Proposed Regs Governing 'Required Taxable Year' for Foreign Corporations With U.S. Shareholder Majority

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed Income Tax Regulations setting forth the required taxable year for specified foreign corporations for taxable years of those foreign corporations beginning after July 10, 1989. This action is necessary because of changes to the applicable tax law made by the Omnibus Budget Reconciliation Act of 1989, which added section 898 to the Internal Revenue Code. The regulations will give guidance on which foreign corporations must change their taxable year and how to effect the change in taxable year.

DATES: Written comments and requests for a public hearing must be received by March 8, 1993.

ADDRESSES: Send written comments and requests for a public hearing to: Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Attention: CC:CORP:T:R (INTL-0848-89), room 5228, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Bill Lundeen of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC 20224 (Attention: CC:CORP:T:R (202-622-3870 (INTL- 0848-89), not a toll-free call).

SUPPLEMENTARY INFORMATION:

A. PAPERWORK REDUCTION ACT

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224.

The collection of information in these proposed regulations is in sections 1.563-3, 1.898-3 and 1.898-4. The Internal Revenue Service requires this information to verify compliance with section 898 of the Internal Revenue Code. The respondents will be certain United States shareholders of specified foreign corporations.

The estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on information as is available to the Internal Revenue Service. Individual respondents may require greater or lesser time, depending on their particular circumstances.

Estimated total annual reporting burden: 600 hours.

Estimated burden per respondent varies from .5 hours to 1.5 hour, depending on individual circumstances, with an estimated average of l hour.

Estimated number of respondents: 600.

Estimated frequency of responses: Once every three years.

B. BACKGROUND

This document contains proposed regulations under sections 441, 442, 563 and 898 of the Internal Revenue Code (Code). Sections 1.898- 1 through l.898-4 are proposed to be effective for taxable years of specified foreign corporations beginning after July 10, 1989. However, section 1.898-3(a)(4) (regarding situations in which inconsistent majority U.S. shareholder years exist) and 1.898- 3(a)(5)(iii) (regarding situations in which additional testing days are required) are proposed to be effective for taxable years beginning after [INSERT DATE 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER], and section 1.898-4(b) is proposed to be effective for changes in the required year of a specified foreign corporation subsequent to its first taxable year beginning after July 10, 1989.

C. EXPLANATION OF PROVISIONS

INTRODUCTION

Section 7401(a) of the Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239, 103 Stat. 2106 ("the Act"), added section 898 to the Code. The purpose of section 898 is to eliminate the deferral of income and, therefore, the understatement in income, by United States shareholders of certain controlled foreign corporations and foreign personal holding companies, referred to in the statute as specified foreign corporations. Deferral results when certain income earned by these corporations is subject to United States income tax in a taxable year of the United States shareholder subsequent to the taxable year during which it was earned. The elimination of deferral is accomplished by requiring a specified foreign corporation to conform its taxable year to the required year, which is generally the majority U.S. shareholder year, for taxable years of specified foreign corporations beginning after July 10, 1989.

SECTION 1.898-1.

Section 1.898-1 provides the general rule that, for purposes of the Internal Revenue Code, the taxable year of any specified foreign corporation shall be the required year determined under section 898(c) and section 1.898-3. In addition, section 1.898-1(b) sets forth the effective dates of the regulations under section 898.

The regulations at paragraph (c) exempt certain specified foreign corporations from section 898 in three circumstances. First, a specified foreign corporation is exempt from section 898 so long as its United States shareholders do not have any amount includible in gross income pursuant to section 951(a) and do not receive any actual or deemed distributions attributable to amounts described in section 553 with respect to that corporation. Once any United States shareholder has such amounts, however, section 898 applies to the specified foreign corporation. Second, a specified foreign corporation that is a foreign insurance company and elects to be treated as a domestic corporation pursuant to section 953(d) is exempt from section 898. Likewise, a specified foreign corporation described in section 1504(d) for which an election has been made to treat it as a domestic corporation is exempt from section 898.

SECTION 1.898-2.

Section 1.898-2(a) defines specified foreign corporation. Generally, a specified foreign corporation is defined to include controlled foreign corporations and foreign personal holding companies. However, specified foreign corporations include only those controlled foreign corporations and foreign personal holding companies that meet certain ownership requirements. Paragraphs (b)(1) and (b)(2) set forth the ownership requirements of a specified foreign corporation and paragraph (b)(3) defines United States shareholder for purposes of these rules. Paragraph (c) provides a special rule for foreign personal holding companies that are specified foreign corporations.

There is an inconsistency in the legislative history of section 898 between the Senate Print and the Conference Report. The conference agreement generally follows the Senate amendment, but misstates the Senate amendment in reporting that section 898 applies only to a controlled foreign corporation or foreign personal holding company, more than 50 percent of the total voting power or value of the U.S.-OWNED stock of which is treated as owned by a United States shareholder, and that section 898 takes into account only the taxable years of those United States shareholders (and certain related persons) in determining the majority U.S. shareholder year. The words "U.S.-owned" did not appear in the Senate amendment, which is the version of the bill that Congress enacted and which became public law. Accordingly, specified foreign corporations include controlled foreign corporations and foreign personal holding companies in which a United States shareholder owns (or is considered to own) more than 50 percent of the voting power of all classes of stock of the corporation entitled to vote, or more than 50 percent of the total value of all classes of stock of the corporation.

SECTION 1.898-3.

Section 1.898-3(a)(1) provides the general rule that the required year of a specified foreign corporation means the majority U.S. shareholder year. Paragraph (a)(2) provides that a specified foreign corporation that is a controlled foreign corporation may elect, in lieu of the required year, a taxable year beginning one month earlier than the majority U.S. shareholder year. Paragraph (a)(3) defines majority U.S. shareholder year, and paragraph (a)(4) provides rules for situations in which more than one majority U.S. shareholder year exists. Paragraph (a)(5) defines testing days which are the days on which a specified foreign corporation must determine whether it is using the required year. Paragraph (b) provides special rules for foreign personal holding companies that are specified foreign corporations.

SECTION 1.898-4.

Section 1.898-4 provides special rules applicable to specified foreign corporations. Paragraph (a) sets forth rules for changes to the required year of a specified foreign corporation for its first taxable year beginning after July 10, 1989, and paragraph (b) provides rules for changes in the required year of a specified foreign corporation during a taxable year subsequent to its first taxable year beginning after July 10, 1989.

Paragraph (c) provides rules for situations in which a specified foreign corporation maintains a foreign taxable year (for purposes of computing income tax liabilities due a foreign country) that is different from its required year, including rules relating to the computation of income and earnings and profits of the corporation and rules for the situation in which the U.S. majority shareholder year is a 52-53-week taxable year and the specified foreign corporation's taxable year is not, or in which the specified foreign corporation's taxable year is a 52-53-week taxable year and the U.S. majority shareholder year is not.

A foreign income tax accrues only when the liability for it is fixed and the amount of the liability can be determined. This event generally occurs at the end of the foreign taxable year with respect to a foreign income tax that is imposed on that year's income. Consequently, with the enactment of section 898, a mismatch may arise between the income that comprises a subpart F or foreign personal holding company inclusion and the creditable foreign taxes related to the inclusion when the foreign taxable year of a specified foreign corporation ends later than the corporation's United States taxable year.

Adherence to the foreign tax accrual rule in the context of section 898 may result in income being taxed under subpart F without the associated foreign income taxes being available as a credit under section 960. While we considered several options to address the effect of the foreign tax accrual rule in this context, we believe that adherence to the foreign tax accrual rule is justified for several reasons. First, unlike section 338(i), there is no direct authority in section 898 to modify the rule. Second, rules that require the pooling of post-1986 undistributed earnings and foreign taxes mitigate the effect of the foreign tax accrual rule. Third, determining the foreign taxes on a specified foreign corporation's taxable income prior to the end of the foreign taxable year may not be possible, especially where that foreign taxable year has not ended by the filing date of the applicable U.S. tax return. Accordingly, modifying the foreign tax accrual rule for specified foreign corporations that have foreign taxable years which differ from their required year would result in speculative foreign tax accruals, necessitating a corrective mechanism, and would result in a set of highly complex rules which would be difficult to administer. Such an approach would place additional pressure on the foreign tax credit rules, in particular, on the section 905(c) rules. Finally, the potential mismatch resulting from adherence to the foreign tax accrual rule is mitigated by the rule, discussed below, that applies to the first taxable year after section 898 was enacted and that spreads over four taxable years the recognition of certain income otherwise required to be recognized in one year as a result of section 898.

Section 1.898-4(d) provides rules to implement section 7401(d)(2)(C) of the Act. That section of the Act provides that if, because of the change in taxable year, any United States person would be required to include in gross income for its taxable year amounts attributable to two taxable years of the specified foreign corporation, the amount of income reported for the short taxable year of the specified foreign corporation shall be included in the United States person's gross income ratably over its next four taxable years beginning with its taxable year in which amounts attributable to two taxable years of the specified foreign corporation would have been included.

The foregoing four-year rule applies only when a United States person would otherwise be required to include deemed distributions of income from more than one taxable year of the specified foreign corporation in any one of its own taxable years, and only if the short taxable year of the specified foreign corporation was its first taxable year beginning after July 10, 1989. If a specified foreign corporation that changed its taxable year in accordance with section 898 derived subpart F income in its first taxable year, but not in its second (short) taxable year, which ended within the one taxable year of the United States person, then the ratable four-year inclusion would not be applicable. Finally, any United States person who would otherwise be subject to the four-year rule may not waive that rule and accelerate an income inclusion due to the application of section 898.

SECTION 1.563-3.

Section 7401(b)(1) of the Act amended section 563 of the Code by adding a new subsection (c) which generally requires that, in determining the dividends paid deduction for purposes of the foreign personal holding company provisions of the Code, a dividend paid after the close of any taxable year, and on or before the 15th day of the third month following the close of that taxable year, will be considered as paid during that taxable year to the extent the foreign personal holding company designates the dividend as being taken into account under section 563(c). Section 1.563-3 provides rules to implement section 7401(b)(1).

D. SPECIAL ANALYSES

It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and therefore, an initial Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on the impact of the rules on small business.

E. COMMENTS AND REQUESTS FOR A PUBLIC HEARING

Before adopting these regulations, consideration will be given to any written comments that are submitted (preferably a signed original and eight copies) to the Internal Revenue Service. All comments will be available for public inspection and copying. A public hearing will be held upon written request by any person who submits timely written comments on the proposed rules. Notice of the time, place and date for the hearing will be published in the Federal Register.

F. DRAFTING INFORMATION

The principal author of this regulation is Bill Lundeen of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service. Other personnel from the Internal Revenue Service and Treasury Department participated in developing the regulations.

LIST OF SUBJECTS

SECTIONS 1.441-1 THROUGH 1.444-3T

Accounting, Income Taxes, Reporting and recordkeeping requirements.

SECTIONS 1.561-1 through 1.565-6

Income taxes, Reporting and recordkeeping requirements.

SECTIONS 1.891-1 through 1.907(f)-1A

Aliens, Foreign investments in United States, Income Taxes, Reporting and recordkeeping requirements, United States investments abroad.

PROPOSED AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for 26 CFR part 1 is amended by adding the following citations:

Authority: 26 U.S.C. 7805 * * * Sections 1.898-1 through 1.898-4 also issued under 26 U.S.C. 898. * * *

Par. 2. Section 1.441-1T is amended by adding paragraph (b)(1)(ii)(I) to read as follows:

SECTION 1.441-1T PERIOD FOR COMPUTATION OF TAXABLE INCOME (TEMPORARY).

* * * * *

(b) * * *

(1) * * *

(ii) * * *

(I) In the case of any controlled foreign corporation or foreign personal holding company that is a specified foreign corporation, within the meaning of section 898 and section 1.898-2, the applicable rules are contained in section 898 and the regulations under that section.

* * * * *

Par. 3. Section 1.442-1 is amended by adding a sentence to the end of paragraphs (a)(1), (b)(3) and (c)(5), to read as follows:

SECTION 1.442-1 CHANGE OF ANNUAL ACCOUNTING PERIOD.

(a) * * *

(1) * * * For special rules relating to controlled foreign corporations and foreign personal holding companies that are specified foreign corporations, within the meaning of section 898 and section 1.898-2, see section 898 and the regulations under that section.

* * * * *

(b) * * *

(3) * * * For special rules relating to controlled foreign corporations and foreign personal holding companies that are specified foreign corporations, within the meaning of section 898 and section 1.898-2, see section 898 and the regulations under that section.

* * * * *

(c) * * *

(5) * * * For special rules relating to controlled foreign corporations and foreign personal holding companies that are specified foreign corporations, within the meaning of section 898 and section 1.898-2, see section 898 and the regulations under that section.

* * * * *

Par. 4. Section 1.442-2T is amended by adding paragraph (a)(9) to read as follows:

SECTION 1.442-2T SPECIAL LIMITATIONS ON CERTAIN CHANGES OF ANNUAL ACCOUNTING PERIOD (TEMPORARY).

(a) * * *

(9) Any specified foreign corporation, within the meaning of section 898 and section 1.898-2, that is required to change its taxable year to the required year under section 898 and the regulations under that section.

* * * * *

Par. 5. Section 1.563-3 is redesignated as section 1.563-4 and new section 1.563-3 is added to read as follows:

SECTION 1.563-3 FOREIGN PERSONAL HOLDING COMPANY TAX; PROCEDURE FOR DESIGNATION OF A DIVIDEND AS BEING TAKEN INTO ACCOUNT UNDER SECTION 563(c).

In determining the deduction for dividends paid under section 561, a foreign personal holding company may designate a dividend paid after the close of any taxable year beginning after July 10, 1989, and on or before the 15th day of the third month following the close of that taxable year, as being taken into account under section 563 (c) and this section by making the designation on an attachment to Schedule N of Form 5471. The designation must set forth the date of the distribution and a statement indicating the extent to which the distribution is being taken into account under section 563(c), and any other information required by Form 5471 and the instructions to that form. The designation must be signed and dated by a duly authorized corporate officer of the foreign personal holding company. If a foreign personal holding company took a dividend paid into account under section 563(c) for any taxable year beginning after July 10, 1989, and ending prior to [INSERT DATE THAT IS 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER] but did not follow the procedures set forth in this paragraph, then a designation on an attachment to Schedule N of Form 5471 setting forth the information required above should be signed in a manner set forth above and attached to the first Form 5471 and, if applicable, Form 1120F, to be filed after [INSERT DATE THAT IS 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER.]

Par. 6. Sections 1.898-0 through 1.898-4 are added under the heading "Miscellaneous Provisions" to read as follows:

 SECTION 1.898-0 OUTLINE OF REGULATIONS FOR SECTION 898.

(a) IN GENERAL. Pursuant to section 898(a), the taxable year of a specified foreign corporation is the required year. The required year is generally the majority U.S. shareholder year. These regulations define specified foreign corporation and United States shareholder, for purposes of these rules, at section 1.898-2(a) and (b)(3), respectively. The ownership requirements of a specified foreign corporation, which are a part of the definition of specified foreign corporation, are set forth at section 1.898-2(b)(1) and (2). A special rule for determining whether a foreign corporation that meets the ownership requirements of a foreign personal holding company is a specified foreign corporation is located at section 1.898-2(c). Section 1.898-3 sets forth the rules for the determination of the required year, including rules by which a specified foreign corporation that is a controlled foreign corporation may elect a taxable year beginning one month earlier than the majority U.S. shareholder year. Section 1.898-4 sets forth special rules including rules at paragraphs (a) and (b) of that section on changes in the required year, rules at paragraph (c) of that section covering situations where the required year under section 898 is different from the specified foreign corporation's foreign taxable year (the taxable year for purposes of computing income tax liabilities due a foreign country), and rules at paragraph (d) of that section regarding the four-year spread of certain income.

(b) EFFECTIVE DATES. Sections 1.898-1 through 1.898-4 are effective for taxable years of specified foreign corporations beginning after July 10, 1989. However, sections 1.898-3(a)(4) (regarding situations in which inconsistent majority U.S. shareholder years exist) and 1.898-3(a)(5)(iii) (regarding situations in which additional testing days are required) are effective for taxable years beginning after [INSERT DATE 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER], and section 1.898-4(b) is effective for changes in the required year of a specified foreign corporation subsequent to its first taxable year beginning after July 10, 1989.

(c) EXCEPTIONS TO SECTION 898 -- (1) SPECIFIED FOREIGN CORPORATIONS WITH NO SECTION 951(a) OR FOREIGN PERSONAL HOLDING COMPANY INCOME. A specified foreign corporation is not required to conform its taxable year to the required year so long as its United States shareholders do not have any amount includible in gross income pursuant to section 951(a) and do not receive any actual or deemed distributions attributable to amounts described in section 553 with respect to that corporation. Once any United States shareholder of that specified foreign corporation has any amount includible in gross income pursuant to section 951(a) or receives any actual or deemed distributions attributable to amounts described in section 553 with respect to that corporation, then the specified foreign corporation must comply with section 898 and sections 1.898-3 and 1.898-4 beginning with its first taxable year subsequent to the taxable year to which that shareholder's income is attributable. Once the specified foreign corporation is required to conform its taxable year to the required year, the fact that the shareholders of the corporation cease to have any such amount includible in gross income pursuant to section 951(a) or section 553 is not relevant. Section 898 continues to apply.

(2) ELECTIONS TO BE TREATED AS DOMESTIC CORPORATIONS. A foreign corporation that is a foreign insurance company and that elects to be treated as a domestic corporation pursuant to section 953(d) is treated as a domestic corporation for all purposes of the Code and, thus, is not subject to section 898. Likewise, a foreign corporation organized under the laws of a contiguous foreign country and described in section 1504(d) is not subject to section 898 if the foreign corporation is treated as a domestic corporation in accordance with section 1504(d).

SECTION 1.898-2 DEFINITION OF SPECIFIED FOREIGN CORPORATION.

(a) IN GENERAL. For purposes of section 898 and sections 1.898-1 through 1.898-4, a specified foreign corporation means any foreign corporation with respect to which the ownership requirements of section 898(b)(2) and paragraph (b) of this section are met and which either is treated as a controlled foreign corporation for any purpose under sections 951 through 964 of the Code (including sections 957(a), 957(b) and 953(c)), or is a foreign personal holding company, as defined in section 552.

(b) OWNERSHIP REQUIREMENTS -- (1) IN GENERAL. The ownership requirements of section 898(b)(2) and this paragraph (b)(1) are met with respect to any foreign corporation if a United States shareholder owns, or is considered to own by applying the attribution rules set forth in paragraph (b)(2) of this section, on each testing day, more than 50 percent of the total voting power of all classes of stock of the foreign corporation entitled to vote, or more than 50 percent of the total value of all classes of stock of the foreign corporation.

(2) OWNERSHIP BY ATTRIBUTION. For purposes of section 898(b)(2)(A) and paragraph (b)(1) of this section, the rules contained in the following sections of the Internal Revenue Code apply in determining ownership --

(i) Section 958(a) and (b) for determining direct, indirect, and constructive stock ownership of a controlled foreign corporation;

(ii) Section 551(f) pertaining to the stock of a foreign personal holding company held through a foreign entity; and,

(iii) Section 554 for determining stock ownership of a foreign personal holding company.

(3) DEFINITION OF UNITED STATES SHAREHOLDER -- (i) IN GENERAL. For purposes of sections 1.898-1 through 1.898-4, United States shareholder has the meaning given to it by section 951(b), except that, in the case of a foreign corporation having related person insurance income, as defined in section 953(c)(2), a person will be treated as a United States shareholder for purposes of section 898 if that person is treated as a United States shareholder under section 953(c)(1). See section 898(b)(3)(A).

(ii) CERTAIN CAPTIVE INSURANCE COMPANIES. The determination of whether certain shareholders are United states shareholders under section 953(c)(1) and, consequently, whether the foreign corporation is a controlled foreign corporation for a particular taxable year, depends on the proportion of related person insurance income to total insurance income earned by the foreign corporation during the taxable year. If the related person insurance income of the foreign corporation is less than 20 percent of its total insurance income for the year, then the special rules of section 953(c) for captive insurance companies will not apply. The determination of whether the related person insurance income of a foreign corporation is less than 20 percent of its total insurance income for a particular taxable year cannot be made until the end of that year. Consequently, a foreign corporation that derives related person insurance income generally will not be required to consider non-10 percent United States shareholders (i.e., persons who are United States shareholders only because of the special captive insurance rules) in determining whether it is a controlled foreign corporation on the first day of the foreign corporation's taxable year to determine further whether it is a specified foreign corporation and, therefore, subject to section 898, unless the foreign corporation was treated as a controlled foreign corporation because of the special captive insurance rules for the immediately preceding taxable year. When a foreign corporation is both a captive insurance company and a specified foreign corporation, it must consider all persons who are United States shareholders under both sections 951(b) and 953(c) in determining its required year.

(iii) FOREIGN PERSONAL HOLDING COMPANIES. In the case of any foreign personal holding company as defined in section 552, which is not also a specified foreign corporation by reason of being a controlled foreign corporation under section 898(b)(1)(A)(i), United States shareholder means any person who is treated as a United States shareholder under section 551(a).

(4) ILLUSTRATIONS. The application of this paragraph (b) may be illustrated by the following examples:

(i) meets the ownership requirements of section 552 (a)(2)(ownership requirements for a foreign personal holding company) for the current taxable year, and

(ii) was a foreign personal holding company for its taxable year immediately preceding the current taxable year.

(2) ILLUSTRATIONS. The application of this paragraph (c) may be illustrated by the following examples:

(a) CONTROLLED FOREIGN CORPORATIONS -- (1) IN GENERAL. The required year is the majority U.S. shareholder year prescribed in section 898(c)(1)(C) and paragraph (a)(3) of this section. If, however, there are inconsistent majority U.S. shareholder years, then the required year is the taxable year prescribed in section 898(c)(1)(A)(ii) and paragraph (a)(4) of this section.

(2) ONE-MONTH DEFERRAL ELECTION. A specified foreign corporation that is a controlled foreign corporation may elect under section 898(c)(1)(B) and section 1.898-4(a)(2)(ii) and (b)(2)(ii) of this section a taxable year beginning one month earlier than the majority U.S. shareholder year. The specified foreign corporation may revoke this election; see section 1.898-4(b). If the specified foreign corporation revokes the election, it may re-elect the one-month deferral only if it follows the procedures set forth in section 1.898-4(b)(2)(iv) and (v). A specified foreign corporation that is a foreign personal holding company, but is not a controlled foreign corporation, may not make this election. Also, this election may not be made by a specified foreign corporation that is a controlled foreign corporation, but whose required year is the taxable year prescribed by section 898(c)(1)(A)(ii) and paragraph (a)(4) of this section because there are inconsistent majority U.S. shareholder years.

(3) MAJORITY U.S. SHAREHOLDER YEAR -- (i) IN GENERAL. For the purpose of determining the required year of a specified foreign corporation, the majority U.S. shareholder year under section 898(c)(1)(C)(i) means the taxable year (if any) which, on each testing day as defined in paragraph (a)(5) of this section, constitutes the taxable year of a United States shareholder described in either paragraph (a)(3)(i)(A) or (B) of this section.

(A) Each United States shareholder, as defined in section 898(b)(3)(A) and section 1.898-2(b)(3), that owns more than 50 percent of the voting power of all classes of stock of the specified foreign corporation entitled to vote, or more than 50 percent of the total value of all classes of stock of the specified foreign corporation, after application of the attribution rules of section 898(b)(2)(B). This shareholder is described in section 898(b)(2)(A) and is referred to in this section as a "more than 50 percent United States shareholder."

(B) Each United States shareholder, as defined in section 898(b)(3)(A) and section 1.898-2(b)(3), that is not a more than 50 percent United States shareholder and whose stock was treated as owned under section 898(b)(2)(B) (the attribution rules) by a more than 50 percent United States shareholder.

(ii) PASSTHROUGHS ENTITIES. For the purpose of determining the required year of a specified foreign corporation, if each United States shareholder described in paragraph (a)(3)(i)(A) or (B) of this section is a passthrough entity, such as an S corporation, partnership, trust, or estate, then the majority U.S. shareholder year is the taxable year which, on a testing day, constitutes the taxable year of the passthrough entity and not the taxable year or years of the passthrough entity's shareholders, partners, or beneficiaries.

(4) INCONSISTENT MAJORITY U.S. SHAREHOLDER YEARS -- (i) IN GENERAL. There may exist more than one majority U.S. shareholder year under section 898(c)(1)(C)(i) and paragraph (a)(3) of this section because the taxable years of shareholders described in paragraph (a)(3)(i)(A) or (B) of this section may be different taxable years. If the majority U.S. shareholder years are inconsistent, then the specified foreign corporation must adopt the taxable year that results in the least aggregate deferral of income to all United States shareholders of the specified foreign corporation, even if that taxable year is not a majority U.S. shareholder year. See paragraph (a)(4)(iii), Example 2, of this section. If the required year is the taxable year prescribed by this paragraph (a)(4) because there are inconsistent majority U.S. shareholder years, then the one- month deferral election under section 898(c)(1)(B) and paragraph (a)(2) of this section is not available.

(ii) FORMULA FOR DETERMINING LEAST AGGREGATE DEFERRAL. The aggregate deferral of income for a particular year is equal to the sum of the products determined by multiplying, on each testing day as defined in paragraph (a)(5) of this section, the number of month(s) of deferral for each United States shareholder, that are shareholders on the testing day, that would be generated by that year end by that United States shareholder's percentage interest in deemed distributions from the specified foreign corporation. The United States shareholder's taxable year that produces the lowest sum when compared to the other United States shareholders' taxable years is the taxable year that results in the least aggregate deferral of income to the United States shareholders. For purposes of this section, the number of months of deferral for a United States shareholder of a specified foreign corporation is measured by the number of months from the end of the taxable year of the specified foreign corporation to the end of the taxable year of the United States shareholder. Part of a month is treated as a month. If the calculation results in more than one taxable year qualifying as the taxable year with the least aggregate deferral, the specified foreign corporation may select any one of such taxable years as its required year. However, if one of such qualifying taxable years is also the specified foreign corporation's existing taxable year, the specified foreign corporation must maintain its existing taxable year.

(iii) ILLUSTRATIONS. The application of this paragraph (a)(4) may be illustrated by the following examples:

(5) TESTING DAYS -- (i) IN GENERAL. A specified foreign corporation must identify its majority U.S. shareholder year(s), if any, for the purpose of determining its required year. The specified foreign corporation must determine its majority U.S. shareholder year on each testing day. In general, the testing day is the first day of the specified foreign corporation's taxable year for U.S. tax purposes, determined without regard to section 898. See section 898(c)(1)(C)(ii).

(ii) ILLUSTRATION. The application of paragraph (a)(5)(i) of this section may be illustrated by the following example:

(iv) ILLUSTRATION. The application of paragraph (a)(5)(iii) of this section may be illustrated by the following example:

(b) FOREIGN PERSONAL HOLDING COMPANIES -- (1) IN GENERAL. The required year is the majority U.S. shareholder year prescribed by section 898(c)(1)(A) and paragraph (a)(3) of this section. If, however, there are inconsistent majority U.S. shareholder years, then the required year is the taxable year determined under the provisions of paragraph (a)(4) of this section.

(2) ONE-MONTH DEFERRAL ELECTION NOT AVAILABLE. A specified foreign corporation that is a foreign personal holding company, but is not a controlled foreign corporation, may not make the one-month deferral election of paragraph (a)(2) of this section.

(3) TESTING DAYS. See paragraph (a)(5) of this section.

SECTION 1.898-4 SPECIAL RULES.

(a) CHANGES IN THE REQUIRED YEAR OF A SPECIFIED FOREIGN CORPORATION FOR ITS FIRST TAXABLE YEAR BEGINNING AFTER JULY 10, 1989 -- (1) IN GENERAL. A specified foreign corporation must conform its taxable year to the required year as defined in section 898(c) for taxable years beginning after July 10, 1989. In addition, section 898(c)(1)(B) permits a specified foreign corporation that is a controlled foreign corporation to elect a taxable year beginning one month earlier than the majority U.S. shareholder year.

(2) PROCEDURE FOR A SPECIFIED FOREIGN CORPORATION TO CONFORM TO THE REQUIRED YEAR FOR THE FIRST TAXABLE YEAR BEGINNING AFTER JULY 10, 1989 -- (i) NO SECTION 898(c)(1)(B) ELECTION. If no election under section 898(c)(1)(B) can be made because the specified foreign corporation is a foreign personal holding company, or no election is being made for a specified foreign corporation that is a controlled foreign corporation, but the specified foreign corporation is changing its first taxable year beginning after July 10, 1989, to conform to the required year, then unless the instructions to the forms provide otherwise, the words "Change in Taxable Year" must be placed in the upper left hand corner of the first page of Form 5471 and, if applicable, on Form 1120F, with respect to the specified foreign corporation for the taxable year for which the change is made. If a specified foreign corporation is not required to change its taxable year, then no notation concerning this fact need appear on Form 5471 and, if applicable, on Form 1120F.

(ii) WITH SECTION 898(c)(1)(B) ELECTION. The election under section 898(c)(1)(B) may be made for a specified foreign corporation that is a controlled foreign corporation for its first taxable year beginning after July 10, 1989, by indicating on Form 5471 and, if applicable, on Form 1120F, that the taxable year shown on the form with respect to the controlled foreign corporation was determined in accordance with section 898(c)(1)(B). The following words must be used unless the instructions to the forms provide otherwise:

(A) If the election involves a change in the taxable year of the controlled foreign corporation, the words "Section 898(c)(1)(B) Election -- Change in Taxable Year" must be placed in the upper left hand corner of the first page of Form 5471 and, if applicable, on Form 1120F; and

(B) If the election does not involve a change in the taxable year of the controlled foreign corporation, the words, "Section 898(c)(1)(B) Election" must be placed in the upper left hand corner of the first page of Form 5471 and, if applicable, on Form 1120.

(iii) FILING REQUIREMENT. If a specified foreign corporation changed its required year for its first taxable year beginning after July 10, 1989, to conform to the requirements of section 898 and section 1.898-3 but did not follow the procedures set forth in Rev. Proc. 90-26 and this paragraph (a)(2), a statement must be attached to the first Form 5471 and, if applicable, Form 1120F, to be filed after [INSERT DATE THAT IS 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER] indicating that the corporation's taxable year was changed to conform to the requirements of section 898. If a specified foreign corporation has not conformed its first taxable year beginning after July 10, 1989, to the taxable year required by section 898 and section 1.898-3, an amended return with an amended Form 5471 (or Form 1120F) must be filed to satisfy the requirements of section 898, section 1.898-3 and this paragraph (a)(2).

(b) CHANGES IN THE REQUIRED YEAR OF A SPECIFIED FOREIGN CORPORATION DURING A TAXABLE YEAR OF A SPECIFIED FOREIGN CORPORATION SUBSEQUENT TO ITS FIRST TAXABLE YEAR BEGINNING AFTER JULY 10, 1989 -- (1) IN GENERAL. A specified foreign corporation must conform its taxable year to a different required year should circumstances arise in which the required year changes under the rules of section 1.898- 3, such as when a substantial change in ownership of a specified foreign corporation results in a new more than 50 percent United States shareholder with a different majority U.S. shareholder year. The change in taxable year of a specified foreign corporation made to conform to a different required year shall be treated as initiated by the taxpayer and as having been made with the consent of the commissioner. The requirements set forth in this paragraph (b) are effective for taxable years subsequent to a specified foreign corporation's first taxable year beginning after July 10, 1989.

(2) PROCEDURE FOR THE CHANGE TO A NEW REQUIRED YEAR OF A SPECIFIED FOREIGN CORPORATION FOR TAXABLE YEARS SUBSEQUENT TO ITS FIRST TAXABLE YEAR BEGINNING AFTER JULY 10, 1989 -- (i) DIFFERENT MAJORITY U.S. SHAREHOLDER YEAR. If the specified foreign corporation is changing its taxable year to conform to a different required year under paragraph (b)(1) of this section, unless the instructions to the forms provide otherwise, the words "Change in Taxable Year" must be placed in the upper left hand corner of the first page of Form 5471 and, if applicable, on Form 1120F, with respect to the specified foreign corporation for the taxable year for which the change is made. This paragraph covers terminations of prior elections under section 898(c)(1)(B) made in conjunction with that change.

(ii) ELECTION UNDER SECTION 898(c)(1)(B). If the specified foreign corporation that is a controlled foreign corporation is changing its taxable year to conform to a different required year under paragraph (b) of this section and an election under section 898(c)(1)(B) is made, the change in taxable year and the election under section 898(c)(1)(B) are to be noted on Form 5471 and, if applicable, on Form 1120F, with respect to that corporation for the taxable year for which the change and election are made. Unless the instructions to the forms provide otherwise, the words "Section 898(c)(1)(B) Election -- Change in Taxable Year" must be placed in the upper left hand corner of the first page of each form. This paragraph covers terminations of prior elections under section 898(c)(1)(B) made in conjunction with that election.

(iii) PROCEDURE FOR PRIOR YEARS. If a specified foreign corporation conformed its taxable year to that required by section 898 and section 1.898-3 prior to [INSERT DATE THAT IS 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER] but did not follow the procedures set forth in this paragraph (b)(2), a statement must be attached to the first Form 5471 and, if applicable, Form 1120F, to be filed after [INSERT DATE THAT IS 120 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS IN THE FEDERAL REGISTER] indicating that the corporation's taxable year was changed to conform to the requirements of section 898 and section 1.898-3. If a specified foreign corporation has not conformed a taxable year subsequent to its first taxable year beginning after July 10, 1989, to the taxable year required by section 898 and section 1.898-3, an amended return, with an amended Form 5471 (or Form 1120F) must be filed to satisfy the requirements of section 898, section 1.898-3 and this paragraph (b)(2).

(iv) MAKING A SECOND ELECTION UNDER SECTION 898(c)(1)(B). Except for an election under section 898(c)(1)(B) that is made in conjunction with a change in its taxable year to conform to a different required year under paragraph (b)(2)(ii) of this section, a specified foreign corporation that has elected the one-month deferral under section 898(c)(1)(B) and subsequently revoked that election shall not be eligible to make an election under section 898(c)(1)(B) for any taxable year before its fifth taxable year which begins after the first taxable year for which the revocation is effective, unless the consent of the commissioner pursuant to the procedures set forth in paragraph (b)(2)(v) of this section is obtained.

(v) PROCEDURE FOR OBTAINING THE CONSENT OF THE COMMISSIONER TO CHANGE THE REQUIRED YEAR OF SPECIFIED FOREIGN CORPORATIONS. In the circumstance described in paragraph (b)(2)(iv) of this section, a specified foreign corporation must request the approval of the commissioner for a change in taxable year by completing and filing Form 1128 (Application for change in Accounting Period) with the commissioner of Internal Revenue. The application may be filed either by the majority United States shareholder on

behalf of the specified foreign corporation or by the specified foreign corporation. The application must be filed on or before the 15th day of the second calendar month following the close of the short period for which a return is required to effect the change in taxable year. Reference to this regulation must be made part of the application by placing the following statement at the top of page one of the application: "FILED UNDER section 1.898-4." Approval of a change in taxable year described in paragraph (b)(2)(iv) of this section will not be granted unless the taxpayer agrees to the terms, conditions, and adjustments, as set forth by the Commissioner, under which the change will be effected. Unless the instructions to the forms indicate otherwise, reelection of section 898(c)(1)(8) must be noted on Form 5471 and, if applicable, on Form 1120F, for the taxable year for which the re-election is made. Unless the instructions to the forms indicate otherwise, the words "Reelected Section 898(c)(1)(B) Election -- Change in Taxable Year" must be placed in the upper left hand corner of the first page of each form.

(3) SHORT PERIOD -- (i) IN GENERAL. Any short period required for a specified foreign corporation to effect the change in taxable year described in paragraph (b)(1) of this section will begin on the first day of the specified foreign corporation's current taxable year and will end on the last day of the new required year within which the change in ownership of the specified foreign corporation (or other event that necessitates a change in taxable year) occurs. If, however, the last day of the specified foreign corporation's current taxable year occurs prior to the last day of the new required year within which the change in ownership of the specified foreign corporation (or other event resulting in a new required year) occurs, then the short period will begin the day following the last day of the specified foreign corporation's current taxable year and end on the last day of the new required year subsequent to the required year within which the change in ownership of the specified foreign corporation (or other event resulting in a new required year) occurred. In no case shall the taxable year of the specified foreign corporation be in excess of one year.

(ii) ILLUSTRATIONS. The application of this paragraph (b)(3) may be illustrated by the following examples:

(c) NONCONFORMING FOREIGN AND UNITED STATES TAXABLE YEARS OF A SPECIFIED FOREIGN CORPORATION -- (1) IN GENERAL. If a specified foreign corporation's foreign taxable year (for purposes of computing income tax liabilities due a foreign country) does not conform to the required year pursuant to section 898(c) and section 1.898-3, then the United States shareholders must compute any income inclusion relating to the specified foreign corporation including, but not limited to, subpart F income, increase in earnings invested in United States property, foreign personal holding company income, and section 864(d) income in accordance with the rules set forth in paragraphs (c)(2) and (3) of this section. However, see section 338 and the regulations under that section for rules applicable to certain domestic and foreign corporations, and the shareholders of those corporations where an election under that section is made.

(2) COMPUTATION OF INCOME AND EARNINGS AND PROFITS OF A SPECIFIED FOREIGN CORPORATION -- (i) SEPARATE BOOKS OF ACCOUNT. A specified foreign corporation that has a foreign taxable year different from its required year, as determined under section 898(c) and section 1.898-3, will have portions of two foreign annual accounting periods in each required year. In this case, either separate books of account for the specified foreign corporation based upon the required year may be maintained, or income (and earnings and profits) shall be computed as set forth in paragraph (c)(2)(ii) of this section. Books of account must be maintained on a consistent basis for each foreign annual accounting period.

(ii) INCOME AND EARNINGS AND PROFITS COMPUTATION IN LIEU OF SEPARATE BOOKS. In lieu of maintaining separate books of account, income and earnings and profits shall be computed in two steps. First, for the foreign annual accounting period of the specified foreign corporation which ends within its required year, the income (and earnings and profits) of the specified foreign corporation is the entire income (or earnings and profits) of the foreign annual accounting period, less the income (or earnings and profits), if any, of that foreign annual accounting period properly allocable to the preceding taxable year, determined under a consistent application of the principles of section 964 and the regulations under that section. Second, for the foreign annual accounting period of the specified foreign corporation which ends after its required year, the income (and earnings and profits) of the specified foreign corporation is the income (and earnings and profits) of each month (or quarter) which has ended within the required year determined on the basis of interim actual book closings and computed by a consistent application of the principles of section 964 and the regulations under that section. If the amount of income properly includable in the gross income of United States shareholders in the preceding taxable year is different from the amount of income actually included by United States shareholders in the preceding taxable year, then an adjustment must be made by each United States person affected by means of an amended return for that preceding taxable year.

(iii) ILLUSTRATION. The application of this paragraph (c)(2) may be illustrated by the following example:

(ii) SPECIFIED FOREIGN CORPORATION WITH A 52-53-WEEK TAXABLE YEAR. If a specified foreign corporation elects to follow a 52-53- week taxable year, and the majority United States shareholder does not intend to follow a 52-53-week taxable year, then the required year, as determined under section 898(c) and section 1.898-3, of the specified foreign corporation shall be a 52-53-week taxable year, which must end within a seven-day period from the last day of the 12- month taxable year of its majority United States shareholder. If the election of the one-month deferral under section 898(c)(1)(B) and section 1.898-3(a)(2) is made, the election will be valid and the specified foreign corporation may retain a 52-53-week taxable year, subject to the condition that the 52-53-week taxable year must end within a seven-day period from the last day of the month which immediately precedes the 12-month taxable year of its majority United States shareholder.

(iii) ILLUSTRATIONS. The application of this paragraph (c)(3) may be illustrated by the following examples:

(d) FOUR-YEAR INCOME SPREAD. For its first taxable year beginning after July 10, 1989, if, because of the change necessitated by section 898 in the taxable year of the specified foreign corporation, any United States person was required to include in gross income for one taxable year amounts attributable to two taxable years of the specified foreign corporation, the amount that the United States person would otherwise have included in gross income for the one taxable year by reason of the short taxable year of the specified foreign corporation resulting from the change shall be included in that person's gross income ratably over a four-taxable- year period beginning with that one taxable year. A United States person who is required by reason of section 898 to include in gross income amounts attributable to two taxable years of a specified foreign corporation may not waive the four-year ratable inclusion of such gross income.