# Prop. Treas. Reg. § 1.961-12: Examples. Proposed regulation, not in force. REG-105479-18, 89 FR 95362, published 2024-12-02 . Interprets 26 U.S.C. § 961. Par. 28. Sections 1.961-3 through 1.961-14 are added to read as follows: (a) In general. This section provides examples that illustrate the application of §§ 1.961-1 through 1.961-11. (b) Assumed facts. For purposes of the examples in this section, unless otherwise indicated, the following facts are assumed for U.S. tax purposes: (1) US1 and US2 are unrelated domestic corporations that are covered shareholders, each of which uses the U.S. dollar as its functional currency and chooses to claim a credit for foreign income taxes pursuant to section 901. Neither US1 nor US2 is a member of a consolidated group (as defined in § 1.1502-1(h)). (2) F1, F2, and F3 are foreign corporations, each of which is a controlled foreign corporation and uses the British pound (£) as its functional currency. (3) PRS1 and PRS2 are partnerships. (4) Each entity uses the calendar year as its taxable year, and no entity has a short taxable year. (5) There are no adjustments under section 743(b) to the basis of any partnership property. (c) Examples —(1) Example 1: Types of property units and basis— (i) Facts. US1 directly owns 60, and US2 directly owns 40, of the 100 shares of the single class of outstanding stock of F1. F1 directly owns all 50 shares of the single class of outstanding stock of F2. This example only analyzes the types of basis provided under section 961 in the items of property. (ii) Analysis. Each of the 60 shares of stock of F1 directly owned by US1 and the 40 shares of stock of F1 directly owned by US2 is a section 961(a) ownership unit in which the covered shareholder (US1 or US2) is provided adjusted basis. See § 1.961-2(c). In addition, each of the 50 shares of stock of F2 directly owned by F1, a controlled foreign corporation, is a section 961(c) ownership unit in which F1 is provided section 961(c) basis. See § 1.961-2(e)(1). F1's section 961(c) basis in each section 961(c) ownership unit is maintained separately with respect to each of US1 and US2. See § 1.961-2(e)(2). Further, each of the section 961(a) ownership units and section 961(c) ownership units is a property unit, and adjusted basis or section 961(c) basis in the property unit, as applicable, is maintained in U.S. dollars. See § 1.961-2(b). (iii) Alternative facts: partnership structure —(A) Facts. The facts are the same as paragraph (c)(1)(i) of this section ( Example 1 ), except that US1 and US2, in the aggregate, directly own all the interests in PRS1, and PRS1 directly owns all 100 of the shares of stock of F1. (B) Analysis. The interest in PRS1 directly owned by each of US1 and US2 is a section 961(a) ownership unit in which the covered shareholder (US1 or US2) is provided adjusted basis. See § 1.961-2(c). In addition, each of the 100 shares of stock of F1 directly owned by PRS1 is a derivative ownership unit in which PRS1 is provided derived basis. See § 1.961-2(d)(1). PRS1's derived basis in each derivative ownership unit is established and maintained separately with respect to each of US1 and US2. See § 1.961-2(d)(2). Further, as is the case in paragraph (c)(1)(ii) of this section, each of the 50 shares of stock of F2 directly owned by F1, a controlled foreign corporation, is a section 961(c) ownership unit in which F1 is provided section 961(c) basis, and that basis is maintained separately with respect to each of US1 and US2. Moreover, each of the section 961(a) ownership units, derivative ownership units, and section 961(c) ownership units is a property unit, and adjusted basis, derived basis, or section 961(c) basis in the property unit, as applicable, is maintained in U.S. dollars. See § 1.961-2(b). (2) Example 2: Basis increases for income inclusions —(i) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1, and F1 directly owns all 50 shares of the single class of outstanding stock of F2. Thus, the shares of stock of F1 directly owned by US1 are section 961(a) ownership units, and the shares of stock of F2 directly owned by F1 are section 961(c) ownership units. For F2's taxable year ending on December 31 of year 3, the last relevant day is December 31 and US1 includes $80x in gross income under section 951(a)(1)(A) (its pro rata share of F2's subpart F income, translated into U.S. dollars in accordance with section 989(b)) and $120x in gross income under section 951A(a) (the portion of its GILTI inclusion amount that is treated as with respect to F2 for the taxable year under section 951A(f)(2)). F2 does not make any covered distributions, and therefore does not distribute any previously taxed earnings and profits, during the taxable year. This example only analyzes basis increases for the income inclusions. See also § 1.312-6(f) (income inclusions increase US1's earnings and profits); § 1.959-3 (adjustments to previously taxed earnings and profits accounts). (ii) Analysis —(A) In general. To reflect US1's income inclusions for F2's taxable year ending on December 31 of year 3, basis of shares of stock of F2, and basis of shares of stock of F1 (property units through which US1 owns stock of F2), is in each case increased in accordance with § 1.961-3. See § 1.961-3(b). In the case of stock of F2, F1's section 961(c) basis with respect to US1 is increased because shares of stock of F2 are section 961(c) ownership units and F2 is a controlled foreign corporation, as required by § 1.961-3(f)(1). In the case of stock of F1, US1's adjusted basis is increased because shares of stock of F1 are section 961(a) ownership units. Paragraph (c)(2)(ii)(B) of this section provides the specific increases to basis. (B) Increases to basis of each property unit. The amount of US1's income inclusions with respect to F2 that give rise to increases to basis under section 961 is $200x ($80x + $120x). See § 1.961-3(c)(1). In determining the specific increases to basis, the actual distribution rule in § 1.961-3(d) does not apply because F2 does not distribute any previously taxed earnings and profits before the last relevant day. See § 1.961-3(c)(3). Thus, the hypothetical distribution rule in § 1.961-3(e) determines the entirety of the increases to basis for the income inclusions. See § 1.961-3(c)(4). Under the hypothetical distribution rule, the basis of each share of stock of F2 is increased by $4x ($200x ÷ 50 shares), and the basis of each share of stock of F1 is increased by $2x ($200x ÷ 100 shares), which in each case is equal to the portion of a $200x hypothetical distribution treated as made by F2 through all tiers to US1 on the last relevant day that would be distributed with respect to the property unit. See § 1.961-3(e). These increases to basis are treated as made at the beginning of F2's taxable year 3 because there are no midyear transactions and the entirety of the $200x of income inclusions is under section 951(a)(1)(A) or 951A(a). See § 1.961-3(c)(2) and (e)(1). Accordingly, at the beginning of F2's taxable year 3, F1 increases its section 961(c) basis with respect to US1 of each share of stock of F2 by $4x, and US1 increases its adjusted basis of each share of stock of F1 by $2x. (iii) Alternative facts: midyear transaction and actual distribution rule —(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this section, except as follows. On January 1 of year 3, US1 directly owns all the stock of F2. On March 31 of year 3, F2 distributes previously taxed earnings and profits to US1 (pro rata with respect to the shares of stock of F2) and, consequently, US1 is required under § 1.961-4 (basis reductions and gain recognition for distributions) to adjust its adjusted basis of each share of stock of F2 by $3x (the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are distributed on the share). On June 30 of year 3, F1 is formed and US1 immediately contributes all its stock of F2 to F1 in exchange for 100 shares of stock of F1. Thus, before the contribution, shares of stock of F2 are section 961(a) ownership units and, beginning as of the contribution, all the shares of stock of F1 are section 961(a) ownership units and all the shares of stock of F2 are section 961(c) ownership units. (B) Analysis —( 1 ) In general. To reflect US1's income inclusions for F2's taxable year ending on December 31 of year 3, basis of shares of stock of F2, and basis of shares of stock of F1 (property units through which US1 owns stock of F2), is in each case increased in accordance with § 1.961-3. See § 1.961-3(b). In the case of stock of F2, because shares of the stock are section 961(a) ownership units before the contribution and section 961(c) ownership units after the contribution, the type of basis that is increased depends on the timing of adjustments. Specifically, in the case of stock of F2 and an increase to basis that is treated as made before the contribution, the basis that is increased is US1's adjusted basis because shares of stock of F2 are section 961(a) ownership units before the contribution. In the case of stock of F2 and an increase to basis that is treated as made after the contribution, the basis that is increased is F1's section 961(c) basis with respect to US1 because shares of stock of F2 are section 961(c) ownership units after the contribution and F2 is a controlled foreign corporation, as required by § 1.961-3(f)(1). In the case of stock of F1, US1's adjusted basis is increased because shares of stock of F1 are section 961(a) ownership units. Paragraph (c)(2)(iii)(B)( 2 ) of this section provides the specific increases to basis. ( 2 ) Increases to basis of each property unit. The amount of US1's income inclusions with respect to F2 that give rise to increases to basis under section 961 is $200x ($80x + $120x). See § 1.961-3(c)(1). In determining the specific increases to basis for the income inclusions, the actual distribution rule in § 1.961-3(d) applies because F2's distribution of previously taxed earnings and profits is made before the last relevant day. See § 1.961-3(c)(3). Under the actual distribution rule, basis of each share of stock of F2 is increased by $3x, which is equal to the adjustment required under § 1.961-4 to the basis of such share by reason of the distribution, and thus basis of stock of F2 increases by $150x in total ($3x × 50 shares). See § 1.961-3(d)(2). These increases to basis are treated as made at the beginning of F2's taxable year because the distribution is made before the contribution of all the stock of F2 to F1, the sole midyear transaction occurring within the taxable year. See § 1.961-3(c)(2) and (d)(1). Then, the hypothetical distribution rule in § 1.961-3(e) determines increases to basis for the remaining $50x of income inclusions ($200x of income inclusions − $150x of basis increases to stock of F2 under the actual distribution rule). See § 1.961-3(c)(4). Under the hypothetical distribution rule, the basis of each share of stock of F2, and the basis of each share of stock of F1, is increased by the portion of a $50x hypothetical distribution treated as made by F2 through all tiers to US1 on the last relevant day that would be distributed with respect to the property unit. See § 1.961-3(e). These increases to basis are treated as made immediately after the contribution (the sole midyear transaction occurring within F2's taxable year). See § 1.961-3(e)(1). Table 1 in this paragraph (c)(2)(iii)(B)( 2 ) provides the increases to basis. **Table 1 to Paragraph ( c )(2)( iii )(B)( 2 ) of This Section—Basis Increases To Reflect US1's Income Inclusions With Respect to F2** | | Basis increases | January 1 of year 3 | June 30 of year 3 | | --- | --- | --- | --- | | US1's adjusted basis of stock of F1 (100 shares) | | $0.5x increase for each share ($50x hypothetical distribution ÷ 100 shares). | | | Stock of F2 (50 shares): | | | | | US1's adjusted basis (before contribution) | $3x increase for each share (actual distribution rule) | | | | F1's section 961(c) basis with respect to US1 (as of contribution) | | $1x increase for each share ($50x hypothetical distribution ÷ 50 shares). | | (iv) Alternative facts: partnership structure and section 951(a)(1)(B) inclusion —(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this section ( Example 2 ), except as follows. US1 is a citizen of the United States (rather than a domestic corporation), referred to as Individual A for purposes of the rest of this paragraph (c)(2)(iv), and does not make an election to apply the provisions of section 962 for any taxable year. PRS1 directly owns all the stock of F1, and Individual A owns 60%, and a nonresident alien individual owns 40%, of the interests in PRS1. Thus, the interest in PRS1 directly owned by Individual A is a section 961(a) ownership unit, the shares of stock of F1 directly owned by PRS1 are derivative ownership units, and the shares of stock of F2 directly owned by F1 are section 961(c) ownership units. In addition, for F2's taxable year ending on December 31 of year 3, Individual A includes $80x in gross income under section 951(a)(1)(A) (its pro rata share of F2's subpart F income, translated into U.S. dollars in accordance with section 989(b)), $120x in gross income under section 951A(a) (the portion of its GILTI inclusion amount that is treated as with respect to F2 for the taxable year under section 951A(f)(2)), and $50x in gross income under section 951(a)(1)(B) (the portion of its section 956 amount that is not allocated to previously taxed earnings and profits, translated into U.S. dollars in accordance with section 989(b)). (B) Analysis —( 1 ) In general. To reflect Individual A's income inclusions for F2's taxable year ending on December 31 of year 3, basis of shares of stock of F2, and basis of shares of stock of F1 and basis of Individual A's interest in PRS1 (property units through which Individual A owns stock of F2), is in each case increased in accordance with § 1.961-3. See § 1.961-3(b). In the case of stock of F2, the basis that is increased is F1's section 961(c) basis with respect to Individual A because shares of stock of F2 are section 961(c) ownership units and F2 is a controlled foreign corporation, as required by § 1.961-3(f)(1). In the case of stock of F1, PRS1's derived basis with respect to Individual A is increased because shares of stock of F1 are derivative ownership units. In the case of Individual A's interest in PRS1, Individual A's adjusted basis is increased because its interest in PRS1 is a section 961(a) ownership unit. Paragraph (c)(2)(iv)(B) of this section provides the specific increases to basis. ( 2 ) Increases to basis of each property unit. The amount of Individual A's income inclusions with respect to F2 that give rise to increases to basis under section 961 is $250x ($80x + $120x + $50x). See § 1.961-3(c)(1). The hypothetical distribution rule in § 1.961-3(e) determines the entirety of the increases to basis for the income inclusions. See § 1.961-3(c)(3) and (4). Under the hypothetical distribution rule, the basis of each property unit is increased by the portion of a $250x hypothetical distribution treated as made by F2 through all tiers to Individual A on the last relevant day that would be distributed with respect to the property unit (determined by regarding stock of F2 and other property only to the extent owned by Individual A on the last relevant day). See § 1.961-3(e). In addition, because 20% of the $250x of income inclusions is under section 951(a)(1)(B) ($50x/$250x), 20% of each increase to basis is treated as made at the end of the last day of F2's taxable year (which is when the previously taxed earnings and profits resulting from the income inclusion under section 951(a)(1)(B) are added to previously taxed earnings and profits accounts), with the remaining 80% treated as made at the beginning of the taxable year (which is when the previously taxed earnings and profits resulting from the income inclusions under sections 951(a)(1)(A) and 951A(a) are added to previously taxed earnings and profits accounts). See § 1.961-3(e)(1). Table 1 in this paragraph (c)(2)(iii)(B)( 2 ) provides the increases to basis. **Table 1 to Paragraph ( c )(2)( iv )(B)( 2 ) of This Section—Basis Increases To Reflect Individual A's Income Inclusions With Respect to F2** | | Basis increases | January 1 of year 3 | December 31 of year 3 | | --- | --- | --- | --- | | Individual A's adjusted basis of its interest in PRS1 | $200x increase ($250x × 80%) | $50x increase ($250x × 20%). | | | PRS1's derived basis with respect to Individual A of stock of F1 (100 shares) | $2x increase for each share ($250x ÷ 100 shares × 80%) | $0.5 increase for each share ($250x ÷ 100 shares × 20%). | | | F1's section 961(c) basis with respect to Individual A of stock of F2 (50 shares) | $4x increase for each share ($250x ÷ 50 shares × 80%) | $1x increase for each share ($250x ÷ 50 shares × 20%). | | (3) Example 3: Basis reductions and gain recognition for distributions —(i) Facts. US1 and US2, in the aggregate, directly own all the shares of the single class of outstanding stock of F1. In year 3, F1 makes a covered distribution (pro rata with respect to the shares of stock of F1). Under § 1.959-4, the entirety of the portion of the covered distribution received by each of US1 and US2 is previously taxed earnings and profits excluded from the covered shareholder's (US1's or US2's) gross income. In addition, the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are distributed on each share of stock of F1 owned by US1 is $6x, and the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are distributed on each share of stock of F1 owned by US2 is $4x. Immediately before the covered distribution, US1's adjusted basis of each of its shares of stock of F1 is $4.5x, and US2's adjusted basis of each of its shares of stock of F1 is $3x. Each of US1 and US2 is deemed to pay the entirety of the associated foreign income taxes of the previously taxed earnings and profits distributed to it under section 960(b) (because all such taxes are sourced from the creditable PTEP tax group and the covered shareholder is a United States shareholder of F1) and is allowed a credit under section 901 for the entirety of such taxes. This example only analyzes adjustments to basis of US1's and US2's shares of stock of F1 (section 961(a) ownership units) under section 961. See also § 1.959-3 (adjustments to previously taxed earnings and profits accounts). (ii) Analysis —(A) In general. Under § 1.961-4(b), each of US1 and US2 reduces its adjusted basis of, and if applicable recognizes gain with respect to, each share of stock of F1 on which it receives previously taxed earnings and profits. The specific adjustments are provided in paragraphs (c)(3)(ii)(B) through (D) of this section and summarized in table 1 in this paragraph (c)(3)(ii)(A). **Table 1 to Paragraph ( c )(3)( ii )(A) of This Section—Basis Adjustments Resulting From F1's Distribution of PTEP** | | | | | | --- | --- | --- | --- | | | Basis immediately before the covered distribution | Adjustments to basis under § 1.961-4(b) | | | US1's adjusted basis of its shares of stock of F1 | $4.5x for each share | $6x adjustment for each share | $4.5x reduction to basis (to $0). $1.5x gain recognized. | | US2's adjusted basis of its shares of stock of F1 | $3x for each share | $4x adjustment for each share | $3x reduction to basis (to $0). $1x gain recognized. | (B) US1's receipt of previously taxed earnings and profits. As a result of US1's receipt of previously taxed earnings and profits, the amount of the adjustment to US1's adjusted basis of each of its shares of stock of F1 is $6x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits received on the share. See § 1.961-4(b)(2)(i). Consequently, US1 reduces its adjusted basis of each of its shares of stock of F1 ($4.5x) to $0 and then is treated as recognizing $1.5x of gain with respect to the share (computed as the excess of the $6x adjustment to basis over the $4.5x reduction to basis). See § 1.961-4(b)(2)(ii) and (iii). (C) US2's receipt of previously taxed earnings and profits. As a result of US2's receipt of previously taxed earnings and profits, the amount of the adjustment to US2's adjusted basis of each of its shares of stock of F1 is $4x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits received on the share. See § 1.961-4(b)(2)(i). Consequently, US2 reduces its adjusted basis of each of its shares of stock of F1 ($3x) to $0 and then is treated as recognizing $1x of gain with respect to the share (computed as the excess of the $4x adjustment to basis over the $3x reduction to basis). See § 1.961-4(b)(2)(ii) and (iii). (D) Timing of adjustments. The reductions to adjusted basis described in paragraphs (c)(3)(ii)(B) and (C) of this section are treated as made, and the gains described in those paragraphs are treated as recognized, concurrently with the covered distribution. See § 1.961-4(e)(1) and (f)(1). (iii) Alternative facts: previously taxed earnings and profits received through a partnership —(A) Facts. The facts are the same as in paragraph (c)(3)(i) of this section ( Example 3 ), except as follows. PRS1 directly owns all the shares of the single class of outstanding stock of F1, and US1 and US2, in the aggregate, directly own all the interests in PRS1. Under § 1.959-4, the entirety of the portion of the covered distribution treated as received by each of US1 and US2 through PRS1 is previously taxed earnings and profits excluded from the covered shareholder's (US1's or US2's) gross income. In addition, the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and distributed on each share of stock of F1 is $6x, and the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and distributed on each share of stock of F1 is $4x. Immediately before the covered distribution, for each share of stock of F1, PRS1's common basis is $2.5x, its derived basis with respect to US1 is $3x, and its derived basis with respect to US2 is $2x. This paragraph (c)(3)(iii) analyzes adjustments to basis of PRS1's shares of stock of F1 (derivative ownership units) under section 961. See also § 1.961-4(b) (related adjustments to basis of US1's and US2's interests in PRS1). (B) Analysis —( 1 ) In general. Under § 1.961-4(c), PRS1 reduces its derived basis of, and if applicable recognizes gain with respect to, each share of stock of F1 on which US1 or US2 receives previously taxed earnings and profits through PRS1. The specific adjustments are provided in paragraphs (c)(3)(iii)(B)( 2 ) through ( 5 ) of this section and summarized in table 1 in this paragraph (c)(3)(iii)(B)( 1 ). **Table 1 to Paragraph ( c )(3)( iii )(B)( 1 ) of This Section—Basis Adjustments Resulting From F1's Distribution of PTEP** | | | | | | --- | --- | --- | --- | | | PRS1 derived basis immediately before the covered distribution | Adjustments to PRS1 derived basis under § 1.961-4(c) | | | PRS1's derived basis with respect to US1 of its shares of stock of F1 | $3x for each share | $6x adjustment for each share | $4.5x reduction to basis (to negative $1.5x). $1.5x gain recognized. | | PRS1's derived basis with respect to US2 of its shares of stock of F1 | $2x for each share | $4x adjustment for each share | $3x reduction to basis (to negative $1x). $1x gain recognized. | ( 2 ) US1's receipt of previously taxed earnings and profits through PRS1. As a result of US1's receipt of previously taxed earnings and profits through PRS1, the amount of the adjustment to PRS1's derived basis with respect to US1 of each of PRS1's shares of stock of F1 is $6x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and received on the share. See § 1.961-4(c)(2)(i). Consequently, PRS1 reduces its derived basis with respect to US1 of each of its shares of stock of F1 ($3x) to $0 and then reduces such derived basis below zero in accordance with the limitation in § 1.961-4(c)(3), which permits a $1.5x reduction below zero to the derived basis because $1.5x of PRS1's common basis of the share is available with respect to US1 (as described in paragraph (c)(3)(iii)(B)( 4 ) of this section). See § 1.961-4(c)(2)(ii) and (iii), (c)(3)(i). Further, PRS1 is treated as recognizing $1.5x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $6x adjustment to basis over the sum of the $3x reduction to positive derived basis and the $1.5x reduction of derived basis below zero), and this gain is allocated solely to US1. See § 1.961-4(c)(2)(iv); see also § 1.961-4(f)(2) (taking the gain into account in adjusting US1's basis in its interest in PRS1 under section 705). ( 3 ) US2's receipt of previously taxed earnings and profits through PRS1. As a result of US2's receipt of previously taxed earnings and profits through PRS1, the amount of the adjustment to PRS1's derived basis with respect to US2 of each of PRS1's shares of stock of F1 is $4x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and received on the share. See § 1.961-4(c)(2)(i). Consequently, PRS1 reduces its derived basis with respect to US2 of each of its shares of stock of F1 ($2x) to $0 and then reduces such derived basis below zero in accordance with the limitation in § 1.961-4(c)(3), which permits a $1x reduction below zero to the derived basis because $1x of PRS1's common basis of the share is available with respect to US2 (as described in paragraph (c)(3)(iii)(B)( 4 ) of this section). See § 1.961-4(c)(2)(ii) and (iii) and (c)(3)(i). Further, PRS1 is treated as recognizing $1x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $4x adjustment to basis over the sum of the $2x reduction to positive derived basis and the $1x reduction of derived basis below zero), and this gain is allocated solely to US2. See § 1.961-4(c)(2)(iv); see also § 1.961-4(f)(2) (taking the gain into account in adjusting US2's basis in its interest in PRS1 under section 705). ( 4 ) Available common basis. For each of PRS1's shares of stock of F1, the amount of common basis of the share that is available with respect to each of US1 and US2 is determined by multiplying $2.5x (the common basis of the share, reduced by all negative derived basis of the share existing immediately before the distribution being analyzed, of which there is none) by a fraction. See § 1.961-4(c)(3)(ii). The numerator of the fraction is the amount by which PRS1's derived basis with respect to the covered shareholder of the share would be reduced below zero if derived basis could be reduced without limitation and, accordingly, is $3x in the case of the derived basis with respect to US1 (computed as the excess of the $6x adjustment to basis over the $3x reduction to positive derived basis) and is $2x in the case of derived basis with respect to US2 (computed as the excess of the $4x adjustment to basis over the $2x reduction to positive derived basis). The denominator of the fraction is the sum of the amounts by which any of PRS1's derived basis of the share would be reduced below zero if derived basis could be reduced without limitation ($5x, computed as the $3x with respect to US1 plus the $2x with respect to US2). Therefore, for each of PRS1's shares of stock of F1, there is $1.5x of common basis available with respect to US1 ($2.5x × $3x/$5x) and $1x of common basis available with respect to US2 ($2.5x × $2x/$5x), and this common basis permits a $1.5x and $1x reduction below zero to derived basis with respect to US1 and US2, respectively (as described in paragraphs (c)(3)(iii)(B)( 2 ) and ( 3 ) of this section). See also § 1.961-10(b) (gain resulting from negative derived basis is allocated to covered shareholders in proportion to relative negative derived basis). ( 5 ) Timing of adjustments. The reductions to derived basis described in paragraphs (c)(3)(iii)(B)( 2 ) and ( 3 ) of this section are treated as made, and the gains described in those paragraphs are treated as recognized, concurrently with the covered distribution. See § 1.961-4(e)(1) and (f)(1). (iv) Alternative facts: previously taxed earnings and profits received by a controlled foreign corporation —(A) Facts. The facts are the same as in paragraph (c)(3)(i) of this section ( Example 3 ), except as follows. US1 and US2, in the aggregate, directly own all the outstanding stock of F2 and are United States shareholders of F2. F2 directly owns all the shares of the single class of outstanding stock of F1. Under § 1.959-4, the entirety of each of US1's and US2's share of F1's covered distribution is previously taxed earnings and profits excluded from F2's gross income for purposes of determining its subpart F income and tested income or tested loss. In addition, the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and distributed on each share of stock of F1 is $6x, and the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and distributed on each share of stock of F1 is $4x. Immediately before the covered distribution, for each share of stock of F1, F2's adjusted basis is £1.25x, its section 961(c) basis with respect to US1 is $3x, and its section 961(c) basis with respect to US2 is $2x. On the day of the covered distribution, the spot rate is $1:£0.5. This paragraph (c)(3)(iv) analyzes adjustments to basis of F2's shares of stock of F1 (section 961(c) ownership units) under section 961. (B) Analysis —( 1 ) In general. Under § 1.961-4(d), F2 reduces its section 961(c) basis of, and if applicable recognizes gain with respect to, each share of stock of F1 on which it receives previously taxed earnings and profits. The specific adjustments are provided in paragraphs (c)(3)(iv)(B)( 2 ) through ( 5 ) of this section and summarized in table 1 in this paragraph (c)(3)(iv)(B)( 1 ). **Table 1 to Paragraph ( c )(3)( iv )(B)( 1 ) of This Section—Basis Adjustments Resulting From F1's Distribution of PTEP** | | | | | | --- | --- | --- | --- | | | F2 section 961(c) basis immediately before the covered distribution | Adjustments to F2 section 961(c) basis under § 1.961-4(d) | | | F2's section 961(c) basis with respect to US1 of its shares of stock of F1 | $3x for each share | $6x adjustment for each share | $4.5x reduction to basis (to negative $1.5x). $1.5x gain recognized. | | F2's section 961(c) basis with respect to US2 of its shares of stock of F1 | $2x for each share | $4x adjustment for each share | $3x reduction to basis (to negative $1x). $1x gain recognized. | ( 2 ) F2's receipt of previously taxed earnings and profits with respect to US1. As a result of F2's receipt of previously taxed earnings and profits with respect to US1, the amount of the adjustment to F2's section 961(c) basis with respect to US1 of each of F2's shares of stock of F1 is $6x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and received on the share. See § 1.961-4(d)(2)(i). Consequently, F2 reduces its section 961(c) basis with respect to US1 of each of its shares of stock of F1 ($3x) to $0 and then reduces such section 961(c) basis below zero in accordance with the limitation in § 1.961-4(d)(3), which permits a $1.5x reduction below zero to the section 961(c) basis because $1.5x of F2's adjusted basis of the share is available with respect to US1 (as described in paragraph (c)(3)(iv)(B)( 4 ) of this section). See § 1.961-4(d)(2)(ii) and (d)(3)(i). Further, F2 is treated as recognizing £0.75x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $6x adjustment to basis over the sum of the $3x reduction to positive section 961(c) basis and the $1.5x reduction of section 961(c) basis below zero ($1.5x excess), with such excess of $1.5x translated into British pounds at $1:£0.5), and this gain is assigned solely to US1. See § 1.961-4(d)(2)(iii) and (f)(4). Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F2) under § 1.961-11. See § 1.961-4(f)(3). ( 3 ) F2's receipt of previously taxed earnings and profits with respect to US2. As a result of F2's receipt of previously taxed earnings and profits with respect to US2, the amount of the adjustment to F2's section 961(c) basis with respect to US2 of each of F2's shares of stock of F1 is $4x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and received on the share. See § 1.961-4(d)(2)(i). Consequently, F2 reduces its section 961(c) basis with respect to US2 of each of its shares of stock of F1 ($2x) to $0 and then reduces such section 961(c) basis below zero in accordance with the limitation in § 1.961-4(d)(3), which permits a $1x reduction below zero to the section 961(c) basis because $1x of F2's adjusted basis of the share is available with respect to US2 (as described in paragraph (c)(3)(iv)(B)( 4 ) of this section). See § 1.961-4(d)(2)(ii) and (d)(3)(i). Further, F2 is treated as recognizing £0.5x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $4x adjustment to basis over the sum of the $2x reduction to positive section 961(c) basis and the $1x reduction of section 961(c) basis below zero ($1x excess), with such excess of $1x translated into British pounds at $1:£0.5), and this gain is assigned solely to US2. See § 1.961-4(d)(2)(iii) and (f)(4). Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F2) under § 1.961-11. See § 1.961-4(f)(3). ( 4 ) Available adjusted basis. For each of F2's shares of stock of F1, the amount of adjusted basis of the share that is available with respect to each of US1 and US2 is determined by multiplying $2.5x (the £1.25x of adjusted basis of the share translated into U.S. dollars at $1:£0.5, reduced by all negative derived basis of the share existing immediately before the distribution being analyzed, of which there is none) by a fraction. See § 1.961-4(d)(3)(ii). The numerator of the fraction is the amount by which F2's section 961(c) basis with respect to the covered shareholder of the share would be reduced below zero if section 961(c) basis could be reduced without limitation and, accordingly, is $3x in the case of the section 961(c) basis with respect to US1 (computed as the excess of the $6x adjustment to basis over the $3x reduction to positive section 961(c) basis) and is $2x in the case of section 961(c) basis with respect to US2 (computed as the excess of the $4x adjustment to basis over the $2x reduction to positive section 961(c) basis). The denominator of the fraction is the sum of the amounts by which any of F2's section 961(c) basis of the share would be reduced below zero if section 961(c) basis could be reduced without limitation ($5x, computed as the $3x with respect to US1 plus the $2x with respect to US2). Therefore, for each of F2's shares of stock of F1, there is $1.5x of adjusted basis available with respect to US1 ($2.5x × $3x/$5x) and $1x of adjusted basis available with respect to US2 ($2.5x × $2x/$5x), and this adjusted basis permits a $1.5x and $1x reduction below zero to section 961(c) basis with respect to US1 and US2, respectively (as described in paragraphs (c)(3)(iv)(B)( 2 ) and ( 3 ) of this section). See also § 1.961-10(c) (gain resulting from negative section 961(c) basis is allocated to covered shareholders in proportion to relative negative section 961(c) basis). ( 5 ) Timing of adjustments. The reductions to section 961(c) basis described in paragraphs (c)(3)(iv)(B)( 2 ) and ( 3 ) of this section are treated as made, and the gains described in those paragraphs are treated as recognized, concurrently with the covered distribution. See § 1.961-4(e)(1) and (f)(1). (4) Example 4: Use of positive derived basis —(i) Facts. US1 and a nonresident alien individual, in the aggregate, directly own all the interests in PRS1. PRS1 directly owns all the shares of the single class of outstanding stock of F1 (derivative ownership units). In year 3, PRS1 sells all the stock of F1 for money equal to the stock's fair market value. Section 304 does not apply to the sale. US1's distributive share of gain recognized by PRS1 on the sale is $60x, determined without regard to derived basis. Immediately before the sale (and taking into account any adjustments under § 1.961-5(b) resulting from the sale), PRS1's positive derived basis with respect to US1 of the shares of stock of F1 is $50x in total. In addition, PRS1 has no negative derived basis in any of the shares. This example only analyzes the application of positive derived basis to US1's distributive share of gain on the sale. See also § 1.959-3 (adjustments to previously taxed earnings and profits accounts); § 1.959-7 (transfer of previously taxed earnings and profits in general successor transactions); § 1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions). (ii) Analysis. PRS1 is treated as applying its $50x of positive derived basis with respect to US1 of the stock of F1 to US1's $60x distributive share of gain on the sale. See § 1.961-8(b). As result, US1's distributive share of gain on the sale is adjusted by $50x, to a $10x distributive share of gain. See also § 1.961-8(c) (for purposes of adjusting US1's adjusted basis of its interest in PRS1 under section 705, US1's distributive share on the sale is $10x of gain). (iii) Alternative facts: positive derived basis creates a distributive share of loss —(A) Facts. The facts are the same as in paragraph (c)(4)(i) of this section, except that PRS1's positive derived basis with respect to US1 of the shares of stock of F1 is $75x in total. In addition, if there were a loss in PRS1's stock of F1, PRS1 would recognize all such loss in the sale and a current deduction in respect of the loss would be allowable. (B) Analysis. PRS1 is treated as applying its $75x of positive derived basis with respect to US1 of the stock of F1 to US1's $60x distributive share of gain on the sale. See § 1.961-8(b). As result, US1's distributive share of the gain on the sale is adjusted by $75x, to a $15x distributive share of loss. See also § 1.961-8(c) (for purposes of adjusting US1's adjusted basis of its interest in PRS1 under section 705, US1's distributive share on the sale is $15x of loss). (iv) Alternative facts: tiered partnerships —(A) Facts. The facts are the same as in paragraph (c)(4)(i) of this section ( Example 4 ), except as follows. US1 and a nonresident alien individual, in the aggregate, directly own all the interests in PRS2. PRS2 and a nonresident alien individual, in the aggregate, directly own all the interests in PRS1. US1's distributive share of gain recognized by PRS1 on the sale (through its interest in PRS2) is $55x, determined without regard to derived basis. (B) Analysis. PRS2 is treated as applying PRS1's $50x of positive derived basis with respect to US1 of the stock of F1 to US1's $55x distributive share of gain on the sale. See § 1.961-8(b). As result, US1's distributive share of gain on the sale is adjusted by $50x, to a $5x distributive share of gain. See also § 1.961-8(c) (for purposes of adjusting US1's adjusted basis of its interest in PRS2 under section 705, US1's distributive share on the sale is $5x of gain); § 1.961-8(d) (for purposes of adjusting PRS2's common basis of its interest in PRS1 under section 705, PRS2's distributive share of gain is determined without regard to the application of positive derived basis; concurrently with the adjustment under section 705, reducing PRS2's derived basis with respect to US1 of the interest in PRS1 by $50x, the amount of positive derived basis applied to US1's distributive share of gain). (5) Example 5: Use of positive section 961(c) basis —(i) Facts. US1 and a nonresident alien individual, in the aggregate, directly own all the shares of the single class of outstanding stock of F1. F1 directly owns all the shares of the single class of outstanding stock of F2 (section 961(c) ownership units). In year 3, F1 sells all the stock of F2 for money equal to the stock's fair market value. Section 304 does not apply to the sale. F1 recognizes £100x of gain on the sale, determined without regard to loss recognized on any share and without regard to section 961(c) basis. This £100x is covered gain and US1 is assigned a £60x portion of the covered gain under § 1.951-2. Immediately before the sale (and taking into account any adjustments under § 1.961-5(b) resulting from the sale), F1's positive section 961(c) basis with respect to US1 of the shares of stock of F2 is £50x in total (as translated from U.S. dollars into British pounds at the spot rate on the day of the sale). In addition, F1 has no negative section 961(c) basis in any of the shares. Table 1 in this paragraph (c)(5)(i) provides the previously taxed earnings and profits of F2 that transfer from US1 in the sale to a successor covered shareholder under § 1.959-7 (total of £44x), along with the foreign income taxes that are associated with such previously taxed earnings and profits (total of £6x, as translated from U.S. dollars into British pounds at the spot rate on the day of the sale for purposes of § 1.961-9(f)(2)). This example only analyzes the extent to which previously taxed earnings and profits result from the application of F1's section 961(c) basis and are excluded from F1's gross income under section 961(c). See also § 1.959-3 (adjustments to previously taxed earnings and profits accounts); § 1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions). **Table 1 to Paragraph ( c )(5)( i ) of This Section—F2 PTEP Transferring From US1 & Associated Foreign Income Taxes** | Taxable year | § 904 category | General category | § 951(a)(1)(A) PTEP group | § 245A(d) PTEP group | Passive category | § 951(a)(1)(A) PTEP group | § 951A category | § 951A PTEP group | | --- | --- | --- | --- | --- | --- | --- | --- | --- | | Year 2: | | | | | | | | | | Transferred PTEP | | | | £10x | | | | | | Taxes | | | | | | | | | | Year 1: | | | | | | | | | | Transferred PTEP | £7.2x | £4x | £4.8x | 18x | | | | | | Taxes | 1.8x | 1x | 1.2x | 2x | | | | | (ii) Analysis —(A) In general. For purposes of analyzing the covered gain, US1's share of the covered gain is £60x because that amount of the covered gain is assigned to US1 under § 1.951-2. See § 1.961-9(d)(1). All £50x of F1's positive section 961(c) basis with respect to US1 of the stock of F2 is applied to such share. See § 1.961-9(d)(2) and (e)(1). As a result, £50x of the covered gain is previously taxed earnings and profits of F1 with respect to US1, characterized as described in paragraph (c)(5)(ii)(B) of this section. See § 1.961-9(d)(3) and (f)(1). F1 excludes the £50x of previously taxed earnings resulting from section 961(c) basis from its gross income, solely for purposes of determining its subpart F income and tested income or tested loss. See § 1.961-9(b). (B) Character of previously taxed earnings and profits resulting from section 961(c) basis. The mirroring rule in § 1.961-9(f)(2) determines the specific character of all £50x of F1's previously taxed earnings and profits resulting from section 961(c) basis because the amount of such previously taxed earnings and profits does not exceed the amount of mirrored PTEP, of which there is £50x. See § 1.961-9(f)(2)(i). The mirrored PTEP is the previously taxed earnings and profits described in table 1 to paragraph (c)(5)(i) of this section, determined by treating foreign income taxes associated with transferred previously taxed earnings and profits as additional previously taxed earnings and profits (£44x + £6x). See § 1.961-9(f)(2)(ii). Under the mirroring rule, the £50x of previously taxed earnings and profits resulting from section 961(c) basis have the same character as the £50x of mirrored PTEP, as summarized in table 1 in this paragraph (c)(5)(ii)(B). See § 1.961-9(f)(2)(i); see also § 1.961-9(g) and (h) (dollar basis rule and rule for allocating previously taxed earnings and profits to specific shares of stock). **Table 1 to Paragraph ( c )(5)( ii )(B) of This Section—F1 PTEP Resulting From § 961(C) Basis** | Taxable year | § 904 category | General category | § 951(a)(1)(A) PTEP group | § 245A(d) PTEP group | Passive category | § 951(a)(1)(A) PTEP group | § 951A category | § 951A PTEP group | | --- | --- | --- | --- | --- | --- | --- | --- | --- | | Year 2 | | | | £10x (£10x + £0). | | | | | | Year 1 | £9x (£7.2x + £1.8x) | £5x (£4x + £1x) | £6x (£4.8x + £1.2x) | £20x (£18x + £2x). | | | | | (iii) Alternative facts: unused section 961(c) basis —(A) Facts. The facts are the same as in paragraph (c)(5)(i) of this section ( Example 5 ), except that the amount of F1's covered gain is £70x (instead of £100x) and US1 is assigned a £42x (instead of £60x) portion of the covered gain under § 1.951-2. (B) Analysis. For purposes of analyzing the covered gain, US1's share of the covered gain is £42x, and £42x of F1's £50x of positive section 961(c) basis with respect to US1 of the stock of F2 is applied to such share. See § 1.961-9(d)(1) and (2), (e)(1). As a result, £42x of the covered gain is previously taxed earnings and profits of F1 with respect to US1, with the same character as a pro rata portion of the previously taxed earnings and profits set forth in table 1 to paragraph (c)(5)(ii)(B) of this section, determined by multiplying all such previously taxed earnings and profits by 84% (computed as $42x of previously taxed earnings and profits resulting from section 961(c) basis divided by £50x of mirrored PTEP). See § 1.961-9(d)(3), (f)(1) and (2). Moreover, the £8x of F1's positive section 961(c) basis that is not applied to the covered gain is taken into account only for purposes of determining amounts included in gross income of United States shareholders of F1 under § 1.961-11. (6) Example 6: Gain recognition for negative derived basis —(i) Facts. US1 and US2, in the aggregate, directly own all the interests in PRS1. PRS1 directly owns all the shares of the single class of stock of F1 (derivative ownership units). In year 3, PRS1 sells all the stock of F1 for money equal to the stock's fair market value. Section 304 does not apply to the sale, and the shares of stock of F1 remain derivative ownership units immediately after the sale (because the buyer is a partnership the interests in which are owned by one or more covered shareholders). PRS1 recognizes $2x of loss with respect to each share of stock of F1, determined without regard to derived basis and allocated to US1 and US2 in accordance with section 704. Immediately before the sale (and taking into account any adjustments under § 1.961-5(b) resulting from the sale), for each share of stock of F1, PRS1's derived basis with respect to US1 is negative $1.5x and its derived basis with respect to US2 is negative $1x. This example only analyzes the consequences of negative derived basis in the sale. See also § 1.959-3 (adjustments to previously taxed earnings and profits accounts); § 1.959-7 (transfer of previously taxed earnings and profits in general successor transactions); § 1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions). (ii) Analysis. As a result of negative derived basis, PRS1 is treated as recognizing gain with respect to each share of stock of F1. See § 1.961- 10(b)(1). For each share of stock of F1, the amount of such gain is $2.5x, which is the lesser amount of loss ($2x, expressed as a positive amount), plus the additional amount of gain ($0.5x), that PRS1 would have recognized with respect to the share if PRS1's common basis of the share were reduced by $2.5x (the sum of all PRS1's negative derived basis of the share), and thus all negative derived basis gives rise to gain. See § 1.961-10(b)(2)(i); compare paragraph (c)(6)(iii) of this section (scenario where less than all negative derived basis gives rise to gain). A pro rata portion of the $2.5x of gain treated as recognized with respect to each share of stock of F1 is allocated to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is PRS1's negative derived basis with respect to the covered shareholder of the share ($1.5x in the case of US1, and $1x in the case of US2), and the denominator of which is the sum of all PRS1's negative derived basis of the share ($2.5x). See § 1.961-10(b)(3). Thus, in addition to the allocation in accordance with section 704 of the $2x of loss that PRS1 recognizes with respect to each share of stock of F1, US1 is allocated $1.5x, and US2 is allocated $1x, of the $2.5x of gain treated as recognized by PRS1 with respect to each share of stock of F1. See § 1.961-10(b)(4); see also § 1.961-4(f)(2) (gain allocated to US1 or US2 is taken into account in adjusting US1's or US2's basis in its interest in PRS1 under section 705). (iii) Alternative facts: section 301(c)(2) distribution —(A) Facts. The facts are the same as in paragraph (c)(6)(i) of this section ( Example 6 ), except as follows. PRS1 does not sell any stock of F1. In year 3, F1 makes a distribution that is $10x with respect to each share of its stock. None of the distribution is a covered distribution because F1 has no accumulated or current year earnings and profits in year 3. Immediately before the distribution, for each share of stock of F1, PRS1's common basis is $12x, its derived basis with respect to US1 is negative $1.5x, and its derived basis with respect to US2 is negative $1x. Thus, section 301(c)(2) applies to the entirety of the $10x that is distributed with respect to each share of stock of F1. This example only analyzes the consequences of negative derived basis in the distribution. (B) Analysis. PRS1 determines the amount of gain it is treated as recognizing as a result of negative derived basis by calculating the additional amount of gain that it would have recognized with respect to each share of stock of F1 under section 301(c)(3) if its common basis of the share were reduced by $2.5x (the sum of all PRS1's negative derived basis of the share). See § 1.961-10(b)(2)(i). Specifically, if PRS1's common basis of each share were reduced by $2.5x, the common basis would be $9.5x ($12x − $2.5x), such that the distribution of $10x on the share would result in $9.5x being treated as a return of basis under section 301(c)(2) and $0.5x being treated as gain recognized under section 301(c)(3). Thus, PRS1 is treated as recognizing $0.5x of gain with respect to each share as a result of the $2.5x of negative derived basis of the share, and PRS1 retains the remaining $2x of negative derived basis of the share (which, under these facts, is equal to the portion of the common basis of the share that is not reduced by the distribution under section 301(c)(2) ($12x − $10x, or $2x)). A pro rata portion of the $0.5x of gain treated as recognized with respect to each share of stock of F1 is allocated to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is PRS1's negative derived basis with respect to the covered shareholder of the share ($1.5x in the case of US1, and $1x in the case of US2), and the denominator of which is the sum of all PRS1's negative derived basis of the share ($2.5x). See § 1.961-10(b)(3). Thus, US1 is allocated $0.3x, and US2 is allocated $0.2x, of the $0.5x of gain treated as recognized by PRS1 with respect to each share of stock of F1. See § 1.961-10(b)(4); see also § 1.961-4(f)(2) (gain allocated to US1 or US2 is taken into account in adjusting US1's or US2's basis in its interest in PRS1 under section 705). Immediately after the distribution, for each share of stock of F1, PRS1's derived basis with respect to US1 is negative $1.2x (negative $1.5x + $0.3x) and its derived basis with respect to US2 is negative $0.8x (negative $1x + $0.2x). See § 1.961-10(b)(5). (7) Example 7: Gain recognition for negative section 961(c) basis —(i) Facts. US1 and US2, in the aggregate, directly own all the shares of the single class of stock of F1 and are United States shareholders of F1. F1 directly owns all the shares of the single class of stock of F2 (section 961(c) ownership units). In year 3, F1 sells all the stock of F2 for money equal to the stock's fair market value. Section 304 does not apply to the sale, and the shares of stock of F2 remain section 961(c) ownership units immediately after the sale (because the buyer is a controlled foreign corporation). F1 recognizes £2x of loss with respect to each share of stock of F2, determined without regard to section 961(c) basis. Immediately before the sale (and taking into account any adjustments under § 1.961-5(b) resulting from the sale), for each share of stock of F2, F1's section 961(c) basis with respect to US1 is negative £1.5x and its section 961(c) basis with respect to US2 is negative £1x (as translated from U.S. dollars into British pounds at the spot rate on the day of the sale). This example only analyzes the consequences of negative section 961(c) basis in the sale. See also § 1.959-3 (adjustments to previously taxed earnings and profits accounts); § 1.959-7 (transfer of previously taxed earnings and profits in general successor transactions); § 1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions). (ii) Analysis. As a result of negative section 961(c) basis, F1 is treated as recognizing gain with respect to each share of stock of F2. See § 1.961-10(c)(1). For each share of stock of F2, the amount of such gain is £2.5x, which is the lesser amount of loss (£2x, expressed as a positive amount), plus the additional amount of gain (£0.5x), that F1 would have recognized with respect to the share if F1's adjusted basis of the share were reduced by £2.5x (the sum of all F1's negative section 961(c) basis of the share), and thus all negative section 961(c) basis gives rise to gain. See § 1.961-10(c)(2)(i); compare paragraph (c)(7)(iii) of this section (scenario where less than all negative section 961(c) basis gives rise to gain). A pro rata portion of the £2.5x of gain treated as recognized with respect to each share of stock of F2 is assigned to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is F1's negative section 961(c) basis with respect to the covered shareholder of the share (£1.5x in the case of US1, and £1x in the case of US2), and the denominator of which is the sum of all F1's negative section 961(c) basis of the share (£2.5x). See § 1.961-10(c)(3). Thus, US1 is assigned £1.5x, and US2 is assigned £1x, of the £2.5x of gain treated as recognized by F1 with respect to each share of stock of F2. Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F1) under § 1.961-11. See § 1.961-10(c)(4); see also §§ 1.961-4(f)(3) (the gain does not affect F1's items of gross income for purposes of section 952 or 951A or its earnings and profits). (iii) Alternative facts: section 351 exchange with boot —(A) Facts. The facts are the same as in paragraph (c)(7)(i) of this section ( Example 7 ), except as follows. Instead of the sale, F1 contributes property, including all its stock of F2, to F3, a controlled foreign corporation, in exchange for stock of F3 and money equal, in the aggregate, to the fair market value of the contributed property. Other unrelated persons also contribute property to F3 in exchange for stock of F3 as part of the same transaction. Section 351(b) applies to F1's exchange, but sections 304 and 362(e) do not, and no income inclusions are required under § 1.367(b)-4. The shares of stock of F2 remain section 961(c) ownership units immediately after the contribution (because F3 is a controlled foreign corporation). In the exchange, for each share of stock of F2, F1 receives stock of F3 and £10x of money but recognizes no gain because F1's adjusted basis of the share is £2x greater than the fair market value of the share. Immediately before the exchange (and taking into account any adjustments under § 1.961-5(b) resulting from the exchange), for each share of stock of F2, F1's section 961(c) basis with respect to US1 is negative £1.5x and its section 961(c) basis with respect to US2 is negative £1x (as translated from U.S. dollars into British pounds at the spot rate on the day of the exchange). This example only analyzes the consequences of negative section 961(c) basis in the exchange. (B) Analysis. F1 determines the amount of gain it is treated as recognizing as a result of negative section 961(c) basis by calculating the additional amount of gain that it would have recognized with respect to each share of stock of F2 under section 351(b) if its adjusted basis of the share were reduced by £2.5x (the sum of all F1's negative section 961(c) basis of the share). See § 1.961-10(c)(2)(i). Specifically, a £2.5x reduction to F1's adjusted basis of each share would convert a £2x loss on the share into a £0.5x gain, which would then be recognized pursuant to section 351(b) in the exchange. Thus, F1 is treated as recognizing £0.5x of gain with respect to each share as a result of the £2.5x of negative section 961(c) basis of the share, and the remaining £2x of negative section 961(c) basis of the share is retained (which, under these facts, is equal to the loss in the share that is not recognized in the exchange (£2x, the excess of the adjusted basis of the share over the fair market value of the share)). A pro rata portion of the £0.5x of gain treated as recognized with respect to each share of stock of F2 is assigned to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is F1's negative section 961(c) basis with respect to the covered shareholder of the share (£1.5x in the case of US1, and £1x in the case of US2), and the denominator of which is the sum of all F1's negative section 961(c) basis of the share (£2.5x). See § 1.961-10(c)(3). Thus, US1 is assigned £0.3x, and US2 is assigned £0.2x, of the £0.5x of gain treated as recognized by F1 with respect to each share of stock of F2. Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F1) under § 1.961-11. See § 1.961-10(c)(4); see also §§ 1.961-4(f)(3) (the gain does not affect F1's items of gross income for purposes of section 952 or 951A or its earnings and profits). Immediately after the exchange, for each share of stock of F2, the functional currency amount of F3's section 961(c) basis with respect to US1 is negative £1.2x (negative £1.5x + £0.3x) and its section 961(c) basis with respect to US2 is negative £0.8x (negative £1x + £0.2x). See § 1.961-10(c)(5). (8) Example 8: Amounts included in gross income of United States shareholders —(i) Facts. US1 and US2, in the aggregate, directly own all the shares of the single class of stock of F1 and are United States shareholders of F1. F1 directly owns all the shares of the single class of stock of each of F2 and F3 (section 961(c) ownership units). For F1's taxable year ending on December 31 of year 3, F1 recognizes £50x of section 961(c) income. The section 961(c) income consists of £10x of gain recognized as a result of F1's receipt of previously taxed earnings and profits from F2 and £40x of gain recognized as a result of F1's sale of stock of F3 with negative section 961(c) basis. US1 and US2 are assigned equal portions of the £10x gain under § 1.961-4(d) (basis reductions and gain recognition for distributions) and US2 is assigned all the £40x gain under § 1.961-10(c) (gain recognition for negative basis). F1 has no positive section 961(c) basis in any of the sold shares of stock of F3. This example only analyzes the allocation of F1's section 961(c) income and resulting inclusions in gross income of United States shareholders under section 961(c). (ii) Analysis. Under § 1.961-11, F1's £50x of section 961(c) income is allocated to each of US1 and US2 by adding up the amounts of the section 961(c) income that are assigned to each United States shareholder. See § 1.961-11(c). No additional computations are required because F1 does not recognize any loss under section 961(c) and there are no transfers of stock of F1. See id. Thus, US1 is allocated £5x (£5x of gain with respect to stock of F2 plus £0 of gain with respect to stock of F3), and US2 is allocated £45x (£5x of gain with respect to stock of F2 plus £40x of gain with respect to stock of F3), of the section 961(c) income. Accordingly, US1 includes £5x in its gross income and US2 includes £45x in its gross income, in each case for the United States shareholder's (US1's or US2's) taxable year ending on December 31 of year 3 and translated into U.S. dollars in accordance with section 989(b). See § 1.961-11(b). Under § 1.961-3, each of US1's and US2's income inclusion increases its adjusted basis of its stock of F1 by the U.S. dollar amount of the inclusion. (iii) Alternative facts: loss under section 961(c) —(A) Facts. The facts are the same as in paragraph (c)(8)(i) of this section ( Example 8 ), except as follows. F1 is treated as recognizing £7x of loss under section 961(c) with respect to US2 because F1 has positive section 961(c) basis with respect to US2 in some of the sold shares of stock of F3 and, under § 1.961-9, all but £7x of such positive section 961(c) basis is applied to US2's share of covered gain recognized by F1 on the sale of stock of F3. (B) Analysis. Under § 1.961-11, F1's £50x of section 961(c) income is allocated to each of US1 and US2 by first adding up the amounts of the section 961(c) income that are assigned to the United States shareholder (£5x in the case of US1, and £45x in the case of US2) and then reducing (but not below zero) such sum by the amount of loss F1 is treated as recognizing under section 961(c) with respect to the United States shareholder (£0 in the case of US1, and £7x in the case of US2). See § 1.961-11(c). Thus, US1 is allocated £5x (£5x − £0), and US2 is allocated £38x (£45x − £7x), of the section 961(c) income. Accordingly, US1 includes £5x in its gross income and US2 includes £38x in its gross income, in each case for the United States shareholder's (US1's or US2's) taxable year ending on December 31 of year 3 and translated into U.S. dollars in accordance with section 989(b). See § 1.961-11(b). Under § 1.961-3, each of US1's and US2's income inclusion increases its adjusted basis of its stock of F1 by the U.S. dollar amount of the inclusion.