Par. 28. Sections 1.961-3 through 1.961-14 are added to read as follows:
(a) Scope. This section describes the consequences of negative derived basis and negative section 961(c) basis. Paragraph (b) of this section sets forth a rule requiring gain recognition for negative derived basis. Paragraph (c) of this section sets forth a rule requiring gain recognition for negative section 961(c) basis. See § 1.961-12(c)(6) and (7) ( Examples 6 and 7 ) for examples illustrating the application of this section.
(b) Gain recognition for negative derived basis —(1) In general. If a partnership has negative derived basis of a derivative ownership unit, then, in any transaction involving the derivative ownership unit (for example, a sale, exchange, or distribution under section 301(c)(2)), the partnership is treated as recognizing gain with respect to the derivative ownership unit in accordance with the rules described in paragraphs (b)(2) through (5) of this section.
(2) Amount of gain —(i) In general. The amount of the gain recognized is equal to the additional amount of gain, plus the lesser amount of loss (expressed as a positive amount), that the partnership would have recognized in the transaction if, immediately before the transaction, the partnership's common basis of the derivative ownership unit were reduced by all negative derived basis of the derivative ownership unit. Thus, for example, in a sale of the derivative ownership unit, the amount of the gain recognized is generally equal to the sum of all negative derived basis of the derivative ownership unit and, in a nonrecognition transaction, the amount of the gain recognized may be less than the sum of all negative derived basis of the derivative ownership unit.
(ii) Special rule if derivative ownership unit ceases to be a derivative ownership unit. If the derivative ownership unit is not a derivative ownership unit immediately after the transaction (including, for example, because the derivative ownership unit is redeemed, or becomes directly owned by a foreign corporation or covered shareholder, in the transaction), then, notwithstanding paragraph (b)(2)(i) of this section, the amount of the gain recognized is equal to the sum of all negative derived basis of the derivative ownership unit.
(iii) Translation rule. If applicable, negative derived basis is translated into functional currency at the spot rate on the day on which the transaction involving the derivative ownership unit occurs.
(3) Allocation of gain. A pro rata portion of the gain is allocated to each covered shareholder, determined by multiplying the amount of such gain by a fraction. The numerator of the fraction is the negative derived basis with respect to the covered shareholder of the derivative ownership unit, and the denominator of the fraction is the sum of all negative derived basis of the derivative ownership unit.
(4) Treatment of gain. The gain is treated in the same manner as gain recognized under § 1.961-4(c) for distributions of previously taxed earnings and profits in excess of basis (and thus the rules in § 1.961-4(f) apply to the gain), except that the gain is recognized concurrently with, but separate from, the transaction.
(5) Negative derived basis eliminated to the extent it gives rise to gain. Negative derived basis is eliminated to the extent it increases the amount of gain recognized under this paragraph (b), concurrent with the transaction.
(c) Gain recognition for negative section 961(c) basis —(1) In general. If a controlled foreign corporation has negative section 961(c) basis of a section 961(c) ownership unit, then, in any transaction involving the section 961(c) ownership unit (for example, a sale, exchange, or distribution under section 301(c)(2)), the controlled foreign corporation is treated as recognizing gain with respect to the section 961(c) ownership unit in accordance with the rules described in paragraphs (c)(2) through (5) of this section.
(2) Amount of gain —(i) In general. The amount of the gain recognized is equal to the additional amount of gain, plus the lesser amount of loss (expressed as a positive amount), that the controlled foreign corporation would have recognized in the transaction if, immediately before the transaction, the controlled foreign corporation's adjusted basis of the section 961(c) ownership unit were reduced by all negative section 961(c) basis of the section 961(c) ownership unit. Thus, for example, in a sale of the section 961(c) ownership unit, the amount of the gain recognized is generally equal to the sum of all negative section 961(c) basis of the section 961(c) ownership unit and, in a nonrecognition transaction, the amount of the gain recognized may be less than the sum of all negative section 961(c) basis of the section 961(c) ownership unit.
(ii) Special rule if section 961(c) ownership unit ceases to be a section 961(c) ownership unit. If the section 961(c) ownership unit is not a section 961(c) ownership unit immediately after the transaction (including, for example, because the section 961(c) ownership unit is redeemed, or becomes directly owned by a covered shareholder, in the transaction), then, notwithstanding paragraph (c)(2)(i) of this section, the amount of the gain recognized is equal to the sum of all negative section 961(c) basis of the section 961(c) ownership unit.
(iii) Translation rule. If applicable, negative section 961(c) basis is translated into functional currency of the controlled foreign corporation at the spot rate on the day on which the transaction involving the section 961(c) ownership unit occurs.
(3) Assignment of gain. A pro rata portion of the gain is assigned to each covered shareholder, determined by multiplying the amount of such gain by a fraction. The numerator of the fraction is the negative section 961(c) basis with respect to the covered shareholder of the section 961(c) ownership unit, and the denominator of the fraction is the sum of all negative section 961(c) basis of the section 961(c) ownership unit.
(4) Treatment of gain. The gain is treated in the same manner as gain recognized under § 1.961-4(d) for distributions of previously taxed earnings and profits in excess of basis (and thus the rules in § 1.961-4(f) apply to the gain), except that the gain is recognized concurrently with, but separate from, the transaction. Thus, the gain is recognized pursuant to section 961(c) and therefore applies only for purposes of determining amounts included in gross income of United States shareholders of the controlled foreign corporation under § 1.961-11.
(5) Negative section 961(c) basis eliminated to the extent it gives rise to gain. Negative section 961(c) basis is eliminated to the extent it increases the amount of gain recognized under this paragraph (c), concurrent with the transaction.