Par. 28. Sections 1.961-3 through 1.961-14 are added to read as follows:
(a) Scope. This section sets forth the rules for reducing basis and recognizing gain under section 961 for distributions of previously taxed earnings and profits. Paragraph (b) of this section describes adjustments to section 961(a) ownership units in the case of distributions of previously taxed earnings and profits to a covered shareholder. Paragraph (c) of this section describes adjustments to derivative ownership units in the case of distributions of previously taxed earnings and profits through one or more partnerships to one or more covered shareholders. Paragraph (d) of this section describes adjustments to section 961(c) ownership units in the case of distributions of previously taxed earnings and profits to a controlled foreign corporation. Paragraph (e) of this section provides timing rules for when adjustments are treated as made. Paragraph (f) of this section provides rules regarding the treatment of gain recognized under this section. See § 1.961-12(c)(3) ( Example 3 ) for an example illustrating the application of this section.
(b) Adjustments to section 961(a) ownership units —(1) In general. If a covered shareholder receives previously taxed earnings and profits that are excluded from its gross income under section 959(a) and § 1.959-4, then the resulting adjustments under section 961 to the covered shareholder's adjusted basis of section 961(a) ownership units are determined in accordance with the rules described in paragraph (b)(2) of this section.
(2) Rules for adjusting basis —(i) Determine amounts of adjustments. First, determine the amount of the adjustment to the covered shareholder's adjusted basis of each section 961(a) ownership unit, which is equal to the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits that are received with respect to such section 961(a) ownership unit (determined under § 1.959-4), but only including foreign income taxes for which the covered shareholder is allowed a credit under section 901.
(ii) Reduce basis. Second, reduce the covered shareholder's adjusted basis of each section 961(a) ownership unit by the amount of the adjustment to such adjusted basis (determined under paragraph (b)(2)(i) of this section), but not below zero.
(iii) Recognize gain. Third, to the extent that the amount of an adjustment to the covered shareholder's adjusted basis of a section 961(a) ownership unit (determined under paragraph (b)(2)(i) of this section) exceeds such adjusted basis, treat the covered shareholder as recognizing gain with respect to such section 961(a) ownership unit in accordance with paragraph (f) of this section.
(c) Adjustments to derivative ownership units —(1) In general. If, through a partnership, one or more covered shareholders receive previously taxed earnings and profits that are excluded from the covered shareholders' gross income under section 959(a) and § 1.959-4, then the resulting adjustments under section 961 to the partnership's derived basis of derivative ownership units are determined in accordance with the rules described in paragraph (c)(2) of this section. In the case of tiered partnerships, each tiered partnership's derived basis of derivative ownership units is adjusted as described in paragraph (c)(2) of this section, starting with the partnership at the lowest tier.
(2) Rules for adjusting basis —(i) Determine amounts of adjustments. First, determine the amount of the adjustment to the partnership's derived basis with respect to each covered shareholder of each derivative ownership unit, which is equal to the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits that are both with respect to such covered shareholder and received with respect to such derivative ownership unit (determined under § 1.959-4).
(ii) Reduce positive derived basis. Second, reduce the partnership's derived basis with respect to each covered shareholder of each derivative ownership unit by the amount of the adjustment to such derived basis (determined under paragraph (c)(2)(i) of this section), but not below zero.
(iii) Reduce positive section 743(b) basis (if applicable) and increase negative derived basis. Third, to the extent that the amount of an adjustment to the partnership's derived basis with respect to a covered shareholder of a derivative ownership unit (determined under paragraph (c)(2)(i) of this section) exceeds the related reduction to positive derived basis (determined under paragraph (c)(2)(ii) of this section), reduce the covered shareholder's positive section 743(b) basis adjustment of such derivative ownership unit (if applicable), but not below zero, and then, if applicable, reduce such derived basis below zero, but only to the extent permitted under paragraph (c)(3) of this section.
(iv) Recognize and allocate gain. Fourth, to the extent that the amount of an adjustment to the partnership's derived basis with respect to a covered shareholder of a derivative ownership unit (determined under paragraph (c)(2)(i) of this section) exceeds the aggregate of the related reductions to derived basis (determined under paragraphs (c)(2)(ii) and (iii) of this section) and positive section 743(b) basis (determined under paragraph (c)(2)(iii) of this section), treat the partnership as recognizing gain with respect to such derivative ownership unit in accordance with paragraph (f) of this section, and allocate the gain solely to the covered shareholder.
(3) Limitation on reducing derived basis —(i) In general. An adjustment to a partnership's derived basis with respect to a covered shareholder of a derivative ownership unit can reduce (or further reduce) such derived basis below zero only to the extent of the amount of common basis of such derivative ownership unit available with respect to the covered shareholder (determined under paragraph (c)(3)(ii) of this section), less, if applicable, the covered shareholder's negative section 743(b) basis adjustment of the derivative ownership unit (expressed as a positive amount).
(ii) Determining common basis available with respect to the covered shareholder. In applying paragraph (c)(3)(i) of this section, the amount of common basis of the derivative ownership unit available with respect to the covered shareholder is equal to the product of the following amounts—
(A) The partnership's common basis of the derivative ownership unit (translated, if applicable, into U.S. dollars at the spot rate on the day on which the adjustment described in paragraph (c)(3)(i) of this section would be treated as reducing basis), reduced by all negative derived basis of the derivative ownership unit (determined immediately before the adjustment described in paragraph (c)(3)(i) of this section would be treated as made); and
(B) A fraction, the numerator of which is the amount by which the adjustment described in paragraph (c)(3)(i) of this section would reduce derived basis with respect to the covered shareholder below zero if derived basis could be reduced without limitation, and the denominator of which is the sum of the amounts by which the adjustment described in paragraph (c)(3)(i) of this section and any concurrent adjustments to derived basis with respect to other covered shareholders would reduce derived basis of the derivative ownership unit below zero if derived basis could be reduced without limitation.
(d) Adjustments to section 961(c) ownership units —(1) In general. If a controlled foreign corporation receives previously taxed earnings and profits that are excluded from its gross income under section 959(b) and § 1.959-4, then the resulting adjustments under section 961 to the controlled foreign corporation's section 961(c) basis of section 961(c) ownership units are determined in accordance with the rules described in paragraph (d)(2) of this section.
(2) Rules for adjusting basis —(i) Determine amounts of adjustments. First, determine the amount of the adjustment to the controlled foreign corporation's section 961(c) basis with respect to each covered shareholder of each section 961(c) ownership unit, which is equal to the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits that are both with respect to such covered shareholder and received with respect to such section 961(c) ownership unit (determined under § 1.959-4).
(ii) Reduce basis. Second, reduce the controlled foreign corporation's section 961(c) basis with respect to each covered shareholder of each section 961(c) ownership unit by the amount of the adjustment to such section 961(c) basis, including below zero, but only to the extent permitted under paragraph (d)(3) of this section.
(iii) Recognize and assign gain. Third, to the extent that the amount of an adjustment to the controlled foreign corporation's section 961(c) basis with respect to a covered shareholder of a section 961(c) ownership unit (determined under paragraph (d)(2)(i) of this section) exceeds the related reduction to section 961(c) basis (determined under paragraph (d)(2)(ii) of this section), treat the controlled foreign corporation as recognizing gain with respect to such section 961(c) ownership unit in accordance with paragraph (f) of this section, and assign the gain solely to the covered shareholder.
(3) Limitation on reducing section 961(c) basis —(i) In general. An adjustment to a controlled foreign corporation's section 961(c) basis with respect to a covered shareholder of a section 961(c) ownership unit can reduce (or further reduce) such section 961(c) basis below zero only to the extent of the amount of adjusted basis of such section 961(c) ownership unit available with respect to the covered shareholder (determined under paragraph (d)(3)(ii) of this section).
(ii) Determining adjusted basis available with respect to the covered shareholder. In applying paragraph (d)(3)(i) of this section, the amount of adjusted basis of the section 961(c) ownership unit available with respect to the covered shareholder is equal to the product of the following amounts—
(A) The controlled foreign corporation's adjusted basis of the section 961(c) ownership unit (translated, if applicable, into U.S. dollars at the spot rate on the day on which the adjustment described in paragraph (d)(3)(i) of this section would be treated as reducing basis), reduced by all negative section 961(c) basis of the section 961(c) ownership unit (determined immediately before the adjustment described in paragraph (d)(3)(i) of this section would be treated as made); and
(B) A fraction, the numerator of which is the amount by which the adjustment described in paragraph (d)(3)(i) of this section would reduce section 961(c) basis with respect to the covered shareholder below zero if section 961(c) basis could be reduced without limitation, and the denominator of which is the sum of the amounts by which the adjustment described in paragraph (d)(3)(i) of this section and any concurrent adjustments to section 961(c) basis with respect to other covered shareholders would reduce section 961(c) basis of the section 961(c) ownership unit below zero if section 961(c) basis could be reduced below zero without limitation.
(e) Timing of basis reductions —(1) Basis of stock. A reduction to basis of stock of a foreign corporation under paragraph (b), (c), or (d) of this section is treated as made concurrently with the distribution giving rise to the basis reduction (and before any other adjustment to basis by reason of the distribution, for example, under section 301(c)(2)).
(2) Basis of partnership interests. A reduction to basis of an interest in a partnership under paragraph (b) or (c) of this section is treated as made concurrently with the adjustment under section 705 to such interest in the partnership by reason of the distribution giving rise to the basis reduction.
(f) Treatment of gain —(1) In general. Gain treated as recognized with respect to a section 961(a) ownership unit, derivative ownership unit, or section 961(c) ownership unit under paragraph (b), (c), or (d) of this section is treated as gain from a sale or exchange of such ownership unit occurring concurrent with when the adjustment described in that paragraph would be treated as reducing basis.
(2) Gain recognized by a partnership. Gain treated as recognized by a partnership under paragraph (c) of this section constitutes an item of gain solely with respect to the covered shareholder to which it is allocated and has no effect on any partnership's computation or allocation of any other item under section 703 or 704 or on the covered shareholder's capital account. The gain is treated as the covered shareholder's distributive share of gain of the partnership (derived through each partnership through which the covered shareholder owns the partnership recognizing the gain, if applicable) and is taken into account in adjusting basis under section 705.
(3) Gain recognized by a controlled foreign corporation. Gain treated as recognized by a controlled foreign corporation under paragraph (d) of this section is gain recognized pursuant to section 961(c). Such gain applies only for purposes of determining amounts included in gross income of United States shareholders of the controlled foreign corporation under § 1.961-11 and, therefore, for example does not affect the controlled foreign corporation's items of gross income for purposes of section 952 or 951A or its earnings and profits.
(4) Translation rule. If applicable, gain treated as recognized by a partnership or controlled foreign corporation under paragraph (c) or (d) of this section is translated into functional currency at the spot rate on the day on which the gain is treated as recognized.