Dual Consolidated Loses (Portfolio 6650)

Tax Management Portfolio 6650 T.M., Dual Consolidated Losses, provides a detailed description of the limitations imposed for federal income tax purposes on the use of a single economic loss twice: the first time against income of the domestic affiliates of the taxpayer, and the second time under foreign law against other income of other affiliates (otherwise called “double-dipping”).

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Description

Tax Management Portfolio 6650 T.M., Dual Consolidated Losses, provides a detailed description of the limitations imposed for federal income tax purposes on the use of a single economic loss twice: the first time against income of the domestic affiliates of the taxpayer, and the second time under foreign law against other income of other affiliates (otherwise called “double-dipping”).

While the focus of this Portfolio is on the current Treasury regulations that are generally applicable to dual consolidated losses incurred in taxable years beginning on or after April 18, 2007, where relevant, the Portfolio also describes prior regulations that are still in effect with respect to losses incurred in prior years. The structure of the Portfolio generally follows the steps of the analysis required when faced with a situation involving a dual consolidated loss. The Portfolio also includes practical advice and examples demonstrating the application of the rules in specific situations. This Portfolio may be cited as Altman and Solomon, 6650 T.M., Dual Consolidated Losses.

Authors

Daniel Z. Altman, Esq.

Dr. Z. Daniel Altman, LL.B., magna cum laude, Bar-Ilan University, Israel (1999); B.A. (economics), magna cum laude, Bar-Ilan University, Israel (1999); LL.M., summa cum laude, Bar-Ilan University, Israel (1999); International Tax Program, Harvard Law School (2003); S.J.D. (doctoral program), Harvard Law School (2005); Bar membership, Israel, New York; member, Executive Committee of the Tax Section of the New York State Bar Association; member, Bloomberg BNA U.S. International Advisory Board; partner, Sidley Austin LLP (New York); formerly Attorney with Sullivan & Cromwell LLP, New York (2005–2015), Dr. Avi Alter & Co., Israel (2008–2012); winner of the International Fiscal Association, Mitchell B. Carroll Prize (Amsterdam, 2006); author, Dispute Resolution Under Tax Treaties (IBFD, 2006), Breaking the Barrier of Conventions: Towards a Multilateral Procedure for the Resolution of International Income Tax Disputes (Harvard Law School, 2005) and numerous articles in professional tax publications.

Andrew P. Solomon, Esq.

Andrew P. Solomon, A.B., with honors, Brown University (1975); J.D., magna cum laude, Harvard Law School (1984); Bar membership, New York; Of counsel, Sullivan & Cromwell LLP (since 2015), former partner, Sullivan & Cromwell LLP (1992–2015), former managing partner of Tax Group, Sullivan & Cromwell LLP (1995–2012); Faculty (adjunct), University of Miami School of Law, Graduate Tax Program; member, Executive Committee of the Tax Section of the New York State Bar Association; Co-chair, committee on “Outbound Activities of U.S. Taxpayers” of the New York State Bar Association; former Co-chair, committee on Treaties and Intergovernmental Agreements, committee on Financial Intermediaries; member, Planning Committee, University of Chicago Tax Conference; member, Editorial Board, Journal of Taxation and Regulation of Financial Institutions.

Table of Contents

Detailed Analysis
I. Introduction
A. The DCL Rules in a Nutshell
B. Purpose and Policy Considerations
1. Preventing Double-Dipping and Undue Competitive Advantage to Foreign Investors
2. How the United States Secures its Share of Revenue Generated by the DCL Rules
3. DCL Rules Permit Consolidation
4. DCL Limitations Apply Even Where the Foreign Income Is Subject to U.S. Tax
5. Extending the DCL Rules to Foreign Branches
6. Additional Policy Considerations and International Initiatives
7. Proposed Repeal of the DCL Rules
II. Definitions and Scope of the DCL Rules
A. Scope of Limitations
1. Limitations Apply to Only Ordinary Losses
2. Limitations Apply Only to Losses of Domestic Corporations (Direct and Indirect)
a. In General
b. Exceptions — REITs, RICs, and S Corporations
3. Limitations Apply Only to Losses of Dual Resident Corporations and Separate Units
B. Dual Resident Corporations — Defined
C. Separate Units — Defined
1. In General
2. Indirect Ownership
3. Foreign Branch Separate Units
a. Exceptions for Foreign Branches that Are Not Permanent Establishments
b. Foreign Branches of Dual Resident Corporations and Hybrid Entities
4. Hybrid Entity Separate Units
5. Separate Unit Combination Rule
a. General Rule
b. Dual Resident Corporations Are Not Combined
c. Unexpected Consequences — Caution Required
d. Separate Units of §953(d) Foreign Insurance Companies
e. Coordination with Other Rules
D. Treatment of Interests in Transparent Entities
1. Overview and Rationale
2. Transparent Entities Defined
E. Other Rules
1. Special Rules for Foreign Insurance Companies that Elect to Be Treated as Domestic Corporations Under § 953(d)
2. Treatment of U.S. Possessions as Foreign Countries
III. Transactions Outside the Scope of the DCL Regulations — The Limits of the DCL Rules
A. International Tax Arbitrage Not Involving Double-Dipping of Losses
B. Domestic Reverse Hybrid Entities
C. Transactions and Items Disregarded for U.S. Federal Income Tax Purposes (Elimination Transactions)
D. Losses of CFCs and Domestic Pass-Through Corporations
1. Losses of CFCs and Other Foreign Corporations
2. Losses of S Corporations, RICs, and REITs
E. Foreign Tax Credits Not Subject to DCL Restrictions
F. Indirect Recognition of a DCL Through the Sale of Stock
IV. DCL Calculation and Attribution Rules
A. In General
1. Dual Resident Corporations
2. Separate Units and Transparent Entities
3. Use of U.S. Tax Accounting Rules
4. Attribution Rules Not to Be Used for Other Purposes
B. Dual Resident Corporations
1. Limited to NOLs Under §172(c)
2. Only Current Year Items Are Taken into Account
3. General Rules of §1502 Apply to Affiliated Dual Resident Corporations
4. Items Attributable to Separate Units or Interests in Transparent Entities Owned by Dual Resident Corporations
C. Separate Units and Transparent Entities
1. General Rules
a. Use of U.S. Tax Accounting Rules
b. Limited to Current Year Operating Losses
c. No Duplicate Attribution
d. Treatment as Separate Domestic Corporations
e. Treatment of Foreign Currency
f. General Rules of §1502 Apply to Affiliated Domestic Owners
2. Attribution Rules for Foreign Branch Separate Units
a. In General — Same Rules as Effectively Connected Income
b. Attribution of Expenses (Other than Interest)
c. Attribution of Interest Expense — Application of Reg. §1.882-5 (As Modified)
(1) In General
(2) Modifications to the Reg. §1.882-5 Rules
(3) Attribution Based on Books and Records Where Foreign Law Attributes Interest Expense Solely Based on Such Books and Records
d. Treaty-Based Methods Not Permitted
e. Use of U.S. Attribution Rules Could Lead to Double-Dipping
3. Attribution Rules Relating to Hybrid Entity Separate Units and Interests in Transparent Entities
a. In General — Books and Records
b. Further Guidance on the Books and Records Approach Under Reg. §1.987-2(b)
c. Anti-Abuse Rule on Booking Practices
(1) In General
(2) Section 987 Regulations
(3) Scope of the Anti-Abuse Rules
d. Attribution of Items from Certain Lower Tier Flow-Through Entities
e. Attribution to Foreign Branch Separate Units Owned by Hybrid Entities or Transparent Entities
4. Attribution to Combined Separate Units
5. Conforming Books and Records to U.S. Tax Principles
6. Attribution Upon a Direct or Indirect Disposition of Separate Units or Interests in Transparent Entities
a. Direct or Indirect Transfer of Single Separate Unit or Transparent Entity
b. Sale of More than One Separate Unit or Transparent Entity
7. Attribution of Assets and Liabilities
8. Attribution Rules for Inclusions Based on Stock Ownership
9. Recapture of DCLs
D. Part-Year Dual Resident Corporation, Separate Unit, or Interest in Transparent Entity
1. Dual Resident Corporations
2. Separate Units and Interests in Transparent Entities
V. Foreign Use
A. “Foreign Use” Defined
1. Overview
a. “Foreign Use” Broadly Defined Under the DCL Rules
b. Policy Considerations
2. General Definition of Foreign Use
a. Loss Used to Offset Items of a Foreign Corporation
b. Loss Used to Offset Items of Foreign Owners of Interests in Hybrid Entities Where Such Owners are Not Domestic Corporations
(1) Partial Owners of Hybrid Entities
(2) Sale of an Interest in a Hybrid Entity Separate Unit
c. All or Nothing Rule
d. Broad Definition — Made Available to Offset or Reduce
(1) Irrelevant Whether Income in a Foreign Country Is Actually Offset or Reduced
(2) Irrelevant Whether DCL Offsets Items that are Not Income Under U.S. Tax Principles
(3) Irrelevant Whether Foreign Income Subject to U.S. Tax
e. Foreign Use Through Tax Basis
f. Use of U.S. Ownership Rules
g. Foreign Use from Timing Differences
h. Important Practical Considerations Upon Changing the Classification of Entities
(1) Mid-Year Changes in Classification
(2) Other Changes in Classification
3. Indirect Foreign Use
a. In General
b. Indirect Use Defined
c. Exception for Ordinary Course Transactions
d. Shifting Loss Not Necessary
4. Mirror Legislation Rule
a. Rationale and Legislative History
b. In General
c. IRS No Ruling Policy
d. Not Applicable Where Foreign Law Does Not Restrict Use of the Particular DCL
e. Not Applicable Where Foreign Law Provides Taxpayer with Option of Using DCL in Foreign Jurisdiction
f. Exceptions to the Mirror Legislation Rules
(1) Stand-Alone Exception
(a) In General
(b) Stand-Alone Domestic Use Agreement and Election
(c) Coordination with Bilateral Elective Agreements
(d) Triggering Event
(2) Bilateral Elective Agreements and Agreement with the United Kingdom
(a) Effect on Stand-Alone Domestic Use Elections
(b) Coordination with the Separate Unit Combination Rule
(c) U.S.-U.K. Competent Authority Agreement
(3) Exception Does Not Apply to §953(d) Foreign Insurance Companies
g. Special Rules for Combined Separate Units
5. Ordering Rules for Determining Foreign Use
a. Use Against Income of Affiliates in the Same Taxable Year (Before Carryover)
b. Losses that Do Not Result in a Triggering Event are Used First, Thereafter Losses are Used on a Last-In/First-Out Basis
c. Pro Rata Use of Losses from the Same Taxable Year
d. Example
B. Exceptions to Foreign Use
1. In General
a. Limited Application of the Exceptions
b. Exceptions Do Not Apply for Purposes of Demonstrating that There is No Possibility of Foreign Use
c. Exceptions Do Not Apply for Purposes of Rebutting an Asset Transfer Triggering Event
2. No Foreign Use if Dependent on Election or Sale
3. Presumption of No Foreign Use in the Absence of Foreign Rule for Determining Use
4. De Minimis Reduction of Interests in Partnerships and Grantor Trusts
a. In General
b. De Minimis Change
c. Liquidation of a Partnership or Grantor Trust
d. Application to Combined Separate Units
5. De Minimis Reductions in Interests in Separate Units
a. In General
b. Application to Combined Separate Units
6. De Minimis Asset Basis Carryovers
a. In General
b. When De Minimis Assets Basis Carryover Exception Applies
7. Assumption of Ordinary Course Liabilities
8. Exception for Multiple-Party Triggering Events
9. Exception for Compulsory Transfers
10. Additional Exceptions
VI. Domestic Use Limitations
A. Overview — Domestic Use Not Permitted
1. “Domestic Use” Defined
2. Permitted Use Against Income of the Dual Resident Corporation or Separate Unit
a. In General
b. DCL of Separate Units Segregated
c. DCL of Dual Resident Corporations Segregated from Their Separate Units
3. Prohibited Indirect Domestic Use
4. Restrictions Apply Even if There are No Tax Benefits
5. Restrictions Generally Apply Even if Loss is Not Used for Foreign Tax Purposes
6. Irrelevant that Foreign Income is Subject to U.S. Tax
B. SRLY Limitations
1. Modified SRLY Limitations
a. The SRLY Limitations and the Cumulative Register
(1) The Cumulative Register
(2) Years with No Consolidated Taxable Income
(3) Years Taken into Account
(a) Substantive Limitation
(b) Procedural Limitations
(4) Income of Predecessors and Successors
(5) Absorption of the DCL in the Year Incurred
(6) Losses Taken into Account in the Cumulative Register
b. Character of Items Composing the DCL that Are Absorbed
c. Separate Unit Must Be Subject to the Same Foreign Tax
d. Dual Resident Corporation that Ceases to be Subject to Foreign Tax
e. Stuffing Assets to Increase SRLY Limitation Permitted Under Certain Circumstances
f. Other Modifications to the SRLY Limitations
(1) Lonely Parent Rule
(2) Section 382 Overlap Rules
(3) SRLY Subgroups
(4) Recapture Income and Interest Charge
g. General §172 Absorption Rules Apply
h. Effects of the SRLY Limitations on Foreign Tax Credit Limitation
2. Exception for Tainted Income of a Dual Resident Corporation
a. In general
b. Tainted Income and Tainted Assets
c. Income Presumed to be Tainted Income
d. Exceptions to Tainted Assets
e. Different Rules for Dual Resident Corporations and Separate Units
C. Exceptions to the Domestic Use Limitations
1. Domestic Use Election and Agreement
2. Bilateral Elective Agreements
a. In General
b. Effect on Stand-Alone Domestic Use Agreement
c. Coordination with the Separate Unit Combination Rule
d. Competent Authority Agreement with the United Kingdom
e. Exception Does Not Apply to §953(d) Foreign Insurance Companies
3. No Possibility of Foreign Use
a. Generally a Tough Standard to Meet
b. Exceptions to Foreign Use Do Not Apply
c. Absence of Foreign Affiliates or Foreign Consolidation Regime is Insufficient
d. All or Nothing Rule
e. Certification and Analysis Requirement
f. Effects of Changes in Law
g. Rebuttal of Triggering Events and Termination of Domestic Use Agreements
h. No Ruling Policy
4. Exceptions Do Not Apply to §953(d) Foreign Insurance Companies
5. Exceptions Do Not Apply to Reconstituted NOL
D. Foreign Tax Credits Not Subject to the Domestic Use Limitations
E. Elimination of Dual Consolidated Losses
1. In General
2. No Carryover Under §381 of a DCL Subject to SRLY Limitations
3. Cessation of Separate Unit Status Where DCL Subject to SRLY Limitations
4. Exceptions
a. Exception with Respect to Dual Resident Corporations
(1) Domestic F Reorganizations
(2) Acquisition by Another Dual Resident Corporation that is Subject to Tax in the Same Foreign Jurisdiction
b. Exceptions with Respect to Separate Units — Acquisition of Separate Unit by Domestic Corporation
(1) Transferee Not a Member of Transferor's Consolidated Group
(2) Transferee Is a Member of the Same Consolidated Group
5. Special Rule for §953(d) Insurance Corporations
VII. Domestic Use Election and Agreement
A. Overview
B. Election Applies to DCL in Whole and Not in Part
C. When Election Is Not Available
1. In General
2. Foreign Insurance Companies Treated as Domestic Corporations
D. Elections and Agreements Under the DCL Regulations
E. Certification Period and Annual Certification Requirements
1. In General
2. Annual Certification Required for All DCLs Subject to a Domestic Use Agreement
3. Reduction of Certification Period for Agreements Entered Under the 1992 Final Regulations
4. Annual Certification Requirements
F. Triggering Events
1. Overview
a. In General
b. Triggering Events After the Five-Year Certification Period
2. Foreign Use
a. All or Nothing Rule
b. Practice Notes
(1) Scope of “Foreign Use”
(2) Combined Separate Units
(3) IRS May Want to Review Foreign Tax Returns
3. Disaffiliation
4. Affiliation
5. Significant Asset Transfers
a. In General
b. Disregarded Transfers
c. Coordination with a Foreign Use Triggering Event
d. Exceptions for Sales in the Ordinary Course of Business
e. Application to Combined Separate Units
f. Exceptions for Interests in Separate Units and Dual Resident Corporations
g. Rebuttal — No Carryover Under Foreign Law
6. Significant Transfers of Interests in a Separate Unit
a. In General
b. Coordination with the Asset Transfer Triggering Event
c. Coordination with Foreign Use Triggering Events
d. Application to Combined Separate Units
7. Conversion to a Foreign Corporation
8. Conversion to a RIC, REIT, or S Corporation
9. Failure to Certify
10. Cessation of Stand-Alone Status
G. Rebuttal of Triggering Events
1. No Possibility of Foreign Use
a. In General — Tough Standard to Meet
b. Required Statement and Support
c. Foreign Use Triggering Event Not Rebuttable
d. Effect on Domestic Use Election and Certification
2. No Carryover Under Foreign Law
a. In General — Only Applicable to Asset Sales
b. Rationale for Different Rebuttal Standard
c. Exceptions to Foreign Use Do Not Generally Apply
d. Reporting Requirement
e. Effect on Domestic Use Election and Certification
3. No Ruling Policy
H. Exceptions to Triggering Events
1. Continuing Ownership
a. Intra-Group Tax-Free Reorganizations
b. Intra-Group Transfers of Assets and Interests
c. Continued Ownership by the Same Taxpayer
d. Uncertainty in Sales to 90% Owned Partnerships or Grantor Trusts
2. Transactions Between Domestic Corporations Requiring a New Domestic Use Agreement
a. Original Elector Does Not Become a Member of the Acquiror's Consolidated Group
(1) Disaffiliation
(2) Transfer of Assets of, or Interests in, a Separate Unit
b. Original Elector Becomes a Member of the Acquiror's Consolidated Group
(1) Becoming a Member of a Consolidated Group
(2) Transfer of Group
c. Requirements to Qualify
(1) New Domestic Use Election
(2) Agreement by Original Elector
d. Effect of the New Agreement on the Old Domestic Use Election
e. Practical Considerations — Partial Sales of Assets or Interests
3. Transactions Qualifying for the De Minimis Exception to Foreign Use — Reduction in Interests in Separate Units
4. Deemed Transactions
5. Compulsory Transfers Under Foreign Law
I. Recapture
1. In General
2. Certification Period
3. Taxable Year of Inclusion
a. Foreign Use Triggering Event
b. Disaffiliation and Consolidation Triggering Events
c. Other Triggering Events
4. Attribution to Separate Units
5. Recapture Amount
a. All or Nothing Rule
b. Presumption — All DCL Is Recaptured
c. Reduction of Recapture Amount
(1) In General
(2) Rebuttal Takes into Account Income and Losses of Other Members
(3) Computation Statement Required
6. Interest Charge
a. In General
b. Interest Charge Even When Recapture Amount is Reduced to Zero — Preventing a Benefit for Accelerated Deductions
c. Calculation of the Interest Charge
d. Deductibility of Interest Charge
e. Rebutting the Amount of the Interest Charge
f. Computation Statement Required
7. Coordination Rules Where Original and Subsequent Electors are Not Members of the Same Consolidated Group
a. In General
b. Original Elector Secondarily Liable for the Recapture Tax
c. Multiple-Party Excepted Events
d. Recapture Tax Amount — “With and Without” Calculations
e. Rebuttal
f. Required Statement by Subsequent Elector
g. Assessment and Collection
(1) Assessment
(2) Liability of Original Elector and Prior Subsequent Electors
(3) Subsequent Elector Pays Only Part of Its Tax Liabilities
(4) Refunds
8. Recapture Amount Not Offset by Other Losses
a. Presumption and Rebuttal
b. Computation Statement Required
9. Character and Source of Recapture Amounts
10. Reconstituted NOL
a. In General — Reconstituted NOL in Amount Equal to Recapture Amount
b. Reconstituted NOL Always Subject to Domestic Use Limitations
c. Reconstituted NOL Only Available for Carryforward
d. Expiration of Reconstituted NOL
e. Attribution of Reconstituted NOL to Separate Units
f. Treatment of Successors and Transferees
(1) Section 381 Transactions
(2) Subsequent Elector Following an Asset or Interest Sale
g. NOL Not Reconstituted if DCL Would Have Been Eliminated
11. Directive to IRS Personnel for Proposing an Adjustment
12. No Failure to Recapture Restrictions
J. Termination of Domestic Use Election and Agreement
1. In General
2. Termination Following a Triggering Event
a. DCL Is Recaptured
b. No Possibility of Foreign Use
c. New Domestic Use Agreement
d. No Ruling Policy
3. Terminations Unrelated to a Triggering Event
a. No Possibility of Foreign Use
(1) In General
(2) Required Statement and Analysis
b. Election Under a Bilateral Elective Agreement
VIII. Other Rules
A. Dual Consolidated Losses of Foreign Insurance Companies that Make a §953(d) Election
1. In General — DCL Always Subject to the Domestic Use Limitations
2. Domestication v. §953(d) Election
3. Treatment of Capital Losses of §953(d) Insurance Companies
B. Basis Adjustments
1. Stock of Members of a Consolidated Group
2. Items of Combined Separate Units
3. Interests in Partnerships
4. Transition Rule
C. Specific Anti-Abuse Rules
1. Section 1503(d)(4) — Acquisition of Income-Producing Assets
2. Attribution Rules Based on Books and Records
a. In General
b. Section 987 Regulations
c. Scope of the Anti-Abuse Rule
D. Reasonable Cause Exception for Untimely Filings
1. In General — No More §9100 Relief
a. In General
b. Situations in Which §9100 Relief Was Previously Granted
2. ‘Reasonable Cause and Not Willful Neglect’ Standard
a. General Requirements
b. Reasonable Cause — IRS Practice
c. Willful Neglect — IRS Practice
3. Automatic Approval After 120 Days
4. Filing Requirements
5. Timing of Request
6. Reasonable Cause Relief for a Closed Taxable Year
7. Protest to Appeals
8. Delegation of Authority
9. Transition Rules — Reasonable Cause Standard Applicable to DCLs Subject to the 1992 Final Regulations
E. Signature Requirements
F. DCL Issues on Which the IRS Will Not Rule
G. Effective Dates and Transition Rules

Working Papers

Table of Worksheets
Worksheet 1 T.D. 8261, 1989-2 C.B. 220, Preamble to the 1989 Temporary Regulations
Worksheet 2 REG-102144-04, 70 Fed. Reg. 29,868, Preamble to the 2005 Proposed Regulations
Worksheet 3 Sample Domestic Use Election and Agreement
Worksheet 4 Sample Annual Certification