# Prop. Treas. Reg. § 1.901-2: Income, war profits, or excess profits tax paid or accrued. Proposed regulation, not in force. REG-101657-20, 87 FR 71271, published 2022-11-22 . Interprets 26 U.S.C. § 901. Par 3. Section 1.901-2 is amended: 1. By revising paragraph (b)(4)(i)(A). 2. By redesignating paragraphs (b)(4)(i)(B), (b)(4)(i)(C)( 3 ), and (b)(4)(i)(D) as paragraph (b)(4)(i)(G), (b)(4)(i)(D), and (b)(4)(i)(E), respectively. 3. By adding new paragraph (b)(4)(i)(B). 4. By revising paragraph (b)(4)(i)(C). 5. By revising the first sentence of newly redesignated paragraph (b)(4)(i)(D). 6. By adding paragraph (b)(4)(i)(F). 7. In newly redesignated paragraph (b)(4)(i)(G)( 1 ), by removing the language “one or more significant costs and expenses” and adding the language “substantially all of each item of significant cost or expense” in its place. 8. In paragraph (b)(4)(iv)(A)( 2 ), by removing the language “significant costs and expenses” and adding the language “substantially all of each item of significant cost or expense” in its place. 9. In paragraph (b)(4)(iv)(B)( 2 ), by removing the language “(b)(4)(i)(B)( 2 )” and adding the language “(b)(4)(i)(G)( 2 )” in its place. 10. By removing and reserving paragraph (b)(4)(iv)(C). 11. In paragraphs (b)(4)(iv)(D)( 2 ) and (b)(4)(iv)(E)( 2 ), by removing the language “(b)(4)(i)(C)( 2 )” and adding the language “(b)(4)(i)(F)( 2 )” in its place. 12. By adding paragraphs (b)(4)(iv)(F) through (J). 13. By revising paragraphs (b)(5)(i)(B)( 2 ), (d)(1)(iii), and (h). The revisions and additions read as follows: * * * * * (b) * * * (4) * * * (i) * * * (A) In general. A foreign tax satisfies the cost recovery requirement if the base of the tax is computed by reducing gross receipts (as described in paragraph (b)(3) of this section) to permit recovery of substantially all of each item of significant cost or expense (including each item of cost or expense related to the categories described in paragraph (b)(4)(i)(B)( 2 ) of this section) attributable, under reasonable principles, to such gross receipts. See paragraph (b)(4)(i)(B) of this section for rules regarding the determination of what is a significant cost or expense, paragraph (b)(4)(i)(C) of this section for rules regarding the recovery of substantially all of an item, paragraph (b)(4)(i)(E) of this section for rules regarding principles for attributing costs and expenses to gross receipts, and paragraph (b)(4)(i)(F) of this section for exceptions to this rule. A foreign tax need not permit recovery of significant costs and expenses, such as certain personal expenses, that are not attributable, under reasonable principles, to gross receipts included in the foreign tax base. A foreign tax whose base is gross receipts, with no reduction for costs and expenses, satisfies the cost recovery requirement only if there are no significant costs and expenses described in paragraph (b)(4)(i)(B) of this section attributable to the gross receipts included in the foreign tax base. See paragraph (b)(4)(iv)(A) of this section ( Example 1 ). A foreign tax that provides an alternative cost allowance satisfies the cost recovery requirement only as provided in paragraph (b)(4)(i)(G) of this section. (B) Significant costs and expenses —( 1 ) In general. Except as provided in paragraph (b)(4)(i)(B)( 2 ) of this section, whether an item of cost or expense is significant for purposes of this paragraph (b)(4)(i) is determined based on whether, for all taxpayers in the aggregate to which the foreign tax applies, the item of cost or expense constitutes a significant portion of the taxpayers' total costs and expenses. ( 2 ) Per se significant costs and expenses. An item of cost or expense (as characterized under foreign law) related to capital expenditures, interest, rents, royalties, wages or other payments for services, and research and experimentation is always treated as an item of significant cost or expense for purposes of this paragraph (b)(4)(i). (C) Recovery of substantially all of each item —( 1 ) In general. Whether a foreign tax permits recovery of substantially all of each item of significant cost or expense is determined based solely on the terms of the foreign tax law. ( 2 ) Safe harbor. One or more disallowances of a stated portion of an item (or multiple items) of significant cost or expense does not prevent a foreign tax from being considered to permit recovery of substantially all of each item of significant cost or expense if the total portion of the item (or items) that is disallowed does not exceed 25 percent. A limitation that caps the recovery of an item of significant cost or expense, or multiple items of cost or expense that relate to a single category of significant costs and expenses described in paragraph (b)(4)(i)(B)( 2 ) of this section does not prevent a foreign tax from being considered to permit recovery of substantially all of each item of significant cost or expense if the limitation is a qualifying cap. For such purpose, a limitation that caps the recovery at a stated portion of gross receipts, gross income, or a similar measure is a qualifying cap if the stated portion of such measure is not less than 15 percent. A limitation that caps the recovery at a stated portion of taxable income (determined without regard to the item at issue) or a similar measure is a qualifying cap if the stated portion of such measure is not less than 30 percent. ( 3 ) Non-recovery of significant costs and expenses. Significant costs and expenses (such as interest expense) are not considered to be recovered by reason of the time value of money attributable to the acceleration of a tax benefit or economic benefit attributable to the timing of the recovery of other costs and expenses (such as the current expensing of debt-financed capital expenditures). (D) * * * A foreign tax law permits recovery of substantially all of each item of significant cost or expense even if such item of cost or expense is recovered earlier or later than it is recovered under the Internal Revenue Code unless the time of recovery is so much later as effectively to constitute a denial of such recovery. * * * * * * * * (F) Exceptions —( 1 ) Disallowances consistent with U.S. principles. Notwithstanding paragraph (b)(4)(i)(A) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if such disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code, including the principles of limiting base erosion or profit shifting and addressing non-tax public policy concerns similar to those reflected in the Internal Revenue Code. For example, a foreign tax may satisfy the cost recovery requirement even if the foreign tax law disallows deductions in connection with hybrid transactions, disallows deductions attributable to gross receipts that in whole or in part are excluded, exempt or eliminated from taxable income, or disallows certain deductions consistent with non-tax public policy considerations similar to those underlying the disallowances contained in section 162. See paragraphs (b)(4)(iv)(I) and (J) of this section ( Examples 9 and 10 ). ( 2 ) Amounts that need not be recovered. A foreign tax law may satisfy the cost recovery requirement even if the foreign tax law does not permit recovery of costs and expenses attributable to wage income or to investment income that is not derived from a trade or business. In addition, in determining whether a foreign tax (the “tested foreign tax”) meets the cost recovery requirement, it is immaterial whether the tested foreign tax allows a deduction for other taxes that would qualify as foreign income taxes (determined without regard to whether such other tax allows a deduction for the tested foreign tax). See paragraphs (b)(4)(iv)(D) and (E) of this section ( Examples 4 and 5 ). * * * * * (iv) * * * (F) Example 6: Substantially all; application of the safe harbor —( 1 ) Facts. Country X imposes a tax (“Country X tax”) on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that Country X tax law disallows a deduction for 25 percent of a taxpayer's costs and expenses for royalties related to patents. ( 2 ) Analysis. Under paragraph (b)(4)(i)(B)( 2 ) of this section, an item of cost or expense related to royalties is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to royalties, including the item of royalties related to patents. The stated percentage of costs and expenses from royalties related to patents (25 percent) that is disallowed under Country X tax law does not exceed 25 percent. Accordingly, under the safe harbor in paragraph (b)(4)(i)(C)( 2 ) of this section, the disallowance does not prevent the Country X tax from being considered to permit recovery of substantially all of each item of cost or expense related to royalties, and therefore the Country X tax satisfies the cost recovery requirement. (G) Example 7: Substantially all; application of the safe harbor —( 1 ) Facts. Country X imposes a tax (“Country X tax”) on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that Country X tax law disallows a deduction for 15 percent of a taxpayer's costs and expenses for rents and 25 percent of a taxpayer's costs and expenses for interest. ( 2 ) Analysis. Under paragraph (b)(4)(i)(B)( 2 ) of this section, an item of cost or expense related to rents or interest is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to royalties and interest. The stated percentage of the costs and expenses related to rents (15 percent) that is disallowed under Country X tax law does not exceed 25 percent. Additionally, the stated percentage of the costs and expenses related to interest (25 percent) that is disallowed under Country X law does not exceed 25 percent. Accordingly, under the safe harbor in paragraph (b)(4)(i)(C)( 2 ) of this section, the disallowances do not prevent the Country X tax from being considered to permit recovery of substantially all of each item of cost or expense related to rents and interest, and therefore the Country X tax satisfies the cost recovery requirement. (H) Example 8: Substantially all; application of the safe harbor —( 1 ) Facts. Country X imposes a tax (“Country X tax”) on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that Country X tax law caps the recovery of the deduction of interest at 30 percent of the taxpayer's taxable income determined without regard to interest expense. ( 2 ) Analysis. Under paragraph (b)(4)(i)(B)( 2 ) of this section, an item of cost or expense related to interest is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to interest. The stated cap on recovery in Country X tax law with respect to interest (30 percent of taxable income determined without regard to interest expense) is not less than 30 percent of taxable income determined without regard to interest expense. Additionally, the cap on recovery relates to a single category of significant costs and expenses described in paragraph (b)(4)(i)(B)( 2 ) of this section. Accordingly, under the safe harbor in paragraph (b)(4)(i)(C)( 2 ) of this section, the disallowance does not prevent the Country X tax from being considered to permit recovery of substantially all of each item of cost or expense related to interest, and therefore the Country X tax satisfies the cost recovery requirement. (I) Example 9: Permissible disallowance based on U.S. principles —( 1 ) Facts. Country X imposes a tax on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that under Country X's anti-hybrid rules, a deduction is disallowed for any payment, including interest, royalties, rents, or payments for services, made by a Country X resident to a related entity located outside of Country X if the payment is not included in gross income by the payee or the payee is not subject to tax. ( 2 ) Analysis. Under paragraph (b)(4)(i)(B)( 2 ) of this section, each item of cost or expense related to interest, rents, royalties, and payments for services is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to interest, rents, royalties, and payments for services. Country X tax law does not permit recovery of any portion of any item of significant cost or expense that is subject to the anti-hybrid rules. As a result, the safe harbor in paragraph (b)(4)(i)(C)( 2 ) of this section does not apply to such item. Further, because a deduction is disallowed for any item of cost or expense that is subject to the Country X anti-hybrid rules, the Country X tax law completely disallows certain items of cost and expense related to interest, rents, royalties, and payments for services and thus does not permit recovery of substantially all of each item of significant cost or expense related to interest, rents, royalties, and payments for services. However, under paragraph (b)(4)(i)(F)( 1 ) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if the disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code. The income tax provisions of the Internal Revenue Code, specifically section 267A, contain disallowances of deductions based on the principle of limiting base erosion or profit shifting. Country X's disallowance of deductions for any payment, including interest, royalties, rents, or payments for services also reflects the principle of limiting base erosion or profit shifting. Accordingly, because Country X's anti-hybrid rules are consistent with the principle of limiting base erosion or profit shifting, the Country X tax satisfies the cost recovery requirement. (J) Example 10: Permissible disallowance based on U.S. principles —( 1 ) Facts. Country X imposes a tax on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable to the gross receipts included in the Country X tax base, except that no deduction is permitted for any stock-based payments for services. ( 2 ) Analysis. Under paragraph (b)(4)(i)(B)( 2 ) of this section, each item of cost or expense related to wages or other payments for services is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to wages or other payments for services. Country X tax law denies a deduction for any stock-based payments for services, and therefore the safe harbor in paragraph (b)(4)(i)(C)( 2 ) of this section is not satisfied. Further, given that no deduction is allowed for stock-based payments for services, the Country X tax law completely disallows an item of cost or expense related to wages or other payments for services and thus does not permit recovery of substantially all of each item of significant cost or expense related to wages or other payments for services. However, under paragraph (b)(4)(i)(F)( 1 ) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if such disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code. The income tax provisions of the Internal Revenue Code contain targeted disallowances or limits on the deductibility of certain items of compensation in particular circumstances based on non-tax public policy reasons, including to influence the amount or use of a certain type of compensation in the labor market. For example, section 162(m) imposes limits on deductions for compensation of certain highly-paid employees, and section 280G limits the deductibility of certain “parachute payments” provided to individuals when an entity undergoes a change of control. Country X's targeted disallowance of deductions for the portion of payments for services attributable to stock-based compensation also reflects a principle of influencing the amount or use of a certain type of compensation (stock-based compensation) in the labor market. Accordingly, because the Country X tax law's disallowance is consistent with a principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code, the Country X tax satisfies the cost recovery requirement. (5) * * * (i) * * * (B) * * * ( 2 ) Royalties. Under the foreign tax law, gross income from royalties must be sourced based on the place of use of, or the right to use, the intangible property, as determined under reasonable principles (which do not include determining the place of use of, or the right to use, the intangible property based on the location of the payor). * * * * * (d) * * * (1) * * * (iii) Tax imposed on nonresidents —(A) In general. A foreign levy imposed on nonresidents is always treated as a separate levy from that imposed on residents, even if the base of the tax as applied to residents and nonresidents is the same, and even if the levies are treated as a single levy under foreign tax law. (B) Withholding tax —( 1 ) In general. Except as otherwise provided in this paragraph (d)(1)(iii)(B), a withholding tax (as defined in section 901(k)(1)(B)) that is imposed on a payment giving rise to gross income of nonresidents is treated as a separate levy as to each separate class of income described in section 61 (for example, interest, dividends, rents, or royalties) subject to the withholding tax. ( 2 ) Subsets of income. If two or more subsets of a separate class of income are subject to a withholding tax based on different income attribution rules (for example, if technical services are subject to tax based on the residence of the payor and other services are subject to tax based on where the services are performed), separate levies are considered to be imposed with respect to each subset of that separate class of income. ( 3 ) Royalty income. A withholding tax that is imposed on a payment giving rise to gross royalty income of a nonresident that is made pursuant to a single-country license (as determined under § 1.903-1(c)(2)(iv)) is treated as a separate levy from a withholding tax that is imposed on other gross royalty income of such nonresident and is also treated as a separate levy from any withholding tax imposed on other nonresidents. * * * * * (h) Applicability dates —(1) In general. Except as provided in paragraphs (h)(2) and (3) of this section, this section applies to foreign taxes paid (within the meaning of paragraph (g) of this section) in taxable years beginning on or after December 28, 2021. For foreign taxes that relate to (and if creditable are considered to accrue in) taxable years beginning before December 28, 2021, and that are remitted in taxable years beginning on or after December 28, 2021, by a taxpayer that accounts for foreign income taxes on the accrual basis, see § 1.901-2 as contained in 26 CFR part 1 revised as of April 1, 2021. (2) Certain foreign taxes paid to Puerto Rico. For foreign taxes paid to Puerto Rico by reason of section 1035.05 of the Puerto Rico Internal Revenue Code of 2011, as amended (13 L.P.R.A. 30155) (treating certain income, gain or loss as effectively connected with the active conduct of a trade or business with Puerto Rico), this section applies to foreign taxes paid (within the meaning of paragraph (g) of this section) in taxable years beginning on or after January 1, 2023. For foreign taxes described in the preceding sentence that are paid in taxable years beginning before January 1, 2023, see § 1.901-2 as contained in 26 CFR part 1 revised as of April 1, 2021. (3) Modifications to cost recovery and royalty attribution rules. Paragraphs (b)(4)(i) and (iv), (b)(5)(i)(B)( 2 ), and (d)(1)(iii) of this section apply to foreign taxes paid (within the meaning of paragraph (g) of this section) in taxable years ending on or after November 18, 2022. For foreign taxes described in the preceding sentence that are paid in taxable years ending before November 18, 2022, see § 1.901-2(b)(4)(i) and (iv), (b)(5)(i)(B)( 2 ), and (d)(1)(iii) as contained in 26 CFR part 1 revised as of July 27, 2022. Taxpayers may choose to apply the rules in paragraphs (b)(4)(i) and (iv) of this section to foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022 provided that they consistently apply those rules to such taxable years. Additionally, taxpayers may choose to apply the rules of paragraphs (b)(5)(i)(B)( 2 ) and (d)(1)(iii) of this section to foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022, provided that they consistently apply those rules and the rules of § 1.903-1(c)(2) and (d)(3), (4), and (8) through (11) to such taxable years. * * * * *