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 adjusting basis under section 961 for foreign currency gain or loss recognized with respect to previously taxed earnings and profits under section 986(c) and for general successor transactions. Paragraph (b) of this section provides the adjustments for foreign currency gain or loss. Paragraph (c) of this section provides the adjustments for general successor transactions. Paragraph (d) of this section coordinates with section 743(b).
(b) Adjustments for foreign currency gain or loss —(1) In general. If a covered shareholder recognizes foreign currency gain or loss with respect to a foreign corporation's previously taxed earnings and profits under § 1.986(c)-1 in a transaction other than a distribution of the previously taxed earnings and profits, then basis of property units that are shares of stock of the foreign corporation owned by the covered shareholder, and basis of any property units through which the covered shareholder owns stock of the foreign corporation, is in each case adjusted in accordance with the rules described in paragraphs (b)(2) through (4) of this section. Generally, under those rules, basis adjustments begin at the level of stock of the foreign corporation and then tier through property units through which the covered shareholder owns such stock, with at each level basis adjustments allocated among property units based on proportionate shares of foreign currency gain or loss. Solely for purposes of this paragraph (b), a reference to the basis of a property unit means adjusted basis in the case of a section 961(a) ownership unit, derived basis with respect to the covered shareholder in the case of a derivative ownership unit, or section 961(c) basis with respect to the covered shareholder in the case of a section 961(c) ownership unit.
(2) Determine net foreign currency gain or loss. First, determine the amount of foreign currency gain or loss that gives rise to adjustments to basis, computed by comparing the sum of all foreign currency gain and the sum of all foreign currency loss that the covered shareholder recognizes with respect to the foreign corporation's previously taxed earnings and profits in the transaction under § 1.986(c)-1(b), without regard to § 1.986(c)-1(b)(3)(i) and (ii) (limitations for previously taxed earnings and profits resulting from section 965). The excess of the sum of foreign currency gain over the sum of foreign currency loss is net foreign currency gain, and the excess of the sum of foreign currency loss over the sum of foreign currency gain is net foreign currency loss.
(3) Determine each property unit's share of net foreign currency gain or loss —(i) In general. Second, determine each property unit's share of net foreign currency gain or net foreign currency loss by multiplying the net foreign currency gain or net foreign currency loss, as applicable, by a fraction (which is based on a hypothetical distribution by the foreign corporation of previously taxed earnings and profits with respect to which the covered shareholder recognizes, or would recognize, foreign currency gain or loss in the transaction). The numerator of the fraction is the portion of the hypothetical distribution described in paragraph (b)(3)(ii) of this section that, under the principles of § 1.951-1(e)(2) through (6), would be distributed with respect to the property unit, and the denominator of the fraction is the amount of such hypothetical distribution.
(ii) Hypothetical distribution. The hypothetical distribution described in this paragraph (b)(3)(ii) is a hypothetical distribution treated as made by the foreign corporation, through all property (if any) through which the covered shareholder owns stock of the foreign corporation, to the covered shareholder immediately before the transaction. The amount of the hypothetical distribution is equal to all previously taxed earnings and profits of the foreign corporation with respect to which the covered shareholder recognizes (or, but for § 1.986(c)-1(b)(3)(i) and (ii), would recognize) any foreign currency gain or loss in the transaction. In the hypothetical distribution, stock of the foreign corporation is taken into account only to the extent owned by the covered shareholder immediately before but not immediately after the transaction, and other property is taken into account only to the extent owned by the covered shareholder immediately before the transaction. The earnings and profits of the foreign corporation and any foreign corporations through which the hypothetical distribution is treated as made are in each case treated as equal to the amount of the hypothetical distribution.
(4) Adjust basis —(i) In general. Third, adjust the basis of each property unit in accordance with paragraph (b)(4)(ii) or (iii) of this section, as applicable, starting with property units at the lowest tier and subject to the limitation in paragraph (b)(4)(iv) of this section. Treat each such adjustment to basis as made immediately before the transaction (and therefore take the adjustments into account in determining the Federal income tax consequences of the transaction).
(ii) Basis increases for net foreign currency gain. In the case of net foreign currency gain, increase the basis of each property unit by the property unit's share of the net foreign currency gain (determined under paragraph (b)(3) of this section).
(iii) Basis reductions and gain recognition for net foreign currency loss. In the case of net foreign currency loss, reduce the basis of each property unit by the property unit's share of net foreign currency loss (determined under paragraph (b)(3) of this section) or recognize gain in accordance with the principles of § 1.961-4 (applied by treating such share of net foreign currency loss as the amount of the adjustment to basis described in § 1.961-4(b)(2)(i), (c)(2)(i), or (d)(2)(i), as applicable).
(iv) Limitation for section 961(c) ownership units. Section 961(c) basis of a section 961(c) ownership unit is adjusted only if the section 961(c) ownership unit is a share of stock of a controlled foreign corporation. A specified foreign corporation (as defined in § 1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign corporation is treated as a controlled foreign corporation for purposes of applying this paragraph (b)(4) to foreign currency gain or loss with respect to previously taxed earnings and profits resulting from the application of section 965(a).
(c) Successor basis —(1) In general. In a general successor transaction, derived basis of each partnership in which the successor covered shareholder acquires ownership of a partnership interest (each an acquired partnership ), and section 961(c) basis of each acquired foreign corporation, transfers from the transferor covered shareholder to the successor covered shareholder (and thus becomes derived basis or section 961(c) basis with respect to the successor covered shareholder) in accordance with the rules described in paragraph (c)(2) this section. Solely for purposes of this paragraph (c), a reference to the basis of a property unit means derived basis with respect to the transferor covered shareholder in the case of a derivative ownership unit, or section 961(c) basis with respect to the transferor covered shareholder in the case of a section 961(c) ownership unit.
(2) Rules for transferring basis —(i) Allocate basis before adjustment for foreign currency gain or loss. First, for each property unit directly owned by an acquired partnership or acquired foreign corporation, allocate to the successor covered shareholder a pro rata portion of the basis of the property unit immediately before the adjustments pursuant to paragraph (b) of this section by reason of the general successor transaction, determined by multiplying such basis by a fraction. The numerator of the fraction is the value of the interest in the acquired partnership or stock of the acquired corporation, as applicable, ownership of which is acquired by the successor covered shareholder in the general successor transaction. The denominator of the fraction is the total value of all the interests of the acquired partnership or all the stock of the acquired foreign corporation, as applicable, that the transferor covered shareholder owns immediately before the general successor transaction.
(ii) Adjust allocations for foreign currency gain or loss. Second, adjust the allocation of basis of each property unit as follows. Increase the allocation to the successor covered shareholder by the amount of the increase to basis of the property unit pursuant to paragraph (b) of this section by reason of the general successor transaction. Decrease the allocation to the successor covered shareholder by the amount of the reduction to basis of the property unit pursuant to paragraph (b) of this section by reason of the general successor transaction.
(iii) Transfer of successor basis. Third, transfer basis from the transferor covered shareholder to the successor covered shareholder by reducing basis with respect to the transferor covered shareholder, and increasing basis with respect to the successor covered shareholder, of each property unit by the amount of basis of the property unit allocated to the successor covered shareholder under paragraphs (c)(2)(i) and (ii) of this section (if such amount is positive) or, if such amount is negative, by increasing basis with respect to the transferor covered shareholder and reducing basis with respect to the successor covered shareholder by such amount, expressed as a positive number. Treat each such transfer of basis as made concurrently with the general successor transaction.
(3) Deemed covered shareholder —(i) In general. For purposes of transferring basis under this paragraph (c), the deemed covered shareholder is treated in the same manner as a covered shareholder and a reference to a covered shareholder includes the deemed covered shareholder. Thus, for example, if a covered shareholder sells an interest in a partnership that directly owns stock of a foreign corporation to a nonresident alien individual in a general successor transaction, then derived basis of the partnership transfers from the seller covered shareholder to the deemed covered shareholder under this paragraph (c). Moreover, if the individual subsequently sells the partnership interest to a covered shareholder, then derived basis of the partnership (adjusted consistent with the section 961 regulations, including to reflect distributions from the foreign corporation to the individual) transfers from the deemed covered shareholder to the buyer covered shareholder under this paragraph (c).
(ii) Treatment as controlled foreign corporation stock. Solely for purposes of determining section 961(c) basis that transfers to or from the deemed covered shareholder under this paragraph (c), any foreign corporation in which the deemed covered shareholder is treated as owning stock is treated as a controlled foreign corporation (to the extent the foreign corporation is not otherwise a controlled foreign corporation). Thus, for example, if a covered shareholder sells stock of an upper-tier foreign corporation that directly owns stock of a lower-tier foreign corporation to a nonresident alien individual in a general successor transaction, the upper-tier foreign corporation's shares of stock in the lower-tier foreign corporation remain section 961(c) ownership units and section 961(c) basis of the upper-tier foreign corporation transfers from the seller covered shareholder to the deemed covered shareholder under this paragraph (c) even if the upper-tier foreign corporation ceases to be a controlled foreign corporation as a result of the sale. Consequently, if the individual subsequently sells the stock of the upper-tier foreign corporation to a covered shareholder and, as a result, the upper-tier foreign corporation becomes a controlled foreign corporation, then section 961(c) basis of the upper-tier foreign corporation (adjusted consistent with the section 961 regulations, including to reflect distributions from the lower-tier foreign corporation to the upper-tier foreign corporation) transfers from the deemed covered shareholder to the buyer covered shareholder under this paragraph (c).
(iii) Determining basis that transfers from the deemed covered shareholder. In a transaction in which basis of a derivative ownership unit or section 961(c) ownership unit transfers from the deemed covered shareholder to a covered shareholder, the covered shareholder must use a reasonable method in determining the amount of transferred basis. Such method must take into account adjustments to basis with respect to the deemed covered shareholder that would have been made under the section 961 regulations if the basis were with respect to a covered shareholder during the time that it was with respect to the deemed covered shareholder.
(d) Coordination of successor derived basis with section 743(b). For purposes of a basis adjustment under section 743(b) with respect to a derivative ownership unit directly owned by an acquired partnership, the amount of any basis adjustment with respect to the successor covered shareholder to the acquired partnership's assets is calculated under § 1.743-1(d) and allocated under § 1.755-1(b) by including any derived basis in the basis of the derivative ownership unit that is transferred to the successor covered shareholder under paragraph (c)(2) of this section for purposes of gain and loss calculations and basis allocations under those provisions.