n-05-38.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Section 965 -- Limitations on dividends received deduction and other guidance

Notice 2005-38
SECTION 1. OVERVIEW
This notice is the second in a series of items of published guidance regarding
new section 965 of the Internal Revenue Code (Code). It supplements guidance
previously set forth in Notice 2005-10, 2005-6 I.R.B. 1, which primarily addressed
requirements regarding a domestic reinvestment plan described in section 965(b)(4).
This notice primarily addresses the limitations, described in section 965(b)(1), (2), and
(3), on the amount of dividends that a corporation that is a U.S. shareholder of a
controlled foreign corporation may treat as eligible for the dividends received deduction
under section 965(a) (DRD or section 965(a) DRD), including the effects of certain
transactions on such limitations.
The Treasury Department and the Internal Revenue Service (IRS) intend to issue
additional guidance concerning section 965 to address certain issues arising with
respect to a U.S. corporation’s computation of its tax liability, including the availability of
foreign tax credits, when section 965 is applied. The Treasury Department and the IRS
expect to issue regulations that incorporate the guidance provided in Notice 2005-10,
this notice, and any subsequent guidance addressing section 965.

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The remainder of this notice is divided into 14 sections. Section 2 provides
background with respect to the issues addressed in this notice. Section 3 sets forth
general principles that apply in determining the amount of cash dividends received by a
U.S. shareholder that is considered extraordinary for purposes of section 965(b)(2).
Section 4 sets forth general principles that apply in determining the maximum amount of
dividends eligible under section 965(b)(1) to be taken into account under section 965(a).
Section 5 addresses the taxable year to which section 965 applies. Section 6 then
addresses the effects of certain transactions on the determination of a U.S.
shareholder’s limitations determined under sections 3 and 4. Section 7 sets forth
guidance and principles for determining under section 965(b)(3) the amount of related
party indebtedness that reduces the amounts taken into account under section 965(a),
including special adjustments made as a result of certain transactions. Section 8
provides guidance regarding the impact of certain transactions on domestic
reinvestment plans. Section 9 addresses other issues arising under section 965,
including the application of section 78, the expenses disallowed under section 965(d)(2),
and the computation of the alternative minimum tax. Section 10 addresses reporting
and other administrative requirements. Section 11 sets forth transition rules that apply
to certain taxpayers that, prior to the issuance of this notice, either adopted a domestic
reinvestment plan or filed a tax return for a taxable year to which section 965 applies.
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

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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. No. 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 of a controlled foreign corporation (CFC) may elect, for one taxable year,
an 85 percent DRD with respect to certain cash dividends it receives from its CFCs.
Section 951(b) defines the term “U.S. shareholder” with respect to any foreign
corporation as a U.S. person who owns (within the meaning of section 958(a)), or is
considered to own (under the constructive ownership rules 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 965(c)(5)(A) provides that 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. For purposes of this notice, the term
“U.S. shareholder” means, unless otherwise indicated, a domestic corporation that, at
any time after the beginning of the base period (defined below), is a U.S. shareholder
(as defined in section 951(b)) with respect to a CFC and that owns (within the meaning
of section 958(a)) stock of such CFC.
For purposes of section 965, the term “dividends” includes cash amounts
included in gross income as dividends under sections 302 and 304, but does not include

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amounts treated as dividends under section 78 or 1248 or, in certain cases, section
367.
1
H.R. Conf. Rep. No. 108-755, at 314-15 (2004). Also for this purpose, a cash
dividend includes a cash distribution from a CFC that is excluded from gross income
under section 959(a) (regarding distributions of previously taxed income (PTI)) to the
extent of inclusions 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(b) imposes four limitations on the section 965(a) DRD. These
limitations are discussed in detail below in paragraphs .02 through .05 of this section.
Section 965(d) and (e) provide special rules that limit the use of foreign tax
credits and the deduction of certain expenses to offset the nondeductible portion of
section 965(a) dividends, respectively. See section 9.01 of this notice. These rules will
be addressed in greater detail in a subsequent notice that the Treasury Department and
the IRS expect to issue soon.
Section 965(f) provides that taxpayers may elect the application of section 965

1
Dividends resulting from liquidations qualifying under section 332 to which section 367(b) applies qualify
as cash dividends to the extent the U.S. shareholder actually receives cash as part of the liquidation.
Section 965(c)(3). A deemed liquidation effectuated through an election under Treas. Reg. §301.7701-
3(c), however, does not by itself result in an actual distribution of cash as required under section 965. See
H.R. Conf. Rep. No. 108-755, at 315, n. 108 (2004).

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for either the taxpayer’s last taxable year which begins before October 22, 2004, or the
taxpayer’s first taxable year which begins during the one-year period beginning on
October 22, 2004. The election must be made on or before the taxpayer’s due date
(including extensions) for filing its Federal income tax return. See Notice 2005-10; see
also H.R. Conf. Rep. No. 108-755, at 314, n. 107 (2004). The taxable year for which a
taxpayer elects to apply section 965 will be referred to in this notice as the “election
year.”
.02 Extraordinary Dividends
Section 965(b)(2) provides that only those cash dividends (within the meaning of
section 965(a)) received from CFCs during the U.S. shareholder’s election year that are
considered “extraordinary” are eligible for the section 965(a) DRD. Cash dividends
received by the U.S. shareholder during the election year are considered extraordinary
only to the extent such dividends exceed the annual average for the base period years
of the following items reported on the U.S. shareholder’s tax return as filed (including
any amended returns that were filed on or before June 30, 2003): (1) dividends received
during each base period year by such shareholder from CFCs
2
; (2) amounts includible
in such shareholder’s gross income for each base period year under section
951(a)(1)(B) (regarding investments in United States property under section 956) with
respect to CFCs; and (3) amounts that would have been included for each base period

2
For this purpose, both cash and non-cash dividends received are taken into account. See section
965(b)(2)(B)(i).

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year but for section 959(a) with respect to CFCs.
3

The term “base period” in this notice means the five most recent taxable years of
the U.S. shareholder that end on or before June 30, 2003. The term “base period
inclusion” in this notice means any amount described in (1), (2), or (3) of the preceding
paragraph, for any of the U.S. shareholder’s taxable years in the base period. Under
section 965(c)(2)(A), the term “base period years” generally includes only three taxable
years in the U.S. shareholder’s base period, determined by disregarding the years in the
base period for which the base period inclusions are the highest and the lowest.
However, if the taxpayer has fewer than five taxable years ending on or before June 30,
2003, then all taxable years ending on or before that date are considered base period
years. The average of the U.S. shareholder’s base period inclusions for its base period
years is referred to in this notice as the “base period amount.”
Section 965(c)(2)(C)(i) sets forth a general rule applicable to companies entering
and exiting corporate groups, which provides that for purposes of determining the base
period inclusions (and ultimately the base period amount), rules similar to the rules of
section 41(f)(3)(A) and (B) apply. Section 41 generally provides for an incremental
credit for qualified research activities, but only to the extent that current year research
expenditures exceed the base amount for that year. For purposes of section 41, the
base amount is computed by multiplying a measure of the taxpayer’s qualified research

3
For this purpose, distributions of PTI for any base period year do not include distributions excluded from
gross income by reason of an amount described in section 965(b)(2)(B)(ii) (relating to investments in
United States property) with respect to a prior taxable year.

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expenses during a specified historical period by its average annual gross receipts for
the four years immediately preceding the credit year. Section 41(f)(3)(A) and (B)
generally provide that, as a result of certain acquisitions and dispositions, a taxpayer
may increase or decrease the amount of its qualified research expenses and gross
receipts to the extent that such amounts are attributable to the acquired or disposed of
portion of a trade or business of the taxpayer.
In addition to the general references to section 41(f)(3)(A) and (B), section
965(c)(2)(C)(ii) provides a special rule for distributions during the base period of stock of
a U.S. shareholder to which section 355 (or so much of section 356 that relates to
section 355) applies. Under this special rule, the U.S. shareholder, the stock of which is
distributed, is treated as having been in existence for the same period that the
distributing corporation has been in existence. Further, the base period inclusions of
the distributing and controlled corporations prior to the distribution are, in general,
allocated between such corporations on the basis of their respective interests in the
CFCs giving rise to such inclusions immediately after such distribution. Section
965(c)(2)(C)(ii) also provides that this rule does not apply if neither the controlled
corporation nor the distributing corporation is a U.S. shareholder of such CFCs
immediately after the distribution.
.03 Maximum Amount Eligible for Section 965(a) -- Greater of $500 Million or
Permanently Reinvested Earnings
Section 965(b)(1) limits the amount of dividends eligible for the section 965(a)

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DRD to the greatest of the following three amounts: (1) $500 million ($500 million
limitation); (2) the amount shown on the taxpayer’s applicable financial statement as
earnings permanently reinvested outside the United States; or (3) in the case of an
applicable financial statement that does not show a specific amount of earnings
permanently reinvested outside the United States but that does show a specific amount
of tax liability attributable to such earnings, the amount of such liability divided by 0.35.
If the applicable financial statement does not show a specific earnings or tax liability
amount, then the $500 million limitation applies. The section 965(b)(1) amount shown
on the taxpayer’s applicable financial statement as earnings permanently reinvested
outside the United States and the amount shown as a specific amount of tax liability
attributable to such earnings divided by 0.35 is referred to in this notice as “APB 23
limitation.”
Under section 965(c)(1), the term “applicable financial statement” means the
most recently audited financial statement (including notes and other documents which
accompany such statement) which is certified on or before June 30, 2003, as being
prepared in accordance with generally accepted accounting principles, and which is
used for the purposes of a statement or report to creditors or shareholders or for any
other substantial nontax purpose. If the taxpayer is required to file with the Securities
and Exchange Commission, the audited financial statement must be so filed on or
before June 30, 2003, to qualify as an applicable financial statement. The legislative
history states:

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[APB 23 limitation] refers to elements of Accounting Principles Board Opinion 23
(“APB 23”), which provides an exception to the general rule of comprehensive
recognition of deferred taxes for temporary book-tax differences. The exception
is for temporary differences related to undistributed earnings of foreign
subsidiaries and foreign corporate joint ventures that meet the indefinite reversal
criterion in APB 23.

H.R. Conf. Rep. No. 108-755, at 315, n. 111 (2004). The last day covered by the
applicable financial statement is referred to in this notice as the “APB 23 determination
date.”
Section 965(c)(5) provides special rules for applying section 965 to controlled
groups of corporations. First, section 965(c)(5)(B) provides that all corporations treated
as a single employer under section 52(a) (section 52(a) group) are limited to one $500
million limitation, and the limitation must be divided among such corporations under
regulations prescribed by the Secretary. A section 52(a) group includes all corporations
that are members of a controlled group of corporations within the meaning of section
1563(a) substituting, however, “more than 50 percent” for “at least 80 percent”
throughout section 1563(a)(1), and making the determination without regard to section
1563(a)(4) and (e)(3)(C). Second, section 965(c)(5)(C) provides that if a financial
statement is an applicable financial statement for more than one U.S. shareholder, APB
23 limitation is divided among such shareholders under regulations prescribed by the
Secretary.
.04 Increase in Related Party Indebtedness
Section 965(b)(3) provides that the amount of a U.S. shareholder’s dividends
otherwise eligible for the deduction under section 965(a) are reduced by any increase in

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the indebtedness of the CFC to any related person (as defined in section 954(d)(3))
between October 3, 2004, and the close of the taxable year for which the election under
section 965 is in effect. For this purpose, all CFCs with respect to which the taxpayer is
a U.S. shareholder are treated as a single CFC and, therefore, indebtedness between
CFCs is disregarded for this purpose. See H.R. Conf. Rep. No. 108-755, at 314, n. 109
(2004). Section 965(b)(3) is intended to prevent a deduction from being claimed with
respect to a section 965 dividend where the dividend is financed, directly or indirectly,
by the U.S. shareholder. In such a case, there may be no net repatriation of funds, and
thus it is inappropriate to allow a deduction under section 965(a). H.R. Conf. Rep. No.
108-755, at 315 (2004).
.05 Investment in the United States Pursuant to a Domestic Reinvestment Plan
Section 965(b)(4) requires a U.S. shareholder claiming a section 965(a) DRD
with respect to a dividend to invest the amount of the dividend in the United States
pursuant to a domestic reinvestment plan. The domestic reinvestment plan must be
approved by the taxpayer’s president, chief executive officer, or comparable official
before the payment of the dividend and subsequently approved by the taxpayer’s board
of directors, management committee, executive committee, or similar body. The
domestic reinvestment plan must provide for the investment of the dividend in the
United States (other than as a payment for executive compensation), including as a
source for the funding of worker hiring and training, infrastructure, research and
development, capital investments, or the financial stabilization of the corporation for the

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purposes of job retention or creation. This list is not intended to be exclusive. H.R.
Conf. Rep. No. 108-755, at 316 (2004). For additional guidance with respect to
domestic reinvestment plans, see sections 8 and 9 of this notice and Notice 2005-10.
SECTION 3. BASE PERIOD AMOUNT -- GENERAL PRINCIPLES
.01 Determination of Base Period Amount
(a) In general. A U.S. shareholder determines its base period inclusions and its
base period amount by applying the rules of section 965(b)(2)(B) and (c)(2) with respect
to CFCs for which it was a U.S. shareholder at any time during its base period.
(b) Consolidated groups. A consolidated group
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determines its base period
inclusions by first aggregating the base period inclusions of each of the members in its
group. It then determines its base period amount by determining the average of such
inclusions as provided under section 965(b)(2)(B) and (c)(2).
(c) Short taxable years. Taxable years of fewer than 12 months are taken into
account as taxable years for purposes of determining the base period years pursuant to
section 965(c)(2). In addition, base period inclusions in a taxable year of fewer than 12
months are not annualized or otherwise adjusted for purposes of calculating the base
period amount.
(d) Intermediary pass-through entities. The Treasury Department and the IRS
expect to issue guidance soon on the treatment of distributions to intermediary pass-

4
The terms “consolidated group,” “member,” “subsidiary,” and “separate return year” are defined in Treas.
Reg. §1.1502-1. In addition, the term “member” also refers, when the context so requires, to a member of
a section 52(a) group.

12
through entities owned by U.S. shareholders for purposes of section 965(b)(2)(B)(i).
(e) Example. The following example illustrates the application of section
965(b)(2) and this section 3.01.
Example
. (i) Facts. USP is the common parent of a consolidated group that
includes USP’s wholly owned subsidiaries US1 and US2. US1 and US2 each wholly
owns a foreign corporation, CFC1 and CFC2, respectively. The USP consolidated
group maintains a taxable year ending July 31. US1 received a $100x dividend from
CFC1 in each of the consolidated taxable years ending July 31, 1996, 1997, and 1998.
US2 received a dividend from CFC2 during each of the consolidated taxable years
ending July 31, 1998, 1999, 2000, 2001, 2002, and 2003 in the amount of $150x,
$150x, $200x, $100x, $50x, and $100x, respectively.

(ii) Result
. USP first determines the base period inclusions of US1 and US2 to
determine the consolidated group’s base period inclusions. Pursuant to section
965(c)(2), the base period includes the five most recent taxable years of the USP group
that ended on or before June 30, 2003, which are the group’s taxable years ending July
31, 1998 (year 1) through July 31, 2002 (year 5). Accordingly, USP will have base
period inclusions as follows:

Taxable year ending
USP group base period inclusions

July 31, 1998 $250x
July 31, 1999 $150x
July 31, 2000 $200x
July 31, 2001 $100x
July 31, 2002 $50x

To determine its base period years pursuant to section 965(c)(2), USP
disregards the taxable years in its base period with the highest and lowest base period
inclusions, which are 1998 ($250x) and 2002 ($50x). To determine it base period
amount, USP then averages the base period inclusions for the remaining three taxable
years (that is, the base period years). Therefore, USP’s base period amount is $150x
(($150x + $200x + 100x)/3).

.02 Translation of Previously Taxed Income Distributed During the Base Period
For purposes of determining the dollar amount of base period inclusions
attributable to distributions of PTI described in section 965(b)(2)(B)(iii), distributions of

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foreign currency are valued by multiplying the distributing CFC’s foreign currency
amount of the PTI distribution by the spot rate (as defined in Treas. Reg. §1.988-
1(d)(1)) on the date of distribution.
SECTION 4. MAXIMUM AMOUNT ELIGIBLE FOR SECTION 965(a) -- GENERAL
PRINCIPLES
.01 Applicable Financial Statement
As noted above, the amount of dividends eligible for the section 965(a) DRD may
be limited by section 965(b)(1)(B) or (C) to either: (1) the amount shown on the
taxpayer’s applicable financial statement as earnings permanently reinvested outside
the United States; or (2) in the case of an applicable financial statement that does not
show a specific amount of earnings permanently reinvested outside the United States
but that does show a specific amount of tax liability attributable to such earnings, the
amount of such liability divided by 0.35. Also as noted above, the term “applicable
financial statement” means the most recently audited financial statement (including
notes and other documents which accompany such statement) which is certified on or
before June 30, 2003, as being prepared in accordance with generally accepted
accounting principles, and which is used for the purposes of a statement or report to
creditors or shareholders or for any other substantial nontax purpose. For purposes of
determining an amount shown on a taxpayer’s applicable financial statement pursuant
to section 965(b)(1)(B) or (C), the parenthetical reference to notes and other documents
accompanying the statement only includes notes and documents that form an integral

14
part of the financial statement; it does not include work papers or other materials
underlying or supporting the statement.
.02 Determination of APB 23 Limitation of a U.S. Shareholder
For purposes of section 965(b)(1)(B) and (C), the specific amount shown on the
applicable financial statement that reflects the amount determined under paragraph 12
of APB 23 (or, in the case of section 965(b)(1)(C), a specific amount of tax liability) and
that is disclosed as required under Financial Accounting Standards Board Statement
109, is treated as an amount of earnings permanently reinvested outside the United
States (or, the amount of tax liability attributable to such earnings), regardless of the
specific language used to describe such specific amount on the applicable financial
statement.
.03 Amount of Tax Liability Attributable to Earnings Permanently Reinvested
If an applicable financial statement fails to show a specific amount of earnings
permanently reinvested outside the United States, but instead shows a specific amount
of tax liability attributable to such earnings, the APB 23 limitation under section
965(b)(1)(C) is the specific amount of such tax liability divided by 0.35. This amount
may not be adjusted (for example, to take into account the foreign taxes imposed on
such earnings).
The following example illustrates the application of section 965(b)(1)(C) and this
section 4.03.
Example
. (i) Facts. A CFC has earnings permanently reinvested outside the
United States that have been subject to foreign tax of $10x. The applicable financial

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statement of the U.S. shareholder that wholly owns such CFC does not show a specific
amount of earnings permanently reinvested outside the United States, but instead
shows a $25x tax liability attributable to such earnings.

(ii) Result
. Although the applicable financial statement of the U.S. shareholder
does not show an amount of permanently reinvested earnings, it does show a tax
liability of $25x attributable to earnings permanently reinvested. Thus, the amount
described in section 965(b)(1)(C) is $71.4x ($25x/0.35). This amount may not be
adjusted to take into account the foreign taxes imposed on such earnings.

.04 Allocation of APB 23 Limitation
As noted above, section 965(c)(5)(C) provides that if a financial statement is an
applicable financial statement for more than one U.S. shareholder, APB 23 limitation is
divided among such shareholders under regulations prescribed by the Secretary. In
such a case, the portion of the APB 23 limitation allocated to the U.S. shareholder is the
amount from the separate company financial statements (or supporting work papers) of
such U.S. shareholder that were prepared in connection with determining the amount
described in section 965(b)(1)(B) or (C) shown on the applicable financial statement that
included such U.S. shareholder.
Section 965(c)(5)(C) contemplates not only the situation where the financial
statement reflects the operations of affiliated corporations that are not consolidated for
tax purposes (for example, a U.S. corporation and a domestic subsidiary thereof that
elects to apply section 936), but also the situation where the financial statement reflects
the operations of corporations that were formerly affiliated and/or consolidated but are
not in such relationship during a section 965 election year. See section 6 of this notice
for rules regarding the allocation of APB 23 limitation in such a case.

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The following example illustrates the application of section 965(b)(1) and this
section 4.04.
Example
. (i) Facts. USP is a domestic corporation that files a consolidated return
with its wholly-owned subsidiaries US1 and US2. USP also wholly owns US3, which
does not join in the USP consolidated return because an election under section 936 is in
effect with respect to US3. US1, US2 and US3 each wholly owns a foreign corporation,
CFC1, CFC2 and CFC3, respectively. Even though US3 is not part of the USP
consolidated group for U.S. tax purposes, US3 is consolidated with USP, US1, and US2
for financial accounting purposes. On USP’s applicable financial statement, USP
reported $350x of earnings permanently reinvested outside the United States. The
separate company financial statements of US1, US2, and US3 that were used in
preparing the USP applicable financial statement reported earnings permanently
reinvested by CFC1, CFC2 and CFC3 to be $100x, $50x and $200x, respectively.

(ii) Result
. The portion of the USP APB 23 limitation allocated to US1, US2, and
US3 is that portion reflected on the separate company financial statements (or
supporting work papers) of US1, US2 and US3 that were used in determining the USP
APB 23 limitation on its applicable financial statement. Thus, US1 is allocated $100x,
US2 is allocated $50x, and US3 is allocated $200x of the $350x APB 23 limitation.
Because US1 and US2 are members of the USP consolidated group and such group is
treated as one U.S. shareholder, the USP consolidated group’s APB 23 limitation equals
$150x ($50x + $100x).

.05 Allocation of $500 Million Limitation
As noted above, section 965(c)(5)(B) provides that all corporations which are
included in a section 52(a) group are limited to one $500 million limitation, which is
divided among such corporations under regulations prescribed by the Secretary. Each
qualified member of a section 52(a) group is allocated a portion of the section 52(a)
group’s single $500 million limitation if it is a qualified member on the last day of the
election year of the qualified member with the last election year to end (apportionment
date). A “qualified member” is either: (1) a domestic corporation that files a separate tax
return and is a member of a section 52(a) group; or (2) a consolidated group that is part

17
of a section 52(a) group. Accordingly, if a consolidated group is not a part of a section
52(a) group, it has its own $500 limitation, and, if a consolidated group is part of a
section 52(a) group, the portion of the $500 million allocated to the consolidated group
is not further allocated between and among the members of the consolidated group.
The section 52(a) group’s single $500 million limitation is allocated to all qualified
members in proportion to the aggregate amount of total current and accumulated
earnings and profits that are not previously taxed (non-PTI earnings and profits) of all
CFCs owned (within the meaning of section 958(a)) by such qualified members. For
purposes of this rule, a consolidated group is treated as owning CFCs within the
meaning of section 958(a), if any member of the group owns CFCs within the meaning
of section 958(a). The amount of non-PTI earnings and profits of a CFC owned (within
the meaning of section 958(a)) by a qualified member is the sum of the amounts of
earnings and profits of such CFC appropriately reported on Schedule J, items 7(a) and
7(b), of the last Form 5471 filed by or on behalf of such qualified member on or before
the apportionment date with respect to such CFC, translated into U.S. dollars at the
average exchange rate for the CFC’s taxable year (see section 989(b)(3)).
The following example illustrates the application of section 965(b)(1) and the
rules of this section 4.05.
Example
. (i) Facts. FP, a foreign corporation, wholly owns two domestic
corporations, US1 and US2. US1 and US2 each wholly owns a foreign corporation,
CFC1 and CFC2, respectively. US1 and US2 each has a taxable year ending July 31,
and they each make an election under section 965 for the taxable year ending July 31,
2006. US1 and US2 have APB 23 limitations of zero. On US1’s last Form 5471 filed on
or before the July 31, 2006 apportionment date with respect to CFC1, US1 reported an

18
amount of non-PTI earnings and profits for CFC1, translated into U.S. dollars using the
average exchange rate, of $100x. On US2’s last Form 5471 filed on or before the July
31, 2006 apportionment date with respect to CFC2, US2 reported an amount of non-PTI
earnings and profits for CFC2, translated into U.S. dollars using the average exchange
rate, of $300x.

(ii) Result
. US1 and US2 do not have an APB 23 limitation and, thus, their
maximum amount eligible for the section 965(a) DRD is $500 million. Because US1 and
US2 are members of the same section 52(a) group, they are limited to one $500 million
limitation, which is allocated between them. Pursuant to this section 4.05, the $500
million limitation is allocated in proportion to the aggregate U.S. dollar amount of non-
PTI earnings and profits reported on the last Form 5471 filed on or before the
apportionment date by US1 and US2 with respect to CFC1 and CFC2, respectively.
The apportionment date for the FP group is July 31, 2006. Consequently, US1 is
allocated $125 million of the $500 limitation ($100x/$400x x $500 million) and US2 is
allocated $375 million of the $500 limitation ($300x/$400x x $500 million).

19
SECTION 5. TAXABLE YEAR TO WHICH SECTION 965 APPLIES
01. In General
Section 965(f) provides that a taxpayer may elect to apply section 965 to either
the taxpayer’s last taxable year beginning before October 22, 2004, or the taxpayer's
first taxable year starting during the one-year period beginning on October 22, 2004
(eligible year). Thus, assuming that the other requirements of section 965 are met, a
taxpayer may elect to apply the section 965(a) DRD with respect to cash dividends (as
defined for purposes of section 965(a)) received by a U.S. shareholder from its CFCs in
an eligible year. Except as otherwise provided in this section 5, an eligible year may
include a short taxable year.
02. Consolidated Groups
For taxpayers that are members of a consolidated group, the common parent
may elect on behalf of all the members to apply section 965 to one of the group's
eligible years. The election applies to each member of the group that is included in the
group’s income tax return for that eligible year, but only for the portion of the eligible
year during which such member is a member of the group. Further, every member can
receive a cash dividend from a CFC that otherwise qualifies under section 965(a) during
any period the recipient is a member of such group. This rule applies even if: (1) as a
result of a subsidiary entering or leaving the group, the group's election year is, with
respect to the particular subsidiary, neither the taxable year that includes October 22,
2004, nor the subsequent taxable year; or (2) a previous separate return year of the

20
subsidiary also was an election year for the subsidiary. This rule also applies as a
result of the acquisition of a consolidated group by an unrelated consolidated group,
where the previous separate return year of the acquired group was an election year.
Under the rules of the preceding paragraph, if a subsidiary leaves the group
during the group’s election year, cash dividends received from the subsidiary’s CFCs
during its short taxable year that ends within the group’s election year are eligible for the
group’s election. As a result, dividends received by the subsidiary during that initial
short taxable year can be eligible for the section 965(a) DRD. Moreover, dividends
received by the subsidiary during its next short taxable year as part of an acquiring
group may also be eligible for the section 965(a) DRD.
In addition, if the departing subsidiary is not immediately thereafter a subsidiary
member of another group, it may treat its next short taxable year as an eligible year and
make an election under section 965 for that year, even if that next taxable year is
neither the taxable year for that subsidiary that includes October 22, 2004, nor the
subsequent taxable year, provided that the two short taxable years together do not
exceed twelve months (or an equivalent 52-53 week year).
General consolidated return principles apply to reverse acquisitions as defined in
Treas. Reg. §1.1502-75(d)(3), so that the taxable year of the continuing group governs
its available eligible years and the terminating group members are subject to the
general rules for members leaving and entering groups, with the common parent in
effect treated as having become a subsidiary of the continuing group.

21
03. Examples
The following examples illustrate the application of the rules of section 965(f) and
this section 5.
Example 1
. Member included in election year of different consolidated groups. (i)
Facts. USP is the common parent of a calendar year consolidated group that elects to
apply section 965 for its taxable year ending December 31, 2004. US1 is a member of
the USP group and a U.S. shareholder. USB is the common parent of an unrelated
consolidated group that elects to apply section 965 to its taxable year ending June 30,
2005. A member of the USB group acquires all the stock of US1 on November 15,
2004.

(ii) Result
. Because US1 is included in the USP group during the USP group’s
section 965 election year (January 1, 2004 through December 31, 2004), US1’s taxable
year beginning January 1, 2004 and ending on November 15, 2004 is an election year
during which cash dividends received from US1’s CFCs may be eligible for the section
965(a) DRD. In addition, because US1 is included in the USB group during the USB
group’s election year (July 1, 2004 through June 30, 2005), cash dividends from US1’s
CFCs during US1’s taxable year beginning on November 16, 2004 and ending June 30,
2005, may be eligible for the section 965(a) DRD of the USB group.

(iii) Alternative facts
. If USB instead makes an election under section 965 for its
taxable year ending June 30, 2006, cash dividends from US1's CFCs during the USB
group's election year may still be eligible for the section 965(a) DRD. In this case,
however, that election year is US1's taxable year from July 1, 2005 through June 30,
2006. Section 965 will not apply to US1’s year beginning November 16, 2004 and
ending June 30, 2005.

Example 2
. Special rule for member departing but not joining a consolidated
group. (i) Facts. Assume the same facts as in Example 1, except instead of being
acquired by an unrelated consolidated group, the stock of US1 is distributed to the
shareholders of USP on November 15, 2004, and US1 becomes the common parent of
a new consolidated group which also maintains a taxable year ending December 31.

(ii) Result
. Because the taxable year ending December 31, 2004 is the USP
group's election year, US1’s taxable year beginning January 1, 2004 and ending on
November 15, 2004 is an election year during which cash dividends received from
US1’s CFCs may be eligible for the section 965(a) DRD. Further, because US1 ceased
to be a member of the USP group during its election year and did not become a
subsidiary member of another consolidated group, US1 may make an election under

22
section 965 for the subsequent short taxable year, which begins on November 16, 2004
and ends on December 31, 2004. This election will also apply to the other members of
the US1 group during that short taxable year. US1 will not be able to make an election
under section 965 for 2005.

Example 3
. Acquisition of target resulting in single short election year. (i) Facts.
USP is the common parent of a calendar year consolidated group that elects to apply
section 965 for its taxable year ending December 31, 2004. US1 is a member of the
USP group and a U.S. shareholder. On November 15, 2004, the stock of US1 is
distributed to the shareholders of USP; after such distribution, US1 is not a member of a
consolidated group and therefore files a separate return. USB is the common parent of
an unrelated consolidated group that plans to apply section 965 to its taxable year
ending December 31, 2005. On December 15, 2005, US1 purchases all the stock of
USB for cash. US1 and its subsidiaries elect to file a consolidated return for the taxable
year ending December 31, 2005.

(ii) Result
. Because the taxable year ending December 31, 2004 is the USP
group's election year, US1's taxable year beginning January 1, 2004 and ending on
November 15, 2004 is an election year during which cash dividends received from
US1's CFCs may be eligible for the section 965(a) DRD. Further, because US1 ceased
to be a member of the USP group during its election year and did not become a
subsidiary member of another consolidated group, US1 may make an election under
section 965 for its short taxable year that begins on November 16, 2004 and ends on
December 31, 2004. However, 2005 is not an eligible year for US1 or its consolidated
group. The USB group's final taxable year ends on December 15, 2005, when it is
acquired by US1. That short taxable year is an eligible year for which the USB group
may make an election under section 965. Thereafter, the members of the former USB
group will become members of the US1 group. Because the USB group was acquired
after the US1 election year, the former USB group members may not participate in an
election under section 965 for any period after December 15, 2005.

Example 4
. Effect of reverse acquisition. (i) Facts. Assume the same facts as in
Example 3
, except that US1's acquisition of USB is for US1 stock rather than cash and
the acquisition is a reverse acquisition described in Treas. Reg. §1.1502-75(d)(3).

(ii) Result
. Under Treas. Reg. §1.1502-75(d)(3)(i), the USB group is treated as
continuing to exist after the reverse acquisition with US1 as its common parent. The
USB group's taxable year ending December 31, 2005 is an eligible year for which the
group may make an election under section 965. This election applies to cash dividends
received by US1 after the acquisition when US1 was in the USB consolidated group (the
period beginning December 16, 2005 and ending December 31, 2005), as well as to
dividends received by the USB group members during the calendar year while USB was

23
the common parent. As in Example 3
, US1’s short taxable year that begins on
November 16, 2004 and ending on December 31, 2004 is an eligible year. However,
US1’s taxable year beginning January 1, 2005 and ending December 15, 2005 is not an
eligible year for US1.

Example 5.
Consolidated group included in election year of different consolidated
groups. (i) Facts. Assume the same facts as in Example 1 (i), except that a member of
the USB group acquires the USP group on November 15, 2004 and the USP group
makes an election under section 965(a) for the taxable year January 1, 2004 through
November 15, 2004.

(ii) Result
. Because the USP group’s election year is January 1, 2004 through
November 15, 2004, USP’s taxable year beginning January 1, 2004 and ending on
November 15, 2004 is an election year during which cash dividends received from the
USP group’s CFCs may be eligible for the section 965(a) DRD. In addition, because
USP is included in the USB group during the USB group’s election year (July 1, 2004
through June 30, 2005), cash dividends from the USP group’s CFCs during USP’s
taxable year beginning on November 16, 2004 and ending June 30, 2005 may be
eligible for the section 965(a) DRD of the USB group. If, in the alternative, USB elects
to apply section 965 to its taxable year ending June 30, 2006, cash dividends from the
USP consolidated group’s CFCs during USP’s taxable year beginning July 1, 2005 and
ending June 30, 2006 may be eligible for the section 965 DRD of the USB consolidated
group.

SECTION 6. EFFECTS OF CERTAIN TRANSACTIONS ON BASE PERIOD
INCLUSIONS AND MAXIMUM AMOUNT ELIGIBLE FOR SECTION 965(a) DRD
.01 Base Period Inclusions and APB 23 Limitation as U.S. Shareholder Attributes
(a) In general. For purposes of section 965, base period inclusions and APB 23
limitation are historical amounts that are treated as tax attributes particular to a U.S.
shareholder as of the date these amounts are fixed under section 965(b)(1) and (2).
See section 2.01 of this notice for the definition of the term “U.S. shareholder” for this
purpose. Consequently, base period inclusions and APB 23 limitation remain with a
particular U.S. shareholder (for example, when a U.S. shareholder ceases to be a

24
member of a consolidated group). See Example 1
of section 6.01(d) of this notice. In
addition, base period inclusions and APB 23 limitation are treated in the same manner
as items described in section 381(c). Therefore, if a corporation acquires the assets of
a U.S. shareholder in a transaction described in section 381(a), the acquiring
corporation succeeds to and takes into account the base period inclusions and APB 23
limitation of the transferor U.S. shareholder under the principles of section 381. See
Example 5
of section 6.01(d) of this notice. For exceptions to these general rules, see
section 6.01(b) and (c) of this notice.
Because these amounts are not treated as tax attributes particular to a CFC, they
are unaffected by a disposition of a CFC. Thus, these rules apply even if the U.S.
shareholder no longer owns the CFC that gave rise to the base period inclusions or
APB 23 limitation. Similarly, because these amounts are tax attributes of the U.S.
shareholder rather than the CFC, a domestic corporation that acquires the assets of a
CFC in a transaction described in section 381(a) does not succeed to and take into
account base period inclusions and APB 23 limitation attributable to the transferor CFC
under the principles of section 381. See Example 1
of section 6.01(d) of this notice.
(b) Adjustments for acquisitions and dispositions of U.S. shareholders that are
included in consolidated returns. (1) In general
. Members of a consolidated group
generally are treated as a single U.S. shareholder for the purpose of determining the
group’s base period amount or APB 23 limitation. However, when a member exits or

25
enters a U.S. consolidated group, adjustments are required to the selling
5
and/or
acquiring group’s base period inclusions and APB 23 limitation to reflect that base
period inclusions and APB 23 limitation generally remain with a particular U.S.
shareholder (that is, with the specific member rather than with the group itself). The
selling group reduces its base period inclusions and APB 23 limitation by the amounts
that are attributable to a departed member, and the acquiring group correspondingly
increases its base period inclusions and APB 23 limitation to account for the new
member. For exceptions to these general rules, see paragraph (2), below, and
Examples 1
, 4, 8 and 9 of section 6.01(d) of this notice. For specific rules addressing
the determination of base period inclusions, see section 6.01(b)(3) of this notice.
When adjusting a consolidated group’s base period inclusions to reflect the entry
or exit of a U.S. shareholder, the consolidated group makes the adjustment to the
specific base period inclusions (as opposed to the base period amount) for the group to
reflect the particular base period inclusions of the acquired or disposed of U.S.
shareholder or its successor. In the same way, the consolidated group makes an
adjustment to its APB 23 limitation to reflect the APB 23 limitation attributable to the
acquired or disposed of U.S. shareholder or its successor.
The rules of this paragraph that apply to dispositions or acquisitions of a member
of a consolidated group also apply, as relevant, in the context of the acquisition of an

5
For purposes of this section 6, the term “selling group” also includes a group in which a U.S. shareholder
ceases to be included as a member as a result of transactions other than sales (for example, through the
distribution of the stock of the member).

26
entire consolidated group.
(2) Special adjustment rules dependent upon timing of certain acquisitions or
dispositions of U.S. shareholders. Certain adjustments to base period inclusions and/or
APB 23 limitation provided under paragraph (b)(1) of this section are not made if certain
transactions occur during the selling group’s election year, or certain transactions occur
before or after a selling group’s or acquiring group’s
6
APB 23 determination date. In
addition, special rules are provided in section 6.01(c) of this notice with respect to
certain spin-off transactions.
Specifically, under this paragraph (b)(2), when a U.S. shareholder ceases to be a
member of a selling group during the selling group’s election year, the selling group’s
base period inclusions and APB 23 limitation are not reduced by amounts attributable to
the departing U.S. shareholder. Nonetheless, the acquiring group still increases its
base period inclusions and, subject to the special rules of this paragraph (b)(2), its APB
23 limitation attributable to the acquired U.S. shareholder under the general rules of
paragraph (b)(1) of this section. See Example 1
of section 6.01(d) of this notice. In
addition, dividends received by the U.S. shareholder from its CFCs in any other election
year may be taken into account in that year for purposes of section 965. See also
section 5 of this notice for a discussion of taxable years to which section 965 applies.
This paragraph provides special rules to ensure that an acquiring consolidated

6
For purposes of section 6, the term “acquiring group” includes a consolidated group that comes into
existence after the acquisition of a corporation.

27
group appropriately reflects an APB 23 limitation with respect to an acquired member
when: (1) that member ceases to be a member of a selling consolidated group before
the selling group’s APB 23 determination date; and/or (2) that member joins an
acquiring group before the acquiring group’s APB 23 determination date. Specifically, if
a U.S. shareholder joins a consolidated group before the acquiring group’s APB 23
determination date, there is no adjustment to the acquiring group’s APB 23 limitation
because the U.S. shareholder’s membership in the new group (and such U.S.
shareholder’s ownership of CFCs at the relevant time with permanently reinvested
earnings) will be taken into account when determining the acquiring group’s APB 23
limitation. Under the preceding sentence, if the selling group’s APB 23 determination
date has passed, the selling group reduces its APB 23 limitation to account for the
departed U.S. shareholder. If a U.S. shareholder ceases to be a member of a
consolidated group before the selling group’s APB 23 determination date, there is no
downward adjustment to the selling group’s APB 23 limitation to reflect the departure
because the selling group’s APB 23 limitation will reflect such disposition. However, if a
U.S. shareholder ceases to be a member of a consolidated group before the selling
group’s APB 23 determination date but after the acquiring group’s APB 23
determination date, the acquiring group‘s APB 23 limitation is increased by the amount
of the selling group’s APB 23 limitation that would be allocated to the acquired U.S.
shareholder under section 4 of this notice if the selling group substituted “the date of the
acquisition” for “June 30, 2003” in applying section 965(c)(1).

28
The rules of this paragraph that apply to dispositions or acquisitions of a member
of a consolidated group also apply, as relevant, in the context of the acquisition of an
entire consolidated group.
(3) Determining the base period inclusions to be inherited
. When an acquiring
group adjusts its base period inclusions to take into account an acquisition of a U.S.
shareholder or consolidated group, the acquiring group takes into account five taxable
years in the relevant base period for any acquired shareholder or group, assuming at
least five taxable years are available. The inclusions are aggregated for taxable years
one through five without regard to whether they are short or full taxable years on either
side. An acquired U.S. shareholder or group cannot contribute more than five taxable
years of inclusions to the base period history of the acquirer. The fifth taxable year in
the acquiring group’s base period is the last potential taxable year in its base period.
If the acquired U.S. shareholder or group joins the acquiring group after the end
of the acquiring group's base period, the acquired U.S. shareholder’s or acquired
group's base period inclusions in its last five taxable years ending on or before June 30,
2003 are aggregated with the acquiring group's base period inclusions in its five base
period taxable years, on a year-by-year basis.
Similarly, if an acquired U.S. shareholder or group joins the acquiring group
before the end of the acquiring group's base period, the acquiring group inherits a base
period inclusion history for the acquired U.S. shareholder or group for each of the
taxable years in the acquiring group’s base period that end on or before the date of the

29
acquisition. The acquired U.S. shareholder’s or acquired group’s taxable year ending
on the date of the acquisition shall correspond to the taxable year in the acquiring
group’s base period that ends on or before the date of the acquisition. The acquiring
group then takes into account base period inclusions from the acquired U.S.
shareholder’s or group’s taxable years prior to the taxable year ending with the date of
the acquisition to the extent necessary to assemble a base period inclusion history for
the inherited years. An acquired U.S. shareholder or acquired group may contribute five
taxable years to the acquiring group's history even if the acquiring group did not itself
exist for its full five taxable year base period. For illustrations of these rules, see
Example 7
and Example 8 of section 6.01(d).
(c) Special rules for spin-offs. (1) In general. Except as provided in paragraphs
(c)(2) and (3) of this section, a distribution to which section 355 (or so much of section
356 as relates to section 355) applies is treated in the same manner as a disposition of
the stock of the controlled corporation (controlled) by the distributing corporation
(distributing) for purposes of section 965 and this notice. See sections 5, 6.01(a) and (b)
of this notice and Example 2
of section 6.01(d) of this notice.
(2) Spin-off of a U.S. shareholder that occurs during the base period -- allocation
of base period inclusions. In the case of a spin-off of the stock of a U.S. shareholder to
which section 355 (or so much of section 356 that relates to section 355) applies that
occurs during the base period, and after which either distributing or controlled is a U.S.
shareholder of a CFC (applicable base period spin-off), any base period inclusions

30
received by either distributing or controlled from such CFC are allocated as provided in
section 965(c)(2)(C)(ii). For purposes of determining distributing’s and controlled’s base
period inclusions and base period amounts under section 965(c)(2)(C)(ii), section
965(c)(2)(C)(ii)(I) treats controlled as having been in existence for the same period that
distributing has been in existence. Further, section 965(c)(2)(C)(ii)(II) allocates base
period inclusions that are received or includible by distributing and controlled from a
CFC prior to an applicable base period spin-off of controlled based on the fair market
values of distributing’s and controlled’s interests in such CFC immediately after such
spin-off.
However, if stock of a member of a consolidated group is distributed pursuant to
an applicable base period spin-off and, as a result of such distribution a controlled
corporation leaves the consolidated group, the base period inclusions of the
consolidated group with respect to each of the group’s CFCs before the applicable base
period spin-off are instead allocated between the members of the consolidated group
that remain in the distributing corporation’s group (distributing group) and the members,
if any, that leave the group and thereafter file a consolidated return with the controlled
corporation (controlled group) in proportion to the fair market values of the distributing
group’s and the controlled group’s respective interests in each CFC owned by the
distributing group and the controlled group immediately after the applicable base period
spin-off. The base period inclusions allocated to the distributing group and the
controlled group are further allocated amongst the members of such groups in

31
proportion to the fair market value of such members’ respective interests in each CFC
immediately after the applicable base period spin-off. See paragraph (c)(3) for the
treatment of APB 23 limitations as a result of applicable base period spin-offs described
in this paragraph (c)(2).
Section 965(c)(2)(C)(ii)(II) does not apply to any distribution that is not an
applicable base period spin-off, such as a distribution that occurs after the base period;
nor does it apply to allocate inclusions from CFCs with respect to which neither
controlled not distributing is a U.S. shareholder at the time of the spin-off. Instead, the
rules of section 6.01(c)(1) of this notice apply to such distributions or inclusions.
(3) Spin-off of a U.S. shareholder that occurs during the base period -- allocation
of APB 23 limitation. If an applicable base period spin-off (as defined in paragraph
(c)(2) of this section) occurs with respect to a U.S. shareholder that is not a member of
a consolidated group after the APB 23 determination date of either distributing or
controlled, the APB 23 limitation of distributing or controlled is adjusted to the extent that
distributing’s or controlled’s APB 23 limitation is attributable to the stock of a CFC that
is transferred between distributing and controlled in connection with the spin-off.
Consistent with the treatment of base period inclusions, such adjustment is made by
allocating the portion of any APB 23 limitation attributable to distributing or controlled
with respect to the earnings of a CFC that is transferred between distributing and
controlled in proportion to the fair market values of such corporations’ respective
interests as U.S. shareholders of such CFC immediately after the spin-off. If a spin-off

32
occurs before the APB 23 determination dates of both distributing and controlled, the
general rules of section 4 apply. See Example 3
of section 6.01(d) of this notice.
If the stock of a member of a consolidated group is distributed pursuant to an
applicable base period spin-off and, as a result of such distribution a controlled
corporation leaves the consolidated group and, the spin-off occurs after the APB 23
determination date of the consolidated group, the APB 23 limitation that is attributable to
each CFC owned by the consolidated group before the applicable base period spin-off
is, instead, allocated between the distributing group and the controlled group in
proportion to the fair market values of the distributing group’s and the controlled group’s
respective interests in each CFC owned by the distributing group and the controlled
group immediately after the applicable base period spin-off. The APB 23 limitation
allocated to the distributing group and the controlled group is further allocated between
and among the members of such groups in proportion to the fair market values of such
members’ respective interests in each CFC immediately after the applicable base period
spin-off.
(d) Examples. The following examples illustrate the application of section
965(b)(1) and (2) and this section 6.01. Unless otherwise indicated, the following facts
are assumed for purposes of these examples. All corporations and consolidated groups
maintain calendar taxable years and were in existence prior to 1997. USP is a domestic
corporation and the common parent of the USP consolidated group. USP wholly owns
US1 and US2. US1 and US2 are U.S. shareholders and members of the USP

33
consolidated group. US1 and US2 each wholly owns a foreign corporation, CFC1 and
CFC2, respectively. USP elects to apply section 965 to its 2005 taxable year. USB is a
domestic corporation and the common parent of the USB consolidated group, which is a
consolidated group prior to any transactions described below. All domestic corporations
acquired by the USB group that are eligible to do so elect to join in filling a consolidated
return with the USB group. USB elects to apply section 965 for its 2005 taxable year.
No elections are made under section 338 with respect to stock purchases.
Example 1
. Sale of U.S. shareholder by consolidated group. (i) Facts. On
December 31, 2003, USP sells the stock of US1 to an unrelated foreign person, FP.
US1 files a separate return for the taxable years following such sale. On October 25,
2004 US2 sells CFC2 to USB for cash.

(ii) Result
. On January 1, 2004, US1 is no longer a member of the USP
consolidated group as a result of the sale of the US1 stock to FP. Accordingly, the USP
group reduces its base period inclusions and APB 23 limitation attributable to US1. In
addition, because US1 files a separate return after it ceases to be a member of the USP
consolidated group, it takes into account its individual base period inclusions and APB
23 limitation. In contrast, US2’s sale of CFC2 does not affect US2’s base period
inclusion history or APB 23 limitation, because base period inclusions and APB 23
limitation are not tax attributes of CFCs. Consequently, the USP group does not reduce
its base period inclusions or APB 23 limitation as a result of the sale of CFC2. Similarly,
USB does not make any adjustment to its base period inclusions or APB 23 limitation as
a result of the acquisition of CFC2.

(iii) Alternative Facts
. Assume the same facts as above, except that USP sells
the stock of US1 to FP on February 15, 2005. On February 16, 2005, US1 is no longer
a member of the USP consolidated group as a result of the sale of the US1 stock to FP.
Because the transaction occurs within the USP election year, the USP group does not
reduce its base period inclusions and APB 23 limitation attributable to US1. Further,
US1 still takes into account its individual base period inclusions and APB 23 limitation
should it make an election with respect to section 965(a) in its short taxable year
following the acquisition (February 16, 2005 through December 31, 2005). The result
with respect to USB is not changed under the alternative facts.

34
Example 2
. Spin-off of U.S. shareholder by consolidated group. (i) Facts. The
facts are the same as in Example 1
, except that instead of USP selling the stock of
US1, it distributes such stock in a distribution to which section 355 applies. US1 files a
separate return for the taxable years following the distribution.

(ii) Result
. The result is the same as that in Example 1. The special rules under
section 965(c)(2)(C)(ii) and section 6.01(c)(2) of this notice do not apply because the
distribution did not occur during USP’s base period (which ended December 31, 2002).

Example 3
. Section 368(a)(1)(D) reorganization/section 355 distribution. (i) Facts.
USP owns CFC3. USP has base period inclusions and APB 23 limitation attributable to
CFC3. On December 31, 2002, USP transfers the stock of CFC3 to controlled, a newly
formed domestic corporation wholly-owned by USP, in a transaction to which section
368(a)(1)(D) applies, and immediately thereafter distributes the stock of controlled in a
distribution to which section 355 applies.

(ii) Result
. The distribution occurs during the USP group’s base period and,
therefore, the special rules under section 965(c)(2)(C)(ii) and section 6.01(c)(2) and (3)
of this notice apply. As a result, USP’s base period inclusions and APB 23 limitation
that are attributable to CFC3 are allocated as provided in section 965(c)(2)(C)(ii) and
section 6.01(c)(2) and (3) of this notice. Therefore, all of the base period inclusions and
APB 23 limitation of USP attributable to CFC3 are allocated to controlled because
controlled owns all the CFC3 stock immediately after the section 355 distribution.

(iii) Alternative facts
. The facts are the same as in Example 3, except that the
transaction occurs on December 31, 2003. Because the distribution does not occur
during USP’s base period, section 965(c)(2)(C)(ii) and section 6.01(c)(2) and (3) of this
notice do not apply. Instead, the general rules of section 6.01(c)(1) of this notice apply.
Therefore, none of the base period inclusions, and no portion of the APB 23 limitation,
attributable to CFC3 are allocated to controlled; such amounts remain with USP.

Example 4
. Internal spin-off of CFC followed by applicable base period spin-off.
(i) Facts
. US1 has base period inclusions with respect to CFC1. On June 30, 2002,
US1 distributes the stock of CFC1 to USP in a transaction to which section 355 applies
(first spin-off). On December 31, 2002, USP transfers the stock of CFC1 to controlled, a
newly formed domestic corporation wholly owned by USP, in a transaction to which
section 368(a)(1)(D) applies, and immediately thereafter distributes the stock of
controlled in a distribution to which section 355 applies (second spin-off).

(ii) Result
. The first and second spin-offs occur during the USP group’s base
period. Section 965(c)(2)(C)(ii)(II) does not apply to the first spin-off because CFC1 is
not a United States shareholder. As a result US1’s base period inclusions attributable

35
to CFC1 are not allocated between US1 and USP in accordance with US1’s and USP’s
proportional ownership of CFC1 after the first spin-off. However, in the second spin-off
controlled is distributed out of USP's consolidated group. Accordingly, the USP group's
base period inclusions with respect to each of its CFCs before the spin-off of controlled
are allocated between the USP group and controlled (or controlled’s group if controlled’s
affiliated group files a consolidated return) in proportion to the USP group's and
controlled's (or the controlled group’s) interests in each CFC owned by the USP group
and controlled (or the controlled group) immediately after the second spin-off.

Example 5
. Merger of a U.S. shareholder and other transactions. (i) Facts. On
January 3, 2003, US1 sells its stock in CFC1 to USB for cash. On December 31, 2003,
in an unrelated transaction US1 merges into US2. The merger of US1 into US2 is a
reorganization under section 368(a)(1)(A). On December 31, 2004, in a transaction
unrelated to the merger of US1 into US2, USP sells the shares of US2 to USB for cash.
The APB 23 determination date for the USP and USB groups is December 31, 2002.

(ii) Result
. The sale of CFC1 stock to USB has no effect on the USP group’s
base period inclusions and APB 23 limitation. The merger of US1 into US2 on
December 31, 2003 is a transaction described in section 381(a), and US2 therefore
succeeds to and takes into account US1’s base period inclusions and APB 23 limitation.

Because US2 ceases to be a member of the USP consolidated group as a result
of the sale of its stock to USB, the USP group reduces its base period inclusions and
APB 23 limitation attributable to US2, including those amounts US2 succeeds to and
takes into account as a result of the merger. Further, because US2 becomes a member
of the USB consolidated group on January 1, 2005, USB’s base period inclusions and
APB 23 limitation are increased by the same amounts by which USP’s base period
inclusions and APB 23 limitation amount were decreased.

(iii) Alternative facts
. The facts are the same as Example 5 (i), except that instead
of USP selling the shares of US2 to USB, US2 sells its assets to USB in exchange for
cash (and the assumption of any liabilities of US2) and distributes the cash proceeds to
USP pursuant to a liquidation described in section 332.

Under the alternative facts, the result is the same as Example 5
(ii), except as
follows. USP does not make any adjustments to its base period inclusions or APB 23
limitation as a result of the sale of US2’s assets to USB because the transaction with
USB is not described in section 381(a) (this may not be the case, however, if the assets
sold by US2 to USB include stock of a U.S. shareholder that is a member of the USP
consolidated group). Further, USP continues to take into account the base period
inclusions and APB 23 limitation attributable to US2 after the liquidation of US2 because
the liquidation into USP is a transaction described in section 381(a). In addition, the

36
USB consolidated group does not take into account the base period inclusions and APB
23 limitation attributable to US2, because US2 does not become a member of the USB
consolidated group (nor does the USB consolidated group acquire the assets of US2
pursuant to a transaction described in section 381(a)).

(iv) Alternative facts
. The facts are the same as Example 5 (i), except that USP
and USB make an election pursuant to section 338(h)(10) with respect to the sale of the
stock of US2. The result under the alternative facts in this paragraph (iv) is the same as
under the alternative facts of paragraph (iii) of this Example 5
. This is the case
regardless of whether an election under section 338 is made with respect to the CFC2
stock owned by US2.

Example 6
. Acquisition of U.S. shareholder consolidated group. (i) Facts. USB
acquires all the stock of USP on January 3, 2003, a date subsequent to the APB 23
determination dates for both the USP and USB groups. As a result of the acquisition,
the USP group terminates and all the members of the USP group become members of
USB consolidated group.

(ii) Result
. USB’s acquisition of all the stock of USP causes the USP consolidated
group to cease to exist as of the end of January 3, 2003, a date after the end of the
base periods of both the USP and USB groups. The USP group’s base period
inclusions for each of the five taxable years in its base period is added to the USB
group’s base period inclusions for each corresponding taxable year in its base period to
determine the USB group’s base period amount. In addition, because the acquisition
occurs after the APB 23 determination dates of both the USB and USP groups, the
USB group’s APB 23 limitation is increased by the USP group’s APB 23 limitation.

Example 7
. Taking into account base period inclusions of acquired U.S.
shareholder transferred after the end of the acquirer’s base period. (i) Facts. The USB
consolidated group uses a taxable year ending March 31. The USB group elects to
apply section 965 to its taxable year that begins on April 1, 2005 and ends on March 31,
2006. On May 31, 2005, USB acquires from USP 100% of the stock of US1 for cash.

(ii) Result
. The acquisition of US1 occurs during the section 965 election year of
the USP group and the section 965 election year of the USB group. Therefore, the
special rules set forth in section 6.01(b)(2) apply. Under those rules, the USB
consolidated group takes into account the base period inclusions of US1 for purposes of
determining its base period amount under section 965(b)(2). Because US1 ceases to
be a member of the USP consolidated group during the election year of such group, the
USP consolidated group will also take into account the base period inclusions of US1 for
purposes of determining its base period amount under section 965(b)(2). Accordingly,
there is no corresponding decrease by the selling group for the increase by the buying

37
group of base period inclusions and APB 23 amounts as a result of the transaction.

The USB consolidated group’s base period includes the five taxable years ending
on or before June 30, 2003 (that is, taxable years ending March 31, 1999 through
March 31, 2003). Similarly, the base period of US1 and USP includes the five taxable
years ending on or before June 30, 2003 (that is, the taxable years ending December
31, 1998 through December 31, 2002).

To determine the USB group’s base period amount, US1’s base period inclusions
for each taxable year in its base period are added to the base period inclusions for each
corresponding taxable year in the USB group’s base period. Thus, US1’s base period
inclusions for its taxable year ending December 31, 2002 are added to the base period
inclusions for the USB group’s year ended March 31, 2003, and US1’s base period
inclusions for the other four years in its base period are added to the USB group base
period inclusions for the other four corresponding years in the USB group’s base period.

Because the acquisition of US1 occurs during the election years of both the USP
group and the USB group, both groups will also take into account the APB 23 limitation
attributable to US1.

Example 8
. Taking into account base period inclusions of acquired U.S.
shareholder transferred before the end of the acquirer’s base period. (i) Facts. The facts
are the same as Example 7, except as follows. USB acquired US1 on February 15,
2002, a date prior to the APB 23 determination dates of both USP and USB. The USB
group’s base period includes the five taxable years ending March 31, 1999, through
March 31, 2003. As a result of its acquisition, the base period of US1 includes its five
taxable years that end on the following dates: February 15, 2002; December 31, 2001;
December 31, 2000; December 31,1999; and December 31, 1998.

(ii) Result
. To determine the USB group’s base period amount, US1’s base
period inclusions for each taxable year in US1’s base period are added to the USB
group’s base period inclusions for each corresponding taxable year in the USB group’s
base period. US1’s short taxable year ending February 15, 2002, corresponds to the
last taxable year in the acquirer’s base period that ends on or before the date of the
acquisition (that is, the USB group’s taxable year that ends March 31, 2001). The USB
group also succeeds to that portion of US1’s base period inclusion history for US1’s
taxable years that precede the short taxable year ending on February 15, 2002, that
correspond to the USB group taxable years in its base period.

The corresponding taxable years in the respective base periods may be
illustrated as follows:

38
US1 base period
USB group base period
year-ends
year-ends

3/31/03 3/31/03
3/31/02 3/31/02
2/15/02 3/31/01
12/31/01 3/31/00
12/31/00 3/31/99
12/31/99
12/31/98

US1’s taxable years ending on December 31, 1999, and December 31, 1998,
correspond to taxable years of the USB group that precede the USB group’s base
period. Accordingly, the USB group does not take into account the base period
inclusions of US1 in those years. Nevertheless, the USP group will reduce its base
period inclusions attributable to US1 for these taxable years.

US1’s base period inclusions after February 15, 2002, are naturally taken into
account by the USB group in determining its base period inclusions because such
inclusions will occur during the time that US1 is a part of the USB consolidated group.
That is, US1 base period inclusions for its taxable year that ends March 31, 2002, and
March 31, 2003, are taken into account in determining the USB group’s inclusions for
such taxable years.

US1 ceased being a member of the USP consolidated group and joined the USB
consolidated group before the APB 23 determination dates of both the USP and USB
consolidated groups. As a result, no adjustment is made to the APB 23 amount of the
USP or USB consolidated groups as a result of the sale of US1 stock as provided in
section 6.01(a)(2) of this notice.

(iii) Alternative facts
. The facts are the same as in Example 8, except that the
USB group’s first taxable year begins on April 1, 2000. The results are unchanged.

Example 9
. Acquisition of U.S. shareholder stock before Acquirer’s but after
Seller’s APB 23 determination date. (i) Facts. The USP group’s applicable financial
statement provides for an APB 23 limitation of $700 million. The limitation is comprised
of, as of the APB 23 determination date (December 31, 2002), earnings permanently
reinvested in CFC1 of $400 million and in CFC2 of $300 million. The $400 million of
CFC1 earnings is attributable to US1, and the $300 million of CFC2 earnings is
attributable to US2. USB maintains a taxable year ending January 31. On January 3,
2003, USP sells to USB 81% of US1’s outstanding stock and 60% of the outstanding
stock of US2. The USB group’s APB determination date is January 31, 2003.

39

(ii) Result. By reason of the transactions, US1 and US2 cease to be members of
the USP consolidated group on January 3, 2003, a date that is after the USP group’s
APB 23 determination date. Therefore, the USP consolidated group reduces its APB 23
limitation by $700 million because US1 and US2 are no longer members of the USP
consolidated group. Similarly, the USP group reduces its base period inclusions to the
extent they are attributable to US1 and US2. Further, the acquisition of US1 and US2
occurred prior to USB’s APB 23 determination date. Therefore, the USB group does not
increase its APB 23 limitation with respect to the transactions because the USB group
will take into account permanently reinvested earnings of US1 and US2 for financial
accounting purposes on its APB 23 determination date. Finally, USB inherits the
relevant base period inclusion history of US1 because US1 joins the USB consolidated
group. After the transaction, US2 is not a member of a consolidated group and
therefore will file a separate return for subsequent taxable years. If US2 elects to apply
section 965 in an eligible year, it will take into account its base period inclusion history
and its APB 23 limitation.

(iii) Alternative facts
. The facts are the same as in Example 9 (i), except that
US1 and US2 are sold on February 1, 2003. The USB group’s reported APB 23
limitation is increased by $400 million as a result of USB’s purchase of 81% of the
shares of US1 because US1 joins the USB consolidated group after the USB group’s
APB 23 determination date; it is not increased by the $300 million attributable to US2
because US2 does not join the USB consolidated group. The base period inclusion
results are unchanged.

.02 Allocated Portion of $500 Limitation
Pursuant to section 4.05 of this notice, the $500 million limitation described in
section 965(b)(1)(A) is allocated among qualified members of a section 52(a) group on
a single date, the apportionment date (as defined in section 4.05 of this notice), and
only amongst the qualified members of the group on such date. A corporation or
consolidated group is not allocated any of the $500 million limitation and it has a $0
limitation for an election year during which the corporation or consolidated group was a
qualified member of a section 52(a) group if, on or after the end of its election year but
before the section 52(a) group’s apportionment date (or, if none, the date that would

40
have been the apportionment date had the transaction not occurred), the corporation or
consolidated group becomes unrelated to the other qualified members of the section
52(a) group or ceases to exist.
Once an allocation occurs on an apportionment date, the allocated limit applies
to a corporation or consolidated group that is a qualified member of the section 52(a)
group for its election years ending while it is a qualified member of such group, including
those years that end before the apportionment date. However, if a corporation or
consolidated group becomes unrelated to the other qualified members of a section
52(a) group before the end of an election year of such corporation or consolidated
group, the corporation or group is entitled to its own $500 million limitation, unless it
becomes part of a different section 52(a) group on or before that group’s apportionment
date. If it becomes part of a different section 52(a) group on or before that group’s
apportionment date, it may be allocated a portion of that section 52(a) group’s $500
limitation. Accordingly, if a corporation or consolidated group is no longer a qualified
member of a section 52(a) group, the former member does not retain any of the section
52(a) group’s $500 million limitation after it leaves such group.
The following examples illustrate the application of section 965(b)(1) and this
section 6.02. Unless otherwise indicated, it is assumed in each example that all U.S.
shareholders have APB 23 limitations of zero.
Example 1
. Disposition of a member which joins an unrelated consolidated
group. (i) Facts. A, an individual, wholly owns two domestic corporations, US1 and
US2. US1 and US2 in turn each wholly own a foreign corporation, CFC1 and CFC2,
respectively. US1 and US2 maintain the calendar year as their taxable year.

41

On September 30, 2005, A sells US1 to USB. USB is an unrelated domestic
corporation and the common parent of a consolidated group that maintains a June 30
taxable year.

US1 elects section 965 for its taxable year ending September 30, 2005. US2
elects section 965 for its taxable year ending December 31, 2005. The USB group
elects section 965 for its taxable year ending June 30, 2006.

(ii) Result
. US2 is entitled to a full $500 million limitation for its election year
ending December 31, 2005, because it is not a member of a section 52(a) group on
December 31, 2005. US1 has a limitation of $0 for its election year ending September
30, 2005, because US1 and US2 would have been members of a section 52(a) group
on an apportionment date, December 31, 2005, but for the disposition of US1 on or after
the end of US1’s election year but before December 31, 2005. The apportioned
limitation does not apply to US1’s second election year as a member of the USB group.
The USB group has its own $500 million limitation, which is not adjusted upward as a
result of the acquisition of US1.

Example 2
. Disposition of a member which does not join an unrelated
consolidated group. (i) Facts. The facts are the same as in Example 1 except that the
buyer of US1 is B, an individual unrelated to A. As in Example 1
, US1 elects section
965 for its taxable year, which however ends on December 31, 2005.

(ii) Result. On December 31, 2005, there is no section 52(a) group, and the
election year of neither corporation ended before that date. Therefore, US1 and US2
each has its own $500 million limitation.

Example 3
. Merger into unrelated corporation. (i) Facts. The facts are the same
as in Example 1 except that instead of the stock of US1 being sold, US1 merges into
USB in a reorganization described in section 368(a)(1)(A).

(ii) Result
. The result is the same as in Example 1.

Example 4
. Merger into related corporation. (i) Facts. The facts are the same
as in Example 3
except that US1 merges into US2 in a reorganization described in
section 368(a)(1)(A).

(ii) Result
. US2 is entitled to a full $500 million limitation for its election year
ending December 31, 2005, because it is not a member of a section 52(a) group on
December 31, 2005. US1 has a limitation of $0 for its election year ending September
30, 2005, because US1 and US2 would have been members of a section 52(a) group

42
on their apportionment date, December 31, 2005, but for the merger of US1 which
results in the end of US1’s election year before December 31, 2005.

Example 5
. Spin-off resulting in unrelated corporation. (i) Facts. USP is a
publicly held corporation and the parent of a consolidated group. C and US1 are wholly
owned domestic subsidiaries of USP. US1 cannot be included in the USP consolidated
group by virtue of section 1504(a)(3) (relating to the five-year period required to elapse
before reconsolidation). The USP group and US1 each maintain the calendar year as
their taxable years and USP, C and US1 are each U.S. shareholders of CFCs.

On September 30, 2005, USP distributes the stock of C to its shareholders.
Thereafter, USP and C are not members of the same section 52(a) group.

The USP group and US1 each elect section 965 for their taxable years ending
December 31, 2005. C also elects section 965 for its short taxable year starting on
October 1, 2005, and ending on December 31, 2005.

(ii) Result
. December 31, 2005 is the apportionment date for the section 52(a)
group that consists of the USP group and US1, and the $500 million limitation is
allocated between the USP group and US1 on that date. None of the limitation is
allocated to C separately for its short taxable year ending September 30, 2005 (its
limitation is $0), but the apportionment does not apply to C’s second election year, the
short taxable year ending December 31, 2005. C has its own $500 million limitation for
that second election year.

Example 6
. Spin-off resulting in related corporation. (i) Facts. The facts are the
same as in Example 5
except that all the stock of USP is owned by A, an individual, and
A acquires all the stock of C in the distribution. As a result, USP and C remain
members of a single section 52(a) group after the distribution.

(ii) Result
. December 31, 2005 is the apportionment date for the section 52(a)
group that consists of the USP group, US1, and C, and the $500 million limitation is
allocated between the USP group, US1, and C on that date. C’s allocation applies to its
second election year, the short taxable year ending December 31, 2005. During the
time that C is a member of the USP group, it is not separately allocated any of the $500
million limitation of the section 52(a) group.

Example 7
. Interaction of APB 23 limitation and $500 million limitation. (i) Facts.
The facts are the same as in Example 1
, except that US1 has an APB 23 limitation of
$300 million, and USB has an APB 23 limitation of $400 million.

(ii) Result
. The result is the same as in Example 1 with respect to the $500

43
million limitation. The maximum repatriations allowed under section 965 for US1 in its
election year ending September 30, 2005, is the greater of its allocated portion of the
$500 million limitation or its APB 23 limitation. US1’s APB 23 limitation of $300 million
exceeds its portion of the $500 million, which is $0. Thus, US1’s maximum amount
under section 965(b)(1) is $300 million. As in Example 1, the USB group’s $500 million
limitation is not adjusted as a result of USB’s acquisition of US1. However, the USB
group’s APB 23 limitation is adjusted upward to reflect the $300 million APB 23
limitation attributable to US1. Because the maximum repatriations allowed under
section 965 for the USB group is the greater of $500 million or APB 23 limitation, the
USB group’s APB 23 limitation exceeds $500 million as a result of the acquisition.
Thus, USB’s maximum amount under section 965(b)(1) is $700 million ($400 million +
$300 million).

SECTION 7. REDUCTION OF BENEFIT FOR INCREASES IN RELATED PARTY
INDEBTEDNESS
.01 Background
(a) General. Section 965(b)(3) provides that a U.S. shareholder reduces the
amount of dividends otherwise eligible for the deduction under section 965(a) by any
increase in the indebtedness of its CFC to any related person (as defined in section
954(d)(3)) between October 3, 2004 and the close of the taxable year for which the
election under section 965 is in effect. For purposes of section 965(b)(3), all CFCs with
respect to which the taxpayer is a U.S. shareholder are treated as a single CFC.
(b) Definitions. For purposes of section 965(b)(3) and this section 7, the following
definitions apply:
(i) The term “CFC” means all CFCs with respect to which the taxpayer is a U.S.
shareholder, treating such CFCs as a single CFC pursuant to section 965(b)(3).
(ii) The term “individual CFC” is used to refer to a single CFC (for example, to
identify a single CFC that is acquired or disposed of by a consolidated group U.S.

44
shareholder).
(iii) The term “U.S. shareholder” as used in this section 7 is defined in section
951(b).
(iv) The term “related person” means a person that is related to a CFC within the
meaning of section 954(d)(3).
(v) The term “related party indebtedness” means the amount of indebtedness of
a CFC to a related person. However, indebtedness between individual CFCs of a U.S.
shareholder is disregarded for purposes of section 965(b)(3).
(vi) The term “initial measurement date” means the close of October 3, 2004 or, if
the U.S. shareholder so chooses, an alternative date which is provided as a matter of
administrative convenience for taxpayers and the IRS. The alternative date is either: (i)
the close of September 30, 2004, if such shareholder used a calendar year or a fiscal
year as its taxable year; or (2) the close of the last day of such shareholder’s fiscal-year
month ending nearest October 3, 2004, if such shareholder used a 52-53 week taxable
year. However, the U.S. shareholder uses the same date as its initial measurement
date for all purposes of section 965.
(vii) The term “last measurement date” means the close of a U.S. shareholder’s
taxable year for which an election is in effect.
.02 Definition of Indebtedness
(a) In general. Except as provided in this section, for purposes of section
965(b)(3), “indebtedness” is defined under general Federal income tax principles.

45
Further, the amount of indebtedness of a CFC to any related person pursuant to section
965(b)(3) is not reduced or otherwise offset by indebtedness of any related person to
the CFC. Thus, for example, if on the initial measurement date or the last measurement
date, there is $100x of indebtedness of a CFC to its U.S. shareholder, and $10x of
indebtedness from such U.S. shareholder to the CFC, the amount of indebtedness
under section 965(b)(3)(A) as of such date is $100x (and not $90x).
For purposes of section 965(b)(3), indebtedness of a CFC to a foreign
disregarded entity that is owned for Federal tax purposes by a related person is treated
as related party indebtedness. Thus, for example, if on the initial measurement date
there is $100x of indebtedness from a CFC to a foreign disregarded entity owned by a
U.S. shareholder, which is a related person to the CFC, such amount is indebtedness
described in section 965(b)(3)(B).
(b) Exception for Intercompany Trade Payables. For purposes of section
965(b)(3), the term “indebtedness” does not include indebtedness arising in the ordinary
course of a business from sales, leases, or the rendition of services provided to or for a
CFC by a related person, provided that such indebtedness is actually paid within 183
days.
.03 Determination of Related Party Indebtedness
A U.S. shareholder considers the indebtedness of its CFC to related persons
only if the U.S. shareholder is a related person with respect to such CFC. For purposes
of determining the related party indebtedness of a CFC pursuant to section 965(b)(3),

46
the relationship between the CFC, its creditors, and any of its U.S. shareholders is
determined independently on the initial measurement date and the last measurement
date, respectively. For example, if on such date the creditor of the CFC is a related
person and a U.S. shareholder is a related person with respect to such CFC, the U.S.
shareholder has an amount of indebtedness that is considered under section 965(b)(3)
and the rules of this section.
.04 Amount of Reduction under Section 965(b)(3)
(a) In General. Pursuant to section 965(b)(3) and the rules of this section, a U.S.
shareholder reduces the amount of cash dividends that would otherwise be taken into
account under section 965(a) by the excess (if any) of its last measurement date RPI
(as determined under section 7.05(b)) over its initial measurement date RPI (as
determined under sections 7.05(a) and 7.05(c)). If two or more U.S. shareholders may
otherwise be considered to have an amount that is considered under section 965(b)(3)
attributable to the same CFC indebtedness, such shareholders take into account such
indebtedness under the rules of 7.06 of this section.
(b) Indirect Financing of Cash Dividend by a U.S. Shareholder. Section 965(b)(3)
is intended to prevent a U.S. shareholder from directly or indirectly financing a cash
dividend qualifying under section 965(a). In addition to the application of the related
party indebtedness rule under section 965(b)(3), general tax law principles such as the
substance-over-form doctrine and circular cash-flow principles may apply to various
financing structures. However, a related party guarantee of CFC indebtedness is not

47
considered to be an indirect financing of a cash dividend for purposes of section
965(b)(3), provided that the CFC is treated as the obligor on the indebtedness for
Federal income tax purposes. See Plantation Patterns, Inc. v. Comm’r, 462 F.2d 712
(5
th
Cir. 1972), cert. denied, 409 U.S. 1076 (1972).
.05 Amount of Related Party Indebtedness on the Initial Measurement Date and the
Last Measurement Date
(a) Initial Measurement Date RPI -- General Rule. A U.S. shareholder
determines the amount of the related party indebtedness of its CFC on the initial
measurement date and such amount is the “initial measurement date RPI” of such U.S.
shareholder. The amount of the initial measurement date RPI is adjusted pursuant to
section 7.05(c) of this notice in certain instances. See Example 1
of section 7.08 of this
notice.
(b) Last Measurement Date RPI -- General Rule. A U.S. shareholder determines
the amount of the related party indebtedness of its CFC on the last measurement date
and such amount is the “last measurement date RPI” of such U.S. shareholder. Thus,
to the extent that a CFC pays all or a portion of the principal on the related party
indebtedness before the last measurement date and does not incur any new related
party indebtedness before such date, the U.S. shareholder’s last measurement date
RPI will be less than its initial measurement date RPI. See Examples 4 and 6
of section
7.08 of this notice.
(c) Special Adjustments to Initial Measurement Date RPI. A U.S. shareholder

48
reduces its initial measurement date RPI to the extent the U.S. shareholder’s initial
measurement date RPI is attributable to any individual CFC with respect to which such
shareholder ceases to be a U.S. shareholder or a related person as the result of a
transaction before the last measurement date. However, the prior sentence does not
apply to the extent, before or as a result of such transaction, all or a portion of the
principal on the indebtedness is paid by the debtor (for example, as a result of the
liquidation of an individual CFC).
A domestic corporation that becomes a U.S. shareholder and a related person
with respect to an individual CFC after such corporation’s initial measurement date, but
before the last day of its election year (or a U.S. shareholder that files a separate return
for its short taxable year immediately after a transaction during the same period), and
that remains a U.S. shareholder and a related person with respect to such individual
CFC on its last measurement date, increases its initial measurement date RPI by the
amount of related party indebtedness of such individual CFC immediately after the
transaction, excluding any indebtedness arising in connection with or as a result of the
transaction (for example, as a result of the incorporation of a branch). See Example 3

and Example 10 of section 7.08 of this notice.
If two or more U.S. shareholders may otherwise be considered to have an
amount that is considered under section 965(b)(3) attributable to the same CFC
indebtedness, such shareholders take into account such indebtedness under the rules
of section 7.06 of this notice.

49
.06 Related Party Indebtedness -- Multiple U.S. Shareholders
An increase in a CFC’s related party indebtedness may not reduce the total
amount of dividends otherwise eligible for the section 965(a) DRD on anything but a
dollar-for-dollar basis. Consequently, if more than one U.S. shareholder is a related
person with respect to a CFC, then the effect of the increase in the related party
indebtedness of the CFC pursuant to section 965(b)(3) is allocated among and
between such U.S. shareholders. For this purpose, such increase is allocated on a
dollar-for-dollar basis to cash dividends received by such U.S. shareholders that are
otherwise eligible for the section 965(a) DRD in the order that those dividends are
received. If such dividends are received by more than one U.S. shareholder on the
same day, each U.S. shareholder takes into account the remaining amount of the
increase in related party indebtedness of such CFC based on the relative amount of
cash dividends received on such day. The overall reduction in dividends of all U.S.
shareholders eligible for the section 965(a) DRD under this rule may not exceed the
total increase in related party indebtedness under section 965(b)(3). See Examples 8
and 9 of section 7.08 of this notice.
.07 Translation of Foreign Currency-Denominated Related Party Indebtedness
The initial measurement date RPI and the last measurement RPI of a U.S.
shareholder is determined in U.S. dollars. The amount of any indebtedness on both the
initial measurement date and the last measurement date is translated into U.S. dollars
using the spot rate (as defined in Treas. Reg. §1.988-1(d)(1)) on the initial

50
measurement date. See Example 7
of section 7.08 of this notice.
.08 Examples
The following examples illustrate the application of section 965(b)(3) and this
section 7. Unless otherwise indicated, the following facts are assumed for purposes of
these examples. USP, a domestic corporation and the common parent of the USP
consolidated group that uses the calendar year as its taxable year, wholly owns US1.
US1 is a domestic corporation and a member of the USP consolidated group. US1
wholly owns CFC1, a foreign corporation that owes US1 $100x at the close of
September 30, 2004 evidenced by a note ($100x note). USP wholly owns CFC2, a
foreign corporation with no indebtedness owed to persons described in section
954(d)(3). The USP group chooses September 30, 2004 as its initial measurement date
and it elects to apply section 965 to its 2005 calendar year tax year.
Example 1
. Determination of the amount of initial measurement date RPI. (i)
Facts. The general facts apply.

(ii) Result
. US1 and USP are each U.S. shareholders with respect to CFC1 and
CFC2 and are considered one U.S. shareholder for purposes of section 965(b)(3).
Further, CFC1 and CFC2 are considered one CFC for purposes of section 965(b)(3).
The USP group’s CFC (CFC1 and CFC2) has indebtedness of $100x owed to the USP
group (and directly to US1 as a member of that group), a related party. Therefore, the
USP group has initial measurement date RPI of $100x.

Example 2
. Determination of initial and last measurement date RPI when CFC
transferred or sold. (i) Facts. On December 31, 2004, US1 sells all the stock of CFC1
and the $100x note to USB, an unrelated U.S. corporation that is the common parent of
a consolidated group. Immediately after the transaction, CFC1 owes $100x to USB.
USB makes an election under section 965 for its calendar year ending December 31,
2005. As of USB’s last measurement date, it is a U.S. shareholder and related person
with respect to CFC1.

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(ii) Result
. Under section 965(b)(3) all CFCs of a U.S. shareholder are treated as
one CFC. Moreover, for purposes of section 965(b)(3), all U.S. shareholders that are
members of a consolidated group are considered one U.S. shareholder. Therefore,
CFC1 and CFC2 are considered one CFC and US1 and USP are considered one U.S.
shareholder (the USP group). Only the relationship between CFC1, CFC2 and the USP
group is taken into account for purposes of determining the initial measurement date
RPI of the USP group, while only the relationship between CFC1 and USB is taken into
account for purposes of determining the last measurement date RPI of the USB group.

As of the initial measurement date the USP group’s CFC (CFC1 and CFC2) owes
$100x to related parties. Therefore, under section 7.05(a), and without regard to the
disposition of CFC1, the USP group’s initial measurement date RPI is $100x. Under
section 7.05(c), however, the USP group reduces its initial measurement date RPI to
account for the disposition of CFC1. Therefore, the USP group’s initial measurement
date RPI is $0. As of the last measurement date, CFC1 is not related to the USP group.
Accordingly, the USP group’s last measurement date RPI is $0.

With respect to the USB group, CFC1 is not related to the USB group on the
USB group’s initial measurement date. Therefore, the USB group’s initial measurement
date RPI, without consideration of the acquisition of CFC1 is $0. Under section 7.05(c),
however, the USB group increases its initial measurement date RPI by $100x, the
amount of the CFC1’s related party indebtedness immediately after the acquisition.
Therefore, the USB group has initial measurement date RPI of $100x. Further, as of its
last measurement date, CFC1 owes USB, a related party, $100x. Therefore, the USB
group’s last measurement date RPI is $100x.

(iii) Alternative facts
. The facts are the same as in (i), except that USB does not
purchase the $100x note due from CFC1. Under section 7.05(c), the USP group
reduces its initial measurement date RPI from $100x to $0, to account for the
disposition of CFC1 (the same result reached in (ii)). Under section 7.05, the USP
group’s last measurement date RPI is $0 (the same result reached in (ii)). Under the
alternative facts, however, the USB group does not adjust its initial measurement date
RPI to take into account the acquisition of CFC1 because immediately after the
acquisition CFC1 will owe an indebtedness to US1, which is not a related person. As a
result, the USB group has an initial measurement date RPI of $0. Further, the USB
group has a last measurement date RPI of $0.

(iv) Alternative facts
. The facts are the same as in (i) except that CFC1 liquidates
(whether by reason of an actual liquidation or by reason of an election under Treas.
Reg. §301.7701-3) into US1 instead of being sold to USB. Under section 7.05(c), the
USP group does not decrease its initial measurement date RPI to account for the
liquidation. Consequently, the USP group’s initial measurement date RPI is $100x.

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Under section 7.05(b), the USP group’s last measurement date RPI is $0.

Example 3. Determination of initial and last measurement date RPI when a U.S.
shareholder is transferred to an unrelated person. (i) Facts. The facts are the same as
in Example 1
, except that on December 31, 2004, all the stock of US1 (and indirectly
CFC1), is sold to an unrelated U.S. shareholder, USB. US1 joins the USB consolidated
group and USB makes an election under section 965 for the taxable year ending
December 31, 2005. As of its last measurement date, USB is a U.S. shareholder and
related person with respect to CFC1.

(ii) Result
. Without regard to the disposition of US1, the USP group’s initial
measurement date RPI is $100x. Under section 7.05(c), the USP group’s initial
measurement date RPI is decreased by $100x, resulting in the USP group having initial
measurement date RPI of $0.

USP computes its last measurement date RPI under section 7.05(b) of this
notice. As of the last measurement date, CFC1 owes an indebtedness to US1, a party
that is not related within the meaning of section 954(d)(3) to USP. Therefore, the USP
group’s last measurement date RPI is $0.

Without regard to the acquisition of US1, the USB group’s initial measurement
date RPI is $0. However, under section 7.05(c), the USB group increases its initial
measurement date RPI by $100x, the amount of the related party indebtedness of its
CFC (CFC1) immediately after the transaction. Further, the USB group’s last
measurement date RPI is $100x because as of its last measurement date, CFC1 owed
$100x to US1, a related person.

(iii) Alternative facts
. Assume that the stock of US1 is sold to USB on March 31,
2005, which is during the USP group’s and the USB group’s election year. The results
are the same as set forth in (ii), above.

Example 4
. Determination of initial and last measurement date RPI when a new
CFC is formed . (i) Facts. The facts are the same as in Example 1, except that USP
incorporates CFC2 on November 1, 2004, and during the USP election year USP
acquires all the stock of USB (and indirectly all of USB’s individual CFCs), an unrelated
U.S. shareholder. Further, USB is a member of the USP consolidated group on the last
day of the USP election year. In part, CFC2 is capitalized with $100x of related party
indebtedness and USP is a U.S. shareholder and a related person with respect to CFC2
on its last measurement date. USB has initial measurement date RPI of $400x,
attributable to its CFCs. Immediately after the acquisition, USB’s CFCs continue to
have indebtedness owed to USB in the amount of $400x.

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(ii) Result
. Without regard to the acquisition of USB or the formation of CFC2,
under section 7.05(a), the USP group has initial measurement date RPI of $100x.
Under section 7.05(c), the USP group increases its initial measurement date RPI by the
related party indebtedness of the USB CFCs immediately after the transaction. Note,
however, that no adjustment is made to the USP group’s initial measurement date RPI
to account for CFC2’s related party indebtedness under section 7.05(c). Thus, after
adjustment, the USP group’s initial measurement date RPI is $500x. Under section
7.05(b), the USP group’s last measurement date RPI is $600x, which includes the
indebtedness of CFC1 ($100x), CFC2 ($100x), and the acquired CFCs of USB ($400x).

(iii) Alternative facts
. The facts are the same as in Example 6 (i), except that
CFC1 pays US1 $70x of the $100x indebtedness on November 1, 2005. The USP
group’s initial measurement date RPI is $500, the same as in (ii). Under section
7.05(b), the USP group’s last measurement date RPI is $530x, which includes the
indebtedness of CFC1 ($30x), CFC2 ($100x), and the acquired CFCs of USB ($400x).
Under section 7.04 of this notice and section 965(b)(3), USP group reduces its
dividends otherwise eligible for the section 965(a) DRD by $30x.

Example 5
. Determination of initial and last measurement date RPI when a U.S.
shareholder and its CFC are transferred but the note due from the CFC is left behind. (i)
Facts. The facts are the same as in Example 1, except that all the stock of US1 (and
indirectly CFC1) is sold to an unrelated U.S. shareholder, USB, on December 31, 2004,
before USP group’s election year ending December 31, 2005. Assume that CFC1’s
related party indebtedness on the initial measurement date ($100x) was the result of the
indebtedness being owed to USP instead of US1. US1 is a member of the USB group
on the USB group’s last measurement date.

(ii) Result
. Without regard to acquisitions and dispositions, the USP group has
initial measurement date RPI of $100x. Because USP was a U.S. shareholder and a
related person with respect to CFC1 on the USP group’s initial measurement date, but
is not a U.S. shareholder or a related person on its last measurement date, section
7.05(c) requires the USP group to reduce its initial measurement date RPI from $100x
to $0.

On the USP group’s last measurement date, CFC1 is not a related person.
Therefore, the USP group’s last measurement date RPI is $0.

USB has initial measurement date RPI of $0, without regard to the acquisition of
US1 (and CFC1). No adjustment is made to this amount under section 7.05(c) because
immediately after the acquisition CFC1 owed an indebtedness to USP, an unrelated
party. Further, the USB group’s last measurement date RPI is $0 because its CFC
(CFC1) does not have an indebtedness to a related party on the last measurement

54
date.

Example 6. Determination of initial and last measurement date RPI when a U.S.
shareholder is transferred without the debtor CFC. (i) Facts. The facts are the same as
in Example 1
, except that on December 31, 2004, before the USP group’s election year,
US1 distributed CFC1 to USP, and then US1 was sold to USB. In addition, CFC1’s
related party indebtedness on the USP group’s initial measurement date was owed to
USP instead of US1. Finally, USB has initial measurement date RPI of $0.

(ii) Result.
Without regard to the distribution of CFC1 or the disposition of US1,
the USP group has initial measurement date RPI of $100x. No adjustment is made
under section 7.05(c) to the USP group’s initial measurement date RPI as a result of the
distribution of CFC1 because after the distribution the USP group is a U.S. shareholder
and related person with respect to CFC1. Further, under section 7.05(c), the sale of
US1 does not require the USP group to reduce its initial measurement date RPI
because after the disposition USP is still a U.S. shareholder and related person with
respect to CFC1. Therefore, USP has initial measurement date RPI of $100x. The
USP group’s last measurement date RPI is also $100x because on the last
measurement date CFC1’s indebtedness is owed to USP, a related party.

USB acquires US1, but US1 has no CFCs when it enters the USB consolidated
group. Therefore, under section 7.05(c), the USB consolidated group does not increase
its initial measurement date RPI. In addition, USB’s last measurement date RPI is $0.

(iii) Alternative facts
. The facts are the same as in (i), except that the CFC1
indebtedness is owed to US1. Under the alternative facts, the USP group would still
have initial measurement date RPI in the amount of $100x. No adjustment is made to
this amount under section 7.05(c) because on the USP group’s initial measurement
date and last measurement date the USP group was a U.S. shareholder and a related
person with respect to CFC1. However, as of the last measurement date, CFC1 will
owe an indebtedness to US1, an unrelated party. Therefore, the USP group’s last
measurement date RPI is $0. The results with respect to the USB group are the same
as set forth in (ii).

Example 7
. Translating RPI denominated in a non-U.S. dollar currency. (i) Facts.
CFC1’s indebtedness to US1 is denominated in currency u. As of the close of
September 30, 2004 (the initial measurement date), CFC1 owed 100u to US1. As of
the close of December 31, 2005, CFC1 continued to owe 100u to US1. As of
September 30, 2004, the spot rate is 1u/$1. As of December 31, 2005, the spot rate is
1u/$1.5.

(ii) Result
. Pursuant to section 7.05 of this notice, the indebtedness of CFC1 to

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US1 on the initial measurement date and the last measurement date is converted into
U.S. dollars on the spot rate on the initial measurement date. As a result, the
indebtedness of CFC1 to US1 on both dates is $100x.

Example 8
. U.S. shareholder not related to CFC (i) Facts. FP, a foreign
corporation, wholly owns US1, a domestic corporation. US1 owns 60% of CFC. US2, a
domestic corporation that is unrelated to FP or US1, owns the remaining 40% of CFC.
As of the initial measurement date of US1 and US2, CFC has related party
indebtedness in the amount of $100x that is owed to FP.

(ii) Result
. US1 is a related person with respect to CFC on its initial
measurement date. As a result, US1 takes into account the related party indebtedness
of CFC for purposes of section 965(b)(3). Because US2 is not a related person with
respect to CFC, the $100x of related party indebtedness is not taken into account by
US2 for purposes of section 965(b)(3).

Example 9
. Application of Section 965(b)(3) reduction to multiple U.S.
shareholders (i) Facts. USP is a domestic corporation and the common parent of a
consolidated group. USP wholly owns US1, a domestic corporation that is not a
member of the USP group because an election under section 936 is in effect with
respect to US1. USP and US1 wholly own CFC1 and CFC2, respectively. The USP
group and US1 both maintain a calendar taxable year and elect to apply section 965 to
the taxable year ending December 31, 2005. USP receives a cash dividend of $200x
from CFC1 on February 1, 2005. US1 receives a cash dividend from CFC2 of $300x on
March 1, 2005. Both cash dividends received by USP and US1 during 2005 are
otherwise eligible for the deduction under section 965(a). There is a $300x increase in
CFC1’s related party indebtedness pursuant to section 965(b)(3). CFC2 does not have
related party indebtedness at any time.

(ii) Result
. Under section 965(d)(3), the USP group and US1 are both U.S.
shareholders and related persons with respect to CFC1. Thus, both the USP group and
US1 are required to take into account CFC1’s increase in related party indebtedness.
Based upon the rules set forth in section 7.06, above, CFC1’s $300x increase in related
party indebtedness reduces the amount of the USP group’s and US1’s dividends eligible
for the deduction under section 965(a) based on the earliest cash dividends eligible for
the section 965(a) DRD received by the USP group and US1 during the election year.
As a result, the USP group takes into account $200x of the $300x increase in RPI
because it received a cash dividend of $200x on February 1, 2005. US1 takes into
account the remaining $100x of such increase because it received its cash dividend on
March 1, 2005.

(iii) Alternative Facts
. The facts are the same as Example 2, except that USP

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and US1 received the cash dividends from CFC1 and CFC2, respectively, on the same
day during the election year. Under section 7.06, the USP group and US1 take into
account the $300x increase in RPI attributable to CFC1 in proportion to their receipt of
cash dividends on such date. Thus, the USP group takes into account $120x of the
increase (($200x/($200x + $300x)) x $300x). US1 takes into account the remaining
$180x of the increase (($300x/($200x + $300x)) x $300x).

Example 10
. Determination of initial and last measurement date RPI when
related party indebtedness arises in connection with or as a result of a transaction. (i)
Facts
. The facts are the same as in Example 3, except that in connection with or as a
result of USB’s purchase of the stock of US1 (and indirectly CFC1), US1 lends CFC1
$50x.

(ii) Result
. With respect to the USP group, the initial measurement date RPI and
the last measurement date RPI are the same as in Example 3
. The USB group’s initial
measurement date RPI and last measurement RPI are affected. Without regard to the
acquisition of US1, the USB group’s initial measurement date RPI is $0. However,
under section 7.05(c), the USB group increases its initial measurement date RPI by
$100x, the amount of the related party indebtedness of its CFC (CFC1) immediately
after the transaction, but excluding the indebtedness arising in connection with, or as a
result of, the transaction. The USB group’s last measurement date RPI, however, is
$150x because as of its last measurement date, CFC1 owes $150x to US1, a related
person. Therefore, under section 7.04 of this notice and section 965(b)(3), the USB
group reduces its dividends otherwise eligible for the section 965(a) DRD by $50x.

SECTION 8. EFFECT OF CERTAIN TRANSACTIONS ON DOMESTIC
REINVESTMENT PLANS
.01 In General
This section addresses the effect of certain transactions on domestic
reinvestment plans adopted pursuant to section 965(b)(4) and Notice 2005-10. Section
8.02 of this notice addresses the effect of members entering and exiting a consolidated
group. Section 8.03 addresses the effect of certain asset acquisitions. Section 8.04
then provides rules that apply to a corporation that may make permitted investments
pursuant to more than one domestic reinvestment plan. Finally, section 8.05 of this

57
notice provides reporting and administrative requirements for transactions addressed by
this section 8.
.02 Members Entering and Exiting a Consolidated Group
A consolidated group may rely on any domestic corporation (regardless of
whether such corporation is a U.S. shareholder) to fulfill the group’s obligations to make
permitted investments under a domestic reinvestment plan if that corporation is a
member of the group at any time on or after the first day of the group’s election year.
For example, if a consolidated group adopts a domestic reinvestment plan and a
member leaves the group during or after the group’s election year, the group may rely
on the former member’s subsequent domestic investment activity to satisfy the group’s
obligations under its domestic reinvestment plan. Similarly, if a domestic corporation
joins a consolidated group during or after the first day of the group’s election year, the
group may rely on the new member’s domestic investment activity after it joins the
group to satisfy the group’s obligations under its domestic reinvestment plan. The rules
of this paragraph apply regardless of the amount of cash or property held by the former
member or new member at the time it leaves or joins the consolidated group, as the
case may be.
In addition, a domestic corporation may rely on any other domestic corporation
(regardless of whether such corporation is a U.S. shareholder) to fulfill its obligations to
make permitted investments under a domestic reinvestment plan if both corporations
are members of the same consolidated group at the time the investment is made, even

58
if they were not members of the same consolidated group during the corporation’s
election year. For example, if a corporation adopts a domestic reinvestment plan and
the corporation joins a consolidated group after the end of the corporation’s election
year, the acquired corporation may rely on the subsequent domestic investment activity
of any member of the acquiring consolidated group to satisfy the corporation’s
obligations under its domestic reinvestment plan. Similarly, if a consolidated group
adopts a domestic reinvestment plan and the group is acquired by another consolidated
group after the acquired group’s election year, the acquired group may rely on the
subsequent domestic investment activity of any member of its new consolidated group
to satisfy the acquired group’s obligations under its domestic reinvestment plan.
.03 Asset Acquisitions
In general, if a corporation acquires assets of another corporation, the acquiring
corporation will not succeed to the obligations of the transferor corporation under a
domestic reinvestment plan, and investments made by the acquiring corporation
therefore are not eligible to satisfy such domestic reinvestment plan. However, if the
corporation acquires the assets of a transferor corporation in a transaction described in
section 381(a), subsequent investments made by the acquiring corporation (or by
members of the acquiring corporation’s consolidated group) therefore may be eligible to
satisfy the transferor’s domestic reinvestment plan.
If, prior to the transaction described in section 381(a), the acquiring corporation
was also required or permitted to make permitted investments in order to satisfy a

59
domestic reinvestment plan, the acquiring corporation will continue to be required or
permitted to satisfy obligations under that domestic reinvestment plan in addition to any
obligations under the transferor’s domestic reinvestment plan.
.04 Designation of Permitted Investment Activity
A single corporation may be able to make permitted investments in satisfaction of
more than one domestic reinvestment plan. However, the same expenditure of funds
may not satisfy the investment requirement of more than one domestic reinvestment
plan. For example, a single $100x investment made by an acquired domestic
corporation cannot be counted toward the investment requirements of both the selling
consolidated group and the acquiring consolidated group. If a permitted investment by
a corporation would satisfy the investment requirement of more than one domestic
reinvestment plan, the corporation may designate which plan is being satisfied. If a
corporation fails to so designate, its domestic investment activities will be treated as
fulfilling domestic reinvestment plan obligations in the following order: first, under any
plan adopted with respect to its own earliest election year; second, under any plan
adopted with respect to its own subsequent election years, if any; and third, with respect
to any plan adopted with respect to any other corporation (for example, a transferor in a
transaction described in section 381(a) or a consolidated group the corporation later
joined) in the order the corporation became required or permitted to make investments
in satisfaction of such plan.
.05 Reporting and Other Administration Requirements under Section 8 of Notice 2005-

60
10
If a former member of a consolidated group contributes to the completion of the
group’s domestic reinvestment plan (in whole or in part), the obligation to comply with
the reporting and other administrative requirements contained in section 8 of Notice
2005-10 will remain with the group if such group continues to exist, or otherwise with the
common parent (or successor agent) for the election year, or the common parent of any
consolidated group that includes such former common parent (or successor agent).
.06 Examples
The following examples illustrate the application of section 965(b)(4) and this
section 8. Unless otherwise indicated, the following facts are assumed for purposes of
these examples: USP is a domestic corporation and the common parent of a
consolidated group that uses the calendar year as its taxable year. USP wholly owns
US1 and US2, which are domestic corporations and members of the USP consolidated
group. US1 and US2 each wholly owns a foreign corporation, CFC1 and CFC2,
respectively. The USP group elects to apply section 965 for its taxable year ending
December 31, 2005. The domestic reinvestment plan approved pursuant to section
965(b)(4) and Notice 2005-10 on behalf of the USP group requires that an amount of
cash equal to the $100x cash dividends that are received from the USP group’s CFCs
will be invested in the United States to fund research and development activities
(performed in the United States) of the USP group over a two-year period. On

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December 31, 2005, CFC1 and CFC2 each distributes $50x of dividends that are
eligible for the section 965(a) DRD.
Example 1
. Member exiting a consolidated group. (i) Facts. On July 1, 2006, all
of the stock of US2 is acquired for cash by USB, a domestic corporation and the
common parent of the USB consolidated group. Any permitted investments required to
be made by the USB group under any domestic reinvestment plan (other than that of
the USP group) are made prior to June 30, 2006. Between July 1, 2006 and December
31, 2007, US2 funds $100x of research and development activities.

(ii) Result
. Because US2 is a member of the USP group after the beginning of the
USP group’s election year, US2’s funding of $100x of research and development
activities made while it is a member of the USB group will satisfy the USP group’s
obligations to make such permitted investments specified under the USP group’s
domestic reinvestment plan. However, the USP group satisfies the reporting and
administrative requirements contained in section 8 of Notice 2005-10 with respect to
such investment.

Example 2
. Member entering a consolidated group. (i) Facts. On March 31,
2006, USP acquires for cash all the stock of US3, a domestic corporation that is not a
member of a consolidated group. US3 elected to apply section 965 to its taxable year
ending December 31, 2005. US3’s domestic reinvestment plan requires that US3
expend $5x to compensate existing employees for services performed in the United
States over a two-year period. Between April 1, 2006 and December 31, 2007, US3
funds $100x of research and development activities. During the same period, US2
expends $5x to compensate existing employees for services performed in the United
States.

(ii) Result
. Because US3 is a member of the USP group after the beginning of the
USP group’s election year, US3’s funding of $100x of research and development
activities after joining the group will satisfy the USP group’s obligations to make such
specified permitted investments under the USP group’s plan. In addition, because US2
is a member of the same consolidated group as US3 when it expends $5 to
compensate existing employees for services performed in the United States (a
permitted investment pursuant to section 965(b)(4) and Notice 2005-10), US3 may rely
on US2’s expenditure to satisfy its obligation specified under its plan. USP is required
to satisfy the administrative requirements with respect to investments under US3’s plan.

Example 3
. Asset acquisition of U.S. shareholder. (i) Facts. The facts are the
same as in Example 2
, except that instead of USP acquiring the stock of US3, US3
merges into US2 in a reorganization under section 368(a)(1)(A) and (a)(2)(D) on March

62
31, 2006, after which US2 remains a member of the USP group. Between April 1, 2006
and December 31, 2007, US2 funds $100x of research and development activities and
pays $5x to compensate existing employees for services performed in the United
States.

(ii) Result
. Because US2 acquired the assets of US3 in a transaction to which
section 381(a) applies, US2 succeeded to US3’s domestic reinvestment plan
obligations. US2’s payment of $5x to compensate existing employees for services
performed in the United States satisfies its obligation to make a permitted investment
specified under US3’s plan. The USP group may also rely on US2’s funding of $100x of
research and development activities to satisfy the USP group’s plan obligations. The
result would be the same if, after the merger of US3 into US2, US1, instead of US2,
paid $5x to compensate existing employees for services performed in the United States,
because US1 is a member of the same consolidated group as US2 and the
compensation is a permitted investment pursuant to section 965(b)(4) and Notice 2005-
10.

Example 4
. Failure to designate sufficient investment activity to fulfill multiple
domestic reinvestment plans. (i) Facts. The facts are the same as in Example 2, except
that US3’s plan also required US3 to expend $5x to fund research and development
activities over a two-year period. The USP group fails to designate specific investment
activities for purposes of section 8.04 of this notice to satisfy either the USP group
domestic reinvestment plan or the US3 domestic reinvestment plan. Between March
31, 2006 and December 31, 2007, US3 funds $5x of research and development
activities and US2 funds $95x of research and development activities.

(ii) Result
. Because the USP group failed to designate specific investment
activities to satisfy US3’s and the USP group’s domestic reinvestment plans, US3’s
permitted investments will first be taken into account under the US3 plan, and US2’s
permitted investments will first be taken into account under the USP group plan.
Consequently, US3’s $5x expenditure will satisfy the US3 plan and cannot be taken into
account by the USP group to satisfy its obligation to conduct $100x of research and
development activities. As a result, the USP group will have conducted only $95x of
research and development activities and the USP group’s 2005 qualifying dividend is
reduced by $5x. If instead, US3 had merged into US2 on March 31, 2006, as in
Example 3
, and US2 spent the $100x without designating, all $100x would have
satisfied the USP domestic reinvestment plan. In addition, the US3 plan would fail to
have been satisfied, resulting in a $5x reduction in US3’s qualifying dividends.

SECTION 9. OTHER GUIDANCE
.01 Section 78 Gross-Up, Disallowance of Expenses Pursuant to Section 965(d)(2), and

63
Computation of Alternative Minimum Tax in Election 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).
The disallowance of expenses in section 965(d)(2) applies only to expenses that
are “directly allocable” to the deductible portion described in section 965(d)(1).
For purposes of calculating alternative minimum tax for the election year under
section 55(a) in accordance with 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.
The IRS and Treasury will incorporate the rules in this section 9.01 into
subsequent guidance. This subsequent guidance will provide detail regarding these
and related rules.
.02 Contiguous Country Branches of Domestic Life Insurance Companies
Amounts added to the life insurance company taxable income of a domestic life
insurance company by reason of section 814(e)(2) (dealing with contiguous country
branches of a domestic life insurance company) are not eligible for the section 965(a)
DRD.
.03 Cash Dividends in Excess of Amounts Covered by Domestic Reinvestment Plans
A domestic reinvestment plan may provide for the investment in the United
States of an amount that is less than the entire amount of cash dividends that are
otherwise eligible for the section 965(a) DRD. In such a case, the section 965(a) DRD

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applies only to the amount of eligible dividends that are reinvested pursuant to the plan
(assuming that all the other requirements under section 965 are satisfied).
.04 Section 958(a) Chain of Ownership -- Stock Deemed Issued Pursuant to Section
304(a)(1)
If stock of an acquiring CFC is deemed to be issued to another CFC pursuant to
section 304(a)(1), the acquiring CFC is treated as being in a chain of ownership
described in section 958(a) for purposes of applying section 965(a)(2).
The following example illustrates the application of section 965(a)(2) and this
section 9.04:
Example
. (i) Facts. USP, a domestic corporation, wholly owns two foreign
corporations, CFC1 and CFC2. CFC1 wholly owns a foreign corporation, CFC3. CFC2
has $100x of current and accumulated earnings and profits described in sections
304(b)(5)(A) and 959(c)(3). During USP’s section 965 election year, CFC1 sells all its
CFC3 stock to CFC2 for $100x. Also during USP’s election year, CFC1 distributes
$100x to USP that is excluded from gross income under section 959(a).

(ii) Result
. Because CFC1 is in control of both CFC3 and CFC2 and receives
property from CFC2 in exchange for its CFC3 stock, CFC1’s sale of CFC3 stock to
CFC2 is subject to section 304(a)(1). Accordingly, CFC1 is treated as receiving $100x
as a distribution in redemption of CFC2 stock. Because CFC1 actually owns 100% of
CFC3 before the sale and is treated as owning 100% of CFC3 after the sale, pursuant
to section 302(d), section 302(a) does not apply to the deemed redemption distribution
and the proceeds of the deemed redemption are treated as a distribution to which
section 301 applies. Therefore, CFC1 is treated as transferring its CFC3 stock to CFC2
in exchange for CFC2 stock in a transaction to which section 351(a) applies. The CFC2
stock CFC1 is treated as receiving in the deemed section 351 exchange is then treated
as redeemed by CFC2 for $100x. Under section 302, that redemption is treated as a
distribution to which section 301 applies because CFC1 owns directly 100% of CFC3
before the redemption of the CFC2 stock that was deemed issued and is treated as
owning 100% of CFC3 after the redemption. The deemed redemption proceeds are
treated as a distribution to which section 301 applies, and CFC1 is treated as receiving
a dividend of $100x from the current and accumulated earnings and profits of CFC2.
For purposes of section 965(a)(2), because CFC1 is treated under section 304(a)(1) as

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receiving CFC2 stock in the deemed section 351 exchange, CFC1 is treated as
receiving the $100x dividend from another CFC that is in a chain of ownership described
in section 958(a).

.05 Acquisitions of Interests in Business Entities -- Modification of Section 5.06 of Notice
2005-10
Section 5.06 of Notice 2005-10 provides, in part, that in valuing assets with
respect to certain acquisitions of interests in business entities, the taxpayer must use
the same methodology that it uses, under section 864(e) and Treas. Reg. §1.861-9T(g)
(that is, tax book value, alternative tax book value, or fair market value), for purposes of
allocating and apportioning its interest expense for the taxable year. Notwithstanding
that section of Notice 2005-10, the Treasury Department and the IRS have decided that
taxpayers may elect to use the fair market value methodology under Treas. Reg.
§1.861-9T(g) for purposes of valuing assets pursuant to section 5.06 of Notice 2005-10,
even if they use the tax book value or alternative tax book value methodology for
purposes of allocating and apportioning interest expense under section 864(e). Such
election is made on the annual report (required under section 8.02(a) of Notice 2005-10)
filed by the taxpayer for the taxable year of the acquisition.
.06 Distributions to Intermediary Disregarded Entities – Clarification of Section 3.02 of
Notice 2005-10
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

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that such shareholder receives cash in the amount of the CFC dividend during the
taxable year for which such election is in effect. For this purpose, a disregarded entity
need not actually distribute cash to a U.S. shareholder of the CFC, provided that the
U.S. shareholder otherwise receives the cash from the disregarded entity and there is
no legal obligation for the U.S. shareholder to repay the cash to the disregarded entity.
7

For purposes of the preceding sentence, the term U.S. shareholder is defined in section
951(b).
Example. (i) Facts. USP, a domestic corporation, wholly owns DE, a disregarded
entity. DE wholly owns CFC, a foreign corporation. Since Year 1, USP has held a
$200x obligation of DE. CFC pays a $100x dividend to DE during Year 3, USP’s
election year. Also during Year 3, DE repays $100x of its obligation to USP.

(ii) Result
. The $100x dividend paid by CFC is paid to DE, a pass-through entity
that is owned by USP. As a result, pursuant to section 3.02 of Notice 2005-10, such
dividend is treated as a cash dividend for purposes of section 965 only if and to the
extent that USP receives $100x from DE during Year 3 without an obligation to repay
those funds to DE. DE’s repayment of $100x of its $200x obligation held by USP
satisfies this requirement, and the $100x dividend paid by CFC during the election year
therefore qualifies as a cash dividend for purposes of section 965. The result is the
same regardless of whether the $100x repayment by DE is of principal, accrued
interest, or both.

(iii) Alternative Facts
. The facts are the same except that instead of using the
$100x to satisfy a portion of an obligation held by USP, DE uses the $100x cash to
acquire an asset from USP. The result is the same.

SECTION 10. REPORTING AND OTHER ADMINSTRATIVE REQUIREMENTS
Pursuant to section 6001, the taxpayer must prepare, maintain, and, upon a

7
See section 3.02 of Notice 2005-10 (providing that a loan of cash from the disregarded entity to the U.S.
shareholder is not considered a distribution of cash for this purpose because there is a legal obligation for
the U.S. shareholder to repay the cash to the disregarded entity).

67
request by the Commissioner, make available within 30 days of such request, a general
description of any transaction that results in: (1) an adjustment to base period inclusions
or APB 23 amounts pursuant to section 6 of this notice; (2) an adjustment to initial
measurement date RPI pursuant to section 7 of this notice; or (3) a permitted
investment being made by a U.S. shareholder that, at the time of such investment, is
not a member of the consolidated group that adopted the domestic reinvestment plan
pursuant to which such investment is made, as provided under section 8 of this notice.
The description must include, as applicable, the name, address, and tax identification
number (if available), of all parties relevant to the transaction (for example, selling
group, departing or joining member, and acquiring group). In addition, it must include all
relevant dates and the amount of adjustments resulting from the transactions.
In addition, pursuant to section 6001, the taxpayer must prepare, maintain, and,
upon a request by the Commissioner, make available within 30 days of such request:
(1) a list of investments that may satisfy more than one domestic reinvestment plan and
the taxpayer designation of which plan the investment satisfies; and (2) those domestic
corporations that have participated in more than one election year.
In the case of an adjustment to base period inclusions pursuant to section 6 of
this notice, such adjustments may be determined by reference to the separate Form
1120 prepared for the departing U.S. shareholder for the base period years in question,
without regard to the fact that the separate Form 1120 does not constitute a processed
return, and was prepared to determine the consolidated return of the group of which it

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was a member.
SECTION 11. TRANSITION RULES
.01 Domestic Reinvestment Plans Approved Prior to May 10, 2005
If a domestic reinvestment plan is approved prior to May 10, 2005, the taxpayer
may modify such plan to take into account the guidance herein not later than July 11,
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 May 10, 2005
If, prior to May 10, 2005, a taxpayer has filed its tax return for the taxable year for
which it acquires an interest in a business entity that qualifies, in whole or in part, as a
permitted investment pursuant to section 5.06 of Notice 2005-10, such taxpayer may
make the election to use the fair market value methodology pursuant to section 9.05 of
this notice with respect to such acquisition on an amended tax return that is filed on or
before December 31, 2005.
SECTION 12. EFFECT OF THIS NOTICE ON OTHER DOCUMENTS
Sections 9.05 and 9.06 of this notice modify section 5.06 and clarify section 3.02
of Notice 2005-10, respectively. See also section 11 of this notice, pursuant to which
domestic reinvestment plans approved prior to May 10, 2005 (including domestic

69
reinvestment plans adopted or modified pursuant to the guidance included in Notice
2005-10), may be modified to take into account the guidance in this notice.
SECTION 13. EFFECTIVE DATE
This notice is effective for the taxable year for which taxpayers have elected
section 965 to apply, and other taxable years as relevant.
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 [
1545-1943].
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 5, 8, 9, 10, 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 determined the maximum amount of cash dividends
eligible for the DRD under section 965(a), taking into account the limitations on the DRD
that are imposed by section 965(b)(1), (b)(2), and (b)(3). The collections of information
are required to obtain the benefit of section 965 for a taxable year. The collections of
information are required to obtain the benefit of section 965 for a taxable year. The
likely respondents are business corporations.

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Estimated total annual reporting and/or recordkeeping burden: 1,250,000 hours.
Estimated average annual burden hours per respondent: 50 hours.
Estimated number of respondents: 25,000.
Estimated annual frequency of responses: on occasion and annually.
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 June 9, 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

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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,
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 authors of this notice are Jeffrey L. Vinnik of the Office of Associate
Chief Counsel (International) and Krishna P. Vallabhaneni, formerly of the Office of
Associate Chief Counsel (Corporate). However, other personnel from the IRS and the
Treasury Department participated in its development. For further information regarding
this notice contact Mr. Vinnik at (202) 622-3840 (not a toll-free call).