The DCL provisions of IRC 1503(d) and its regulations are intended to prevent an entity from using a loss to offset income of a domestic affiliate in the United States while using the same loss to offset income of a foreign affiliate which is not subject to U.S. tax. The DCL provisions are intended to prevent the "double dipping" of a single loss.

IRS personnel should have at least a basic understanding of the substantive DCL rules in order to effectively use this IRM section. This IRM section is not intended as an exhaustive explanation of the substantive DCL rules. For guidance on the substantive DCL rules refer to the Transfer Pricing Practice Network SharePoint site.

See IRM 4.46.1.1.2, Authority.

IRC 1503(d) and the regulations promulgated thereunder provide the operating rules for DCLs. See 26 CFR 1.1503(d)-1 et. seq.

IRS personnel performing examinations involving DCLs, their managers and executives share an equal responsibility in the conduct of quality examinations and an understanding of the DCL rules as they may apply to such examinations.

Program Goals: The goal of this program is to provide general guidance to IRS personnel on identifying DCLs and examination techniques to develop DCL issues. The guidance includes:

The following are commonly used acronyms in this IRM section:

Related resources include the following:

In the early stages of the examination, the issue team should identify any entity which is a dual resident corporation (DRC) or any business operation, or interest in an entity, which is a separate unit (including an interest in a hybrid entity separate unit) and whether any of these incurred a DCL. See 26 CFR 1.1503(d)-1(b)(2) and 26 CFR 1.1503(d)-1(b)(4) for the definitions of a DRC and separate unit.

A DRC is a domestic corporation that is subject to an income tax of a foreign country on its worldwide income or on a residence basis. See 26 CFR 1.1503(d)-(b)(2). In addition, for taxable years ending on or after December 20, 2018, a DRC includes a certain domestic reverse hybrid entity that elected to be treated as an association for U.S. tax purposes but is treated as fiscally transparent under the tax law of its investors. See 26 CFR 1.1503(d)-1(c).

A separate unit is either of the following carried on or owned by a domestic corporation:

Based on the organizational chart of the taxpayer, the issue team can generally determine whether the taxpayer has any DRCs or separate units. See 26 CFR 1.1503(d)-1(b)(2) and 26 CFR 1.1503(d)-1(b)(4) for the definitions of a DRC and separate unit. See IRM 4.61.13.2.1.1, Organizational Chart of Worldwide Operations, for details on the creation of the organizational chart.

The following may indicate the existence of an interest in a separate unit:

If two or more individual separate units are owned by a domestic owner or two or more domestic owners that are members of the same consolidated group and the individual separate units are located or subject to tax in the same foreign country, then such individual separate units shall be treated as one separate unit (a "combined separate unit" ). This separate unit combination rule is mandatory and not elective. See 26 CFR 1.1503(d)-1(b)(4)(ii) for further details.

The issue team should review the prior international examiner's audit reports for potential leads on identifying DRCs or separate units and/or DCLs claimed in prior years that may have an impact on the current examination.

Generally, the loss of a DRC or a separate unit (or an interest in a hybrid entity separate unit) is a DCL.

If a DRC or separate unit exists and that DRC or separate unit incurs a loss which is a DCL in the tax year, the general rule is that the DCL may not be used to offset the income of any domestic affiliate on the U.S. return in that tax year or any other tax year ("domestic use limitation" ).

However, there are exceptions to the general rule. For these exceptions see:

If the taxpayer uses a DCL to offset income of a domestic affiliate in the year the loss is incurred, the issue team should determine whether the taxpayer was able to do so and appropriately did so.

If the taxpayer files a domestic use election for a DCL, the taxpayer must file an annual certification in each of the subsequent five taxable years. During the certification period, the taxpayer is prohibited from making a foreign use of the DCL. See IRM 4.61.13.4.2.4, Certification Period.

If the taxpayer fails to file an annual certification, the taxpayer generally must recapture into income the amount of the DCL covered by the domestic use election to which the annual certification relates. The failure to file an annual certification is a "triggering event." See IRM 4.61.13.4.2, Triggering Events, and IRM 4.61.13.5, Recapture of a DCL.

A taxpayer may seek to remedy a failure to timely file an annual certification by requesting reasonable cause relief pursuant to 26 CFR 1.1503(d)-1(d). See IRM 4.61.13.7, Requests for Reasonable Cause Relief.

On audit, the issue team should review the income tax returns for the taxable years under audit and, if feasible, the five prior taxable years in order to:

Review prior cycle international examiner's reports and/or planning files to identify any domestic use elections that require annual certifications to be included with the return(s) for tax years currently under examination.

The DCL regulations provide that upon the occurrence of certain events, the taxpayer may be required to recapture into income some or all of a DCL subject to a domestic use election. These events are called "triggering events."

26 CFR 1.1503(d)-6(e) provides a list of triggering events. Possible triggering events include, but are not limited to:

In connection with the DCL recapture, the taxpayer must pay an interest charge computed under IRC 6601(a).

The interest charge is determined by treating the additional tax resulting from the DCL recapture for the year of the triggering event as though the additional tax had been due and unpaid from the taxable year in which the DCL gave rise to a tax benefit. The taxable year in which the DCL gave rise to a tax benefit is typically the taxable year in which the DCL was incurred.

Normally for corporations, the additional tax owed as a result of the DCL recapture will equal the amount of the DCL recapture amount multiplied by the applicable corporate income tax rate.

For other taxpayers, the additional tax owed as a result of the DCL recapture will equal the amount of the DCL recapture amount multiplied by the taxpayer's applicable income tax rate.

A manual computation of the interest charge by the issue team will be necessary.

The interest charge becomes a part of the tax liability for the taxable year of the triggering event and should be included as an identifiable "Miscellaneous Tax" on the examination report. See IRM 4.61.13.6.2.1, Report Writing for the Interest Charge Upon Recapture, for guidance on report writing.

If the taxpayer reports the DCL recapture on the original return for the year of the triggering event, confirm that the taxpayer paid the additional interest charge.

The additional interest charge may be reflected on the front page of the return as a write-in amount.

If the taxpayer properly reports the DCL recapture on its return for the year of the triggering event, but does not pay the interest charge, a Form 5701, Notice of Proposed Adjustment, should be issued for the interest charge. See IRM 4.61.13.6.3, Report Writing for Interest Charge on Properly Reported DCL Recapture Amount, for the administrative procedures in addressing the interest charge in the audit report.

The taxpayer may rebut the presumptive rule requiring recapture of the full amount of the DCL and thus reduce the recapture amount that must be included in income in the year of the triggering event.

To rebut the presumptive amount of full recapture, the taxpayer must establish an amount by which the presumptive full amount of recapture is reduced (a "lesser amount" or "reduction of recapture amount" ).

The "reduction of recapture amount" is an amount by which the DCL would have offset other taxable income reported on a timely filed U.S. income tax return for any taxable year up to and including the taxable year of the triggering event if no domestic use election had been made for the loss.

If the taxpayer establishes the reduction of recapture amount, the taxpayer will report as recapture income the full amount of recapture less the reduction of recapture amount.

The taxpayer bears the burden of establishing the reduction of recapture amount.

The taxpayer may rebut the full amount of the interest charge. See IRM 4.61.13.5.1, Interest Charge.

To rebut the full amount of the interest charge the taxpayer must demonstrate that the "net interest owed" is less than the presumptive full amount.

The taxpayer demonstrates the lesser amount of net interest owed by computing the amount of interest owed had the taxpayer filed an amended return for the taxable year in which the DCL was incurred and any other affected taxable years up to and including the year of recapture and no domestic use election had been filed for the DCL.

The taxpayer bears the burden of establishing the net interest amount owed.

Presumptive rule. Except as provided in (2) below for the computation of the taxable income for the year of recapture, no current, carryover, or carryback losses may be used to offset and absorb the recapture amount. See 26 CFR 1.1503(d)-6(h)(4)(i).

Exception to presumptive rule. The recapture amount included in gross income may be offset and absorbed by that portion of a taxpayer’s NOL carryover that is attributable to the DRC or separate unit that incurred the DCL being recaptured.

The recapture income will be treated as ordinary income. For additional rules on the character and source of recapture income, see 26 CFR 1.1503(d)-6(h)(5).

If the issue team determines that the taxpayer used all or a part of a DCL to offset income of a domestic affiliate in the year the DCL was incurred, and no exception to the domestic use limitation applies, the issue team may propose to disallow that use of the DCL. The issue team should use a Form 5701, Notice of Proposed Adjustment, to propose the disallowance.

The issue team should prepare a Form 886-A, Explanation of Items, in addition to the Form 5701. The Form 886–A should:

If the issue team determines that a taxpayer must recapture a DCL because of the occurrence of one or more triggering events and no exception applies, the issue team may propose the recapture of the presumptive full amount of the DCL. The issue team should use a Form 5701 to propose the recapture.

The issue team should prepare a Form 886–A in addition to the Form 5701. The Form 886–A should:

If the taxpayer properly reports the correct amount of recapture of a DCL on its income tax return and pays the correct amount of additional tax on the recapture amount but fails to report and pay the interest charge, the issue team should propose an adjustment for the interest charge. The issue team should use a Form 5701 to propose this adjustment.

The issue team should include on the Form 5701 a separate line item for the amount of the interest charge that results from the recapture. The line item should be labeled "Interest Charge – Due to Dual Consolidated Loss Recapture." See IRM 4.61.13.5.1, Interest Charge, for computation of the interest charge.

The following explanation of the interest charge should be included on the Form 5701:

The issue team should prepare a Form 886–A in addition to the Form 5701. The Form 886–A attached to the Form 5701 should:

To make a request for reasonable cause relief, the taxpayer must file an amended return which amends the return to which the document(s) should have been attached. The amended return must include:

The taxpayer must file the original amended return referred to in this section with the applicable IRS Service Center with which the taxpayer filed its original return to which the documents should have been attached.

In addition to filing the amended return referred to in this section with the IRS Service Center, the taxpayer must provide a copy of the amended return and all required attachments to the director (see paragraph (4) of this section for the definition of "director" ) as follows:

For purposes of this section "director" is, as appropriate, the Area Director, Field Examination, SB/SE or the Director of Field Operations (DFO), LB&I having jurisdiction over the taxpayer’s return for the taxable year.

The taxpayer must file a separate amended return for each year it requests reasonable cause relief.

It may not be appropriate to consider a request for reasonable cause relief if the period of limitations on assessment under IRC 6501(a) has expired for the tax year in which the DCL was incurred, or the tax year in which the DCL should have been recaptured as a result of a failure to file an annual certification.

Processing the receipt of a request for reasonable cause relief will depend on whether the taxpayer is under examination.

The review, development and determination of the taxpayer's request for reasonable cause relief does not constitute or initiate an examination of any taxable year of the taxpayer.

The director has the authority to determine whether the taxpayer has established reasonable cause.

The authority of the director to determine whether the taxpayer has established reasonable cause has been delegated to LB&I team managers. See Delegation Order LB&I-193-6.

The authority of the director to determine whether the taxpayer has established reasonable cause has been formally delegated to specific examination management personnel in SB/SE pursuant to Delegation Order SB/SE 1-23-57. See IRM 1.2.65.4.33, SB/SE 1-23-57, Determination of Reasonable Cause for Failure to File Dual Consolidated Loss Documents.

Any reference made to the director determining reasonable cause in this IRM includes any person who has been delegated such authority.

While the director has the authority to determine reasonable cause, any appropriately assigned issue team may develop the issue. See IRM 4.61.13.7.4, Guidance on Developing the Issue of Reasonable Cause.

This section provides the issue team with guidance on developing whether the taxpayer has demonstrated reasonable cause.

During the 120-day period set forth in 26 CFR 1.1503(d)-1(d)(1) and in the course of reviewing the copy of the taxpayer’s amended return including the written statement setting forth the reasons for reasonable cause relief, the issue team may conclude that additional time is needed to develop whether the taxpayer has demonstrated reasonable cause. In such a case, the director should notify the taxpayer that additional time is needed. This will make the 120-day period inapplicable.

The director should use Letter 4294, Additional Time Notification Letter for Final Determination of the Dual Consolidated Loss Reasonable Cause, to notify the taxpayer that additional time is needed.

The issuance of Letter 4294 or Letter 4296 will make the 120-day determination period inapplicable. See IRM 4.61.13.7.2.2, The 120-Day Determination Period.

A manager with authority under Delegation Order LMSB 193-6 or Delegation Order SB/SE 1-23-57, as applicable, should sign and issue to the taxpayer the appropriate Letter 4294 or Letter 4296 to notify the taxpayer that additional time is needed. See IRM 4.61.13.7.3, Authority to Determine Reasonable Cause, for delegation of authority.

A separate additional time notification letter is issued as needed for each amended return.

During the course of developing whether the taxpayer has demonstrated reasonable cause, the issue team may determine that additional information is needed from the taxpayer.

The issue team should use Letter 4295, Request for Additional Information on Dual Consolidated Loss Reasonable Cause Determination, to request additional information.

The additional information sought should be included in the body of the letter provided to the taxpayer. See Letter 4295.

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To avoid confusion, the issue team should not use Information Documents Requests (IDRs) to request additional information because the review, development and determination of the taxpayer’s request for reasonable cause relief is not an examination of any taxable year of taxpayer.

If the 120-day period is applicable and the director determines that the taxpayer has demonstrated that its failure to comply was due to reasonable cause (and not willful neglect) it is recommended that the director provide written notification of the determination to the taxpayer.

If the 120-day period is not applicable (i.e., a Letter 4294 or Letter 4296 has been issued) and the director determines that the taxpayer has demonstrated reasonable cause, the director should provide written notification of the determination to the taxpayer.

In any event, the director is the only IRS personnel who provides the written notification of determination to the taxpayer.

A separate written notification of the IRS’s determination should be provided for each taxable year for which the taxpayer filed an amended return requesting reasonable cause relief.

If the taxpayer is currently under examination for any taxable year, the issue team should charge time spent working the request for reasonable cause relief to the current examination cycle of the taxpayer or the examination of the taxable year for which the amended return was filed.

If the taxpayer is under the Large Corporate Compliance (LCC) program (which replaced the Coordinated Industry Case (CIC) program), a copy of the acceptance letter should be incorporated into the planning file for future reference.

If the taxpayer is not currently under examination, the examiner should charge the time spent working the request for reasonable cause relief to the Miscellaneous Examination Activity Code 514 - Specialist Consultations or Informal Assistance (in IMS, use code 514000). The review, development and determination of the taxpayer's request for reasonable cause relief is not an examination of any taxable year of the taxpayer.

The IRS Service Center with which the original amended return was filed does not provide the original or any copy of the amended return to IRS field personnel. The taxpayer provides a copy of the original amended return to the appropriate IRS personnel in the field. See IRM 4.61.13.7.9, Administrative Procedures on Reasonable Cause Determination Workpapers, for the recommended administrative procedures for the retention of the determination letter sent to the taxpayer and/or any related documents/workpapers.

If the director determines that the taxpayer has not demonstrated reasonable cause, the director provides written notification of this determination to the taxpayer.

The director is the only IRS employee who may provide written notification of the determination to the taxpayer.

A separate written notification of the IRS’s determination should be provided for each taxable year for which the taxpayer filed an amended return requesting reasonable cause relief.

If the taxpayer is currently under examination for any taxable year, the issue team should charge time working the request for reasonable cause relief to the current examination cycle of the taxpayer or the examination of the taxable year for which the amended return was filed.

If the taxpayer is under the LCC Program, a copy of the denial letter should be retained in the planning file for future reference.

If the taxpayer is not currently under examination, the examination should charge the time spent working the request for reasonable cause relief to the Miscellaneous Examination Activity Code 514 - Specialist Consultations or Informal Assistance. The review, development and determination of the taxpayer's request for reasonable cause relief is not an examination of any taxable year of the taxpayer.

The IRS Service Center with which the original amended return was filed does not provide the original or any copy of the amended return to IRS field personnel. The taxpayer provides a copy of the original amended return to the appropriate IRS personnel in the field. See IRM 4.61.13.7.9, Administrative Procedures on Reasonable Cause Determination Workpapers, for the recommended administrative procedures for the retention of the determination letter sent to the taxpayer and/or any related documents/workpapers.

The determination of a request for reasonable cause relief, including the review and development of reasonable cause, is not by itself an examination.

Once the determination of the request for reasonable cause relief is made (or deemed), this section should be followed to administratively process the determination letter sent to the taxpayer ("determination letter" ) and/or related documents and workpapers.

As discussed below, the administrative procedure differs depending on whether the taxable year for which the request was made is under examination.