Sec. 1.1503(d)-4 Domestic use limitation and related operating rules.
(a) Scope. This section prescribes rules that apply when the general limitation on the domestic use of a dual consolidated loss under paragraph (b) of this section applies. Thus, the rules of this section do not apply when an exception to the domestic use limitation applies (for example, as a result of a domestic use election under § 1.1503(d)-6(d)). In general, when the domestic use limitation applies, the dual consolidated loss of a dual resident corporation or separate unit is subject to the separate return limitation year (SRLY) provisions of § 1.1502-21(c), as modified under this section. Paragraph (c) of this section provides rules that determine the effect of a dual consolidated loss on a consolidated group, an unaffiliated dual resident corporation, or an unaffiliated domestic owner. Paragraph (d) of this section provides rules that eliminate dual consolidated losses following certain transactions or events. Paragraph (e) of this section contains provisions that prevent dual consolidated losses from offsetting tainted income. Finally, paragraph (f) of this section provides rules for computing foreign tax credits.
(b) Limitation on domestic use of a dual consolidated loss. Except as provided in § 1.1503(d)-6, the domestic use of a dual consolidated loss is not permitted. See § 1.1503(d)-2 for the definition of a domestic use. See also § 1.1503(d)-7(c) Examples 2 through 4.
(c) Effect of a dual consolidated loss on a consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner. For any taxable year in which a dual resident corporation or separate unit has a dual consolidated loss that is subject to the domestic use limitation of paragraph (b) of this section, the following rules shall apply:
(1) Dual resident corporation. This paragraph (c)(1) applies to a dual consolidated loss of a dual resident corporation. The unaffiliated dual resident corporation, or consolidated group that includes the dual resident corporation, shall compute its taxable income (or loss), or consolidated taxable income (or loss), respectively, without taking into account those items of deduction and loss that compose the dual resident corporation's dual consolidated loss. For this purpose, the dual consolidated loss shall be treated as composed of a pro rata portion of each item of deduction and loss of the dual resident corporation taken into account in calculating the dual consolidated loss. The dual consolidated loss is subject to the limitations on its use contained in paragraph (c)(3) of this section and, subject to such limitations, may be carried over or back for use in other taxable years as a separate net operating loss carryover or carryback of the dual resident corporation arising in the year incurred. If the dual resident corporation owns a separate unit or an interest in a transparent entity, the limitations contained in paragraph (c)(3) of this section shall apply to the dual resident corporation as if the separate unit or interest in a transparent entity were a separate domestic corporation that filed a consolidated return with the unaffiliated dual resident corporation, or with the consolidated group of the affiliated dual resident corporation, as applicable.
(2) Separate unit. This paragraph (c)(2) applies to a dual consolidated loss that is attributable to a separate unit. The unaffiliated domestic owner of a separate unit, or the consolidated group of an affiliated domestic owner of a separate unit, shall compute its taxable income (or loss) or consolidated taxable income (or loss), respectively, without taking into account those items of deduction and loss that compose the separate unit's dual consolidated loss. For this purpose, the dual consolidated loss shall be treated as composed of a pro rata portion of each item of deduction and loss of the separate unit taken into account in calculating the dual consolidated loss. The dual consolidated loss is subject to the limitations contained in paragraph (c)(3) of this section as if the separate unit to which the dual consolidated loss is attributable were a separate domestic corporation that filed a consolidated return with its unaffiliated domestic owner or with the consolidated group of its affiliated domestic owner, as applicable. Subject to such limitations, the dual consolidated loss may be carried over or back for use in other taxable years as a separate net operating loss carryover or carryback of the separate unit arising in the year incurred. See § 1.1503(d)-7(c) Examples 29 and 38.
(3) SRLY limitation. The dual consolidated loss shall be treated as a loss incurred by the dual resident corporation or separate unit in a separate return limitation year and shall be subject to all of the limitations of § 1.1502-21(c) (SRLY limitation), subject to the following modifications --
(i) Notwithstanding § 1.1502-1(f)(2)(i), the SRLY limitation is applied to any dual consolidated loss of a common parent that is a dual resident corporation, or any dual consolidated loss attributable to a separate unit of a common parent;
(ii) The SRLY limitation is applied without regard to § 1.1502-21(c)(2) (SRLY subgroup limitation) and 1.1502-21(g) (overlap with section 382);
(iii) For purposes of calculating the general SRLY limitation under § 1.1502-21(c)(1)(i), the calculation of aggregate consolidated taxable income shall only include items of income, gain, deduction, and loss generated --
(A) In the case of a hybrid entity separate unit, in years in which the hybrid entity (an interest in which is a separate unit) is taxed as a corporation (or otherwise at the entity level) either on its worldwide income or as a resident in the same foreign country in which it was so taxed during the year in which the dual consolidated loss was generated; and
(B) In the case of a foreign branch separate unit, in years in which the foreign branch qualified as a separate unit in the same foreign country in which it so qualified during the year in which the dual consolidated loss was generated;
(iv) For purposes of calculating the general SRLY limitation under § 1.1502-21(c)(1)(i), the calculation of aggregate consolidated taxable income shall not include any amount included in income pursuant to § 1.1503(d)-6(h) (relating to the recapture of a dual consolidated loss); and
(v) The SRLY limitation is applied without regard to §1.1502-21(c)(1)(i)(E) (section 172(a) limitation applicable to a SRLY member).
(4) Items of a dual consolidated loss used in other taxable years. A pro rata portion of each item of deduction or loss that composes the dual consolidated loss shall be considered to be used when the dual consolidated loss is used in other taxable years. See § 1.1503(d)-7(c) Examples 29 and 38.
(5) Reconstituted net operating losses. For additional rules and limitations that apply to reconstituted net operating losses, see § 1.1503(d)-6(h)(6).
(d) Elimination of a dual consolidated loss after certain transactions.
(1) General rule. In general, a dual resident corporation has a net operating loss (and, therefore, a dual consolidated loss) only if it sustains such loss, or succeeds to such loss as a result of acquiring the assets of a corporation that sustained the loss in a transaction described in section 381(a). Similarly, a net loss generally is attributable to a separate unit of a domestic owner (and therefore is a dual consolidated loss) only if the domestic owner incurs the deductions or losses, or succeeds to such deductions or losses in a transaction described in section 381(a). Except as provided in § 1.1503(d)-6(h)(6)(iii), section 1503(d) and these regulations do not alter these general rules. Thus, the provisions of §§ 1.1503(d)-1 through 1.1503(d)-8 generally do not cause a corporation to have a dual consolidated loss if it did not sustain (or inherit) the loss. Instead, these regulations either eliminate a dual consolidated loss that a corporation sustained (or inherited), or prevent the carryover of a dual consolidated loss under section 381 that would ordinarily occur, as a result of certain transactions.
(i) Transactions described in section 381(a). This paragraph (d)(1)(i) applies to a dual consolidated loss of a dual resident corporation, or of a domestic owner attributable to a separate unit, that is subject to the domestic use limitation rule of paragraph (b) of this section. In such a case, and except as provided in paragraph (d)(2) of this section, the dual consolidated loss shall not carry over to another corporation in a transaction described in section 381(a) and, as a result, shall be eliminated. See § 1.1503(d)-7(c) Example 20.
(ii) Cessation of separate unit status. This paragraph (d)(1)(ii) applies when a separate unit of an unaffiliated domestic owner ceases to be a separate unit of its domestic owner, or when a separate unit of an affiliated domestic owner ceases to be a separate unit with respect to its domestic owner and all other members of the affiliated domestic owner's consolidated group. In such a case, and except as provided in paragraph (d)(2)(iii) of this section, a dual consolidated loss of the domestic owner attributable to such separate unit, that is subject to the domestic use limitation of paragraph (b) of this section, shall be eliminated. For purposes of this paragraph (d)(1)(ii), a separate unit may cease to be a separate unit if, for example, such separate unit is terminated, dissolved, liquidated, sold, or otherwise disposed of. See § 1.1503(d)-7(c) Example 21.
(2) Exceptions.
(i) Certain section 368(a)(1)(F) reorganizations. Paragraph (d)(1)(i) of this section (relating to transactions described in section 381(a)) shall not apply to a dual consolidated loss of a dual resident corporation that undergoes a reorganization described in section 368(a)(1)(F) in which the resulting corporation is a domestic corporation. In such a case, the dual consolidated loss of the resulting corporation continues to be subject to the limitations of paragraphs (b) and (c) of this section, applied as if the resulting corporation incurred the dual consolidated loss.
(ii) Acquisition of a dual resident corporation by another dual resident corporation. If a dual resident corporation transfers its assets to another dual resident corporation in a transaction described in section 381(a), and the transferee corporation is a resident of (or is taxed on its worldwide income by) the same foreign country of which the transferor was a resident (or was taxed on its worldwide income), then paragraph (d)(1)(i) of this section shall not apply with respect to dual consolidated losses of the dual resident corporation, and income generated by the transferee may be offset by the carryover dual consolidated losses of the transferor, subject to the limitations of paragraphs (b) and (c) of this section applied as if the transferee incurred the dual consolidated loss. Dual consolidated losses of the transferor dual resident corporation may not, however, be used to offset income attributable to separate units or interests in transparent entities owned by the transferee because they constitute domestic affiliates under § 1.1503(d)-1(b)(12)(iii) and (iv), respectively.
(iii) Acquisition of a separate unit by a domestic corporation. This paragraph (d)(2)(iii) provides exceptions to the general rules in paragraphs (d)(1)(i) and (ii) of this section that eliminate the dual consolidated loss of a domestic owner that is attributable to a separate unit following certain transactions or events. The exceptions set forth in this paragraph (d)(2)(iii) shall only apply where a domestic owner transfers its assets to a domestic corporation (transferee corporation) in a transaction described in section 381(a).
(A) Acquisition by a corporation that is not a member of the same consolidated group.
(1) General rule. If a domestic owner transfers either an individual separate unit or a combined separate unit to a transferee corporation that is not a member of its consolidated group in a transaction described in section 381(a), and the transferee corporation, or a member of the transferee's consolidated group, is a domestic owner of the transferred separate unit immediately after the transaction, then paragraphs (d)(1)(i) and (ii) of this section shall not apply to such transfer. In addition, income of the transferee, or a member of the transferee's consolidated group, that is attributable to the transferred separate unit may be offset by the carryover dual consolidated losses of the transferor domestic owner that were attributable to the transferred separate unit, subject to the limitations of paragraphs (b) and (c) of this section applied as if the transferee incurred the dual consolidated losses and such losses were attributable to the separate unit. See § 1.1503(d)-7(c) Example 21.
(2) Combination with separate units of the transferee. This paragraph (d)(2)(iii)(A)(2) applies to a transaction described in paragraph (d)(2)(iii)(A)(1) of this section where the transferred separate unit is combined with another separate unit of the transferee, or another member of the transferee's consolidated group, immediately after the transfer as provided under § 1.1503(d)-1(b)(4)(ii). In such a case, income generated by the transferee, or another member of the transferee's consolidated group, that is attributable to the combined separate unit may be offset by the carryover dual consolidated losses that were attributable to the transferred separate unit, subject to the limitations of paragraphs (b) and (c) of this section, applied as if the transferee incurred the dual consolidated losses and such losses were attributable to the combined separate unit.
(B) Acquisition by a member of the same consolidated group. If an affiliated domestic owner transfers its assets to another member of its consolidated group in a transaction described in section 381(a), and the transferee corporation or another member of such consolidated group is a domestic owner of the separate unit to which the dual consolidated loss was attributable, then paragraphs (d)(1)(i) and (ii) of this section shall not apply. In addition, income generated by the transferee that is attributable to the transferred separate unit may be offset by the carryover dual consolidated losses that were attributable to the transferred separate unit, subject to the limitations of paragraphs (b) and (c) of this section, applied as if the transferee incurred the dual consolidated losses and such losses were attributable to the separate unit. See § 1.1503(d)-7(c) Example 21.
(iv) Special rules for foreign insurance companies. See § 1.1503(d)-6(a) for additional limitations that apply where the transferor is a foreign insurance company that is a dual resident corporation under § 1.1503(d)-1(b)(2)(ii).
(e) Special rule denying the use of a dual consolidated loss to offset tainted income.
(1) In general. Dual consolidated losses incurred by a dual resident corporation that are subject to the domestic use limitation rule under paragraph (b) of this section shall not be used to offset income it earns after it ceases to be a dual resident corporation to the extent that such income is tainted income.
(2) Tainted income.
(i) Definition. For purposes of paragraph (e)(1) of this section, the term tainted income means --
(A) Income or gain recognized on the sale or other disposition of tainted assets; and
(B) Income derived as a result of holding tainted assets.
(ii) Income presumed to be derived from holding tainted assets. In the absence of evidence establishing the actual amount of income that is attributable to holding tainted assets, the portion of a corporation's income in a particular taxable year that is treated as tainted income derived as a result of holding tainted assets shall be an amount equal to the corporation's taxable income for the year (other than income described in paragraph (e)(2)(i)(A) of this section) multiplied by a fraction, the numerator of which is the fair market value of all tainted assets acquired by the corporation (determined at the time such assets were so acquired) and the denominator of which is the fair market value of the total assets owned by the corporation at the end of such taxable year. To establish the actual amount of income that is attributable to holding tainted assets, documentation must be attached to, and filed by the due date (including extensions) of, the domestic corporation's tax return or the consolidated tax return of an affiliated group of which it is a member, as the case may be, for the taxable year in which the income is generated. See § 1.1503(d)-7(c) Example 22.
(3) Tainted assets defined. For purposes of paragraph (e)(2) of this section, tainted assets are any assets acquired by a domestic corporation in a nonrecognition transaction, as defined in section 7701(a)(45), any assets otherwise transferred to the corporation as a contribution to capital, or any assets otherwise received from a separate unit or a transparent entity owned by such domestic corporation, at any time during the three taxable years immediately preceding the taxable year in which the corporation ceases to be a dual resident corporation or at any time thereafter.
(4) Exceptions. Income derived from assets acquired by a domestic corporation shall not be subject to the limitation described in paragraph (e)(1) of this section, and in addition shall not be treated as tainted assets as defined in paragraph (e)(3) of this section, if--
(i) For the taxable year in which the assets were acquired, the corporation did not have a dual consolidated loss (or a carryforward of a dual consolidated loss to such year); or
(ii) The assets were acquired as replacement property in the ordinary course of business.
(f) Computation of foreign tax credit limitation. If a dual consolidated loss is subject to the domestic use limitation rule under paragraph (b) of this section, the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner shall compute its foreign tax credit limitation by applying the limitations of paragraph (c) of this section. Thus, the items constituting the dual consolidated loss are not taken into account until the year in which such items are absorbed.
[Added by T.D. 9315, 72 FR 12902-12946, Mar. 19, 2007; amended by T.D. 9927, 85 FR 67966-67988, Oct. 27, 2020.]
