Amendment from August 04, 2006
26 CFR--PART 1.861-8T
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71 FR 44515 in PDF format.Amendment(s) published August 4, 2006, in 71 FR 44515
Effective Date(s): January 1, 2007
Par. 16. Section 1.861–8T is amended as follows:
1. Paragraphs (a)(3) and (a)(4) are removed and reserved and paragraph (a)(5)(ii) is revised.
2. Paragraphs (b)(3) are revised.
3. Paragraph (e)(4) is added.
4. Paragraph (f)(4)(i) is revised.
5. Paragraph (g), Example 17, Example 18, and Example 30 are added.
6. Paragraph (h) is revised.
The addition and revisions read as follows:
§ 1.861-8T Computation of taxable income from sources within the United States and from other sources and activities (temporary).
(a) * * *
(5) * * *
(ii) Paragraph (e)(4), the last sentence of paragraph (f)(4)(i), and paragraph (g), Example 17, Example 18, and Example 30 of this section are generally applicable for taxable years beginning after December 31, 2006. In addition, a person may elect to apply the provisions of paragraph (e)(4) of this section to earlier years. Such election shall be made in accordance with the rules set forth in §1.482–9T(n)(2).
(b) * * *
(3) Supportive functions. Deductions which are supportive in nature (such as overhead, general and administrative, and supervisory expenses) may relate to other deductions which can more readily be allocated to gross income. In such instance, such supportive deductions may be allocated and apportioned along with the deductions to which they relate. On the other hand, it would be equally acceptable to attribute supportive deductions on some reasonable basis directly to activities or property ordinarily be accomplished by allocating the supportive expenses to all gross income or to another broad class of gross income and apportioning the expenses in accordance with paragraph (c)(1) of this section. For this purpose, reasonable departmental overhead rates may be utilized. For examples of the application of the principles of this paragraph (b)(3) to expenses other than expenses attributable to stewardship activities, see Examples 19 through 21 of paragraph (g) of this section. See paragraph (e)(4)(ii) of this section for the allocation and apportionment of deductions attributable to stewardship expenses. However, supportive deductions that are described in 1.861–14T(e)(3) shall be allocated and apportioned by reference only to the gross income of a single member of an affiliated group of corporations as defined in 1.861–14T.
* * * * *
(e) * * *
(4) Stewardship and controlled services—(i) Expenses attributable to controlled services. If a corporation performs a controlled services transaction (as defined in §1.482–9T(l)(3)), which includes any activity by one member of a group of controlled taxpayers that results in a benefit to a related corporation, and the rendering corporation charges the related corporation for such services, section 482 and these regulations provide for an allocation where the charge is not consistent with an arm's length result as determined. The deductions for expenses of the corporation attributable to the controlled services transaction are considered definitely related to the amounts so charged and are to be allocated to such amounts.
(ii) Stewardship expenses attributable to dividends received. Stewardship expenses, which result from “overseeing” functions undertaken for a corporation's own benefit as an investor in a related corporation, shall be considered definitely related and allocable to dividends received, or to be received, from the related corporation. For purposes of this section, stewardship expenses of a corporation are those expenses resulting from “duplicative activities” (as defined in §1.482–9T(l)(3)(iii)) or “shareholder activities” (as defined in §1.482–9T(l)(3)(iv)) of the corporation with respect to the related corporation. Thus, for example, stewardship expenses include expenses of an activity the sole effect of which is either to protect the corporation's capital investment in the related corporation or to facilitate compliance by the corporation with reporting, legal, or regulatory requirements applicable specifically to the corporation, or both. If a corporation has a foreign or international department which exercises overseeing functions with respect to related foreign corporations and, in addition, the department performs other functions that generate other foreign-source income (such as fees for services rendered outside of the United States for the benefit of foreign related corporations, foreign-source royalties, and gross income of foreign branches), some part of the deductions with respect to that department are considered definitely related to the other foreign-source income. In some instances, the operations of a foreign or international department will also generate United States source income (such as fees for services performed in the United States). Permissible methods of apportionment with respect to stewardship expenses include comparisons of time spent by employees weighted to take into account differences in compensation, or comparisons of each related corporation's gross receipts, gross income, or unit sales volume, assuming that stewardship activities are not substantially disproportionate to such factors. See paragraph (f)(5) of this section for the type of verification that may be required in this respect. See §1.482–9T(l)(5) for examples that illustrate the principles of §1.482–9T(l)(3). See Example 17 and Example 18 of paragraph (g) of this section for the allocation and apportionment of stewardship expenses. See paragraph (b)(3) of this section for the allocation and apportionment of deductions attributable to supportive functions other than stewardship expenses, such as expenses in the nature of day-to-day management, and paragraph (e)(5) of this section generally for the allocation and apportionment of deductions attributable to legal and accounting fees and expenses.
(f) * * *
(4) Adjustments made under other provisions of the Code—(i) In general. If an adjustment which affects the taxpayer is made under section 482 or any other provision of the Code, it may be necessary to recompute the allocations and apportionments required by this section in order to reflect changes resulting from the adjustment. The recomputation made by the Commissioner shall be made using the same method of allocation and apportionment as was originally used by the taxpayer, provided such method as originally used conformed with paragraph (a)(5) of this section and, in light of the adjustment, such method does not result in a material distortion. In addition to adjustments which would be made aside from this section, adjustments to the taxpayer's income and deductions which would not otherwise be made may be required before applying this section in order to prevent a distortion in determining taxable income from a particular source of activity. For example, if an item included as a part of the cost of goods sold has been improperly attributed to specific sales, and, as a result, gross income under one of the operative sections referred to in paragraph (f)(1) of this section is improperly determined, it may be necessary for the Commissioner to make an adjustment to the cost of goods sold, consistent with the principles of this section, before applying this section. Similarly, if a domestic corporation transfers the stock in its foreign subsidiaries to a domestic subsidiary and the parent corporation continues to incur expenses in connection with protecting its capital investment in the foreign subsidiaries (see paragraph (e)(4) of this section), it may be necessary for the Commissioner to make an allocation under section 482 with respect to such expenses before making allocations and apportionments required by this section, even though the section 482 allocation might not otherwise be made.
(g) * * *
Example 17.
Stewardship Expenses (Consolidation). (i) (A) Facts. X, a domestic corporation, wholly owns M, N, and O, also domestic corporations. X, M, N, and O file a consolidated income tax return. All the income of X and O is from sources within the United States, all of M's income is general limitation income from sources within South America, and all of N's income is general limitation income from sources within Africa. X receives no dividends from M, N, or O. During the taxable year, the consolidated group of corporations earned consolidated gross income of $550,000 and incurred total deductions of $370,000 as follows:
------------------------------------------------------------------------ Gross income Deductions------------------------------------------------------------------------Corporations: X................................... $100,000 $50,000 M................................... 250,000 100,000 N................................... 150,000 200,000 O................................... 50,000 20,000 ------------------------------- Total........................... 550,000 370,000------------------------------------------------------------------------
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(B) Of the $50,000 of deductions incurred by X, $15,000 relates to X's ownership of M; $10,000 relates to X's ownership of N; $5,000 relates to X's ownership of O; and the sole effect of the entire $30,000 of deductions is to protect X's capital investment in M, N, and O. X properly categorizes the $30,000 of deductions as stewardship expenses. The remainder of X's deductions ($20,000) relates to production of United States source income from its plant in the United States.
(ii) (A) Allocation. X's deductions of $50,000 are definitely related and thus allocable to the types of gross income to which they give rise, namely $25,000 wholly to general limitation income from sources outside the United States ($15,000 for stewardship of M and $10,000 for stewardship of N) and the remainder ($25,000) wholly to gross income from sources within the United States. Expenses incurred by M and N are entirely related and thus wholly allocable to general limitation income earned from sources without the United States, and expenses incurred by O are entirely related and thus wholly allocable to income earned within the United States. Hence, no apportionment of expenses of X, M, N, or O is necessary. For purposes of applying the foreign tax credit limitation; the statutory grouping is general limitation gross income from sources without the United States and the residual grouping is gross income from sources within the United States. As a result of the allocation of deductions, the X consolidated group has taxable income from sources without the United States in the amount of $75,000, computed as follows:
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------------------------------------------------------------------------ ------------------------------------------------------------------------Foreign source general limitation gross income: ($250,000 from M + $150,000 from N)................. $400,000Less: Deductions allocable to foreign source general limitation gross income: ($25,000 from X, $100,000 from M, and $200,000 from 325,000 N)................................................. --------------- Total foreign-source taxable income............. 75,000------------------------------------------------------------------------
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(B) Thus, in the combined computation of the general limitation, the numerator of the limiting fraction (taxable income from sources outside the United States) is $75,000.
Example 18.
Stewardship and Supportive Expenses. (i) (A) Facts. X, a domestic corporation, manufactures and sells pharmaceuticals in the United States. X's domestic subsidiary S, and X's foreign subsidiaries T, U, and V perform similar functions in the United States and foreign countries T, U, and V, respectively. Each corporation derives substantial net income during the taxable year that is general limitation income described in section 904(d)(1). X's gross income for the taxable year consists of:
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Domestic sales income................................... $32,000,000Dividends from S (before dividends received deduction).. 3,000,000Dividends from T........................................ 2,000,000Dividends from U........................................ 1,000,000Dividends from V........................................ 0Royalties from T and U.................................. 1,000,000Fees from U for services performed by X................. 1,000,000 --------------- Total gross income.................................. 40,000,000
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(B) In addition, X incurs expenses of its supervision department of $1,500,000.
(C) X's supervision department (the Department) is responsible for the supervision of its four subsidiaries and for rendering certain services to the subsidiaries, and this Department provides all the supportive functions necessary for X's foreign activities. The Department performs three principal types of activities. The first type consists of services for the direct benefit of U for which a fee is paid by U to X. The cost of the services for U is $900,000 (which results in a total charge to U of $1,000,000). The second type consists of activities described in §1.482–9(l)(3)(iii) that are in the nature of shareholder oversight that duplicate functions performed by the subsidiaries' own employees and that do not provide an additional benefit to the subsidiaries. For example, a team of auditors from X's accounting department periodically audits the subsidiaries' books and prepares internal reports for use by X's management. Similarly, X's treasurer periodically reviews for the board of directors of X the subsidiaries' financial policies. These activities do not provide an additional benefit to the related corporations. The cost of the duplicative services and related supportive expenses is $540,000. The third type of activity consists of providing services which are ancillary to the license agreements which X maintains with subsidiaries T and U. The cost of the ancillary services is $60,000.
(ii) Allocation. The Department's outlay of $900,000 for services rendered for the benefit of U is allocated to the $1,000,000 in fees paid by U. The remaining $600,000 in the Department's deductions are definitely related to the types of gross income to which they give rise, namely dividends from subsidiaries S, T, U, and V and royalties from T and U. However, $60,000 of the $600,000 in deductions are found to be attributable to the ancillary services and are definitely related (and therefore allocable) solely to royalties received from T and U, while the remaining $540,000 in deductions are definitely related (and therefore allocable) to dividends received from all the subsidiaries.
(iii) (A) Apportionment. For purposes of applying the foreign tax credit limitation, the statutory grouping is general limitation gross income from sources outside the United States and the residual grouping is gross income from sources within the United States. X's deduction of $540,000 for the Department's expenses and related supportive expenses which are allocable to dividends received from the subsidiaries must be apportioned between the statutory and residual groupings before the foreign tax credit limitation may be applied. In determining an appropriate method for apportioning the $540,000, a basis other than X's gross income must be used since the dividend payment policies of the subsidiaries bear no relationship either to the activities of the Department or to the amount of income earned by each subsidiary. This is evidenced by the fact that V paid no dividends during the year, whereas S, T, and U paid dividends of $1 million or more each. In the absence of facts that would indicate a material distortion resulting from the use of such method, the stewardship expenses ($540,000) may be apportioned on the basis of the gross receipts of each subsidiary.
(B) The gross receipts of the subsidiaries were as follows:
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S....................................................... $4,000,000T....................................................... 3,000,000U....................................................... 500,000V....................................................... 1,500,000 --------------- Total............................................... 9,000,000
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(C) Thus, the expenses of the Department are apportioned for purposes of the foreign tax credit limitation as follows:
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Apportionment of stewardship expenses to the statutory $300,000 grouping of gross income: $540,000 x [($3,000,000 + $500,000 + $1,500,000)/$9,000,000].....................Apportionment of supervisory expenses to the residual 240,000 grouping of gross income: $540,000 x [$4,000,000/ 9,000,000]............................................. --------------- Total: Apportioned stewardship expense.............. 540,000
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* * * * *
Example 30.
Income Taxes. (i) (A) Facts. As in Example 17 of this paragraph, X is a domestic corporation that wholly owns M, N, and O, also domestic corporations. X, M, N, and O file a consolidated income tax return. All the income of X and O is from sources within the United States, all of M's income is general limitation income from sources within South America, and all of N's income is general limitation income from sources within Africa. X receives no dividends from M, N, or O. During the taxable year, the consolidated group of corporations earned consolidated gross income of $550,000 and incurred total deductions of $370,000. X has gross income of $100,000 and deductions of $50,000, without regard to its deduction for state income tax. Of the $50,000 of deductions incurred by X, $15,000 relates to X's ownership of M; $10,000 relates to X's ownership of N; $5,000 relates to X's ownership of O; and the entire $30,000 constitutes stewardship expenses. The remainder of X's $20,000 of deductions (which is assumed not to include state income tax) relates to production of U.S. source income from its plant in the United States. M has gross income of $250,000 and deductions of $100,000, which yield foreign-source general limitation taxable income of $150,000. N has gross income of $150,000 and deductions of $200,000, which yield a foreign-source general limitation loss of $50,000. O has gross income of $50,000 and deductions of $20,000, which yield U.S. source taxable income of $30,000.
(B) Unlike Example 17 of this paragraph (g), however, X also has a deduction of $1,800 for state A income taxes. X's state A taxable income is computed by first making adjustments to the Federal taxable income of X to derive apportionable taxable income for state A tax purposes. An analysis of state A law indicates that state A law also includes in its definition of the taxable business income of X which is apportionable to X's state A activities, the taxable income of M, N, and O, which is related to X's business. As in Example 25, the amount of apportionable taxable income attributable to business activities conducted in state A is determined by multiplying apportionable taxable income by a fraction (the “state apportionment fraction”) that compares the relative amounts of payroll, property, and sales within state A with worldwide payroll, property, and sales. Assuming that X's apportionable taxable income equals $180,000, $100,000 of which is from sources without the United States, and $80,000 is from sources within the United States, and that the state apportionment fraction is equal to 10 percent, X has state A taxable income of $18,000. The state A income tax of $1,800 is then derived by applying the state A income tax rate of 10 percent to the $18,000 of state A taxable income.
(C)
(i) Allocation and apportionment. Assume that under Example 29, it is determined that X's deduction for state A income tax is definitely related to a class of gross income consisting of income from sources both within and without the United States, and that the state A tax is apportioned $1,000 to sources without the United States, and $800 to sources within the United States. Under Example 17, without regard to the deduction for X's state A income tax, X has a separate loss of ($25,000) from sources without the United States. After taking into account the deduction for state A income tax, X's separate loss from sources without the United States is increased by the $1,000 state A tax apportioned to sources without the United States, and equals a loss of ($26,000), for purposes of computing the numerator of the consolidated general limitation foreign tax credit limitation.
(h) Effective dates—(1) In general. In general, the rules of this section, as well as the rules of §§1.861–9T, 1.861–10T, 1.861–11T, 1.861–12T, and 1.861–14T apply for taxable years beginning after December 31, 1986, except for paragraphs (a)(5)(ii), (b)(3), (e)(4), (f)(4)(i), paragraph (g) Example 17, Example 18, and Example 30, and paragraph (h) of this section, which are generally applicable for taxable years beginning after December 31, 2006. However, see 1.861–8(e)(12)(iv) and 1.861–14(e)(6) for rules concerning the allocation and apportionment of deductions for charitable contributions. In the case of corporate taxpayers, transition rules set forth in 1.861–13T provide for the gradual phase-in of certain provisions of this and the foregoing sections. However, the following rules are effective for taxable years commencing after December 31, 1988:
(i) Section 1.861–9T(b)(2) (concerning the treatment of certain foreign currency).
(ii) Section 1.861–9T(d)(2) (concerning the treatment of interest incurred by nonresident aliens).
(iii) Section 1.861–10T(b)(3)(ii) (providing an operating costs test for purposes of the nonrecourse indebtedness exception).
(iv) Section 1.861–10T(b)(6) (concerning excess collaterilzation of nonrecourse borrowings).
(2) In addition, 1.861–10T(e) (concerning the treatment of related controlled foreign corporation indebtedness) is applicable for taxable years commencing after December 31, 1987. For rules for taxable years beginning before January 1, 1987, and for later years to the extent permitted by 1.861–13T, see 1.861–8 (revised as of April 1, 1986).
(3) Expiration date. The applicability of the paragraphs (a)(5)(ii), (b)(3), (e)(4), (f)(4)(i), paragraph (g) Example 17, Example 18, and Example 30, and paragraph (h) of this section, expires on or before July 31, 2009.
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