Sections 245A(e) and 267A were added to the Internal Revenue Code (“Code”) by the Tax Cuts and Jobs Act, Pub. L. No. 115-97 (2017) (the “Act”), which was enacted on December 22, 2017. On December 28, 2018, the Department of the Treasury (“Treasury Department”) and the IRS published proposed regulations (REG-104352-18) under sections 245A(e), 267A, 1503(d), 6038, 6038A, 6038C, and 7701 in the Federal Register (83 FR 67612) (the “proposed regulations”). Terms used but not defined in this preamble have the meaning provided in the final regulations.

A public hearing on the proposed regulations was scheduled for March 20, 2019, but it was not held because no speaker outlines were submitted to the IRS by the due date for submission, March 15, 2019. The Treasury Department and the IRS received written comments with respect to the proposed regulations. Comments received outside the scope of this rulemaking are generally not addressed but may be considered in connection with future regulations. All written comments received in response to the proposed regulations are available at www.regulations.gov or upon request.

The principal authors of the final regulations are Shane M. McCarrick and Tracy M. Villecco of the Office of Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in the development of the final regulations.

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.

Accordingly, 26 CFR parts 1 and 301 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding sectional authorities for §§1.245A(e)-1 and 1.267A-1 through 1.267A-7 in numerical order and revising the entry for §1.6038A-2 to read in part as follows:

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

Section 1.245A(e)-1 also issued under 26 U.S.C. 245A(g).

* * * * *

Sections 1.267A-1 through 1.267A-7 also issued under 26 U.S.C. 267A(e).

* * * * *

Section 1.6038A-2 also issued under 26 U.S.C. 6038A and 6038C.

* * * * *

Par. 2. Section 1.245A(e)-1 is added to read as follows:

§1.245A(e)-1 Special rules for hybrid dividends.

(a) Overview. This section provides rules for hybrid dividends. Paragraph (b) of this section disallows the deduction under section 245A(a) for a hybrid dividend received by a United States shareholder from a CFC. Paragraph (c) of this section provides a rule for hybrid dividends of tiered corporations. Paragraph (d) of this section sets forth rules regarding a hybrid deduction account. Paragraph (e) of this section provides an anti-avoidance rule. Paragraph (f) of this section provides definitions. Paragraph (g) of this section illustrates the application of the rules of this section through examples. Paragraph (h) of this section provides the applicability date.

(b) Hybrid dividends received by United States shareholders—(1) In general. If a United States shareholder receives a hybrid dividend, then—

(i) The United States shareholder is not allowed a deduction under section 245A(a) for the hybrid dividend; and

(ii) The rules of section 245A(d) (disallowance of foreign tax credits and deductions) apply to the hybrid dividend. See paragraph (g)(1) of this section for an example illustrating the application of paragraph (b) of this section.

(2) Definition of hybrid dividend. The term hybrid dividend means an amount received by a United States shareholder from a CFC for which, without regard to section 245A(e) and this section as well as §1.245A-5T, the United States shareholder would be allowed a deduction under section 245A(a), to the extent of the sum of the United States shareholder’s hybrid deduction accounts (as described in paragraph (d) of this section) with respect to each share of stock of the CFC, determined at the close of the CFC’s taxable year (or in accordance with paragraph (d)(5) of this section, as applicable). No other amount received by a United States shareholder from a CFC is a hybrid dividend for purposes of section 245A.

(3) Special rule for certain dividends attributable to earnings of lower-tier foreign corporations. This paragraph (b)(3) applies if a domestic corporation directly or indirectly (as determined under the principles of §1.245A-5T(g)(3)(ii)) sells or exchanges stock of a foreign corporation and, pursuant to section 1248, the gain recognized on the sale or exchange is included in gross income as a dividend. In such a case, for purposes of this section—

(i) To the extent that earnings and profits of a lower-tier CFC gave rise to the dividend under section 1248(c)(2), those earnings and profits are treated as distributed as a dividend by the lower-tier CFC directly to the domestic corporation under the principles of §1.1248-1(d); and

(ii) To the extent the domestic corporation indirectly owns (within the meaning of section 958(a)(2), and determined by treating a domestic partnership as foreign) shares of stock of the lower-tier CFC, the hybrid deduction accounts with respect to those shares are treated as the domestic corporation’s hybrid deduction accounts with respect to stock of the lower-tier CFC. Thus, for example, if a domestic corporation sells or exchanges all the stock of an upper-tier CFC and under this paragraph (b)(3) there is considered to be a dividend paid directly by the lower-tier CFC to the domestic corporation, then the dividend is generally a hybrid dividend to the extent of the sum of the upper-tier CFC’s hybrid deduction accounts with respect to stock of the lower-tier CFC.

(4) Ordering rule. Amounts received by a United States shareholder from a CFC are subject to the rules of section 245A(e) and this section based on the order in which they are received. Thus, for example, if on different days during a CFC’s taxable year a United States shareholder receives dividends from the CFC, then the rules of section 245A(e) and this section apply first to the dividend received on the earliest date (based on the sum of the United States shareholder’s hybrid deduction accounts with respect to each share of stock of the CFC), and then to the dividend received on the next earliest date (based on the remaining sum).

(c) Hybrid dividends of tiered corporations—(1) In general. If a CFC (the receiving CFC) receives a tiered hybrid dividend from another CFC, and a domestic corporation is a United States shareholder with respect to both CFCs, then, notwithstanding any other provision of the Code—

(i) For purposes of section 951(a) as to the United States shareholder, the tiered hybrid dividend is treated for purposes of section 951(a)(1)(A) as subpart F income of the receiving CFC for the taxable year of the CFC in which the tiered hybrid dividend is received;

(ii) The United States shareholder includes in gross income an amount equal to its pro rata share (determined in the same manner as under section 951(a)(2)) of the subpart F income described in paragraph (c)(1)(i) of this section; and

(iii) The rules of section 245A(d) (disallowance of foreign tax credit, including for taxes that would have been deemed paid under section 960(a) or (b), and deductions) apply to the amount included under paragraph (c)(1)(ii) of this section in the United States shareholder’s gross income. See paragraph (g)(2) of this section for an example illustrating the application of paragraph (c) of this section.

(2) Definition of tiered hybrid dividend. The term tiered hybrid dividend means an amount received by a receiving CFC from another CFC to the extent that the amount would be a hybrid dividend under paragraph (b)(2) of this section if, for purposes of section 245A and the regulations in this part under section 245A (except for section 245A(e)(2) and this paragraph (c)), the receiving CFC were a domestic corporation. A tiered hybrid dividend does not include an amount described in section 959(b). No other amount received by a receiving CFC from another CFC is a tiered hybrid dividend for purposes of section 245A.

(3) Special rule for certain dividends attributable to earnings of lower-tier foreign corporations. This paragraph (c)(3) applies if a CFC directly or indirectly (as determined under the principles of §1.245A-5T(g)(3)(ii)) sells or exchanges stock of a foreign corporation and pursuant to section 964(e)(1) the gain recognized on the sale or exchange is included in gross income as a dividend. In such a case, the rules of paragraph (b)(3) of this section apply, by treating the CFC as the domestic corporation described in paragraph (b)(3) of this section and substituting the phrase “sections 964(e)(1) and 1248(c)(2)” for the phrase “section 1248(c)(2)” in paragraph (b)(3)(i) of this section.

(4) Interaction with rules under section 964(e). To the extent a dividend described in section 964(e)(1) (gain on certain stock sales by CFCs treated as dividends) is a tiered hybrid dividend, the rules of section 964(e)(4) do not apply as to a domestic corporation that is a United States shareholder of both of the CFCs described in paragraph (c)(1) of this section and, therefore, such United States shareholder is not allowed a deduction under section 245A(a) for the amount included in gross income under paragraph (c)(1)(ii) of this section.

(d) Hybrid deduction accounts—(1) In general. A specified owner of a share of CFC stock must maintain a hybrid deduction account with respect to the share. The hybrid deduction account with respect to the share must reflect the amount of hybrid deductions of the CFC allocated to the share (as determined under paragraphs (d)(2) and (3) of this section), and must be maintained in accordance with the rules of paragraphs (d)(4) through (6) of this section.

(2) Hybrid deductions—(i) In general. The term hybrid deduction of a CFC means a deduction or other tax benefit (such as an exemption, exclusion, or credit, to the extent equivalent to a deduction) for which the requirements of paragraphs (d)(2)(i)(A) and (B) of this section are both satisfied.

(A) The deduction or other tax benefit is allowed to the CFC (or a person related to the CFC) under a relevant foreign tax law, regardless of whether the deduction or other tax benefit is used, or otherwise reduces tax, currently under the relevant foreign tax law.

(B) The deduction or other tax benefit relates to or results from an amount paid, accrued, or distributed with respect to an instrument issued by the CFC and treated as stock for U.S. tax purposes, or is a deduction allowed to the CFC with respect to equity. Examples of such a deduction or other tax benefit include an interest deduction, a dividends paid deduction, and a notional interest deduction (or similar deduction determined with respect to the CFC’s equity). However, a deduction or other tax benefit relating to or resulting from a distribution by the CFC that is a dividend for purposes of the relevant foreign tax law is considered a hybrid deduction only to the extent it has the effect of causing the earnings that funded the distribution to not be included in income (determined under the principles of §1.267A-3(a)) or otherwise subject to tax under such tax law. Thus, for example, upon a distribution by a CFC that is treated as a dividend for purposes of the CFC’s tax law to a shareholder of the CFC, a dividends paid deduction allowed to the CFC under its tax law (or a refund to the shareholder, including through a credit, of tax paid by the CFC on the earnings that funded the distribution) pursuant to an integration or imputation system is not a hybrid deduction of the CFC to the extent that the shareholder, if a tax resident of the CFC’s country, includes the distribution in income under the CFC’s tax law or, if not a tax resident of the CFC’s country, is subject to withholding tax (as defined in section 901(k)(1)(B)) on the distribution under the CFC’s tax law. As an additional example, upon a distribution by a CFC to a shareholder of the CFC that is a tax resident of the CFC’s country, a dividends received deduction allowed to the shareholder under the tax law of such foreign country pursuant to a regime intended to relieve double-taxation within the group is not a hybrid deduction of the CFC (though if the CFC were also allowed a deduction or other tax benefit for the distribution under such tax, such deduction or other tax benefit would be a hybrid deduction of the CFC). See paragraphs (g)(1) and (2) of this section for examples illustrating the application of paragraph (d) of this section.

(ii) Coordination with foreign disallowance rules. The following special rules apply for purposes of determining whether a deduction or other tax benefit is allowed to a CFC (or a person related to the CFC) under a relevant foreign tax law:

(A) Whether the deduction or other tax benefit is allowed is determined without regard to a rule under the relevant foreign tax law that disallows or suspends deductions if a certain ratio or percentage is exceeded (for example, a thin capitalization rule that disallows interest deductions if debt to equity exceeds a certain ratio, or a rule similar to section 163(j) that disallows or suspends interest deductions if interest exceeds a certain percentage of income).

(B) Except as provided in this paragraph (d)(2)(ii)(B), whether the deduction or other tax benefit is allowed is determined without regard to hybrid mismatch rules, if any, under the relevant foreign tax law that may disallow such deduction or other tax benefit. However, whether the deduction or other tax benefit is allowed is determined with regard to hybrid mismatch rules under the relevant foreign tax law if the amount giving rise to the deduction or other tax benefit neither gives rise to a dividend for U.S. tax purposes nor, based on all the facts and circumstances, is reasonably expected to give rise to a dividend for U.S. tax purposes that will be paid within 12 months from the end of the taxable period for which the deduction or other tax benefit would be allowed but for the hybrid mismatch rules. For purposes of this paragraph (d)(2)(ii)(B), the term hybrid mismatch rules has the meaning provided in §1.267A-5(b)(10).

(iii) Anti-duplication rule. A deduction or other tax benefit allowed to a CFC (or a person related to the CFC) under a relevant foreign tax law for an amount paid, accrued, or distributed with respect to an instrument issued by the CFC is not a hybrid deduction to the extent that treating it as a hybrid deduction would have the effect of duplicating a hybrid deduction that is a deduction or other tax benefit allowed under such tax law for an amount paid, accrued, or distributed with respect to an instrument that is issued by a CFC at a higher tier and that has terms substantially similar to the terms of the first instrument. For example, if an upper tier CFC issues to a corporate United States shareholder a hybrid instrument (the “upper tier instrument”), a lower tier CFC issues to the upper tier CFC a hybrid instrument that has terms substantially similar to the terms of the upper tier instrument (the “mirror instrument”), the CFCs are tax residents of the same foreign country, and the upper tier CFC includes in income under its tax law (as determined under the principles of §1.267A-3(a)) amounts accrued with respect to the mirror instrument, then a deduction allowed to the lower tier CFC under such foreign tax law for an amount accrued pursuant to the mirror instrument is not a hybrid deduction (but a deduction allowed to the upper tier CFC under the foreign tax law for an amount accrued with respect to the upper tier instrument is a hybrid deduction).

(iv) Application limited to items allowed in taxable years ending on or after December 20, 2018; special rule for deductions with respect to equity. A deduction or other tax benefit, other than a deduction with respect to equity, allowed to a CFC (or a person related to the CFC) under a relevant foreign tax law is taken into account for purposes of this section only if it was allowed with respect to a taxable year under the relevant foreign tax law ending on or after December 20, 2018. A deduction with respect to equity allowed to a CFC under a relevant foreign tax law is taken into account for purposes of this section only if it was allowed with respect to a taxable year under the relevant foreign tax law beginning on or after December 20, 2018.

(3) Allocating hybrid deductions to shares. A hybrid deduction is allocated to a share of stock of a CFC to the extent that the hybrid deduction (or amount equivalent to a deduction) relates to an amount paid, accrued, or distributed by the CFC with respect to the share. However, in the case of a hybrid deduction that is a deduction with respect to equity (such as a notional interest deduction), the deduction is allocated to a share of stock of a CFC based on the product of—

(i) The amount of the deduction allowed for all of the equity of the CFC; and

(ii) A fraction, the numerator of which is the value of the share and the denominator of which is the value of all of the stock of the CFC.

(4) Maintenance of hybrid deduction accounts—(i) In general. A specified owner’s hybrid deduction account with respect to a share of stock of a CFC is, as of the close of the taxable year of the CFC, adjusted pursuant to the following rules.

(A) First, the account is increased by the amount of hybrid deductions of the CFC allocated to the share for the taxable year.

(B) [Reserved]

(C) Third, the account is decreased by the amount of hybrid deductions in the account that gave rise to a hybrid dividend or tiered hybrid dividend during the taxable year. If the specified owner has more than one hybrid deduction account with respect to its stock of the CFC, then a pro rata amount in each hybrid deduction account is considered to have given rise to the hybrid dividend or tiered hybrid dividend, based on the amounts in the accounts before applying this paragraph (d)(4)(i)(C).

(ii) [Reserved]

(iii) Acquisition of account and certain other adjustments—(A) In general. The following rules apply when a person (the acquirer) directly or indirectly through a partnership, trust, or estate acquires a share of stock of a CFC from another person (the transferor).

(1) In the case of an acquirer that is a specified owner of the share immediately after the acquisition, the transferor’s hybrid deduction account, if any, with respect to the share becomes the hybrid deduction account of the acquirer.

(2) In the case of an acquirer that is not a specified owner of the share immediately after the acquisition, the transferor’s hybrid deduction account, if any, is eliminated and accordingly is not thereafter taken into account by any person.

(B) Additional rules. The following rules apply in addition to the rules of paragraph (d)(4)(iii)(A) of this section.

(1) Certain section 354 or 356 exchanges. The following rules apply when a shareholder of a CFC (the CFC, the target CFC; the shareholder, the exchanging shareholder) exchanges stock of the target CFC for stock of another CFC (the acquiring CFC) pursuant to an exchange described in section 354 or 356 that occurs in connection with a transaction described in section 381(a)(2) in which the target CFC is the transferor corporation.

(i) In the case of an exchanging shareholder that is a specified owner of one or more shares of stock of the acquiring CFC immediately after the exchange, the exchanging shareholder’s hybrid deduction accounts with respect to the shares of stock of the target CFC that it exchanges are attributed to the shares of stock of the acquiring CFC that it receives in the exchange.

(ii) In the case of an exchanging shareholder that is not a specified owner of one or more shares of stock of the acquiring CFC immediately after the exchange, the exchanging shareholder’s hybrid deduction accounts with respect to its shares of stock of the target CFC are eliminated and accordingly are not thereafter taken into account by any person.

(2) Section 332 liquidations. If a CFC is a distributor corporation in a transaction described in section 381(a)(1) (the distributor CFC) in which a controlled foreign corporation is the acquiring corporation (the distributee CFC), then each hybrid deduction account with respect to a share of stock of the distributee CFC is increased pro rata by the sum of the hybrid deduction accounts with respect to shares of stock of the distributor CFC.

(3) Recapitalizations. If a shareholder of a CFC exchanges stock of the CFC pursuant to a reorganization described in section 368(a)(1)(E) or a transaction to which section 1036 applies, then the shareholder’s hybrid deduction accounts with respect to the stock of the CFC that it exchanges are attributed to the shares of stock of the CFC that it receives in the exchange.

(4) Certain distributions involving section 355 or 356. In the case of a transaction involving a distribution under section 355 (or so much of section 356 as it relates to section 355) by a CFC (the distributing CFC) of stock of another CFC (the controlled CFC), the balance of the hybrid deduction accounts with respect to stock of the distributing CFC is attributed to stock of the controlled CFC in a manner similar to how earnings and profits of the distributing CFC and controlled CFC are adjusted. To the extent the balance of the hybrid deduction accounts with respect to stock of the distributing CFC is not so attributed to stock of the controlled CFC, such balance remains as the balance of the hybrid deduction accounts with respect to stock of the distributing CFC.

(5) Effect of section 338(g) election—(i) In general. If an election under section 338(g) is made with respect to a qualified stock purchase (as described in section 338(d)(3)) of stock of a CFC, then a hybrid deduction account with respect to a share of stock of the old target is not treated as (or attributed to) a hybrid deduction account with respect to a share of stock of the new target. Accordingly, immediately after the deemed asset sale described in §1.338-1, the balance of a hybrid deduction account with respect to a share of stock of the new target is zero; the account must then be maintained in accordance with the rules of paragraph (d) of this section.

(ii) Special rule regarding carryover FT stock. Paragraph (d)(4)(iii)(B)(5)(i) of this section does not apply as to a hybrid deduction account with respect to a share of carryover FT stock (as described in §1.338-9(b)(3)(i)). A hybrid deduction account with respect to a share of carryover FT stock is attributed to the corresponding share of stock of the new target.

(5) Determinations and adjustments made during year of transfer in certain cases. This paragraph (d)(5) applies if on a date other than the date that is the last day of the CFC’s taxable year a United States shareholder of the CFC or an upper-tier CFC with respect to the CFC directly or indirectly (as determined under the principles of §1.245A-5T(g)(3)(ii)) transfers a share of stock of the CFC, and, during the taxable year, but on or before the transfer date, the United States shareholder or upper-tier CFC receives an amount from the CFC that is subject to the rules of section 245A(e) and this section. In such a case, the following rules apply:

(i) As to the United States shareholder or upper-tier CFC and the United States shareholder’s or upper-tier CFC’s hybrid deduction accounts with respect to each share of stock of the CFC (regardless of whether such share is transferred), the determinations and adjustments under this section that would otherwise be made at the close of the CFC’s taxable year are made at the close of the date of the transfer. When making these determinations and adjustments at the close of the date of the transfer, each hybrid deduction account described in the previous sentence is pursuant to paragraph (d)(4)(ii)(A) of this section increased by a ratable portion (based on the number of days in the taxable year within the pre-transfer period to the total number of days in the taxable year) of the hybrid deductions of the CFC allocated to the share for the taxable year, and pursuant to paragraph (d)(4)(ii)(C) of this section decreased by the amount of hybrid deductions in the account that gave rise to a hybrid dividend or tiered hybrid dividend during the portion of the taxable year up to and including the transfer date. Thus, for example, if a United States shareholder of a CFC exchanges stock of the CFC in an exchange described in §1.367(b)-4(b)(1)(i) and is required to include in income as a deemed dividend the section 1248 amount attributable to the stock exchanged, then: as of the close of the date of the exchange, each of the United States shareholder’s hybrid deductions accounts with respect to a share of stock of the CFC is increased by a ratable portion of the hybrid deductions of the CFC allocated to the share for the taxable year (based on the number of days in the taxable year within the pre-transfer period to the total number of days in the taxable year); the deemed dividend is a hybrid dividend to the extent of the sum of the United States shareholder’s hybrid deduction accounts with respect to each share of stock of the CFC; and, as the close of the date of the exchange, each of the accounts is decreased by the amount of hybrid deductions in the account that gave rise to a hybrid dividend during the portion of the taxable year up to and including the date of the exchange.

(ii) As to a hybrid deduction account described in paragraph (d)(5)(i) of this section, the adjustments to the account as of the close of the taxable year of the CFC must take into account the adjustments, if any, occurring with respect to the account pursuant to paragraph (d)(5)(i) of this section. Thus, for example, if an acquisition of a share of stock of a CFC occurs on a date other than the date that is the last day of the CFC’s taxable year and pursuant to paragraph (d)(4)(iii)(A)(1) of this section the acquirer succeeds to the transferor’s hybrid deduction account with respect to the share, then, as of the close of the taxable year of the CFC, the account is increased by a ratable portion of the hybrid deductions of the CFC allocated to the share for the taxable year (based on the number of days in the taxable year within the post-transfer period to the total number of days in the taxable year), and, decreased by the amount of hybrid deductions in the account that gave rise to a hybrid dividend or tiered hybrid dividend during the portion of the taxable year following the transfer date.

(6) Effects of CFC functional currency—(i) Maintenance of the hybrid deduction account. A hybrid deduction account with respect to a share of CFC stock must be maintained in the functional currency (within the meaning of section 985) of the CFC. Thus, for example, the amount of a hybrid deduction and the adjustments described in paragraphs (d)(4)(i)(A) and (B) of this section are determined based on the functional currency of the CFC. In addition, for purposes of this section, the amount of a deduction or other tax benefit allowed to a CFC (or a person related to the CFC) is determined taking into account foreign currency gain or loss recognized with respect to such deduction or other tax benefit under a provision of foreign tax law comparable to section 988 (treatment of certain foreign currency transactions).

(ii) Determination of amount of hybrid dividend. This paragraph (d)(6)(ii) applies if a CFC’s functional currency is other than the functional currency of a United States shareholder or upper-tier CFC that receives an amount from the CFC that is subject to the rules of section 245A(e) and this section. In such a case, the sum of the United States shareholder’s or upper-tier CFC’s hybrid deduction accounts with respect to each share of stock of the CFC is, for purposes of determining the extent that a dividend is a hybrid dividend or tiered hybrid dividend, translated into the functional currency of the United States shareholder or upper-tier CFC based on the spot rate (within the meaning of §1.988-1(d)) as of the date of the dividend.

(e) Anti-avoidance rule. Appropriate adjustments are made pursuant to this section, including adjustments that would disregard the transaction or arrangement, if a transaction or arrangement is undertaken with a principal purpose of avoiding the purposes of section 245A(e) and this section. For example, if a specified owner of a share of CFC stock transfers the share to another person, and a principal purpose of the transfer is to shift the hybrid deduction account with respect to the share to the other person or to cause the hybrid deduction account to be eliminated, then for purposes of this section the shifting or elimination of the hybrid deduction account is disregarded as to the transferor. As another example, if a transaction or arrangement is undertaken to affirmatively fail to satisfy the holding period requirement under section 246(c)(5) with a principal purpose of avoiding the tiered hybrid dividend rules described in paragraph (c) of this section, the transaction or arrangement is disregarded for purposes of this section. This paragraph (e) will not apply, however, to disregard (or make other adjustments with respect to) a transaction pursuant to which an instrument or arrangement that gives rise to hybrid deductions is eliminated or otherwise converted into another instrument or arrangement that does not give rise to hybrid deductions.

(f) Definitions. The following definitions apply for purposes of this section.

(1) The term controlled foreign corporation (or CFC) has the meaning provided in section 957.

(2) The term domestic corporation means an entity classified as a domestic corporation under section 7701(a)(3) and (4) or otherwise treated as a domestic corporation by the Internal Revenue Code. However, for purposes of this section, a domestic corporation does not include a regulated investment company (as described in section 851), a real estate investment trust (as described in section 856), or an S corporation (as described in section 1361).

(3) The term person has the meaning provided in section 7701(a)(1).

(4) The term related has the meaning provided in this paragraph (f)(4). A person is related to a CFC if the person is a related person within the meaning of section 954(d)(3). See also §1.954-1(f)(2)(iv)(B)(1) (neither section 318(a)(3), nor §1.958-2(d) or the principles thereof, applies to attribute stock or other interests).

(5) The term relevant foreign tax law means, with respect to a CFC, any regime of any foreign country or possession of the United States that imposes an income, war profits, or excess profits tax with respect to income of the CFC, other than a foreign anti-deferral regime under which a person that owns an interest in the CFC is liable to tax. If a foreign country has an income tax treaty with the United States that applies to taxes imposed by a political subdivision or other local authority of that country, then the tax law of the political subdivision or other local authority is deemed to be a tax law of a foreign country. Thus, the term includes any regime of a foreign country or possession of the United States that imposes income, war profits, or excess profits tax under which—

(i) The CFC is liable to tax as a resident;

(ii) The CFC has a branch that gives rise to a taxable presence in the foreign country or possession of the United States; or

(iii) A person related to the CFC is liable to tax as a resident, provided that under such person’s tax law the person is allowed a deduction for amounts paid or accrued by the CFC (because the CFC is fiscally transparent under the person’s tax law).

(6) The term specified owner means, with respect to a share of stock of a CFC, a person for which the requirements of paragraphs (f)(6)(i) and (ii) of this section are satisfied.

(i) The person is a domestic corporation that is a United States shareholder of the CFC, or is an upper-tier CFC that would be a United States shareholder of the CFC were the upper-tier CFC a domestic corporation (provided that, for purposes of sections 951 and 951A, a domestic corporation that is a United States shareholder of the upper-tier CFC owns (within the meaning of section 958(a), and determined by treating a domestic partnership as foreign) one or more shares of stock of the upper-tier CFC).

(ii) The person owns the share directly or indirectly through a partnership, trust, or estate. Thus, for example, if a domestic corporation directly owns all the shares of stock of an upper-tier CFC and the upper-tier CFC directly owns all the shares of stock of another CFC, the domestic corporation is the specified owner with respect to each share of stock of the upper-tier CFC and the upper-tier CFC is the specified owner with respect to each share of stock of the other CFC.

(7) The term United States shareholder has the meaning provided in section 951(b).

(g) Examples. This paragraph (g) provides examples that illustrate the application of this section. For purposes of the examples in this paragraph (g), unless otherwise indicated, the following facts are presumed. US1 is a domestic corporation. FX and FZ are CFCs formed at the beginning of year 1, and the functional currency (within the meaning of section 985) of each of FX and FZ is the dollar. FX is a tax resident of Country X and FZ is a tax resident of Country Z. US1 is a United States shareholder with respect to FX and FZ. No distributed amounts are attributable to amounts which are, or have been, included in the gross income of a United States shareholder under section 951(a). All instruments are treated as stock for U.S. tax purposes. Only the tax law of the United States contains hybrid mismatch rules.

(1) Example 1. Hybrid dividend resulting from hybrid instrument—(i) Facts. US1 holds both shares of stock of FX, which have an equal value. One share is treated as indebtedness for Country X tax purposes (“Share A”), and the other is treated as equity for Country X tax purposes (“Share B”). During year 1, under Country X tax law, FX accrues $80x of interest to US1 with respect to Share A and is allowed a deduction for the amount (the “Hybrid Instrument Deduction”). During year 2, FX distributes $30x to US1 with respect to each of Share A and Share B. For U.S. tax purposes, each of the $30x distributions is treated as a dividend for which, without regard to section 245A(e) and this section as well as §1.245A-5T, US1 would be allowed a deduction under section 245A(a). For Country X tax purposes, the $30x distribution with respect to Share A represents a payment of interest for which a deduction was already allowed (and thus FX is not allowed an additional deduction for the amount), and the $30x distribution with respect to Share B is treated as a dividend (for which no deduction is allowed).

(ii) Analysis. The entire $30x of each dividend received by US1 from FX during year 2 is a hybrid dividend, because the sum of US1’s hybrid deduction accounts with respect to each of its shares of FX stock at the end of year 2 ($80x) is at least equal to the amount of the dividends ($60x). See paragraph (b)(2) of this section. This is the case for the $30x dividend with respect to Share B even though there are no hybrid deductions allocated to Share B. See paragraph (b)(2) of this section. As a result, US1 is not allowed a deduction under section 245A(a) for the entire $60x of hybrid dividends and the rules of section 245A(d) (disallowance of foreign tax credits and deductions) apply. See paragraph (b)(1) of this section. Paragraphs (g)(1)(ii)(A) through (D) of this section describe the determinations under this section.

(A) At the end of year 1, US1’s hybrid deduction accounts with respect to Share A and Share B are $80x and $0, respectively, calculated as follows.

(1) The $80x Hybrid Instrument Deduction allowed to FX under Country X tax law (a relevant foreign tax law) is a hybrid deduction of FX, because the deduction is allowed to FX and relates to or results from an amount accrued with respect to an instrument issued by FX and treated as stock for U.S. tax purposes. See paragraph (d)(2)(i) of this section. Thus, FX’s hybrid deductions for year 1 are $80x.

(2) The entire $80x Hybrid Instrument Deduction is allocated to Share A, because the deduction was accrued with respect to Share A. See paragraph (d)(3) of this section. As there are no additional hybrid deductions of FX for year 1, there are no additional hybrid deductions to allocate to either Share A or Share B. Thus, there are no hybrid deductions allocated to Share B.

(3) At the end of year 1, US1’s hybrid deduction account with respect to Share A is increased by $80x (the amount of hybrid deductions allocated to Share A). See paragraph (d)(4)(i)(A) of this section. Because FX did not pay any dividends with respect to either Share A or Share B during year 1 (and therefore did not pay any hybrid dividends or tiered hybrid dividends), no further adjustments are made. See paragraph (d)(4)(i)(C) of this section. Therefore, at the end of year 1, US1’s hybrid deduction accounts with respect to Share A and Share B are $80x and $0, respectively.

(B) At the end of year 2, and before the adjustments described in paragraph (d)(4)(i)(C) of this section, US1’s hybrid deduction accounts with respect to Share A and Share B remain $80x and $0, respectively. This is because there are no hybrid deductions of FX for year 2. See paragraph (d)(4)(i)(A) of this section.

(C) Because at the end of year 2 (and before the adjustments described in paragraph (d)(4)(i)(C) of this section) the sum of US1’s hybrid deduction accounts with respect to Share A and Share B ($80x, calculated as $80x plus $0) is at least equal to the aggregate $60x of year 2 dividends, the entire $60x dividend is a hybrid dividend. See paragraph (b)(2) of this section.

(D) At the end of year 2, US1’s hybrid deduction account with respect to Share A is decreased by $60x, the amount of the hybrid deductions in the account that gave rise to a hybrid dividend or tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(C) of this section. Because there are no hybrid deductions in the hybrid deduction account with respect to Share B, no adjustments with respect to that account are made under paragraph (d)(4)(i)(C) of this section. Therefore, at the end of year 2 and taking into account the adjustments under paragraph (d)(4)(i)(C) of this section, US1’s hybrid deduction account with respect to Share A is $20x ($80x less $60x) and with respect to Share B is $0.

(iii) Alternative facts – notional interest deductions. The facts are the same as in paragraph (g)(1)(i) of this section, except that for each of year 1 and year 2 FX is allowed $10x of notional interest deductions with respect to its equity, Share B, under Country X tax law (the “NIDs”). In addition, during year 2, FX distributes $47.5x (rather than $30x) to US1 with respect to each of Share A and Share B. For U.S. tax purposes, each of the $47.5x distributions is treated as a dividend for which, without regard to section 245A(e) and this section as well as §1.245A-5T, US1 would be allowed a deduction under section 245A(a). For Country X tax purposes, the $47.5x distribution with respect to Share A represents a payment of interest for which a deduction was already allowed (and thus FX is not allowed an additional deduction for the amount), and the $47.5x distribution with respect to Share B is treated as a dividend (for which no deduction is allowed). The entire $47.5x of each dividend received by US1 from FX during year 2 is a hybrid dividend, because the sum of US1’s hybrid deduction accounts with respect to each of its shares of FX stock at the end of year 2 ($80x plus $20x, or $100x) is at least equal to the amount of the dividends ($95x). See paragraph (b)(2) of this section. As a result, US1 is not allowed a deduction under section 245A(a) for the $95x hybrid dividend and the rules of section 245A(d) (disallowance of foreign tax credits and deductions) apply. See paragraph (b)(1) of this section. Paragraphs (g)(1)(iii)(A) through (D) of this section describe the determinations under this section.

(A) The $10x of NIDs allowed to FX under Country X tax law in year 1 are hybrid deductions of FX for year 1. See paragraph (d)(2)(i) of this section. The $10x of NIDs is allocated equally to each of Share A and Share B, because the hybrid deduction is with respect to equity and the shares have an equal value. See paragraph (d)(3) of this section. Thus, $5x of the NIDs is allocated to each of Share A and Share B for year 1. For the reasons described in paragraph (g)(1)(ii)(A)(2) of this section, the entire $80x Hybrid Instrument Deduction is allocated to Share A. Therefore, at the end of year 1, US1’s hybrid deduction accounts with respect to Share A and Share B are $85x and $5x, respectively.

(B) Similarly, the $10x of NIDs allowed to FX under Country X tax law in year 2 are hybrid deductions of FX for year 2, and $5x of the NIDs is allocated to each of Share A and Share B for year 2. See paragraphs (d)(2)(i) and (d)(3) of this section. Thus, at the end of year 2 (and before the adjustments described in paragraph (d)(4)(i)(C) of this section), US1’s hybrid deduction account with respect to Share A is $90x ($85x plus $5x) and with respect to Share B is $10x ($5x plus $5x). See paragraph (d)(4)(i) of this section.

(C) Because at the end of year 2 (and before the adjustments described in paragraph (d)(4)(i)(C) of this section) the sum of US1’s hybrid deduction accounts with respect to Share A and Share B ($100x, calculated as $90x plus $10x) is at least equal to the aggregate $95x of year 2 dividends, the entire $95x of dividends are hybrid dividends. See paragraph (b)(2) of this section.

(D) At the end of year 2, US1’s hybrid deduction accounts with respect to Share A and Share B are decreased by the amount of hybrid deductions in the accounts that gave rise to a hybrid dividend or tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(C) of this section. A total of $95x of hybrid deductions in the accounts gave rise to a hybrid dividend during year 2. For the hybrid deduction account with respect to Share A, $85.5x in the account is considered to have given rise to a hybrid deduction (calculated as $95x multiplied by $90x/$100x). See paragraph (d)(4)(i)(C) of this section. For the hybrid deduction account with respect to Share B, $9.5x in the account is considered to have given rise to a hybrid deduction (calculated as $95x multiplied by $10x/$100x). See paragraph (d)(4)(i)(C) of this section. Thus, following these adjustments, at the end of year 2, US1’s hybrid deduction account with respect to Share A is $4.5x ($90x less $85.5x) and with respect to Share B is $0.5x ($10x less $9.5x).

(iv) Alternative facts – deduction in branch country—(A) Facts. The facts are the same as in paragraph (g)(1)(i) of this section, except that for Country X tax purposes Share A is treated as equity (and thus the Hybrid Instrument Deduction does not exist, and under Country X tax law FX is not allowed a deduction for the $30x distributed in year 2 with respect to Share A). However, FX has a branch in Country Z that gives rise to a taxable presence under Country Z tax law, and for Country Z tax purposes Share A is treated as indebtedness and Share B is treated as equity. Also, during year 1, for Country Z tax purposes, FX accrues $80x of interest to US1 with respect to Share A and is allowed an $80x interest deduction with respect to its Country Z branch income. Moreover, for Country Z tax purposes, the $30x distribution with respect to Share A in year 2 represents a payment of interest for which a deduction was already allowed (and thus FX is not allowed an additional deduction for the amount), and the $30x distribution with respect to Share B in year 2 is treated as a dividend (for which no deduction is allowed).

(B) Analysis. The $80x interest deduction allowed to FX under Country Z tax law (a relevant foreign tax law) with respect to its Country Z branch income is a hybrid deduction of FX for year 1. See paragraphs (d)(2)(i) and (f)(5) of this section. For reasons similar to those discussed in paragraph (g)(1)(ii) of this section, at the end of year 2 (and before the adjustments described in paragraph (d)(4)(i)(C) of this section), US1’s hybrid deduction accounts with respect to Share A and Share B are $80x and $0, respectively, and the sum of the accounts is $80x. Accordingly, the entire $60x of the year 2 dividend is a hybrid dividend. See paragraph (b)(2) of this section. Further, for the reasons described in paragraph (g)(1)(ii)(D) of this section, at the end of year 2 and taking into account the adjustments under paragraph (d)(4)(i)(C) of this section, US1’s hybrid deduction account with respect to Share A is $20x ($80x less $60x) and with respect to Share B is $0.

(2) Example 2. Tiered hybrid dividend rule; tax benefit equivalent to a deduction—(i) Facts. US1 holds all the stock of FX, and FX holds all 100 shares of stock of FZ (the “FZ shares”), which have an equal value. The FZ shares are treated as equity for Country Z tax purposes. At the end of year 1, the sum of FX’s hybrid deduction accounts with respect to each of its shares of FZ stock is $0. During year 2, FZ distributes $10x to FX with respect to each of the FZ shares, for a total of $1,000x. The $1,000x is treated as a dividend for U.S. and Country Z tax purposes, and is not deductible for Country Z tax purposes. If FX were a domestic corporation, then, without regard to section 245A(e) and this section as well as §1.245A-5T, FX would be allowed a deduction under section 245A(a) for the $1,000x. Under Country Z tax law, 75% of the corporate income tax paid by a Country Z corporation with respect to a dividend distribution is refunded to the corporation’s shareholders (regardless of where such shareholders are tax residents) upon a dividend distribution by the corporation. The corporate tax rate in Country Z is 20%. With respect to FZ’s distributions, FX is allowed a refundable tax credit of $187.5x. The $187.5x refundable tax credit is calculated as $1,250x (the amount of pre-tax earnings that funded the distribution, determined as $1,000x (the amount of the distribution) divided by 0.8 (the percentage of pre-tax earnings that a Country Z corporation retains after paying Country Z corporate tax)) multiplied by 0.2 (the Country Z corporate tax rate) multiplied by 0.75 (the percentage of the Country Z tax credit). Under Country Z tax law, FX is not subject to Country Z withholding tax (or any other tax) with respect to the $1,000x dividend distribution.

(ii) Analysis. As described in paragraphs (g)(2)(ii)(A) and (B) of this section, the sum of FX’s hybrid deduction accounts with respect to each of its shares of FZ stock at the end of year 2 is $937.5x and, as a result, $937.5x of the $1,000x of dividends received by FX from FZ during year 2 is a tiered hybrid dividend. See paragraphs (b)(2) and (c)(2) of this section. The $937.5x tiered hybrid dividend is treated for purposes of section 951(a)(1)(A) as subpart F income of FX and US1 must include in gross income its pro rata share of such subpart F income, which is $937.5x. See paragraph (c)(1) of this section. This is the case notwithstanding any other provision of the Code, including section 952(c) or section 954(c)(3) or (6). In addition, the rules of section 245A(d) (disallowance of foreign tax credits and deductions) apply with respect to US1’s inclusion. See paragraph (c)(1) of this section. Paragraphs (g)(2)(ii)(A) through (C) of this section describe the determinations under this section. The characterization of the FZ stock for Country X tax purposes (or for purposes of any other foreign tax law) does not affect this analysis.

(A) The $187.5x refundable tax credit allowed to FX under Country Z tax law (a relevant foreign tax law) is equivalent to a $937.5x deduction, calculated as $187.5x (the amount of the credit) divided by 0.2 (the Country Z corporate tax rate). The $937.5x is a hybrid deduction of FZ because it is allowed to FX (a person related to FZ), it relates to or results from amounts distributed with respect to instruments issued by FZ and treated as stock for U.S. tax purposes, and it has the effect of causing the earnings that funded the distributions to not be included in income under Country Z tax law. See paragraph (d)(2)(i) of this section. $9.375x of the hybrid deduction is allocated to each of the FZ shares, calculated as $937.5x (the amount of the hybrid deduction) multiplied by 1/100 (the value of each FZ share relative to the value of all the FZ shares). See paragraph (d)(3) of this section. The result would be the same if FX were instead a tax resident of Country Z (and not Country X), FX were allowed the $187.5x refundable tax credit under Country Z tax law, and under Country Z tax law FX were to not include the $1,000x in income (because, for example, Country Z tax law provides Country Z resident corporations a 100% exclusion or dividends received deduction with respect to dividends received from a resident corporation). See paragraph (d)(2)(i) of this section.

(B) At the end of year 2, and before the adjustments described in paragraph (d)(4)(i)(C) of this section, the sum of FX’s hybrid deduction accounts with respect to each of its shares of FZ stock is $937.5x, calculated as $9.375x (the amount in each account) multiplied by 100 (the number of accounts). See paragraph (d)(4)(i) of this section. Accordingly, $937.5x of the $1,000x dividend received by FX from FZ during year 2 is a tiered hybrid dividend. See paragraphs (b)(2) and (c)(2) of this section.

(C) At the end of year 2, each of FX’s hybrid deduction accounts with respect to its shares of FZ is decreased by the $9.375x in the account that gave rise to a hybrid dividend or tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(C) of this section. Thus, following these adjustments, at the end of year 2, each of FX’s hybrid deduction accounts with respect to its shares of FZ stock is $0, calculated as $9.375x (the amount in the account before the adjustments described in paragraph (d)(4)(i)(C) of this section) less $9.375x (the adjustment described in paragraph (d)(4)(i)(C) of this section with respect to the account).

(iii) Alternative facts – imputation system that taxes shareholders. The facts are the same as in paragraph (g)(2)(i) of this section, except that under Country Z tax law the $1,000x dividend to FX is subject to a 30% gross basis withholding tax, or $300x, and the $187.5x refundable tax credit is applied against and reduces the withholding tax to $112.5x. The $187.5x refundable tax credit provided to FX is not a hybrid deduction because FX was subject to Country Z withholding tax of $300x on the $1,000x dividend (such withholding tax being greater than the $187.5x credit). See paragraph (d)(2)(i) of this section. If instead FZ were allowed a $1,000x dividends paid deduction for the $1,000x dividend (and FX were not allowed the refundable tax credit) and the dividend were subject to 5% gross basis withholding tax (or $50x), then $750x of the dividends paid deduction would be a hybrid deduction, calculated as the excess of $1,000x (the dividends paid deduction) over $250x (the amount of income that under Country Z tax law would produce an amount of tax equal to the $50x of withholding tax, calculated as $50x, the amount of withholding tax, divided by 0.2, the Country Z corporate tax rate). See paragraph (d)(2)(i) of this section.

(h) Applicability dates—(1) In general. Except as provided in paragraph (h)(2) of this section, this section applies to distributions made after December 31, 2017, provided that such distributions occur during taxable years ending on or after December 20, 2018. However, taxpayers may apply this section in its entirety to distributions made after December 31, 2017 and occurring during taxable years ending before December 20, 2018. In lieu of applying the regulations in this section, taxpayers may apply the provisions matching this section from the Internal Revenue Bulletin (IRB) 2019-03 (https://www.irs.gov/pub/irs-irbs/irb19-03.pdf) in their entirety for all taxable years ending on or before April 8, 2020.

(2) [Reserved]

Par. 3. Sections 1.267A-1 through 1.267A-7 are added to read as follows:

Sec.

* * * * *

1.267A-1 Disallowance of certain interest and royalty deductions.

1.267A-2 Hybrid and branch arrangements.

1.267A-3 Income inclusions and amounts not treated as disqualified hybrid amounts.

1.267A-4 Disqualified imported mismatch amounts.

1.267A-5 Definitions and special rules.

1.267A-6 Examples.

1.267A-7 Applicability dates.

* * * * *

§1.267A-1 Disallowance of certain interest and royalty deductions.

(a) Scope. This section and §§1.267A-2 through 1.267A-5 provide rules regarding when a deduction for any interest or royalty paid or accrued is disallowed under section 267A. Section 1.267A-2 describes hybrid and branch arrangements. Section 1.267A-3 provides rules for determining income inclusions and provides that certain amounts are not amounts for which a deduction is disallowed. Section 1.267A-4 provides an imported mismatch rule. Section 1.267A-5 sets forth definitions and special rules that apply for purposes of section 267A. Section 1.267A-6 illustrates the application of section 267A through examples. Section 1.267A-7 provides applicability dates.

(b) Disallowance of deduction. This paragraph (b) sets forth the exclusive circumstances in which a deduction is disallowed under section 267A. Except as provided in paragraph (c) of this section, a specified party’s deduction for any interest or royalty paid or accrued (the amount paid or accrued with respect to the specified party, a specified payment) is disallowed under section 267A to the extent that the specified payment is described in this paragraph (b). See also §1.267A-5(b)(5) (treating structured payments as interest paid or accrued for purposes of section 267A and the regulations in this part under section 267A). A specified payment is described in this paragraph (b) to the extent that it is—

(1) A disqualified hybrid amount, as described in §1.267A-2 (hybrid and branch arrangements);

(2) A disqualified imported mismatch amount, as described in §1.267A-4 (payments offset by a hybrid deduction); or

(3) A specified payment for which the requirements of the anti-avoidance rule of §1.267A-5(b)(6) are satisfied.

(c) De minimis exception. Paragraph (b) of this section does not apply to a specified party for a taxable year in which the sum of the specified party’s specified payments that but for this paragraph (c) would be described in paragraph (b) of this section is less than $50,000. For purposes of this paragraph (c), specified parties that are related (within the meaning of §1.267A-5(a)(14)) are treated as a single specified party.

§1.267A-2 Hybrid and branch arrangements.

(a) Payments pursuant to hybrid transactions—(1) In general. If a specified payment is made pursuant to a hybrid transaction, then, subject to §1.267A-3(b) (amounts included or includible in income), the payment is a disqualified hybrid amount to the extent that—

(i) A specified recipient of the payment does not include the payment in income, as determined under §1.267A-3(a) (to such extent, a no-inclusion); and

(ii) The specified recipient’s no-inclusion is a result of the payment being made pursuant to the hybrid transaction. For purposes of this paragraph (a)(1)(ii), the specified recipient’s no-inclusion is a result of the specified payment being made pursuant to the hybrid transaction to the extent that the no-inclusion would not occur were the specified recipient’s tax law to treat the payment as interest or a royalty, as applicable. See §1.267A-6(c)(1) and (2) for examples illustrating the application of paragraph (a) of this section.

(2) Definition of hybrid transaction—(i) In general. The term hybrid transaction means any transaction, series of transactions, agreement, or instrument one or more payments with respect to which are treated as interest or royalties for U.S. tax purposes but are not so treated for purposes of the tax law of a specified recipient of the payment. Examples of a hybrid transaction include an instrument a payment with respect to which is treated as interest for U.S. tax purposes but, for purposes of a specified recipient’s tax law, is treated as a distribution with respect to equity or a recovery of principal with respect to indebtedness.

(ii) Special rules—(A) Long-term deferral. A specified payment is deemed to be made pursuant to a hybrid transaction if the taxable year in which a specified recipient of the payment takes the payment into account in income under its tax law (or, based on all the facts and circumstances, is reasonably expected to take the payment into account in income under its tax law) ends more than 36 months after the end of the taxable year in which the specified party would be allowed a deduction for the payment under U.S. tax law. In addition, if the tax law of a specified recipient of the specified payment does not impose an income tax, then such tax law does not cause the payment to be deemed to be made pursuant to a hybrid transaction under this paragraph (a)(2)(ii)(A). See §1.267A-6(c)(8) for an example illustrating the application of this paragraph (a)(2)(ii)(A) in the context of the imported mismatch rule.

(B) Royalties treated as payments in exchange for property under foreign law. In the case of a specified payment that is a royalty for U.S. tax purposes and for purposes of the tax law of a specified recipient of the payment is consideration received in exchange for property, the tax law of the specified recipient is not treated as causing the payment to be made pursuant to a hybrid transaction.

(C) Coordination with disregarded payment rule. A specified payment is not considered made pursuant to a hybrid transaction if the payment is a disregarded payment, as described in paragraph (b)(2) of this section.

(3) Payments pursuant to securities lending transactions, sale-repurchase transactions, or similar transactions. This paragraph (a)(3) applies if a specified payment is made pursuant to a repo transaction and is not regarded under a foreign tax law, but another amount connected to the payment (the connected amount) is regarded under such foreign tax law. For purposes of this paragraph (a)(3), a repo transaction means a transaction one or more payments with respect to which are treated as interest (as defined in §1.267A-5(a)(12)) or a structured payment (as defined in §1.267A-5(b)(5)(ii)) for U.S. tax purposes and that is a securities lending transaction or sale-repurchase transaction (including as described in §1.861-2(a)(7)), or other similar transaction or series of related transactions in which legal title to property is transferred and the property (or similar property, such as securities of the same class and issue) is reacquired or expected to be reacquired. For example, this paragraph (a)(3) applies if a specified payment arising from characterizing a repo transaction of stock in accordance with its substance (that is, characterizing the specified payment as interest) is not regarded as such under a foreign tax law but an amount consistent with the form of the transaction (such as a dividend) is regarded under such foreign tax law. When this paragraph (a)(3) applies, the determination of the identity of a specified recipient of the specified payment under the foreign tax law is made with respect to the connected amount. In addition, if the specified recipient includes the connected amount in income (as determined under §1.267A-3(a), by treating the connected amount as the specified payment), then the amount of the specified recipient’s no-inclusion with respect to the specified payment is correspondingly reduced. Further, the principles of this paragraph (a)(3) apply to cases similar to repo transactions in which a foreign tax law does not characterize the transaction in accordance with its substance. See §1.267A-6(c)(2) for an example illustrating the application of this paragraph (a)(3).

(4) Payments pursuant to interest-free loans and similar arrangements. In the case of a specified payment that is interest for U.S. tax purposes, the following special rules apply:

(i) The payment is deemed to be made pursuant to a hybrid transaction to the extent that—

(A) Under U.S. tax law, the payment is imputed (for example, under section 482 or 7872, including because the instrument pursuant to which it is made is indebtedness but the terms of the instrument provide for an interest rate equal to or less than the risk-free rate or the rate on sovereign debt with similar terms in the relevant foreign currency); and

(B) A tax resident or taxable branch to which the payment is made does not take the payment into account in income under its tax law because such tax law does not impute any interest. The rules of paragraph (b)(4) of this section apply for purposes of determining whether the specified payment is made indirectly to a tax resident or taxable branch.

(ii) A tax resident or taxable branch the tax law of which causes the payment to be deemed to be made pursuant to a hybrid transaction under paragraph (a)(4)(i) of this section is deemed to be a specified recipient of the payment for purposes of paragraph (a)(1) of this section.

(b) Disregarded payments—(1) In general. Subject to §1.267A-3(b) (amounts included or includible in income), the excess (if any) of the sum of a specified party’s disregarded payments for a taxable year over its dual inclusion income for the taxable year is a disqualified hybrid amount. See §1.267A-6(c)(3) and (4) for examples illustrating the application of paragraph (b) of this section.

(2) Definition of disregarded payment—(i) In general. The term disregarded payment means a specified payment to the extent that, under the tax law of a tax resident or taxable branch to which the payment is made, the payment is not regarded (for example, because under such tax law it is a payment involving a single taxpayer or members of a group) and, were the payment to be regarded (and treated as interest or a royalty, as applicable) under such tax law, the tax resident or taxable branch would include the payment in income, as determined under §1.267A-3(a).

(ii) Special rules—(A) Foreign consolidation and similar regimes. A disregarded payment includes a specified payment that, under the tax law of a tax resident or taxable branch to which the payment is made, is a payment that gives rise to a deduction or similar offset allowed to the tax resident or taxable branch (or group of entities that include the tax resident or taxable branch) under a foreign consolidation, fiscal unity, group relief, loss sharing, or any similar regime.

(B) Certain payments of a U.S. taxable branch. In the case of a specified payment of a U.S. taxable branch, the payment is not a disregarded payment to the extent that under the tax law of the tax resident to which the payment is made the payment is otherwise taken into account. See paragraph (c)(2) of this section for an example of when an amount may be otherwise taken into account.

(C) Coordination with other hybrid and branch arrangements. A disregarded payment does not include a deemed branch payment described in paragraph (c)(2) of this section, a specified payment pursuant to a repo transaction or similar transaction described in paragraph (a)(3) of this section, or a specified payment pursuant to an interest-free loan or similar transaction described in paragraph (a)(4) of this section.

(3) Definition of dual inclusion income—(i) In general. With respect to a specified party, the term dual inclusion income means the excess, if any, of—

(A) The sum of the specified party’s items of income or gain for U.S. tax purposes that are included in the specified party’s income, as determined under §1.267A-3(a) (by treating the items of income or gain as the specified payment; and, in the case of a specified party that is a CFC, by treating U.S. tax law as the CFC’s tax law), to the extent the items of income or gain are included in the income of the tax resident or taxable branch to which the disregarded payments are made, as determined under §1.267A-3(a) (by treating the items of income or gain as the specified payment); over

(B) The sum of the specified party’s items of deduction or loss for U.S. tax purposes (other than deductions for disregarded payments), to the extent the items of deduction or loss are allowable (or have been or will be allowable during a taxable year that ends no more than 36 months after the end of the specified party’s taxable year) under the tax law of the tax resident or taxable branch to which the disregarded payments are made.

(ii) Special rule for certain dividends. An item of income or gain of a specified party that is included in the specified party’s income but not included in the income of the tax resident or taxable branch to which the disregarded payments are made is considered described in paragraph (b)(3)(i)(A) of this section to the extent that, under the tax resident’s or taxable branch’s tax law, the item is a dividend that would have been included in the income of the tax resident or taxable branch but for an exemption, exclusion, deduction, credit, or other similar relief particular to the item, provided that the party paying the item is not allowed a deduction or other tax benefit for it under its tax law. Similarly, an item of income or gain of a specified party that is included in the income of the tax resident or taxable branch to which the disregarded payments are made but not included in the specified party’s income is considered described in paragraph (b)(3)(ii)(A) of this section to the extent that, under U.S. tax law, the item is a dividend that would have been included in the income of the specified party but for a dividends received deduction with respect to the dividend (for example, a deduction under section 245A(a)), provided that the party paying the item is not allowed a deduction or other tax benefit for it under its tax law. See §1.267A-6(c)(3)(iv) for an example illustrating the application of this paragraph (b)(3)(ii).

(4) Payments made indirectly to a tax resident or taxable branch. A specified payment made to an entity an interest of which is directly or indirectly (determined under the rules of section 958(a) without regard to whether an intermediate entity is foreign or domestic, or under substantially similar rules under a tax resident’s or taxable branch’s tax law) owned by a tax resident or taxable branch is considered made to the tax resident or taxable branch to the extent that, under the tax law of the tax resident or taxable branch, the entity to which the payment is made is fiscally transparent (and all intermediate entities, if any, are also fiscally transparent).

(c) Deemed branch payments—(1) In general. If a specified payment is a deemed branch payment, then the payment is a disqualified hybrid amount if the tax law of the home office provides an exclusion or exemption for income attributable to the branch. See §1.267A-6(c)(4) for an example illustrating the application of this paragraph (c).

(2) Definition of deemed branch payment. The term deemed branch payment means, with respect to a U.S. taxable branch that is a U.S. permanent establishment of a treaty resident eligible for benefits under an income tax treaty between the United States and the treaty country, any amount of interest or royalties allowable as a deduction in computing the business profits of the U.S. permanent establishment, to the extent the amount is deemed paid to the home office (or other branch of the home office), is not regarded (or otherwise taken into account) under the home office’s tax law (or the other branch’s tax law), and, were the payment to be regarded (and treated as interest or a royalty, as applicable) under the home office’s tax law (or other branch’s tax law), the home office (or other branch) would include the payment in income, as determined under §1.267A-3(a). An amount may be otherwise taken into account for purposes of this paragraph (c)(2) if, for example, under the home office’s tax law a corresponding amount of interest or royalties is allocated and attributable to the U.S. permanent establishment and is therefore not deductible.

(d) Payments to reverse hybrids—(1) In general. If a specified payment is made to a reverse hybrid, then, subject to §1.267A-3(b) (amounts included or includible in income), the payment is a disqualified hybrid amount to the extent that—

(i) An investor, the tax law of which treats the reverse hybrid as not fiscally transparent, does not include the payment in income, as determined under §1.267A-3(a) (to such extent, a no-inclusion); and

(ii) The investor’s no-inclusion is a result of the payment being made to the reverse hybrid. For purposes of this paragraph (d)(1)(ii), the investor’s no-inclusion is a result of the specified payment being made to the reverse hybrid to the extent that the no-inclusion would not occur were the investor’s tax law to treat the reverse hybrid as fiscally transparent (and treat the payment as interest or a royalty, as applicable). See §1.267A-6(c)(5) for an example illustrating the application of paragraph (d) of this section.

(2) Definition of reverse hybrid. The term reverse hybrid means an entity (regardless of whether domestic or foreign) that is fiscally transparent under the tax law of the country in which it is created, organized, or otherwise established but not fiscally transparent under the tax law of an investor of the entity.

(3) Payments made indirectly to a reverse hybrid. A specified payment made to an entity an interest of which is directly or indirectly (determined under the rules of section 958(a) without regard to whether an intermediate entity is foreign or domestic, or under substantially similar rules under a tax resident’s or taxable branch’s tax law) owned by a reverse hybrid is considered made to the reverse hybrid to the extent that, under the tax law of an investor of the reverse hybrid, the entity to which the payment is made is fiscally transparent (and all intermediate entities, if any, are also fiscally transparent).

(4) Exception for inclusion by taxable branch in establishment country. Paragraph (d)(1) of this section does not apply to a specified payment made to a reverse hybrid to the extent that a taxable branch located in the country in which the reverse hybrid is created, organized, or otherwise established (and the activities of which are carried on by one or more investors of the reverse hybrid) includes the payment in income, as determined under §1.267A-3(a).

(e) Branch mismatch payments—(1) In general. If a specified payment is a branch mismatch payment, then, subject to §1.267A-3(b) (amounts included or includible in income), the payment is a disqualified hybrid amount to the extent that—

(i) A home office, the tax law of which treats the payment as income attributable to a branch of the home office, does not include the payment in income, as determined under §1.267A-3(a) (to such extent, a no-inclusion); and

(ii) The home office’s no-inclusion is a result of the payment being a branch mismatch payment. For purposes of this paragraph (e)(1)(ii), the home office’s no-inclusion is a result of the specified payment being a branch mismatch payment to the extent that the no-inclusion would not occur were the home office’s tax law to treat the payment as income that is not attributable a branch of the home office (and treat the payment as interest or a royalty, as applicable). See §1.267A-6(c)(6) for an example illustrating the application of paragraph (e) of this section.

(2) Definition of branch mismatch payment. The term branch mismatch payment means a specified payment for which the following requirements are satisfied:

(i) Under a home office’s tax law, the payment is treated as income attributable to a branch of the home office; and

(ii) Either—

(A) The branch is not a taxable branch; or

(B) Under the branch’s tax law, the payment is not treated as income attributable to the branch.

(f) Relatedness or structured arrangement limitation. A specified recipient, a tax resident or taxable branch to which a specified payment is made, an investor, or a home office is taken into account for purposes of paragraphs (a), (b), (d), and (e) of this section, respectively, only if the specified recipient, the tax resident or taxable branch, the investor, or the home office, as applicable, is related (as defined in §1.267A-5(a)(14)) to the specified party or is a party to a structured arrangement (as defined in §1.267A-5(a)(20)) pursuant to which the specified payment is made.

§1.267A-3 Income inclusions and amounts not treated as disqualified hybrid amounts.

(a) Income inclusions—(1) General rule. For purposes of section 267A, a tax resident or taxable branch includes in income a specified payment to the extent that, under the tax law of the tax resident or taxable branch--

(i) It takes the payment into account (or has taken the payment into account, or, based on all the facts and circumstances, is reasonably expected to take the payment into account during a taxable year that ends no more than 36 months after the end of the specified party’s taxable year) in its income or tax base at the full marginal rate imposed on ordinary income (or, if different, the full marginal rate imposed on interest or a royalty, as applicable); and

(ii) The payment is not reduced or offset by an exemption, exclusion, deduction, credit (other than for withholding tax imposed on the payment), or other similar relief particular to such type of payment. Examples of such reductions or offsets include a participation exemption, a dividends received deduction, a deduction or exclusion with respect to a particular category of income (such as income attributable to a branch, or royalties under a patent box regime), a credit for underlying taxes paid by a corporation from which a dividend is received, and a recovery of basis with respect to stock or a recovery of principal with respect to indebtedness. A specified payment is not considered reduced or offset by a deduction or other similar relief particular to the type of payment if it is offset by a generally applicable deduction or other tax attribute, such as a deduction for depreciation or a net operating loss. For purposes of this paragraph (a)(1)(ii), a deduction may be treated as being generally applicable even if it arises from a transaction related to the specified payment (for example, if the deduction and payment are in connection with a back-to-back financing arrangement).

(2) Coordination with foreign hybrid mismatch rules. Whether a tax resident or taxable branch includes in income a specified payment is determined without regard to any defensive or secondary rule contained in hybrid mismatch rules, if any, under the tax law of the tax resident or taxable branch. For purposes of this paragraph (a)(2), a defensive or secondary rule means a provision of hybrid mismatch rules that requires a tax resident or taxable branch to include an amount in income if a deduction for the amount is not disallowed under the payer’s tax law. However, a defensive or secondary rule does not include a rule pursuant to which a participation exemption or similar relief particular to a dividend is inapplicable as to a dividend for which the payer is allowed a deduction or other tax benefit under its tax law. Thus, a defensive or secondary rule does not include a rule consistent with recommendation 2.1 in Chapter 2 of OECD/G-20, Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report (October 2015).

(3) Inclusions with respect to reverse hybrids. With respect to a tax resident or taxable branch that is an investor of a reverse hybrid, whether the investor includes in income a specified payment made to the reverse hybrid is determined without regard to a distribution from the reverse hybrid (or the right to a distribution from the reverse hybrid triggered by the payment). However, if the reverse hybrid distributes all of its income during a taxable year, then, for that year, the determination of whether an investor includes in income a specified payment made to the reverse hybrid is made with regard to one or more distributions from the reverse hybrid during the year, by treating a portion of the specified payment as relating to each distribution during the year. For purposes of this paragraph (a)(3), the portion of the specified payment that is considered to relate to a distribution is the lesser of—

(i) The specified payment multiplied by a fraction, the numerator of which is the amount of the distribution and the denominator of which is the aggregate amount of distributions from the reverse hybrid during the taxable year; and

(ii) The amount of the distribution multiplied by a fraction, the numerator of which is the specified payment and the denominator of which is the sum of all specified payments made to the reverse hybrid during the taxable year.

(4) Inclusions with respect to certain payments pursuant to hybrid transactions. This paragraph (a)(4) applies to a specified payment that is interest and that is made pursuant to a hybrid transaction, to the extent that, under the tax law of a specified recipient of the payment, the payment is a recovery of basis with respect to stock or a recovery of principal with respect to indebtedness such that, but for this paragraph (a)(4), a no-inclusion would occur with respect to the specified recipient. In such a case, an amount that is a repayment of principal for U.S. tax purposes and that is or has been paid (or, based on all the facts and circumstances, is reasonably expected to be paid) by the specified party pursuant to the hybrid transaction (such amount, the principal payment) is, to the extent included in the income of the specified recipient, treated as correspondingly reducing the specified recipient’s no-inclusion with respect to the specified payment. For purposes of this paragraph (a)(4), whether the specified recipient includes the principal payment in income is determined under paragraph (a)(1) of this section, by treating the principal payment as the specified payment and the taxable year period described in paragraph (a)(1) as being composed of taxable years of the specified recipient ending no more than 36 months after the end of the specified party’s taxable year during which the specified payment is made (as opposed to, for example, being composed of taxable years of the specified recipient ending no more than 36 months after the end of the specified party’s taxable year during which the principal payment is reasonably expected to be made). Moreover, once a principal payment reduces a no-inclusion with respect to a specified payment, it is not again taken into account for purposes of applying this paragraph (a)(4) to another specified payment. See §1.267A-6(c)(1)(vi) for an example illustrating the application of this paragraph (a)(4).

(5) Deemed full inclusions and de minimis inclusions. A preferential rate, exemption, exclusion, deduction, credit, or similar relief particular to a type of payment that reduces or offsets 90 percent or more of the payment is considered to reduce or offset 100 percent of the payment. In addition, a preferential rate, exemption, exclusion, deduction, credit, or similar relief particular to a type of payment that reduces or offsets 10 percent or less of the payment is considered to reduce or offset none of the payment.

(b) Certain amounts not treated as disqualified hybrid amounts to extent included or includible in income for U.S. tax purposes—(1) In general. A specified payment, to the extent that but for this paragraph (b) it would be a disqualified hybrid amount (such amount, a tentative disqualified hybrid amount), is reduced under the rules of paragraphs (b)(2) through (4) of this section, as applicable. The tentative disqualified hybrid amount, as reduced under such rules, is the disqualified hybrid amount. See §1.267A-6(c)(3) and (7) for examples illustrating the application of paragraph (b) of this section.

(2) Included in income of United States tax resident or U.S. taxable branch. A tentative disqualified hybrid amount is reduced to the extent that a specified recipient that is a tax resident of the United States or a U.S. taxable branch takes the tentative disqualified hybrid amount into account in determining its gross income.

(3) Includible in income under section 951(a)(1)(A). A tentative disqualified hybrid amount is reduced to the extent that the tentative disqualified hybrid amount is received by a CFC and includible under section 951(a)(1)(A) (determined without regard to properly allocable deductions of the CFC, qualified deficits under section 952(c)(1)(B), and the earnings and profits limitation under §1.952-1(c)) in the gross income of a United States shareholder of the CFC. However, if the United States shareholder is a domestic partnership, then the amount includible under section 951(a)(1)(A) in the gross income of the United States shareholder reduces the tentative disqualified hybrid amount only to the extent that a tax resident of the United States would take into account the amount.

(4) Includible in income under section 951A(a). A tentative disqualified hybrid amount is reduced to the extent that the tentative disqualified hybrid amount increases a United States shareholder’s pro rata share of tested income (as determined under §§1.951A-1(d)(2) and 1.951A-2(b)(1)) with respect to a CFC, reduces the shareholder’s pro rata share of tested loss (as determined under §§1.951A-1(d)(4) and 1.951A-2(b)(2)) of the CFC, or both. However, to the extent that a deduction for the tentative disqualified hybrid amount would be allowed to a tax resident of the United States or a U.S. taxable branch, or would be allowed to a CFC but would be allocated and apportioned to gross income of the CFC that is gross income taken into account in determining subpart F income (as described in section 952) or gross income that is effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States (as described in §1.882-4(a)(1)), the reduction provided under this paragraph (b)(4) is equal to the reduction that would be provided under this paragraph (b)(4) but for this sentence multiplied by the difference of 100 percent and the percentage described in section 250(a)(1)(B).

(5) Includible in income under section 1293. A tentative disqualified hybrid amount is reduced to the extent that the tentative disqualified hybrid amount is received by a qualified electing fund (as described in section 1295) and is includible under section 1293 in the gross income of a United States person that owns stock of that fund. However, if the United States person is a domestic partnership, then the amount includible under section 1293 in the gross income of the United States person reduces the tentative disqualified hybrid amount only to the extent that a tax resident of the United States would take into account the amount.

§1.267A-4 Disqualified imported mismatch amounts.

(a) Disqualified imported mismatch amounts—(1) Rule. An imported mismatch payment is a disqualified imported mismatch amount to the extent that, under the set-off rules of paragraph (c) of this section, the income attributable to the payment is directly or indirectly offset by a hybrid deduction incurred by a foreign tax resident or foreign taxable branch that is related to the imported mismatch payer (or that is a party to a structured arrangement pursuant to which the payment is made). See §1.267A-6(c)(8) through (12) for examples illustrating the application of this section.

(2) Definitions of certain terms. The following definitions apply for purposes of this section:

(i) A foreign tax resident means a tax resident that is not a tax resident of the United States.

(ii) A foreign taxable branch means a taxable branch that is not a U.S. taxable branch.

(iii) An imported mismatch payee means, with respect to an imported mismatch payment, a foreign tax resident or foreign taxable branch that includes the payment in income, as determined under §1.267A-3(a).

(iv) An imported mismatch payer means, with respect to an imported mismatch payment, the specified party.

(v) An imported mismatch payment means a specified payment to the extent that it is neither a disqualified hybrid amount nor included or includible in income in the United States. For purposes of this paragraph (a)(2)(v), a specified payment is included or includible in income in the United States to the extent that, if the payment were a tentative disqualified hybrid amount (as described in §1.267A-3(b)(1)), it would be reduced under the rules of §1.267A-3(b)(2) through (5).

(b) Hybrid deduction—(1) In general. A hybrid deduction means any of the following:

(i) A deduction allowed to a foreign tax resident or foreign taxable branch under its tax law for an amount paid or accrued that is interest (including an amount that would be a structured payment under the principles of §1.267A-5(b)(5)(ii)) or royalty under such tax law, to the extent that a deduction for the amount would be disallowed if such tax law contained rules substantially similar to those under §§1.267A-1 through 1.267A-3 and 1.267A-5. Such a deduction is a hybrid deduction regardless of whether or how the amount giving rise to the deduction would be recognized under U.S. tax law.

(ii) A deduction allowed to a foreign tax resident or foreign taxable branch under its tax law with respect to equity (including deemed equity), such as a notional interest deduction (or similar deduction determined with respect to the foreign tax resident’s or foreign taxable branch’s equity). However, a deduction allowed to a foreign tax resident or foreign taxable branch with respect to equity is a hybrid deduction only to the extent that an investor of the foreign tax resident, or the home office of the foreign taxable branch, would include the amount in income if, for purposes of the investor’s or home office’s tax law, the amount were interest paid by the foreign tax resident ratably (by value) with respect to the interests of the foreign tax resident, or interest paid by the foreign taxable branch to the home office. For purposes of this paragraph (b)(1)(ii), the rules of §1.267A-3(a) apply to determine the extent that an investor or home office would include an amount in income, by treating the amount as the specified payment.

(2) Special rules—(i) Foreign tax law contains hybrid mismatch rules. In the case of a foreign tax resident or foreign taxable branch the tax law of which contains hybrid mismatch rules, only the following deductions allowed to the foreign tax resident or foreign taxable branch under its tax law are hybrid deductions:

(A) A deduction described in paragraph (b)(1)(i) of this section, to the extent that the deduction would be disallowed if the foreign tax resident’s or foreign taxable branch’s tax law—

(1) Contained a rule substantially similar to §1.267A-2(a)(4) (payments pursuant to interest-free loans and similar arrangements); or

(2) Did not permit an inclusion in income in a third country to discharge the application of its hybrid mismatch rules as to the amount giving rise to the deduction when the amount is not included in income in another country as a result of a hybrid or branch arrangement.

(B) A deduction described in paragraph (b)(1)(ii) of this section (deductions with respect to equity).

(ii) Dual inclusion income used to determine hybrid deductions arising from deemed branch payments in certain cases. In the case of a foreign taxable branch the tax law of which permits a loss of the foreign taxable branch to be shared with a tax resident or taxable branch (without regard to whether it is in fact so shared or whether there is a tax resident or taxable branch with which the loss can be shared), a deduction allowed to the foreign taxable branch for an amount that would be a deemed branch payment were such tax law to contain a provision substantially similar to §1.267A-2(c) is a hybrid deduction to the extent of the excess (if any) of the sum of all such amounts over the foreign taxable branch’s dual inclusion income (as determined under the principles of §1.267A-2(b)(3)). The rule in this paragraph (b)(2)(ii) applies without regard to whether the tax law of the home office provides an exclusion or exemption for income attributable to the branch.

(iii) Certain deductions are hybrid deductions only if allowed for an accounting period beginning on or after December 20, 2018. A deduction described in paragraph (b)(1)(ii) of this section (deductions with respect to equity), or a deduction that would be disallowed if the foreign tax resident’s or foreign taxable branch’s tax law contained a rule substantially similar to §1.267A-2(a)(4) (payments pursuant to interest-free loans and similar arrangements), is a hybrid deduction only if allowed for an accounting period beginning on or after December 20, 2018.

(iv) Certain deductions of a CFC are not hybrid deductions. A deduction that but for this paragraph (b)(2)(iv) would be a hybrid deduction is not a hybrid deduction to the extent that the amount paid or accrued giving rise to the deduction is—

(A) A disqualified hybrid amount (but subject to the special rule of paragraph (g) of this section); or

(B) Included or includible in income in the United States. For purposes of this paragraph (b)(2)(iv)(B), an amount is included or includible in income in the United States to the extent that, if the amount were a tentative disqualified hybrid amount (as described in §1.267A-3(b)(1)), it would be reduced under the rules of §1.267A-3(b)(2) through (5).

(v) Loss carryovers. A hybrid deduction for a particular accounting period includes a loss carryover from another accounting period, but only to the extent that a hybrid deduction incurred in an accounting period ending on or after December 20, 2018, comprises the loss carryover.

(c) Set-off rules—(1) In general. In the order described in paragraph (c)(2) of this section, a hybrid deduction directly or indirectly offsets the income attributable to an imported mismatch payment to the extent that, under paragraph (c)(3) of this section, the payment directly or indirectly funds the hybrid deduction. The rules of paragraphs (c)(2) and (3) of this section are applied by taking into account the application of paragraph (c)(4) of this section (adjustments to ensure that amounts not taken into account more than once).

(2) Ordering rules. The following ordering rules apply for purposes of determining the extent that a hybrid deduction directly or indirectly offsets income attributable to imported mismatch payments.

(i) First, the hybrid deduction offsets income attributable to a factually-related imported mismatch payment that directly or indirectly funds the hybrid deduction. For purposes of this paragraph (c)(2)(i), a factually-related imported mismatch payment means an imported mismatch payment that is made pursuant to a transaction, agreement, or instrument entered into pursuant to the same plan or series of related transactions that includes the transaction, agreement, or instrument pursuant to which the hybrid deduction is incurred, provided that a design of the plan or series of related transactions was for the hybrid deduction to offset income attributable to the payment (as determined under the principles of §1.267A-5(a)(20)(i), by treating the offset as the “hybrid mismatch” described in §1.267A-5(a)(20)(i)).

(ii) Second, to the extent remaining, the hybrid deduction offsets income attributable to an imported mismatch payment (other than a factually-related imported mismatch payment) that directly funds the hybrid deduction.

(iii) Third, to the extent remaining, the hybrid deduction offsets income attributable to an imported mismatch payment (other than a factually-related imported mismatch payment) that indirectly funds the hybrid deduction.

(3) Funding rules. The following funding rules apply for purposes of determining the extent that an imported mismatch payment directly or indirectly funds a hybrid deduction.

(i) The imported mismatch payment directly funds a hybrid deduction to the extent that the imported mismatch payee incurs the hybrid deduction.

(ii) The imported mismatch payment indirectly funds a hybrid deduction to the extent that the imported mismatch payee is allocated the hybrid deduction, and provided that the imported mismatch payee is related to the imported mismatch payer (or is a party to a structured arrangement pursuant to which the imported mismatch payment is made).

(iii) The imported mismatch payee is allocated a hybrid deduction to the extent that the imported mismatch payee directly or indirectly makes a funded taxable payment to the foreign tax resident or foreign taxable branch that incurs the hybrid deduction.

(iv) An imported mismatch payee indirectly makes a funded taxable payment to the foreign tax resident or foreign taxable branch that incurs a hybrid deduction to the extent that a chain of funded taxable payments connects the imported mismatch payee, each intermediary foreign tax resident or foreign taxable branch, and the foreign tax resident or foreign taxable branch that incurs the hybrid deduction, and provided that each intermediary foreign tax resident or foreign taxable branch is related to the imported mismatch payer (or is a party to a structured arrangement pursuant to which the imported mismatch payment is made).

(v) The term funded taxable payment means an amount paid or accrued by a foreign tax resident or foreign taxable branch under its tax law (other than an amount that gives rise to a hybrid deduction), to the extent that—

(A) The amount is deductible (but, if such tax law contains hybrid mismatch rules, determined without regard to a provision substantially similar to this section);

(B) Another foreign tax resident or foreign taxable branch includes the amount in income, as determined under §1.267A-3(a) (by treating the amount as the specified payment); and

(C) The amount is neither a disqualified hybrid amount (but subject to the special rule of paragraph (g) of this section) nor included or includible in income in the United States. For purposes of this paragraph (c)(3)(v)(C), an amount is included or includible in income in the United States to the extent that, if the amount were a tentative disqualified hybrid amount (as described in §1.267A-3(b)(1)), it would be reduced under the rules of §1.267A-3(b)(2) through (5).

(vi) If a deduction or loss that is not incurred by a foreign tax resident or foreign taxable branch is directly or indirectly made available to offset income of the foreign tax resident or foreign taxable branch under its tax law, then, for purposes of this paragraph (c), the foreign tax resident or foreign taxable branch to which the deduction or loss is made available and the foreign tax resident or foreign taxable branch that incurs the deduction or loss are treated as a single foreign tax resident or foreign taxable branch. For example, if a deduction or loss of one foreign tax resident is made available to offset income of another foreign tax resident under a tax consolidation, fiscal unity, group relief, loss sharing, or any similar regime, then the foreign tax residents are treated as a single foreign tax resident for purposes of this paragraph (c).

(vii) An imported mismatch payee that directly makes a funded taxable payment to the foreign tax resident or foreign taxable branch that incurs a hybrid deduction is allocated the hybrid deduction before the hybrid deduction (to the extent remaining) is allocated to an imported mismatch payee that indirectly makes a funded taxable payment to the foreign tax resident or foreign taxable branch that incurs the hybrid deduction.

(viii) An imported mismatch payee that, through a chain of funded taxable payments consisting of a particular number of funded taxable payments, indirectly makes a funded taxable payment to the foreign tax resident or foreign taxable branch that incurs a hybrid deduction is allocated the hybrid deduction before the hybrid deduction (to the extent remaining) is allocated to an imported mismatch payee that, through a chain of funded taxable payments consisting of a greater number of funded taxable payments, indirectly makes a funded taxable payment to the foreign tax resident or foreign taxable branch that incurs the hybrid deduction.

(4) Adjustments to ensure amounts not taken into account more than once. To the extent that the income attributable to an imported mismatch payment is directly or indirectly offset by a hybrid deduction, the imported mismatch payment, the hybrid deduction, and, if applicable, each funded taxable payment comprising the chain of funded taxable payments connecting the imported mismatch payee, each intermediary foreign tax resident or foreign taxable branch, and the foreign tax resident or foreign taxable branch that incurs the hybrid deduction is correspondingly reduced; as a result, such amounts are not again taken into account under this section.

(d) Calculations based on aggregate amounts during accounting period. For purposes of this section, amounts are determined on an accounting period basis. Thus, for example, the amount of imported mismatch payments made by an imported mismatch payer to a particular imported mismatch payee is equal to the aggregate amount of all such payments made by the imported mismatch payer during the accounting period.

(e) Pro rata adjustments. Amounts are allocated on a pro rata basis if there would otherwise be more than one permissible manner in which to allocate the amounts. Thus, for example, if multiple imported mismatch payers make an imported mismatch payment to a single imported mismatch payee, the sum of such payments exceeds the hybrid deduction incurred by the imported mismatch payee, and the payments are not factually-related imported mismatch payments, then a pro rata portion of each imported mismatch payer’s payment is considered to directly fund the hybrid deduction. See §1.267A-6(c)(9) and (12) for examples illustrating the application of this paragraph (e).

(f) Special rules regarding manner in which this section is applied—(1) Initial application of this section. This section is first applied without regard to paragraph (f)(2) of this section and by taking into account only the following hybrid deductions:

(i) A hybrid deduction described in paragraph (b)(1)(i) of this section, to the extent that—

(A) The deduction would be disallowed if the foreign tax resident’s or foreign taxable branch’s tax law contained a rule substantially similar to §1.267A-2(a)(4) (payments pursuant to interest-free loans and similar arrangements); or

(B) The paid or accrued amount giving rise to the deduction is included in income in a third country but is not included in income in another country as a result of a hybrid or branch arrangement.

(ii) A hybrid deduction described in paragraph (b)(1)(ii) of this section (deductions with respect to equity).

(2) Subsequent application of this section takes into account certain amounts deemed to be imported mismatch payments. After this section is applied pursuant to the rules of paragraph (f)(1) of this section, the section is then applied by taking into account only hybrid deductions other than those described in paragraph (f)(1) of this section. In addition, when applying this section in the manner described in the previous sentence, for purposes of determining the extent to which the income attributable to an imported mismatch payment is directly or indirectly offset by a hybrid deduction, an amount paid or accrued by a foreign tax resident or foreign taxable branch that is not a specified party is deemed to be an imported mismatch payment (and such foreign tax resident or foreign taxable branch and a foreign tax resident or foreign taxable branch that includes the amount in income, as determined under §1.267A-3(a), by treating the amount as the specified payment, are deemed to be an imported mismatch payer and an imported mismatch payee, respectively) to the extent that—

(i) The tax law of such foreign tax resident or foreign taxable branch contains hybrid mismatch rules; and

(ii) The amount is subject to disallowance under a provision of the hybrid mismatch rules substantially similar to this section. See §1.267A-6(c)(10) and (12) for examples illustrating the application of paragraph (f)(2) of this section.

(g) Special rule regarding extent to which a disqualified hybrid amount of a CFC prevents a hybrid deduction or a funded taxable payment. A disqualified hybrid amount of a CFC is taken into account for purposes of paragraph (b)(2)(iv)(A) or (c)(3)(v)(C) of this section (certain deductions not hybrid deductions or funded taxable payments to the extent the amount giving rise to the deduction is a disqualified hybrid amount) only to the extent of the excess (if any) of the disqualified hybrid amount over the sum of the amounts described in paragraphs (g)(1) through (3) of this section. See §1.267A-6(c)(11) for an example illustrating the application of this paragraph (g).

(1) The disqualified hybrid amount to the extent that, if allowed as a deduction, it would be allocated and apportioned to residual CFC gross income (as described in §1.951A-2(c)(5)(iii)(B)) of the CFC.

(2) The disqualified hybrid amount to the extent that, if allowed as a deduction, it would be allocated and apportioned (under the rules of section 954(b)(5)) to gross income that is taken into account in determining the CFC’s subpart F income (as described in section 952 and §1.952-1), multiplied by the difference of 100 percent and the percentage of stock (by value) of the CFC that, for purposes of sections 951 and 951A, is owned (within the meaning of section 958(a), and determined by treating a domestic partnership as foreign) by one or more tax residents of the United States that are United States shareholders of the CFC.

(3) The disqualified hybrid amount to the extent that, if allowed as a deduction, it would be allocated and apportioned (under the rules of §1.951A-2(c)(3)) to gross tested income of the CFC (as described in section 951A(c)(2)(A) and §1.951A-2(c)(1)), multiplied by the difference of 100 percent and the percentage of stock (by value) of the CFC that, for purposes of sections 951 and 951A, is owned (within the meaning of section 958(a), and determined by treating a domestic partnership as foreign) by one or more tax residents of the United States that are United States shareholders of the CFC.

§1.267A-5 Definitions and special rules.

(a) Definitions. For purposes of §§1.267A-1 through 1.267A-7 the following definitions apply.

(1) The term accounting period means a taxable year, or a period of similar length over which, under a provision of hybrid mismatch rules substantially similar to §1.267A-4, computations similar to those under §1.267A-4 are made under a foreign tax law.

(2) The term branch means a taxable presence of a tax resident in a country other than its country of residence as determined under either the tax resident’s tax law or such other country’s tax law.

(3) The term branch mismatch payment has the meaning provided in §1.267A-2(e)(2).

(4) The term controlled foreign corporation (or CFC) has the meaning provided in section 957.

(5) The term deemed branch payment has the meaning provided in §1.267A-2(c)(2).

(6) The term disregarded payment has the meaning provided in §1.267A-2(b)(2).

(7) The term entity means any person as described in section 7701(a)(1), including an entity that under §§301.7701-1 through 301.7701-3 of this chapter is disregarded as an entity separate from its owner, other than an individual.

(8) The term fiscally transparent means, with respect to an entity, fiscally transparent with respect to an item of income as determined under the principles of §1.894-1(d)(3)(ii) and (iii), without regard to whether a tax resident (either the entity or interest holder in the entity) that derives the item of income is a resident of a country that has an income tax treaty with the United States. In addition, the following special rules apply with respect to an item of income received by an entity:

(i) The entity is fiscally transparent with respect to the item under the tax law of the country in which the entity is created, organized, or otherwise established if, under that tax law, the entity does not take the item into account in its income (without regard to whether such tax law requires an investor of the entity, wherever resident, to separately take into account on a current basis the investor’s respective share of the item), and the effect under that tax law is that an investor of the entity is required to take the item into account in its income as if the item were realized directly from the source from which realized by the entity, whether or not distributed.

(ii) The entity is fiscally transparent with respect to the item under the tax law of an investor of the entity if, under that tax law, an investor of the entity takes the item into account in its income (without regard to whether such tax law requires the investor to separately take into account on a current basis the investor’s respective share of the item) as if the item were realized directly from the source from which realized by the entity, whether or not distributed.

(iii) The entity is fiscally transparent with respect to the item under the tax law of the country in which the entity is created, organized, or otherwise established if—

(A) That tax law imposes a corporate income tax; and

(B) Under that tax law, neither the entity is required to take the item into account in its income nor an investor of the entity is required to take the item into account in its income as if the item were realized directly from the source from which realized by the entity, whether or not distributed.

(9) The term home office means a tax resident that has a branch.

(10) The term hybrid mismatch rules means rules, regulations, or other tax guidance substantially similar to section 267A, and includes rules the purpose of which is to neutralize the deduction/no-inclusion outcome of hybrid and branch mismatch arrangements. Examples of such rules would include rules based on, or substantially similar to, the recommendations contained in OECD/G-20, Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report (October 2015), and OECD/G-20, Neutralising the Effects of Branch Mismatch Arrangements, Action 2: Inclusive Framework on BEPS (July 2017).

(11) The term hybrid transaction has the meaning provided in §1.267A-2(a)(2).

(12) The term interest means any amount described in paragraph (a)(12)(i) or (ii) of this section that is paid or accrued, or treated as paid or accrued, for the taxable year or that is otherwise designated as interest expense in paragraph (a)(12)(i) or (ii) of this section.

(i) In general. Interest is an amount paid, received, or accrued as compensation for the use or forbearance of money under the terms of an instrument or contractual arrangement, including a series of transactions, that is treated as a debt instrument for purposes of section 1275(a) and §1.1275-1(d), and not treated as stock under §1.385-3, or an amount that is treated as interest under other provisions of the Internal Revenue Code (Code) or the regulations in this part. Thus, interest includes, but is not limited to, the following—

(A) Original issue discount (OID);

(B) Qualified stated interest, as adjusted by the issuer for any bond issuance premium;

(C) OID on a synthetic debt instrument arising from an integrated transaction under §1.1275-6;

(D) Repurchase premium to the extent deductible by the issuer under §1.163-7(c);

(E) Deferred payments treated as interest under section 483;

(F) Amounts treated as interest under a section 467 rental agreement;

(G) Forgone interest under section 7872;

(H) De minimis OID taken into account by the issuer;

(I) Amounts paid in connection with a sale-repurchase agreement treated as indebtedness under Federal tax principles;

(J) Redeemable ground rent treated as interest under section 163(c); and

(K) Amounts treated as interest under section 636.

(ii) Swaps with significant nonperiodic payments—(A) In general. Except as provided in paragraphs (a)(12)(ii)(B) and (C) of this section, a swap with significant nonperiodic payments is treated as two separate transactions consisting of an on-market, level payment swap and a loan. The loan must be accounted for by the parties to the contract independently of the swap. The time value component associated with the loan, determined in accordance with §1.446-3(f)(2)(iii)(A), is recognized as interest expense to the payor.

(B) Exception for cleared swaps. Paragraph (a)(12)(ii)(A) of this section does not apply to a cleared swap. The term cleared swap means a swap that is cleared by a derivatives clearing organization, as such term is defined in section 1a of the Commodity Exchange Act (7 U.S.C. 1a), or by a clearing agency, as such term is defined in section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c), that is registered as a derivatives clearing organization under the Commodity Exchange Act or as a clearing agency under the Securities Exchange Act of 1934, respectively, if the derivatives clearing organization or clearing agency requires the parties to the swap to post and collect margin or collateral.

(C) Exception for non-cleared swaps subject to margin or collateral requirements. Paragraph (a)(12)(ii)(A) of this section does not apply to a non-cleared swap that requires the parties to meet the margin or collateral requirements of a Federal regulator or that provides for margin or collateral requirements that are substantially similar to a cleared swap or a non-cleared swap subject to the margin or collateral requirements of a Federal regulator. For purposes of this paragraph (a)(12)(ii)(C), the term Federal regulator means the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), or a prudential regulator, as defined in section 1a(39) of the Commodity Exchange Act (7 U.S.C. 1a), as amended by section 721 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Public Law No. 111-203, 124 Stat. 1376, Title VII.

(13) The term investor means, with respect to an entity, any tax resident or taxable branch that directly or indirectly (determined under the rules of section 958(a) without regard to whether an intermediate entity is foreign or domestic, or under substantially similar rules under a tax resident’s or taxable branch’s tax law) owns an interest in the entity.

(14) The term related has the meaning provided in this paragraph (a)(14). A tax resident or taxable branch is related to a specified party if the tax resident or taxable branch is a related person within the meaning of section 954(d)(3), determined by treating the specified party as the “controlled foreign corporation” referred to in section 954(d)(3) and the tax resident or taxable branch as the “person” referred to in section 954(d)(3). In addition, for the purposes of this paragraph (a)(14), a tax resident that under §§301.7701-1 through 301.7701-3 of this chapter is disregarded as an entity separate from its owner for U.S. tax purposes, as well as a taxable branch, is treated as a corporation. See also §1.954-1(f)(2)(iv)(B)(1) (neither section 318(a)(3), nor §1.958-2(d) or the principles thereof, applies to attribute stock or other interests).

(15) The term reverse hybrid has the meaning provided in §1.267A-2(d)(2).

(16) The term royalty includes amounts paid or accrued as consideration for the use of, or the right to use—

(i) Any copyright, including any copyright of any literary, artistic, scientific or other work (including cinematographic films and software);

(ii) Any patent, trademark, design or model, plan, secret formula or process, or other similar property (including goodwill); or

(iii) Any information concerning industrial, commercial or scientific experience, but does not include—

(A) Amounts paid or accrued for after-sales services;

(B) Amounts paid or accrued for services rendered by a seller to the purchaser under a warranty;

(C) Amounts paid or accrued for pure technical assistance; or

(D) Amounts paid or accrued for an opinion given by an engineer, lawyer or accountant.

(17) The term specified party means a tax resident of the United States, a CFC (other than a CFC with respect to which there is not a tax resident of the United States that, for purposes of sections 951 and 951A, owns (within the meaning of section 958(a), and determined by treating a domestic partnership as foreign) at least ten percent (by vote or value) of the stock of the CFC), and a U.S. taxable branch. Thus, an entity that is fiscally transparent for U.S. tax purposes is not a specified party, though an owner of the entity may be a specified party. For example, in the case of a payment by a partnership, a domestic corporation that is a partner of the partnership is a specified party and a deduction for its allocable share of the payment is subject to disallowance under section 267A.

(18) The term specified payment has the meaning provided in §1.267A-1(b).

(19) The term specified recipient means, with respect to a specified payment, any tax resident that derives the payment under its tax law or any taxable branch to which the payment is attributable under its tax law (or any tax resident that, based on all the facts and circumstances, is reasonably expected to derive the payment under its tax law, or any taxable branch to which, based on all the facts and circumstances, the payment is reasonably expected to be attributable under its tax law). The principles of §1.894-1(d)(1) apply for purposes of determining whether a tax resident derives (or is reasonably expected to derive) a specified payment under its tax law, without regard to whether the tax resident is a resident of a country that has an income tax treaty with the United States. There may be more than one specified recipient with respect to a specified payment.

(20) The terms structured arrangement and party to a structured arrangement have the meaning set forth in this paragraph (a)(20).

(i) Structured arrangement. A structured arrangement means an arrangement with respect to which one or more specified payments would be a disqualified hybrid amount (or a disqualified imported mismatch amount) without regard to the relatedness limitation in §1.267A-2(f) (or without regard to the phrase “that is related to the specified party” in §1.267A-4(a)) (either such outcome, a hybrid mismatch), provided that, based on all the facts and circumstances (including the terms of the arrangement), the arrangement is designed to produce the hybrid mismatch. Facts and circumstances that indicate the arrangement is designed to produce the hybrid mismatch include the following:

(A) The hybrid mismatch is priced into the terms of the arrangement, including—

(1) The pricing of the arrangement is different from what the pricing would have been absent the hybrid mismatch;

(2) Features that alter the terms of the arrangement, including its return if the hybrid mismatch is no longer available; or

(3) A below-market return absent the tax effects or benefits resulting from the hybrid mismatch.

(B) The arrangement is marketed as tax-advantaged where some or all of the tax advantage derives from the hybrid mismatch.

(C) The arrangement is marketed to tax residents of a country the tax law of which enables the hybrid mismatch.

(ii) Party to a structured arrangement. A party to a structured arrangement means a tax resident or taxable branch that participates in the structured arrangement. For purposes of this paragraph (a)(20)(ii), in the case of a tax resident or a taxable branch that is an entity, the tax resident’s or taxable branch’s participation in a structured arrangement is imputed to its investors. However, a tax resident or taxable branch is considered to participate in the structured arrangement only if—

(A) The tax resident or taxable branch (or a related tax resident or taxable branch) could, based on all the facts and circumstances, reasonably be expected to be aware of the hybrid mismatch; and

(B) The tax resident or taxable branch (or a related tax resident or taxable branch) shares in the value of the tax benefit resulting from the hybrid mismatch.

(21) The term tax law of a country includes statutes, regulations, administrative or judicial rulings, and income tax treaties of the country. If a country has an income tax treaty with the United States that applies to taxes imposed by a political subdivision or other local authority of that country, then the tax law of the political subdivision or other local authority is deemed to be a tax law of a country. When used with respect to a tax resident or branch, tax law refers to—

(i) In the case of a tax resident, the tax law of the country or countries where the tax resident is resident; and

(ii) In the case of a branch, the tax law of the country where the branch is located.

(22) The term taxable branch means a branch that has a taxable presence under its tax law.

(23) The term tax resident means either of the following:

(i) A body corporate or other entity or body of persons liable to tax under the tax law of a country as a resident. For purposes of this paragraph (a)(23)(i), an entity that is created, organized, or otherwise established under the tax law of a country that does not impose a corporate income tax is treated as liable to tax under the tax law of such country as a resident if under the corporate or commercial laws of such country the entity is treated as a body corporate or a company. A body corporate or other entity or body of persons may be a tax resident of more than one country.

(ii) An individual liable to tax under the tax law of a country as a resident. An individual may be a tax resident of more than one country.

(24) The term United States shareholder has the meaning provided in section 951(b).

(25) The term U.S. taxable branch means a trade or business carried on in the United States by a tax resident of another country, except that if an income tax treaty applies, the term means a permanent establishment of a tax treaty resident eligible for benefits under an income tax treaty between the United States and the treaty country. Thus, for example, a U.S. taxable branch includes a U.S. trade or business of a foreign corporation taxable under section 882(a) or a U.S. permanent establishment of a tax treaty resident.

(b) Special rules. For purposes of §§1.267A-1 through 1.267A-7, the following special rules apply.

(1) Coordination with other provisions—(i) In general. Except as provided in paragraph (b)(1)(ii) of this section, a specified payment is subject to section 267A after the application of any other applicable provisions of the Code and regulations in this part. Thus, the determination of whether a deduction for a specified payment is disallowed under section 267A is made with respect to the taxable year for which a deduction for the payment would otherwise be allowed for U.S. tax purposes. See, for example, sections 163(e)(3) and 267(a)(3) for rules that may defer the taxable year for which a deduction is allowed. See also §1.882-5(a)(5) (providing that provisions that disallow interest expense apply after the application of §1.882-5). In addition, provisions that characterize amounts paid or accrued as something other than interest or royalties, such as §1.894-1(d)(2), govern the treatment of such amounts and therefore such amounts would not be treated as specified payments. Moreover, to the extent that a specified payment is not described in §1.267A-1(b) when it is subject to section 267A, the payment is not again subject to section 267A at a later time. For example, if for the taxable year in which a specified payment is paid the payment is not described in §1.267A-1(b) but under section 163(j) a deduction for the payment is deferred, the payment is not again subject to section 267A in the taxable year for which section 163(j) no longer defers the deduction.

(ii) Section 267A applied before certain provisions. In addition to the extent provided in any other applicable provision of the Code or regulations in this part, section 267A applies before the application of sections 163(j), 461(l), 465, and 469.

(iii) Coordination with capitalization and recovery provisions. To the extent a specified payment is described in §1.267A-1(b), a deduction for the payment is considered permanently disallowed for all purposes of the Code and regulations in this part and, therefore, the payment is not taken into account for purposes of computing costs that are required to be capitalized and recovered through depreciation, amortization, cost of goods sold, adjustment to basis, or similar forms of recovery under any applicable provision of the Code or in regulations in this part. Thus, for example, to the extent an interest or royalty payment is a specified payment described in §1.267A-1(b), the payment is not capitalized and included in inventory cost or added to basis under section 263A. As an additional example, to the extent that a debt issuance cost is a specified payment described in §1.267A-1(b), it is neither capitalized under section 263 or the regulations in this part under section 263 nor recoverable under §1.446-5.

(iv) Specified payments arising in taxable years beginning before January 1, 2018. Section 267A does not apply to a specified payment that is paid or accrued in a taxable year beginning before January 1, 2018, regardless of whether under a provision of the Code or regulations in this part (for example, section 267(a)(3)) a deduction for the payment is deferred to a taxable year beginning after December 31, 2017, or whether the payment is carried over to another taxable year and under another provision of the Code (for example, section 163(j)) is considered paid or accrued in such taxable year.

(2) Foreign currency gain or loss. Except as set forth in this paragraph (b)(2), section 988 gain or loss is not taken into account under section 267A. Foreign currency gain or loss recognized with respect to a specified payment is taken into account under section 267A to the extent that a deduction for the specified payment is disallowed under section 267A, provided that the foreign currency gain or loss is described in §1.988-2(b)(4) (relating to exchange gain or loss recognized by the issuer of a debt instrument with respect to accrued interest) or §1.988-2(c) (relating to items of expense or gross income or receipts which are to be paid after the date accrued). If a deduction for a specified payment is disallowed under section 267A, then a proportionate amount of foreign currency loss under section 988 with respect to the specified payment is also disallowed, and a proportionate amount of foreign currency gain under section 988 with respect to the specified payment reduces the amount of the disallowance. For purposes of this paragraph (b)(2), the proportionate amount is the amount of the foreign currency gain or loss under section 988 with respect to the specified payment multiplied by a fraction, the numerator of which is the amount of the specified payment for which a deduction is disallowed under section 267A and the denominator of which is the total amount of the specified payment.

(3) U.S. taxable branch payments—(i) Amounts considered paid or accrued by a U.S. taxable branch. For purposes of section 267A, a U.S. taxable branch is considered to pay or accrue an amount of interest or royalty equal to either—

(A) The amount of interest or royalty allocable to effectively connected income of the U.S. taxable branch under section 873(a) or 882(c)(1), as applicable; or

(B) In the case of a U.S. taxable branch that is a U.S. permanent establishment of a treaty resident eligible for benefits under an income tax treaty between the United States and the treaty country, the amount of interest or royalty allowable in computing the business profits attributable to the U.S. permanent establishment.

(ii) Treatment of U.S. taxable branch payments—(A) Interest. Interest considered paid or accrued by a U.S. taxable branch of a foreign corporation under paragraph (b)(3)(i) of this section (the “U.S. taxable branch interest payment”) is treated as a payment directly to the person to which the interest is payable, to the extent it is paid or accrued with respect to a liability described in §1.882-5(a)(1)(ii)(A) or (B) (resulting in directly allocable interest) or with respect to a U.S. booked liability, as described in §1.882-5(d)(2). If the U.S. taxable branch interest payment exceeds in the aggregate the interest paid or accrued on the U.S. taxable branch’s directly allocable interest and interest paid or accrued on U.S. booked liabilities, the excess amount is treated as paid or accrued by the U.S. taxable branch on a pro-rata basis to the same persons and pursuant to the same terms that the home office paid or accrued interest, excluding any directly allocable interest or interest paid or accrued on a U.S. booked liability. The rules of this paragraph (b)(3)(ii) for determining to whom interest is paid or accrued apply without regard to whether the U.S. taxable branch interest payment is determined under the method described in §1.882-5(b) through (d) or the method described in §1.882-5(e).

(B) Royalties. Royalties considered paid or accrued by a U.S. taxable branch under paragraph (b)(3)(i) of this section are treated solely for purposes of section 267A as paid or accrued on a pro-rata basis by the U.S. taxable branch to the same persons and pursuant to the same terms that the home office paid or accrued such royalties.

(C) Permanent establishments and interbranch payments. If a U.S. taxable branch is a permanent establishment in the United States, the principles of the rules in paragraphs (b)(3)(ii)(A) and (B) of this section apply with respect to interest and royalties allowed in computing the business profits of a treaty resident eligible for treaty benefits. This paragraph (b)(3)(ii)(C) does not apply to interbranch interest or royalty payments allowed as deduction under certain U.S. income tax treaties (as described in §1.267A-2(c)(2)).

(4) Effect on earnings and profits. The disallowance of a deduction under section 267A does not affect whether the amount paid or accrued that gave rise to the deduction reduces earnings and profits of a corporation. However, for purposes of section 952(c)(1) and §1.952-1(c), a CFC’s earnings and profits are not reduced by a specified payment a deduction for which is disallowed under section 267A, if a principal purpose of the transaction pursuant to which the payment is made is to reduce or limit the CFC’s subpart F income.

(5) Application to structured payments—(i) In general. For purposes of section 267A and the regulations in this part under section 267A, a structured payment (as defined in paragraph (b)(5)(ii) of this section) is treated as interest. Thus, a structured payment is treated as subject to section 267A and the regulations in this part under section 267A to the same extent as if the payment were an amount of interest paid or accrued.

(ii) Structured payment. A structured payment means any amount described in paragraph (b)(5)(ii)(A) or (B) of this section.

(A) Substitute interest payments. A substitute interest payment described in §1.861-2(a)(7) is treated as a structured payment for purposes of section 267A, unless the payment relates to a sale-repurchase agreement or a securities lending transaction that is entered into by the payor in the ordinary course of the payor’s business. This paragraph (b)(5)(ii)(A) does not apply to an amount described in paragraph (a)(12)(i)(I) of this section.

(B) Amounts economically equivalent to interest—(1) Principal purpose to reduce interest expense. Any expense or loss economically equivalent to interest is treated as a structured payment for purposes of section 267A if a principal purpose of structuring the transaction(s) is to reduce an amount incurred by the taxpayer that otherwise would have been described in paragraph (a)(12) or (b)(5)(ii)(A) of this section. For purposes of this paragraph (b)(5)(ii)(B)(1), the fact that the taxpayer has a business purpose for obtaining the use of funds does not affect the determination of whether the manner in which the taxpayer structures the transaction(s) is with a principal purpose of reducing the taxpayer’s interest expense. In addition, the fact that the taxpayer has obtained funds at a lower pre-tax cost based on the structure of the transaction(s) does not affect the determination of whether the manner in which the taxpayer structures the transaction(s) is with a principal purpose of reducing the taxpayer’s interest expense. For purposes of this paragraph (b)(5)(ii)(B), any expense or loss is economically equivalent to interest to the extent that the expense or loss is—

(i) Deductible by the taxpayer;

(ii) Incurred by the taxpayer in a transaction or series of integrated or related transactions in which the taxpayer secures the use of funds for a period of time;

(iii) Substantially incurred in consideration of the time value of money; and

(iv) Not described in paragraph (a)(12) or (b)(5)(ii)(A) of this section.

(2) Principal purpose. Whether a transaction or a series of integrated or related transactions is entered into with a principal purpose described in paragraph (b)(5)(ii)(B)(1) of this section depends on all the facts and circumstances related to the transaction(s). A purpose may be a principal purpose even though it is outweighed by other purposes (taken together or separately). Factors to be taken into account in determining whether one of the taxpayer’s principal purposes for entering into the transaction(s) include the taxpayer’s normal borrowing rate in the taxpayer’s functional currency, whether the taxpayer would enter into the transaction(s) in the ordinary course of the taxpayer’s trade or business, whether the parties to the transaction(s) are related persons (within the meaning of section 267(b) or 707(b)), whether there is a significant and bona fide business purpose for the structure of the transaction(s), whether the transactions are transitory, for example, due to a circular flow of cash or other property, and the substance of the transaction(s).

(6) Anti-avoidance rule. A specified party’s deduction for a specified payment is disallowed to the extent that both of the following requirements are satisfied:

(i) The payment (or income attributable to the payment) is not included in the income of a tax resident or taxable branch, as determined under §1.267A-3(a) (but without regard to the deemed full inclusion rule in §1.267A-3(a)(5)).

(ii) A principal purpose of the terms or structure of the arrangement (including the form and the tax laws of the parties to the arrangement) is to avoid the application of the regulations in this part under section 267A in a manner that is contrary to the purposes of section 267A and the regulations in this part under section 267A.

§1.267A-6 Examples.

(a) Scope. This section provides examples that illustrate the application of §§1.267A-1 through 1.267A-5.

(b) Presumed facts. For purposes of the examples in this section, unless otherwise indicated, the following facts are presumed:

(1) US1, US2, and US3 are domestic corporations that are tax residents solely of the United States.

(2) FW, FX, and FZ are bodies corporate established in, and tax residents of, Country W, Country X, and Country Z, respectively. They are not fiscally transparent under the tax law of any country. They are not specified parties.

(3) Under the tax law of each country, interest and royalty payments are deductible.

(4) The tax law of each country provides a 100 percent participation exemption for dividends received from non-resident corporations.

(5) The tax law of each country, other than the United States, provides an exemption for income attributable to a branch.

(6) Except as provided in paragraphs (b)(4) and (5) of this section, all amounts derived (determined under the principles of §1.894-1(d)(1)) by a tax resident, or attributable to a taxable branch, are included in income, as determined under §1.267A-3(a).

(7) Only the tax law of the United States contains hybrid mismatch rules.

(c) Examples—(1) Example 1. Payment pursuant to a hybrid financial instrument—(i) Facts. FX holds all the interests of US1. FX also holds an instrument issued by US1 that is treated as equity for Country X tax purposes and indebtedness for U.S. tax purposes (the FX-US1 instrument). On date 1, US1 pays $50x to FX pursuant to the instrument. The amount is treated as an excludible dividend for Country X tax purposes (by reason of the Country X participation exemption) and as interest for U.S. tax purposes.

(ii) Analysis. US1 is a specified party and thus a deduction for its $50x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(1)(ii)(A) through (C) of this section, the entire $50x payment is a disqualified hybrid amount under the hybrid transaction rule of §1.267A-2(a) and, as a result, a deduction for the payment is disallowed under §1.267A-1(b)(1).

(A) US1’s payment is made pursuant to a hybrid transaction because a payment with respect to the FX-US1 instrument is treated as interest for U.S. tax purposes but not for purposes of Country X tax law (the tax law of FX, a specified recipient that is related to US1). See §1.267A-2(a)(2) and (f). Therefore, §1.267A-2(a) applies to the payment.

(B) For US1’s payment to be a disqualified hybrid amount under §1.267A-2(a), a no-inclusion must occur with respect to FX. See §1.267A-2(a)(1)(i). As a consequence of the Country X participation exemption, FX includes $0 of the payment in income and therefore a $50x no-inclusion occurs with respect to FX. See §1.267A-3(a)(1). The result is the same regardless of whether, under the Country X participation exemption, the $50x payment is simply excluded from FX’s taxable income or, instead, is reduced or offset by other means, such as a $50x dividends received deduction. See §1.267A-3(a)(1).

(C) Pursuant to §1.267A-2(a)(1)(ii), FX’s $50x no-inclusion gives rise to a disqualified hybrid amount to the extent that it is a result of US1’s payment being made pursuant to the hybrid transaction. FX’s $50x no-inclusion is a result of the payment being made pursuant to the hybrid transaction because, were the payment to be treated as interest for Country X tax purposes, FX would include $50x in income and, consequently, the no-inclusion would not occur.

(iii) Alternative facts – multiple specified recipients. The facts are the same as in paragraph (c)(1)(i) of this section, except that FX holds all the interests of FZ, which is fiscally transparent for Country X tax purposes, and FZ holds all of the interests of US1. Moreover, the FX-US1 instrument is held by FZ (rather than by FX) and US1 makes its $50x payment to FZ (rather than to FX); the payment is derived by FZ under its tax law and by FX under its tax law and, accordingly, both FZ and FX are specified recipients of the payment. Further, the payment is treated as interest for Country Z tax purposes and FZ includes it in income. For the reasons described in paragraph (c)(1)(ii) of this section, FX’s no-inclusion causes the payment to be a disqualified hybrid amount. FZ’s inclusion in income (regardless of whether Country Z has a low or high tax rate) does not affect the result, because the hybrid transaction rule of §1.267A-2(a) applies if any no-inclusion occurs with respect to a specified recipient of the payment as a result of the payment being made pursuant to the hybrid transaction.

(iv) Alternative facts – preferential rate. The facts are the same as in paragraph (c)(1)(i) of this section, except that for Country X tax purposes US1’s payment is treated as a dividend subject to a 4% tax rate, whereas the marginal rate imposed on ordinary income is 20%. FX includes $10x of the payment in income, calculated as $50x multiplied by 0.2 (.04, the rate at which the particular type of payment (a dividend for Country X tax purposes) is subject to tax in Country X, divided by 0.2, the marginal tax rate imposed on ordinary income). See §1.267A-3(a)(1). Thus, a $40x no-inclusion occurs with respect to FX ($50x less $10x). The $40x no-inclusion is a result of the payment being made pursuant to the hybrid transaction because, were the payment to be treated as interest for Country X tax purposes, FX would include the entire $50x in income at the full marginal rate imposed on ordinary income (20%) and, consequently, the no-inclusion would not occur. Accordingly, $40x of US1’s payment is a disqualified hybrid amount.

(v) Alternative facts – no-inclusion not the result of hybridity. The facts are the same as in paragraph (c)(1)(i) of this section, except that Country X has a pure territorial regime (that is, Country X only taxes income with a domestic source). Although US1’s payment is pursuant to a hybrid transaction and a $50x no-inclusion occurs with respect to FX, FX’s no-inclusion is not a result of the payment being made pursuant to the hybrid transaction. This is because if Country X tax law were to treat the payment as interest, FX would include $0 in income and, consequently, the $50x no-inclusion would still occur. Accordingly, US1’s payment is not a disqualified hybrid amount. See §1.267A-2(a)(1)(ii). The result would be the same if Country X instead did not impose a corporate income tax.

(vi) Alternative facts – indebtedness under both tax laws but different ordering rules give rise to hybrid transaction; reduction of no-inclusion by reason of inclusion of a principal payment. The facts are the same as in paragraph (c)(1)(i) of this section, except that the FX-US1 instrument is indebtedness for both U.S. and Country X tax purposes. In addition, the $50x date 1 payment is treated as interest for U.S. tax purposes and a repayment of principal for Country X tax purposes. On date 1, based on all the facts and circumstances (including the terms of the FX-US1 instrument, the tax laws of the United States and Country X, and an absence of a plan pursuant to which FX would dispose of the FX-US1 instrument), it is reasonably expected that on date 2 (a date that is within 36 months after the end of the taxable year of US1 that includes date 1), US1 will pay a total of $200x to FX and that, for U.S. tax purposes, $25x will be treated as interest and $175x as a repayment of principal, and, for Country X tax purposes, $75x will be treated as interest (and included in FX’s income) and $125x as a repayment of principal. US1’s $50x specified payment is made pursuant to a hybrid transaction and, but for §1.267A-3(a)(4), a $50x no-inclusion would occur with respect to FX. See §§1.267A-2(a)(2) and 1.267A-3(a)(1). However, pursuant to §1.267A-3(a)(4), FX’s inclusion in income with respect to $50x of the date 2 amount that is a repayment of principal for U.S. tax purposes is treated as correspondingly reducing FX’s no-inclusion with respect to the specified payment. As a result, as to US1’s $50x specified payment, a no-inclusion does not occur with respect to FX. See §1.267A-3(a)(4). Therefore, US1’s $50x specified payment is not a disqualified hybrid amount. See §1.267A-2(a)(1)(i).

(2) Example 2. Payment pursuant to a repo transaction—(i) Facts. FX holds all the interests of US1, and US1 holds all the interests of US2. On date 1, US1 and FX enter into a sale and repurchase transaction. Pursuant to the transaction, US1 transfers shares of preferred stock of US2 to FX in exchange for $1,000x, subject to a binding commitment of US1 to reacquire those shares on date 3 for an agreed price, which represents a repayment of the $1,000x plus a financing or time value of money return reduced by the amount of any distributions paid with respect to the preferred stock between dates 1 and 3 that are retained by FX. On date 2, US2 pays a $100x dividend on its preferred stock to FX. For Country X tax purposes, FX is treated as owning the US2 preferred stock and therefore is the beneficial owner of the dividend. For U.S. tax purposes, the transaction is treated as a loan from FX to US1 that is secured by the US2 preferred stock. Thus, for U.S. tax purposes, US1 is treated as owning the US2 preferred stock and is the beneficial owner of the dividend. In addition, for U.S. tax purposes, US1 is treated as paying $100x of interest to FX (an amount corresponding to the $100x dividend paid by US2 to FX). Further, the marginal tax rate imposed on ordinary income under Country X tax law is 25%. Moreover, instead of a participation exemption, Country X tax law provides its tax residents a credit for underlying foreign taxes paid by a non-resident corporation from which a dividend is received; with respect to the $100x dividend received by FX from US2, the credit is $10x.

(ii) Analysis. US1 is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(2)(ii)(A) through (D) of this section, $40x of the payment is a disqualified hybrid amount under the hybrid transaction rule of §1.267A-2(a) and, as a result, $40x of the deduction is disallowed under §1.267A-1(b)(1).

(A) Although US1’s $100x interest payment is not regarded under Country X tax law, a connected amount (US2’s dividend payment) is regarded and derived by FX under such tax law. Thus, FX is considered a specified recipient with respect to US1’s interest payment. See §1.267A-2(a)(3).

(B) US1’s payment is made pursuant to a hybrid transaction because a payment with respect to the sale and repurchase transaction is treated as interest for U.S. tax purposes but not for purposes of Country X tax law (the tax law of FX, a specified recipient that is related to US1), which does not regard the payment. See §1.267A-2(a)(2) and (f). Therefore, §1.267A-2(a) applies to the payment.

(C) For US1’s payment to be a disqualified hybrid amount under §1.267A-2(a), a no-inclusion must occur with respect to FX. See §1.267A-2(a)(1)(i). As a consequence of Country X tax law not regarding US1’s payment, FX includes $0 of the payment in income and therefore a $100x no-inclusion occurs with respect to FX. See §1.267A-3(a). However, FX includes $60x of a connected amount (US2’s dividend payment) in income, calculated as $100x (the amount of the dividend) less $40x (the portion of the connected amount that is not included in income in Country X due to the foreign tax credit, determined by dividing the amount of the credit, $10x, by 0.25, the tax rate in Country X). See §1.267A-3(a). Pursuant to §1.267A-2(a)(3), FX’s inclusion in income with respect to the connected amount correspondingly reduces the amount of its no-inclusion with respect to US1’s payment. Therefore, for purposes of §1.267A-2(a), FX’s no-inclusion with respect to US1’s payment is $40x ($100x less $60x). See §1.267A-2(a)(3).

(D) Pursuant to §1.267A-2(a)(1)(ii), FX’s $40x no-inclusion gives rise to a disqualified hybrid amount to the extent that FX’s no-inclusion is a result of US1’s payment being made pursuant to the hybrid transaction. FX’s $40x no-inclusion is a result of US1’s payment being made pursuant to the hybrid transaction because, were the sale and repurchase transaction to be treated as a loan from FX to US1 for Country X tax purposes, FX would include US1’s $100x interest payment in income (because it would not be entitled to a foreign tax credit) and, consequently, the no-inclusion would not occur.

(iii) Alternative facts – structured arrangement. The facts are the same as in paragraph (c)(2)(i) of this section, except that FX is a bank that is unrelated to US1. In addition, the sale and repurchase transaction is a structured arrangement and FX is a party to the structured arrangement. The result is the same as in paragraph (c)(2)(ii) of this section. That is, even though FX is not related to US1, it is taken into account with respect to the determinations under §1.267A-2(a) because it is a party to a structured arrangement pursuant to which the payment is made. See §1.267A-2(f).

(3) Example 3. Disregarded payment—(i) Facts. FX holds all the interests of US1. For Country X tax purposes, US1 is a disregarded entity of FX. During taxable year 1, US1 pays $100x to FX pursuant to a debt instrument. The amount is treated as interest for U.S. tax purposes but is disregarded for Country X tax purposes as a transaction involving a single taxpayer. During taxable year 1, US1’s only other items of income, gain, deduction, or loss are $125x of gross income (the entire amount of which is included in US1’s income) and a $60x item of deductible expense. The $125x item of gross income is included in FX’s income, and the $60x item of deductible expense is allowable for Country X tax purposes.

(ii) Analysis. US1 is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(3)(ii)(A) and (B) of this section, $35x of the payment is a disqualified hybrid amount under the disregarded payment rule of §1.267A-2(b) and, as a result, $35x of the deduction is disallowed under §1.267A-1(b)(1).

(A) US1’s $100x payment is not regarded under the tax law of Country X (the tax law of FX, a related tax resident to which the payment is made) because under such tax law the payment involves a single taxpayer. See §1.267A-2(b)(2) and (f). In addition, were the tax law of Country X to regard the payment (and treat it as interest), FX would include it in income. Therefore, the payment is a disregarded payment to which §1.267A-2(b) applies. See §1.267A-2(b)(2).

(B) Under §1.267A-2(b)(1), the excess (if any) of US1’s disregarded payments for taxable year 1 ($100x) over its dual inclusion income for the taxable year is a disqualified hybrid amount. US1’s dual inclusion income for taxable year 1 is $65x, calculated as $125x (the amount of US1’s gross income that is included in FX’s income) less $60x (the amount of US1’s deductible expenses, other than deductions for disregarded payments, that are allowable for Country X tax purposes). See §1.267A-2(b)(3). Therefore, $35x is a disqualified hybrid amount ($100x less $65x). See §1.267A-2(b)(1).

(iii) Alternative facts – non-dual inclusion income arising from hybrid transaction. The facts are the same as in paragraph (c)(3)(i) of this section, except that US1 holds all the interests of FZ (a specified party that is a CFC) and US1’s only item of income, gain, deduction, or loss during taxable year 1 (other than the $100x payment to FX) is $80x paid to US1 by FZ pursuant to an instrument treated as indebtedness for U.S. and Country Z tax purposes and equity for Country X tax purposes (the US1-FZ instrument). The $80x is treated as interest for Country Z and U.S. tax purposes (the entire amount of which is included in US1’s income) and is treated as an excludible dividend for Country X tax purposes (by reason of the Country X participation exemption). Paragraphs (c)(3)(iii)(A) and (B) of this section describe the extent to which the specified payments by FZ and US1, each of which is a specified party, are disqualified hybrid amounts.

(A) The hybrid transaction rule of §1.267A-2(a) applies to FZ’s payment because the payment is made pursuant to a hybrid transaction, as a payment with respect to the US1-FZ instrument is treated as interest for U.S. tax purposes but not for purposes of Country X’s tax law (the tax law of FX, a specified recipient that is related to FZ). As a consequence of the Country X participation exemption, an $80x no-inclusion occurs with respect to FX, and such no-inclusion is a result of the payment being made pursuant to the hybrid transaction. Thus, but for §1.267A-3(b), the entire $80x of FZ’s payment would be a disqualified hybrid amount. However, because US1 (a tax resident of the United States that is also a specified recipient of the payment) takes the entire $80x payment into account in its gross income, no portion of the payment is a disqualified hybrid amount. See §1.267A-3(b)(2).

(B) The disregarded payment rule of §1.267A-2(b) applies to US1’s $100x payment to FX, for the reasons described in paragraph (c)(3)(ii)(A) of this section. In addition, US1 has no dual inclusion income for taxable year 1 because, as a result of the Country X participation exemption, no portion of FZ’s $80x payment to US1 (which is derived by FX under its tax law) is included in FX’s income. See §§1.267A-2(b)(3) and 1.267A-3(a). Therefore, the entire $100x payment from US1 to FX is a disqualified hybrid amount, calculated as $100x (the amount of the payment) less $0 (the amount of dual inclusion income). See §1.267A-2(b)(1).

(iv) Alternative facts – dual inclusion income despite participation exemption. The facts are the same as in paragraph (c)(3)(iii) of this section, except that the US1-FZ instrument is treated as indebtedness for U.S. tax purposes and equity for Country Z and Country X tax purposes. In addition, the $80x paid to US1 by FZ is treated as interest for U.S. tax purposes (the entire amount of which is included in US1’s income), a dividend for Country Z tax purposes (for which FZ is not allowed a deduction or other tax benefit), and an excludible dividend for Country X tax purposes (by reason of the Country X participation exemption). For the reasons described in paragraph (c)(3)(iii)(A) of this section, the hybrid transaction rule of §1.267A-2(a) applies to FZ’s payment but no portion of the payment is a disqualified hybrid amount. In addition, the disregarded payment rule of §1.267A-2(b) applies to US1’s $100x payment to FX, for the reasons described in paragraph (c)(3)(ii)(B) of this section. US1’s dual inclusion income for taxable year 1 is $80x. This is because the $80x paid to US1 by FZ is included in US1’s income and, although not included in FX’s income, it is a dividend for Country X tax purposes that would have been included in FX’s income but for the Country X participation exemption, and FZ is not allowed a deduction or other tax benefit for it under Country Z tax law. See §1.267A-2(b)(3)(ii). Therefore, $20x of US1’s $100x payment is a disqualified hybrid amount ($100x less $80x). See §1.267A-2(b)(1).

(4) Example 4. Payment allocable to a U.S. taxable branch—(i) Facts. FX1 and FX2 are foreign corporations that are bodies corporate established in and tax residents of Country X. FX1 holds all the interests of FX2, and FX1 and FX2 file a consolidated return under Country X tax law. FX2 has a U.S. taxable branch (“USB”). During taxable year 1, FX2 pays $50x to FX1 pursuant to an instrument (the “FX1-FX2 instrument”). The amount paid pursuant to the instrument is treated as interest for U.S. tax purposes but, as a consequence of the Country X consolidation regime, is treated as a disregarded transaction between group members for Country X tax purposes. Also during taxable year 1, FX2 pays $100x of interest to an unrelated bank that is not a party to a structured arrangement (the instrument pursuant to which the payment is made, the “bank-FX2 instrument”). FX2’s only other item of income, gain, deduction, or loss for taxable year 1 is $200x of gross income. Under Country X tax law, the $200x of gross income is attributable to USB, but is not included in FX2’s income because Country X tax law exempts income attributable to a branch. Under U.S. tax law, the $200x of gross income is effectively connected income of USB. Further, under section 882(c)(1), $75x of interest is, for taxable year 1, allocable to USB’s effectively connected income. USB has neither liabilities that are directly allocable to it, as described in §1.882-5(a)(1)(ii)(A), nor U.S. booked liabilities, as defined in §1.882-5(d)(2).

(ii) Analysis. USB is a specified party and thus any interest or royalty allowable as a deduction in determining its effectively connected income is subject to disallowance under section 267A. Pursuant to §1.267A-5(b)(3)(i)(A), USB is treated as paying $75x of interest, and such interest is thus a specified payment. Of that $75x, $25x is treated as paid to FX1, calculated as $75x (the interest allocable to USB under section 882(c)(1)) multiplied by 1/3 ($50x, FX2’s payment to FX1, divided by $150x, the total interest paid by FX2). See §1.267A-5(b)(3)(ii)(A). As described in paragraphs (c)(4)(ii)(A) and (B) of this section, the $25x of the specified payment treated as paid by USB to FX1 is a disqualified hybrid amount under the disregarded payment rule of §1.267A-2(b) and, as a result, a deduction for that amount is disallowed under §1.267A-1(b)(1).

(A) USB’s $25x payment to FX1 is not regarded under the tax law of Country X (the tax law of FX1, a related tax resident to which the payment is made) because under such tax law it is a disregarded transaction between group members. See §1.267A-2(b)(2) and (f). In addition, were the tax law of Country X to regard the payment (and treat it as interest), FX1 would include it in income. Therefore, the payment is a disregarded payment to which §1.267A-2(b) applies. See §1.267A-2(b)(2).

(B) Under §1.267A-2(b)(1), the excess (if any) of USB’s disregarded payments for taxable year 1 ($25x) over its dual inclusion income for the taxable year is a disqualified hybrid amount. USB’s dual inclusion income for taxable year 1 is $0. This is because, as a result of the Country X exemption for income attributable to a branch, no portion of USB’s $200x item of gross income is included in FX2’s income. See §1.267A-2(b)(3). Therefore, the entire $25x of the specified payment treated as paid by USB to FX1 is a disqualified hybrid amount, calculated as $25x (the amount of the payment) less $0 (the amount of dual inclusion income). See §1.267A-2(b)(1).

(iii) Alternative facts – deemed branch payment. The facts are the same as in paragraph (c)(4)(i) of this section, except that FX2 does not pay any amounts during taxable year 1 (thus, it does not pay the $50x to FX1 or the $100x to the bank). However, under an income tax treaty between the United States and Country X, USB is a U.S. permanent establishment and, for taxable year 1, $25x of royalties is allowable as a deduction in computing the business profits of USB and is deemed paid to FX2. Under Country X tax law, the $25x is not regarded. Accordingly, the $25x is a specified payment that is a deemed branch payment. See §§1.267A-2(c)(2) and 1.267A-5(b)(3)(i)(B). In addition, the entire $25x is a disqualified hybrid amount for which a deduction is disallowed because the tax law of Country X provides an exclusion or exemption for income attributable to a branch. See §1.267A-2(c)(1).

(5) Example 5. Payment to a reverse hybrid—(i) Facts. FX holds all the interests of US1 and FY, and FY holds all the interests of FV. FY is an entity established in Country Y, and FV is an entity established in Country V. FY is fiscally transparent for Country Y tax purposes but is not fiscally transparent for Country X tax purposes. FV is fiscally transparent for Country X tax purposes. On date 1, US1 pays $100x to FY. The payment is treated as interest for U.S. tax purposes and Country X tax purposes.

(ii) Analysis. US1 is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(5)(ii)(A) through (C) of this section, the entire $100x payment is a disqualified hybrid amount under the reverse hybrid rule of §1.267A-2(d) and, as a result, a deduction for the payment is disallowed under §1.267A-1(b)(1).

(A) US1’s payment is made to a reverse hybrid because FY is fiscally transparent under the tax law of Country Y (the tax law of the country in which it is established) but is not fiscally transparent under the tax law of Country X (the tax law of FX, an investor that is related to US1). See §1.267A-2(d)(2) and (f). Therefore, §1.267A-2(d) applies to the payment. The result would be the same if the payment were instead made to FV. See §1.267A-2(d)(3).

(B) For US1’s payment to be a disqualified hybrid amount under §1.267A-2(d), a no-inclusion must occur with respect to FX, an investor the tax law of which treats FY as not fiscally transparent. See §1.267A-2(d)(1)(i). Because FX does not derive the $100x payment under Country X tax law (as FY is not fiscally transparent under such tax law), FX includes $0 of the payment in income and therefore a $100x no-inclusion occurs with respect to FX. See §1.267A-3(a).

(C) Pursuant to §1.267A-2(d)(1)(ii), FX’s $100x no-inclusion gives rise to a disqualified hybrid amount to the extent that it is a result of US1’s payment being made to the reverse hybrid. FX’s $100x no-inclusion is a result of the payment being made to the reverse hybrid because, were FY to be treated as fiscally transparent for Country X tax purposes, FX would include $100x in income and, consequently, the no-inclusion would not occur. The result would be the same if Country X tax law instead viewed US1’s payment as a dividend, rather than interest. See §1.267A-2(d)(1)(ii).

(iii) Alternative facts – inclusion under anti-deferral regime. The facts are the same as in paragraph (c)(5)(i) of this section, except that, under a Country X anti-deferral regime, FX takes into account $100x attributable to the $100x payment received by FY. If under the rules of §1.267A-3(a) FX includes the entire attributed amount in income (that is, if FX takes the amount into account in its income at the full marginal rate imposed on ordinary income and the amount is not reduced or offset by certain relief particular to the amount), then a no-inclusion does not occur with respect to FX. As a result, in such a case, no portion of US1’s payment would be a disqualified hybrid amount under §1.267A-2(d).

(iv) Alternative facts – multiple investors. The facts are the same as in paragraph (c)(5)(i) of this section, except that FX holds all the interests of FZ, which is fiscally transparent for Country X tax purposes; FZ holds all the interests of FY, which is fiscally transparent for Country Z tax purposes; and FZ includes the $100x payment in income. Thus, each of FZ and FX is an investor of FY, as each directly or indirectly holds an interest of FY. See §1.267A-5(a)(13). A $100x no-inclusion occurs with respect to FX, an investor the tax law of which treats FY as not fiscally transparent. FX’s no-inclusion is a result of the payment being made to the reverse hybrid because, were FY to be treated as fiscally transparent for Country X tax purposes, then FX would include $100x in income (as FZ is fiscally transparent for Country X tax purposes). Accordingly, FX’s no-inclusion is a result of US1’s payment being made to the reverse hybrid and, consequently, the entire $100x payment is a disqualified hybrid amount. However, if instead FZ were not fiscally transparent for Country X tax purposes, then FX’s no-inclusion would not be a result of US1’s payment being made to the reverse hybrid and, therefore, the payment would not be a disqualified hybrid amount under §1.267A-2(d).

(v) Alternative facts – portion of no-inclusion not the result of hybridity. The facts are the same as in paragraph (c)(5)(i) of this section, except that the $100x is viewed as a royalty for U.S. tax purposes and Country X tax purposes, and Country X tax law contains a patent box regime that provides an 80% deduction with respect to certain royalty income. If the royalty payment would qualify for the Country X patent box deduction were FY to be treated as fiscally transparent for Country X tax purposes, then only $20x of FX’s $100x no-inclusion would be the result of the payment being paid to a reverse hybrid, calculated as $100x (the no-inclusion with respect to FX that actually occurs) less $80x (the no-inclusion with respect to FX that would occur if FY were to be treated as fiscally transparent for Country X tax purposes). See §1.267A-2(d)(1)(ii) and 1.267A-3(a)(1)(ii). Accordingly, in such a case, only $20x of US1’s payment would be a disqualified hybrid amount under §1.267A-2(d).

(vi) Alternative facts – payment to a discretionary trust—(A) Facts. The facts are the same as in paragraph (c)(5)(i) of this section, except that FY is a discretionary trust established in, and a tax resident of, Country Y (and as a result, FY is generally not fiscally transparent for Country Y tax purposes under the principles of §1.894-1(d)(3)(ii)). In general, under Country Y tax law, FX, an investor of FY, is not required to separately take into account in its income US1’s $100x payment received by FY; instead, FY is required to take the payment into account in its income. However, under the trust agreement, the trustee of FY may, with respect to certain items of income received by FY, allocate such an item to FY’s beneficiary, FX. When this occurs, then, for Country Y tax purposes, FY does not take the item into account in its income, and FX is required to take the item into account in its income as if it received the item directly from the source from which realized by FY. For Country X tax purposes, FX in all cases does not take into account in its income any item of income received by FY. With respect to the $100x paid from US1 to FY, the trustee allocates the $100x to FX.

(B) Analysis. FY is fiscally transparent with respect to US1’s $100x payment under the tax law of Country Y (the tax law of the country in which FY is established). See §1.267A-5(a)(8)(i). In addition, FY is not fiscally transparent with respect to US1’s $100x payment under the tax law of Country X (the tax law of FX, the investor of FY). See §1.267A-5(a)(8)(ii). Thus, FY is a reverse hybrid with respect to the payment. See §1.267A-2(d)(2) and (f). Therefore, for reasons similar to those discussed in paragraphs (c)(5)(ii)(B) and (C) of this section, the entire $100x payment is a disqualified hybrid amount.

(6) Example 6. Branch mismatch payment—(i) Facts. FX holds all the interests of US1 and FZ. FZ owns BB, a Country B branch that gives rise to a taxable presence in Country B under Country Z tax law but not under Country B tax law. On date 1, US1 pays $50x to FZ. The amount is treated as a royalty for U.S. tax purposes and Country Z tax purposes. Under Country Z tax law, the amount is treated as income attributable to BB and, as a consequence of County Z tax law exempting income attributable to a branch, is excluded from FZ’s income.

(ii) Analysis. US1 is a specified party and thus a deduction for its $50x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(6)(ii)(A) through (C) of this section, the entire $50x payment is a disqualified hybrid amount under the branch mismatch rule of §1.267A-2(e) and, as a result, a deduction for the payment is disallowed under §1.267A-1(b)(1).

(A) US1’s payment is a branch mismatch payment because under Country Z tax law (the tax law of FZ, a home office that is related to US1) the payment is treated as income attributable to BB, and BB is not a taxable branch (that is, under Country B tax law, BB does not give rise to a taxable presence). See §1.267A-2(e)(2) and (f). Therefore, §1.267A-2(e) applies to the payment. The result would be the same if instead BB were a taxable branch and, under Country B tax law, US1’s payment were treated as income attributable to FZ, the home office, and not BB. See §1.267A-2(e)(2).

(B) For US1’s payment to be a disqualified hybrid amount under §1.267A-2(e), a no-inclusion must occur with respect to FZ. See §1.267A-2(e)(1)(i). As a consequence of the Country Z branch exemption, FZ includes $0 of the payment in income and therefore a $50x no-inclusion occurs with respect to FZ. See §1.267A-3(a).

(C) Pursuant to §1.267A-2(e)(1)(ii), FZ’s $50x no-inclusion gives rise to a disqualified hybrid amount to the extent that it is a result of US1’s payment being a branch mismatch payment. FZ’s $50x no-inclusion is a result of the payment being a branch mismatch payment because, were the payment to not be treated as income attributable to BB for Country Z tax purposes, FZ would include $50x in income and, consequently, the no-inclusion would not occur.

(7) Example 7. Reduction of disqualified hybrid amount for certain amounts includible in income—(i) Facts. US1 and FW hold 60% and 40%, respectively, of the interests of FX, and FX holds all the interests of FZ. Each of FX and FZ is a specified party that is a CFC. FX holds an instrument issued by FZ that it is treated as equity for Country X tax purposes and as indebtedness for U.S. tax purposes (the FX-FZ instrument). On date 1, FZ pays $100x to FX pursuant to the FX-FZ instrument. The amount is treated as a dividend for Country X tax purposes and as interest for U.S. tax purposes. In addition, pursuant to section 954(c)(6), the amount is not foreign personal holding company income of FX and, under section 951A, the amount is gross tested income (as described in §1.951A-2(c)(1)) of FX. Further, were FZ allowed a deduction for the amount, it would be allocated and apportioned to gross tested income (as described in §1.951A-2(c)(1)) of FZ. Lastly, Country X tax law provides an 80% participation exemption for dividends received from nonresident corporations and, as a result of such participation exemption, FX includes $20x of FZ’s payment in income.

(ii) Analysis. FZ, a CFC, is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. But for §1.267A-3(b), $80x of FZ’s payment would be a disqualified hybrid amount (such amount, a “tentative disqualified hybrid amount”). See §§1.267A-2(a) and 1.267A-3(b)(1). Pursuant to §1.267A-3(b), the tentative disqualified hybrid amount is reduced by $48x. See §1.267A-3(b)(4). The $48x is the tentative disqualified hybrid amount to the extent that it increases US1’s pro rata share of tested income with respect to FX under section 951A (calculated as $80x multiplied by 60%). See §1.267A-3(b)(4). Accordingly, $32x of FZ’s payment ($80x less $48x) is a disqualified hybrid amount under §1.267A-2(a) and, as a result, $32x of the deduction is disallowed under §1.267A-1(b)(1).

(iii) Alternative facts – United States shareholder is a domestic partnership. The facts are the same as in paragraph (c)(7)(i) of this section, except that US1 is a domestic partnership, 90% of the interests of which are held by US2 and the remaining 10% of which are held by an individual that is a nonresident alien (as defined in section 7701(b)(1)(B)). Thus, although each of US1 and US2 is a United States shareholder of FX, only US2 has a pro rata share of any tested item of FX. See §1.951A-1(e). In addition, $43.2x of the $80x tentative disqualified hybrid amount increases US2’s pro rata share of the tested income of FX (calculated as $80x multiplied by 60% multiplied by 90%). Thus, $36.8x of FZ’s payment ($80x less $43.2x) is a disqualified hybrid amount under §1.267A-2(a). See §1.267A-3(b)(4).

(8) Example 8. Imported mismatch rule – direct offset—(i) Facts. FX holds all the interests of FW, and FW holds all the interests of US1. FX holds an instrument issued by FW that is treated as equity for Country X tax purposes and indebtedness for Country W tax purposes (the FX-FW instrument). FW holds an instrument issued by US1 that is treated as indebtedness for Country W and U.S. tax purposes (the FW-US1 instrument). In accounting period 1, FW pays $100x to FX pursuant to the FX-FW instrument. The amount is treated as an excludible dividend for Country X tax purposes (by reason of the Country X participation exemption) and as interest for Country W tax purposes. Also in accounting period 1, US1 pays $100x to FW pursuant to the FW-US1 instrument. The amount is treated as interest for Country W and U.S. tax purposes and is included in FW’s income. The FX-FW instrument was not entered into pursuant to the same plan or series of related transactions pursuant to which the FW-US1 instrument was entered into.

(ii) Analysis. US1 is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. US1’s $100x payment is neither a disqualified hybrid amount nor included or includible in income in the United States. See §1.267A-4(a)(2)(v). In addition, FW’s $100x deduction is a hybrid deduction because it is a deduction allowed to FW that results from an amount paid that is interest under Country W tax law, and were Country W law to have rules substantially similar to those under §§1.267A-1 through 1.267A-3 and 1.267A-5, a deduction for the payment would be disallowed (because under such rules the payment would be pursuant to a hybrid transaction and FX’s no-inclusion would be a result of the hybrid transaction). See §§1.267A-2(a) and 1.267A-4(b). Under §1.267A-4(a)(2), US1’s payment is an imported mismatch payment, US1 is an imported mismatch payer, and FW (the foreign tax resident that includes the imported mismatch payment in income) is an imported mismatch payee. The imported mismatch payment is a disqualified imported mismatch amount to the extent that the income attributable to the payment is directly or indirectly offset by the hybrid deduction incurred by FW (a foreign tax resident that is related to US1). See §1.267A-4(a)(1). Under §1.267A-4(c)(1), the $100x hybrid deduction directly or indirectly offsets the income attributable to US1’s imported mismatch payment to the extent that the payment directly or indirectly funds the hybrid deduction. The entire $100x of US1’s payment directly funds the hybrid deduction because FW (the imported mismatch payee) incurs at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i). Accordingly, the entire $100x payment is a disqualified imported mismatch amount under §1.267A-4(a)(1) and, as a result, a deduction for the payment is disallowed under §1.267A-1(b)(2).

(iii) Alternative facts – long-term deferral. The facts are the same as in paragraph (c)(8)(i) of this section, except that the FX-FW instrument is treated as indebtedness for Country X and Country W tax purposes, and FW does not pay any amounts pursuant to the instrument during accounting period 1. In addition, under Country W tax law, FW is allowed to deduct interest under the FX-FW instrument as it accrues, whereas under Country X tax law FX does not take into account in its income interest under the FX-FW instrument until the interest is paid. Further, FW accrues $100x of interest during accounting period 1, and FW will not pay such amount to FX for more than 36 months after the end of accounting period 1. The results are the same as in paragraph (c)(8)(ii) of this section. That is, FW’s $100x deduction for the accrued interest is a hybrid deduction, see §§1.267A-2(a), 1.267A-3(a), and 1.267A-4(b), and the income attributable to US1’s $100x imported mismatch payment is offset by the hybrid deduction for the reasons described in paragraph (c)(8)(ii) of this section. As a result, a deduction for the payment is disallowed under §1.267A-1(b)(2). The result would be the same even if the FX-FW instrument is expected to be redeemed or capitalized before the $100x of interest is paid such that FX will never take into account in its income (and therefore will not include in income) the $100x of interest.

(iv) Alternative facts – notional interest deduction. The facts are the same as in paragraph (c)(8)(i) of this section, except that there is no FX-FW instrument and thus FW does not pay any amounts to FX during accounting period 1. However, during accounting period 1, FW is allowed a $100x notional interest deduction with respect to its equity under Country W tax law. Pursuant to §1.267A-4(b)(1)(ii), FW’s notional interest deduction is a hybrid deduction. The results are the same as in paragraph (c)(8)(ii) of this section. That is, the income attributable to US1’s $100x imported mismatch payment is offset by FW’s hybrid deduction for the reasons described in paragraph (c)(8)(ii) of this section. As a result, a deduction for the payment is disallowed under §1.267A-1(b)(2). The result would be the same if the tax law of Country W contains hybrid mismatch rules because FW’s deduction is a deduction with respect to equity. See §1.267A-4(b)(2)(i).

(v) Alternative facts – foreign hybrid mismatch rules prevent hybrid deduction. The facts are the same as in paragraph (c)(8)(i) of this section, except that the tax law of Country W contains hybrid mismatch rules, and under such rules FW is not allowed a deduction for the $100x that it pays to FX pursuant to the FX-FW instrument. The $100x paid by FW therefore does not give rise to a hybrid deduction. See §1.267A-4(b). Accordingly, because the income attributable to US1’s payment to FW is not directly or indirectly offset by a hybrid deduction, the payment is not a disqualified imported mismatch amount. Therefore, a deduction for the payment is not disallowed under §1.267A-1(b)(2).

(9) Example 9. Imported mismatch rule – indirect offsets and pro rata allocations—(i) Facts. FX holds all the interests of FZ, and FZ holds all the interests of US1 and US2. FX has a Country B branch that, for Country X and Country B tax purposes, gives rise to a taxable presence in Country B and is therefore a taxable branch (“BB”). Under the Country B-Country X income tax treaty, BB is a permanent establishment entitled to deduct expenses properly attributable to BB for purposes of computing its business profits under the treaty. In addition, BB is deemed to pay a royalty to FX for the right to use intangibles developed by FX equal to cost plus y%. The deemed royalty is a deductible expense properly attributable to BB under the Country B-Country X income tax treaty. For Country X tax purposes, any transactions between BB and X are disregarded. The deemed royalty is $80x for accounting period 1. Country B tax law does not permit a loss of a taxable branch to be shared with a tax resident or another taxable branch. In addition, an instrument issued by FZ to FX is properly reflected as an asset on the books and records of BB (the FX-FZ instrument). The FX-FZ instrument is treated as indebtedness for Country X, Country Z, and Country B tax purposes. In accounting period 1, FZ pays $80x to FX pursuant to the FX-FZ instrument; the amount is treated as interest for Country X, Country Z, and Country B tax purposes, and is treated as income attributable to BB for Country X and Country B tax purposes (but, for Country X tax purposes, is excluded from FX’s income as a consequence of the Country X exemption for income attributable to a branch). Further, in accounting period 1, US1 and US2 pay $60x and $40x, respectively, to FZ pursuant to instruments that are treated as indebtedness for Country Z and U.S. tax purposes; the amounts are treated as interest for Country Z and U.S. tax purposes and are included in FZ’s income. Lastly, neither the instrument pursuant to which US1 pays the $60x nor the instrument pursuant to which US2 pays the $40x was entered into pursuant to a plan or series of related transactions that includes the transaction or agreement giving rise to BB’s deduction for the deemed royalty.

(ii) Analysis. US1 and US2 are specified parties and thus deductions for their specified payments are subject to disallowance under section 267A. Neither of the payments is a disqualified hybrid amount, nor is either of the payments included or includible in income in the United States. See §1.267A-4(a)(2)(v). In addition, BB’s $80x deduction for the deemed royalty is a hybrid deduction because it is a deduction allowed to BB that results from an amount paid that is treated as a royalty under Country B tax law (regardless of whether a royalty deduction would be allowed under U.S. law), and were Country B tax law to have rules substantially similar to those under §§1.267A-1 through 1.267A-3 and 1.267A-5, a deduction for the payment would be disallowed because under such rules the payment would be a deemed branch payment and Country X has an exclusion for income attributable to a branch. See §§1.267A-2(c) and 1.267A-4(b). Under §1.267A-4(a)(2), each of US1’s and US2’s payments is an imported mismatch payment, US1 and US2 are imported mismatch payers, and FZ (the foreign tax resident that includes the imported mismatch payments in income) is an imported mismatch payee. The imported mismatch payments are disqualified imported mismatch amounts to the extent that the income attributable to the payments is directly or indirectly offset by the hybrid deduction incurred by BB (a foreign taxable branch that is related to US1 and US2). See §1.267A-4(a). Under §1.267A-4(c)(1), the $80x hybrid deduction directly or indirectly offsets the income attributable to the imported mismatch payments to the extent that the payments directly or indirectly fund the hybrid deduction. Paragraphs (c)(9)(ii)(A) and (B) of this section describe the extent to which the imported mismatch payments directly or indirectly fund the hybrid deduction.

(A) Neither US1’s nor US2’s payment directly funds the hybrid deduction because FZ (the imported mismatch payee) does not incur the hybrid deduction. See §1.267A-4(c)(3)(i). To determine the extent to which the payments indirectly fund the hybrid deduction, the amount of the hybrid deduction that is allocated to FZ must be determined. See §1.267A-4(c)(3)(ii). FZ is allocated the hybrid deduction to the extent that it directly or indirectly makes a funded taxable payment to BB (the foreign taxable branch that incurs the hybrid deduction). See §1.267A-4(c)(3)(iii). The $80x that FZ pays pursuant to the FX-FZ instrument is a funded taxable payment of FZ to BB. See §1.267A-4(c)(3)(v). Therefore, because FZ makes a funded taxable payment to BB that is at least equal to the amount of the hybrid deduction, FZ is allocated the entire amount of the hybrid deduction. See §1.267A-4(c)(3)(iii).

(B) But for US2’s imported mismatch payment, the entire $60x of US1’s imported mismatch payment would indirectly fund the hybrid deduction because FZ is allocated at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(ii). Similarly, but for US1’s imported mismatch payment, the entire $40x of US2’s imported mismatch payment would indirectly fund the hybrid deduction because FZ is allocated at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(ii). However, because the sum of US1’s and US2’s imported mismatch payments to FZ ($100x) exceeds the hybrid deduction allocated to FZ ($80x), pro rata adjustments must be made. See §1.267A-4(e). Thus, $48x of US1’s imported mismatch payment is considered to indirectly fund the hybrid deduction, calculated as $80x (the amount of the hybrid deduction) multiplied by 60% ($60x, the amount of US1’s imported mismatch payment to FZ, divided by $100x, the sum of the imported mismatch payments that US1 and US2 make to FZ). Similarly, $32x of US2’s imported mismatch payment is considered to indirectly fund the hybrid deduction, calculated as $80x (the amount of the hybrid deduction) multiplied by 40% ($40x, the amount of US2’s imported mismatch payment to FZ, divided by $100x, the sum of the imported mismatch payments that US1 and US2 make to FZ). Accordingly, $48x of US1’s imported mismatch payment, and $32x of US2’s imported mismatch payment, are disqualified imported mismatch amounts under §1.267A-4(a)(1) and, as a result, deductions for such amounts are disallowed under §1.267A-1(b)(2).

(iii) Alternative facts – loss made available through foreign group relief regime. The facts are the same as in paragraph (c)(9)(i) of this section, except that FZ holds all the interests in FZ2, a body corporate that is a tax resident of Country Z, FZ2 (rather than FZ) holds all the interests of US1 and US2, and US1 and US2 make their respective $60x and $40x payments to FZ2 (rather than to FZ). Further, in accounting period 1, a $10x loss of FZ is made available to offset income of FZ2 through a Country Z foreign group relief regime. Pursuant to §1.267A-4(c)(3)(vi), FZ and FZ2 are treated as a single foreign tax resident for purposes of §1.267A-4(c) because a loss that is not incurred by FZ2 (FZ’s $10x loss) is made available to offset income of FZ2 under the Country Z group relief regime. Accordingly, the results are the same as in paragraph (c)(9)(ii) of this section. That is, by treating FZ and FZ2 as a single foreign tax resident for purposes of §1.267A-4(c), BB’s hybrid deduction offsets the income attributable to US1’s and US2’s imported mismatch payments to the same extent as described in paragraph (c)(9)(ii) of this section.

(10) Example 10. Imported mismatch rule – ordering rules and rule deeming certain payments to be imported mismatch payments—(i) Facts. FX holds all the interests of FW, and FW holds all the interests of US1, US2, and FZ. FZ holds all the interests of US3. FX transfers cash to FW in exchange for an instrument that is treated as equity for Country X tax purposes and indebtedness for Country W tax purposes (the FX-FW instrument). FW transfers cash to US1 in exchange for an instrument that is treated as indebtedness for Country W and U.S. tax purposes (the FW-US1 instrument). The FX-FW instrument and the FW-US1 instrument were entered into pursuant to a plan a design of which was for deductions incurred by FW pursuant to the FX-FW instrument to offset income attributable to payments by US1 pursuant to the FW-US1 instrument. In accounting period 1, FW pays $125x to FX pursuant to the FX-FW instrument; the amount is treated as an excludible dividend for Country X tax purposes (by reason of the Country X participation exemption regime) and as interest for Country W tax purposes. Also in accounting period 1, US1 pays $50x to FW pursuant to the FW-US1 instrument; US2 pays $50x to FW pursuant to an instrument treated as indebtedness for Country W and U.S. tax purposes (the FW-US2 instrument); US3 pays $50x to FZ pursuant to an instrument treated as indebtedness for Country Z and U.S. tax purposes (the FZ-US3 instrument); and FZ pays $50x to FW pursuant to an instrument treated as indebtedness for Country W and Country Z tax purposes (FW-FZ instrument). The amounts paid by US1, US2, US3, and FZ are treated as interest for purposes of the relevant tax laws and are included in the income of FW (in the case of US1’s, US2’s and FZ’s payment) or FZ (in the case of US3’s payment). Lastly, neither the FW-US2 instrument, the FW-FZ instrument, nor the FZ-US3 instrument was entered into pursuant to a plan or series of related transactions that includes the transaction pursuant to which the FX-FW instrument was entered into.

(ii) Analysis. US1, US2, and US3 are specified parties (but FZ is not a specified party, see §1.267A-5(a)(17)) and thus deductions for US1’s, US2’s, and US3’s specified payments are subject to disallowance under section 267A. None of the specified payments is a disqualified hybrid amount, nor is any of the payments included or includible in income in the United States. See §1.267A-4(a)(2)(v). Under §1.267A-4(a)(2), each of the payments is an imported mismatch payment, US1, US2, and US3 are imported mismatch payers, and FW and FZ (the foreign tax residents that include the imported mismatch payments in income) are imported mismatch payees. The imported mismatch payments are disqualified imported mismatch amounts to the extent that the income attributable to the payments is directly or indirectly offset by FW’s $125x hybrid deduction. See §1.267A-4(a)(1) and (b). Under §1.267A-4(c)(1), the $125x hybrid deduction directly or indirectly offsets the income attributable to the imported mismatch payments to the extent that the payments directly or indirectly fund the hybrid deduction. Paragraphs (c)(10)(ii)(A) through (C) of this section describe the extent to which the imported mismatch payments directly or indirectly fund the hybrid deduction and are therefore disqualified hybrid amounts for which a deduction is disallowed under §1.267A-1(b)(2).

(A) First, the $125x hybrid deduction offsets the income attributable to US1’s imported mismatch payment, a factually-related imported mismatch payment that directly funds the hybrid deduction. See §1.267A-4(c)(2)(i). The entire $50x of US1’s payment directly funds the hybrid deduction because FW (the imported mismatch payee) incurs at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i). Accordingly, the entire $50x of the payment is a disqualified imported mismatch amount under §1.267A-4(a)(1).

(B) Second, the remaining $75x hybrid deduction offsets the income attributable to US2’s imported mismatch payment, a factually-unrelated imported mismatch payment that directly funds the remaining hybrid deduction. See §1.267A-4(c)(2)(ii). The entire $50x of US2’s payment directly funds the remaining hybrid deduction because FW (the imported mismatch payee) incurs at least that amount of the remaining hybrid deduction. See §1.267A-4(c)(3)(i). Accordingly, the entire $50x of the payment is a disqualified imported mismatch amount under §1.267A-4(a)(1).

(C) Third, the remaining $25x hybrid deduction offsets the income attributable to US3’s imported mismatch payment, a factually-unrelated imported mismatch payment that indirectly funds the remaining hybrid deduction. See §1.267A-4(c)(2)(iii). The imported mismatch payment indirectly funds the remaining hybrid deduction to the extent that FZ (the imported mismatch payee) is allocated the remaining hybrid deduction. See §1.267A-4(c)(3)(ii). FZ is allocated the remaining hybrid deduction to the extent that it directly or indirectly makes a funded taxable payment to FW (the tax resident that incurs the hybrid deduction). See §1.267A-4(c)(3)(iii). The $50x that FZ pays to FW pursuant to the FW-FZ instrument is a funded taxable payment of FZ to FW. See §1.267A-4(c)(3)(v). Therefore, because FZ makes a funded taxable payment to FW that is at least equal to the amount of the remaining hybrid deduction, FZ is allocated the remaining hybrid deduction. See §1.267A-4(c)(3)(iii). Accordingly, $25x of US3’s payment indirectly funds the $25x remaining hybrid deduction and, consequently, $25x of US3’s payment is a disqualified imported mismatch amount under §1.267A-4(a)(2).

(iii) Alternative facts – amount deemed to be an imported mismatch payment. The facts are the same as in paragraph (c)(10)(i) of this section, except that US1 is not a domestic corporation but instead is a body corporate that is only a tax resident of Country E (hereinafter, “FE”) (thus, for purposes of this paragraph (c)(10)(iii), the FW-US1 instrument is instead issued by FE and is the “FW-FE instrument”). In addition, the tax law of Country E contains hybrid mismatch rules and the $50x FE pays to FW pursuant to the FW-FE instrument is subject to disallowance under a provision of the hybrid mismatch rules substantially similar to §1.267A-4. Pursuant to §1.267A-4(f)(2), the $50x that FE pays to FW pursuant to the FW-FE instrument is deemed to be an imported mismatch payment for purposes of determining the extent to which the income attributable to an imported mismatch payment is offset by FW’s hybrid deduction (a hybrid deduction other than one described in §1.267A-4(f)(1)). The results are the same as in paragraphs (c)(10)(ii)(B) and (C) of this section. That is, by treating the $50x that FE pays to FW as an imported mismatch payment, and for reasons similar to those described in paragraphs (c)(10)(ii)(A) through (C) of this section, $50x of FW’s $125x hybrid deduction offsets income attributable to FE’s imported mismatch payment, $50x of the remaining $75x hybrid deduction offsets income attributable to US2’s imported mismatch payment, and the remaining $25x hybrid deduction offsets income attributable to US3’s imported mismatch payment. Accordingly, the entire $50x of US2’s payment is a disqualified imported mismatch amount, and $25x of US3’s payment is a disqualified imported mismatch amount.

(iv) Alternative facts – amount deemed to be an imported mismatch payment and “waterfall” approach. The facts are the same as in paragraph (c)(10)(i) of this section, except that FZ holds all of the interests of US3 indirectly through FE, a body corporate that is only a tax resident of Country E (hereinafter, “FE”), and US3 makes its $50x payment to FE (rather than to FZ); such amount is treated as interest for Country E tax purposes and is included in FE’s income. In addition, during accounting period 1, FE pays $50x to FZ pursuant to an instrument; such amount is treated as interest for Country E and Country Z tax purposes, and is included in FZ’s income. Further, the tax law of Country E contains hybrid mismatch rules and the $50x FE pays to FZ pursuant to the instrument is subject to disallowance under a provision of the hybrid mismatch rules substantially similar to §1.267A-4. For purposes of determining the extent to which the income attributable to an imported mismatch payment is directly or indirectly offset by a hybrid deduction, the $50x that FE pays to FZ is deemed to be an imported mismatch payment (and FE and FZ are deemed to be an imported mismatch payer and imported mismatch payee, respectively). See §1.267A-4(f)(2). With respect to US1 and US2, the results are the same as described in paragraphs (c)(10)(ii)(A) and (B) of this section. No portion of US3’s payment is a disqualified imported mismatch amount because, by treating the $50x that FE pays to FZ as an imported mismatch payment, the remaining $25x of FW’s hybrid deduction offsets income attributable to FE’s imported mismatch payment. This is because the remaining $25x of FW’s hybrid deduction is indirectly funded solely by FE’s imported mismatch payment (as opposed to also being funded by US3’s imported mismatch payment), as FZ (the imported mismatch payee with respect to FE’s payment) directly makes a funded taxable payment to FW, whereas FE (the imported mismatch payee with respect to US3’s payment) indirectly makes a funded taxable payment to FW. See §1.267A-4(c)(3)(ii) through (v) and (vii).

(11) Example 11. Imported mismatch rule – hybrid deduction of a CFC—(i) Facts. FX holds all the interests of US1, and FX and US1 hold 80% and 20%, respectively, of the interests of FZ, a specified party that is a CFC. US1 also holds all the interests of US2, and FX also holds all the interests of FY. FY is an entity established in Country Y, and is fiscally transparent for Country Y tax purposes but is not fiscally transparent for Country X tax purposes. In accounting period 1, US2 pays $100x to FZ pursuant to an instrument (the FZ-US2 instrument). The amount is treated as interest for U.S. tax purposes and Country Z tax purposes, and is included in FZ’s income; in addition, for U.S. tax purposes, the amount is foreign personal holding company income of FZ. Also in accounting period 1, FZ pays $100x to FY pursuant to an instrument (the FY-FZ instrument). The amount is treated as interest for U.S. tax purposes and Country Z tax purposes, and none of the amount is included in FX’s income. Under Country Z tax law, FZ is allowed a deduction for its entire $100x payment. Under §1.267A-2(d), the entire $100x of FZ’s payment is a disqualified hybrid amount (by reason of being made to a reverse hybrid) and, as a result, a deduction for the payment is disallowed under §1.267A-1(b)(1); in addition, if a deduction were allowed for the $100x, it would be allocated and apportioned (under the rules of section 954(b)(5)) to gross subpart F income of FZ. Lastly, the FZ-US2 instrument was not entered into pursuant to a plan or series of related transactions that includes the transaction pursuant to which the FY-FZ instrument was entered into.

(ii) Analysis. US2 is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(11)(ii)(A) through (C) of this section, $80x of US2’s payment is a disqualified imported mismatch amount for which a deduction is disallowed under §1.267A-1(b)(2).

(A) $80x of US2’s specified payment is an imported mismatch payment, calculated as $100x (the amount of the payment) less $0 (the disqualified hybrid amount with respect to the payment) less $20 (the amount of the payment that is included or includible in income in the United States). See §1.267A-4(a)(2)(v). US2 is an imported mismatch payer and FZ (a foreign tax resident that includes the imported mismatch in income) is an imported mismatch payee. See §1.267A-4(a)(2).

(B) But for §1.267A-4(b)(2)(iv), the entire $100x deduction allowed to FZ under its tax law would be a hybrid deduction. See §§1.267A-2(d) and 1.267A-4(b)(1). However, pursuant to §1.267A-4(b)(2)(iv), only $80x of the deduction is a hybrid deduction, calculated as $100x (the deduction to the extent that it would be a hybrid deduction but for §1.267A-4(b)(2)(iv)) less $20x (the extent that FZ’s payment giving rise to the deduction is a disqualified hybrid amount that is taken into account for purposes of §1.267A-4(b)(2)(iv)(A)), less $0 (the extent that FZ’s payment giving rise to the deduction is included or includible in income in the United States). See §1.267A-4(b)(2)(iv). The $20x disqualified hybrid amount that is taken into account for purposes of §1.267A-4(b)(2)(iv)(A) is calculated as $100x (the extent that FZ’s payment is a disqualified hybrid amount) less $80x ($100x, the disqualified hybrid amount to the extent that, if allowed as a deduction, it would be allocated and apportioned to gross subpart F income, multiplied by 80%, the difference of 100% and the percentage of the stock (by value) of FZ that is owned by US1)). See §1.267A-4(g).

(C) The $80x hybrid deduction offsets the income attributable to US2’s imported mismatch payment, an imported mismatch payment that directly funds the hybrid deduction. See §1.267A-4(c)(2)(ii). The entire $80x of US2’s imported mismatch payment directly funds the hybrid deduction because FZ (the imported mismatch payee) incurs at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i). Accordingly, the entire $80x of US2’s imported mismatch payment is a disqualified imported mismatch amount under §1.267A-4(a)(1).

(12) Example 12. Imported mismatch rule – application first with respect to certain hybrid deductions, then with respect to other hybrid deductions—(i) Facts. FX holds all the interests of FZ, and FZ holds all the interests of each of US1 and FE. The tax law of Country E contains hybrid mismatch rules. FX holds an instrument issued by FZ that is treated as equity for Country X tax purposes and indebtedness for Country Z tax purposes (the FX-FZ instrument). In accounting period 1, FZ pays $10x to FX pursuant to the FX-FZ instrument. The amount is treated as an excludible dividend for Country X tax purposes (by reason of the Country X participation exemption) and as interest for Country Z tax purposes. Also in accounting period 1, FZ is allowed a $90x notional interest deduction with respect to its equity under Country Z tax law. In addition, in accounting period 1, US1 pays $100x to FZ pursuant to an instrument (the FZ-US1 instrument); the amount is treated as interest for U.S. tax purposes and Country Z tax purposes, and is included in FZ’s income. Further, in accounting period 1, FE pays $40x to FZ pursuant to an instrument (the FZ-FE instrument); the amount is treated as interest for Country E and Country Z tax purposes, is included in FZ’s income, and is subject to disallowance under a provision of Country E hybrid mismatch rules substantially similar to §1.267A-4. Lastly, neither the FZ-US1 instrument nor the FZ-FE instrument was entered into pursuant to a plan or series of related transactions that includes the transaction pursuant to which the FX-FZ instrument was entered into.

(ii) Analysis. US1 is a specified party and thus a deduction for its $100x specified payment is subject to disallowance under section 267A. As described in paragraphs (c)(12)(ii)(A) through (D) of this section, $92x of US1’s payment is a disqualified imported mismatch amount for which a deduction is disallowed under §1.267A-1(b)(2).

(A) The entire $100x of US1’s specified payment is an imported mismatch payment. See §1.267A-4(a)(2)(v). US1 is an imported mismatch payer and FZ (a foreign tax resident that includes the imported mismatch payment in income) is an imported mismatch payee. See §1.267A-4(a)(2).

(B) FZ has $100x of hybrid deductions (the $10x deduction for the payment pursuant to the FX-FZ instrument plus the $90x notional interest deduction). See §1.267A-4(b). Pursuant to §1.267A-4(f)(1), §1.267A-4 is first applied by taking into account only the $90x hybrid deduction consisting of the notional interest deduction; in addition, for purposes of applying §1.267A-4 in this manner, FE’s $40x payment is not treated as an imported mismatch payment. Thus, the $90x hybrid deduction offsets the income attributable to US1’s imported mismatch payment, an imported mismatch payment that directly funds the hybrid deduction. See §1.267A-4(c)(2)(ii). Moreover, $90x of US1’s imported mismatch payment directly funds the hybrid deduction because FZ (the imported mismatch payee) incurs at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i).

(C) Section §1.267A-4 is next applied by taking into account only the $10x hybrid deduction consisting of the deduction for the payment pursuant to the FX-FZ instrument. See §1.267A-4(f)(2). When applying §1.267A-4 in this manner, and for purposes of determining the extent to which the income attributable to an imported mismatch payment is directly or indirectly offset by a hybrid deduction, FE’s $40x payment is treated as an imported mismatch payment. See §1.267A-4(f)(2). In addition, US1’s imported mismatch payment is reduced from $100x to $10x. See §1.267A-4(c)(4). But for FE’s imported mismatch payment, the entire $10x of US1’s imported mismatch payment would directly fund the $10x hybrid deduction because FZ incurred at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i). Similarly, but for US1’s imported mismatch payment, the entire $40x of FE’s imported mismatch payment would directly fund the $10x hybrid deduction because FZ incurred at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i). However, because the sum of US1’s and FE’s imported mismatch payments to FZ ($50x) exceeds the hybrid deduction incurred by FZ ($10x), pro rata adjustments must be made. See §1.267A-4(e). Thus, $2x of US1’s imported mismatch payment is considered to directly fund the hybrid deduction, calculated as $10x (the amount of the hybrid deduction) multiplied by 20% ($10x, the amount of US1’s imported mismatch payment to FZ, divided by $50x, the sum of the imported mismatch payments that US1 and FE make to FZ). Similarly, $8x of FE’s imported mismatch payment is considered to directly fund the hybrid deduction, calculated as $10x (the amount of the hybrid deduction) multiplied by 80% ($40x, the amount of FE’s imported mismatch payment to FZ, divided by $50x, the sum of the imported mismatch payments that US1 and FE make to FZ). Accordingly, $2x of FZ’s $10x hybrid deduction offsets income attributable to US1’s $10x imported mismatch payment, and $8x of the hybrid deduction offsets income attributable to FE’s $40x imported mismatch payment.

(D) Therefore, $92x of US1’s imported mismatch payment is a disqualified imported mismatch amount, calculated as $90x (the amount that is a disqualified imported mismatch amount determined by applying §1.267A-4 in the manner set forth in §1.267A-4(f)(1)) plus $2x (the amount that is a disqualified imported mismatch amount determined by applying §1.267A-4 in the manner set forth in §1.267A-4(f)(2)). See §1.267A-4(a)(1) and (f).

(iii) Alternative facts – amount deemed to be an imported mismatch payment solely funds hybrid instrument deduction. The facts are the same as in paragraph (c)(12)(i) of this section, except that FZ holds all of the interests of US1 indirectly through FE, and US1 makes its $100x payment to FE (rather than to FZ); such amount is treated as interest for U.S. and Country E tax purposes, and is included in FE’s income. Moreover, FE pays $100x to FZ (rather than $40x); such amount is included in FZ’s income, and is subject to disallowance under a provision of Country E hybrid mismatch rules substantially similar to §1.267A-4. As described in paragraphs (c)(12)(iii)(A) through (D) of this section, $90x of US1’s payment is a disqualified imported mismatch amount for which a deduction is disallowed under §1.267A-1(b)(2).

(A) The entire $100x of US1’s specified payment is an imported mismatch payment. See §1.267A-4(a)(2)(v). US1 is an imported mismatch payer and FE (a foreign tax resident that includes the imported mismatch payment in income) is an imported mismatch payee. See §1.267A-4(a)(2).

(B) FZ has $100x of hybrid deductions. See §1.267A-4(b). Pursuant to §1.267A-4(f)(1), §1.267A-4 is first applied by taking into account only the $90x hybrid deduction consisting of the notional interest deduction; in addition, for purposes of applying §1.267A-4 in this manner, FE’s $100x payment is not treated as an imported mismatch payment. Thus, the $90x hybrid deduction offsets the income attributable to US1’s imported mismatch payment, an imported mismatch payment that indirectly funds the hybrid deduction. See §1.267A-4(c)(2)(iii). The imported mismatch payment indirectly funds the hybrid deduction because FE (the imported mismatch payee) is allocated the deduction, as FE makes a funded taxable payment (the $100x payment to FZ) that is at least equal to the amount of the deduction. See §1.267A-4(c)(3)(ii), (iii), and (v).

(C) Section §1.267A-4 is next applied by taking into account only the $10x hybrid deduction consisting of the deduction for the payment pursuant to the FX-FZ instrument. See §1.267A-4(f)(2). For purposes of applying §1.267A-4 in this manner, FE’s $100x payment is reduced from $100x to $10x, and similarly US1’s imported mismatch payment is reduced from $100x to $10x. See §1.267A-4(c)(4). Further, FE’s $10x payment is treated as an imported mismatch payment. See §1.267A-4(f)(2). The entire $10x of FE’s imported mismatch payment directly funds the hybrid deduction because FZ (the imported mismatch payee with respect to FE’s imported mismatch payment) incurs at least that amount of the hybrid deduction. See §1.267A-4(c)(3)(i). Accordingly, the $10x hybrid deduction offsets the income attributable to FE’s imported mismatch payment, and none of the income attributable to US1’s imported mismatch payment.

(D) Therefore, $90x of US1’s imported mismatch payment is a disqualified imported mismatch amount, calculated as $90x (the amount that is a disqualified imported mismatch amount determined by applying §1.267A-4 in the manner set forth in §1.267A-4(f)(1)) plus $0 (the amount that is a disqualified imported mismatch amount determined by applying §1.267A-4 in the manner set forth in §1.267A-4(f)(2)). See §1.267A-4(a)(1) and (f).

§1.267A-7 Applicability dates.

(a) General rule. Except as provided in paragraph (b) of this section, §§1.267A-1 through 1.267A-6 apply to taxable years ending on or after December 20, 2018, provided that such taxable years begin after December 31, 2017. However, taxpayers may apply the regulations in §§1.267A-1 through 1.267A-6 in their entirety for taxable years beginning after December 31, 2017, and ending before December 20, 2018. In lieu of applying the regulations in §§1.267A-1 through 1.267A-6, taxpayers may apply the provisions matching §§1.267A-1 through 1.267A-6 from the Internal Revenue Bulletin (IRB) 2019-03 (https://www.irs.gov/pub/irs-irbs/irb19-03.pdf) in their entirety for all taxable years ending on or before April 8, 2020.

(b) Special rules. The following special rules apply regarding applicability dates:

(1) Sections 1.267A-2(a)(4) (payments pursuant to interest-free loans and similar arrangements), (b) (disregarded payments), (c) (deemed branch payments), and (e) (branch mismatch transactions), 1.267A-4 (imported mismatch rule), and 1.267A-5(b)(5) (structured payments), except as provided in paragraph (b)(5) of this section, apply to taxable years beginning on or after December 20, 2018.

(2) Section 1.267A-5(a)(20) (defining structured arrangement), as well as the portions of §§1.267A-1 through 1.267A-3 that relate to structured arrangements and that are not otherwise described in paragraph (b) of this section, apply to taxable years beginning on or after December 20, 2018. However, in the case of a specified payment made pursuant to an arrangement entered into before December 22, 2017, §1.267A-5(a)(20), and the portions of §§1.267A-1 through 1.267A-3 that relate to structured arrangements and that are not otherwise described in paragraph (b) of this section, apply to taxable years beginning after December 31, 2020.

(3) Except as provided in paragraph (b)(4) of this section, the rules provided in §1.267A-5(a)(12)(ii) (swaps with significant nonperiodic payments) apply to notional principal contracts entered into on or after April 8, 2021. However, taxpayers may apply the rules provided in §1.267A-5(a)(12)(ii) to notional principal contracts entered into before April 8, 2021.

(4) For a notional principal contract entered into before April 8, 2021, the interest equivalent rules provided in §1.267A-5(b)(5)(ii)(B) (applied without regard to the references to §1.267A-5(a)(12)(ii)) apply to a notional principal contract entered into on or after April 8, 2020.

(5) Section 1.267A-5(b)(5)(ii)(B) (interest equivalent rules) applies to transactions entered into on or after April 8, 2020.

Par. 4 Section 1.1503(d)-1 is amended by:

The additions read as follows:

§1.1503(d)-1 Definitions and special rules for filings under section 1503(d).

* * * * *

(b) * * *

(2) * * *

(iii) A domestic consenting corporation (as defined in §301.7701-3(c)(3)(i) of this chapter), as provided in paragraph (c)(1) of this section. See §1.1503(d)-7(c)(41) for an example illustrating the application of section 1503(d) to a domestic consenting corporation.

* * * * *

(c) Treatment of domestic consenting corporation as a dual resident corporation—(1) Rule. A domestic consenting corporation is treated as a dual resident corporation under paragraph (b)(2)(iii) of this section for a taxable year if, on any day during the taxable year, the following requirements are satisfied:

(i) Under the tax law of a foreign country where a specified foreign tax resident is tax resident, the specified foreign tax resident derives or incurs (or would derive or incur) items of income, gain, deduction, or loss of the domestic consenting corporation (because, for example, the domestic consenting corporation is fiscally transparent under such tax law).

(ii) The specified foreign tax resident bears a relationship to the domestic consenting corporation that is described in section 267(b) or 707(b). See §1.1503(d)-7(c)(41) for an example illustrating the application of paragraph (c) of this section.

(2) Definitions. The following definitions apply for purposes of this paragraph (c).

(i) The term fiscally transparent means, with respect to a domestic consenting corporation or an intermediate entity, fiscally transparent as determined under the principles of §1.894-1(d)(3)(ii) and (iii), without regard to whether a specified foreign tax resident is a resident of a country that has an income tax treaty with the United States.

(ii) The term specified foreign tax resident means a body corporate or other entity or body of persons liable to tax under the tax law of a foreign country as a resident.

* * * * *

Par. 5. Section 1.1503(d)-3 is amended by adding the language “or (3)” after the language “paragraph (e)(2)” in paragraph (e)(1) introductory text and adding paragraph (e)(3) to read as follows:

§1.1503(d)-3 Foreign use.

* * * * *

(e) * * *

(3) Exception for domestic consenting corporations. Paragraph (e)(1) of this section will not apply so as to deem a foreign use of a dual consolidated loss incurred by a domestic consenting corporation that is a dual resident corporation under §1.1503(d)-1(b)(2)(iii).

§1.1503(d)-6 [Amended]

Par. 6. Section 1.1503(d)-6 is amended by:

1. Removing the language “a foreign government” and “a foreign country” in paragraph (f)(5)(i) and adding the language “a government of a country” and “the country” in their places, respectively.

2. Removing the language “a foreign government” in paragraph (f)(5)(ii) and adding the language “a government of a country” in its place.

3. Removing the language “the foreign government” in paragraph (f)(5)(iii) and adding the language “a government of a country” in its place.

Par. 7. Section 1.1503(d)-7 is amended by:

1. Designating Examples 1 through 40 of paragraph (c) as paragraphs (c)(1) through (40), respectively.

2. In newly designated paragraphs (c)(1) through (40), removing “Alternative Facts” and adding “Alternative facts” in its place wherever it appears.

3. For each newly designated paragraph listed in the table, remove the language in the ‘‘Remove’’ column and add in its place the language in the ‘‘Add’’ column:

 

4. In newly designated paragraphs (c)(29)(i)(A) and (c)(38)(i)(A), adding headings to the tables.

5. Adding paragraph (c)(41).

The additions read as follows:

§1.1503(d)-7 Examples.

* * * * *

(c) * * *

(29) * * *

(i) * * *

(A) * * *

Table 1 to paragraph (c)(29)(i)(A)

* * * * *

(38) * * *

(i) * * *

(A)

Table 2 to paragraph (c)(38)(i)(A)

* * * * *

(41) Example 41. Domestic consenting corporation—treated as dual resident corporation—(i) Facts. FSZ1, a Country Z entity that is subject to Country Z tax on its worldwide income or on a residence basis and is classified as a foreign corporation for U.S. tax purposes, owns all the interests in DCC, a domestic eligible entity that has filed an election to be classified as an association. Under Country Z tax law, DCC is fiscally transparent. For taxable year 1, DCC’s only item of income, gain, deduction, or loss is a $100x deduction and such deduction comprises a $100x net operating loss of DCC. For Country Z tax purposes, FSZ1’s only item of income, gain, deduction, or loss, other than the $100x loss attributable to DCC, is $60x of operating income.

(ii) Result. DCC is a domestic consenting corporation because by electing to be classified as an association, it consents to be treated as a dual resident corporation for purposes of section 1503(d). See §301.7701-3(c)(3) of this chapter. For taxable year 1, DCC is treated as a dual resident corporation under §1.1503(d)-1(b)(2)(iii) because FSZ1 (a specified foreign tax resident that bears a relationship to DCC that is described in section 267(b) or 707(b)) derives or incurs items of income, gain, deduction, or loss of DCC. See §1.1503(d)-1(c). FSZ1 derives or incurs items of income, gain, deduction, or loss of DCC because, under Country Z tax law, DCC is fiscally transparent. Thus, DCC has a $100x dual consolidated loss for taxable year 1. See §1.1503(d)-1(b)(5). Because the loss is available to, and in fact does, offset income of FSZ1 under Country Z tax law, there is a foreign use of the dual consolidated loss in year 1. Accordingly, the dual consolidated loss is subject to the domestic use limitation rule of §1.1503(d)-4(b). The result would be the same if FSZ1 were to indirectly own its DCC stock through an intermediate entity that is fiscally transparent under Country Z tax law, or if an individual were to wholly own FSZ1 and FSZ1 were a disregarded entity. In addition, the result would be the same if FSZ1 had no items of income, gain, deduction, or loss, other than the $100x loss attributable to DCC.

(iii) Alternative facts – DCC not treated as a dual resident corporation. The facts are the same as in paragraph (c)(41)(i) of this section, except that DCC is not fiscally transparent under Country Z tax law and thus under Country Z tax law FSZ1 does not derive or incur items of income, gain, deduction, or loss of DCC. Accordingly, DCC is not treated as a dual resident corporation under §1.1503(d)-1(b)(2)(iii) for year 1 and, consequently, its $100x net operating loss in that year is not a dual consolidated loss.

(iv) Alternative facts – mirror legislation. The facts are the same as in paragraph (c)(41)(i) of this section, except that, under provisions of Country Z tax law that constitute mirror legislation under §1.1503(d)-3(e)(1) and that are substantially similar to the recommendations in Chapter 6 of OECD/G-20, Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report (October 2015), Country Z tax law prohibits the $100x loss attributable to DCC from offsetting FSZ1’s income that is not also subject to U.S. tax. As is the case in paragraph (c)(41)(ii) of this section, DCC is treated as a dual resident corporation under §1.1503(d)-1(b)(2)(iii) for year 1 and its $100x net operating loss is a dual consolidated loss. Pursuant to §1.1503(d)-3(e)(3), however, the dual consolidated loss is not deemed to be put to a foreign use by virtue of the Country Z mirror legislation. Therefore, DCC is eligible to make a domestic use election for the dual consolidated loss.

Par. 8. Section 1.1503(d)-8 is amended by removing the language “§1.1503(d)-1(c)” and adding in its place the language “§1.1503(d)-1(d)” wherever it appears in paragraphs (b)(3)(i) and (iii) and adding paragraphs (b)(6) and (7) to read as follows:

§1.1503(d)-8 Effective dates.

* * * * *

(b) * * *

(6) Rules regarding domestic consenting corporations. Section 1.1503(d)-1(b)(2)(iii) and (c), as well §1.1503(d)-3(e)(1) and (3), apply to determinations under §§1.1503(d)-1 through 1.1503(d)-7 relating to taxable years ending on or after December 20, 2018. For taxable years ending before December 20, 2018, see §1.1503(d)-3(e)(1) as contained in 26 CFR part 1 revised as of April 1, 2018.

(7) Compulsory transfer triggering event exception. Section 1.1503(d)-6(f)(5)(i) through (iii) applies to transfers that occur on or after December 20, 2018. For transfers occurring before December 20, 2018, see §1.1503(d)-6(f)(5)(i) through (iii) as contained in 26 CFR part 1 revised as of April 1, 2018. However, taxpayers may consistently apply §1.1503(d)-6(f)(5)(i) through (iii) to transfers occurring before December 20, 2018.

Par. 9. Section 1.6038-2 is amended by adding paragraphs (f)(13) and (14) and (m)(3) to read as follows:

§1.6038-2 Information returns required of United States persons with respect to annual accounting periods of certain foreign corporations.

* * * * *

(f) * * *

(13) Amounts involving hybrid transactions or hybrid entities under section 267A. If for the annual accounting period, the corporation pays or accrues interest or royalties for which a deduction is disallowed under section 267A and the regulations in this part under section 267A of the Internal Revenue Code, then Form 5471 (or successor form) must contain such information about the disallowance in the form and manner and to the extent prescribed by the form, instruction, publication, or other guidance.

(14) Hybrid dividends under section 245A(e). If for the annual accounting period, the corporation pays or receives a hybrid dividend or a tiered hybrid dividend under section 245A(e) and the regulations in this part under section 245A(e) of the Internal Revenue Code, then Form 5471 (or successor form) must contain such information about the hybrid dividend or tiered hybrid dividend in the form and manner and to the extent prescribed by the form, instruction, publication, or other guidance. Form 5471 (or successor form) must also contain any other information relating to the rules of section 245A(e) and the regulations in this part under section 245A(e) of the Internal Revenue Code (including information related to a specified owner’s hybrid deduction account), as prescribed by the form, instruction, publication, or other guidance.

* * * * *

(m) * * *

(3) Rules relating to certain hybrid arrangements. Paragraphs (f)(13) and (14) of this section apply with respect to information for annual accounting periods beginning on or after December 20, 2018.

Par. 10. Section 1.6038-3 is amended by:

1. Adding paragraph (g)(3).

2. Redesignating paragraph (1) at the end of the section as paragraph (l).

3. In newly redesignated paragraph (l), revising the heading and adding a sentence at the end.

The additions and revision read as follows:

§1.6038-3 Information returns required of certain United States persons with respect to controlled foreign partnerships (CFPs).

* * * * *

(g) * * *

(3) Amounts involving hybrid transactions or hybrid entities under section 267A. In addition to the information required pursuant to paragraphs (g)(1) and (2) of this section, if, during the partnership’s taxable year for which the Form 8865 is being filed, the partnership paid or accrued interest or royalties for which a deduction is disallowed under section 267A and the regulations in this part under section 267A, the controlling fifty-percent partners must provide information about the disallowance in the form and manner and to the extent prescribed by Form 8865 (or successor form), instruction, publication, or other guidance.

* * * * *

(l) Applicability dates. * * * Paragraph (g)(3) of this section applies for taxable years of a foreign partnership beginning on or after December 20, 2018.

Par. 11. Section 1.6038A-2 is amended by adding paragraph (b)(5)(iii) and adding a sentence at the end of paragraph (g) to read as follows:

§1.6038A-2 Requirement of return.

* * * * *

(b) * * *

(5) * * *

(iii) If, for the taxable year, a reporting corporation pays or accrues interest or royalties for which a deduction is disallowed under section 267A and the regulations in this part under section 267A, then the reporting corporation must provide such information about the disallowance in the form and manner and to the extent prescribed by Form 5472 (or successor form), instruction, publication, or other guidance.

* * * * *

(g) * * * Paragraph (b)(5)(iii) of this section applies with respect to information for annual accounting periods beginning on or after December 20, 2018.

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 12. The authority citation for part 301 continues to read in part as follows:

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

Par. 13. Section 301.7701-3 is amended by revising the sixth sentence of paragraph (a) and adding paragraph (c)(3) to read as follows:

§301.7701-3 Classification of certain business entities.

(a) In general. * * * Paragraph (c) of this section provides rules for making express elections, including a rule under which a domestic eligible entity that elects to be classified as an association consents to be subject to the dual consolidated loss rules of section 1503(d). * * *

* * * * *

(c) * * *

(3) Consent to be subject to section 1503(d)—(i) Rule. A domestic eligible entity that elects to be classified as an association consents to be treated as a dual resident corporation for purposes of section 1503(d) (such an entity, a domestic consenting corporation), for any taxable year for which it is classified as an association and the condition set forth in §1.1503(d)-1(c)(1) of this chapter is satisfied.

(ii) Transition rule — deemed consent. If, as a result of the applicability date (see paragraph (c)(3)(iii) of this section) relating to paragraph (c)(3)(i) of this section, a domestic eligible entity that is classified as an association has not consented to be treated as a domestic consenting corporation pursuant to paragraph (c)(3)(i) of this section, then the domestic eligible entity is deemed to consent to be so treated as of its first taxable year beginning on or after December 20, 2019. The first sentence of this paragraph (c)(3)(ii) does not apply if the domestic eligible entity elects, on or after December 20, 2018 and effective before its first taxable year beginning on or after December 20, 2019, to be classified as a partnership or disregarded entity such that it ceases to be a domestic eligible entity that is classified as an association. For purposes of the election described in the second sentence of this paragraph (c)(3)(ii), the sixty month limitation under paragraph (c)(1)(iv) of this section is waived.

(iii) Applicability date. The sixth sentence of paragraph (a) of this section and paragraph (c)(3)(i) of this section apply to a domestic eligible entity that on or after December 20, 2018 files an election to be classified as an association (regardless of whether the election is effective before December 20, 2018). Paragraph (c)(3)(ii) of this section applies as of December 20, 2018.

* * * * *

Sunita Lough,

Deputy Commissioner for Services and Enforcement.

Approved: February 26, 2020.

David J. Kautter,

Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on April 7, 2020, 8:45 a.m., and published in the issue of the Federal Register for April 8, 2020, 85 F.R. 19802)

¹ As an additional example, in the case of a CFC and a corporate shareholder of the CFC that are tax residents of different foreign countries, an exclusion (similar to the exclusion for previously taxed earnings and profits under section 959) allowed to the corporate shareholder under its tax law upon a distribution by the CFC of earnings and profits previously taxed under such tax law by reason of an anti-deferral regime is not a hybrid deduction of the CFC.

² In these cases, the anti-duplication rule described in part II.C.3 of this Summary of Comments and Explanation of Revisions section, which applies only to certain deductions or tax benefits under the same relevant foreign tax law, would not apply.

³ For instance, in the case of a structured arrangement pursuant to which a domestic corporation (US1) makes a specified payment to a CFC of an unrelated domestic corporation (US2), a deduction allowed to US1 for the specified payment would offset income subject to tax at the full U.S. corporate tax rate, whereas US2’s GILTI inclusion attributable to the payment would generally be subject to tax at a reduced rate by reason of the deduction under section 250(a)(1)(B).

⁴ Treasury and IRS regulations contain a so-called “check-the-box” provision under which certain taxpayers can choose whether they are treated as a corporation or as a partnership or disregarded entity. It is this election that facilitates the creation of hybrid entities.

⁵ While section 267A applies to both interest and royalty deductions, the Treasury Department and IRS do not have readily available data on royalty deductions.

⁶ These percentages are comparable to estimates provided in OECD Measuring and Monitoring BEPS, Action 11 – 2015 Final Report. https://doi.org/10.1787/9789264241343-en.

⁷ Because the most recently available complete tax data available for this exercise are from 2017, we multiplied average effective tax rates by 21/35 to reflect the 21 percent corporate tax rate that applies to these final regulations relative to the 35 percent rate that applied in 2017. Because effective tax rates are not readily defined for taxpayers with zero or negative taxable income, our model assumes the effective rate to be the statutory rate for those taxpayers.

⁸ The semi-elasticity measures the percent change in taxable income that results from a one percentage point change in the effective tax rate. The parameter used for this exercise reflects the fact that this income is generally considered to be a supernormal return to investment. Supernormal income is highly inelastic.

⁹ Approximately 1,000 taxpayers are affected by both sections, so the number of taxpayers affected by at least one provision is approximately 9,000.

¹⁰ Because of the complexities involved, primarily only large taxpayers engage in hybrid arrangements. The estimate that the top 10 percent of otherwise-relevant taxpayers (by gross receipts) are likely to engage in hybrid arrangements is based on the judgment of the Treasury Department and IRS.

¹¹ Other areas of the Code similarly adopt a 36-month period for administrability purposes. See, for example, §1.884-1(g) (36-month period for testing whether a foreign corporation is eligible to claim an exemption from, or a reduced rate of, branch profits tax); §1.7874-10 (36-month period for measuring whether prior distributions should be taken into account for purposes of the non-ordinary course distribution rule).

¹² This estimate is limited to those taxpayers who report gross receipts above $0.

This notice provides relief for certain taxpayers to allow them to take advantage of amendments made to the net operating loss (NOL) provisions set forth in § 172 of the Internal Revenue Code (Code) by section 2303 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281 (March 27, 2020). Specifically, this notice extends the deadline for filing an application for a tentative carryback adjustment under § 6411 of the Code with respect to the carryback of an NOL that arose in any taxable year that began during calendar year 2018 and that ended on or before June 30, 2019.

Section 2303(b) of the CARES Act amends § 172(b)(1) to carry back any NOL arising in a taxable year beginning after December 31, 2017, and before January 1, 2021, to each of the five taxable years preceding the taxable year in which the NOL arises (carryback period). As a result of that amendment, taxpayers take into account such NOLs in the earliest taxable year in the carryback period, carrying forward unused amounts to each succeeding taxable year. Section 2303(a) of the CARES Act amends § 172(a) to allow a deduction for a taxable year beginning before January 1, 2021, in an amount equal to the aggregate of the NOL carryovers and carrybacks to such year.

Section 2305(a) of the CARES Act amended § 53(e) of the Code to accelerate the recovery of 100 percent of any remaining minimum tax credits of a corporation in its taxable year beginning in 2019, as opposed to its taxable year beginning in 2021. Section 2305(b) of the CARES Act added § 53(e)(5) to the Code to permit a corporation to elect instead to recover 100 percent of any of its remaining minimum tax credits in its taxable year beginning in 2018.

Section 6411 allows a taxpayer to file an application for a tentative carryback adjustment of the tax liability for a prior taxable year that is affected by an NOL carryback provided in § 172(b) or by carrybacks provided for in other Code sections. Under § 1.6411-1(b)(1) of the Income Tax Regulations, taxpayers that are corporations must make the application on Form 1139, Corporation Application for Tentative Refund, and taxpayers other than corporations must make the application on Form 1045, Application for Tentative Refund. The Code and regulations require that an application must be filed within 12 months of the close of the taxable year in which the NOL arose. Section 6411(a); § 1.6411-1(c). The tentative carryback adjustment procedure allows a taxpayer to obtain a quick tentative tax refund based on an NOL carryback. Under § 6411(b), the Internal Revenue Service (IRS) conducts a limited examination of the application and makes the resulting credit or refund within 90 days of the filing of the application.

Section 2305(d) of the CARES Act permits a corporation to file an application for a tentative refund of any amount for which a refund with respect to its taxable year beginning in 2018 is due by reason of an election under § 53(e)(5), and provides generally that such application is to be treated and processed as an application made under § 6411 of the Code, provided the application is filed prior to December 31, 2020.

The CARES Act did not provide additional time to file tentative carryback adjustment applications with respect to NOLs arising in a taxable year beginning on or after January 1, 2018, and ending before March 27, 2019, even though the time to file those applications had expired as of the date of enactment. Taxpayers whose losses in these taxable years may now be carried back to an earlier taxable year due to application of section 2303 of the CARES Act will generally be able to file amended returns to claim refunds or credits resulting from the change in the law. These taxpayers, however, would not be able to take advantage of the expedited § 6411 tentative carryback adjustment procedure without an extension of time to file Form 1139 or Form 1045.

Section 6081 of the Code provides that the Secretary of the Treasury or his delegate may grant a reasonable extension of time (generally not to exceed six months) for filing any return, declaration, statement, or other document required by the Code or by regulations thereunder.

The Department of the Treasury and the IRS grant a six-month extension of time to file Form 1045 or Form 1139, as applicable, to taxpayers that have an NOL that arose in a taxable year that began during calendar year 2018 and that ended on or before June 30, 2019. This extension of time is limited to requesting a tentative refund to carry back an NOL and does not extend the time to carry back any other item.

For example, in the case of an NOL that arose in a taxable year ending on December 31, 2018, a taxpayer normally would have until December 31, 2019, to file the Form 1045 or Form 1139, as applicable, but due to this relief, will now have until June 30, 2020, to file the Form 1045 or Form 1139, as applicable. For this same taxpayer, if the taxpayer is a corporation, the deadline to claim a minimum tax credit described in § 53(e)(5) is December 30, 2020, but in order to file one application for a tentative refund and claim both the NOL carryback and the minimum tax credit at the same time, the taxpayer must do so by the earlier of the two deadlines.

To take advantage of the extension of time for requesting a tentative refund based on an NOL carryback, the taxpayer must perform the following actions:

(a) File the applicable form no later than 18 months after the close of the taxable year in which the NOL arose (that is, no later than June 30, 2020, for a taxable year ending December 31, 2018); and

(b) Include on the top of the applicable form “Notice 2020-26, Extension of Time to File Application for Tentative Carryback Adjustment.”

For instructions and additional information, visit IRS.gov/Form1045 or IRS.gov/Form1139, as applicable.

The principal author of this notice is Alexander Wu of the Office of the Associate Chief Counsel (Procedure and Administration). For further information, please contact Mr. Wu at (202) 317-5436 (not a toll-free number).

Before the 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.

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. If a public hearing is scheduled, then notice of the date, time, and place for the public hearing will be published in the Federal Register.

The principal authors of these regulations are Shane M. McCarrick and Richard F. Owens 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, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

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

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

Par. 2. Section 1.245A(e)-1 is amended by:

1. Adding paragraphs (d)(4)(i)(B) and (d)(4)(ii).

2. Adding a sentence at the end of the introductory text of paragraph (g).

3. Adding paragraphs (g)(1)(v) and (h)(2).

The additions read as follows:

§1.245A(e)-1 Special rules for hybrid dividends.

* * * * *

(d) * * *

(4) * * *

(i) * * *

(B) Second, the account is decreased (but not below zero) pursuant to the rules of paragraphs (d)(4)(i)(B)(1) through (3) of this section, in the order set forth in this paragraph (d)(4)(i)(B).

(1) Adjusted subpart F inclusions—(i) In general. Subject to the limitation in paragraph (d)(4)(i)(B)(1)(ii) of this section, the account is reduced by an adjusted subpart F inclusion with respect to the share for the taxable year, as determined pursuant to the rules of paragraph (d)(4)(ii) of this section.

(ii) Limitation. The reduction pursuant to paragraph (d)(4)(i)(B)(1)(i) of this section cannot exceed the hybrid deductions of the CFC allocated to the share for the taxable year multiplied by a fraction, the numerator of which is the subpart F income of the CFC for the taxable year and the denominator of which is the taxable income (as determined under §1.952-2(b)) of the CFC for the taxable year. However, if the denominator of the fraction would be zero or less, then the fraction is considered to be zero.

(iii) Special rule allocating reductions across accounts in certain cases. This paragraph (d)(4)(i)(B)(1)(iii) applies after each of the specified owner’s hybrid deduction accounts with respect to its shares of stock of the CFC are adjusted pursuant to paragraph (d)(4)(i)(B)(1)(i) of this section but before the accounts are adjusted pursuant to paragraph (d)(4)(i)(B)(2) of this section, to the extent that one or more of the hybrid deduction accounts would have been reduced by an amount pursuant to paragraph (d)(4)(i)(B)(1)(i) of this section but for the limitation in paragraph (d)(4)(i)(B)(1)(ii) of this section (the aggregate of the amounts that would have been reduced but for the limitation, the excess amount, and the accounts that would have been reduced by the excess amount, the excess amount accounts). When this paragraph (d)(4)(i)(B)(1)(iii) applies, the specified owner’s hybrid deduction accounts other than the excess amount accounts (if any) are ratably reduced by the lesser of the excess amount and the difference of the following two amounts: the hybrid deductions of the CFC allocated to the specified owner’s shares of stock of the CFC for the taxable year multiplied by the fraction described in paragraph (d)(4)(i)(B)(1)(ii) of this section; and the reductions pursuant to paragraph (d)(4)(i)(B)(1)(i) of this section with respect to the specified owner’s shares of stock of the CFC.

(2) Adjusted GILTI inclusions—(i) In general. Subject to the limitation in paragraph (d)(4)(i)(B)(2)(ii) of this section, the account is reduced by an adjusted GILTI inclusion with respect to the share for the taxable year, as determined pursuant to the rules of paragraph (d)(4)(ii) of this section.

(ii) Limitation. The reduction pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section cannot exceed the hybrid deductions of the CFC allocated to the share for the taxable year multiplied by a fraction, the numerator of which is the tested income of the CFC for the taxable year and the denominator of which is the taxable income (as determined under §1.952-2(b)) of the CFC for the taxable year. However, if the denominator of the fraction would be zero or less, then the fraction is considered to be zero.

(iii) Special rule allocating reductions across accounts in certain cases. This paragraph (d)(4)(i)(B)(2)(iii) applies after each of the specified owner’s hybrid deduction accounts with respect to its shares of stock of the CFC are adjusted pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section but before the accounts are adjusted pursuant to paragraph (d)(4)(i)(B)(3) of this section, to the extent that one or more of the hybrid deduction accounts would have been reduced by an amount pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section but for the limitation in paragraph (d)(4)(i)(B)(2)(ii) of this section (the aggregate of the amounts that would have been reduced but for the limitation, the excess amount, and the accounts that would have been reduced by the excess amount, the excess amount accounts). When this paragraph (d)(4)(i)(B)(2)(iii) applies, the specified owner’s hybrid deduction accounts other than the excess amount accounts (if any) are ratably reduced by the lesser of the excess amount and the difference of the following two amounts: the hybrid deductions of the CFC allocated to the specified owner’s shares of stock of the CFC for the taxable year multiplied by the fraction described in paragraph (d)(4)(i)(B)(2)(ii) of this section; and the reductions pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section with respect to the specified owner’s shares of stock of the CFC.

(3) Certain section 956 inclusions. The account is reduced by an amount included in the gross income of a domestic corporation under sections 951(a)(1)(B) and 956 with respect to the share for the taxable year of the domestic corporation in which or with which the CFC’s taxable year ends, to the extent so included by reason of the application of section 245A(e) and this section to the hypothetical distribution described in §1.956-1(a)(2).

* * * * *

(ii) Rules regarding adjusted subpart F and GILTI inclusions. (A) The term adjusted subpart F inclusion means, with respect to a share of stock of a CFC for a taxable year of the CFC, a domestic corporation’s pro rata share of the CFC’s subpart F income included in gross income under section 951(a)(1)(A) for the taxable year of the domestic corporation in which or with which the CFC’s taxable year ends, to the extent attributable to the share (as determined under the principles of section 951(a)(2) and §1.951-1(b) and (e)), adjusted by—

(1) Adding to the amount the associated foreign income taxes with respect to the amount; and

(2) Subtracting from such sum the quotient of the associated foreign income taxes divided by the percentage described in section 11(b).

(B) The term adjusted GILTI inclusion means, with respect to a share of stock of a CFC for a taxable year of the CFC, a domestic corporation’s GILTI inclusion amount (within the meaning of §1.951A-1(c)(1)) for the U.S. shareholder inclusion year (within the meaning of §1.951A-1(f)(7)), to the extent attributable to the share (as determined under paragraph (d)(4)(ii)(C) of this section), adjusted by—

(1) Adding to the amount the associated foreign income taxes with respect to the amount;

(2) Multiplying such sum by the difference of 100 percent and the percentage described in section 250(a)(1)(B); and

(3) Subtracting from such product the quotient of 80 percent of the associated foreign income taxes divided by the percentage described in section 11(b).

(C) A domestic corporation’s GILTI inclusion amount for a U.S. shareholder inclusion year is attributable to a share of stock of the CFC based on a fraction—

(1) The numerator of which is the domestic corporation’s pro rata share of the tested income of the CFC for the U.S. shareholder inclusion year, to the extent attributable to the share (as determined under the principles of §1.951A-1(d)(2)); and

(2) The denominator of which is the aggregate of the domestic corporation’s pro rata share of the tested income of each tested income CFC (as defined in §1.951A-2(b)(1)) for the U.S. shareholder inclusion year.

(D) The term associated foreign income taxes means—

(1) With respect to a domestic corporation’s pro rata share of the subpart F income of the CFC included in gross income under section 951(a)(1)(A) and attributable to a share of stock of a CFC for a taxable year of the CFC, current year tax (as described in §1.960-1(b)(4)) allocated and apportioned under §1.960-1(d)(3)(ii) to the subpart F income groups (as described in §1.960-1(b)(30)) of the CFC for the taxable year, to the extent allocated to the share under paragraph (d)(4)(ii)(E) of this section; and

(2) With respect to a domestic corporation’s GILTI inclusion amount under section 951A attributable to a share of stock of a CFC for a taxable year of the CFC, current year tax (as described in §1.960-1(b)(4)) allocated and apportioned under §1.960-1(d)(3)(ii) to the tested income groups (as described in §1.960-1(b)(33)) of the CFC for the taxable year, to the extent allocated to the share under paragraph (d)(4)(ii)(F) of this section, multiplied by the domestic corporation’s inclusion percentage (as described in §1.960-2(c)(2)).

(E) Current year tax allocated and apportioned to a subpart F income group of a CFC for a taxable year is allocated to a share of stock of the CFC by multiplying the foreign income tax by a fraction—

(1) The numerator of which is the domestic corporation’s pro rata share of the subpart F income of the CFC for the taxable year, to the extent attributable to the share (as determined under the principles of section 951(a)(2) and §1.951-1(b) and (e)); and

(2) The denominator of which is the subpart F income of the CFC for the taxable year.

(F) Current year tax allocated and apportioned to a tested income group of a CFC for a taxable year is allocated to a share of stock of the CFC by multiplying the foreign income tax by a fraction—

(1) The numerator of which is the domestic corporation’s pro rata share of tested income of the CFC for the taxable year, to the extent attributable to the share (as determined under the principles §1.951A-1(d)(2)); and

(2) The denominator of which is the tested income of the CFC for the taxable year.

* * * * *

(g) * * * No amounts are included in the gross income of US1 under sections 951(a)(1)(A), 951A(a), or 951(a)(1)(B) and 956.

(1) * * *

(v) Alternative facts – account reduced by adjusted GILTI inclusion. The facts are the same as in paragraph (g)(1)(i) of this section, except that for taxable year 1 FX has $130x of gross tested income and $10.5x of current year tax (as described in §1.960-1(b)(4)) that is allocated and apportioned under §1.960-1(d)(3)(ii) to the tested income groups of FX. In addition, FX has $119.5x of tested income ($130x of gross tested income, less the $10.5x of current year tax deductions properly allocable to the gross tested income). Further, of US1’s pro rata share of the tested income ($119.5x), $80x is attributable to Share A and $39.5x is attributable to Share B (as determined under the principles of §1.951A-1(d)(2)). Moreover, US1’s net deemed tangible income return (as defined in §1.951A-1(c)(3)) for taxable year 1 is $71.7x, and US1 does not own any stock of a CFC other than its stock of FX. Thus, US1’s GILTI inclusion amount (within the meaning of §1.951A-1(c)(1)) for taxable year 1, the U.S. shareholder inclusion year, is $47.8x (net CFC tested income of $119.5x, less net deemed tangible income return of $71.7x) and US1’s inclusion percentage (as described in §1.960-2(c)(2)) is 40 ($47.8x/$119.5x). At the end of year 1, US1’s hybrid deduction account with respect to Share A is: first, increased by $80x (the amount of hybrid deductions allocated to Share A); and second, decreased by $10x (the sum of the adjusted GILTI inclusion with respect to Share A, and the adjusted GILTI inclusion with respect to Share B that is allocated to the hybrid deduction account with respect to Share A) to $70x. See paragraphs (d)(4)(i)(A) and (B) of this section. In year 2, the entire $30x of each dividend received by US1 from FX during year 2 is a hybrid dividend, because the sum of US1’s hybrid deduction accounts with respect to each of its shares of FX stock at the end of year 2 ($70x) is at least equal to the amount of the dividends ($60x). See paragraph (b)(2) of this section. At the end of year 1, US1’s hybrid deduction account with respect to Share A is decreased by $60x (the amount of the hybrid deductions in the account that give rise to a hybrid dividend or tiered hybrid dividend during year 1) to $10x. See paragraph (d)(4)(i)(C) of this section. Paragraphs (g)(1)(v)(A) through (C) of this section describe the computations pursuant to paragraph (d)(4)(i)(B)(2) of this section.

(A) To determine the adjusted GILTI inclusion with respect to Share A for taxable year 1, it must be determined to what extent US1’s $47.8x GILTI inclusion amount is attributable to Share A. See paragraph (d)(4)(ii)(B) of this section. Here, $32x of the inclusion is attributable to Share A, calculated as $47.8x multiplied by a fraction, the numerator of which is $80x (US1’s pro rata share of the tested income of FX attributable to Share A) and denominator of which is $119.5x (US1’s pro rata share of the tested income of FX, its only CFC). See paragraph (d)(4)(ii)(C) of this section. Next, the associated foreign income taxes with respect to the $32x GILTI inclusion amount attributable to Share A must be determined. See paragraphs (d)(4)(ii)(B) and (D) of this section. Such associated foreign income taxes are $2.8x, calculated as $10.5x (the current year tax allocated and apportioned to the tested income groups of FX) multiplied by a fraction, the numerator of which is $80x (US1’s pro rata share of the tested income of FX attributable to Share A) and the denominator of which is $119.5x (the tested income of FX), multiplied by 40% (US1’s inclusion percentage). See paragraphs (d)(4)(ii)(D) and (F) of this section. Thus, pursuant to paragraph (d)(4)(ii)(B) of this section, the adjusted GILTI inclusion with respect to Share A is $6.7x, computed by—

(1) Adding $2.8x (the associated foreign income taxes with respect to the $32x GILTI inclusion attributable to Share A) to $32x, which is $34.8x;

(2) Multiplying $34.8x (the sum of the amounts in paragraph (g)(1)(v)(A)(1) of this section) by 50% (the difference of 100 percent and the percentage described in section 250(a)(1)(B)), which is $17.4x; and

(3) Subtracting $10.7x (calculated as $2.24x (80% of the $2.8x of associated foreign income taxes) divided by .21 (the percentage described in section 11(b)) from $17.4x (the product of the amounts in paragraph (g)(1)(v)(A)(2) of this section), which is $6.7x.

(B) Pursuant to computations similar to those discussed in paragraph (g)(1)(v)(A) of this section, the adjusted GILTI inclusion with respect to Share B is $3.3x. However, the hybrid deduction account with respect to Share B is not reduced by such $3.3x, because of the limitation in paragraph (d)(4)(i)(B)(2)(ii) of this section, which, with respect to Share B, limits the reduction pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section to $0 (calculated as $0, the hybrid deductions allocated to the share for the taxable year, multiplied by 1, the fraction described in paragraph (d)(4)(i)(B)(2)(ii) of this section (computed as the $119.5x of tested income divided by the $119.5x of taxable income)). See paragraphs (d)(4)(i)(B)(2)(i) and (ii) of this section.

(C) US1’s hybrid deduction account with respect to Share A is reduced by the entire $6.7x adjusted GILTI inclusion with respect to the share, as such $6.7x does not exceed the limit in paragraph (d)(4)(i)(B)(2)(ii) of this section ($80x, calculated as $80x, the hybrid deductions allocated to the share for the taxable year, multiplied by 1, the fraction described in paragraph (d)(4)(i)(B)(2)(ii) of this section). See paragraphs (d)(4)(i)(B)(2)(i) and (ii) of this section. In addition, the hybrid deduction account is reduced by another $3.3x, the amount of the adjusted GILTI inclusion with respect to Share B that is allocated to the hybrid deduction account with respect to Share A. See paragraph (d)(4)(i)(B)(2)(iii) of this section. As a result, pursuant to paragraph (d)(4)(i)(B)(2) of this section, US1’s hybrid deduction account with respect to Share A is reduced by $10x ($6.7x plus $3.3x).

* * * * *

(h) * * *

(2) Special rules. Paragraphs (d)(4)(i)(B) and (d)(4)(ii) of this section (decrease of hybrid deduction accounts; rules regarding adjusted subpart F and GILTI inclusions) apply to taxable years ending on or after [date of publication of the final regulations in the Federal Register]. However, a taxpayer may apply those paragraphs to taxable years ending before that date, so long as the taxpayer consistently applies paragraphs (d)(4)(i)(B) and (d)(4)(ii) to those taxable years.

Par. 3. Section 1.881-3 is amended by:

1.Adding a sentence at the end of paragraph (a)(1).

2.Revising paragraph (a)(2)(i)(C).

3.In paragraph (a)(2)(ii)(B)(1) introductory text, removing “one of the following” and adding “one or more of the following” in its place.

4.In paragraph (a)(2)(ii)(B)(1)(ii), removing the word “or” at the end of the paragraph.

5. In paragraph (a)(2)(ii)(B)(1)(iii), removing the period at the end and adding a semicolon in its place.

6. Adding paragraphs (a)(2)(ii)(B)(1)(iv) and (v) and (d)(1)(iii).

7. Adding a sentence at the end of paragraph (e) introductory text.

8. In paragraph (e), designating Examples 1 through 26 as paragraphs (e)(1) through (26), respectively.

9. In newly designated paragraph (e)(3), removing “Example 2” and “§301.7701-3” and adding “paragraph (e)(2) of this section (the facts in Example 2)” and “§301.7701-3 of this chapter” in their places, respectively.

10. Redesignating newly designated paragraphs (e)(4) through (26) as paragraphs (e)(6) through (28), respectively.

11. Adding new paragraphs (e)(4) and (5);

12. In newly redesignated paragraph (e)(9)(ii), removing “(a)(4)(i)” and adding “(a)(4)(i) of this section” in its place.

13. In newly redesignated paragraph (e)(23)(i), removing “Example 20” and adding “paragraph (e)(22) of this section (the facts in Example 22)” in its place.

14. In newly redesignated paragraph (e)(23)(ii), removing “Example 19” and “paragraph (i) of this Example 21” and adding “paragraph (e)(21) of this section (Example 21)” and “paragraph (e)(23)(i) of this section (this Example 23)” in their places, respectively.

15. In newly redesignated paragraph (e)(25)(i), removing “Example 22” and adding “paragraph (e)(24) of this section (the facts in Example 24)” in its place.

16. In newly redesignated paragraph (e)(26)(i), removing “Example 22” and adding in its place “paragraph (e)(24) of this section (the facts in Example 24)”.

17. Adding paragraph (e)(29).

18. In paragraph (f):

i. Revising the paragraph heading.

ii. Removing “Paragraph (a)(2)(i)(C) and Example 3 of paragraph (e) of this section” and adding “Paragraphs (a)(2)(i)(C) and (e)(3) of this section” in its place.

iii. Adding a sentence at the end of the paragraph.

The additions and revision read as follows:

§1.881-3 Conduit financing arrangements.

(a) * * *

(1) * * * See §1.1471-3(f)(5) for the application of a conduit transaction for purposes of sections 1471 and 1472. See also §§1.267A-1 and 1.267A-4 (disallowing a deduction for certain interest or royalty payments to the extent the income attributable to the payment is offset by a deduction with respect to equity).

(2) * * *

(i) * * *

(C) Treatment of disregarded entities. For purposes of this section, the term person includes a business entity that is disregarded as an entity separate from its single member owner under §§301.7701-1 through 301.7701-3 of this chapter and therefore such entity may be treated as a party to a financing transaction with its owner.

(ii) * * *

(B) * * *

(1) * * *

(iv) The issuer is allowed a deduction or another tax benefit (such as an exemption, exclusion, credit, or a notional deduction determined with respect to the stock or similar interest) for amounts paid, accrued, or distributed (deemed or otherwise) with respect to the stock or similar interest, either under the laws of the issuer’s country of residence or a country in which the issuer has a taxable presence, such as a permanent establishment, to which a payment on a financing transaction is attributable; or

(v) A person related to the issuer is, under the tax laws of the issuer’s country of residence, allowed a refund (including through a credit), or similar tax benefit for taxes paid by the issuer to its country of residence on amounts paid, accrued, or distributed (deemed or otherwise) with respect to the stock or similar interest, without regard to any related person’s tax liability under the laws of the issuer’s country of residence.

* * * * *

(d) * * *

(1) * * *

(iii) Limitation for certain types of stock. If a financing transaction linking one of the parties to the financing arrangement is stock (or a similar interest in a partnership, trust, or other person) described in paragraph (a)(2)(ii)(B)(1)(iv) of this section, and the issuer is allowed a notional interest deduction with respect to its stock or similar interest (under the laws of its country of residence or another country in which it has a place of business or permanent establishment), the portion of the payment made by the financed entity that is recharacterized under paragraph (d)(1)(i) of this section attributable to such financing transaction will not exceed the financing transaction’s principal amount as determined under paragraph (d)(1)(ii) of this section multiplied by the rate used to compute the issuer’s notional interest deduction for the taxable year in which the payment is made.

* * * * *

(e) Examples. * * * For purposes of these examples, unless otherwise indicated, it is assumed that no stock is of the types described in paragraph (a)(2)(ii)(B)(1)(iv) or (v) of this section.

* * * * *

(4) Example 4. Hybrid instrument as financing arrangement. The facts are the same as in paragraph (e)(2) of this section (the facts in Example 2), except that FP assigns the DS note to FS in exchange for stock issued by FS. The stock issued by FS is in form convertible debt with a 49-year term that is treated as debt under the tax laws of Country T. The FS stock is not subject to any of the redemption, acquisition, or payment rights or requirements specified in paragraphs (a)(2)(ii)(B)(1)(i) through (iii) of this section. Because the FS stock gives rise to a deduction under the tax laws of Country T, the FS stock is a financing transaction under paragraph (a)(2)(ii)(B)(1)(iv) of this section. Therefore, the DS note held by FS and the FS stock held by FP are financing transactions within the meaning of paragraphs (a)(2)(ii)(A)(1) and (2) of this section, respectively, and together constitute a financing arrangement within the meaning of paragraph (a)(2)(i) of this section. See also §1.267A-4 for rules applicable to disqualified imported mismatch amounts.

(5) Example 5. Refundable tax credit treated as financing transaction. FS lends $1,000,000 to DS in exchange for a note issued by DS. Additionally, Country T has a regime whereby FP, as the sole shareholder of FS, is allowed a refund with respect to distributions of earnings by FS that is equal to 90% of the Country T taxes paid by FS associated with any such distributed earnings. FP is not itself subject to Country T tax on distributions from FS. The loan from FS to DS is a financing transaction within the meaning of paragraph (a)(2)(ii)(A)(1) of this section. FP’s stock in FS constitutes a financing transaction within the meaning of paragraph (a)(2)(ii)(B)(1)(v) of this section because FP, a person related to FS, is allowed a refund of FS’s Country T taxes even though FP is not subject to Country T tax on such payments. Together, the FS stock held by FP and the DS note held by FS constitute a financing arrangement within the meaning of paragraph (a)(2)(i) of this section.

* * * * *

(29) Example 29. Amount of payment subject to recharacterization. (i) FP lends $10,000,000 to FS in exchange for a ten-year note with a stated interest rate of 6%. FP also contributes $5,000,000 to FS in exchange for FS stock. Pursuant to Country T tax law, FS is entitled to a notional interest deduction with respect to the stock equal to the prevailing Country T government bond rate multiplied by the taxpayer’s net equity for the previous taxable year. FS, pursuant to a tax avoidance plan, lends $20,000,000 to DS in exchange for a note that pays 8% interest annually. DS makes its first $1,600,000 payment on this note in year X, when the prevailing Country T bond rate is 1%.

(ii) Both the note and the stock issued by FS to FP are financing transactions. The note is an advance of money under paragraph (a)(2)(i)(A) of this section. The stock is described in paragraph (a)(2)(ii)(A)(2) of this section, by reason of paragraph (a)(2)(ii)(B)(1)(iv) of this section, because Country T law entitles FS to a notional interest deduction with respect to its stock. The note issued by DS is also financing transaction by reason of paragraph (a)(2)(ii)(A)(1) of this section. Accordingly, FP is advancing money and DS receives money, effected through FS an intermediary entity, and the receipt and advance are effected through financing transactions (that is, the FS note, FS stock, and the DS note linking all three entities). As such, the arrangement may be treated as a financing arrangement. See paragraph (a)(2)(i)(A) of this section. FP is the financing entity, FS is the intermediate entity, and DS is the financed entity. The aggregate principal amount of financing transactions linking DS to the financing arrangement ($20,000,000) is greater than the aggregate principal amount of the financing transactions linking FP to the financing arrangement ($15,000,000). Therefore, under paragraph (d)(1)(i) of this section, the amount of DS’s payment recharacterized as a payment directly between DS and FP would be $1,200,000 ($1,600,000 x $15,000,000 / $20,000,000) prior to the application of paragraph (d)(1)(iii) of this section. However, of the $1,200,000 subject to re-characterization, $400,000 ($1,200,000 x $5,000,000 / $15,000,000) is attributable to NID stock and thus subject to the limitation in paragraph (d)(1)(iii) of this section. Thus, only $50,000 ($5,000,000 x 1%) of the $400,000 may be recharacterized as a transaction between DS and FP. The remaining $800,000 is not subject to the limitation in paragraph (d)(1)(iii) of this section because it is not attributable to stock that entitles the issuer to a notional interest deduction. Accordingly, only $850,000 of DS’s payment is recharacterized as going directly from DS to FP. See also §1.267A-4 for rules applicable to disqualified imported mismatch amounts.

(f) Applicability date. * * * Paragraphs (a)(2)(ii)(B)(1)(iv) and (v) and (d)(1)(iii) of this section apply to payments made on or after [date of publication of the final regulations in the Federal Register].

Par. 4. Section 1.951A-0, as proposed to be amended at 84 FR 29114 (June 21, 2019), is further amended by adding entries for §1.951A-2(c)(6), (c)(6)(i) and (ii), (c)(6)(ii)(A) through (C), (c)(6)(iii), (c)(6)(iv), (c)(6)(iv)(A), (c)(6)(iv)(A)(1) and (2), (c)(6)(iv)(B), (c)(6)(iv)(B)(1) and (2), (c)(7), (c)(7)(i) and (ii), (c)(7)(ii)(A), (c)(7)(ii)(A)(1) and (2), (c)(7)(ii)(B), (c)(7)(iii) through (v), (c)(7)(v)(A) through (D), (c)(7)(v)(D)(1) and (2), (c)(7)(v)(D)(2)(i) and (ii), (c)(7)(v)(E), (c)(7)(v)(E)(1) and (2), (c)(7)(vi), (c)(7)(vi)(A), (c)(7)(vi)(A)(1) and (2), and (c)(7)(vi)(B) and §1.951A-7(d) to read as follows:

§1.951A-0 Outline of section 951A regulations.

* * * * *

§1.951A-2 Tested income and tested loss.

* * * * *

(c) * * *

(6) Allocation of deductions attributable to certain disqualified payments.

(i) In general.

(ii) Definitions related to disqualified payment.

(A) Disqualified payment.

(B) Disqualified period.

(C) Related recipient CFC.

(iii) Treatment of partnerships.

(iv) Examples.

(A) Example 1: Deduction related directly to disqualified payment to related recipient CFC.

(1) Facts.

(2) Analysis.

(B) Example 2: Deduction related indirectly to disqualified payment to partnership in which related recipient CFC is a partner.

(1) Facts.

(2) Analysis.

(7) Election for application of high tax exception of section 954(b)(4).

(i) In general.

(ii) Definitions.

(A) Tentative gross tested income item.

(1) In general.

(2) Income attributable to a QBU.

(B) Tentative net tested income item.

(iii) Effective rate at which taxes are imposed.

(iv) Taxes paid or accrued with respect to a tentative net tested income item.

(v) Rules regarding the election.

(A) Manner of making election.

(B) Scope of election.

(C) Duration of election.

(D) Revocation of election.

(1) In general.

(2) Limitations by reason of revocation.

(i) In general.

(ii) Exception for change of control.

(E) Rules applicable to controlling domestic shareholder groups.

(1) In general.

(2) Definition of controlling domestic shareholder group.

(vi) Example.

(A) Example: Effect of disregarded payments between QBUs.

(1) Facts.

(2) Analysis.

(B) [Reserved]

* * * * *

§1.951A-7 Applicability dates.

* * * * *

(d) Deduction for certain disqualified payments.

Par. 5. Section 1.951A-2, as proposed to be amended at 84 FR 29114 (June 21, 2019), is further amended by redesignating paragraph (c)(6) as paragraph (c)(7) and adding a new paragraph (c)(6) and a reserved paragraph (c)(7)(vi)(B) to read as follows:

§1.951A-2 Tested income and tested loss.

* * * * *

(c) * * *

(6) Allocation of deductions attributable to certain disqualified payments—(i) In general. A deduction related directly or indirectly to a disqualified payment is allocated or apportioned solely to residual CFC gross income, and any deduction related to a disqualified payment is not properly allocable to property produced or acquired for resale under section 263, section 263A, or section 471.

(ii) Definitions related to disqualified payment. The following definitions apply for purposes of this paragraph (c)(6).

(A) Disqualified payment. The term disqualified payment means a payment made by a person to a related recipient CFC during the disqualified period with respect to the related recipient CFC, to the extent the payment would constitute income described in section 951A(c)(2)(A)(i) and paragraph (c)(1) of this section without regard to whether section 951A applies.

(B) Disqualified period. The term disqualified period has the meaning provided in §1.951A-3(h)(2)(ii)(C)(1), substituting “related recipient CFC” for “transferor CFC.”

(C) Related recipient CFC. The term related recipient CFC means, with respect to a payment by a person, a recipient of the payment that is a controlled foreign corporation that bears a relationship to the payor described in section 267(b) or 707(b) immediately before or after the payment.

(iii) Treatment of partnerships. For purposes of determining whether a payment is made by a person to a related recipient CFC for purposes of paragraph (c)(6)(ii)(A) of this section, a payment by or to a partnership is treated as made proportionately by or to its partners, as applicable.

(iv) Examples. The following examples illustrate the application of this paragraph (c)(6).

(A) Example 1: Deduction related directly to disqualified payment to related recipient CFC—(1) Facts. USP, a domestic corporation, owns all of the stock in CFC1 and CFC2, each a controlled foreign corporation. Both USP and CFC2 use the calendar year as their taxable year. CFC1 uses a taxable year ending November 30. On October 15, 2018, before the start of its first CFC inclusion year, CFC1 receives and accrues a payment from CFC2 of $100x of prepaid royalties with respect to a license. The $100x payment is excluded from subpart F income pursuant to section 954(c)(6) and would constitute income described in section 951A(c)(2)(A)(i) and paragraph (c)(1) of this section without regard to whether section 951A applies.

(2) Analysis. CFC1 is a related recipient CFC (within the meaning of paragraph (c)(6)(ii)(C) of this section) with respect to the royalty prepayment by CFC2 because it is related to CFC2 within the meaning of section 267(b). The royalty prepayment is received by CFC1 during its disqualified period (within the meaning of paragraph (c)(6)(ii)(B) of this section) because it is received during the period beginning January 1, 2018, and ending November 30, 2018. Because it would constitute income described in section 951A(c)(2)(A)(i) and paragraph (c)(1) of this section without regard to whether section 951A applies, the payment is a disqualified payment. Accordingly, CFC2’s deductions related to such payment accrued during taxable years ending on or after April 7, 2020 are allocated or apportioned solely to residual CFC gross income under paragraph (c)(6)(i) of this section.

(B) Example 2: Deduction related indirectly to disqualified payment to partnership in which related recipient CFC is a partner—(1) Facts. The facts are the same as in paragraph (c)(6)(iv)(A)(1) of this section (the facts in Example 1), except that CFC1 and USP own 99% and 1%, respectively of FPS, a foreign partnership, which has a taxable year ending November 30. USP receives a prepayment of $110x from CFC2 for the performance of future services. USP subcontracts the performance of these future services to FPS for which FPS receives and accrues a $100x prepayment from USP. The services will be performed in the same country under the laws of which CFC1 and FPS are created or organized, and the $100x prepayment is not foreign base company services income under section 954(e) and §1.954-4(a). The $100x prepayment would constitute income described in section 951A(c)(2)(A)(i) and paragraph (c)(1) of this section without regard to whether section 951A applies.

(2) Analysis. CFC1 is a related recipient CFC (within the meaning of paragraph (c)(6)(ii)(C) of this section) with respect to the services prepayment by USP because, under paragraph (c)(6)(iii) of this section, it is treated as receiving $99x (99% of $100x) of the services prepayment from USP, and it is related to USP within the meaning of section 267(b). The services prepayment is received by CFC1 during its disqualified period (within the meaning of paragraph (c)(6)(ii)(B) of this section) because it is received during the period beginning January 1, 2018, and ending November 30, 2018. Because it would constitute income described in section 951A(c)(2)(A)(i) and paragraph (c)(1) of this section without regard to whether section 951A applies, the prepayment is a disqualified payment. CFC2’s deductions related to its prepayment to USP are indirectly related to the disqualified payment by USP. Accordingly, CFC2’s deductions related to such payment accrued during taxable years ending on or after April 7, 2020 are allocated or apportioned solely to residual CFC gross income under paragraph (c)(6)(i) of this section.

* * * * *

Par. 6. Section 1.951A-7, as proposed to be amended at 84 FR 29114 (June 21, 2019), is further amended by adding paragraph (d) to read as follows:

§1.951A-7 Applicability dates.

* * * * *

(d) Deduction for certain disqualified payments. Section §1.951A-2(c)(6) applies to taxable years of foreign corporations ending on or after April 7, 2020, and to taxable years of United States shareholders in which or with which such taxable years end.

Sunita Lough,

Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on April 7, 2020, 8:45 a.m., and published in the issue of the Federal Register for April 8, 2020, 85 F.R. 19858)

¹ Thus, for example, in a case in which the subpart F inclusion attributable to a share is $94.75x and the associated foreign income taxes with respect to such is $5.25x, the adjusted subpart F inclusion with respect to the share would be $75x, calculated as $100x ($94.75x + $5.25x) less $25x ($5.25x ÷ 21%).

² Hybrid arrangements are tax-avoidance tools used by certain multinational corporations (MNCs) that have operations both in the U.S. and a foreign country. These hybrid arrangements use differences in tax treatment by the U.S. and a foreign country to reduce taxes in one or both jurisdictions. Hybrid arrangements can be “hybrid entities,” in which a taxpayer is treated as a flow-through or disregarded entity in one country but as a corporation in another, or “hybrid instruments,” which are financial transactions that are treated as debt in one country and as equity in another.

³ The tax treatment under which certain payments are deductible in one jurisdiction and not included in income in a second jurisdiction is referred to as a deduction/no-inclusion outcome (“D/NI outcome”.)

⁴ On December 22, 2008, the Treasury Department and the IRS published a notice of proposed rulemaking (REG-113462-08) (“2008 proposed regulations”) that proposed adding §1.881-3(a)(2)(i)(C) to the conduit financing regulations. The preamble to the 2008 proposed regulations provides that the Treasury Department and the IRS are also studying transactions where a financing entity advances cash or other property to an intermediate entity in exchange for a hybrid instrument (that is, an instrument treated as debt under the tax laws of the foreign country in which the intermediary is resident and equity for U.S. tax purposes), and states that they may issue separate guidance to address the treatment under §1.881-3 of certain hybrid instruments.

⁵ Typically, deductions or credits are not available to offset income inclusions under sections 951(a)(1)(B) and 956, the third category addressed by the proposed regulations.

⁶ Because of the complexities involved, primarily only large taxpayers engage in hybrid arrangements. The estimate that the top 10 percent of otherwise-relevant taxpayers (by gross receipts) are likely to engage in hybrid arrangements is based on the judgment of the Treasury Department and IRS.

⁷ Because of the complexities involved, primarily only large taxpayers engage in conduit financing arrangements. The estimate that the top 10 percent of otherwise-relevant taxpayers (by gross receipts) are likely to engage in conduit financing arrangements is based on the judgment of the Treasury Department and IRS.

⁸ This estimate is limited to those taxpayers who report gross receipts above $0.