n-05-64.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Foreign tax credit and other guidance under section 965

Notice 2005-64

SECTION 1. OVERVIEW

This notice is the third in a series of items of published guidance regarding new
section 965 of the Internal Revenue Code (Code). This notice supplements the
guidance set forth in Notice 2005-10, 2005-6 I.R.B. 474, which primarily addressed the
requirements for a domestic reinvestment plan described in section 965(b)(4), and
Notice 2005-38, 2005-22 I.R.B. 1100, which primarily addressed the limitations
described in section 965(b)(1), (2), and (3) on the amount of dividends eligible for the
dividends received deduction under section 965(a), including the effects of certain
acquisitions, dispositions, and similar transactions on those limitations. This notice sets
forth guidance on various issues arising under section 965, including issues relating to
the foreign tax credit and minimum tax credit, expense allocation and apportionment,
and currency translation. The Treasury Department and the Internal Revenue Service
(IRS) expect to issue regulations that incorporate the guidance provided in Notice 2005-
10, Notice 2005-38, this notice, and any subsequent guidance that may be issued
addressing section 965.
The remainder of this notice is divided into 14 sections. Section 2 provides

2
background with respect to the issues discussed in this notice. Section 3 provides
guidance on the identification of cash dividends and qualifying dividends and foreign
currency translation rules for certain cash dividends. Section 4 provides guidance on
the disallowance of a credit or deduction under section 965(d)(1) for foreign taxes paid
or accrued with respect to the deductible portion of section 965 dividends and related
issues arising under section 78. Section 5 provides guidance on the disallowance of
deductions for certain expenses under section 965(d)(2). Section 6 provides rules for
the treatment of deductions related to section 904(d) separate categories containing
qualifying dividends. Section 7 then provides guidance on the limitation under section
965(e)(2) that prevents the reduction of taxable income below the amount of
nondeductible CFC dividends. Section 8 addresses the application of the overall foreign
loss and separate limitation loss allocation and recapture rules of section 904(f) to
taxpayers with nondeductible CFC dividends. Section 9 provides rules for implementing
the restrictions under section 965(e)(1) on the use of credits to offset U.S. tax on
nondeductible CFC dividends, in part through the application of an additional foreign tax
credit limitation that is applied after expenses and losses are allocated and the regular
section 904(d) limitation is calculated, and provides rules relating to the computation of
alternative minimum tax and the credit for prior year minimum tax in the election year.
Section 10 then addresses other issues arising under section 965, including the
treatment of dividends paid to certain intermediary pass-through entities for purposes of
determining base period inclusions under section 965(b)(2)(B)(i). Section 11 sets forth
transition rules that apply to certain taxpayers that approved a domestic reinvestment

3
plan or filed a tax return for a taxable year to which section 965 applies prior to the
issuance of this notice. Section 12 describes the effect of this notice on other
documents. Section 13 provides the effective date of this notice, and section 14
provides information required under the Paperwork Reduction Act of 1995. Finally,
section 15 provides drafting information.

SECTION 2. BACKGROUND
.01 Section 965—In General
The American Jobs Creation Act of 2004 (P.L. 108-357) (the Act), enacted on
October 22, 2004, added new section 965 to the Code. In general, and subject to
limitations discussed below, section 965(a) provides that a corporation that is a U.S.
shareholder
1
of a controlled foreign corporation (CFC) may elect, for one taxable year,
an 85 percent dividends received deduction (DRD) with respect to certain cash
dividends it receives from its CFCs.
2
For this purpose, all U.S. shareholders that are
members of an affiliated group filing a consolidated return under section 1501 are
treated as one U.S. shareholder. Section 965(c)(5)(A).
For purposes of section 965, the term “cash dividends” includes cash
amounts included in gross income as dividends under sections 302, 304, and 356(a)(2),
but does not include subpart F inclusions or amounts treated as dividends under section

1
The term U.S. shareholder means, with respect to any foreign corporation, a U.S. person who owns
(within the meaning of section 958(a)), or is considered as owning by applying the rules of ownership of
section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to
vote of such foreign corporation. Section 951(b).

4
78 or 1248 or, except in certain cases, section 367. H.R. Conf. Rep. No. 108-755, at
314-15; see Notice 2005-10, sections 2 and 3. For this purpose, a cash dividend also
includes a cash distribution from a CFC to a U.S. shareholder that is excluded from
gross income under section 959(a) to the extent of amounts included in income by such
U.S. shareholder under section 951(a)(1)(A) as a result of a cash dividend during the
election year to: (1) such CFC from another CFC in a section 958(a) chain of ownership;
or (2) any other CFC in such chain of ownership from another CFC in such chain of
ownership, but only to the extent of cash distributions described in section 959(b) made
during such year to the CFC from which such U.S. shareholder received such
distribution. Section 965(a)(2).
The amount of cash dividends eligible for the section 965(a) DRD (qualifying
dividends) is determined after applying certain limitations. Notice 2005-38 addressed
the rules limiting qualifying dividends to certain dollar threshold amounts determined
with reference to the greater of $500 million or the amount of earnings permanently
reinvested outside the United States, the amount of dividends received in excess of
certain base period average amounts, and certain increases in related-party
indebtedness. See sections 965(b)(1) through (3) and 965(c). Notice 2005-10
addressed the requirement in section 965(b)(4) that the amount of the dividends be
invested in the United States pursuant to a domestic reinvestment plan that meets
specified criteria. Notice 2005-10 also provided rules for electing the application of

2
Section 965(c)(4) provides that no deduction is allowed under section 243 or 245 for any dividend for
which a deduction is allowed under section 965.

5
section 965 for a taxable year by filing Form 8895 with a timely-filed tax return. See
section 965(b)(4) and (f). The taxable year for which a taxpayer elects section 965 to
apply is referred to in this notice as the “election year.”
.02 Disallowance of Credit or Deduction for Certain Expenses Related to Deductible
Portion of Qualifying Dividends and Related Matters
Section 965(d)(1) provides that no credit or deduction is allowed for certain
foreign taxes paid or accrued (or treated as paid or accrued) with respect to the
deductible portion of any qualifying dividend. Section 965(d)(2) further provides that no
deduction shall be allowed for certain other expenses. Section 9.01 of Notice 2005-38
confirmed that section 78 does not apply to any tax which is not allowable as a credit
under section 901 by reason of section 965(d) and that the disallowance of deductions
in section 965(d)(2) applies only to deductions for expenses that are directly allocable to
the deductible portion described in section 965(d)(1).
Section 965(d)(3) provides that, unless the taxpayer otherwise specifies, the
deductible portion of any qualifying dividend is the amount which bears the same ratio
to the amount of such dividend as the amount allowed as a deduction under section
965(a) for the election year bears to the total amount of dividends the taxpayer received
from its CFCs during the election year, as described in section 965(b)(2)(A). For
purposes of determining which dividends are subject to the foreign tax credit and
expense disallowance, the taxpayer may specifically identify which cash dividends are
treated as carrying the DRD (and thus entail proportionate disallowance of any
associated deductions and foreign tax credits) and which are not. H.R. Conf. Rep. No.

6
108-755, at 316. In the absence of such a specification, a pro rata amount of foreign
tax credits and deductions will be disallowed with respect to every cash dividend
repatriated during the election year. See H.R. Conf. Rep. No. 108-755, at 316 n. 112.
.03 Limitation on Use of Credits and Deductions Related to Nondeductible Portion of
Qualifying Dividends
For purposes of this notice, the term “nondeductible CFC dividends” refers to the
excess of the amount of qualifying dividends over the 85 percent deduction allowed for
such dividends under section 965(a). See section 965(e)(3). Section 965(e) provides
limitations on the extent to which credits may offset the U.S. tax on nondeductible CFC
dividends, and also provides that allowable deductions may not reduce taxable income
below the amount of nondeductible CFC dividends. Specifically, section 965(e)(1)
provides that the U.S. tax on nondeductible CFC dividends may not be offset by tax
credits, other than a foreign tax credit under section 27 for taxes attributable to such
dividends and the credit for prior year minimum tax under section 53.
Section 965(e)(1) further provides that the U.S. tax on nondeductible CFC
dividends is not treated as tax imposed by chapter 1 for purposes of computing the
alternative minimum tax imposed by section 55 (AMT). Accordingly, the tax on
nondeductible CFC dividends cannot reduce the AMT that otherwise would be owed by
the taxpayer. H.R. Conf. Rep. No. 108-755, at 316.
3
Section 9.01 of Notice 2005-38
provided that for purposes of calculating AMT for the election year in accordance with

3
However, the DRD is not treated as a preference item for purposes of computing the AMT. Section
56(g)(4)(C)(vi). Thus, the deduction is allowed in computing alternative minimum taxable income

7
section 965(e)(1)(B), the taxpayer’s regular tax described in section 55(c) and tentative
minimum tax determined under section 55(b)(1)(B) do not include tax attributable to
nondeductible CFC dividends.
Section 965(e)(2)(A) provides that taxable income shall in no event be less than
the amount of nondeductible CFC dividends received during the election year. While
the income attributable to nondeductible CFC dividends may not be offset by expenses,
losses, or deductions, such amounts may have the effect of reducing the taxpayer’s
other income. H.R. Conf. Rep. No. 108-755, at 316 n. 113. Section 965(e)(2)(B)
provides that the nondeductible CFC dividends are not taken into account in
determining the amount of any net operating loss (NOL) for the election year, or in
determining taxable income for the election year for purposes of the second sentence of
section 172(b)(2), which applies in determining the allowable NOL carryover or
carryback to other years.

SECTION 3. IDENTIFICATION OF CASH DIVIDENDS, QUALIFYING DIVIDENDS,
AND SEPARATE CATEGORIES; FOREIGN CURRENCY TRANSLATION RULES
.01 Identification of Cash Dividends
In order for cash dividends that are paid to a partnership or a disregarded entity
that is owned by a U.S. shareholder to qualify as cash dividends described in section
965(a), cash in the amount of the dividend must be received by the U.S. shareholder in

notwithstanding the fact that it may not be deductible in computing earnings and profits. H.R. Conf. Rep.
No. 108-755, at 316-317.

8
the election year from the partnership or disregarded entity. See section 3.02 of Notice
2005-10. In the case of a disregarded entity, cash may be received in a form other than
a distribution. See section 9.06 of Notice 2005-38 and section 10.09 of this notice. In
addition, as described in section 2.01 of this notice, under section 965(a)(2) a cash
distribution from a CFC of previously-taxed earnings and profits attributable to amounts
which are or have been included in income of the U.S. shareholder and are excluded
from gross income under section 959(a) (previously-taxed income or PTI) is treated as a
cash dividend only to the extent of amounts included in income by the U.S. shareholder
under subpart F in the election year as a result of cash dividends that are both paid and
distributed through a chain of CFCs to the U.S. shareholder in the election year. Finally,
a deemed liquidation effected through an election under §301.7701-3(c) results in a
cash dividend only to the extent the shareholder receives cash as part of the liquidation
in the election year. Section 965(c)(3); see section 2, footnote 2, of Notice 2005-10.
This section 3.01 provides rules for identifying the amounts treated as cash dividends if
a U.S. shareholder receives cash from a partnership or disregarded entity or cash
distributions of PTI from a CFC that exceed the cash dividends paid to such partnership,
disregarded entity, or CFC (or the cash deemed received in a deemed liquidation) in the
election year. See section 3.02 of this notice for rules for identifying specific cash
dividends (including both cash dividends described in this section 3.01 and cash
dividends described in section 965(a)(1) that are paid directly by a CFC to a U.S.
shareholder) as qualifying dividends eligible for the section 965(a) DRD.
For purposes of this section 3, the term “eligible cash amount” refers to (a) cash

9
received by the U.S. shareholder on any day in the election year from a partnership or
disregarded entity in a form that satisfies the requirements of section 3.02 of Notice
2005-10 and section 9.06 of Notice 2005-38, and (b) cash distributions of PTI to the
U.S. shareholder on any day in the election year from a CFC. A taxpayer that receives
eligible cash amounts from a disregarded entity or partnership that in the aggregate
exceed the total amount of cash dividends paid to (or the amount of cash deemed
received in a deemed liquidation from) such disregarded entity or the taxpayer’s
distributive share of cash dividends paid to such partnership during the election year,
respectively, may specifically identify which eligible cash amounts are treated as
attributable to the underlying cash dividends (and therefore considered to be a cash
dividend described in section 965(a)(1) or (2)). Similarly, a taxpayer that receives
eligible cash amounts of PTI from a CFC in excess of the amount eligible to be treated
as a cash dividend under section 965(a)(2) may specifically identify which cash PTI
distributions from that CFC are treated as attributable to the underlying subpart F
inclusions (and therefore considered to be a cash dividend described in section
965(a)(2)).
Taxpayers make this identification by including the cash dividends and identifying
information on Part V of Form 8895.
4
Taxpayers may identify all or a portion of any
specific eligible cash amount received by the U.S. shareholder from a disregarded
entity, partnership or CFC in the election year as the cash dividend. To the extent a

10
taxpayer fails to identify specific eligible cash amounts in an amount equal to the full
amount of the taxpayer’s share of cash dividends received by the disregarded entity,
partnership or CFC, a pro rata portion of each eligible cash amount received but not
otherwise identified by the taxpayer as a cash dividend will be treated as a cash
dividend. The pro rata portion is the amount which bears the same ratio to the eligible
cash amount as the unidentified portion of the taxpayer’s share of the cash dividends
paid to the disregarded entity, partnership or CFC bears to the total amount of eligible
cash amounts received during the election year but not otherwise identified as cash
dividends.
If a U.S. shareholder receives eligible cash amounts from a disregarded entity
owned by the U.S. shareholder in an amount less than or equal to the total amount of
cash dividends paid to the disregarded entity during the election year, then 100 percent
of each eligible cash amount received from such disregarded entity is a cash dividend
described in section 965(a). Similarly, if a U.S. shareholder receives eligible cash
amounts from a partnership in an amount less than or equal to the total amount of the
U.S. shareholder’s distributive share of cash dividends paid to the partnership during
the election year, then 100 percent of each eligible cash amount received from such
partnership is a cash dividend described in section 965(a). Finally, if a U.S. shareholder
(or a disregarded entity or partnership owned by the U.S. shareholder) receives cash
distributions of PTI from a CFC in an amount less than or equal to the amount of

4
Any taxpayer that had filed its return for the election year before Form 8895 was made available to the
public in final form need not file Form 8895 to identify the cash dividends, but should retain the information

11
earnings and profits included in income by the U.S. shareholder under section
951(a)(1)(A) as a result of one or more cash dividends paid to the distributing CFC or
another CFC in the same chain of ownership described in section 958(a), then 100
percent of each cash distribution of PTI from that CFC is a cash dividend described in
section 965(a)(2).
The taxpayer may choose to associate each cash dividend received from a
disregarded entity or partnership with one or more of the cash dividends paid to that
disregarded entity or partnership during the election year. Similarly, the taxpayer may
choose to associate each cash dividend described in section 965(a)(2) that is received
from a CFC with the earnings and profits attributable to the taxpayer’s subpart F
inclusion from one or more of the CFCs in the ownership chain. Taxpayers make this
identification by including the identifying information required by Part V of Form 8895
and consistently calculating the tax consequences under section 965 and this notice for
those cash dividends that are qualifying dividends, determined as provided in section
3.02 of this notice.
5

.02 Identification of Qualifying Dividends and Separate Categories
In addition to other limitations, the amount of cash dividends eligible for the DRD
is limited to the excess of the cash dividends received by the taxpayer from its CFCs
during the election year over the taxpayer’s base period amount. See section 965(b)(2)
and sections 2 and 3 of Notice 2005-38. A taxpayer may specifically identify which cash

requested on the Form to be made available to the IRS on request.
5
See footnote 4.

12
dividends are treated as qualifying dividends carrying the DRD and which cash
dividends are treated as meeting the base-period repatriation level or are otherwise
ineligible for the DRD. H.R. Conf. Rep. No. 108-755, at 316. Taxpayers identify the
qualifying dividends by completing Form 8895, Part V, column (e).
6

A taxpayer generally must identify each cash dividend received during the
election year as either a qualifying dividend or a non-qualifying dividend in its entirety,
but may identify a portion of one dividend as a qualifying dividend to the extent
necessary to prevent the total amount identified in Part V, column (e) of Form 8895 from
exceeding the total amount of qualifying dividends. To the extent a taxpayer fails to
identify specific cash dividends equal to the full amount of qualifying dividends, a pro
rata portion of each cash dividend received by the taxpayer during the election year that
is not otherwise identified by the taxpayer as a qualifying dividend will be treated as a
qualifying dividend. The pro rata portion is the amount which bears the same ratio to
the amount of the dividend as the total amount of qualifying dividends not otherwise
identified bears to the total amount of cash dividends received during the election year
described in section 965(b)(2)(A) that are not otherwise identified as qualifying
dividends. See Example 3
of section 3.05 of this notice.
Qualifying dividends described in section 965(a)(1) will be considered paid pro
rata out of the non-previously-taxed earnings and profits in the CFC’s separate

6
Section 7.06 of Notice 2005-38 provides that an increase in a CFC’s related party indebtedness is
allocated among U.S. shareholders that are related persons with respect to the CFC in the order that cash
dividends are received. The provision of Notice 2005-38 allocates among the U.S. shareholders the
reduction in the amount of cash dividends eligible for the section 965(a) DRD, but does not preclude a
U.S. shareholder from identifying any specific cash dividend as a qualifying dividend.

13
categories from which the dividend was paid, in accordance with the look-through rules
of section 904(d)(3)(D). Subpart F inclusions attributable to dividends paid to a CFC
from another CFC in the same chain of ownership (including CFCs engaged in section
304 transactions described in section 9.04 of Notice 2005-38) are treated as income in
the same separate categories to which the dividend is assigned, under the look-through
rules of section 904(d)(3)(B) and (D). See Treas. Reg. §1.904-5. Cash dividends
described in section 965(a)(2), whether or not identified by the U.S. shareholder as
qualifying dividends, will be considered paid first out of the previously-taxed earnings
and profits described in section 959(c)(2) that are attributable to the amount included in
the United States shareholder’s income under section 951(a)(1)(A) in the election year
as a result of the CFC-to-CFC cash dividend described in section 965(a)(2), to the
extent thereof.
.03 Allocation of Dividends Received Deduction
The DRD allowed under section 965(a) is definitely related to and allocated to
reduce gross income in the U.S. shareholder’s separate categories to which the
qualifying dividends described in section 965(a)(1) and the subpart F inclusions
underlying qualifying dividends described in section 965(a)(2) are assigned. See Treas.
Reg. §1.861-8(a)(2) and (b)(2).
.04 Foreign Currency Exchange Rate Conventions
(a) Cash dividends described in section 965(a)(1)
. Cash dividends described in
section 965(a)(1) that are paid directly to the U.S. shareholder are translated into U.S.

14
dollars at the spot rate on the date of distribution as provided in section 989(b)(1).
7
A
cash dividend paid by a CFC to a pass-through entity that is owned by a U.S.
shareholder is treated as received by such U.S. shareholder for purposes of section
965(a) only if and to the extent that such shareholder receives cash in the amount of the
CFC dividend during the election year. See Notice 2005-10, section 3.02, Notice 2005-
38, section 9.06, and section 10.09 of this notice. Such cash dividends are translated
from the functional currency of the payor CFC into U.S. dollars at the spot rate on the
date the amount of the cash dividend is received by the U.S. shareholder, rather than at
the spot rate on the date the dividend is received by the partnership or disregarded
entity. Accordingly, the receipt of cash itself will not result in currency gain or loss to the
U.S. shareholder.
(b) Cash dividends described in section 965(a)(2)
. Cash dividends described in
section 965(a)(2) are distributions of PTI to the U.S. shareholder in an amount that does
not exceed the subpart F inclusions in the election year that result from cash dividends
that are paid by lower-tier CFCs and that are distributed as PTI through a chain of CFCs
and received by the U.S. shareholder during the election year. The subpart F inclusions
that result in cash dividends will be translated from the functional currency of the CFC
receiving the dividend into U.S. dollars at the spot rate on the date the PTI is distributed
to the U.S. shareholder, rather than at the average rate generally used to translate
subpart F inclusions under section 989(b)(3), and the PTI distribution will not result in

7
In the case of cash received as part of a deemed liquidation resulting from an election under Treas.
Reg. §301.7701-3(c), the date of distribution is the date the cash is received, not the date of the deemed

15
currency gain or loss under section 986(c).
.05 Examples

The following examples illustrate the application of section 965(d)(3) and this
section 3. Unless otherwise indicated, the following facts are assumed for purposes of
these examples. All corporations use calendar taxable years for U.S. tax purposes.
USP is a domestic corporation that elects to apply section 965 to its 2005 taxable year
and meets all applicable requirements to claim the section 965(a) DRD with respect to
the qualifying dividends described in the examples.
Example 1
. Identification of cash dividends where PTI distributions exceed
subpart F inclusions attributable to cash dividends. (i) Facts. USP owns all the stock
of CFC1, which owns all the stock of CFC2. CFC1 and CFC2 are organized under the
laws of different foreign countries and each uses the “u” as its functional currency. On
September 1, 2005, CFC2 pays a cash dividend of 200u to CFC1 that is subpart F
income of CFC1 under sections 952(a) and 954(c)(1)(A), resulting in a 200u income
inclusion to USP under section 951(a)(1)(A). On each of March 1, 2005, when the spot
exchange rate is 1u = $1, and November 1, 2005, when the spot exchange rate is 1u =
$1.25, CFC1 distributes 200u to USP. Each of the 200u distributions is a distribution of
previously-taxed earnings and profits of CFC1 that is excluded from USP’s gross
income under section 959(a).

(ii) Result
. USP received cash distributions of PTI from CFC1 in the election
year in an amount (400u) that exceeds the amount included in income by USP under
section 951(a)(1)(A) as a result of cash dividends during the election year to CFC1 from
CFC2, another CFC in a chain of ownership described in section 958(a) (200u).
Pursuant to section 3.01 of this notice, USP may identify either the March 1, 2005 PTI
distribution of 200u = $200 or the November 1, 2005 PTI distribution of 200u = $250 as
the cash dividend described in section 965(a)(2) of previously-taxed earnings
attributable to the subpart F inclusion resulting from the cash dividend paid by CFC2 to
CFC1. Pursuant to section 3.04 of this notice, USP’s subpart F inclusion of 200u is
translated into U.S. dollars at the spot exchange rate on the date of the associated PTI
distribution, and that PTI distribution does not result in currency gain or loss under
section 986(c). The other PTI distribution may result in currency gain or loss under
section 986(c).

liquidation.

16

Example 2
. Identification of amounts underlying cash dividends where multiple
subpart F inclusions exceed PTI distributions. (i) Facts. USP owns all the stock of
CFC1, which owns all the stock of CFC2 and CFC3. CFC2 owns all the stock of CFC4.
The four CFCs are each organized under the laws of a different foreign country and
each uses the U.S. dollar as its functional currency. In 2005, CFC3 pays a $100 cash
dividend to CFC1 that, after taking into account $10 of allocable foreign taxes and $5 of
other expenses, is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A)
that results in an $85 income inclusion to USP with respect to CFC1 under section
951(a)(1)(A). Also in 2005, CFC4 pays a $100 cash dividend to CFC2 that, after taking
into account $30 of allocable taxes and $10 of other expenses, is subpart F income of
CFC2 under sections 952(a) and 954(c)(1)(A) that results in a $60 income inclusion to
USP under section 951(a)(1)(A). CFC2 distributes $60 of cash to CFC1 and CFC1
distributes $60 of cash to USP in 2005.

(ii) Result
. USP received cash distributions of PTI from CFC1 in the election
year in an amount ($60) that is less than $145, the total of amounts included in income
by USP under section 951(a)(1)(A) as a result of cash dividends during the election year
from CFC3 to CFC1 ($85), and cash dividends during the election year from CFC4 to
CFC2 that were distributed in cash to CFC1 ($60). Accordingly, pursuant to section
3.01 of this notice, the entire $60 cash PTI distribution is a cash dividend described in
section 965(a)(2). Furthermore, also pursuant to section 3.01 of this notice, USP may
associate the $60 cash dividend with either the $60 cash PTI distribution to CFC1 that is
attributable to the subpart F inclusion from CFC2 or a ratable portion of the $85 subpart
F inclusion from CFC1.

Example 3
. Identification of qualifying dividends. (i) Facts. USP owns all the
stock of CFC1 and CFC2, and CFC1 owns all the stock of CFC3. CFC1, CFC2, and
CFC3 are organized under the laws of different foreign countries, and each uses the “u”
as its functional currency. In 2005, CFC3 pays an 80u cash dividend to CFC1. The
dividend is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A), resulting
in an income inclusion to USP under section 951(a)(1)(A). Also in 2005, CFC1
distributes to USP 160u with a value of $200 at the 0.8u = $1 spot exchange rate on the
date of distribution, all of which constitutes previously-taxed earnings of CFC1 described
in section 959(c)(2). In addition, USP receives a 100u cash dividend, equal to $100 at
the spot rate on the date of distribution, from each of CFC1 and CFC2 in 2005. USP’s
base period amount described in section 965(b)(2)(B) is $100, and, taking into account
the other limitations under section 965(b), USP’s total amount of qualifying dividends is
$150.

(ii) Result
. Under section 3.04 of this notice, USP’s subpart F inclusion
attributable to the 80u cash dividend paid by CFC3 to CFC1 is translated into dollars at
the spot rate on the date an equivalent amount of cash is distributed to USP, rather than

17
at the average exchange rate for the year. Accordingly, USP includes $100 in income
under section 951(a)(1)(A), and 80u of the PTI distribution, which has a value of $100
on the date of distribution, is excluded from USP’s gross income under section 959(a)
and results in no currency gain or loss under section 986(c). The remaining 80u of the
160u PTI distribution, which also has a value of $100 on the date of distribution, is
excluded from USP’s gross income under section 959(a) and may result in currency
gain or loss under section 986(c).

USP received three $100 cash dividends described in section 965(b)(2)(A) during
2005, of which $150 is eligible to be taken into account under section 965(a): the $100
dividend from CFC2, the $100 dividend from CFC1, and $100 of the $200 PTI
distribution received from CFC1. The remaining $100 of the PTI distribution received
from CFC1 is not a cash dividend described in section 965(a)(2) because it exceeds the
amount included in income by USP under section 951(a)(1)(A) as a result of the cash
dividend paid by CFC3 to CFC1. Pursuant to section 3.02 of this notice, USP may
identify any one of the three distributions in its entirety, and one-half of either of the
remaining two distributions, as qualifying dividends on Form 8895. If USP does not
identify specific distributions as the qualifying dividends, $50 ($150 total qualifying
dividends not otherwise identified divided by $300 total cash dividends received during
the election year, multiplied by $100 cash dividend) of each of the three $100 cash
dividends will be treated as a qualifying dividend.

Example 4
. Cash dividend equivalent to cash received in actual inbound
liquidation. (i) Facts. USP owns all the stock of CFC1, which owns all the stock of
CFC2. CFC1 and CFC2 are organized in Country X and each uses the ”u” as its
functional currency. On June 30, 2005, in an inbound liquidation of CFC1 described in
sections 332 and 367(b), CFC1 legally dissolves and, in connection with such
dissolution, USP acquires all the assets of CFC1, consisting of 100u of cash in a
Country X bank account and certain other noncash assets (including all of the stock of
CFC2). In connection with the liquidation USP includes in income as a dividend an all
earnings and profits amount of 300u equal to $600 on June 30, 2005, when the spot
exchange rate is 1u = $2. After the liquidation USP continues to operate the business
of CFC1 in Country X with the Country X bank account.

(ii) Result
. Pursuant to section 3.02 of this notice, USP may identify as a
qualifying dividend described in section 965(a)(1) the 100u of cash received by USP in
the liquidation of CFC1 that is taxed as a dividend under section 367(b). Pursuant to
section 3.04 of this notice, the amount of the cash dividend from CFC1 is $200 (100u of
cash received by USP in the liquidation of CFC1, translated at the spot rate of 1u = $2
on the date of the liquidating dividend).

Example 5
. Cash dividends less than cash received in check-the-box liquidation
plus cash dividend received by disregarded entity. (i) Facts. The facts are the same as

18
in Example 4, except that, instead of actually liquidating CFC1, USP elects to treat
CFC1 as a disregarded entity by filing an entity classification election under Treas. Reg.
§301.7701-3, effective July 1, 2005, CFC2 pays a dividend of 100u to the disregarded
entity CFC1 on September 1, 2005, when the spot exchange rate is 1u = $1.50, and the
disregarded entity CFC1 distributes 100u of cash to USP on October 1, 2005, when the
spot exchange rate is 1u = $1.75.

(ii) Result
. USP’s check-the-box election with respect to CFC1 does not give
rise to an eligible dividend under section 965(c)(3) because the resulting deemed
liquidation in and of itself does not result in an actual receipt by USP of the 100u of cash
owned by CFC1. In addition, the cash dividend paid from CFC2 to CFC1, at that time a
disregarded entity, is treated as a cash dividend received by USP in the election year
only to the extent USP receives cash from the disregarded entity during the election
year. See Notice 2005-10, section 3.02. Because the disregarded entity CFC1
distributed 100u of cash to USP in the year of the liquidation, the 100u cash distribution
is a cash dividend within the meaning of section 965(c)(3). Pursuant to section 3.01 of
this notice, USP may identify the October 1, 2005 100u cash dividend as attributable to
either the deemed dividend resulting from the check-the-box election or the cash
dividend paid by CFC2. If USP treats the cash dividend as attributable to cash actually
received by USP in connection with the deemed liquidation, the deemed dividend
constitutes a dividend described in section 965(c)(3) to the extent of 100u.
Alternatively, USP may treat the 100u cash dividend as attributable to the cash dividend
paid from CFC2 to CFC1, a disregarded entity, which is eligible to be treated as a cash
dividend because USP received 100u of cash from CFC1 during the election year.

If USP chooses to treat the dividend from CFC2 as the cash dividend underlying
the 100u cash dividend on October 1, 2005, then pursuant to section 3.04 of this notice
the dollar amount of the 100u dividend from CFC2 is $175, the spot value of 100u on
October 1, 2005, the date CFC1 distributes an amount of cash equal to the CFC2
dividend to USP, and CFC1’s distribution of 100u to USP does not give rise to currency
gain or loss. As in Example 4
, the entire 300u all earnings and profits amount is $600,
translated into dollars at the 1u = $2 exchange rate, the spot rate on the date of the
deemed dividend.

If, instead, USP chooses to treat the 100u cash dividend as cash received in
connection with the deemed liquidation, pursuant to section 3.04 of this notice the dollar
amount of 100u of the 300u deemed dividend from CFC1 is $175, the spot value of
100u on October 1, 2005, the date USP receives that amount of cash in connection with
the deemed liquidation. The dollar amount of the 200u remainder of the deemed
dividend is $400, translated into dollars at the 1u = $2 exchange rate, the spot rate on
the date of the deemed dividend. The dollar amount of the 100u dividend from CFC2 is
$150, the spot value of 100u on September 1, 2005, the date CFC2 paid the dividend to
the disregarded entity CFC1.

19

Example 6
. CFC-to-CFC dividend and equivalent PTI distribution. (i) Facts.
USP owns all the stock of CFC1, which owns all the stock of CFC2. CFC1 is organized
in Country X and uses the “u” as its functional currency. CFC2 is organized in Country
Y and uses the euro as its functional currency. On June 30, 2005, when the spot
exchange rate is 1u = €2, CFC2 pays a cash dividend of €200 to CFC1. CFC1 has no
other items of income or expense in 2005. The dividend from CFC2 is subpart F
income of CFC1 under sections 952(a)(2) and 954(c)(1)(A) that is included in income by
USP under section 951(a)(1)(A)(i). On September 1, 2005, when the spot exchange
rate is 1u = $1, CFC1 distributes 100u in cash to USP. The 100u cash distribution is
PTI of CFC1 that is excluded from USP’s income under section 959(a). The average
exchange rate determined under section 989(b)(3) for 2005 is 1u = $.90.

(ii) Result
. Pursuant to section 989(b)(1), the ”u” amount of CFC1’s subpart F
income attributable to the €200 dividend from CFC2 is 100u, the spot value of €200 on
the date CFC1 includes the CFC2 dividend in income. The 100u cash distribution from
CFC1 to USP is a cash dividend described in section 965(a)(2) because it is PTI in an
amount not in excess of the 100u subpart F income of CFC1 that results from a cash
dividend paid during the election year by CFC2, another CFC in the chain of ownership
described in section 958(a). Regardless of whether USP identifies the PTI distribution
from CFC1 as a qualifying dividend, pursuant to section 3.04 of this notice the dollar
amount of USP’s subpart F inclusion with respect to CFC1 under section 951(a)(1)(A)
attributable to the CFC2 dividend is $100, the spot rate on the date CFC1 distributes an
amount of cash equal to the CFC2 dividend to USP. The PTI distribution does not
result in currency gain or loss under section 986(c).

Example 7
. CFC-to-CFC dividend and smaller PTI distribution. (i) Facts. The
facts are the same as in Example 6, except that CFC2’s dividend to CFC1 is €400
rather than €200.

(ii) Result
. The €400 dividend, translated at the spot rate on the date of
distribution from CFC2 to CFC1, results in 200u of subpart F income of CFC1 that is
included in USP’s income in the election year. The result with respect to the 100u of the
subpart F inclusion and resulting PTI that CFC1 distributes to USP in the election year
are the same as in Example 6
. USP’s subpart F inclusion with respect to the remaining
100u of CFC1’s subpart F income that is not distributed is $90 (100u translated at the
average exchange rate of 1u = $.90). CFC1’s distribution of the remaining 100u of PTI
to USP after the election year is not subject to the rules of this notice and may give rise
to currency gain or loss under section 986(c).

SECTION 4. DISALLOWANCE OF CREDIT OR DEDUCTION FOR FOREIGN TAXES

20
ON DEDUCTIBLE PORTION OF QUALIFYING DIVIDENDS
.01 Identification of Foreign Income Taxes Paid or Accrued with Respect to the
Deductible Portion of Qualifying Dividends
Under section 965(d)(1), no credit or deduction is allowed for foreign taxes
described in section 901 that are paid or accrued (or treated as paid or accrued) with
respect to the deductible portion of each qualifying dividend, including distributions of
PTI that are treated as cash dividends under section 965(a)(2). This disallowance
applies to 85 percent of the U.S. dollar amount of (1) foreign taxes paid or accrued by
the U.S. shareholder with respect to the qualifying dividend (including the U.S.
shareholder’s distributive share of foreign taxes that are paid or accrued by a
partnership with respect to the dividend and that are properly allocated to the U.S.
shareholder-partner under the rules of sections 702 and 704 and the regulations
thereunder and separately stated to the partner under Treas. Reg. §1.702-1(a)(6)); (2)
foreign taxes deemed paid under section 902 with respect to a qualifying dividend
described in section 965(a)(1); and (3) foreign taxes deemed paid under section 960,
including taxes described in section 960(a)(3), with respect to a subpart F inclusion
resulting from a CFC-to-CFC dividend and the associated PTI distribution described in
section 965(a)(2).
Section 965 does not modify the computation of foreign taxes deemed paid
under sections 902 and 960. As a result, for purposes of section 902 the post-1986
undistributed earnings, post-1986 foreign income taxes, pre-1987 accumulated profits,
pre-1987 foreign income taxes, and previously-taxed earnings and profits and tax

21
accounts of CFCs paying qualifying dividends are reduced by the full amount of
earnings distributed and the full amount of foreign taxes attributable to the distributed
earnings, without regard to the amount of the DRD or the amount of foreign tax for
which section 965(d)(1) disallows a credit or deduction.
.02 Section 78 Gross-Up
Under section 78, an amount equal to the taxes deemed paid under section
902(a) or section 960(a)(1) by a domestic corporation generally is included in income as
a dividend if the domestic corporation chooses the benefits of the foreign tax credit for
the taxable year. Section 78 does not apply to any tax which is not allowable as a credit
under section 901 by reason of section 965(d). See also section 9.01 of Notice 2005-
38.
.03 Examples
The following examples illustrate the application of section 965(d)(1) and this
section 4. Unless otherwise indicated, the following facts are assumed for purposes of
these examples. All corporations use calendar taxable years for U.S. tax purposes.
USP is a domestic corporation that elects to apply section 965 to its 2005 taxable year
and meets all applicable requirements to claim the section 965(a) DRD with respect to
the qualifying dividends described in the examples. All the earnings and profits and
creditable foreign taxes of each CFC constitute general limitation post-1986
undistributed earnings and general limitation post-1986 foreign income taxes, and no
exceptions apply to prevent USP from including in income its pro rata share of any
CFC’s subpart F income in the election year. Except as specifically provided, a CFC

22
has no other items of gross income or expense for the election year, has no previously-
taxed earnings and profits described in section 959(c)(1) or (2), and makes no
distributions in the election year.
Example 1. Qualifying dividend under section 965(a)(1) from first-tier CFC. (i)
Facts. USP owns all the stock of CFC1, a foreign corporation that uses the ”u” as its
functional currency. On June 30, 2005, CFC1 pays a cash dividend of 80u, equal to
$100 translated at the spot rate on that date of 0.8u = $1, out of its post-1986
undistributed earnings to USP. The dividend is subject to a 10 percent withholding tax
of 8u = $10, so USP receives cash of $90. USP has a base period amount of $0 and its
total amount of qualifying dividends is $100. As of the close of 2005, computed without
regard to the June 30 distribution to USP, CFC1 has post-1986 undistributed earnings
of 800u and post-1986 foreign income taxes of $200.

(ii) Result
. Under section 902(a), $20 ((80u/800u) x $200) of foreign income
taxes are deemed paid by USP with respect to the $100 dividend from CFC1. Subject
to other applicable limitations, USP may claim a foreign tax credit or deduction for $1.50
(15 percent of the $10 withholding tax), and may also claim a credit for $3 (15 percent of
the $20 of deemed-paid taxes). Under section 965(d)(1), no credit or deduction is
allowed for the remaining $8.50 of withholding tax or $17 of deemed-paid tax, which
represent the taxes paid or deemed paid with respect to the 85 percent deductible
portion of the $100 dividend. USP includes $100 in gross income and claims an $85
DRD under section 965(a) with respect to the qualifying dividend of $100 described in
section 965(a)(1). If USP elects to credit foreign taxes in 2005, USP also includes $3 in
income under section 78. No gross-up is required under section 78 for the $17 of
deemed-paid tax which is not allowed as a credit. CFC1’s post-1986 undistributed
earnings and post-1986 foreign income taxes are reduced by the full amount of
earnings distributed and foreign taxes deemed paid in 2005, without regard to the
amount of the DRD under section 965(a) or the disallowance under section 965(d)(1) of
a credit for taxes deemed paid with respect to the deductible portion of the qualifying
dividend. Accordingly, CFC1’s post-1986 undistributed earnings and post-1986 foreign
income taxes, computed as of January 1, 2006, are 720u (800u - 80u) and $180 ($200 -
$20), respectively.

Example 2
. Qualifying dividend under section 965(a)(1) from first-tier CFC to
disregarded entity. (i) Facts. USP is the sole owner of DE, a disregarded entity
organized in Country X. DE owns all the stock of CFC1, which is incorporated in
Country Y. Each of DE and CFC1 uses the U.S. dollar as its functional currency. On
June 30, 2005, CFC1 pays a cash dividend of $135 to DE, with respect to which USP is
deemed under section 902(a) to pay $20 of foreign income tax paid by CFC1. DE pays
Country Y withholding tax of $20 and Country X net income tax of $15 with respect to

23
the dividend from CFC1. Also on June 30, 2005, DE distributes $135 to USP. The
distribution from DE is not subject to Country X withholding tax. USP has a base period
amount of $0 and qualifying dividends of $135.

(ii) Result
. USP is entitled to a DRD of $114.75 (.85 x $135) under section
965(a) with respect to the $135 dividend paid by CFC1 to DE and distributed in cash to
USP in 2005. Subject to other applicable limitations, USP may claim a foreign tax credit
or deduction for $5.25 (15 percent of the $35 of foreign tax paid by DE), and may also
claim a credit for $3 (15 percent of the $20 of foreign taxes paid by CFC1 that are
deemed paid by USP with respect to the dividend paid by CFC1). If USP elects to
credit foreign taxes in 2005, USP includes $3 in income under section 78. No gross-up
is required under section 78 for the $17 of deemed-paid tax which is not allowed as a
credit. Under section 965(d)(1), no credit or deduction is allowed for the remaining
$29.75 of tax paid under section 901 or $17 of tax deemed paid under section 902,
which represent the taxes paid or deemed paid with respect to the 85 percent
deductible portion of the $135 qualifying dividend. CFC1’s post-1986 undistributed
earnings and post-1986 foreign income taxes, computed as of January 1, 2006, are
reduced by $135 and $20, respectively.

Example 3
. Qualifying dividend under section 965(a)(2) attributable to dividend
from second-tier CFC, subpart F inclusion, and PTI distribution from first-tier CFC to
USP. (i) Facts. USP owns all the stock of CFC1, which owns all the stock of CFC2.
CFC1 is incorporated in Country X, and CFC2 is incorporated in Country Y. Each of
CFC1 and CFC2 uses the U.S. dollar as its functional currency. On June 30, 2005,
CFC2 pays a cash dividend of $135 to CFC1. CFC1 pays Country Y withholding tax of
$20 and Country X net income tax of $15 with respect to the dividend from CFC2.
CFC1 has no other items of income or expense in 2005, so its subpart F income and
earnings and profits for 2005 are $100, all attributable to the dividend from CFC2, and
USP includes $100 in income under section 951(a)(1)(A) with respect to CFC1 for 2005.
Also on June 30, 2005, CFC1 distributes $100 of cash to USP. The PTI distribution is
subject to Country X withholding tax of $10. As of the close of 2005, including taxes
paid and deemed paid under section 902(b) by CFC1 with respect to the distribution
from CFC2 but before accounting for the effect of the subpart F inclusion or distribution
to USP, CFC1 has post-1986 undistributed earnings of $1,000 and post-1986 foreign
income taxes of $200. USP has a base period amount of $0 and qualifying dividends of
$100.

(ii) Result
. Under sections 960(a)(1) and 902(a), $20 (($100/$1,000) x $200) of
foreign income taxes are deemed paid by USP with respect to the $100 subpart F
inclusion attributable to CFC1. Under section 965(a)(2), the cash distribution of PTI
from CFC1 is a qualifying dividend to the extent of $100, the amount USP included in
income under section 951(a)(1)(A) in 2005 as a result of the cash dividend paid from
CFC2 to CFC1 in 2005. USP is entitled to a DRD of $85 under section 965(a) with

24
respect to the $100 subpart F inclusion and associated PTI distribution. Subject to
other applicable limitations, USP may claim a foreign tax credit or deduction for 15
percent of the $10 withholding tax, or $1.50, and may claim a credit for 15 percent of the
$20 of deemed-paid taxes, or $3. If USP elects to credit foreign taxes in 2005, USP
includes $3 in income under section 78. No gross-up is required under section 78 for
the $17 of deemed-paid tax which is not allowed as a credit. Under section 965(d)(1),
no credit or deduction is allowed for the remaining $8.50 of withholding tax or $17 of
deemed-paid tax, which represent the taxes paid or deemed paid with respect to the 85
percent deductible portion of the $100 qualifying dividend. CFC1’s post-1986
undistributed earnings and post-1986 foreign income taxes, computed as of January 1,
2006, are $900 ($1,000 - $100) and $180 ($200 - $20), respectively.

Example 4
. Qualifying dividend under section 965(a)(2) attributable to multiple
dividends from second-tier CFCs, subpart F inclusion, and distribution from first-tier
CFC to USP
. (i) Facts. USP owns all the stock of CFC1, which owns all the stock of
CFC2 and CFC3. CFC1, CFC2, and CFC3 are organized under the laws of different
foreign countries, and each uses the ”u” as its functional currency. In 2005, CFC2 and
CFC3 each pays an 80u cash dividend to CFC1 that is subpart F income of CFC1 under
sections 952(a) and 954(c)(1)(A) that results in an income inclusion to USP under
section 951(a)(1)(A). Under section 902(b)(1), CFC1 is deemed to pay foreign taxes of
$8 with respect to the 80u dividend from CFC2, and CFC1 is deemed to pay foreign
taxes of $40 with respect to the 80u dividend from CFC3.

Also in 2005, CFC1 makes two distributions of 80u, totaling 160u, to USP, all of
which constitutes previously-taxed earnings and profits of CFC1 described in section
959(c)(2). The first 80u distribution has a value of $100 at the 0.8u = $1 spot exchange
rate on the date of distribution, and the second 80u distribution has a value of $80 at the
1u = $1 spot exchange rate on the date of distribution. Under section 3.04 of this
notice, USP’s subpart F inclusion attributable to CFC1’s 160u of foreign personal
holding company income attributable to cash dividends paid by CFC2 and CFC3 is
translated into dollars at the spot rate on the dates an equivalent amount of cash is
distributed to USP, rather than at the average exchange rate for the year. Accordingly,
USP includes $180 ($100 + $80) in income under section 951(a)(1)(A), and neither of
the 80u PTI distributions results in exchange gain or loss under section 986(c). USP’s
total cash dividends are $180. USP has a base period amount of $80 and qualifying
dividends of $100.

As of the close of 2005, taking into account the dividends received from CFC2
and CFC3 and the associated deemed-paid taxes but before giving effect to the subpart
F inclusion to USP, CFC1 has post-1986 undistributed earnings of 1,600u and post-
1986 foreign income taxes of $400.

(ii) Result
. Under sections 960(a)(1) and 902(a), $40 ((160u/1,600u) x $400) of

25
foreign income taxes are deemed paid by USP with respect to the 160u subpart F
inclusion attributable to CFC1. Of this amount, $20 is attributable to the first cash
dividend of 80u = $100, and $20 is attributable to the second cash dividend of 80u =
$80. If USP identifies the first distribution in its entirety as the qualifying dividend, USP
is entitled to a DRD of $85 under section 965(a) with respect to the $100 subpart F
inclusion and associated PTI distribution. Subject to other applicable limitations, USP
may claim a foreign tax credit for $23, equal to the sum of $3 (.15 x $20) of deemed-
paid taxes attributable to the qualifying dividend and $20 of deemed-paid taxes
attributable to the remaining $80 of the subpart F inclusion. If USP elects to credit
foreign taxes in 2005, USP includes $23 in income under section 78. Under section
965(d)(1), no credit is allowed for the remaining $17 of deemed-paid taxes, which are
attributable to the 85 percent deductible portion of the $100 qualifying dividend. No
gross-up is required under section 78 for the $17 of deemed-paid tax which is not
allowed as a credit.

If, instead, USP identifies $20 of the $100 first cash dividend and the entire $80
of the second cash dividend as the qualifying dividends, USP is entitled to a DRD of $17
(.85 x $20) with respect to the first qualifying dividend and $68 (.85 x $80) with respect
to the second qualifying dividend, for a total DRD of $85. Subject to other applicable
limitations, USP may claim a foreign tax credit for $19.60, equal to the sum of $0.60 (.15
x ($20/$100) x $20) of deemed-paid taxes attributable to the $20 qualifying dividend,
$16 (($80/$100) x $20) of deemed-paid taxes attributable to the remaining $80 of the
subpart F inclusion associated with the first cash dividend, and $3 (.15 x $20) of
deemed-paid taxes attributable to the $80 qualifying dividend. If USP elects to credit
foreign taxes in 2005, USP includes $19.60 in income under section 78. Under section
965(d)(1), no credit is allowed for the remaining $20.40 ($3.40 + $17) of deemed-paid
taxes, which are attributable to the 85 percent deductible portion of the $20 and $80
qualifying dividends. No gross-up is required under section 78 for the $20.40 of
deemed-paid tax which is not allowed as a credit.

Because under sections 960(a)(1) and 902(a) USP’s foreign taxes deemed paid
with respect to the subpart F inclusion underlying the qualifying dividends described in
section 965(a)(2) are computed on the basis of CFC1’s year-end post-1986
undistributed earnings and post-1986 foreign income taxes, a ratable portion of CFC1’s
post-1986 foreign income taxes, and not the specific taxes associated with the
underlying dividends from CFC2 and CFC3, are considered attributable to the qualifying
dividends.

Example 5
. Qualifying dividend under section 965(a)(2) attributable to dividend
from third-tier CFC, subpart F inclusion from second-tier CFC, and distribution through
first-tier CFC to USP. (i) Facts. USP owns all the stock of CFC1, which owns all the
stock of CFC2, which owns all the stock of CFC3. CFC1 is incorporated in Country X,
CFC2 is incorporated in Country Y, and CFC3 is incorporated in Country Z. Each of

26
CFC1, CFC2, and CFC3 uses the U.S. dollar as its functional currency. On June 30,
2005, CFC3 pays a dividend of $150 to CFC2. CFC2 pays Country Z withholding tax of
$20 and Country Y net income tax of $15 with respect to the dividend from CFC3.
CFC2 has no other items of income or expense in 2005, so its subpart F income and
earnings and profits for 2005 are $115, all attributable to the dividend from CFC3, and
USP includes $115 in income under section 951(a)(1)(A) with respect to CFC2 for 2005.
Also on June 30, 2005, CFC2 distributes $115 of cash to CFC1 that is PTI excluded
from CFC1’s gross income under section 959(b). The distribution is subject to $10 of
Country Y withholding tax and $5 of Country X income tax in the hands of CFC1, which
are taxes on PTI excluded from CFC1’s post-1986 foreign income taxes and accounted
for under section 960(a)(3). Later in 2005, CFC1 distributes $100 of PTI to USP. USP
pays $10 of withholding tax to Country X with respect to the $100 PTI distribution,
receiving cash of $90. As of the close of 2005, including taxes paid and deemed paid
under section 902(b) by CFC2 with respect to the distribution from CFC3 but before
accounting for the effect of the subpart F inclusion or distribution to CFC1, CFC2 has
post-1986 undistributed earnings of $1,150 and post-1986 foreign income taxes of
$200. USP has a base period amount of $0.

(ii) Result
. Under sections 960(a)(1) and 902(a), $20 (($115/$1,150) x $200) of
foreign income taxes paid by CFC2 are deemed paid by USP with respect to the $115
subpart F inclusion attributable to CFC2. Under section 960(a)(3), $15 of foreign taxes
($10 of withholding tax and $5 of income tax) paid by CFC1 with respect to the $115
distribution of PTI from CFC2 are deemed paid by USP with respect to the $100 of
remaining PTI distributed from CFC1 to USP. However, under section 965(a)(2), the
$100 PTI distribution from CFC1 is a cash dividend and, therefore, a qualifying dividend
only to the extent of $100, the lesser of the amount USP included in income under
section 951(a)(1)(A) in 2005 as a result of the cash dividend paid from CFC3 to CFC2 in
2005 ($115) or the amount of the PTI distribution from CFC1 to USP ($100). The
amount of foreign taxes deemed paid under section 960(a)(1) with respect to the $100
section 965(a)(2) dividend is $17.39 (($100/$115) x $20), and the amount of foreign
taxes deemed paid under section 960(a)(3) with respect to the $100 PTI distribution is
$15.

USP is entitled to a DRD of $85 under section 965(a) with respect to $100 of the
$115 subpart F inclusion and associated PTI distribution. Subject to other applicable
limitations, USP may claim a foreign tax credit or deduction for $1.50 (15 percent of the
$10 withholding tax imposed on the $100 PTI distribution), and may claim a credit for
$2.61 (15 percent of the $17.39 of taxes deemed paid under section 960(a)(1) with
respect to the $100 qualifying portion of the subpart F inclusion from CFC2), plus $2.25
(15 percent of the $15 of tax deemed paid under section 960(a)(3) with respect to the
$100 PTI distribution). USP may also claim a credit for the $2.61 of foreign tax deemed
paid under section 960(a)(1) with respect to the $15 of USP’s subpart F inclusion that
does not result in a qualifying dividend. If USP elects to credit foreign taxes in 2005,

27
USP includes $5.22 in income under section 78 with respect to the $2.61 of foreign tax
deemed paid under section 902 with respect to the $15 nondeductible CFC dividend
and the $2.61 of foreign tax deemed paid under section 960(a)(1) with respect to the
$15 of USP’s subpart F inclusion that does not result in a qualifying dividend. No gross-
up is required under section 78 with respect to the $2.25 of taxes deemed paid under
section 960(a)(3), equal to 15 percent of the $15 of the taxes paid by CFC1 on the $115
PTI distribution from CFC2, which was included in USP’s income under section
951(a)(1)(A). Under section 965(d)(1), no credit or deduction is allowed for the
remaining $8.50 of withholding tax, $14.78 of tax deemed paid under section 960(a)(1),
or $12.75 of tax deemed paid under section 960(a)(3), which represent the taxes paid or
deemed paid with respect to the 85 percent deductible portion of the $100 qualifying
dividend. No gross-up is required under section 78 for the $14.78 of tax deemed paid
under section 960(a)(1) which is not allowed as a credit or for any portion of the taxes
deemed paid under section 960(a)(3). CFC2’s post-1986 undistributed earnings and
post-1986 foreign income taxes, computed as of January 1, 2006, are $1,035 ($1,150 -
$115) and $180 ($200 - $20), respectively.

Example 6
. Qualifying dividend under section 965(a)(2) attributable to dividend
from third-tier CFC, subpart F inclusion from second-tier CFC, distribution through first-
tier CFC to USP, and additional PTI distribution. (i) Facts. The facts are the same as
Example 5
, except that CFC1 distributes an additional $15 of PTI described in section
959(c)(2) to USP in the election year, subject to Country X withholding tax of $1.50.
The additional $15 of PTI is attributable to subpart F income of CFC1 that was included
in USP’s income in a year prior to the election year.

(ii) Result
. The additional $15 of PTI distributed is a cash dividend that is eligible
to be treated as a qualifying dividend described in section 965(a)(2) because during the
election year USP included $115 in income under section 951(a)(1)(A) attributable to
the cash dividend paid from CFC3 to CFC2, and CFC2 made cash distributions
described in section 959(b) of $115 to CFC1. USP may identify the additional $15 PTI
distribution as a qualifying dividend and claim an 85 percent DRD of $12.75 with respect
to the remaining $15 of the subpart F inclusion resulting from the dividend paid by CFC3
to CFC2. The amount of foreign taxes deemed paid under section 960(a)(1) with
respect to the $115 of section 965(a)(2) dividends is $20 (($115/$115) x $20), and the
amount of foreign taxes deemed paid under section 960(a)(3) with respect to the $115
of PTI distributions is $15 ($15 of foreign taxes paid by CFC1 with respect to the $115
distribution of PTI from CFC2). Subject to other applicable limitations, USP may claim a
foreign tax credit or deduction for $1.73 (15 percent of the $11.50 withholding tax
imposed on the $115 PTI distribution), and may claim a credit for $3 (15 percent of the
$20 of taxes deemed paid under section 960(a)(1) with respect to the $115 subpart F
inclusion from CFC2), plus $2.25 (15 percent of the $15 of tax deemed paid under
section 960(a)(3) with respect to the $115 PTI distribution). If USP elects to credit
foreign taxes in 2005, USP includes $3 in income under section 78. Under section

28
965(d)(1), no credit or deduction is allowed for the remaining $9.77 of withholding tax,
$17 of tax deemed paid under section 960(a)(1), or $12.75 of tax deemed paid under
section 960(a)(3), which represent the taxes paid or deemed paid with respect to the 85
percent deductible portion of the $115 qualifying dividend. No gross-up is required
under section 78 for the $17 of tax deemed paid under section 960(a)(1) which is not
allowed as a credit or for any portion of the taxes deemed paid under section 960(a)(3).
The adjustments to CFC2’s post-1986 undistributed earnings and post-1986 foreign
income taxes are the same as in Example 5
.

SECTION 5. DISALLOWANCE OF DEDUCTIONS FOR CERTAIN EXPENSES
RELATED TO DEDUCTIBLE PORTION OF QUALIFYING DIVIDENDS
.01 Expenses Incurred by Taxpayer
The disallowance of deductions for expenses under section 965(d)(2) applies
only to expenses that are directly allocable to the deductible portion of qualifying
dividends. See section 9.01 of Notice 2005-38. Therefore, section 965(d)(2) disallows
a deduction for 85 percent of directly allocable expenses, which are those expenses
that relate directly to generating qualifying dividends. These expenses are:
(a) Stewardship expenses described in Treas. Reg. §1.861-8(e)(4) that are
definitely related and allocable to qualifying dividends;
(b) Legal, tax, accounting, consulting and similar fees and expenses, including
expenses for employee compensation, for the rendering of advice and the preparation
of documents directly related to (i) plans to repatriate earnings in the election year,
including the determination of the potentially eligible amount of qualifying dividends, the
decision to repatriate earnings from particular CFCs, and the identification of particular
distributions as cash dividends, qualifying dividends, or other amounts, (ii) the adoption

29
and approval of a domestic reinvestment plan, and (iii) the declaration and payment of
qualifying dividends;
(c) Fees and expenses related to tax accounting and reporting for qualifying
dividends in the election year; and
(d) Wire transfer, currency exchange, and similar fees incurred in connection with
the payment of qualifying dividends.
For purposes of this section 5.01, only a pro rata portion of stewardship
expenses accrued in the election year with respect to each CFC in which the taxpayer is
a U.S. shareholder is considered definitely related and allocable to qualifying dividends.
The pro rata portion is the amount that bears the same ratio to the stewardship
expenses as the qualifying dividends paid by a CFC bear to the total amount of
dividends and subpart F inclusions included in the U.S. shareholder’s income with
respect to that CFC and subpart F inclusions attributable to stock of any other CFCs
held indirectly by the U.S. shareholder in the same chain of ownership described in
section 958(a) in the election year. Deductions for other directly allocable expenses
described in the preceding paragraph are subject to disallowance in the year paid or
accrued, whether that year is the election year or a different taxable year.
Deductions for the allowable 15 percent portion of expenses that are directly
allocable to qualifying dividends are allocated and apportioned in accordance with the
generally applicable rules of sections 861 through 865 and the regulations thereunder.
See section 6 of this notice.
The disallowance of deductions under section 965(d)(2) does not extend to

30
expenses that, while treated as definitely related to the production of income in a
category that includes qualifying dividends, do not relate directly to generating qualifying
dividends. Expenses described in the preceding sentence include interest expense,
research and experimental expenses, general and administrative expenses,
depreciation and amortization, sales and marketing expenses, state and local taxes,
and any other expenses not described in the first paragraph of this section 5.01. In
addition, legal, tax, accounting, consulting, and similar fees and expenses related to the
implementation of investments in the United States contemplated by a domestic
reinvestment plan are not considered directly allocable to qualifying dividends.
.02 Expenses Incurred by CFCs
Deductions for expenses properly incurred by CFCs that are otherwise deductible
in computing subpart F income and earnings and profits are not limited by section
965(d)(2).

SECTION 6. ALLOCATION AND APPORTIONMENT OF EXPENSES TO SEPARATE
CATEGORIES WITH QUALIFYING DIVIDENDS
.01 No New Separate Category
Section 965 does not provide for qualifying dividends to be assigned to a special
separate category or otherwise modify the generally applicable look-through rules of
section 904(d)(3) for determining the separate category to which dividends and subpart
F inclusions from CFCs are assigned. For purposes of allocating expenses on the basis
of assets in the election year, stock of CFCs paying qualifying dividends is

31
characterized under the generally applicable rules of Treas. Reg. §1.861-12T(c)(3).
.02 Treatment of CFC Stock and Qualifying Dividends under Section 864(e)
The first sentence of section 864(e)(3) (section 864(e)(3)(A) for transactions
before January 1, 2005) provides that, for purposes of allocating and apportioning any
deductible expense, any tax-exempt asset (and any income from such an asset) shall
not be taken into account. The second sentence of section 864(e)(3) provides that a
similar rule applies in the case of the portion of certain dividends equal to the deduction
allowable under section 243 or 245(a) with respect to such dividend, and in the case of
a like portion of any stock the dividends on which would be so deductible. A qualifying
dividend is not exempt income, and the CFC stock on which qualifying dividends are
paid is not an exempt asset, within the meaning of the first sentence of section
864(e)(3). In addition, the similar rule in the second sentence of section 864(e)(3) does
not apply to qualifying dividends or the CFC stock on which qualifying dividends are
paid, since no deduction is allowed under section 243 or 245 for any dividend for which
a deduction is allowed under section 965. Section 965(c)(4). Accordingly, gross
income attributable to a qualifying dividend is not considered exempt income, and no
portion of the stock of a CFC paying a qualifying dividend is considered an exempt
asset, for purposes of allocating and apportioning interest and other expenses in the
election year.
.03 Expenses Allocated and Apportioned to Separate Categories that Include
Qualifying Dividends
Section 965 does not modify the generally applicable rules of sections 861

32
through 865 and the regulations thereunder for allocating and apportioning expenses
and losses to separate categories described in section 904(d)(1) and Treas. Reg.
§1.904-5(m) (separate categories) that include nondeductible CFC dividends. However,
the amount of nondeductible CFC dividends in a separate category must be determined
for purposes of applying the limitations on the allowable foreign tax credit

for the
election year under section 904 and section 965(e)(1) and related computations under
sections 53 and 55. See sections 7, 8, and 9 of this notice. For this purpose, expenses
that are allocated and apportioned to a separate category that includes qualifying
dividends will be considered to reduce other foreign source gross income in the
separate category before reducing foreign source income attributable to nondeductible
CFC dividends. Except as provided in section 7.01 of this notice (relating to the taxable
income limitation of section 965(e)(2)(A)), if expenses and other deductions properly
allocated and apportioned to foreign source gross income in a separate category
exceed the amount of foreign source gross income exclusive of nondeductible CFC
dividends in that separate category, such excess will reduce foreign source income
attributable to nondeductible CFC dividends in the separate category to the extent
thereof, and any excess deductions will constitute a separate limitation loss described in
section 904(f)(5). See section 8 of this notice for rules relating to the allocation and
recapture of separate limitation losses in the election year and subsequent years.
The amount of qualifying dividends eligible for the DRD, the amount of
nondeductible CFC dividends described in section 965(e)(3), and the amount of taxable
income for the election year are determined without regard to the manner in which

33
deductible expenses are allocated and apportioned in the election year. Therefore, the
amount of the section 965(a) DRD, the amount of foreign taxes and expenses for which
credit or deduction is disallowed under section 965(d), the amount of taxable income
determined under section 965(e)(2)(A), and the allowable NOL deduction determined
under section 965(e)(2)(B) are not affected if nondeductible CFC dividends in a
separate category are reduced or eliminated by reason of the allocation and
apportionment of expenses pursuant to sections 861 through 865 and the regulations
thereunder and this section 6.
.04 Examples
The following examples illustrate the application of this section 6. Expenses
described in the examples do not include any expenses for which a deduction is
disallowed under section 965(d)(2) or any other applicable Code provision.
Example 1
. Separate limitation income exceeds nondeductible CFC dividends.
(i) Facts. USP has the following items of gross income and expense for the election
year: $1,200 of foreign source general limitation gross income, including $1,000 of
qualifying dividends, $1,000 of expenses allocated and apportioned to general limitation
income (including the 85 percent DRD of $850, which pursuant to section 3.03 of this
notice is allocated to reduce general limitation income), $300 of U.S. source gross
income, and $100 of expenses allocated and apportioned to U.S. source income.
Accordingly, USP has $400 of taxable income and $150 of nondeductible CFC
dividends in the election year, and the taxable income limitation of section 965(e)(2)(A)
does not apply.

(ii) Result
. Under section 6.03 of this notice, general limitation expenses are
considered to reduce other general limitation income before reducing nondeductible
CFC dividends. Accordingly, USP has $200 of foreign source general limitation taxable
income, of which $150 is attributable to nondeductible CFC dividends, and $200 of U.S.
source taxable income.

Example 2
. Nondeductible CFC dividends exceed separate limitation income;
nondeductible CFC dividends reduced. (i) Facts. The facts are the same as in

34
Example 1, except that USP has an additional $100 of deductible expenses allocated
and apportioned to general limitation income. Accordingly, USP has $300 of taxable
income and $150 of nondeductible CFC dividends in the election year, and the taxable
income limitation of section 965(e)(2)(A) does not apply.

(ii) Result
. Under section 6.03 of this notice, general limitation expenses reduce
nondeductible CFC dividends after reducing other general limitation income.
Accordingly, USP has $100 of foreign source general limitation income, all attributable
to nondeductible CFC dividends, and $200 of U.S. source taxable income.

Example 3
. Nondeductible CFC dividends exceed separate limitation income;
separate limitation loss with U.S. source taxable income. (i) Facts. The facts are the
same as in Example 1
, except that USP has an additional $250 of deductible expenses
allocated and apportioned to general limitation income. Accordingly, USP has $150 of
taxable income and $150 of nondeductible CFC dividends in the election year, and the
taxable income limitation of section 965(e)(2)(A) does not apply.

(ii) Result
. Under section 6.03 of this notice, general limitation expenses reduce
nondeductible CFC dividends after reducing other general limitation income, and the
excess deductions constitute a separate limitation loss. Accordingly, prior to the
application of section 904(f) USP has a ($50) foreign source general limitation separate
limitation loss, no general limitation nondeductible CFC dividends, and $200 of U.S.
source taxable income.

Example 4
. Nondeductible CFC dividends exceed separate limitation income;
separate limitation loss with U.S. and foreign source taxable income. (i) Facts. The
facts are the same as in Example 3
, except that instead of $300 of U.S. source gross
income USP has $200 of U.S. source gross income and $100 of foreign source passive
gross income. Accordingly, USP has $150 of taxable income and $150 of
nondeductible CFC dividends in the election year, and the taxable income limitation of
section 965(e)(2)(A) does not apply.

(ii) Result
. Under section 6.03 of this notice, general limitation expenses reduce
nondeductible CFC dividends after reducing other general limitation income, and the
excess deductions constitute a separate limitation loss. Accordingly, prior to the
application of section 904(f) USP has a ($50) foreign source general limitation separate
limitation loss, no general limitation nondeductible CFC dividends, $100 of foreign
source passive taxable income, no passive limitation nondeductible CFC dividends, and
$100 of U.S. source taxable income.

SECTION 7. LIMITATION ON REDUCTION IN TAXABLE INCOME BELOW AMOUNT

35
OF NONDEDUCTIBLE CFC DIVIDENDS PURSUANT TO SECTION 965(e)(2)
.01 In General
Under section 965(e)(2)(A), taxable income for the election year cannot be less
than the amount of nondeductible CFC dividends received during such year. In
addition, section 965(e)(2)(B)(i) provides that nondeductible CFC dividends are not
taken into account under section 172 in determining the amount of any NOL for the
election year. Accordingly, if deductible expenses and losses for the election year
(including the DRD allowed under section 965(a) but not including expenses for which
section 965(d)(2) disallows a deduction) exceed the taxpayer’s gross income exclusive
of the amount of nondeductible CFC dividends, taxable income will be equal to the
amount of nondeductible CFC dividends, and the excess deductions will constitute an
NOL for the taxable year. If, determined without regard to section 965(e)(2)(A), taxable
income for the election year would be less than the amount of nondeductible CFC
dividends received during such year, the excess of the deductions allocated and
apportioned to a separate category over the amount of gross income in the separate
category exclusive of the nondeductible CFC dividends will constitute a separate
limitation loss with respect to that separate category for the election year. Such
separate limitation loss is allocated in accordance with section 904(f) and section 8 of
this notice.
Section 965(e)(2)(B)(ii) provides that nondeductible CFC dividends are not taken
into account in determining taxable income for the election year for purposes of the
second sentence of section 172(b)(2), which applies in determining the allowable NOL

36
carryover or carryback to other years. Therefore, the amount of the allowable NOL
deduction that is absorbed in the election year is limited to the excess of taxable income
over the amount of nondeductible CFC dividends. However, taxable income attributable
to nondeductible CFC dividends is taken into account in determining the source and
allocation of NOL deductions taken into account in the election year under paragraph 1
of Notice 89-3, 1989-1 C.B. 623.
.02 Examples
The following examples illustrate the application of section 965(e)(2) and this
section 7.
Example 1
. Taxable income limitation; one income category. (i) Facts. USP
has the following items of gross income and expense for the election year: $1,000 of
foreign source general limitation gross income, including $100 of qualifying dividends,
and $1,000 of deductible expenses allocated and apportioned to general limitation
income (computed after the disallowance of expenses directly allocable to the
deductible portion of the qualifying dividends), including the $85 DRD allowed under
section 965(a) and $20 of expenses relating to nondeductible CFC dividends.

(ii) Result
. Under section 965(e)(2)(A), USP’s taxable income for the election
year cannot be less than $15, the amount of nondeductible CFC dividends received
during such year. Because taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($15), under
section 7.01 of this notice the $1,000 of general limitation expenses reduce general
limitation income only to the extent of $985 ($1,000 - $15), the excess of general
limitation gross income over general limitation nondeductible CFC dividends.
Accordingly, USP has $15 of general limitation taxable income, all attributable to
nondeductible CFC dividends.

Under section 965(e)(2)(B)(i), the amount of USP’s NOL for the election year is
computed without regard to the $15 of nondeductible CFC dividends. Accordingly, USP
has general limitation taxable income of $15 and a general limitation loss of ($15) that
constitutes a net operating loss of ($15) for the election year.

Example 2
. Taxable income limitation; U.S. and foreign source income. (i)
Facts
. The facts are the same as in Example 1, except that USP has $1,500 rather

37
than $1,000 of deductible expenses allocated and apportioned to general limitation
income, and also has $1,000 of U.S. source gross income and $500 of deductible
expenses allocated and apportioned to U.S. source income.

(ii) Result
. Under section 965(e)(2)(A), USP’s taxable income for the election
year cannot be less than $15, the amount of nondeductible CFC dividends received
during such year. Because taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($15), under
section 7.01 of this notice the $1,500 of general limitation expenses reduce general
limitation income only to the extent of $985 ($1,000 - $15), the excess of general
limitation gross income over general limitation nondeductible CFC dividends, and the
$515 ($1,500 - $985) excess of general limitation deductions over that amount
constitutes a separate limitation loss. Accordingly, prior to the application of section
904(f) USP has $15 of general limitation taxable income, all attributable to
nondeductible CFC dividends, a general limitation separate limitation loss of ($515), and
U.S. source taxable income of $500 ($1,000 - $500).

Under section 965(e)(2)(B)(i), the amount of USP’s NOL for the election year is
computed without regard to the $15 of nondeductible CFC dividends. Accordingly, USP
has taxable income of $15 and a net operating loss of ($15) for the election year.

Example 3
. Taxable income limitation; U.S. loss and foreign source income. (i)
Facts. The facts are the same as in Example 2, except that instead of $1,000 of U.S.
source gross income USP has $400 of U.S. source gross income and $600 of foreign
source passive gross income.

(ii) Result
. Under section 965(e)(2)(A), USP’s taxable income for the election
year cannot be less than $15, the amount of nondeductible CFC dividends received
during such year. Because taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($15), under
section 7.01 of this notice the $1,500 of general limitation expenses reduce general
limitation income only to the extent of $985 ($1,000 - $15), the excess of general
limitation gross income over general limitation nondeductible CFC dividends, and the
$515 ($1,500 - $985) excess of general limitation deductions over that amount
constitutes a separate limitation loss. Accordingly, prior to the application of section
904(f) USP has $15 of general limitation taxable income, all attributable to
nondeductible CFC dividends, a general limitation separate limitation loss of ($515),
foreign source passive income of $600, and U.S. source loss of ($100) ($400 - $500).

Under section 965(e)(2)(B)(i), the amount of USP’s NOL for the election year is
computed without regard to the $15 of nondeductible CFC dividends. Accordingly, USP
has taxable income of $15 and a net operating loss of ($15) for the election year.

38
Example 4. Net operating loss absorption. (i) Facts. Before taking into account
the NOL deduction or applying section 904(f) in the election year, USP has $100 of
general limitation taxable income, all attributable to nondeductible CFC dividends, $200
of passive limitation taxable income, and a $100 NOL from prior years, all attributable to
general limitation income.

(ii) Result
. Because USP’s available NOL ($100) does not exceed the amount
of taxable income exclusive of nondeductible CFC dividends for the election year
($200), the taxable income limitation of section 965(e)(2)(A) does not apply to limit
USP’s NOL deduction for the election year. Under section 965(e)(2)(B)(ii) and section
7.01 of this notice, USP’s $100 of nondeductible CFC dividends is not taken into
account in determining the amount of USP’s allowable NOL absorbed in the election
year, but is taken into account in determining the source and allocation of NOL
deductions absorbed in the election year. Accordingly, under paragraph (1)(b)(ii) of
Notice 89-3, the $100 general limitation NOL deduction reduces USP’s $100 of general
limitation income to zero. After allocation of the NOL deduction but before application of
section 904(f), USP has $200 of passive limitation taxable income and no general
limitation or passive limitation nondeductible CFC dividends in the election year.

Example 5
. Net operating loss limitation. (i) Facts. Before taking into account
the NOL deduction or applying section 904(f), USP has $500 of general limitation
foreign source taxable income, including $15 of nondeductible CFC dividends, $500 of
passive limitation foreign source taxable income, and $1,000 of U.S. source taxable
income for the election year. USP also has a net operating loss carryover of $2,000,
consisting of $1,000 of U.S. loss, $600 of general limitation loss, and $400 of passive
limitation loss.

(ii) Result
. Under section 965(e)(2)(A), the amount of USP’s NOL deduction
absorbed in the election year is limited to $1,985, the amount of USP’s taxable income
exclusive of nondeductible CFC dividends. Under paragraph (1)(b)(i) of Notice 89-3,
the $1,000 U.S. loss component of the NOL carryover is absorbed first, and $985 of the
NOL carryover is available to offset foreign source income. Under paragraph (1)(b)(ii)
of Notice 89-3, separate limitation losses that are part of the NOL carryover are
tentatively carried over to the extent of separate limitation income in the same category.
Pursuant to section 965(e)(2)(B)(ii) and section 7.01 of this notice, the $15 of
nondeductible CFC dividends is not taken into account in determining the amount of the
allowable NOL deduction absorbed in the election year, but is taken into account in
determining the amount of general limitation income available to be absorbed by the
allowable NOL. Accordingly, $500 of the $600 general limitation component of the NOL
and $400 of the passive limitation component of the NOL are tentatively carried over to
the election year, eliminating the $500 of general limitation income (including the $15 of
nondeductible CFC dividends) and $400 of the $500 of passive income.

39
Under paragraph (1)(b)(iii) of Notice 89-3, a proportionate part of the remaining
loss from each separate limitation category is next carried over, to the extent of the
remaining NOL carryover amount of $85, and allocated in accordance with section
904(f)(5). Accordingly, an additional $85 of the general limitation component of the NOL
is carried over to the election year and allocated to passive income in accordance with
section 904(f)(5). At the conclusion of these steps, USP has $15 of passive income in
the election year and a remaining NOL carryover to other years of ($15), all attributable
to general limitation loss.

.03 Other Deduction Limitations
For purposes of applying other Code provisions that contain limitations based on
the amount of the taxpayer’s gross income or taxable income for the taxable year, gross
income includes qualifying dividends, and taxable income includes nondeductible CFC
dividends.
.04 Examples
The following examples illustrate the application of section 7.03 of this notice.
Example 1
. No taxable income limitation under section 965(e)(2)(A). (i) Facts.
Before calculating its allowable charitable contribution deduction under section 170,
USP has the following items of gross income and expense for the election year: $1,000
of foreign source general limitation gross income, including $200 of qualifying dividends,
$500 of deductible expenses allocated and apportioned to general limitation income
(computed after the disallowance of expenses directly allocable to the deductible portion
of the qualifying dividends), including the $170 DRD allowed under section 965(a) and
$20 of expenses relating to nondeductible CFC dividends, $1,000 of U.S. source gross
income, and $500 of deductible expenses allocated and apportioned to U.S. source
income. Under section 7.01 of this notice, without regard to the charitable deduction
USP has $500 of general limitation taxable income, including $30 of nondeductible CFC
dividends, and $500 of U.S. source taxable income for the election year.

(ii) Result
. Section 170(b)(2), which limits a corporation’s charitable contribution
deduction to 10 percent of taxable income computed without regard to section 170 and
certain other provisions not relevant on these facts, limits USP’s allowable deduction to
$100, 10 percent of USP’s taxable income of $1,000 for the election year. If USP
claims the $100 deduction, USP has $900 of taxable income for the election year.

Example 2
. Section 965(e)(2)(A) taxable income limitation. (i) Facts. Before

40
calculating its allowable charitable contribution deduction under section 170, USP has
the following items of gross income and expense for the election year: $1,000 of foreign
source general limitation gross income, including $200 of qualifying dividends, and
$1,000 of deductible expenses allocated and apportioned to general limitation income
(computed after the disallowance of expenses directly allocable to the deductible portion
of the qualifying dividends), including the $170 DRD allowed under section 965(a) and
$20 of expenses relating to nondeductible CFC dividends. Under section 965(e)(2)(A)
and section 7.01 of this notice, without regard to the charitable contribution deduction,
USP's current year deductions are limited to $970 and USP has $30 of general
limitation taxable income, all attributable to nondeductible CFC dividends. Under
section 965(e)(2)(B)(i) and section 7.01 of this notice, USP has a general limitation loss
of $30 that constitutes a net operating loss of $30 for the election year.

(ii) Result
. Section 170(b)(2), which limits a corporation’s charitable contribution
deduction to 10 percent of taxable income computed without regard to section 170 and
certain other provisions not relevant on these facts, limits USP’s allowable deduction to
$3, 10 percent of USP’s taxable income of $30 for the election year. If USP claims the
$3 deduction, USP has $30 of taxable income and a $33 NOL for the election year.

.05 No Other Limits on Use of Deductions to Reduce Taxable Income
Section 965(e)(2) limits the use of deductions to reduce taxable income below
the amount of nondeductible CFC dividends, but does not restrict the use of deductions
to offset income in excess of the amount of nondeductible CFC dividends. Therefore,
deductions may offset income in excess of the amount of nondeductible CFC dividends,
including income attributable to the section 78 gross-up that is required with respect to
foreign taxes deemed paid with respect to nondeductible CFC dividends.

SECTION 8. OVERALL FOREIGN LOSS AND SEPARATE LIMITATION LOSS RULES
.01 In General
Section 965 does not modify the operation of the overall foreign loss and
separate limitation loss allocation and recapture rules or the U.S. loss allocation rules of

41
section 904(f). Accordingly, except in situations where the taxable income limitation of
section 965(e)(2)(A) applies, as provided in paragraph .02 of this section, section 904(f)
may operate to reduce amounts of foreign source income, which may include
nondeductible CFC dividends in a separate category, or recharacterize such amount as
U.S. source income or foreign source income in a different separate category for
purposes of applying the limitations on the allowable foreign tax credit under sections
904(d) and 965(e)(1).
The amount of taxable income and the amount of the allowable NOL deduction
for the election year are determined prior to the application of section 904(f). Therefore,
the amount of the section 965(a) DRD, the amount of foreign taxes and expenses for
which a credit or deduction is disallowed under section 965(d), the amount of taxable
income determined under section 965(e)(2)(A), and the allowable NOL deduction
determined under section 965(e)(2)(B) are not affected if nondeductible CFC dividends
are reduced or recharacterized as U.S. source income or foreign source income in
another separate category pursuant to section 904(f).
.02 Loss Allocation
To the extent a separate limitation loss or U.S. loss is allocated under section
904(f)(5)(B) or 904(f)(5)(D) to reduce foreign source taxable income in a separate
category that includes nondeductible CFC dividends, such loss will be considered first to
reduce other foreign source income in the separate category before foreign source
income attributable to nondeductible CFC dividends is reduced. Even if nondeductible
CFC dividends are reduced as a result of a separate limitation loss or U.S. loss

42
allocation, income in a later year in the separate category that is recharacterized under
section 904(f)(5)(C) or section 904(f)(1) as income in the loss category or as U.S.
source income, as the case may be, will not be considered nondeductible CFC
dividends.
If the taxable income limitation of section 965(e)(2)(A) applies in the election
year, taxable income equals the amount of nondeductible CFC dividends. In this case,
after the allocation and apportionment of expenses and the determination and allocation
of the allowable NOL deduction for the election year described in sections 6 and 7 of
this notice, but prior to the application of section 904(f), a taxpayer may have separate
limitation income attributable to nondeductible CFC dividends with or without a separate
limitation loss in the same separate category, and may have separate limitation income
or separate limitation losses in other separate categories as well as U.S. source taxable
income or loss. Because separate limitation losses and U.S. losses in the aggregate
may not reduce the sum of separate limitation income and U.S. source income below
the amount of nondeductible CFC dividends in the election year, the excess of such
losses over the amount of such income exclusive of the amount of nondeductible CFC
dividends will constitute a net operating loss for the election year. For purposes of
determining which losses are absorbed in the election year and which losses make up
the net operating loss in the election year if the taxable income limitation of section
965(e)(2)(A) applies, separate limitation losses and U.S. losses are allocated under
section 904(f)(5)(B) and (D) without regard to nondeductible CFC dividends. See
Examples 3
and 4 in section 8.05 of this notice.

43
.03 Loss Recapture
After separate limitation losses for the taxable year are allocated to reduce
separate limitation income in other separate categories, any remaining separate
limitation income may be recharacterized as income in another separate category or as
U.S. source income, if the taxpayer had separate limitation losses in that same separate
category in a prior taxable year that were allocated to reduce separate limitation income
in that other separate category or U.S. source income. This recharacterization of
income operates to recapture the prior year separate limitation loss or overall foreign
loss. See section 904(f)(1), section 904(f)(5)(C), and Notice 89-3. Separate limitation
losses and overall foreign losses may be recaptured in the election year out of income
in any separate category with separate limitation income, including income attributable
to nondeductible CFC dividends, whether or not the taxable income limitation of section
965(e)(2)(A) applies in the election year.
Separate limitation losses and overall foreign losses with respect to a separate
category that includes nondeductible CFC dividends will be considered recaptured first
out of other income in the separate category before any income attributable to
nondeductible CFC dividends is recharacterized. See Example 5
in section 8.05 of this
notice. If nondeductible CFC dividends are recharacterized as U.S. source income or
income in a different separate category, the recharacterized income is not treated as
nondeductible CFC dividends. See Examples 6
and 7 in section 8.05 of this notice.
.04 Treatment of Foreign Taxes Imposed with Respect to Nondeductible CFC
Dividends

44
The recharacterization of income under the overall foreign loss or separate
limitation loss recapture rules does not result in the recharacterization of any tax.
Section 904(f)(5)(C). Accordingly, foreign tax attributable to nondeductible CFC
dividends in a separate category remains in that separate category even if the income
attributable to the nondeductible CFC dividends is recharacterized. See section 9.02 of
this notice for rules relating to the application of section 965(e)(1) to foreign taxes
attributable to nondeductible CFC dividends when a portion of nondeductible CFC
dividends is recharacterized under section 904(f) and this section 8.
.05 Examples

The following examples illustrate the application of the rules of section 904(f) and
this section 8.
Example 1
. No taxable income limitation; allocation of separate limitation loss.
(i) Facts. After the allocation and apportionment of expenses but before the application
of section 904(f), USP has the following items of taxable income for the election year:
$100 of general limitation income, all attributable to nondeductible CFC dividends,
($100) of passive limitation loss, and $200 of U.S. source taxable income.

(ii) Result
. Because USP’s taxable income in the election year ($200) exceeds
the amount of nondeductible CFC dividends ($100), the taxable income limitation of
section 965(e)(2)(A) does not apply. Under section 904(f)(5)(B), paragraph (2) of Notice
89-3, and section 8.02 of this notice, USP’s $100 passive limitation loss is allocated to
reduce the $100 of general limitation income to zero. After allocation of the separate
limitation loss, USP has no general limitation or passive income, no general limitation or
passive limitation nondeductible CFC dividends, and $200 of U.S. source taxable
income. USP has a passive limitation loss recapture account of $100 with respect to
general limitation income.

Example 2
. Taxable income limitation; allocation of separate limitation loss. (i)
Facts. The facts are the same as in Example 1, except that USP has $40, rather than
$200, of U.S. source taxable income in the election year.

(ii) Result
. Because USP’s taxable income computed without regard to section

45
965(e)(2)(A) ($40) is less than the amount of nondeductible CFC dividends ($100), the
taxable income limitation of section 965(e)(2)(A) applies. Therefore, under section 8.02
of this notice the loss allocation rules of section 904(f)(5) and Notice 89-3 are applied
without regard to the nondeductible CFC dividends. Accordingly, under section
904(f)(5)(A) and section 8.02 of this notice $40 of USP’s $100 passive limitation loss is
allocated to reduce U.S. source taxable income to zero, and the remaining $60 passive
loss constitutes an NOL for the election year. After allocation of the separate limitation
loss, USP has $100 of general limitation income, all attributable to nondeductible CFC
dividends, a $60 passive limitation loss that constitutes an NOL, and no U.S. source
taxable income. USP has a $40 overall foreign loss account in the passive category.

Example 3
. Taxable income limitation; allocation of U.S. loss. (i) Facts. After
the allocation and apportionment of expenses but before the application of section
904(f), USP has the following items of taxable income for the election year: $750 of
general limitation income, of which $500 is attributable to nondeductible CFC dividends,
and $750 of U.S. source loss.

(ii) Result
. Because USP’s taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($500), the
taxable income limitation of section 965(e)(2)(A) applies. Therefore, under section 8.02
of this notice the loss allocation rules of section 904(f)(5) and Notice 89-3 are applied
without regard to the nondeductible CFC dividends. Accordingly, under section
904(f)(5)(D) and section 8.02 of this notice $250 of USP’s $750 U.S. loss is allocated to
reduce general limitation income to $500, and the remaining $500 U.S. loss constitutes
an NOL for the election year. After allocation of the U.S. loss, USP has $500 of general
limitation income, all attributable to nondeductible CFC dividends, and a $500 U.S. loss
that constitutes an NOL.

Example 4
. Taxable income limitation; allocation of separate limitation loss and
U.S. loss. (i) Facts. After the allocation and apportionment of expenses but before the
application of section 904(f), USP has the following items of taxable income for the
election year: $100 of general limitation income attributable to nondeductible CFC
dividends, ($100) of general limitation loss, $100 of passive income, and ($100) of U.S.
source loss.

(ii) Result
. Because USP’s taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($100), the
taxable income limitation of section 965(e)(2)(A) applies. Therefore, under section 8.02
of this notice the loss allocation rules of section 904(f)(5) and Notice 89-3 are applied
without regard to the nondeductible CFC dividends. Accordingly, under section
904(f)(5)(B) and section 8.02 of this notice USP’s $100 general limitation loss is
allocated to reduce passive income to zero, and the $100 U.S. loss constitutes an NOL
for the election year. After allocation of the separate limitation loss, USP has $100 of

46
general limitation income, all attributable to nondeductible CFC dividends, and a $100
U.S. loss that constitutes an NOL. USP has a $100 general limitation loss recapture
account with respect to passive income.

Example 5
. OFL recapture from other income. (i) Facts. After the allocation
and apportionment of expenses but before the application of section 904(f), USP has
the following items of taxable income for the election year: $150 of general limitation
income attributable to nondeductible CFC dividends and $190 of other general limitation
income. USP has a pre-2005 general limitation OFL account of $400.

(ii) Result
. Under section 904(f)(1), 50 percent or $170 of USP’s general
limitation income is recharacterized as U.S. source income. Since the recapture
amount does not exceed USP’s foreign source general limitation income exclusive of
nondeductible CFC dividends, after OFL recapture USP has $150 of nondeductible CFC
dividends and $20 of other income in the general limitation category, and $170 of U.S.
source income. USP’s general limitation OFL recapture account is reduced by $170.

Example 6
. OFL recapture from nondeductible CFC dividends. (i) Facts. After
the allocation and apportionment of expenses but before the application of section
904(f), USP has the following items of taxable income for the election year: $150 of
general limitation income, all attributable to nondeductible CFC dividends. USP has a
pre-2005 general limitation OFL account of $200.

(ii) Result
. Under section 904(f)(1), unless USP elects to recapture a larger
percentage of the OFL account, 50 percent or $75 of USP’s general limitation income is
recharacterized as U.S. source income. After OFL recapture USP has $75 of
nondeductible CFC dividends in the general limitation category, and $75 of U.S. source
income. USP’s OFL recapture account is reduced by $75.

Example 7
. Separate limitation loss recapture from nondeductible CFC
dividends. (i) Facts. After the allocation and apportionment of expenses but before the
application of section 904(f), USP has the following items of taxable income for the
election year: $240 of general limitation income, of which $150 is attributable to
nondeductible CFC dividends. USP has a general limitation separate limitation loss
recapture account with respect to passive income of $200.

(ii) Result
. Since the $200 recapture amount exceeds $90, USP’s foreign
source general limitation income exclusive of nondeductible CFC dividends ($240 -
$150), a portion of the nondeductible CFC dividends is recaptured after all other general
limitation income is recaptured under section 904(f)(5)(C). Accordingly, $200 of USP’s
general limitation income, equal to $90 of other income plus $110 of nondeductible CFC
dividends, is recharacterized as passive income. After recapture of the separate
limitation loss, USP has $40 of general limitation income, all attributable to

47
nondeductible CFC dividends, and $200 of passive income. USP’s general limitation
separate limitation loss recapture account with respect to passive income is reduced by
$200 to 0.

SECTION 9. RESTRICTION ON USE OF CREDITS TO OFFSET TAX ON
NONDEDUCTIBLE CFC DIVIDENDS AND COMPUTATION OF ALTERNATIVE
MINIMUM TAX PURSUANT TO SECTION 965(e)(1)
.01 In General
Section 965(e)(1) provides that tax on nondeductible CFC dividends is not
treated as a tax when determining the amount of any allowable credit or the amount of
alternative minimum tax imposed by section 55. However, this rule does not apply to
the credit under section 53 for prior year minimum tax, or to the credit under section
27(a) for foreign taxes attributable to nondeductible CFC dividends. Therefore, the
portion of the pre-credit U.S. tax that is attributable to the nondeductible CFC dividends
may not be offset by any credit other than prior year minimum tax credits and a foreign
tax credit for foreign taxes attributable to the nondeductible CFC dividends.
.02 Additional Limitation on Foreign Tax Credits
(a) In general. The limitation under section 965(e) on the use of foreign tax
credits against the U.S. tax on nondeductible CFC dividends (the section 965(e)
limitation) is implemented through an additional foreign tax credit limitation for each
separate category that includes nondeductible CFC dividends. Section 965 does not
provide for a distinct separate category for qualifying dividends. Instead, qualifying
dividends are characterized as income in separate categories under the generally

48
applicable look-through rules of sections 904(d)(3)(B) and 904(d)(3)(D). See sections
3.02 and 6.01 of this notice. The section 965(e) limitation is applied after gross income
and deductible expenses, including the NOL deduction, are allocated and apportioned
to determine U.S. source taxable income and foreign source taxable income in the
separate categories, as described in sections 6 and 7 of this notice, after the allocation
of separate limitation losses, overall foreign losses, and U.S. losses and the recapture
of overall foreign losses and separate limitation losses pursuant to section 904(f), as
described in section 8 of this notice, and after computing the regular section 904
limitation for each separate category that contains nondeductible CFC dividends.
The section 965(e) limitation for any separate category equals the sum of (i) the
creditable foreign taxes paid or accrued with respect to the nondeductible CFC
dividends in the separate category and (ii) the modified section 904 limitation for that
separate category. The modified section 904 limitation for a separate category is
calculated by subtracting the amount of nondeductible CFC dividends in the separate
category from both the numerator and denominator of the regular section 904 limitation
fraction and subtracting the pre-credit U.S. tax attributable to the nondeductible CFC
dividends in the separate category from the pre-credit U.S. tax used in the regular
section 904 limitation calculation. See Examples 1
through 4 of section 9.02(c) of this
notice. For this purpose, the pre-credit U.S. tax attributable to the nondeductible CFC
dividends in the separate category equals 35 percent (20 percent for alternative
minimum tax purposes) of the amount of nondeductible CFC dividends in the separate
category.

49
For purposes of applying the section 965(e) limitation to a separate category that
included nondeductible CFC dividends that were reduced by deductions or
recharacterized as U.S. source income or income in a different separate category
pursuant to sections 6 and 8 of this notice and section 904(f), the amount of
nondeductible CFC dividends in the separate category is the portion, if any, of the
nondeductible CFC dividends that was not reduced by deductions or recharacterized,
and the amount of foreign tax attributable to the nondeductible CFC dividends is the
portion of the foreign taxes paid with respect to nondeductible CFC dividends that are
attributable to such reduced amount.
The applicable foreign tax credit limitation for each separate category is the
smaller of the regular section 904 limitation or the section 965(e) limitation, and the
allowable foreign tax credit for each separate category is the smaller of the foreign taxes
in the separate category or the applicable foreign tax credit limitation. In effect, the
section 965(e) limitation will reduce the otherwise allowable foreign tax credit only if
nondeductible CFC dividends are considered to bear a lower effective rate of foreign tax
than other income in the same separate category and the other income is effectively
taxed in excess of the U.S. rate. In this situation, section 965(e)(1) is intended to
prevent the excess credits associated with the other income from reducing the U.S. tax
on the nondeductible CFC dividends. See Example 4
in section 9.02(c) of this notice.
(b) No Limitation on Use of Foreign Tax Credits against U.S. Tax on Income
Other than Nondeductible CFC Dividends. Section 965(e)(1) does not restrict the use
of foreign tax credits, including credits for foreign taxes paid or deemed paid with

50
respect to nondeductible CFC dividends, to reduce the U.S. tax on income other than
nondeductible CFC dividends. Therefore, to the extent otherwise allowable, foreign tax
credits for foreign taxes paid with respect to nondeductible CFC dividends or other
income may reduce the U.S. tax on other foreign source taxable income, including
income attributable to the section 78 gross-up for foreign taxes deemed paid with
respect to nondeductible CFC dividends.
(c) Examples. The following examples illustrate the application of section
965(e)(1) and this section 9.02.
Example 1.
All Low-Taxed Income. (i) Facts. USP wholly owns CFC1 and
CFC2 and elects to apply section 965 to its 2005 calendar tax year. As of the close of
2005, CFC1 has post-1986 undistributed earnings and post-1986 foreign income taxes
of $1,000x and $100x, respectively, and CFC2 has post-1986 undistributed earnings
and post-1986 foreign income taxes of $1,000x and $200x, respectively. All post-1986
undistributed earnings of CFC1 and CFC2 are general limitation earnings and profits,
and neither CFC1 nor CFC2 has any previously-taxed earnings and profits described in
sections 959(c)(1) or 959(c)(2). USP’s base period amount is $100x, and the
requirements of section 965 are met for the election year. CFC1 distributes a cash
dividend of $1,000x resulting in deemed-paid taxes of $100x (($1,000x/$1,000x) x
$100x), CFC2 distributes a cash dividend of $100x resulting in deemed-paid taxes of
$20x (($100x/$1,000x) x $200x), and USP accrues no other items of income or expense
in the election year. USP identifies the lower-taxed cash dividend from CFC1 as the
qualifying dividend.

(ii) Result
. Step 1. Determine creditable foreign taxes. USP is entitled to an
$850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from
CFC1, and has $150x of nondeductible CFC dividends. Under section 965(d)(1) and
section 4.01 of this notice, USP may claim a credit for $15x (.15 x $100x) of deemed-
paid foreign tax attributable to the nondeductible CFC dividend. Because no section
965 DRD is allowed with respect to the $100x dividend from CFC2, all $100x is taxed,
and all $20x of deemed-paid tax attributable to the CFC2 dividend is creditable. Thus,
USP’s creditable foreign taxes, prior to the application of the limitation rules, are $35x
($15x + $20x), and USP includes $35x in income under section 78.

Step 2
. Determine regular section 904 limitation. Total foreign source taxable
income (FSTI) equals $285x ($1,000x CFC1 dividend - $850x DRD + $100x CFC2

51
dividend + $35x gross-up). Because USP has no other income, worldwide taxable
income (WWTI) is also $285x. USP’s pre-credit U.S. tax is $99.75x (.35 x $285x). The
regular section 904 limitation is $99.75x (($285x FSTI/$285x WWTI) x $99.75x). Thus,
all $35 of foreign taxes are eligible for the credit under the regular section 904
limitation.

Step 3
. Determine section 965(e) limitation. Pursuant to this section 9.02, the
section 965(e) limitation is the sum of the creditable foreign taxes paid or accrued with
respect to the nondeductible CFC dividends and the modified section 904 limitation that
results from subtracting the amount of the nondeductible CFC dividends from the
numerator and denominator of the regular section 904 limitation fraction and subtracting
the pre-credit U.S. tax on the nondeductible CFC dividends from the pre-credit U.S. tax
in the regular section 904 limitation. The foreign taxes on the $150x of nondeductible
CFC dividends are $15x. Subtracting the $150x of nondeductible CFC dividends from
the numerator and denominator of the regular section 904 limitation fraction, USP has
$135x of other FSTI and WWTI ($100x CFC2 dividend plus $35x of gross-up income)
and a pre-credit U.S. tax on this amount of $47.25x ($99.75x – (.35 x $150x)). The
modified section 904 limitation equals $47.25x (($135x FSTI/$135x WWTI) x $47.25x).
The section 965(e) limitation equals $62.25x ($15x + $47.25x). Because the total
amount of creditable foreign taxes is less than both the section 965(e) limitation and the
regular section 904 limitation, USP may credit all $35x of foreign tax in the election
year.

Example 2
. All High-Taxed Income. (i) Facts. The facts are the same as in
Example 1, except that CFC1 has post-1986 undistributed earnings and post-1986
foreign income taxes of $1,000x and $600x, respectively, and CFC2 has post-1986
undistributed earnings and post-1986 foreign income taxes of $1,000x and $750x,
respectively. Accordingly, the $1,000x dividend from CFC1 results in foreign taxes
deemed paid of $600x (($1,000x/$1,000x) x $600x), and the $100x dividend from CFC2
results in foreign taxes deemed paid of $75x (($100x/$1,000x) x $750x).

(ii) Result
. Step 1. Determine creditable foreign taxes. USP is entitled to an
$850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from
CFC1, and has $150 of nondeductible CFC dividends. Under section 965(d)(1) and
section 4.01 of this notice, USP may claim a credit for $90x (.15 x $600x) of deemed-
paid foreign tax attributable to the nondeductible CFC dividend. Because no section
965 DRD is allowed with respect to the $100x dividend from CFC2, all $100x is taxed,
and all $75x of deemed-paid tax attributable to the CFC2 dividend is creditable. Thus,
USP’s creditable foreign taxes, prior to the application of the limitation rules, are $165x
($90x + $75x), and USP includes $165x in income under section 78.

Step 2
. Determine regular section 904 limitation. USP's FSTI equals $415x
($1,000x qualifying dividend from CFC1 - $850x DRD + $100x dividend from CFC2 +

52
$165x gross-up). Because USP has no other income, WWTI is also $415x. USP’s pre-
credit U.S. tax is $145.25x (.35 x $415x). Thus, the limitation equals $145.25x (($415x
FSTI/$415x WWTI) x $145.25x). Because the limitation is less than the total creditable
taxes of $165x, the regular section 904 limitation prevents the excess $19.75x from
being credited in the current year.

Step 3
. Determine section 965(e) limitation. The foreign taxes on the $150x of
nondeductible CFC dividends are $90x. Subtracting the $150x of nondeductible CFC
dividends from the numerator and denominator of the regular section 904 limitation
fraction, USP has $265x of other FSTI and WWTI ($415x - $150x) and a pre-credit U.S.
tax on this amount of $92.75x ($145.25x – (.35 x $150x)). The modified section 904
limitation equals $92.75x (($265x FSTI/$265x WWTI) x $92.75x). The section 965(e)
limitation equals $182.75x ($90x + $92.75x). Because the section 965(e) limitation is
higher than the regular section 904 limitation, the total amount of creditable foreign
taxes are subject to the regular section 904 limitation of $145.25x.

Example 3
. High-Taxed Nondeductible CFC Dividend/Low-Taxed Other Income.
(i) Facts. The facts are the same as in Example 1, except that CFC1 has post-1986
undistributed earnings and post-1986 foreign income taxes of $1,000x and $400x,
respectively, CFC2 does not pay a dividend in the election year, and USP has an
additional $100x of general limitation income subject to no foreign tax. Accordingly, the
$1,000x dividend from CFC1 results in foreign taxes deemed paid of $400x
(($1,000x/$1,000x) x $400x), and no foreign taxes of CFC2 are deemed paid in the
election year.

(ii) Result
. Step 1. Determine creditable foreign taxes. USP is entitled to an
$850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from
CFC1, and has $150x of nondeductible CFC dividends. Under section 965(d)(1) and
section 4.01 of this notice, USP may claim a credit for $60x (.15 x $400x) of deemed-
paid foreign tax attributable to the nondeductible CFC dividend. Thus, USP’s creditable
foreign taxes, prior to the application of the limitation rules, are $60x, and USP includes
$60x in income under section 78.

Step 2
. Determine regular section 904 limitation. USP’s FSTI equals $310x
($1,000x qualifying dividend from CFC1 - $850x DRD + $60x gross-up + $100x of other
income). Because USP has no other income, WWTI is also $310x. USP’s pre-credit
U.S. tax is $108.50x (.35 x $310x). Thus, the regular section 904 limitation equals
$108.50x (($310x FSTI/$310x WWTI) x $108.50x). All $60x of foreign tax would be
creditable, because the foreign taxes paid in excess of the U.S. tax on the
nondeductible CFC dividend can reduce the U.S. tax on the gross-up income and the
other foreign source income.

Step 3
. Determine section 965(e) limitation. The foreign taxes on the $150x of

53
nondeductible CFC dividends are $60x. Subtracting the $150x of nondeductible CFC
dividends from the numerator and denominator of the regular section 904 limitation
fraction, USP has $160x of other FSTI and WWTI ($310x - $150x) and a pre-credit U.S.
tax on this amount of $56x ($108.50x – (.35 x $150x)). The modified section 904
limitation equals $56x (($160x FSTI/$160x WWTI) x $56x). The section 965(e)
limitation equals $116x ($60x + $56x). Because the section 965(e) limitation is higher
than the regular section 904 limitation, the $60x total amount of creditable foreign taxes
are subject to the regular section 904 limitation of $108.50x, and the excess foreign
taxes on the nondeductible CFC dividend can reduce the U.S. tax on USP’s other
foreign source income.

Example 4
. Low-Taxed Nondeductible CFC Dividend/High-Taxed Other Income.
(i) Facts
. The facts are the same as in Example 1, except that CFC2 has post-1986
undistributed earnings and post-1986 foreign income taxes of $1,000x and $750x,
respectively. Accordingly, the $1,000x dividend from CFC1 results in foreign taxes
deemed paid of $100x (($1,000x/$1,000x) x $100x), and the $100x dividend from CFC2
results in foreign taxes deemed paid of $75x (($100x/$1,000x) x $750x).

(ii) Result
. Step 1. Determine creditable foreign taxes. USP is entitled to an
$850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from
CFC1, and has $150x of nondeductible CFC dividends. Under section 965(d)(1) and
section 4.01 of this notice, USP may claim a credit for $15x (.15 x $100x) of deemed-
paid foreign tax attributable to the nondeductible CFC dividend. Because no section
965 DRD is allowed with respect to the $100x dividend from CFC2, all $100x is taxed,
and all $75x of deemed-paid tax attributable to the CFC2 dividend is creditable. Thus,
USP’s creditable foreign taxes, prior to the application of the limitation rules, are $90x
($15x + $75x), and USP includes $90x in income under section 78.

Step 2
. Determine regular section 904 limitation. USP's FSTI equals $340x
($1,000x qualifying dividend from CFC1 - $850x DRD + $100x dividend from CFC2 +
$90x gross-up). Because USP has no other income, WWTI is also $340x. USP’s pre-
credit U.S. tax is $119x (.35 x $340x). Thus, the regular section 904 limitation equals
$119x (($340x FSTI/$340x WWTI) x $119x). The regular section 904 limitation would
allow all $90x of foreign tax to be credited, because the foreign taxes paid in excess of
the U.S. tax on the CFC2 dividend could reduce the U.S. tax on the low-taxed
nondeductible CFC dividend from CFC1.

Step 3
. Determine section 965(e) limitation. The foreign taxes on the $150x of
nondeductible CFC dividends are $15x. Subtracting the $150x of nondeductible CFC
dividends from the numerator and denominator of the regular section 904 limitation
fraction, USP has $190x of other FSTI and WWTI ($340x - $150x) and a pre-credit U.S.
tax on this amount of $66.50x ($119x – (.35 x $150x)). The modified section 904
limitation equals $66.50x (($160x FSTI/$160x WWTI) x $66.50x). The section 965(e)

54
limitation equals $81.50x ($15x + $66.50x). Because the section 965(e) limitation is
less than the regular section 904 limitation of $119x, the section 965(e) limitation
applies and prevents USP from crediting $8.50x of the $90x of potentially creditable
taxes. The $8.50x of tax which is not creditable under the section 965(e) limitation
equals the excess foreign taxes on the other foreign source income that would have
been creditable against the U.S. tax on the nondeductible CFC dividend under the
regular section 904 limitation (i.e., the excess of the $75x of foreign tax on the CFC2
dividend over $66.50x, the pre-credit U.S. tax on $190x of other foreign source income
($100x CFC2 dividend + $75x gross-up attributable to tax deemed paid on the CFC2
dividend + $15x gross-up attributable to the nondeductible CFC dividend from CFC1)).
The excess taxes may be carried over and used as a credit in other years to the extent
allowed under section 904(c).

.03 No Use of Credits Other than Credit for Prior Year Minimum Tax to Offset U.S. Tax
on Nondeductible CFC Dividends
Section 965(e)(1) provides that no credit other than a foreign tax credit for foreign
taxes attributable to nondeductible CFC dividends and the credit for prior year minimum
tax under section 53 may offset the U.S. tax on nondeductible CFC dividends.
However, section 965 does not limit the application of credits against the U.S. tax on
income other than nondeductible CFC dividends. Because other credits, including the
possessions tax credit allowed under sections 27(b) and 30A, the nonconventional
source fuel credit allowed under section 29, the qualified electric vehicle credit allowed
under section 30, and the general business credit allowed under section 38, as well as
the credit for prior year minimum tax that is allowed under section 53, are applied after
the foreign tax credit, taxpayers must identify the portion of their pre-credit U.S. tax and
allowable foreign tax credit for the election year that is attributable to nondeductible
CFC dividends and the portion that is attributable to other income in order to determine
the amount of their other allowable credits.

55
For purposes of this determination and section 9.05 of this notice, the portion of a
taxpayer’s pre-credit U.S. tax that is attributable to nondeductible CFC dividends equals
the smaller of the taxpayer’s total pre-credit U.S. tax or 35 percent of the amount of
nondeductible CFC dividends. For this purpose, the amount of nondeductible CFC
dividends is the amount determined under section 965(e)(3), without regard to any
reduction or recharacterization of nondeductible CFC dividends in a separate category
for purposes of determining the foreign tax credit limitation as provided in sections 6
through 8 of this notice. The portion of the taxpayer’s pre-credit U.S. tax that is
attributable to other income equals the excess, if any, of the taxpayer’s total pre-credit
U.S. tax over the pre-credit U.S. tax attributable to nondeductible CFC dividends. To
determine the total allowable foreign tax credit for the election year, the taxpayer must
first compute the allowable credit for each separate category, applying the section
965(e) limitation described in section 9.02 of this notice. The portion of the taxpayer’s
allowable foreign tax credit in each separate category that is attributable to
nondeductible CFC dividends equals the smaller of 35 percent of the amount of
nondeductible CFC dividends in the separate category, determined after applying
sections 6 through 8 of this notice, or the foreign taxes paid or accrued with respect to
the nondeductible CFC dividends in that separate category, determined in accordance
with section 9.02(a) of this notice. The portion of the allowable foreign tax credit that is
attributable to nondeductible CFC dividends is the sum of the amounts determined
under the preceding sentence in all of the taxpayer’s separate categories. The
remainder, if any, of the allowable foreign tax credit is considered attributable to other

56
income.
The taxpayer’s residual U.S. tax on nondeductible CFC dividends, as reduced by
the portion of the allowable foreign tax credit that is attributable to that income, may not
be reduced by any credit other than the prior year minimum tax credit. The taxpayer’s
residual U.S. tax on other income, as reduced by the balance of the allowable foreign
tax credit, may be reduced by other credits in accordance with the rules generally
applicable to such credits.
.04 Computation of Section 53 Credit in Election Year
Under section 965(e)(1), the U.S. tax on nondeductible CFC dividends is taken
into account in determining the allowable amount of prior year minimum tax credits
under section 53 for the election year. Accordingly, for purposes of section 53 the
taxpayer’s regular tax and tentative minimum tax are computed taking into account the
regular tax and tentative minimum tax on nondeductible CFC dividends, as reduced by
allowable foreign tax credits computed in accordance with section 965(e)(1) and section
9.02 of this notice. As a result, credits for prior year minimum tax may be allowed in the
election year to reduce the regular tax on nondeductible CFC dividends and other
income, subject to the limitation of section 53(c), even if the taxpayer’s entire taxable
income is attributable to nondeductible CFC dividends or if the taxpayer is subject to
AMT on taxable income other than nondeductible CFC dividends in the election year.
See Examples 3
through 6 of section 9.06 of this notice.
.05 Computation of Alternative Minimum Tax in Election Year
Section 965(e)(1) provides that the U.S. tax on nondeductible CFC dividends is

57
not treated as tax imposed by chapter 1 for purposes of computing the AMT imposed by
section 55. For purposes of computing AMT for the election year, the taxpayer’s regular
tax described in section 55(c) does not include the portion of the taxpayer’s pre-credit
regular tax liability that is attributable to nondeductible CFC dividends, and the foreign
tax credit taken into account does not include the portion of the taxpayer’s allowable
foreign tax credit that is attributable to nondeductible CFC dividends. Similarly, the
taxpayer’s tentative minimum tax determined under section 55(b)(1)(B) does not include
the portion of the taxpayer’s tentative minimum tax or alternative minimum tax foreign
tax credit that is attributable to nondeductible CFC dividends. In addition, the deductible
portion of qualifying dividends is not treated as a preference item in computing
alternative minimum taxable income. Accordingly, the additional tax owed by the
taxpayer by reason of the AMT in the election year is the same that would be owed if
the qualifying dividends were not paid. See Examples 1
, 2, 4 and 5 of section 9.06 of
this notice.
.06 Examples
The following examples illustrate the application of section 965(e)(1) and sections
9.04 and 9.05 of this notice.
Example 1.
Calculation of AMT with no foreign tax credit. (i) Facts. For the
election year USP’s taxable income consists of $200x of foreign source general
limitation nondeductible CFC dividends subject to no foreign tax and $400x of U.S.
source income. USP’s pre-credit regular tax liability is $210x (.35 x $600x). USP has
$600x of U.S. source preference items.

(ii) Result
. Taking into account the adjustments required by section 965(e)(1)(B)
for purposes of computing USP’s alternative minimum tax under section 55 in the
election year, USP’s taxable income computed without regard to the $200x of

58
nondeductible CFC dividends is $400x, which would result in a pre-credit regular tax
liability of $140x (.35 x $400x). USP’s alternative minimum taxable income computed
without regard to the $200x of nondeductible CFC dividends is increased by $600x of
preference items from $400x to $1,000x. USP’s tentative minimum tax, computed
without regard to the nondeductible CFC dividends, is $200x (.20 x $1,000x). The
excess of USP’s adjusted tentative minimum tax of $200x over its adjusted regular tax
of $140x results in alternative minimum tax of $60x. USP’s pre-credit tax for the
election year is $270x ($210x of regular tax plus $60x of alternative minimum tax). This
amount is equivalent to 20 percent of $1,000x, USP’s alternative minimum taxable
income exclusive of the nondeductible CFC dividends, plus 35 percent of $200x of
nondeductible CFC dividends.

Example 2
. Alternative minimum tax foreign tax credit. (i) Facts. The facts are
the same as in Example 1, except that instead of $400x of U.S. source income, USP
has $200x of U.S. source income and $200x of other foreign source general limitation
income, and USP’s foreign taxes paid or deemed paid with respect to general limitation
income are $100x, including $20x of foreign tax paid or accrued with respect to the
$200x of nondeductible CFC dividends.

(ii) Result
. As in Example 1, USP’s pre-credit regular tax on $400x of taxable
income in excess of the $200x of nondeductible CFC dividends is $140x and its pre-
credit tentative minimum tax on $1,000x of alternative minimum taxable income in
excess of the nondeductible CFC dividends ($400x plus $600x of preference items) is
$200x. USP’s allowable foreign tax credit computed for regular tax purposes is $90x,
the lesser of $100x, the foreign taxes paid, $140x, the regular section 904 limitation
(($400x FSTI/$600x WWTI) x $210x pre-credit U.S. tax), or $90x, the section 965(e)
limitation ($20x foreign tax on nondeductible CFC dividends + $70x, the limitation on
other income of ($200x FSTI/$400x WWTI) x $140x). The portion of the allowable
regular foreign tax credit that is attributable to the nondeductible CFC dividends is $20x,
the smaller of the $70x pre-credit U.S. tax on the nondeductible CFC dividends (.35 x
$200x) or $20x, the foreign taxes paid or accrued with respect to the nondeductible
CFC dividends. The remaining $70x of the allowable regular foreign tax credit is the
amount attributable to USP’s other foreign source income. Accordingly, USP’s regular
tax described in section 55(c), computed without regard to the tax on nondeductible
CFC dividends, is $70x ($140x regular tax - $70x foreign tax credit).

Computed without regard to section 965(e)(1)(B), USP’s alternative minimum tax
foreign tax credit is $60x, the lesser of $100x, the foreign taxes paid, $80x, the regular
alternative minimum tax foreign tax credit limitation (($400x FSAMTI/$1200x WWAMTI)
x $240x), or $60x, the section 965(e) limitation ($20x + ($200x FSAMTI/ $1000x
WWAMTI) x $200x). The portion of the alternative minimum tax foreign tax credit that is
attributable to nondeductible CFC dividends is $20x, the lesser of $40x, the pre-credit
U.S. alternative minimum tax on the nondeductible CFC dividends (.20 x $200x) or

59
$20x, the foreign taxes paid or accrued with respect to the nondeductible CFC
dividends. The $40x balance of the alternative minimum tax foreign tax credit is
attributable to USP’s other foreign source income.

Accordingly, USP’s tentative minimum tax described in section 55(b)(1)(B),
computed without regard to the tax on nondeductible CFC dividends, is $160x ($200x -
$40x). Under section 55 as modified by section 965(e)(1)(B), USP’s alternative
minimum tax is $90x, the excess of its tentative minimum tax over its regular tax ($160x
- $70x). Accordingly, USP’s tax for the election year is $210x ($210x regular tax on
$600x of taxable income - $90x regular foreign tax credit + $90x alternative minimum
tax). This amount is equivalent to 20 percent of USP’s $1,000x of alternative minimum
taxable income exclusive of the nondeductible CFC dividends less the $40x alternative
minimum tax foreign tax credit on that amount ($200x - $40x), plus 35 percent of $200x
of nondeductible CFC dividends less the $20x regular foreign tax credit on that amount
($70x - $20x).

Example 3
. No AMT; prior year minimum tax credit. (i) Facts. For the election
year USP’s taxable income consists of $200x of foreign source nondeductible CFC
dividends subject to no foreign tax. USP’s pre-credit regular tax liability is $70x (.35 x
$200x). USP has no preference items.

(ii) Result
. Taking into account the adjustments required by section 965(e)(1)(B)
for purposes of computing USP’s alternative minimum tax under section 55 in the
election year, USP’s taxable income computed without regard to the $200x of
nondeductible CFC dividends is $0, which would result in a pre-credit regular tax liability
of $0. USP’s alternative minimum taxable income computed without regard to the
$200x of nondeductible CFC dividends is also $0, so its tentative minimum tax,
computed without regard to the nondeductible CFC dividends, is $0. The excess of
USP’s adjusted tentative minimum tax of $0 over its adjusted regular tax of $0 results in
alternative minimum tax of $0. USP’s pre-credit tax for the election year is $70x ($70x
of regular tax plus $0 alternative minimum tax), equal to 35 percent of $200x of
nondeductible CFC dividends.

For purposes of computing USP’s prior year minimum tax credit under section 53
for the election year, the modifications to section 55 that are required under section
965(e)(1)(B) do not apply. Accordingly, for purposes of computing the limitation of
section 53(c), USP’s regular tax liability is $70x (.35 x $200x of taxable income
including nondeductible CFC dividends), its tentative minimum tax is $40x (.20 x $200x
of alternative minimum taxable income including nondeductible CFC dividends), and the
excess of the regular tax liability over the tentative minimum tax for the election year is
$30x ($70x - $40x). USP may claim a credit under section 53(a) in the election year for
the excess (if any) of its adjusted net minimum tax imposed for all post-1986 taxable
years prior to the election year over the amount allowable as a credit under section

60
53(a) for such prior taxable years, up to the $30x limitation computed under section
53(c).

Example 4
. AMT with no foreign tax credit and prior year minimum tax credit. (i)
Facts
. For the election year USP’s taxable income consists of $200x of foreign source
general limitation nondeductible CFC dividends subject to no foreign tax and $400x of
U.S. source income. USP’s pre-credit regular tax liability is $210x (.35 x $600x). USP
has $350x of U.S. source preference items described in section 57(a)(5).

(ii) Result
. Taking into account the adjustments required by section 965(e)(1)(B)
for purposes of computing USP’s alternative minimum tax under section 55 in the
election year, USP’s taxable income computed without regard to the $200x of
nondeductible CFC dividends is $400x, which would result in a pre-credit U.S. regular
tax liability of $140x (.35 x $400x). USP’s alternative minimum taxable income
computed without regard to the $200x of nondeductible CFC dividends is $750x, taxable
income of $400x increased by $350x of preference items. USP’s tentative minimum
tax, computed without regard to the nondeductible CFC dividends, is $150x (.20 x
$750x). The excess of USP’s adjusted tentative minimum tax of $150x over its adjusted
regular tax of $140x results in alternative minimum tax of $10x. USP’s pre-credit tax for
the election year is $220x ($210x of regular tax plus $10x of alternative minimum tax).
This amount is equivalent to $150x (20 percent of $750x, USP’s alternative minimum
taxable income exclusive of the nondeductible CFC dividends), plus $70x (35 percent of
$200x of nondeductible CFC dividends).

For purposes of computing USP’s prior year minimum tax credit under section 53
for the election year, the modifications to section 55 that are required under section
965(e)(1)(B) do not apply. Accordingly, for purposes of computing the limitation of
section 53(c), USP’s regular tax liability is $210x (.35 x $600x of regular taxable income
including nondeductible CFC dividends), its tentative minimum tax is $190x (.20 x $950x
of alternative minimum taxable income including nondeductible CFC dividends), and the
excess of the regular tax liability over the tentative minimum tax for the election year is
$20x ($210x - $190x). USP may claim a credit under section 53(a) in the election year
for the excess (if any) of its adjusted net minimum tax imposed for all post-1986 taxable
years prior to the election year over the amount allowable as a credit under section
53(a) for such prior taxable years, up to the $20x limitation computed under section
53(c).

Example 5
. AMT with foreign tax credit and prior year minimum tax credit. (i)
Facts
. The facts are the same as in Example 2, except that USP has $200x rather than
$600x of U.S. source preference items.

(ii) Result
. Taking into account the adjustments required by section 965(e)(1)(B)
for purposes of computing USP’s alternative minimum tax under section 55 in the

61
election year, USP’s taxable income computed without regard to the $200x of
nondeductible CFC dividends is $400x, which would result in a pre-credit U.S. regular
tax liability of $140x (.35 x $400x). USP’s pre-credit tentative minimum tax, computed
without regard to the nondeductible CFC dividends, is $120x (.20 x $600x).

USP’s allowable foreign tax credit computed for regular tax purposes is $90x, the
lesser of $100x, the foreign taxes paid, $140x, the regular section 904 limitation (($400x
FSTI/$600x WWTI) x $210x pre-credit U.S. tax), or $90x, the section 965(e) limitation
($20x foreign tax on nondeductible CFC dividends + $70x, the limitation on other
income of (($200x FSTI/$400x WWTI) x $140x). The portion of the allowable regular
foreign tax credit that is attributable to the nondeductible CFC dividends is $20x, the
smaller of the $70x pre-credit U.S. tax on the nondeductible CFC dividends (.35 x
$200x) or $20x, the foreign taxes paid or accrued with respect to the nondeductible
CFC dividends. The remaining $70x of the allowable regular foreign tax credit is the
amount attributable to USP’s other foreign source income. Accordingly, USP’s regular
tax described in section 55(c), computed without regard to the tax on nondeductible
CFC dividends, is $70x ($140x regular tax - $70x foreign tax credit).

Computed without regard to section 965(e)(1)(B), USP’s alternative minimum tax
foreign tax credit is $60x, the lesser of $100x, the foreign taxes paid, $80x, the regular
alternative minimum tax foreign tax credit limitation (($400x FSAMTI/$800x WWAMTI) x
$160x), or $60x, the section 965(e) limitation ($20x + ($200x FSAMTI/ $600x WWAMTI)
x $120x). The portion of the alternative minimum tax foreign tax credit that is
attributable to nondeductible CFC dividends is $20x, the lesser of $40x, the pre-credit
tentative minimum tax on the nondeductible CFC dividends (.20 x $200x) or $20x, the
foreign taxes paid or accrued with respect to the nondeductible CFC dividends. The
$40x balance of the alternative minimum tax foreign tax credit is attributable to USP’s
other foreign source income. Accordingly, USP’s tentative minimum tax described in
section 55(b)(1)(B), computed without regard to the tax on nondeductible CFC
dividends, is $80x ($120x - $40x). Under section 55 as modified by section
965(e)(1)(B), the excess of USP’s tentative minimum tax over its regular tax is $10x
($80x - $70x).

For purposes of computing USP’s prior year minimum tax credit under section 53
for the election year, the modifications to section 55 that are required under section
965(e)(1)(B) do not apply. Accordingly, for purposes of computing the limitation of
section 53(c), USP’s pre-credit regular tax liability is $210x (.35 x $600x of taxable
income including nondeductible CFC dividends) and its pre-credit tentative minimum tax
liability is $160x (.20 x $800x of alternative minimum taxable income including
nondeductible CFC dividends). As described above, USP’s regular and AMT foreign tax
credits are limited under section 965(e) to $90x and $60x, respectively. Therefore, for
purposes of section 53(c) USP’s regular tax liability is $120x ($210x - $90x foreign tax
credit), its tentative minimum tax is $100x ($160x - $60x alternative minimum tax foreign

62
tax credit), and the excess of its regular tax over its tentative minimum tax is $20x
($120x - $100x). USP may claim a credit under section 53(a) in the election year for the
excess (if any) of its adjusted net minimum tax imposed for all post-1986 taxable years
prior to the election year over the amount allowable as a credit under section 53(a) for
such prior taxable years, up to $20x, the limitation computed under section 53(c).

Example 6
. Minimum tax credit after OFL recapture. (i) Facts. The facts are
the same as in Example 5
, except that USP has a pre-2005 general limitation OFL
account of $500x.

(ii) Result
. Under section 904(f)(1), unless USP elects to recapture a larger
percentage of the OFL account, 50 percent or $250x of USP’s $400x of foreign source
general limitation income is recharacterized as U.S. source income. After OFL
recapture USP has $150x of foreign source general limitation income, all attributable to
nondeductible CFC dividends. See section 8.03 of this notice. Pursuant to section 9.02
of this notice, $15x (($150x/$200x) x $20x) of foreign tax is paid or accrued with respect
to the $150x of nondeductible CFC dividends.

Pursuant to sections 9.03 and 9.05 of this notice, for purposes of computing
USP’s alternative minimum tax under section 55 in the election year, USP’s pre-credit
regular tax and pre-credit tentative minimum tax are computed without regard to the
$200x of nondeductible CFC dividends, as determined under section 965(e)(3) without
regard to the recharacterization of $50x of nondeductible CFC dividends as U.S. source
income pursuant to the recapture of USP’s general limitation OFL account under section
904(f) and section 8.03 of this notice. As in Example 5
, USP’s pre-credit regular tax and
pre-credit tentative minimum tax, computed without regard to nondeductible CFC
dividends, are $140x and $120x, respectively.

USP’s allowable foreign tax credit computed for regular tax purposes is $15x, the
lesser of $100x, the foreign taxes paid, $52.50x, the regular section 904 limitation
(($150x FSTI/$600x WWTI) x $210x pre-credit U.S. tax), or $15x, the section 965(e)
limitation ($15x foreign tax on nondeductible CFC dividends + $0, the limitation on other
income of ($0 FSTI/$400x WWTI) x $140x). Pursuant to section 9.03 of this notice, the
portion of the allowable regular foreign tax credit that is attributable to the nondeductible
CFC dividends is $15x, the smaller of the $52.50x pre-credit U.S. tax on the reduced
amount of nondeductible CFC dividends (.35 x $150x) or $15x, the foreign taxes paid or
accrued with respect to the reduced amount of nondeductible CFC dividends.
Therefore, no foreign tax credit is attributable to USP’s other foreign source income.
Accordingly, USP’s regular tax described in section 55(c), computed without regard to
the tax on nondeductible CFC dividends, is $140x ($140x regular tax - $0 foreign tax
credit).

Computed without regard to section 965(e)(1)(B), USP’s alternative minimum tax

63
foreign tax credit is $15x, the lesser of $100x, the foreign taxes paid, $30x, the regular
alternative minimum tax foreign tax credit limitation (($150x FSAMTI/$800x WWAMTI) x
$160x) or $15x, the section 965(e) limitation ($15x + ($0 FSAMTI/ $600x WWAMTI) x
$120x). Pursuant to section 9.03 of this notice, the portion of the alternative minimum
tax foreign tax credit that is attributable to nondeductible CFC dividends is $15x, the
lesser of $30x, the pre-credit tentative minimum tax on the nondeductible CFC
dividends (.20 x $150x) or $15x, the foreign taxes paid or accrued with respect to the
nondeductible CFC dividends. Accordingly, none of the alternative minimum tax foreign
tax credit is attributable to USP’s other foreign source income. Therefore, USP’s
tentative minimum tax described in section 55(b)(1)(B), computed without regard to the
tax on nondeductible CFC dividends, is $120x ($120x tentative minimum tax - $0
alternative minimum tax foreign tax credit). Under section 55 as modified by section
965(e)(1)(B), USP’s regular tax of $140x exceeds its tentative minimum tax of $120x.
Therefore, USP does not owe AMT for the election year.

For purposes of computing USP’s prior year minimum tax credit under section 53
for the election year, the modifications to section 55 that are required under section
965(e)(1)(B) do not apply. Accordingly, for purposes of computing the limitation of
section 53(c), USP’s pre-credit regular tax is $210x (.35 x $600x of taxable income
including nondeductible CFC dividends) and its pre-credit tentative minimum tax is
$160x (.20 x $800x of alternative minimum taxable income including nondeductible CFC
dividends). As described above, USP’s regular and AMT foreign tax credits are limited
under section 965(e) to $15x, all attributable to nondeductible CFC dividends.
Therefore, for purposes of section 53(c) USP’s regular tax liability is $195x ($210x -
$15x foreign tax credit), its tentative minimum tax is $145x ($160x - $15x alternative
minimum tax foreign tax credit), and the excess of its regular tax over its tentative
minimum tax is $50x ($195x - $145x). USP may claim a credit under section 53(a) in
the election year for the excess (if any) of its adjusted net minimum tax imposed for all
post-1986 taxable years prior to the election year over the amount allowable as a credit
under section 53(a) for such prior taxable years, up to $50x, the limitation computed
under section 53(c).

SECTION 10. OTHER GUIDANCE
.01 Application of General Tax Law Principles

Unless otherwise specifically provided, general tax law principles, including the
circular cash flow, step-transaction, and substance-over-form doctrines, apply for
purposes of determining the federal income tax consequences of transactions

64
undertaken in connection with section 965. For example, assume USP, a domestic
corporation, wholly owns CFC1 which, in turn, wholly owns CFC2. If CFC2 declares a
dividend and CFC1 declares a dividend of the same amount, and, at the direction of
CFC1, CFC2 pays the amount of its dividend in cash directly to USP, then under
applicable Code provisions, including section 965, such payment shall be treated as a
distribution of cash from CFC2 to CFC1, followed by a distribution of cash from CFC1 to
USP. See, e.g., Rev. Rul. 80-292, 1980-2 C.B. 104.
.02 Base Period Inclusions under Section 965(b)(2)(B)
In computing a taxpayer’s base period amount, section 965(b)(2)(B)(i) includes
dividends described in section 965(c)(3) that were received during each base period
year from CFCs, section 965(b)(2)(B)(ii) includes amounts includible in gross income for
each base period year under section 951(a)(1)(B) with respect to CFCs, and section
965(b)(2)(B)(iii) includes amounts that would have been included for each base period
year but for section 959(a). For this purpose, dividends received from CFCs by a
disregarded entity or a partnership owned by a U.S. shareholder during a base period
year shall be treated as received by such U.S. shareholder to the extent the dividend
was included in income shown on the U.S. shareholder’s return described in section
965(b)(2) for the base period year, regardless of whether cash or property in the amount
of the dividend was received by the shareholder in the base period year. In addition, for
purposes of section 965(b)(2)(B), amounts includible under section 951(a)(1)(B) (or that
would have been so included but for section 959(a)) in gross income of a domestic
partnership that was owned by a U.S. shareholder during a base period year shall be

65
treated as includible in the U.S. shareholder’s income under section 951(a)(1)(B), or
excluded under section 959(a), to the extent the includible amount was (i) allocated to
the U.S. shareholder-partner under the rules of sections 702 and 704 and the
regulations thereunder in a base period year; and (ii) separately stated to the partner
under Treas. Reg. §1.702-1(a)(8)(ii).
.03 Allocation of $500 Million Limitation—Clarification of Section 4.05 of Notice 2005-38
Section 4.05 of Notice 2005-38 provides that the $500 million limitation on
qualifying dividends described in section 965(b)(1)(A) is allocated among the qualified
members of a section 52(a) group in proportion to the aggregate amount of total current
and accumulated non-previously-taxed earnings and profits of all CFCs owned (within
the meaning of section 958(a)) by such qualified members, determined with reference to
the earnings and profits appropriately reported on Schedule J of the last Form 5471 filed
on or before the apportionment date. For this purpose, the amount of non-PTI earnings
and profits of a CFC taken into account by a qualified member is that member’s pro rata
share of the CFC’s earnings and profits, determined in accordance with section
951(a)(2) for the year for which Form 5471 was filed.
.04 Effect of Restatement of Certified Financial Statement
A restatement of a previously filed and certified financial statement described in
section 965(c)(1) that occurs after June 30, 2003, does not alter the statement’s status
as having been filed and certified on or before June 30, 2003. In such a case, the
limitations described in section 965(b)(1)(B) and (C) are the amount of earnings
permanently reinvested outside the United States, and a specific amount of tax liability,

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respectively, that are shown on the statement as originally filed, not the amounts shown
on the restatement.
.05 Definition of United States
For purposes of section 965, the term “United States” includes the 50 states, the
District of Columbia, the territorial waters of the United States, and the seabed and
subsoil of those submarine areas that are adjacent to the territorial waters of the United
States and over which the United States has exclusive rights, in accordance with
international law, with respect to the exploration and exploitation of natural resources.
The term “United States” does not include possessions and territories of the United
States or the airspace over the United States and these areas.
.06 Treatment of Accounts Payable Resulting from Section 482 Adjustments
Accounts payable established under Rev. Proc. 99-32, 1999-2 C.B. 296, in
connection with section 482 adjustments are treated as indebtedness for purposes of
section 965(b)(3).
.07 Exceptions to Related Party Indebtedness for Certain Ordinary Course
Transactions of Banks and Dealers in Securities—Addition to Section 7.02 of Notice
2005-38
For purposes of section 965(b)(3), the term “indebtedness” does not include
indebtedness of a CFC arising in the ordinary course of business as a bank or as a
dealer in securities that would not be treated as U.S. property under section
956(c)(2)(A)(i), (J), (K), or (L) were it an obligation of a United States person (and not of
the CFC). For purposes of applying the exception under section 956(c)(2)(A)(i), a

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“bank” is a CFC that meets the definition of a bank in section 585(a)(2)(B), without
regard to the second sentence thereof, and without regard to whether the CFC is
engaged in a U.S. trade or business, provided that the CFC operates under the laws of
the foreign jurisdiction where it is engaged in business and is subject to supervision and
examination by an authority having supervision over banking institutions in that
jurisdiction (in lieu of supervision by a Federal or State supervisory authority).
.08 Intercompany Trade Payables--Modification of Section 7.02 of Notice 2005-38
For purposes of section 965(b)(3), in addition to the exceptions described in
section 7.02 of Notice 2005-38 and section 10.07 of this notice, the term “indebtedness”
does not include indebtedness of a CFC arising in the ordinary course of a business
from licenses, provided that such indebtedness is actually paid within 183 days.
.09 Distributions to Intermediary Partnerships—Clarification of Section 3.02 of Notice
2005-10 and Section 9.06 of Notice 2005-38
Section 3.02 of Notice 2005-10 provides that for purposes of section 965(a), a
cash dividend paid by a CFC to a pass-through entity that is owned by a U.S.
shareholder is treated as received by such U.S. shareholder only if and to the extent
that such shareholder receives a cash distribution in the amount of the CFC dividend
during the election year. Section 9.06 of Notice 2005-38 provides a limited exception to
the general cash distribution requirement with respect to cash dividends paid to a
disregarded entity. This limited exception does not apply to cash dividends paid to a
partnership. Therefore, a cash dividend paid by a CFC to a partnership that is owned
by a U.S. shareholder is treated as received by such U.S. shareholder only if and to the

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extent the partnership distributes cash to the shareholder-partner in the election year.
For this purpose, a distribution of cash does not include a guaranteed payment, as
defined in section 707(c), or a payment made to the shareholder other than in its
capacity as a member of the partnership.
.10 Domestic Reinvestment Plans—Clarification of Section 4.01 of Notice 2005-10
Section 965(b)(4)(B) provides that section 965(a) shall not apply to any dividend
received by a U.S. shareholder unless the amount of the dividend is invested in the
United States pursuant to a domestic reinvestment plan which provides for the
reinvestment of such dividend in the United States. Section 4.01 of Notice 2005-10
provides that a taxpayer may adopt separate domestic reinvestment plans to apply to
different cash dividends made during the election year. A taxpayer may, but is not
required to, adopt a domestic reinvestment plan that provides for the reinvestment of
cash dividends only from specified CFCs, to the extent of the dollar amounts of
anticipated investments that are specified in the plan in accordance with section 4.03 of
Notice 2005-10. In this situation, cash dividends from other CFCs in the election year
that are not covered by another domestic reinvestment plan will not be subject to the
section 965(a) DRD or to the disallowance of deductions and credits under section
965(d), even if the dollar amount of cash dividends from the specified CFCs is less than
the total dollar amount of anticipated investments specified in the plan and if the
taxpayer in fact expends the total dollar amount specified in the plan on permitted
investments. On the other hand, a taxpayer may not choose to claim the section 965(a)
DRD with respect to less than all of the qualifying dividends that are covered by a

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domestic reinvestment plan, assuming that all such amounts are properly reinvested in
accordance with the plan and that all the other requirements under section 965 are
satisfied. For example, assume that USP wholly owns CFC1 and CFC2. USP properly
adopts a domestic reinvestment plan that provides for the reinvestment of up to $10
million of qualifying dividends in the United States. During the election year CFC1 pays
qualifying dividends of $8 million, CFC2 pays qualifying dividends of $2 million, USP
invests at least $10 million in permitted investments, and all the other requirements of
section 965 are met. Unless the plan provides only for the reinvestment of qualifying
dividends from either CFC1 or CFC2, the entire $10 million of qualifying dividends is
subject to section 965.
.11 Qualified Plan Funding--Clarification of Section 5.05(b) of Notice 2005-10
Section 5.05(b) of Notice 2005-10 provides, in part, that the satisfaction of an
obligation to fund a qualified plan ordinarily will contribute to the financial stabilization of
the taxpayer. For this purpose, contributions to a qualified pension plan that do not give
rise to excise tax under section 4972 (which imposes a tax on certain nondeductible
pension contributions) will be considered to satisfy an obligation to fund a qualified plan
even if those contributions are not currently deductible.
Contributions to a qualified
profit sharing or stock bonus plan also qualify for this purpose if those contributions to
the plan are required under a fixed contribution formula provided under the terms of the
plan. Contributions to a qualified profit sharing or stock bonus plan do not qualify if
contributions to the plan are made on a discretionary basis.

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SECTION 11. TRANSITION RULES
.01 Domestic Reinvestment Plans Approved Prior to August 19, 2005
If a domestic reinvestment plan is approved prior to August 19, 2005, the
taxpayer may modify such plan to take into account the guidance herein not later than
October 19, 2005, even if the dividend to which the domestic reinvestment plan relates
has already been paid. Any plan that is so modified must be subsequently approved by
the taxpayer’s president, chief executive officer, or comparable official and by the
taxpayer’s board of directors, management committee, executive committee, or similar
body.
.02 Tax Returns Filed Prior to August 19, 2005
If, prior to August 19, 2005, a taxpayer has filed its tax return for the taxable year
to which it elects section 965 to apply, such taxpayer may revise its computations or
annual reporting to conform to the guidance in this notice on an amended tax return that
is filed by December 31, 2005.

SECTION 12. EFFECT ON OTHER DOCUMENTS
Sections 10.09, 10.10, and 10.11 of this notice clarify sections 3.02, 4.01, and
5.05(b), respectively, of Notice 2005-10. Section 10.03 of this notice modifies section
4.05, section 10.09 clarifies section 9.06, and section 10.07 makes an addition to and
section 10.08 modifies section 7.02, of Notice 2005-38. See also section 11 of this
notice, pursuant to which domestic reinvestment plans approved prior to August 19,
2005 (including domestic reinvestment plans adopted or modified pursuant to the

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guidance included in Notice 2005-10 and Notice 2005-38), may be modified to take into
account the guidance in this notice.

SECTION 13. EFFECTIVE DATE
This notice is effective for taxable years ending on or after October 22, 2004.

SECTION 14. PAPERWORK REDUCTION ACT
The collections of information contained in this notice have been reviewed and
approved by the Office of Management and Budget in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number
1545-1957.
An agency may not conduct or sponsor, and a person is not required to respond
to, a collection of information unless the collection of information displays a valid control
number.
The collections of information are in sections 3 and 11 of this notice. This
information is required to provide the IRS sufficient information to determine whether a
taxpayer has properly elected to apply section 965 to a taxable year and whether the
taxpayer has properly calculated its taxable income and allowable credits with respect to
qualifying dividends, taking into account the limitations imposed by sections 965(d) and
(e). The collections of information are required to obtain the benefit of section 965 for a
taxable year. The likely respondents are business corporations.
Estimated total annual reporting and/or recordkeeping burden: 250,000 hours.
Estimated average annual burden hours per respondent: 10 hours.

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Estimated number of respondents: 25,000.
Estimated annual frequency of responses: once.
The collections of information contained in this notice have been submitted to the
Office of Management and Budget for review in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collections of information
should be received by October 19, 2005. Comments are specifically requested
concerning:
Whether the proposed collections of information are necessary for the proper
performance of the functions of the Internal Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the proposed collections
of information (see below);
How the quality, utility, and clarity of the information to be collected may be
enhanced;
How the burden of complying with the proposed collections of information may be
minimized, including through the application of automated collection techniques or other
forms of information technology; and
Estimates of capital or start-up costs and costs of operation, maintenance, and
purchase of services to provide information.
Comments concerning the accuracy of the burden estimate and suggestions for
reducing the burden of the final or temporary regulations should be sent to the Office of
Management and Budget, Attn: Desk Officer for the Department of the Treasury,

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Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP,
Washington DC 20224.
Books or records relating to a collection of information must be retained as long
as their contents may become material in the administration of any internal revenue law.
Generally, tax returns and tax return information are confidential, as required by 26
U.S.C. 6103.

SECTION 15. DRAFTING INFORMATION

The principal author of this notice is Barbara Allen Felker of the Office of
Associate Chief Counsel (International). However, other personnel from the IRS and the
Treasury Department participated in its development. For further information regarding
this notice contact Ms. Felker or Michael Gilman at (202) 622-3850 (not a toll-free call).