[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.861-8T]

[Page 164-169]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.861-8T  Computation of taxable income from sources within the 
United States and from other sources and activities (temporary).

    (a) In general. (1) [Reserved]
    (2) Allocation and apportionment of deductions in general. If an 
affiliated group of corporations joins in filing a consolidated return 
under section 1501, the provisions of this section are to be applied 
separately to each member in that affiliated group for purposes of 
determining such member's taxable income, except to the extent that 
expenses, losses, and other deductions are allocated and apportioned as 
if all domestic members of an affiliated group were a single corporation 
under section 864(e) and the regulations thereunder. See Sec. 1.861-9T 
through Sec. 1.861-11T for rules regarding the affiliated group 
allocation and apportionment of interest expense, and Sec. 1.861-14T 
for rules regarding the affiliated group allocation and apportionment of 
expenses other than interest.
    (3)-(5) [Reserved]
    (b) Allocation. (1)-(2) [Reserved]
    (3) Supportive functions. Deductions which are supportive in nature 
(such as overhead, general and administrative, and supervisory expenses) 
may relate to other deductions which can more readily be allocated to 
gross income. In such instance, such supportive deductions may be 
allocated and apportioned along with the deductions to which they 
relate. On the other hand, it would be equally acceptable to attribute 
supportive deductions on some reasonable basis directly to activities or 
property which generate, have generated, or could be reasonably expected

[[Page 165]]

to generate gross income. This would ordinarily be accomplished by 
allocating the supportive expenses to all gross income or to another 
broad class of gross income and apportioning the expenses in accordance 
with paragraph (c)(1) of this section. For this purpose, reasonable 
departmental overhead rates may be utilized. For examples of the 
application of the principles of this paragraph (b)(3) other than to 
expenses attributable to stewardship activities, see examples 19 through 
21 of paragraph (g) of this section. See paragraph (e)(4) of this 
section for the allocation and apportionment of deductions attributable 
to stewardship activities. However, supportive deductions that are 
described in Sec. 1.861-14T(e)(3) shall be allocated and apportioned in 
accordance with the rules of Sec. 1.1861-14T and shall not be allocated 
and apportioned by reference only to the gross income of a single member 
of an affiliated group of corporations as defined in Sec. 1.861-14T(d).
    (4)-(5) [Reserved]
    (c) Apportionment of deductions--(1) Deductions definitely related 
to a class of gross income. Where a deduction has been allocated in 
accordance with paragraph (b) of this section to a class of gross income 
which is included in one statutory grouping and the residual grouping, 
the deduction must be apportioned between the statutory grouping and the 
residual grouping. Where a deduction has been allocated to a class of 
gross income which is included in more than one statutory grouping, such 
deduction must be apportioned among the statutory groupings and, where 
necessary, the residual grouping. Thus, in determining the separate 
limitations on the foreign tax credit imposed by section 904(d)(1) or by 
section 907, the income within a separate limitation category 
constitutes a statutory grouping of income and all other income not 
within that separate limitation category (whether domestic or within a 
different separate limitation category) constitutes the residual 
grouping. In this regard, the same method of apportionment must be used 
in apportioning a deduction to each separate limitation category. Also, 
see paragraph (f)(1)(iii) of this section with respect to the 
apportionment of deductions among the statutory groupings designated in 
section 904(d)(1). If the class of gross income to which a deduction has 
been allocated consists entirely of a single statutory grouping or the 
residual grouping, there is no need to apportion that deduction. If a 
deduction is not definitely related to any gross income, it must be 
apportioned ratably as provided in paragraph (c)(3) of this section. A 
deduction is apportioned by attributing the deduction to gross income 
(within the class to which the deduction has been allocated) which is in 
one or more statutory groupings and to gross income (within the class) 
which is in the residual grouping. Such attribution must be accomplished 
in a manner which reflects to a reasonably close extent the factual 
relationship between the deduction and the grouping of gross income. In 
apportioning deductions, it may be that for the taxable year there is no 
gross income in the statutory grouping or that deductions will exceed 
the amount of gross income in the statutory grouping. See paragraph 
(d)(1) of this section with respect to cases in which deductions exceed 
gross income. In determining the method of apportionment for a specific 
deduction, examples of bases and factors which should be considered 
include, but are not limited to--
    (i) Comparison of units sold,
    (ii) Comparison of the amount of gross sales or receipts,
    (iii) Comparison of costs of goods sold,
    (iv) Comparison of profit contribution,
    (v) Comparison of expenses incurred, assets used, salaries paid, 
space utilized, and time spent which are attributable to the activities 
or properties giving rise to the class of gross income, and
    (iv) Comparison of the amount of gross income.

Paragraph (e) (2) through (8) of this section provides the applicable 
rules for allocation and apportionment of deductions for interest, 
research and development expenses, and certain other deductions. The 
effects on tax liability of the apportionment of deductions and the 
burden of maintaining records not otherwise maintained and making

[[Page 166]]

computations not otherwise made shall be taken into consideration in 
determining whether a method of apportionment and its application are 
sufficiently precise. A method of apportionment described in this 
paragraph (c)(1) may not be used when it does not reflect, to a 
reasonably close extent, the factual relationship between the deduction 
and the groupings of income. Furthermore, certain methods of 
apportionment described in this paragraph (c)(1) may not be used in 
connection with any deduction for which another method is prescribed. 
The principles set forth above are applicable in apportioning both 
deductions definitely related to a class which constitutes less than all 
of the taxpayer's gross income and to deductions related to all of the 
taxpayer's gross income. If a deduction is not related to any class of 
gross income, it must be apportioned ratably as provided in paragraph 
(c)(3) of this section.
    (2) Apportionment based on assets. Certain taxpayers are required by 
paragraph (e)(2) of this section and Sec. 1.861-9T to apportion 
interest expense on the basis of assets. A taxpayer may apportion other 
deductions based on the comparative value of assets that generate income 
within each grouping, provided that such method reflects the factual 
relationship between the deduction and the groupings of income and is 
applied in accordance with the rules of Sec. 1.861-9T(g). In general, 
such apportionments must be made either on the basis of the tax book 
value of those assets or on their fair market value. However, once the 
taxpayer uses fair market value, the taxpayer and all related persons 
must continue to use such method unless expressly authorized by the 
Commissioner to change methods. For purposes of this paragraph (c)(2) 
the term related persons means two or more persons in a relationship 
described in section 267(b). In determining whether two or more 
corporations are members of same controlled group under section 
267(b)(3), a person is considered to own stock owned directly by such 
person, stock owned with the application of section 1563(e)(1), and 
stock owned by the application of section 267(c). In determining whether 
a corporation is related to a partnership under section 267(b)(10), a 
person is considered to own the partnership interest owned directly by 
such person and the partnership interest owned with the application of 
section 267(e)(3). In the case of any corporate taxpayer that--
    (i) Uses tax book value, and
    (ii) Owns directly or indirectly (within the meaning of Sec. 1.861-
11T(b)(2)(ii)) 10 percent or more of the total combined voting power of 
all classes of stock entitled to vote in any other corporation (domestic 
or foreign) that is not a member of the affiliated group (as defined in 
section 864(e)(5)), such taxpayer shall adjust its basis in that stock 
in the manner described in Sec. 1.861-11T(b).
    (3) [Reserved]
    (d) Excess of deductions and excluded and eliminated items of 
income. (1) [Reserved]
    (2) Allocation and apportionment to exempt, excluded or eliminated 
income--(i) In general. In the case of taxable years beginning after 
December 31, 1986, except to the extent otherwise permitted by Sec. 
1.861-13T, the following rules shall apply to take account of income 
that is exempt or excluded, or assets generating such income, with 
respect to allocation and apportionment of deductions.
    (A) Allocation of deductions. In allocating deductions that are 
definitely related to one or more classes of gross income, exempt income 
(as defined in paragraph (d)(2)(ii) of this section) shall be taken into 
account.
    (B) Apportionment of deductions. In apportioning deductions that are 
definitely related either to a class of gross income consisting of 
multiple groupings of income (whether statutory or residual) or to all 
gross income, exempt income and exempt assets (as defined in paragraph 
(d)(2)(ii) of this section) shall not be taken into account.


For purposes of apportioning deductions which are not taken into account 
under Sec. 1.1502-13 in determining gain or loss from intercompany 
transactions, as defined in Sec. 1.1502-13, income from such 
transactions shall be taken into account in the year such income is 
ultimately included in gross income.

[[Page 167]]

    (ii) Exempt income and exempt asset defined--(A) In general. For 
purposes of this section, the term exempt income means any income that 
is, in whole or in part, exempt, excluded, or eliminated for federal 
income tax purposes. The term exempt asset means any asset the income 
from which is, in whole or in part, exempt, excluded, or eliminated for 
federal tax purposes.
    (B) Certain stock and dividends. The term ``exempt income'' includes 
the portion of the dividends that are deductible under--
    (1) Section 243(a) (1) or (2) (relating to the dividends received 
deduction),
    (2) Section 245(a) (relating to the dividends received deduction for 
dividends from certain foreign corporations).

Thus, for purposes of apportioning deductions using a gross income 
method, gross income would not include a dividend to the extent that it 
gives rise to a dividend received deduction under either section 
243(a)(1), section 243(a)(2), or section 245(a). In the case of a life 
insurance company taxable under section 801, the amount of such stock 
that is treated as tax exempt shall not be reduced because a portion of 
the dividends received deduction is disallowed as attributable to the 
policyholder's share of such dividends. See Sec. 1.861-14T(h) for a 
special rule concerning the allocation of reserve expenses of a life 
insurance company. In addition, for purposes of apportioning deductions 
using an asset method, assets would not include that portion of stock 
equal to the portion of dividends paid thereon that would be deductible 
under either section 243(a)(1), section 243(a)(2), or section 245(a). In 
the case of stock which generates, has generated, or can reasonably be 
expected to generate qualifying dividends deductible under section 
243(a)(3), such stock shall not constitute a tax exempt asset. Such 
stock and the dividends thereon will, however, be eliminated from 
consideration in the apportionment of interest expense under the 
consolidation rule set forth in Sec. 1.861-10T(c), and in the 
apportionment of other expenses under the consolidation rules set forth 
in Sec. 1.861-14T.
    (iii) Income that is not considered tax exempt. The following items 
are not considered to be exempt, eliminated, or excluded income and, 
thus, may have expenses, losses, or other deductions allocated and 
apportioned to them:
    (A) In the case of a foreign taxpayer (including a foreign sales 
corporation (FSC)) computing its effectively connected income, gross 
income (whether domestic or foreign source) which is not effectively 
connected to the conduct of a United States trade or business;
    (B) In computing the combined taxable income of a DISC or FSC and 
its related supplier, the gross income of a DISC or a FSC;
    (C) For all purposes under subchapter N of the Code, including the 
computation of combined taxable income of a possessions corporation and 
its affiliates under section 936(h), the gross income of a possessions 
corporation for which a credit is allowed under section 936(a); and
    (D) Foreign earned income as defined in section 911 and the 
regulations thereunder (however, the rules of Sec. 1.911-6 do not 
require the allocation and apportionment of certain deductions, 
including home mortgage interest, to foreign earned income for purposes 
of determining the deductions disallowed under section 911(d)(6)).
    (iv) Prior years. For expense allocation and apportionment rules 
applicable to taxable years beginning before January 1, 1987, and for 
later years to the extent permitted by Sec. 1.861-13T, see Sec. 1.861-
8(d)(2) (Revised as of April 1, 1986).
    (e) Allocation and apportionment of certain deductions. (1) 
[Reserved]. For further guidance, see Sec. 1.861-8(e)(1).
    (2) Interest. The rules concerning the allocation and apportionment 
of interest expense and certain interest equivalents are set forth in 
Sec. Sec. 1.861-9T through Sec. 1.861-13T.
    (3)-(11) [Reserved]. For further guidance, see Sec. 1.861-8(e)(3) 
through (e)(11).
    (f) Miscellaneous matters--(1) Operative sections. (i) [Reserved]
    (ii) Separate limitations to the foreign tax credit. Section 
904(d)(1) requires that the foreign tax credit limitation be determined 
separately in the case of the types of income specified therein. 
Accordingly, the income within each

[[Page 168]]

separate limitation category constitutes a statutory grouping of income 
and all other income not within that separate limitation category 
(whether domestic or within a different separate limitation category) 
constitutes the residual groups.
    (iii) [Reserved]
    (2)-(5) [Reserved]
    (g) [Reserved]

    Examples (1)-(23). [Reserved]
    Example (24)- Exempt, excluded, or eliminated income--(i) Income 
method--(A) Facts. X, a domestic corporation organized on January 1, 
1987, is engaged in a number of businesses worldwide. X owns a 25-
percent voting interest in each of five corporations engaged in the 
business A, two of which are domestic and three of which are foreign. X 
incurs stewardship expenses in connection with these five stock 
investments in the amount of $100. X apportions its stewardship expenses 
using a gross income method. Each of the five companies pays a dividend 
in the amount of $100. X is entitled to claim the 80-percent dividends 
received deduction on dividends paid by the two domestic companies. 
Because tax exempt income is considered in the allocation of deductions, 
X's $100 stewardship expense is allocated to the class of income 
consisting of dividends from business A companies. However, because tax 
exempt income is not considered in the apportionment of deductions 
within a class of gross income, the gross income of the two domestic 
companies must be reduced to reflect the availability of the dividends 
received deduction. Thus, for purposes of apportionment, the gross 
income paid by the three foreign companies is considered to be $100 
each, while the gross income paid by the domestic companies is 
considered to be $20 each. Accordingly, X has total gross income from 
business A companies, for purposes of apportionment, of $340. As a 
result, $29.41 of X's stewardship expense is apportioned to each of the 
foreign companies and $5.88 of X's stewardship expense is apportioned to 
each of the domestic companies.
    (ii) Asset method--(A) Facts. X, a domestic corporation organized on 
January 1, 1987, carries on a trade or business in the United States. X 
has deductible interest expense incurred in 1987 of $60,000. X owns all 
the stock of Y, a foreign corporation. X also owns 49 percent of the 
voting stock of Z, a domestic corporation. Neither Y nor Z has retained 
earnings and profits at the end of 1987. X apportions its interest 
expense on the basis of the fair market value of its assets. X has 
assets worth $1,500,000 that generate domestic source income, among 
which are tax exempt municipal bonds worth $100,000, and the stock of Z, 
which has a value of $500,000. The Y stock owned by X has a fair market 
value of $2,000,000 and generates solely foreign source general 
limitation income.
    (B) Allocation. No portion of X's interest expense is directly 
allocable solely to identified property within the meaning of Sec. 
1.861-1OT. Thus, X's deduction for interest is definitely related to all 
its gross income as a class.
    (C) Apportionment. For purposes of apportioning expenses, assets 
that generate exempt, eliminated, or excluded income are not taken into 
account. Because X's municipal bonds are tax exempt, they are not taken 
into account in apportioning interest expense. Since X is entitled to 
claim under section 243 to 80-percent dividends received deduction with 
respect to the dividend it received from Z, 80 percent of the value of 
that stock is not taken into account as an asset for purposes of 
apportionment under the asset method. X apportions its interest 
deduction between the statutory grouping of foreign source general 
limitation income and the residual grouping of domestic source income as 
follows:
    To foreign source general limitation income:

[[Page 169]]

[GRAPHIC] [TIFF OMITTED] TC07OC91.000

[GRAPHIC] [TIFF OMITTED] TC07OC91.001

    (h) Effective dates. In general, the rules of this section, as well 
as the rules of Sec. Sec. 1.861-9T, 1.861-10T, 1.861-11T, 1.861-12T, 
and 1.861-14T shall apply for taxable years beginning after December 31, 
1986. In the case of corporate taxpayers, transition rules set forth in 
Sec. 1.861-13T provide for the gradual phase-in of certain the 
provisions of this and the foregoing sections. However, the following 
rules are effective for taxable years commencing after December 31, 
1988:
    (1) Section 1.861-9T(b)(2) (concerning the treatment of certain 
foreign currency borrowings),
    (2) Section 1.861-9T(d)(2) (concerning the treatment of interest 
incurred by nonresident aliens),
    (3) Section 1.861-10T(b)(3)(ii) (providing an operating costs test 
for purposes of the nonrecourse indebtedness exception), and
    (4) Section 1.861-10T(b)(6) (concerning excess collaterilization of 
nonrecourse borrowings).

In addition, Sec. 1.861-10T(e) (concerning the treatment of related 
controlled foreign corporation indebtedness) is effective for taxable 
years commencing after December 31, 1987. For rules for taxable years 
beginning before January 1, 1987, and for later years to the extent 
permitted by Sec. 1.861-13T, see Sec. 1.861-8 (Revised as of April 1, 
1986).

[T.D. 8228, 53 FR 35474, Sept. 14, 1988, as amended by T.D. 8286, 55 FR 
3054, Jan. 30, 1990; T.D. 8337, 56 FR 10369, Mar. 12, 1991; T.D.8597, 60 
FR 36679, July 18, 1995; T.D. 8805, 64 FR 1509, Jan. 11, 1999; T.D. 
8973, 66 FR 67083, Dec. 28, 2001]