Par. 12. Add section 1.951-2 to read as follows:
(a) Scope. This section sets forth the rules for assigning a foreign corporation's covered items to covered shareholders. Under §§ 1.959-4 and 1.961-9, these assignments determine the extent to which shareholder-specific attributes (previously taxed earnings and profits or section 961(c) basis) are applied to the covered items. Paragraph (b) of this section defines a covered item. Paragraph (c) of this section describes the rules for assigning covered items. Paragraph (d) of this section describes a fraction determining assignments under the general assignment rule. Paragraph (e) of this section adjusts assignments to account for general successor transactions. Paragraph (f) of this section provides a currency translation rule. Paragraph (g) of this section provides definitions and rules of general applicability for purposes of this section. Paragraph (h) of this section provides examples illustrating the application of this section. Paragraph (i) of this section provides the applicability date of this section.
(b) Covered items. A covered item is gross income of a foreign corporation that consists of either the portion of a covered distribution received by the foreign corporation (determined under § 1.959-4) or a covered gain recognized by the foreign corporation (determined under § 1.961-9). Covered shareholders that own stock of a foreign corporation during a taxable year of the foreign corporation in which the foreign corporation receives or recognizes a covered item are assigned portions of the covered item in accordance with the rules described in paragraph (c) of this section. See also paragraph (g) of this section, incorporating § 1.959-1(b) for the definition of covered shareholder, § 1.959-4(c) for the definition of covered distribution, and § 1.961-9(c) for the definition of covered gain.
(c) Rules for assigning a covered item —(1) Determine assignments based on stock ownership on the last relevant day. First, assign a pro rata portion of the covered item to each covered shareholder that owns stock of the foreign corporation on the last relevant day of the foreign corporation's taxable year (defined in § 1.959-1(b) as the last day of the taxable year on which the foreign corporation is a controlled foreign corporation), determined by multiplying the amount of the covered item by the fraction computed in accordance with paragraph (d) of this section. If there is no day during the taxable year on which the foreign corporation is a controlled foreign corporation, then treat the last day of the taxable year as the last relevant day.
(2) Adjust assignments for general successor transactions. Second, if the foreign corporation is an acquired foreign corporation in one or more general successor transactions that occur during the foreign corporation's taxable year, then, for each such general successor transaction (starting with the earliest transaction), adjust covered shareholders' assigned portions of the covered item in accordance with paragraph (e) of this section. See also paragraph (g) of this section, incorporating § 1.959-7(b) for the definitions of acquired foreign corporation and general successor transaction.
(d) Fraction in determining assignments —(1) In general. In determining a covered shareholder's assigned portion of a covered item of a foreign corporation under paragraph (c)(1) of this section, the fraction described in that paragraph is computed as follows. The numerator of the fraction is the amount that would be the covered shareholder's share of the hypothetical distribution described in § 1.951-1(e) for the foreign corporation's taxable year if, for purposes of this paragraph (d), § 1.951-1(e) were applied with the modifications described in paragraph (d)(2) of this section. The denominator of the fraction is the amount that would be the hypothetical distribution described in § 1.951-1(e) for the foreign corporation's taxable year if, for purposes of this paragraph (d), § 1.951-1(e) were applied with the modifications described in paragraph (d)(2) of this section.
(2) Modifications —(i) Allocable earnings and profits. For purposes of this paragraph (d), the foreign corporation's allocable earnings and profits (as defined in § 1.951-1(e)(1)(ii)) are treated as the amount that is the greater of—
(A) The earnings and profits of the foreign corporation for the taxable year, determined under section 964 and not reduced by distributions during the taxable year; and
(B) The sum of all covered items of the foreign corporation for the taxable year.
(ii) Controlled foreign corporation status. For purposes of this paragraph (d), § 1.951-1(e) applies without regard to whether the foreign corporation is a controlled foreign corporation. In addition, if there is no day during the taxable year on which the foreign corporation is a controlled foreign corporation, then the hypothetical distribution date (as defined in § 1.951-1(e)(1)(i)) is treated as the last day of the taxable year.
(e) Rules for general successor transactions —(1) In general. In adjusting covered shareholders' assignments of a covered item for a general successor transaction under paragraph (c)(2) of this section, increase an assignment in accordance with paragraph (e)(2) of this section, and then decrease assignments in accordance with paragraphs (e)(3) and (4) of this section. Generally, under these rules (together with §§ 1.959-4 and 1.961-9), previously taxed earnings and profits or section 961(c) basis with respect to the transferor covered shareholder (if the general successor transaction occurs before the last relevant day) or successor covered shareholder (if the general successor transaction occurs on or after the last relevant day) are applied to a covered item to the same extent such previously taxed earnings and profits or section 961(c) basis would have been applied if the general successor transaction had not occurred.
(2) Increase —(i) General successor transaction occurring before the last relevant day. If the general successor transaction occurs before the last relevant day of the taxable year but after the covered item is received or recognized, then, subject to the limitation in paragraph (e)(2)(iii) of this section, increase the transferor covered shareholder's assignment of the covered item as follows. Increase the assignment by the additional portion of the covered item that would have been assigned to the transferor covered shareholder under paragraph (c)(1) of this section if the day on which the covered item is received or recognized were the last relevant day and the hypothetical distribution described in paragraph (d)(1) of this section were treated as made immediately before the covered item is received or recognized.
(ii) General successor transaction occurring on or after the last relevant day. If the general successor transaction occurs on or after the last relevant day of the taxable year but before the covered item is received or recognized, then, subject to the limitation in paragraph (e)(2)(iii) of this section, increase the successor covered shareholder's assignment of the covered item as follows. Increase the assignment by the additional portion of the covered item that would have been assigned to the successor covered shareholder under paragraph (c)(1) of this section if the day on which the covered item is received or recognized were the last relevant day and the hypothetical distribution described in paragraph (d)(1) of this section were treated as made immediately before the covered item is received or recognized.
(iii) Limitations. The increase pursuant to paragraph (e)(2)(i) or (ii) of this section applies only to the extent it results in an additional portion of the covered item being previously taxed earnings and profits that are both with respect to the covered shareholder described in that paragraph and excluded from the foreign corporation's gross income under section 959(b) and § 1.959-4 or section 961(c) and § 1.961-9. Further, the increase cannot exceed the aggregate of each connected covered shareholder's assigned portion of the covered item under paragraph (c)(1) of this section.
(3) Decreases for connected covered shareholders owning acquired stock. For each connected covered shareholder that owns acquired stock of the foreign corporation on the last relevant day of the taxable year, decrease the connected covered shareholder's assignment (but not below zero) by the product of the increase pursuant to paragraph (e)(2) of this section and a fraction. The numerator of the fraction is the connected covered shareholder's assigned portion of the covered item under paragraph (c)(1) of this section, and the denominator of the fraction is the aggregate of the assigned portion of the covered item under paragraph (c)(1) of this section of each connected covered shareholder described in the preceding sentence.
(4) Decreases for connected covered shareholders not owning acquired stock. For each connected covered shareholder that does not own acquired stock of the foreign corporation on the last relevant day of the taxable year, decrease the connected covered shareholder's assignment by the product of the increase pursuant to paragraph (e)(2) of this section, reduced by the decreases pursuant to paragraph (e)(3) of this section, and a fraction. The numerator of the fraction is the connected covered shareholder's assigned portion of the covered item under paragraph (c)(1) of this section, and the denominator of the fraction is the aggregate of the assigned portion of the covered item under paragraph (c)(1) of this section of each connected covered shareholder described in the preceding sentence.
(f) Currency rule. For purposes of this section, if a covered item of a foreign corporation is denominated in a currency other than the foreign corporation's functional currency, then the covered item is translated into the foreign corporation's functional currency at the spot rate on the day on which the covered item is received or recognized.
(g) Definitions and rules of general applicability. The definitions in §§ 1.959-1(b) and 1.961-(b), and the rules of general applicability in §§ 1.959-1(c) and (d) and 1.961-1(c) and (d), apply for purposes of this section, with the following additions.
Acquired stock. The term acquired stock means, in a general successor transaction, stock of an acquired foreign corporation the ownership of which is acquired by the successor covered shareholder.
Connected covered shareholder. The term connected covered shareholder means, in a general successor transaction, a covered shareholder that owns acquired stock of an acquired foreign corporation on the last relevant day of the acquired foreign corporation's taxable year in which the general successor transaction occurs, or any covered shareholder bearing a relationship described in section 267(b) (determined without regard to section 267(c)(3)) or 707(b) to a covered shareholder first described in this sentence.
Covered item. The term covered item has the meaning provided in paragraph (b) of this section.
(h) Examples —(1) In general. This paragraph (h) provides examples illustrating the application of this section.
(2) Assumed facts. For purposes of the examples in this paragraph (h), unless otherwise indicated, the following facts are assumed:
(i) US1 and US2 are unrelated domestic corporations that are covered shareholders. Neither US1 nor US2 is a member of a consolidated group (as defined in § 1.1502-1(h)).
(ii) F1, F2, and F3 are foreign corporations, each of which is a controlled foreign corporation and uses the British pound (£) as its functional currency.
(iii) Each entity uses the calendar year as its taxable year, and no entity has a short taxable year.
(3) Examples —(i) Example 1: General assignment rule and single class of stock —(A) Facts. US1 and US2 each directly own 50% of the single class of outstanding stock of F1. F1 directly owns all the outstanding stock of each of F2 and F3. For F1's taxable year ending on December 31 of year 3, the last relevant day is December 31, and F1 has £500x of earnings and profits and two covered items. The covered items are a £60x covered distribution received from F2 and £40x of covered gain recognized with respect to stock of F3.
(B) Analysis. The portion of each covered item assigned to each of US1 and US2 is determined by multiplying the amount of the covered item by a fraction, the numerator of which is the portion of a £500x hypothetical distribution treated as made by F1 on the last relevant day that would be distributed with respect to stock of F1 that the covered shareholder owns (£250x in the case of each US1 and US2), and the denominator of which is the amount of the hypothetical distribution (£500x). See paragraphs (c)(1) and (d)(1) of this section; see also paragraph (d)(2) of this section (treating F1's hypothetical distribution as equal to the greater of £500x, F1's earnings and profits for the taxable year, and £100x, the sum of F1's covered items for the taxable year). Thus, US1 and US2 are each assigned £30x of the covered distribution (£60x × £250x/£500x) and £20x of the covered gain (£40x × £250x/£500x).
(C) Alternative facts: common stock and preferred stock —( 1 ) Facts. The facts are the same as in paragraph (h)(3)(i)(A) of this section ( Example 1 ), except as follows. The stock of F1 owned by US1 is an 8% nonparticipating, voting preferred share of stock with a par value of £1,000x, and the stock of F1 owned by US2 is common stock. There are no accrued but unpaid dividends with respect to the preferred stock.
( 2 ) Analysis. The portion of each covered item assigned to each of US1 and US2 is determined by multiplying the amount of the covered item by a fraction, the numerator of which is the portion of a £500x hypothetical distribution treated as made by F1 on the last relevant day that would be distributed with respect to stock of F1 that the covered shareholder owns (£80x in the case of US1, computed as 0.08 × £1,000x, and £420x in the case of US2, computed as £500x − £80x), and the denominator of which is the amount of the hypothetical distribution (£500x). See paragraphs (c)(1) and (d) of this section. Thus, US1 is assigned £9.6x of the covered distribution (£60x × £80x/£500x) and £6.4x of the covered gain (£40x × £80x/£500x), and US2 is assigned £50.4x of the covered distribution (£60x × £420x/£500x) and £33.6x of the covered gain (£40x × £420x/£500x).
(ii) Example 2: General successor transaction occurs before the last relevant day and after a covered distribution —(A) Facts. US1 directly owns all the shares of the single class of outstanding stock of F1, and F1 directly owns all the outstanding stock of F2. On June 30 of year 3, US1 sells all the stock of F1 to US2 for money equal to the fair market value of the stock in a general successor transaction. For F1's taxable year ending on December 31 of year 3, the last relevant day is December 31, and F1 has £500x of earnings and profits and one covered item. The covered item is a £100x covered distribution received by F1 from F2 on March 31. Immediately before the covered distribution, F2 has £100x of previously taxed earnings and profits with respect to US1.
(B) Analysis —( 1 ) In general. Without regard to paragraphs (c)(2) and (e) of this section (adjustments for general successor transactions), US2 would be assigned all £100x (and thus US1 would be assigned none) of the covered item because US2 owns all the stock of F1 on the last relevant day and therefore US2 would have a 100% share of a £500x hypothetical distribution treated as made by F1 on that day. See paragraphs (c)(1) and (d) of this section. However, because the sale is a general successor transaction occurring before the last relevant day but after F1 receives the covered item, the assignments to US1 (the transferor covered shareholder) and US2 (a connected covered shareholder by reason of owning acquired stock of F1 on the last relevant day) are adjusted. See paragraphs (c)(2) and (e)(1) of this section. The specific adjustments are described in paragraph (h)(3)(ii)(B)( 2 ) of this section. As a result of these adjustments, the entirety of the covered item is a distribution to F1 of F2's previously taxed earnings and profits with respect to US1 under § 1.959-4. Moreover, the previously taxed earnings and profits could be distributed by F1 to US1 before the sale and, to the extent not so distributed, are previously taxed earnings and profits of F1 that transfer from US1 to US2 in the sale under § 1.959-7.
( 2 ) Adjustments. US1's assigned portion of the covered item is increased by £100x, which is the additional portion of the covered item that would have been assigned to US1 under paragraph (c)(1) of this section if March 31 were the last relevant day (and, thus, F1's £500x hypothetical distribution were treated as made when US1 owned all the stock of F1 and would therefore have a 100% share of the hypothetical distribution). See paragraph (e)(2)(i) of this section. In determining this increase, the first limitation in paragraph (e)(2)(iii) of this section does not apply because a £100x increase does not exceed the amount of F2's previously taxed earnings and profits with respect to US1 that could be applied to exclude such additional portion of the covered item from F1's gross income under section 959(b). In addition, the second limitation in paragraph (e)(2)(iii) of this section does not apply because a £100x increase does not exceed the amount of the covered item assigned to US2 under paragraph (c)(1) of this section. The £100x increase to US1's assigned portion of the covered item decreases US2's assigned portion of the covered item from £100x to £0. See paragraph (e)(3) of this section.
(C) Alternative facts: limitation on increase and multiple connected covered shareholders —( 1 ) Facts. The facts are the same as in paragraph (h)(3)(ii)(A) of this section ( Example 2 ), except as follows. Immediately before the £100x covered distribution on March 31, F2 has £90x (rather than £100x) of previously taxed earnings and profits with respect to US1. On September 30 of year 3, F1 issues shares of its single class of outstanding stock to US3, a corporate covered shareholder related to US2 within the meaning of section 267(b), with the result that US2 and US3 each own half of the stock of F1 on the last relevant day.
( 2 ) Analysis —( i ) In general. Without regard to paragraphs (c)(2) and (e) of this section (adjustments for general successor transactions), US2 and US3 would each be assigned £50x (and thus US1 would be assigned none) of the covered item because US2 and US3 each own half of the stock of F1 on the last relevant day and therefore would each have a 50% share of a £500x hypothetical distribution treated as made by F1 on that day. See paragraphs (c)(1) and (d) of this section. However, because the sale is a general successor transaction occurring before the last relevant day but after F1 receives the covered item, the assignments to US1 (the transferor covered shareholder), US2 (a connected covered shareholder by reason of owning acquired stock of F1 on the last relevant day), and US3 (a connected covered shareholder by reason of bearing a relationship described in section 267(b) to US2) are adjusted. See paragraphs (c)(2) and (e)(1) of this section. The specific adjustments are described in paragraph (h)(3)(ii)(C)( 2 )( ii ) of this section. As a result of these adjustments, £90x of the covered item is a distribution to F1 of F2's previously taxed earnings and profits with respect to US1 under § 1.959-4. Moreover, the previously taxed earnings and profits could be distributed by F1 to US1 before the sale and, to the extent not so distributed, are previously taxed earnings and profits of F1 that transfer from US1 to US2 in the sale under § 1.959-7.
( ii ) Adjustments. US1's assigned portion of the covered item is increased by £90x, which is the lesser of the additional portion of the covered item that would have been assigned to US1 if March 31 were the last relevant day (£100x) and the amount of F2's previously taxed earnings and profits with respect to US1 that could be applied to exclude such additional portion of the covered item from F1's gross income under section 959(b) (£90x). See paragraphs (e)(2)(i) and (iii) of this section. Because US2 owns acquired stock of F1 on the last relevant day, the £90x increase to US1's assigned portion of the covered item first decreases US2's assigned portion of the covered item, from £50x to £0. See paragraph (e)(3) of this section. Then, the remaining £40x increase to US1's assigned portion of the covered item decreases US3's assigned portion of the covered item, from £50x to £10x. See paragraph (e)(4) of this section.
(iii) Example 3: General successor transaction occurs after the last relevant day —(A) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1. F1 directly owns all the outstanding stock of F2. On March 31 of year 3, F1 issues 100 shares of its single class of outstanding stock to a nonresident alien individual and, consequently, F1 ceases to be a controlled foreign corporation. On June 30 of year 3, US1 sells its 100 shares of stock of F1 to US2 for money equal to the stock's fair market value in a general successor transaction. For F1's taxable year ending on December 31 of year 3, the last relevant day is March 31 and F1 has £500x of earnings and profits and one covered item. The covered item is a £100x covered distribution received by F1 from F2 on September 30. Immediately before the covered distribution, F2 has £50x of previously taxed earnings and profits with respect to US2 (all of which transferred from US1 to US2 in the Sale).
(B) Analysis —( 1 ) In general. Without regard to paragraphs (c)(2) and (e) of this section (adjustments for general successor transactions), US2 would be assigned none of the covered item because US2 owns none of the stock of F1 on the last relevant day and therefore US2 would have a 0% share of a £500x hypothetical distribution treated as made by F1 on that day. See paragraphs (c)(1) and (d) of this section. However, because the sale is a general successor transaction occurring on or after the last relevant day but before F1 receives the covered item, the assignments to US2 (the successor covered shareholder) and US1 (a connected covered shareholder by reason of owning acquired stock of F1 on the last relevant day) are adjusted. See paragraphs (c)(2) and (e)(1) of this section. The specific adjustments are described in paragraph (h)(3)(iii)(B)( 2 ) of this section. As a result of these adjustments, £50x of the covered item is a distribution to F1 of F2's previously taxed earnings and profits with respect to US2 under § 1.959-4.
( 2 ) Adjustments. US2's assigned portion of the covered item is increased by £50x, which is the additional portion of the covered item that would have been assigned to US2 under paragraph (c)(1) of this section if September 30 were the last relevant day (and, thus, F1's £500x hypothetical distribution were treated as made when US2 owned half of the stock of F1 and would therefore have a 50% share of the hypothetical distribution). See paragraph (e)(2)(ii) of this section. In determining this increase, the first limitation in paragraph (e)(2)(iii) of this section does not apply because a £50x increase does not exceed the amount of F2's previously taxed earnings and profits with respect to US2 that could be applied to exclude such additional portion of the covered item from F1's gross income under section 959(b). In addition, the second limitation in paragraph (e)(2)(iii) of this section does not apply because a £50x increase does not exceed the amount of the covered item assigned to US1 under paragraph (c)(1) of this section. The £50x increase to US2's assigned portion of the covered item decreases US1's assigned portion of the covered item by £50x. See paragraph (e)(3) of this section.
(i) Applicability date. This section applies to taxable years of foreign corporations that begin on or after [date of publication of final regulations in the Federal Register ] or are early application years (as described in § 1.959-12(d)) and to taxable years of persons for which such taxable years of those foreign corporations are relevant.