Section 430 specifies the minimum funding requirements that apply to single-employer plans (except for CSEC plans under § 414(y)) pursuant to § 412. Section 430(h)(2) specifies the interest rates that must be used to determine a plan’s target normal cost and funding target. Under this provision, present value is generally determined using three 24-month average interest rates (“segment rates”), each of which applies to cash flows during specified periods. To the extent provided under § 430(h)(2)(C)(iv), these segment rates are adjusted by the applicable percentage of the 25-year average segment rates for the period ending September 30 of the year preceding the calendar year in which the plan year begins.¹ However, an election may be made under § 430(h)(2)(D)(ii) to use the monthly yield curve in place of the segment rates.

Notice 2007-81, 2007-44 I.R.B. 899, provides guidelines for determining the monthly corporate bond yield curve, and the 24-month average corporate bond segment rates used to compute the target normal cost and the funding target. Consistent with the methodology specified in Notice 2007-81, the monthly corporate bond yield curve derived from October 2022 data is in Table 2022-10 at the end of this notice. The spot first, second, and third segment rates for the month of October 2022 are, respectively, 5.10, 5.83, and 5.68.

The 24-month average segment rates determined under § 430(h)(2)(C)(i) through (iii) must be adjusted pursuant to § 430(h)(2)(C)(iv) to be within the applicable minimum and maximum percentages of the corresponding 25-year average segment rates. The 25-year average segment rates for plan years beginning in 2021, 2022 and 2023 were published in Notice 2020-72, 2020-40 I.R.B. 789, Notice 2021-54, 2021-41 I.R.B. 457, and Notice 2022-40, 2022-40 I.R.B. 266, respectively.

The three 24-month average corporate bond segment rates applicable for November 2022 without adjustment for the 25-year average segment rate limits are as follows:

 

Section 9706(a) of the American Rescue Plan Act of 2021, Pub. L. 117-2 (the ARP), which was enacted on March 11, 2021, changed the 25-year average segment rates and the applicable minimum and maximum percentages used under § 430(h)(2)(C)(iv) of the Code to adjust the 24-month average segment rates.² Prior to this change, the applicable minimum and maximum percentages were 85% and 115% for a plan year beginning in 2021, and 80% and 120% for a plan year beginning in 2022, respectively. After this change, the applicable minimum and maximum percentages are 95% and 105% for a plan year beginning in 2021 or 2022. In addition, pursuant to this change, any 25-year average segment rate that is less than 5% is deemed to be 5%.³

Pursuant to § 9706(c)(1) of the ARP, these changes apply with respect to plan years beginning on or after January 1, 2020. However, § 9706(c)(2) of the ARP provides that a plan sponsor may elect not to have these changes apply to any plan year beginning before January 1, 2022.⁴

The adjusted 24-month average segment rates set forth in the chart below reflect § 430(h)(2)(C)(iv) of the Code as amended by § 9706(a) of the ARP. These adjusted 24-month average segment rates apply only for plan years for which an election under § 9706(c)(2) of the ARP is not in effect. For a plan year for which such an election does not apply, the 24-month averages applicable for November 2022, adjusted to be within the applicable minimum and maximum percentages of the corresponding 25-year average segment rates in accordance with § 430(h)(2)(C)(iv) of the Code, are as follows:

 

The adjusted 24-month average segment rates set forth in the chart below do not reflect the changes to § 430(h)(2)(C)(iv) of the Code made by § 9706(a) of the ARP. These adjusted 24-month average segment rates apply only for plan years for which an election under § 9706(c)(2) of the ARP is in effect. For a plan year for which such an election applies, the 24-month averages applicable for November 2022, adjusted to be within the applicable minimum and maximum percentages of the corresponding 25-year average segment rates in accordance with § 430(h)(2)(C)(iv) of the Code, are as follows:

Section 431 specifies the minimum funding requirements that apply to multiemployer plans pursuant to § 412. Section 431(c)(6)(B) specifies a minimum amount for the full-funding limitation described in § 431(c)(6)(A), based on the plan’s current liability. Section 431(c)(6)(E)(ii)(I) provides that the interest rate used to calculate current liability for this purpose must be no more than 5 percent above and no more than 10 percent below the weighted average of the rates of interest on 30-year Treasury securities during the four-year period ending on the last day before the beginning of the plan year. Notice 88-73, 1988-2 C.B. 383, provides guidelines for determining the weighted average interest rate. The rate of interest on 30-year Treasury securities for October 2022 is 4.02 percent. The Service determined this rate as the average of the daily determinations of yield on the 30-year Treasury bond maturing in August 2052. For plan years beginning in November 2022, the weighted average of the rates of interest on 30-year Treasury securities and the permissible range of rate used to calculate current liability are as follows:

In general, the applicable interest rates under § 417(e)(3)(D) are segment rates computed without regard to a 24-month average. Notice 2007-81 provides guidelines for determining the minimum present value segment rates. Pursuant to that notice, the minimum present value segment rates determined for October 2022 are as follows:

The principal author of this notice is Tom Morgan of the Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes). However, other personnel from the IRS participated in the development of this guidance. For further information regarding this notice, contact Mr. Morgan at 202-317-6700 or Tony Montanaro at 626-927-1475 (not toll-free calls).

 

¹ Pursuant to § 433(h)(3)(A), the third segment rate determined under § 430(h)(2)(C) is used to determine the current liability of a CSEC plan (which is used to calculate the minimum amount of the full funding limitation under § 433(c)(7)(C)).

² Section 80602 of the Infrastructure Investment and Jobs Act, Pub. L. 117-58, makes further changes to the time periods for which specified applicable minimum and maximum percentages apply.

³ Pursuant to this change, the 25-year averages of the first segment rate for 2021 and 2022 are increased to 5.00% because those 25-year averages as originally published are below 5.00%.

⁴ This election may be made either for all purposes for which the amendments under § 9706 of the ARP apply or solely for purposes of determining the adjusted funding target attainment percentage under § 436 of the Code for the plan year.

On December 17, 2019, the Treasury Department and the IRS published proposed regulations (REG-105495-19) addressing changes made by the Tax Cuts and Jobs Act (Pub. L. 115-97, 131 Stat. 2054 (2017)) (the “TCJA”) and other related foreign tax credit rules in the Federal Register (84 FR 69124) (the “2019 Foreign Tax Credit (“FTC”) proposed regulations”). Correcting amendments to the 2019 FTC proposed regulations were published in the Federal Register on May 15, 2020 (85 FR 29368). The 2019 FTC proposed regulations were finalized as part of TD 9922, published in the Federal Register (85 FR 71998) on November 12, 2020 (the “2020 FTC final regulations”). On the same date, the Treasury Department and the IRS published proposed regulations (REG-101657-20) in the Federal Register (85 FR 72078) (the “2020 FTC proposed regulations”). The 2020 FTC proposed regulations addressed changes made by the TCJA and other foreign tax credit issues. Correcting amendments to the 2020 FTC final regulations were published in the Federal Register on October 1, 2021 (86 FR 54367). A public hearing on the 2020 FTC proposed regulations was held on April 7, 2021. The 2020 FTC proposed regulations were finalized in TD 9959, published in the Federal Register (87 FR 276) on January 4, 2022 (the “2022 FTC final regulations”). Correcting amendments to the 2022 FTC final regulations were published in the Federal Register on July 27, 2022 (87 FR 45018 and 87 FR 45021).

This document contains proposed regulations (the “proposed regulations”) addressing the following issues: (1) the definition of a reattribution asset for purposes of allocating and apportioning foreign income taxes; (2) the application of the cost recovery requirement; and (3) the application of the source-based attribution requirement to withholding taxes on certain royalty payments.

The Treasury Department and the IRS intend to make conforming amendments to other regulations, including the cost recovery rules that are not being revised in these proposed regulations and the examples in §§1.901-2(b)(4)(iv) and 1.903-1(d), upon finalization of the proposed regulations.

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules, and specifically on the issues identified in Parts I.B and II.C.3 of the Explanation of Provisions. All comments will be available at www.regulations.gov or upon request.

A public hearing will be scheduled if requested in writing by any person that timely submits written comments. Requests for a public hearing are encouraged to be made electronically. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register. Announcement 2020-4, 2020-17 IRB 1, provides that until further notice, public hearings conducted by the IRS will be held telephonically. Any telephonic hearing will be made accessible to people with disabilities.

The principal authors of the proposed regulations are Jeffrey L. Parry, Teisha M. Ruggiero, and Suzanne M. Walsh of the Office of Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Accordingly, the Treasury Department and IRS propose to amend 26 CFR part 1 as follows:

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.861-20 is amended by revising paragraphs (d)(3)(v)(E)(6) and (i) to read as follows:

§1.861-20 Allocation and apportionment of foreign income taxes.

* * * * *

(d) * * *

(3) * * *

(v) * * *

(E) * * *

(6) Reattribution asset. The term reattribution asset means an asset that produces one or more items of gross income, computed under Federal income tax law, to which a disregarded payment, other than a disregarded payment received in exchange for property, is allocated under the rules of paragraph (d)(3)(v)(B)(2) of this section.

* * * * *

(i) Applicability dates. (1) Except as provided in paragraphs (i)(2) through (4) of this section, this section applies to taxable years beginning after December 31, 2019.

(2) Paragraphs (b)(19) and (23) and (d)(3)(i), (ii), and (v) of this section apply to taxable years that begin after December 31, 2019, and end on or after November 2, 2020.

(3) Paragraph (d)(3)(v)(E)(6) of this section applies to taxable years that end on or after [date the final rule is filed with the Federal Register]. Taxpayers may choose to apply the rules in paragraph (d)(3)(v)(E)(6) of this section to taxable years beginning after December 31, 2019, and ending before [date the final rule is filed with the Federal Register], provided they apply paragraph (d)(3)(v)(E)(6) of this section consistently to their first taxable year beginning after December 31, 2019, and any subsequent taxable year beginning before [date the final rule is filed with the Federal Register]. Otherwise, for taxable years beginning after December 31, 2019, and ending before [date the final rule is filed with the Federal Register], see §1.861-20(d)(3)(v)(E)(6) as contained in 26 CFR part 1 revised as of July 27, 2022.

(4) Paragraph (h) of this section applies to taxable years beginning after December 28, 2021.

Par 3. Section 1.901-2 is amended:

The revisions and additions read as follows:

§ 1.901-2 Income, war profits, or excess profits tax paid or accrued.

* * * * *

(b) * * *

(4) * * *

(i) * * *

(A) In general. A foreign tax satisfies the cost recovery requirement if the base of the tax is computed by reducing gross receipts (as described in paragraph (b)(3) of this section) to permit recovery of substantially all of each item of significant cost or expense (including each item of cost or expense related to the categories described in paragraph (b)(4)(i)(B)(2) of this section) attributable, under reasonable principles, to such gross receipts. See paragraph (b)(4)(i)(B) of this section for rules regarding the determination of what is a significant cost or expense, paragraph (b)(4)(i)(C) of this section for rules regarding the recovery of substantially all of an item, paragraph (b)(4)(i)(E) of this section for rules regarding principles for attributing costs and expenses to gross receipts, and paragraph (b)(4)(i)(F) of this section for exceptions to this rule. A foreign tax need not permit recovery of significant costs and expenses, such as certain personal expenses, that are not attributable, under reasonable principles, to gross receipts included in the foreign tax base. A foreign tax whose base is gross receipts, with no reduction for costs and expenses, satisfies the cost recovery requirement only if there are no significant costs and expenses described in paragraph (b)(4)(i)(B) of this section attributable to the gross receipts included in the foreign tax base. See paragraph (b)(4)(iv)(A) of this section (Example 1). A foreign tax that provides an alternative cost allowance satisfies the cost recovery requirement only as provided in paragraph (b)(4)(i)(G) of this section.

(B) Significant costs and expenses—(1) In general. Except as provided in paragraph (b)(4)(i)(B)(2) of this section, whether an item of cost or expense is significant for purposes of this paragraph (b)(4)(i) is determined based on whether, for all taxpayers in the aggregate to which the foreign tax applies, the item of cost or expense constitutes a significant portion of the taxpayers’ total costs and expenses.

(2) Per se significant costs and expenses. An item of cost or expense (as characterized under foreign law) related to capital expenditures, interest, rents, royalties, wages or other payments for services, and research and experimentation is always treated as an item of significant cost or expense for purposes of this paragraph (b)(4)(i).

(C) Recovery of substantially all of each item—(1) In general. Whether a foreign tax permits recovery of substantially all of each item of significant cost or expense is determined based solely on the terms of the foreign tax law.

(2) Safe harbor. One or more disallowances of a stated portion of an item (or multiple items) of significant cost or expense does not prevent a foreign tax from being considered to permit recovery of substantially all of each item of significant cost or expense if the total portion of the item (or items) that is disallowed does not exceed 25 percent. A limitation that caps the recovery of an item of significant cost or expense, or multiple items of cost or expense that relate to a single category of significant costs and expenses described in paragraph (b)(4)(i)(B)(2) of this section does not prevent a foreign tax from being considered to permit recovery of substantially all of each item of significant cost or expense if the limitation is a qualifying cap. For such purpose, a limitation that caps the recovery at a stated portion of gross receipts, gross income, or a similar measure is a qualifying cap if the stated portion of such measure is not less than 15 percent. A limitation that caps the recovery at a stated portion of taxable income (determined without regard to the item at issue) or a similar measure is a qualifying cap if the stated portion of such measure is not less than 30 percent.

(3) Non-recovery of significant costs and expenses. Significant costs and expenses (such as interest expense) are not considered to be recovered by reason of the time value of money attributable to the acceleration of a tax benefit or economic benefit attributable to the timing of the recovery of other costs and expenses (such as the current expensing of debt-financed capital expenditures).

(D) * * * A foreign tax law permits recovery of substantially all of each item of significant cost or expense even if such item of cost or expense is recovered earlier or later than it is recovered under the Internal Revenue Code unless the time of recovery is so much later as effectively to constitute a denial of such recovery. * * *

* * * * *

(F) Exceptions—(1) Disallowances consistent with U.S. principles. Notwithstanding paragraph (b)(4)(i)(A) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if such disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code, including the principles of limiting base erosion or profit shifting and addressing non-tax public policy concerns similar to those reflected in the Internal Revenue Code. For example, a foreign tax may satisfy the cost recovery requirement even if the foreign tax law disallows deductions in connection with hybrid transactions, disallows deductions attributable to gross receipts that in whole or in part are excluded, exempt or eliminated from taxable income, or disallows certain deductions consistent with non-tax public policy considerations similar to those underlying the disallowances contained in section 162. See paragraphs (b)(4)(iv)(I) and (J) of this section (Examples 9 and 10).

(2) Amounts that need not be recovered. A foreign tax law may satisfy the cost recovery requirement even if the foreign tax law does not permit recovery of costs and expenses attributable to wage income or to investment income that is not derived from a trade or business. In addition, in determining whether a foreign tax (the “tested foreign tax”) meets the cost recovery requirement, it is immaterial whether the tested foreign tax allows a deduction for other taxes that would qualify as foreign income taxes (determined without regard to whether such other tax allows a deduction for the tested foreign tax). See paragraphs (b)(4)(iv)(D) and (E) of this section (Examples 4 and 5).

* * * * *

(iv) * * *

(F) Example 6: Substantially all; application of the safe harbor—(1) Facts. Country X imposes a tax (“Country X tax”) on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that Country X tax law disallows a deduction for 25 percent of a taxpayer’s costs and expenses for royalties related to patents.

(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, an item of cost or expense related to royalties is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to royalties, including the item of royalties related to patents. The stated percentage of costs and expenses from royalties related to patents (25 percent) that is disallowed under Country X tax law does not exceed 25 percent. Accordingly, under the safe harbor in paragraph (b)(4)(i)(C)(2) of this section, the disallowance does not prevent the Country X tax from being considered to permit recovery of substantially all of each item of cost or expense related to royalties, and therefore the Country X tax satisfies the cost recovery requirement.

(G) Example 7: Substantially all; application of the safe harbor—(1) Facts. Country X imposes a tax (“Country X tax”) on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that Country X tax law disallows a deduction for 15 percent of a taxpayer’s costs and expenses for rents and 25 percent of a taxpayer’s costs and expenses for interest.

(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, an item of cost or expense related to rents or interest is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to royalties and interest. The stated percentage of the costs and expenses related to rents (15 percent) that is disallowed under Country X tax law does not exceed 25 percent. Additionally, the stated percentage of the costs and expenses related to interest (25 percent) that is disallowed under Country X law does not exceed 25 percent. Accordingly, under the safe harbor in paragraph (b)(4)(i)(C)(2) of this section, the disallowances do not prevent the Country X tax from being considered to permit recovery of substantially all of each item of cost or expense related to rents and interest, and therefore the Country X tax satisfies the cost recovery requirement.

(H) Example 8: Substantially all; application of the safe harbor—(1) Facts. Country X imposes a tax (“Country X tax”) on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that Country X tax law caps the recovery of the deduction of interest at 30 percent of the taxpayer’s taxable income determined without regard to interest expense.

(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, an item of cost or expense related to interest is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to interest. The stated cap on recovery in Country X tax law with respect to interest (30 percent of taxable income determined without regard to interest expense) is not less than 30 percent of taxable income determined without regard to interest expense. Additionally, the cap on recovery relates to a single category of significant costs and expenses described in paragraph (b)(4)(i)(B)(2) of this section. Accordingly, under the safe harbor in paragraph (b)(4)(i)(C)(2) of this section, the disallowance does not prevent the Country X tax from being considered to permit recovery of substantially all of each item of cost or expense related to interest, and therefore the Country X tax satisfies the cost recovery requirement.

(I) Example 9: Permissible disallowance based on U.S. principles—(1) Facts. Country X imposes a tax on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable under reasonable principles to the gross receipts included in the Country X tax base, except that under Country X’s anti-hybrid rules, a deduction is disallowed for any payment, including interest, royalties, rents, or payments for services, made by a Country X resident to a related entity located outside of Country X if the payment is not included in gross income by the payee or the payee is not subject to tax.

(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, each item of cost or expense related to interest, rents, royalties, and payments for services is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to interest, rents, royalties, and payments for services. Country X tax law does not permit recovery of any portion of any item of significant cost or expense that is subject to the anti-hybrid rules. As a result, the safe harbor in paragraph (b)(4)(i)(C)(2) of this section does not apply to such item. Further, because a deduction is disallowed for any item of cost or expense that is subject to the Country X anti-hybrid rules, the Country X tax law completely disallows certain items of cost and expense related to interest, rents, royalties, and payments for services and thus does not permit recovery of substantially all of each item of significant cost or expense related to interest, rents, royalties, and payments for services. However, under paragraph (b)(4)(i)(F)(1) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if the disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code. The income tax provisions of the Internal Revenue Code, specifically section 267A, contain disallowances of deductions based on the principle of limiting base erosion or profit shifting. Country X’s disallowance of deductions for any payment, including interest, royalties, rents, or payments for services also reflects the principle of limiting base erosion or profit shifting. Accordingly, because Country X’s anti-hybrid rules are consistent with the principle of limiting base erosion or profit shifting, the Country X tax satisfies the cost recovery requirement.

(J) Example 10: Permissible disallowance based on U.S. principles—(1) Facts. Country X imposes a tax on the income of corporations that are resident in Country X. Under Country X tax law, full deductions are allowed for each item of significant cost or expense attributable to the gross receipts included in the Country X tax base, except that no deduction is permitted for any stock-based payments for services.

(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, each item of cost or expense related to wages or other payments for services is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to wages or other payments for services. Country X tax law denies a deduction for any stock-based payments for services, and therefore the safe harbor in paragraph (b)(4)(i)(C)(2) of this section is not satisfied. Further, given that no deduction is allowed for stock-based payments for services, the Country X tax law completely disallows an item of cost or expense related to wages or other payments for services and thus does not permit recovery of substantially all of each item of significant cost or expense related to wages or other payments for services. However, under paragraph (b)(4)(i)(F)(1) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if such disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code. The income tax provisions of the Internal Revenue Code contain targeted disallowances or limits on the deductibility of certain items of compensation in particular circumstances based on non-tax public policy reasons, including to influence the amount or use of a certain type of compensation in the labor market. For example, section 162(m) imposes limits on deductions for compensation of certain highly-paid employees, and section 280G limits the deductibility of certain “parachute payments” provided to individuals when an entity undergoes a change of control. Country X’s targeted disallowance of deductions for the portion of payments for services attributable to stock-based compensation also reflects a principle of influencing the amount or use of a certain type of compensation (stock-based compensation) in the labor market. Accordingly, because the Country X tax law’s disallowance is consistent with a principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code, the Country X tax satisfies the cost recovery requirement.

(5) * * *

(i) * * *

(B) * * *

(2) Royalties. Under the foreign tax law, gross income from royalties must be sourced based on the place of use of, or the right to use, the intangible property, as determined under reasonable principles (which do not include determining the place of use of, or the right to use, the intangible property based on the location of the payor).

* * * * *

(d) * * *

(1) * * *

(iii) Tax imposed on nonresidents—(A) In general. A foreign levy imposed on nonresidents is always treated as a separate levy from that imposed on residents, even if the base of the tax as applied to residents and nonresidents is the same, and even if the levies are treated as a single levy under foreign tax law.

(B) Withholding tax—(1) In general. Except as otherwise provided in this paragraph (d)(1)(iii)(B), a withholding tax (as defined in section 901(k)(1)(B)) that is imposed on a payment giving rise to gross income of nonresidents is treated as a separate levy as to each separate class of income described in section 61 (for example, interest, dividends, rents, or royalties) subject to the withholding tax.

(2) Subsets of income. If two or more subsets of a separate class of income are subject to a withholding tax based on different income attribution rules (for example, if technical services are subject to tax based on the residence of the payor and other services are subject to tax based on where the services are performed), separate levies are considered to be imposed with respect to each subset of that separate class of income.

(3) Royalty income. A withholding tax that is imposed on a payment giving rise to gross royalty income of a nonresident that is made pursuant to a single-country license (as determined under §1.903-1(c)(2)(iv)) is treated as a separate levy from a withholding tax that is imposed on other gross royalty income of such nonresident and is also treated as a separate levy from any withholding tax imposed on other nonresidents.

* * * * *

(h) Applicability dates—(1) In general. Except as provided in paragraphs (h)(2) and (3) of this section, this section applies to foreign taxes paid (within the meaning of paragraph (g) of this section) in taxable years beginning on or after December 28, 2021. For foreign taxes that relate to (and if creditable are considered to accrue in) taxable years beginning before December 28, 2021, and that are remitted in taxable years beginning on or after December 28, 2021, by a taxpayer that accounts for foreign income taxes on the accrual basis, see §1.901-2 as contained in 26 CFR part 1 revised as of April 1, 2021.

(2) Certain foreign taxes paid to Puerto Rico. For foreign taxes paid to Puerto Rico by reason of section 1035.05 of the Puerto Rico Internal Revenue Code of 2011, as amended (13 L.P.R.A. 30155) (treating certain income, gain or loss as effectively connected with the active conduct of a trade or business with Puerto Rico), this section applies to foreign taxes paid (within the meaning of paragraph (g) of this section) in taxable years beginning on or after January 1, 2023. For foreign taxes described in the preceding sentence that are paid in taxable years beginning before January 1, 2023, see §1.901-2 as contained in 26 CFR part 1 revised as of April 1, 2021.

(3) Modifications to cost recovery and royalty attribution rules. Paragraphs (b)(4)(i) and (iv), (b)(5)(i)(B)(2), and (d)(1)(iii) of this section apply to foreign taxes paid (within the meaning of paragraph (g) of this section) in taxable years ending on or after November 18, 2022. For foreign taxes described in the preceding sentence that are paid in taxable years ending before November 18, 2022, see §1.901-2(b)(4)(i) and (iv), (b)(5)(i)(B)(2), and (d)(1)(iii) as contained in 26 CFR part 1 revised as of July 27, 2022. Taxpayers may choose to apply the rules in paragraphs (b)(4)(i) and (iv) of this section to foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022 provided that they consistently apply those rules to such taxable years. Additionally, taxpayers may choose to apply the rules of paragraphs (b)(5)(i)(B)(2) and (d)(1)(iii) of this section to foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022, provided that they consistently apply those rules and the rules of §1.903-1(c)(2) and (d)(3), (4), and (8) through (11) to such taxable years.

* * * * *

Par 4. Section 1.903-1 is amended:

The revisions and additions read as follows:

§ 1.903-1 Taxes in lieu of income taxes.

* * * * *

(c) * * *

(2) Covered withholding tax. A tested foreign tax is a covered withholding tax if, based on the foreign tax law (except as provided in paragraph (c)(2)(iii)(B) of this section), the requirements in paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are met with respect to the tested foreign tax. See also §1.901-2(d)(1)(iii) for rules treating withholding taxes as separate levies with respect to each class of income subject to the tax, with respect to each subset of a class of income that is subject to different income attribution rules, or with respect to withholding tax that is imposed on a payment giving rise to gross royalty income of a nonresident that is made pursuant to a single-country license (as determined under paragraph (c)(2)(iv) of this section).

* * * * *

(iii) Source-based attribution requirement. The income subject to the tested foreign tax satisfies the requirements in paragraph (c)(2)(iii)(A) or (B) of this section.

(A) The income subject to the tested foreign tax satisfies the attribution requirement described in §1.901-2(b)(5)(i)(B).

(B) The income subject to the tested foreign tax is characterized as royalty income and the payment giving rise to such income is made pursuant to a single-country license as determined under paragraph (c)(2)(iv) of this section. For purposes of this paragraph (c)(2)(iii)(B) and paragraph (c)(2)(iv) of this section, whether the income is characterized as royalty income is determined under the foreign tax law, except that income from the sale of a copyrighted article (as determined under rules similar to §1.861-18) is not characterized as royalty income regardless of the characterization of the income under the foreign tax law.

(iv) Single-country license—(A) In general. Except as otherwise provided in this paragraph (c)(2)(iv), for purposes of paragraph (c)(2)(iii)(B) of this section, a payment is made pursuant to a single-country license if the terms of the license agreement pursuant to which the payment is made characterize the payment as a royalty and limit the territory of the license to the foreign country imposing the tested foreign tax.

(B) Separately stated portions. If a written agreement that is not described in paragraph (c)(2)(iv)(A) of this section separately states a portion (whether as a specified amount or as a formula) of the payment subject to the tested foreign tax and such portion is both characterized as a royalty under the terms of the agreement and is attributable to the part of the territory of the license that is solely within the foreign country imposing the tested foreign tax, then that portion of the payment is treated as made pursuant to a single-country license.

(C) Validity of agreement. A payment is considered not made pursuant to a single-country license if the taxpayer knows, or has reason to know, that the terms of the agreement pursuant to which the payment is made misstate the territory in which the relevant intangible property is used or overstate the amount of the royalty with respect to the part of the territory of the license that is solely within the foreign country imposing the tested foreign tax. A taxpayer is considered to have reason to know if its knowledge of relevant of facts or circumstances is such that a reasonably prudent person in the position of the taxpayer would question whether the terms of the agreement misstate the territory in which the relevant intangible property is used or overstate the amount of a royalty. For purposes of this section, the principles of sections 482 and 861 apply to determine whether the terms of the agreement misstate the territory in which the relevant intangible property is used or overstate the amount of a royalty. See paragraph (d)(11) of this section (Example 11).

(D) Documentation. A taxpayer must provide the agreement described in paragraph (c)(2)(iv)(A) or (B) of this section, as applicable (the “required agreement”), within 30 days of a request by the Commissioner or another period as agreed between the Commissioner and the taxpayer. Except as provided in the next sentence, the required agreement pursuant to which the royalty is paid must be executed no later than the date of payment that gives rise to the gross royalty income that is subject to the tested foreign tax. In the case of a royalty that is paid before the date on which the required agreement is executed, in order to meet the requirement of this paragraph (c)(2)(iv)(D), the required agreement must be executed no later than May 17, 2023, and the agreement must state that royalties paid on or before the date of execution of the agreement are, for purposes of this paragraph (c)(2)(iv), considered paid pursuant to the terms of the agreement.

(d) * * *

(3) Example 3: Withholding tax on royalties; attribution requirement—(i) Facts. YCo, a resident of Country Y, is a controlled foreign corporation wholly owned by USP, a domestic corporation. In Year 1, YCo enters into a written license agreement (the “Agreement”) with XCo, a resident of Country X unrelated to YCo or USP, for the right to use YCo’s intangible property (“IP”) in a territory defined by the Agreement as the entire world, including Country X, in exchange for payments that the terms of the Agreement characterize as royalties. The payments made by XCo to YCo under the Agreement are also characterized as royalties under the laws of Country X. Under Country X’s tax law, all gross royalty payments made by a Country X resident to a nonresident are treated as giving rise to Country X source income and are subject to a 20 percent withholding tax, regardless of whether the nonresident payee has a taxable presence in Country X. Country X has a generally-imposed net income tax within the meaning of paragraph (c)(1)(i) of this section, and nonresidents subject to the withholding tax on royalties are not also subject to a Country X net income tax on their royalty income. In Year 1, XCo withholds 20u (units of Country X currency) of tax on a 100u royalty paid to YCo under the Agreement.

(ii) Analysis—(A) Separate levy. Under §1.901-2(d)(1)(iii)(B)(1), Country X’s withholding tax imposed on gross royalty income of nonresidents is treated as a separate levy. Under §1.901-2(d)(1)(iii)(B)(3), the 20u of Country X withholding tax imposed on the 100u of royalties paid by XCo to YCo is treated as a separate levy from the Country X withholding tax on royalties if the Agreement pursuant to which the royalties are paid is a single-country license under paragraph (c)(2)(iv) of this section. The Agreement does not meet the requirements of paragraph (c)(2)(iv) of this section because it neither limits the territory of the license to Country X nor separately states the portion of the payment that is with respect to the part of the territory of the license that is solely within Country X. Thus, the 20u of Country X withholding tax paid by YCo is not treated as a separate levy under §1.901-2(d)(1)(iii)(B)(3).

(B) Covered withholding tax. Under paragraph (c)(2) of this section, a tested foreign tax is a covered withholding tax if paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are met. Country X’s withholding tax on royalties meets the requirements of paragraphs (c)(1)(i) and (c)(2)(i) and (ii) of this section because Country X has a generally-imposed net income tax, Country X’s withholding tax on the royalties paid pursuant to the Agreement is imposed on the gross royalty income of persons who are nonresidents of Country X, and nonresidents subject to the withholding tax on royalties are not also subject to the Country X generally-imposed net income tax on their royalty income. However, the Country X withholding tax on royalties paid pursuant to the Agreement does not meet the requirements of §1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X’s sourcing rule for royalties (based on residence of the payor) is not based on the place of use of, or the right to use, the intangible property. Additionally, the payment that is subject to Country X’s withholding tax is not made pursuant to a single-country license under paragraph (c)(2)(iv) of this section for the reasons described in paragraph (d)(3)(ii)(A) of this section (the separate levy analysis of this paragraph (d)(3) (Example 3)). Therefore, the requirement in paragraph (c)(2)(iii)(B) of this section is not met. Accordingly, the Country X withholding tax paid by YCo is not a covered withholding tax, and none of the 20u Country X withholding tax paid by YCo with respect to the 100u royalty payment made to XCo is a foreign income tax.

* * * * *

(8) Example 8: Withholding tax on royalties; single-country license—(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3) except that in Year 1, YCo enters into a written license agreement (the “Agreement”) with XCo for the right to use YCo’s IP in a territory defined by the Agreement as Country X, in exchange for payments that the terms of the Agreement characterize as royalties, and XCo in fact only uses the IP in Country X. In Year 1, XCo withholds 20u of tax from 100u of royalties paid to YCo under the Agreement.

(ii) Analysis—(A) Separate levy. Under §1.901-2(d)(1)(iii)(B)(1), Country X’s withholding tax imposed on gross royalty income of nonresidents is treated as a separate levy. Under §1.901-2(d)(1)(iii)(B)(3), the 20u of Country X withholding tax imposed on the 100u of royalties paid by XCo to YCo is treated as a separate levy from the Country X withholding tax on royalties if the Agreement pursuant to which the royalties are paid is a single-country license under paragraph (c)(2)(iv) of this section. The Agreement meets the requirements of paragraph (c)(2)(iv)(A) of this section because it is a written license agreement that characterizes the payment as a royalty and limits the territory of the license to Country X. Thus, the 20u Country X withholding tax paid by YCo is treated as a separate levy under §1.901-2(d)(1)(iii)(B)(3).

(B) Covered withholding tax. Under paragraph (c)(2) of this section, a tested foreign tax is a covered withholding tax if paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are met. Country X has a generally-imposed net income tax, Country X’s withholding tax on the royalties paid pursuant to the Agreement is a withholding tax that is imposed on the gross income of persons who are nonresidents of Country X, and nonresidents subject to the withholding tax on royalties paid pursuant to the Agreement are not also subject to a net income tax on their royalty income. Thus, the requirements of paragraphs (c)(1)(i) and (c)(2)(i) and (ii) of this section are met. The withholding tax paid by YCo does not meet the requirements of §1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X’s source rule for royalties (based on residence of the payor) is not based on the place of use of, or the right to use, the intangible property. However, the payment that is subject to Country X’s withholding tax is made pursuant to a single-country license under paragraph (c)(2)(iv) of this section for the reasons described in paragraph (d)(8)(ii)(A) of this section (the separate levy analysis of this Example 8). Therefore, the requirement in paragraph (c)(2)(iii)(B) of this section is met. Accordingly, the Country X withholding tax on the payment made by XCo to YCo pursuant to the Agreement is a covered withholding tax and all of the 20u of Country X withholding tax paid by YCo with respect to the 100u of royalties under the Agreement is a foreign income tax.

(9) Example 9: Withholding tax on royalties; separately stated portion—(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3) except that in Year 1, YCo enters into a written agreement (the “Agreement”) with XCo for the right to use YCo’s IP in a territory defined by the Agreement as the entire world, as well as for YCo to provide certain services to XCo in Country Y, in exchange for a payment equal to 10 percent of XCo’s annual revenue. The Agreement provides a formula for determining the amount of the payment that is characterized as a royalty and that is with respect to the part of the territory that is within Country X (the “separately stated formula”). The separately stated formula provides that the first 30u of the payment represents payment for services provided by YCo, and that 40 percent of the remainder of the payment represents payment of a royalty with respect to the part of the territory of the license that is solely within Country X. The portion of the payment by XCo to YCo that is characterized as services income under the Agreement is also characterized as services income under the laws of Country X. Additionally, all payments by a resident of Country X for services provided by a nonresident are treated as giving rise to Country X source income, regardless of where the services are performed, and gross income from services is subject to the same 20 percent withholding tax as gross royalty income. In Year 1, XCo earns gross income of 1,800u and pays YCo 180u under the Agreement. XCo withholds 12u of tax from the 60u of royalties attributable to the part of the territory of the license that is solely within Country X that are paid to YCo under the separately stated formula in the Agreement. The portion of the payment by XCo to YCo that is characterized as a royalty with respect to the part of the territory of the license that is solely within Country X under the separately stated formula in the Agreement is also characterized as a royalty under the laws of Country X. XCo withholds 24u of tax from the remaining 120u payment paid to YCo under the Agreement, consisting of 6u of tax on the 30u payment for services and 18u of tax on 90u of royalties. YCo does not know, or have reason to know, that the terms of the Agreement misstate the territory in which YCo’s IP is used or overstate the amount of the royalty with respect to the part of the territory of the license that is solely within Country X.

(ii) Analysis—(A) Separately stated portion. The analysis is the same as in paragraph (d)(8)(ii) of this section (the analysis of Example 8), except that the portion of the payment that is a royalty with respect to the part of the territory of the license that is solely within Country X under the separately stated formula in the Agreement is treated as made pursuant to a single-country license under paragraph (c)(2)(iv) of this section because the Agreement is a written agreement that separately states the portion of the payment that is characterized as a royalty and that is with respect to the part of the territory of the license that is solely within Country X. Thus, the Country X withholding tax on the portion of the payment from XCo to YCo that is a payment of a royalty with respect to the part of the territory of the license that is solely within Country X under the separately stated formula under the Agreement is a separate levy and a covered withholding tax. Accordingly, the 12u Country X withholding tax paid by YCo from the 60u of royalties with respect to the part of the territory of the license that is solely within Country X is a foreign income tax.

(B) Remaining portion of royalties. The analysis is the same as paragraph (d)(3)(ii) of this section (the analysis of Example 3). Specifically, the 18u Country X withholding tax on the 90u royalty payment that is not with respect to the part of the territory that is within Country X is neither a separate levy nor a covered withholding tax. Accordingly, none of the 18u Country X withholding tax paid by YCo with respect to the remaining 90u royalty payment under the Agreement is a payment of foreign income tax.

(C) Services portion. Under §1.901-2(d)(1)(iii)(B)(1), Country X’s withholding tax imposed on gross services income of nonresidents is a separate levy. The Country X withholding tax of 6u on the 30u payment for services made by XCo to YCo under the Agreement is not a covered withholding tax. The withholding tax paid by YCo does not meet the requirements of §1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X’s sourcing rule for services (based on residence of the payor) is not reasonably similar to the sourcing rule that applies under the Internal Revenue Code (based on where the services are performed). The special separate levy and covered withholding tax rules for single-country licenses under §1.901-2(d)(1)(iii)(B)(3) and paragraph (c)(2)(iii)(B) of this section do not apply to withholding taxes on payments for services. Accordingly, none of the 6u of Country X withholding tax paid by YCo with respect to the 30u payment for services under the Agreement is a payment of foreign income tax.

(10) Example 10: Characterization of payment—(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3), except that in Year 1, YCo enters into a written license agreement (the “Agreement”) with XCo for the right to use YCo’s IP in a territory defined by the Agreement as Country X, in exchange for a payment that the terms of the Agreement characterize as a royalty, but that is characterized as a payment for services under the laws of Country X, and all payments of services paid by a resident of Country X to a nonresident are treated as giving rise to Country X source income, regardless of where the services are performed, and are subject to a 20 percent withholding tax.

(ii) Analysis. Under §1.901-2(d)(1)(iii)(B)(1), Country X’s withholding tax imposed on gross services income of nonresidents is a separate levy. The Country X withholding tax of 20u on the 100u payment for services made by XCo to YCo under the Agreement is not a covered withholding tax. The withholding tax paid by YCo does not meet the requirements of §1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X’s sourcing rule for services (based on residence of the payor) is not reasonably similar to the sourcing rule that applies under the Internal Revenue Code (based on where the services are performed). The special separate levy and covered withholding tax rules for single-country licenses under §1.901-2(d)(1)(iii)(B)(3) and paragraph (c)(2)(iii)(B) of this section do not apply to withholding taxes on income that is not characterized as royalty income under the foreign tax law. Accordingly, none of the 20u Country X withholding tax paid by YCo with respect to the 100u paid under the Agreement is a payment of foreign income tax.

(11) Example 11: Withholding tax on royalties, validity of agreement—(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3), except that XCo is a controlled foreign corporation wholly owned by USP. Additionally, in Year 2, XCo and YCo cancel the written license agreement entered into in Year 1 and YCo enters into two new written license agreements with XCo, one agreement which grants XCo the right to use certain YCo IP in a territory defined as Country X (the “Country X Agreement”), and one of which grants XCo the right to use the same YCo IP in a territory defined as the entire world except for Country X (the “Rest of World Agreement”). Both agreements characterize the payments under the agreements as royalties, and the payments are also characterized as royalties under the laws of Country X. In Year 2, XCo withholds a total of 20u of tax from a total of 100u of royalties paid to YCo under the Country X Agreement and the Rest of World Agreement. Based on the terms of each agreement, 18u of tax was withheld from 90u of royalties paid to YCo under the Country X Agreement, and 2u of tax from 10u of royalties paid to YCo under the Rest of World Agreement. YCo knew or had reason to know that under the principles of sections 482 and 861, with respect to the 100u of royalties paid by XCo to YCo, 40u is attributable to XCo’s use of YCo IP in Country X and 60u is attributable to use of YCo IP outside Country X.

(ii) Analysis—(A) Rest of World Agreement. The analysis is the same as paragraph (d)(3)(ii) of this section (the analysis of Example 3). Specifically, the 2u Country X withholding tax on the 10u royalty payment under the Rest of World Agreement is neither a separate levy nor a covered withholding tax. Accordingly, none of the 2u Country X withholding tax paid by YCo with respect to the 10u royalty payment under the Rest of World Agreement is a payment of foreign income tax.

(B) Country X Agreement. The analysis is the same as paragraph (d)(3)(ii) of this section (the analysis of Example 3), except that the reason that the Country X Agreement does not meet the requirements of paragraph (c)(2)(iv) of this section is that YCo knew or had reason to know that the terms of the Country X Agreement overstate the amount of the royalty with respect to Country X. Thus, the 18u Country X withholding tax on the 90u royalty payment under the Country X Agreement is neither a separate levy nor a covered withholding tax. Accordingly, none of the 18u Country X withholding tax paid by YCo with respect to the 90u royalty payment under the Country X Agreement is a payment of foreign income tax.

(e) Applicability dates—(1) In general. Except as provided in paragraphs (e)(2) and (3) of this section, this section applies to foreign taxes paid (within the meaning of §1.901-2(g)) in taxable years beginning on or after December 28, 2021. For foreign taxes that relate to (and if creditable are considered to accrue in) taxable years beginning before December 28, 2021, and that are remitted in taxable years beginning on or after December 28, 2021, by a taxpayer that accounts for foreign income taxes on the accrual basis, see §1.903-1 as contained in 26 CFR part 1 revised as of April 1, 2021.

(2) Certain foreign taxes paid to Puerto Rico. For foreign taxes paid to Puerto Rico under section 3070.01 of the Puerto Rico Internal Revenue Code of 2011, as amended (13 L.P.R.A. 31771) (imposing an excise tax on a controlled group member’s acquisition from another group member of certain personal property manufactured or produced in Puerto Rico and certain services performed in Puerto Rico), this section applies to foreign taxes paid (within the meaning of §1.901-2(g)) in taxable years beginning on or after January 1, 2023. For foreign taxes described in the preceding sentence that are paid in taxable years beginning before January 1, 2023, see §1.903-1 as contained in 26 CFR part 1 revised as of April 1, 2021.

(3) Modifications to the covered withholding tax rules. Paragraphs (c)(2) and (d)(3), (4), and (8) through (11) of this section apply to foreign taxes paid (within the meaning of §1.901-2(g)) in taxable years ending on or after November 18, 2022. For foreign taxes that are paid in taxable years ending before November 18, 2022, see §1.903-1(c)(2) and (d)(3) and (4) as contained in 26 CFR part 1 revised as of July 27, 2022. Taxpayers may choose to apply the rules in paragraphs (c)(2) and (d)(3), (4), and (8) through (11) of this section to foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022, provided that they consistently apply those rules and the rules of §1.901-2(b)(5)(i)(B)(2) and (d)(1)(iii) to such taxable years.

Melanie R. Krause,

Acting Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on November 18, 2022, 11:15 a.m., and published in the issue of the Federal Register for November 22, 2022, 87 F.R. 71271)

¹ The Treasury Department and the IRS received a petition for rulemaking with respect to the attribution requirement as applied to a tax on a resident but declined to engage in rulemaking on that subject. The Treasury Department and the IRS have determined that the attribution requirement as contained in the 2022 FTC final regulations, including as applied to residents, is appropriate to ensure that a foreign tax is consistent with the general principles of income taxation reflected in the Code. These principles include not only those related to determining realization, gross receipts, and cost recovery, but also principles for determining the scope of the items of gross receipts and costs that may be properly taken into account in computing the tax base on which the foreign tax is imposed.

² The estimated number of respondents in this Table 1 is based on the number of respondents from the 2020 tax year.

³ As explained in part II.C.3 of the Explanation of Provisions, the collection of information in proposed §1.903-1(c)(2)(iv)(D) also impacts partnerships and S corporations that pay a withholding tax that is imposed at the partnership or S corporation level under foreign law even though it is the partners or S corporation shareholder that claims the credit for those taxes. The Treasury Department and the IRS lack sufficient data to identify the number of partnerships and S corporations that pay foreign withholding taxes on royalty income. However, the IRS and Treasury Department do not expect that this will impact the number of affected taxpayers since the partners and shareholders that claim a credit for the royalty withholding tax would be captured within the Form 1116 and Form 1118 filers.