)(4)(viii)(c)(4)(ii) and (iii) clarify discussed herein) income that is single activity is treated as income from that a guaranteed payment or excluded from a foreign tax base as a a separate activity if necessary to preferential allocation is considered result of the status of a partner. The prevent separating CFTEs from the deductible under foreign law for inclusion and subsequent removal of the related foreign income. Example 24(iii) purposes of the special rules if the cross-reference did not change the of § 1.704–1(b)(5) illustrates that if a foreign jurisdiction allows a deduction purpose of current § 1.704– partnership agreement makes a special from its taxable base either in the 1(b)(4)(viii)(c)(3)(ii) or expand its scope allocation of income earned by a current year or in a different taxable to provide for reductions in income in disregarded entity (DE1) in order to year. a CFTE category if a partnership makes reflect a disregarded inter-branch asabaliauskas on DSK5VPTVN1PROD with RULES a disregarded payment that is payment paid by DE1 to a second III. Inter-Branch Payments deductible under foreign law. These disregarded entity, then the payment is For taxable years beginning before regulations under § 1.704– treated as a divisible part of an activity January 1, 2012, the special rules under 1T(b)(4)(viii)(c)(4)(iii) clarify that the and treated as a separate activity. These § 1.704–1(b)(4)(viii)(c)(3)(ii) included a special rule for preferential allocations regulations confirm this result by cross-reference confirming that certain applies only to allocations (or adding language in § 1.704– inter-branch payments that were distributions of allocated amounts) to a 1T(b)(4)(viii)(c)(2)(iii) clarifying that described in § 1.704–1(b)(4)(viii)(d)(3) partner that are deductible under income from a divisible part of a single VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00030 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations 5911 activity is treated as income from a ‘‘distributive share of income’’ to ‘‘CFTE Special Analyses separate activity whenever the income category share of income.’’ No Certain IRS regulations, including this is subject to different allocations. difference in meaning or purpose is These regulations also confirm in one, are exempt from the requirements intended by the change in terminology. § 1.704–1T(b)(4)(viii)(c)(2)(iii) that a of Executive Order 12866, as The Treasury Department and the IRS guaranteed payment or preferential supplemented and reaffirmed by will update Examples 20, 21, 22, 23, 24, allocation of income that is determined Executive Order 13563. Therefore, a 26, and 27 in § 1.704–1(b)(5) (which are by reference to all the income from a regulatory impact assessment is not not revised under these temporary single activity generally will not result regulations) to reflect the new required. It has also been determined in dividing a single activity into terminology when these temporary that section 553(b) of the Administrative separate activities. This clarification is regulations are finalized. In the interim, Procedure Act (5 U.S.C. chapter 5) does consistent with the rule in § 1.704– any reference to ‘‘distributive share of not apply to these regulations, and 1(b)(4)(viii)(c)(2)(ii), which generally income’’ under the current final because the regulations do not impose a provides that a guaranteed payment, regulations should be treated as a collection of information on small gross income allocation, or other reference to a ‘‘CFTE category share of entities, the Regulatory Flexibility Act preferential allocation that is income’’ as defined in § 1.704– (5 U.S.C. chapter 6) does not apply. determined by reference to income from 1T(b)(4)(viii)(c)(4)(i). Pursuant to section 7805(f) of the Code, all of the partnership’s activities does these regulations have been submitted not result in different allocations of V. Effective Date to the Chief Counsel for Advocacy of the income from separate activities. For an These temporary regulations apply for Small Business Administration for illustration of the application of partnership taxable years that both comment on its impact on small § 1.704–1(b)(4)(viii)(c)(2)(iii) prior to begin on or after January 1, 2016, and business. this clarification, see § 1.704–1(b)(5) end after February 4, 2016. The Drafting Information Example 22 and Example 25, the latter temporary regulations also modify an of which has also been updated as part existing transition rule with respect to The principal author of these of these temporary regulations. certain inter-branch payments for regulations is Suzanne M. Walsh of the In order to more clearly explain how partnerships whose agreements were Office of Chief Counsel (International). the rules for determining a partnership’s entered into prior to February 14, 2012. However, other personnel from the net income in a CFTE category operate The current transition rule provides that Treasury Department and the IRS and to assist taxpayers in applying these if there has been no material participated in their development. rules, these temporary regulations modification to their partnership List of Subjects in 26 CFR Part 1 reorganize § 1.704–1(b)(4)(viii)(c)(3) and agreements on or after February 14, provide an introductory paragraph at 2012, then, for tax years beginning on or Income taxes, Reporting and § 1.704–1T(b)(4)(viii)(c)(3)(i) that after January 1, 2012, these partnerships recordkeeping requirements. describes the steps for computing a may apply the provisions of §§ 1.704– Amendments to the Regulations partnership’s net income in a CFTE 1(b)(4)(viii)(c)(3)(ii) and 1.704– category. 1(b)(4)(viii)(d)(3) (revised as of April 1, Accordingly, 26 CFR part 1 is The current final regulations provide 2011). That transition rule is modified amended as follows: that only items of gross income to provide that for tax years that both recognized by a branch for U.S. income begin on or after January 1, 2016, and PART 1—INCOME TAXES tax purposes are taken into account to end after February 4, 2016, these Paragraph 1. The authority citation determine net income attributable to partnerships may continue to apply the for part 1 continues to read in part as any activity of a branch. Example 24 in provisions of § 1.704–1(b)(4)(viii)(d)(3) follows: § 1.704–1(b)(5) further illustrates that a (revised as of April 1, 2011) but must disregarded inter-branch payment does apply the provisions of § 1.704– Authority: 26 U.S.C. 7805 * * * not move income from one activity to 1T(b)(4)(viii)(c)(3)(ii). See § 1.704– ■ Par. 2. Section 1.704–1 is amended as another. These temporary regulations 1T(b)(1)(ii)(b)(3)(B). For purposes of this follows: confirm at § 1.704–1T(b)(4)(viii)(c)(3)(iv) transition rule, any change in ownership ■ 1. In Paragraph (b)(0): that disregarded payments are never constitutes a material modification to ■ i. Add an entry for § 1.704– taken into account in determining the the partnership agreement. This 1(b)(1)(ii)(b)(1). amount of net income attributable to an transition rule does not apply to any ■ ii. Revise the entries for § 1.704– activity (although, as noted above, a taxable year (and all subsequent taxable 1(b)(4)(viii)(c)(1) through (4) and special allocation of income used to years) in which persons bearing a (b)(4)(viii)(d)(1). make a disregarded payment may result relationship to each other that is in that income being treated as a specified in section 267(b) or section ■ 2. Revise paragraphs (b)(1)(ii)(b)(1), divisible part of the activity giving rise 707(b) collectively have the power to (b)(1)(ii)(b)(3)(B), (b)(4)(viii)(a)(1), to the income), and that therefore an amend the partnership agreement (b)(4)(viii)(c)(1), (b)(4)(viii)(c)(2)(ii) and item of gross income is assigned to the without the consent of any unrelated (iii), (b)(4)(viii)(c)(3) and (4), activity that generates the item of party. (b)(4)(viii)(d)(1), and Example 25 of income that is recognized for U.S. No inference is intended as to the paragraph (b)(5). federal income tax purposes. application of the provisions amended ■ 3. Add Examples 36 and 37 to asabaliauskas on DSK5VPTVN1PROD with RULES In addition, the current final by these temporary regulations under paragraph (b)(5). regulations use the term ‘‘distributive current law. The IRS may, where The revisions and additions read as share of income,’’ which has a general appropriate, challenge transactions, follows: meaning under subchapter K but is used including those described in these for a different purpose under § 1.704– temporary regulations and this § 1.704–1 Partner’s distributive share. 1(b)(4)(viii)(c)(4). To avoid confusion, preamble, under currently applicable * * * * * these temporary regulations at § 1.704– Code or regulatory provisions or judicial (b) Determination of partner’s 1T(b)(4)(viii)(c)(4)(i) revise the term doctrines. distributive share–(0) Cross-references. VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00031 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

5912 Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations Heading Section otherwise provided in this paragraph the partnership agreement. This (b)(1)(ii)(b)(1), the provisions of transition rule does not apply to any paragraphs (b)(3)(iv) and (b)(4)(viii) of taxable year in which persons bearing a * * * * * this section (regarding the allocation of relationship to each other that is [Reserved] ............. 1.704–1(b)(1)(ii)(b)(1) creditable foreign taxes) apply for specified in section 267(b) or section partnership taxable years beginning on 707(b) collectively have the power to * * * * * or after October 19, 2006. The rules that amend the partnership agreement [Reserved] ............. 1.704–1(b)(4)(viii)(c)(1) [Reserved] ............. 1.704–1(b)(4)(viii)(c)(2) apply to allocations of creditable foreign without the consent of any unrelated [Reserved] ............. 1.704–1(b)(4)(viii)(c)(3) taxes made in partnership taxable years party (and all subsequent taxable years). [Reserved] ............. 1.704–1(b)(4)(viii)(c)(4) beginning before October 19, 2006 are (b)(1)(iii) through (b)(4)(viii)(a) contained in § 1.704–1T(b)(1)(ii)(b)(1) [Reserved]. For further guidance, see * * * * * and (b)(4)(xi) as in effect prior to § 1.704–1(b)(1)(iii) through [Reserved] ............. 1.704–1(b)(4)(viii)(d)(1) October 19, 2006 (see 26 CFR part 1 (b)(4)(viii)(a). revised as of April 1, 2005). However, (1) The CFTE is allocated (whether or * * * * * taxpayers may rely on the provisions of not pursuant to an express provision in paragraphs (b)(3)(iv) and (b)(4)(viii) of the partnership agreement) to each (1) * * * this section for partnership taxable years partner and reported on the partnership (ii) * * * beginning on or after April 21, 2004. return in proportion to the partners’ (b) Rules relating to foreign tax The provisions of paragraphs CFTE category shares of income to expenditures. (1) [Reserved]. For further (b)(4)(viii)(a)(1), (b)(4)(viii)(c)(1), which the CFTE relates; and guidance, see § 1.704–1T(b)(1)(ii)(b)(1). (b)(4)(viii)(c)(2)(ii) and (iii), (b)(4)(viii)(a)(2) through (b)(4)(viii)(b) * * * * * (b)(4)(viii)(c)(3) and (4), (b)(4)(viii)(d)(1), [Reserved]. For further guidance, see (3) * * * and Examples 25, 36, and 37 of § 1.704–1(b)(4)(viii)(a)(2) through (B) [Reserved]. For further guidance, paragraph (b)(5) of this section apply for (b)(4)(viii)(b). see § 1.704–1T(b)(1)(ii)(b)(3)(B). partnership taxable years that both (c) Income to which CFTEs relate—(1) begin on or after January 1, 2016, and In general. For purposes of paragraph * * * * * end after February 4, 2016. For the rules (b)(4)(viii)(a) of this section, CFTEs are (4) * * * that apply to partnership taxable years related to net income in the (viii) * * * beginning on or after October 19, 2006, partnership’s CFTE category or (a) * * * and before January 1, 2016, and to categories to which the CFTE is (1) [Reserved]. For further guidance, taxable years that both begin on or after allocated and apportioned in see § 1.704–1T(b)(4)(viii)(a)(1). January 1, 2016, and end on or before accordance with the rules of paragraph * * * * * (b)(4)(viii)(d) of this section. Paragraph (c) Income to which CFTEs relate. (1) February 4, 2016, see § 1.704– 1(b)(1)(ii)(b), (b)(4)(viii)(a)(1), (b)(4)(viii)(c)(2) of this section provides [Reserved]. For further guidance, see rules for determining a partnership’s § 1.704–1T(b)(4)(viii)(c)(1). (b)(4)(viii)(c)(1), (b)(4)(viii)(c)(2)(ii) and (iii), (b)(4)(viii)(c)(3) and (4), CFTE categories. Paragraph (2) * * * (b)(4)(viii)(c)(3) of this section provides (ii) and (iii) [Reserved]. For further (b)(4)(viii)(d)(1), and (b)(5), Example 25 (as contained in 26 CFR part 1 revised rules for determining the net income in guidance, see § 1.704– each CFTE category. Paragraph 1T(b)(4)(viii)(c)(2)(ii) and (iii). as of April 1, 2015). (b)(1)(ii)(b)(2) through (b)(4)(viii)(c)(4) of this section provides (3) [Reserved]. For further guidance, rules for determining a partner’s CFTE (b)(1)(ii)(b)(3)(A) [Reserved]. For further see § 1.704–1T(b)(4)(viii)(c)(3). category share of income, including guidance, see § 1.704–1(b)(1)(ii)(b)(2) (4) [Reserved]. For further guidance, rules that require adjustments to net through (b)(1)(ii)(b)(3)(A). see § 1.704–1T(b)(4)(viii)(c)(4). (B) Transition rule. Transition relief is income in a CFTE category for purposes * * * * * provided herein to partnerships whose of determining the partners’ CFTE (d) Allocation and apportionment of agreements were entered into prior to category share of income with respect to CFTEs to CFTE categories. (1) February 14, 2012. In such cases, if certain CFTEs. Paragraph [Reserved]. For further guidance, see there has been no material modification (b)(4)(viii)(c)(5) of this section provides § 1.704–1T(b)(4)(viii)(d)(1). to the partnership agreement on or after a special rule for allocating CFTEs when * * * * * February 14, 2012, then, for taxable a partnership has no net income in a (5) * * * years beginning on or after January 1, CFTE category. Example 25. [Reserved]. For further 2012, and before January 1, 2016, and (2)(i) [Reserved]. For further guidance, guidance, see § 1.704–1T(b)(5) Example 25. for taxable years that both begin on or see § 1.704–1(b)(4)(viii)(c)(2)(i). * * * * * after January 1, 2012, and end on or (ii) Different allocations. Different Example 36. [Reserved]. For further before February 4, 2016, these allocations of net income (or loss) guidance, see § 1.704–1T(b)(5) Example 36. partnerships may apply the provisions generally will result from provisions of Example 37. [Reserved]. For further of § 1.704–1(b)(4)(viii)(c)(3)(ii) (see 26 the partnership agreement providing for guidance, see § 1.704–1T(b)(5) Example 37. CFR part 1 revised as of April 1, 2011) different sharing ratios for net income * * * * * and § 1.704–1(b)(4)(viii)(d)(3) (see 26 (or loss) from separate activities. ■ Par. 3. Section 1.704–1T is added to CFR part 1 revised as of April 1, 2011). Different allocations of net income (or read as follows: For taxable years that both begin on or loss) from separate activities generally asabaliauskas on DSK5VPTVN1PROD with RULES after January 1, 2016, and end after will also result if any partnership item § 1.704–1T Partner’s distributive share February 4, 2016, these partnerships is shared in a different ratio than any (temporary). may apply the provisions of § 1.704– other partnership item. A guaranteed (a) through (b)(1)(ii)(a) [Reserved]. For 1(b)(4)(viii)(d)(3) (see 26 CFR part 1 payment described in paragraph further guidance, see § 1.704–1(a) revised as of April 1, 2011). For (b)(4)(viii)(c)(4)(ii) of this section, gross through (b)(1)(ii)(a). purposes of this paragraph income allocation, or other preferential (b) Rules relating to foreign tax (b)(1)(ii)(b)(3), any change in ownership allocation will result in different expenditures—(1) In general. Except as constitutes a material modification to allocations of net income (or loss) from VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00032 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations 5913 separate activities only if the amount of (b)(4)(viii)(c)(3)(ii) of this section. Third, (b)(4)(viii)(c)(4)(ii) through (iv) of this the payment or the allocation is partnership items attributable to each section, that is allocated to a partner. To determined by reference to income from activity are aggregated within the the extent provided in paragraph less than all of the partnership’s relevant CFTE category as determined (b)(4)(viii)(c)(4)(ii) of this section, a activities. under paragraph (b)(4)(viii)(c)(2) of this guaranteed payment is treated as an (iii) Activity. Whether a partnership section in order to compute the net allocation to the recipient of the has one or more activities, and the scope income in a CFTE category. guaranteed payment for this purpose. If of each activity, is determined in a (ii) Assignment of partnership items more than one partner receives positive reasonable manner taking into account to activities. The items of gross income income allocations (income in excess of all the facts and circumstances. In attributable to an activity must be expenses) from a CFTE category, which evaluating whether aggregating or determined in a consistent manner in the aggregate exceed the total net disaggregating income from particular under any reasonable method taking income in the CFTE category, then such business or investment operations into account all the facts and partner’s CFTE category share of income constitutes a reasonable method of circumstances. Except as otherwise equals the partner’s positive income determining the scope of an activity, the provided in paragraph allocation from the CFTE category, principal consideration is whether the (b)(4)(viii)(c)(3)(iii) of this section, divided by the aggregate positive proposed determination has the effect of expenses, losses, or other deductions income allocations from the CFTE separating CFTEs from the related must be allocated and apportioned to category, multiplied by the net income foreign income. Relevant considerations gross income attributable to an activity in the CFTE category. Paragraphs include whether the partnership in accordance with the rules of (b)(4)(viii)(c)(4)(ii) through (iv) of this conducts business in more than one §§ 1.861–8 and 1.861–8T. Under these section require adjustments to the net geographic location or through more rules, if an expense, loss, or other income in a CFTE category for purposes than one entity or branch, and whether deduction is allocated to gross income of determining the partners’ CFTE certain types of income are exempt from from more than one activity, such category share of income if one or more foreign tax or subject to preferential expense, loss, or deduction must be foreign jurisdictions impose a tax that foreign tax treatment. In addition, apportioned among each such activity provides for certain exclusions or income from a divisible part of a single using a reasonable method that reflects deductions from the foreign taxable activity is treated as income from a to a reasonably close extent the factual base. Such adjustments apply only with separate activity if necessary to prevent relationship between the deduction and respect to CFTEs attributable to the separating CFTEs from the related the gross income from such activities. taxes that allow such exclusions or foreign income, such as when income See § 1.861–8T(c). For the effect of deductions. Thus, net income in a CFTE from divisible parts of a single activity disregarded payments in determining category may vary for purposes of is subject to different allocations. A the amount of net income attributable to applying paragraph (b)(4)(viii)(a)(1) of guaranteed payment, gross income an activity, see paragraph this section to different CFTEs within allocation, or other preferential (b)(4)(viii)(c)(3)(iv) of this section. that CFTE category. allocation of income that is determined (iii) Interest expense and research and by reference to all the income from a experimental expenditures. The (ii) Guaranteed payments. Except as single activity generally will not result partnership’s interest expense and otherwise provided in this paragraph in the division of an activity into research and experimental expenditures (b)(4)(viii)(c)(4)(ii), solely for purposes divisible parts. See Examples 22 and 25 described in section 174 may be of applying the safe harbor provisions of of paragraph (b)(5) of this section. The allocated and apportioned under any paragraph (b)(4)(viii)(a)(1) of this partnership’s activities must be reasonable method, including but not section, net income in the CFTE determined consistently from year to limited to the methods prescribed in category from which a guaranteed year absent a material change in facts §§ 1.861–9 through 1.861–13T (interest payment (within the meaning of section and circumstances. expense) and § 1.861–17 (research and 707(c)) is made is increased by the (3) Net income in a CFTE category— experimental expenditures). amount of the guaranteed payment that (i) In general. A partnership computes (iv) Disregarded payments. An item of is deductible for U.S. federal income tax net income in a CFTE category as gross income is assigned to the activity purposes, and such amount is treated as follows: First, the partnership that generates the item of income that is an allocation to the recipient of such determines for U.S. federal income tax recognized for U.S. federal income tax guaranteed payment for purposes of purposes all of its partnership items, purposes. Consequently, disregarded determining the partners’ CFTE category including items of gross income, gain, payments are not taken into account in shares of income. If a foreign tax allows loss, deduction, and expense, and items determining the amount of net income (whether in the current or in a different allocated pursuant to section 704(c). For attributable to an activity, although a taxable year) a deduction from its this purpose, the items of the special allocation of income used to taxable base for a guaranteed payment, partnership are determined without make a disregarded payment may result then solely for purposes of applying the regard to any adjustments under section in the subdivision of an activity into safe harbor provisions of paragraph 743(b) that its partners may have to the divisible parts. See paragraph (b)(4)(viii)(a)(1) of this section to basis of property of the partnership. (b)(4)(viii)(c)(2)(iii) of this section and allocations of CFTEs that are However, if the partnership is a Examples 24, 36, and 37 of paragraph attributable to that foreign tax, net transferee partner that has a basis (b)(5) of this section (relating to inter- income in the CFTE category is asabaliauskas on DSK5VPTVN1PROD with RULES adjustment under section 743(b) in its branch payments). increased only to the extent that the capacity as a direct or indirect partner (4) CFTE category share of income— amount of the guaranteed payment that in a lower-tier partnership, the (i) In general. CFTE category share of is deductible for U.S. federal income tax partnership does take such basis income means the portion of the net purposes exceeds the amount allowed adjustment into account. Second, the income in a CFTE category, determined as a deduction for purposes of the partnership must assign those in accordance with paragraph foreign tax, and such excess is treated as partnership items to its activities (b)(4)(viii)(c)(3) of this section as an allocation to the recipient of the pursuant to paragraph modified by paragraphs guaranteed payment for purposes of VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00033 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

5914 Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations determining the partners’ CFTE category (b)(4)(viii)(d)(1)(i) through (b)(5) allows a deduction for the $100,000 shares of income. See Example 25 of Example 24 [Reserved]. For further allocation of gross income and, as a result, paragraph (b)(5) of this section. guidance, see § 1.704– AB pays or accrues only $20,000 of foreign tax. Under paragraph (b)(4)(viii)(c)(4)(iii) of (iii) Preferential allocations. To the 1(b)(4)(viii)(d)(1)(i) through (b)(5) this section, the net income in the single extent that a foreign tax allows (whether Example 24. CFTE category is $100,000, determined by in the current or in a different taxable Example 25. (i) A contributes $750,000 reducing the net income in the CFTE year) a deduction from its taxable base and B contributes $250,000 to form AB, a category by the $100,000 of gross income that for an allocation (or distribution of an country X eligible entity (as defined in is allocated to A and for which country X allocated amount) to a partner, then § 301.7701–3(a) of this chapter) treated as a allows a deduction in determining AB’s solely for purposes of applying the safe partnership for U.S. federal income tax taxable income. Pursuant to the partnership purposes. AB operates business M in country agreement, AB allocates the country X tax 50 harbor provisions of paragraph percent to A ($10,000) and 50 percent to B X. Country X imposes a 20 percent tax on the (b)(4)(viii)(a)(1) of this section to ($10,000). This allocation is in proportion to net income from business M, which tax is a allocations of CFTEs that are CFTE. In 2016, AB earns $300,000 of gross the partners’ CFTE category shares of the attributable to that foreign tax, the net income, has deductible expenses of $100,000, $100,000 net income. Accordingly, AB’s income in the CFTE category from and pays or accrues $40,000 of country X tax. allocations of country X taxes are deemed to which the allocation is made is reduced Pursuant to the partnership agreement, the be in accordance with the partners’ interests by the amount of the allocation, and that first $100,000 of gross income each year is in the partnership under paragraph specially allocated to A as a preferred return (b)(4)(viii)(a) of this section. amount is not treated as an allocation (iv) The facts are the same as in paragraph for purposes of determining the on excess capital contributed by A. All remaining partnership items, including (iii) of this Example 25, except that, in partners’ CFTE category shares of addition to $20,000 of country X tax, AB is CFTEs, are split evenly between A and B (50 income. See Example 25 of paragraph percent each). The gross income allocation is subject to $30,000 of country Y withholding (b)(5) of this section. not deductible in determining AB’s taxable tax with respect to the $300,000 of gross (iv) Foreign law exclusions due to income under country X law. Assume that income that it earns in 2016. Country Y does status of partner. If a foreign tax allocations of all items other than CFTEs are not allow any deductions for purposes of valid. determining the withholding tax. As excludes an amount from its taxable described in paragraph (ii) of this Example base as a result of the status of a partner, (ii) AB has a single CFTE category because all of AB’s net income is allocated in the 25, there is a single CFTE category with then solely for purposes of applying the respect to AB’s net income. Both the $20,000 same ratio. See paragraph (b)(4)(viii)(c)(2) of safe harbor provisions of paragraph of country X tax and the $30,000 of country this section. Under paragraph (b)(4)(viii)(c)(3) (b)(4)(viii)(a)(1) of this section to of this section, the net income in the single Y withholding tax relate to that income and allocations of CFTEs that are are therefore allocated to the single CFTE CFTE category is $200,000. The $40,000 of attributable to that foreign tax, the net category. Under paragraph taxes is allocated to the single CFTE category income in the relevant CFTE category is (b)(4)(viii)(c)(4)(iii) of this section, however, and, thus, is related to the $200,000 of net net income in a CFTE category is reduced by reduced by the excluded amounts that income in the single CFTE category. In 2016, the amount of an allocation for which a are allocable to such partners. See AB’s partnership agreement results in an deduction is allowed in determining a Example 27 of paragraph (b)(5) of this allocation of $150,000 or 75 percent of the foreign taxable base, but only for purposes of section. net income to A ($100,000 attributable to the applying paragraph (b)(4)(viii)(a) of this gross income allocation plus $50,000 of the section to allocations of CFTEs that are (b)(4)(viii)(c)(5) [Reserved]. For remaining $100,000 of net income) and further guidance, see § 1.704– attributable to that foreign tax. Accordingly, $50,000 or 25 percent of the net income to because the $100,000 allocation of gross 1(b)(4)(viii)(c)(5). B. AB’s partnership agreement allocates the income is deductible for country X tax (d) Allocation and apportionment of country X taxes in accordance with the purposes but not for country Y tax purposes, CFTEs to CFTE categories—(1) In partners’ shares of partnership items the allocations of the CFTEs attributable to general. CFTEs are allocated and remaining after the $100,000 gross income country X tax and country Y tax are analyzed apportioned to CFTE categories in allocation. Therefore, AB allocates the separately. For purposes of applying accordance with the principles of country X taxes 50 percent to A ($20,000) paragraph (b)(4)(viii)(a)(1) of this section to and 50 percent to B ($20,000). AB’s allocations of the CFTEs attributable to the § 1.904–6. Under these principles, a allocations of country X taxes are not deemed $20,000 tax imposed by country X, the CFTE is related to income in a CFTE to be in accordance with the partners’ category if the income is included in the analysis described in paragraph (iii) of this interests in the partnership under paragraph Example 25 applies. For purposes of base upon which the foreign tax is (b)(4)(viii) of this section because they are not applying paragraph (b)(4)(viii)(a)(1) of this imposed. See Examples 36 and 37 of in proportion to the allocations of the CFTE section to allocations of the CFTEs paragraph (b)(5) of this section, which category shares of income to which the attributable to the $30,000 tax imposed by illustrate the application of this country X taxes relate. Accordingly, the country Y, which did not allow a deduction paragraph in the case of serial country X taxes will be reallocated according for the $100,000 gross income allocation, the disregarded payments subject to to the partners’ interests in the partnership. net income in the single CFTE category is Assuming that the partners do not reasonably $200,000. Pursuant to the partnership withholding tax. In accordance with expect to claim a deduction for the CFTEs in agreement, AB allocates the country Y tax 50 § 1.904–6(a)(1)(ii) as modified by this determining their U.S. federal income tax percent to A ($15,000) and 50 percent to B paragraph (b)(4)(viii)(d), if the foreign liabilities, a reallocation of the CFTEs under ($15,000). These allocations are not deemed tax base includes income in more than paragraph (b)(3) of this section would be 75 to be in accordance with the partners’ one CFTE category, the CFTEs are percent to A ($30,000) and 25 percent to B interests in the partnership under paragraph apportioned among the CFTE categories ($10,000). If the reallocation of the CFTEs (b)(4)(viii) of this section because they are not based on the relative amounts of taxable causes the partners’ capital accounts not to in proportion to the partners’ CFTE category asabaliauskas on DSK5VPTVN1PROD with RULES income computed under foreign law in reflect their contemplated economic shares of the $200,000 of net income in the each CFTE category. For purposes of arrangement, the partners may need to category, which is allocated 75 percent to A reallocate other partnership items to ensure and 25 percent to B under the partnership this paragraph (b)(4)(viii)(d), references that the tax consequences of the partnership’s agreement. Accordingly, the country Y taxes in § 1.904–6 to a separate category or allocations are consistent with their will be reallocated according to the partners’ separate categories mean ‘‘CFTE contemplated economic arrangement over the interests in the partnership as described in category’’ or ‘‘CFTE categories’’ and the term of the partnership. paragraph (ii) of this Example 25. rules in § 1.904–6(a)(1)(ii) are modified (iii) The facts are the same as in paragraph (v) The amount of net income in the single as follows: (i) of this Example 25, except that country X CFTE category of AB for purposes of VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00034 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations 5915 applying paragraph (b)(4)(viii)(a)(1) of this attributable to each of businesses X, Y, and special allocations of the $10,000 and section to allocations of CFTEs would be the Z is income in separate CFTE categories. See $80,000 treated under the partnership same as in the fact patterns described in paragraph (b)(4)(viii)(c)(2) of this section. agreement as attributable to the business Y paragraphs (ii), (iii) and (iv) if, rather than Under paragraph (b)(4)(viii)(c)(3)(iv) of this and the business Z activities, respectively, being a preferential gross income allocation, section, an item of gross income that is which do not follow the allocation ratios that the $100,000 was a guaranteed payment to A recognized for U.S. federal income tax otherwise apply under the partnership within the meaning of section 707(c). See purposes is assigned to the activity that agreement to items of income in the business paragraph (b)(4)(viii)(c)(4)(ii) of this section. generated the item, and disregarded inter- X activity, are treated as divisible parts of the branch payments are not taken into account business X activity and, therefore, as separate (b)(5) Examples 26 through 35 in determining net income attributable to an activities. See paragraph (b)(4)(viii)(c)(2)(iii) [Reserved]. For further guidance, see activity. Consequently, all $100,000 of ABC’s of this section. Because the divisible part of § 1.704–1(b)(5) Examples 26 through 35. income is attributable to the business X the business X activity attributable to the Example 36. (i) A, B, and C form ABC, an activity for U.S. federal income tax purposes, portion of the disregarded payment received eligible entity (as defined in § 301.7701–3(a) and no net income is in the business Y or Z by DEY and not paid on to DEZ ($10,000) and of this chapter) treated as a partnership for CFTE category. Under paragraph the net income from the business Y activity U.S. federal income tax purposes. ABC owns (b)(4)(viii)(d)(1) of this section, the $3,000 of ($0) are both shared 80 percent to B and 10 three entities, DEX, DEY, and DEZ, which are country X taxes imposed on DEX is allocated percent each to A and C, that divisible part organized in, and treated as corporations to the business X CFTE category. The of the business X activity and the business under the laws of, countries X, Y, and Z, additional $9,000 of country X withholding Y activity are treated as a single CFTE respectively, and as disregarded entities for tax imposed with respect to the inter-branch category. Because the divisible part of the U.S. federal income tax purposes. DEX payment to DEY is also allocated to the business X activity attributable to the operates business X in country X, DEY business X CFTE category because for U.S. disregarded payment paid to DEZ ($80,000) operates business Y in country Y, and DEZ federal income tax purposes the related and the net income from the business Z operates business Z in country Z. Businesses $90,000 of income on which the country X activity ($0) are both shared 80 percent to C X, Y, and Z relate to the licensing and withholding tax is imposed is in the business and 10 percent each to A and B, that divisible sublicensing of intellectual property owned X CFTE category. Therefore, $12,000 of taxes part of the business X activity and the by DEZ. During 2016, DEX earns $100,000 of ($3,000 of country X income taxes and $9,000 business Z activity are also treated as a single royalty income from unrelated payors on of the country X withholding taxes) is related CFTE category. See paragraph which it pays no withholding taxes. Country to the $100,000 of net income in the business (b)(4)(viii)(c)(2)(i) of this section. X imposes a 30 percent tax on DEX’s net X CFTE. See paragraph (b)(4)(viii)(c)(1) of Accordingly, $10,000 of net income income. DEX makes royalty payments of this section. The allocations of country X attributable to business X is in the business $90,000 during 2016 to DEY that are taxes will be in proportion to the CFTE X CFTE category, $10,000 of net income of deductible by DEX for country X purposes category shares of income to which they business X attributable to the net disregarded and subject to a 10 percent withholding tax relate and will be deemed to be in payments of DEY is in the business Y CFTE imposed by country X. DEY earns no other accordance with the partners’ interests in the category, and $80,000 of net income of income in 2016. Country Y does not impose partnership if such taxes are allocated 80 business X attributable to the disregarded income or withholding taxes. DEY makes percent to A and 10 percent each to B and payment to DEZ is in the business Z CFTE royalty payments of $80,000 during 2016 to C. category. Under paragraph (b)(4)(viii)(d)(1) of DEZ. DEZ earns no other income in 2016. Example 37. (i) Assume that the facts are this section, the $3,000 of country X tax Country Z does not impose income or the same as in paragraph (i) of Example 36 imposed on DEX’s income is allocated to the withholding taxes. The royalty payments of this section, except that in order to reflect business X CFTE category. Because the from DEX to DEY and from DEY to DEZ are the $90,000 payment from DEX to DEY and $90,000 on which the country X withholding disregarded for U.S. federal income tax the $80,000 payment from DEY to DEZ, the tax is imposed is split between the business purposes. partnership agreement treats only $10,000 of Y CFTE category and the business Z CFTE As a result of these payments, DEX has the gross income as attributable to the category, those withholding taxes are taxable income of $10,000 for country X business X activity, which the partnership allocated on a pro rata basis, $1,000 [$9,000 purposes on which $3,000 of taxes are agreement allocates 80 percent to A and 10 × ($10,000/$90,000)] to the business Y CFTE imposed, and DEY has $90,000 of income for percent each to B and C. Of the remaining category and $8,000 [$9,000 × ($80,000/ country X withholding tax purposes on $90,000 of gross income, the partnership $90,000)] to the business Z CFTE category. which $9,000 of withholding taxes are agreement treats $10,000 of the gross income See paragraph (b)(4)(viii)(d)(1) of this section. imposed. Pursuant to the partnership as attributable to the business Y activity, To satisfy the safe harbor of paragraph agreement, all partnership items from which the partnership agreement allocates 80 (b)(4)(viii) of this section, the $3,000 of business X, excluding CFTEs paid or accrued percent to B and 10 percent each to A and country X taxes allocated to the business X by business X, are allocated 80 percent to A C; and the partnership agreement treats CFTE category must be allocated in and 10 percent each to B and C. All $80,000 of the gross income as attributable to proportion to the CFTE category shares of partnership items from business Y, excluding the business Z activity, which the income to which they relate, and therefore CFTEs paid or accrued by business Y, are partnership agreement allocates 80 percent to would be deemed to be in accordance with allocated 80 percent to B and 10 percent each C and 10 percent each to A and B. In the partners’ interests in the partnership if to A and C. All partnership items from addition, the partnership agreement allocates such taxes were allocated 80 percent to A business Z, excluding CFTEs paid or accrued the country X taxes among A, B, and C in and 10 percent each to B and C. The by business Z, are allocated 80 percent to C accordance with which disregarded entity is allocation of the $1,000 of country X and 10 percent each to A and B. Because only considered to have paid the taxes for country withholding taxes allocated to the business Y business X has items that are regarded for X purposes. The partnership agreement CFTE category would be in proportion to the U.S. federal income tax purposes (the allocates the $3,000 of country X income CFTE category shares of income to which $100,000 of royalty income), only business X taxes 80 percent to A and 10 percent to each they relate, and therefore would be deemed has partnership items. Accordingly A is of B and C, and allocates the $9,000 of to be in accordance with the partners’ allocated 80 percent of the income from country X withholding taxes 80 percent to B interests in the partnership if such taxes were asabaliauskas on DSK5VPTVN1PROD with RULES business X ($80,000) and B and C are each and 10 percent to each of A and C. Thus, allocated 80 percent to B and 10 percent each allocated 10 percent of the income from ABC allocates the country X taxes $3,300 to to A and C. The allocation of the $8,000 of business X ($10,000 each). There are no A (80 percent of $3,000 plus 10 percent of country X withholding taxes allocated to the partnership items of income from business Y $9,000), $7,500 to B (10 percent of $3,000 business Z CFTE category would be in or Z to allocate. plus 80 percent of $9,000), and $1,200 to C proportion to the CFTE category shares of (ii) Because the partnership agreement (10 percent of $3,000 plus 10 percent of income to which they relate, and therefore provides for different allocations of $9,000). would be deemed to be in accordance with partnership net income attributable to (ii) In order to prevent separating the the partners’ interests in the partnership if businesses X, Y, and Z, the net income CFTEs from the related foreign income, the such taxes were allocated 80 percent to C and VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00035 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1

5916 Federal Register / Vol. 81, No. 23 / Thursday, February 4, 2016 / Rules and Regulations 10 percent each to A and B. Thus, to satisfy FOR FURTHER INFORMATION CONTACT: If deviation from the operating regulations the safe harbor, ABC must allocate the you have questions on this temporary is authorized under 33 CFR 117.35. country X taxes $3,300 to A (80 percent of deviation, call or email Mr. Steven $3,000 plus 10 percent of $1,000 plus 10 Dated: January 29, 2016. percent of $8,000), $1,900 to B (10 percent of Fischer, Bridge Administrator, Steven M. Fischer, $3,000 plus 80 percent of $1,000 plus 10 Thirteenth Coast Guard District; Bridge Administrator, Thirteenth Coast Guard percent of $8,000), and $6,800 to C (10 telephone 206–220–7282, email d13-pf- District. percent of $3,000 plus 10 percent of $1,000 d13bridges@uscg.mil. [FR Doc. 2016–02098 Filed 2–3–16; 8:45 am] plus 80 percent of $8,000). ABC’s allocations of country X taxes are not deemed to be in SUPPLEMENTARY INFORMATION: BNSF BILLING CODE 9110–04–P accordance with the partners’ interests in the requested that the BNSF Swing Bridge partnership under paragraph (b)(4)(viii) of across the Columbia River, mile 105.6, this section because they are not in remain closed to vessel traffic to remove DEPARTMENT OF HOMELAND proportion to the partners’ CFTE category and replace rail joints. During this SECURITY shares of income to which the country X installation period, the swing span of taxes relate. Accordingly, the country X taxes the bridge will be in the closed-to- Coast Guard will be reallocated according to the partners’ interests in the partnership. navigation position; however, the span may be opened for maritime 33 CFR Part 117 (c) through (e) [Reserved]. For further emergencies, but any emergency [Docket No. USCG–2016–0057] guidance, see § 1.704–1(c) through (e). opening will necessitate a time (f) Expiration date. The applicability extension to the approved dates. The Drawbridge Operation Regulation; of this section expires on February 4, BNSF Swing Bridge, mile 105.6, James River, Isle of Wight and 2019. provides 39 feet of vertical clearance Newport News, VA John Dalrymple, above Columbia River Datum 0.0 while AGENCY: Coast Guard, DHS. Deputy Commissioner for Services and in the closed position. The current ACTION:Notice of deviation from Enforcement. operations for the swing bridge is in 33 drawbridge regulation. Approved: January 14, 2016. CFR 117.5. This deviation allows the Mark J. Mazur, swing span of the BNSF Railway Bridge SUMMARY: The Coast Guard has issued a Assistant Secretary of the Treasury (Tax across the Columbia River, mile 105.6, temporary deviation from the operating Policy). to remain in the closed-to-navigation schedule that governs the James River [FR Doc. 2016–01949 Filed 2–3–16; 8:45 am] position, and need not open for Bridge (US17) across the James River, BILLING CODE 4830–01–P maritime traffic from 7 a.m. to 7 p.m. on mile 5.0, at Isle of Wight and Newport March 8, March 10, March 15, March 16 News, VA. The deviation is necessary to and March 17, 2016. These dates perform bridge maintenance and coincide with the Columbia River repairs. This deviation allows the bridge DEPARTMENT OF HOMELAND SECURITY Bonneville lock and the Dalles lock. The to remain in the closed-to-navigation bridge shall operate in accordance to 33 position. Coast Guard CFR 117.5 at all other times. Waterway DATES: This deviation is effective from usage on this part of the Columbia River 5 a.m. on February 7, 2016 to 7 p.m. on 33 CFR Part 117 includes vessels ranging from February 14, 2016. commercial tug and tow vessels to [Docket No. USCG–2016–0076] ADDRESSES: The docket for this recreational pleasure craft including cabin cruisers and sailing vessels. deviation, [USCG–2016–0057] is Drawbridge Operation Regulation; available at http://www.regulations.gov. Columbia River, Vancouver, WA Vessels able to pass through the Type the docket number in the bridge in the closed positions may do so ‘‘SEARCH’’ box and click ‘‘SEARCH’’. AGENCY: Coast Guard, DHS. at anytime. For the duration of the Click on Open Docket Folder on the line ACTION:Notice of deviation from repair work, vessels will not be allowed associated with this deviation. drawbridge regulations. to pass through the bridge. The bridge FOR FURTHER INFORMATION CONTACT: If SUMMARY: The Coast Guard has issued a will be able to open for emergencies and you have questions on this temporary temporary deviation from the operating there is no immediate alternate route for deviation, call or email Hal R. Pitts, schedule that governs the Burlington vessels to pass. The bridge can be Bridge Administration Branch Fifth Northern Santa Fe (BNSF) Railway opened for emergency vessels in District, Coast Guard, telephone 757– Bridge across the Columbia River, mile response to a call, however, if an 398–6222, email Hal.R.Pitts@uscg.mil. 105.6, at Vancouver, WA. This deviation opening for emergencies is needed, an SUPPLEMENTARY INFORMATION: The is necessary to accommodate extension of this deviation will be required to complete the work. No Virginia Department of Transportation, maintenance to replace movable rail that owns and operates the James River joints. This deviation allows the bridge immediate alternate route for vessels to pass is available on this part of the river. Bridge (US17), has requested a to remain in the closed position during temporary deviation from the current maintenance activities. The Coast Guard will also inform the operating regulations to perform repairs DATES: This deviation is effective from users of the waterways through our to the aerial electrical cable connecting 7 a.m. on March 8, 2016, to 7 p.m. on Local and Broadcast Notices to Mariners the north tower to the south tower. The asabaliauskas on DSK5VPTVN1PROD with RULES March 17, 2016. of the change in operating schedule for bridge is a vertical lift draw bridge and ADDRESSES: The docket for this the bridge so that vessels can arrange has a vertical clearance in the closed deviation, [USCG–2016–0076] is their transits to minimize any impact position of 60 feet above mean high available at http://www.regulations.gov. caused by the temporary deviation. water. Type the docket number in the In accordance with 33 CFR 117.35(e), The current operating schedule is ‘‘SEARCH’’ box and click ‘‘SEARCH.’’ the drawbridge must return to its regular open on signal as set out in 33 CFR Click on Open Docket Folder on the line operating schedule immediately at the 117.5. Under this temporary deviation, associated with this deviation. end of the designated time period. This the bridge will remain in the closed-to- VerDate Sep<11>2014 16:15 Feb 03, 2016 Jkt 238001 PO 00000 Frm 00036 Fmt 4700 Sfmt 4700 E:\FR\FM\04FER1.SGM 04FER1


Document Created: 2016-02-04 00:31:17
Document Modified: 2016-02-04 00:31:17
CategoryRegulatory Information
CollectionFederal Register
sudoc ClassAE 2.7:
GS 4.107:
AE 2.106:
PublisherOffice of the Federal Register, National Archives and Records Administration
SectionRules and Regulations
ActionFinal and temporary regulations.
ContactSuzanne M. Walsh, (202) 317-4908 (not a toll-free call).
FR Citation81 FR 5908 
RIN Number1545-BM57
CFR AssociatedIncome Taxes and Reporting and Recordkeeping Requirements
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