[Code of Federal Regulations] [Title 26, Volume 10] [Revised as of April 1, 2004] From the U.S. Government Printing Office via GPO Access [CITE: 26CFR1.921-3T] [Page 42-46] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) PART 1_INCOME TAXES--Table of Contents Sec. 1.921-3T Temporary regulations; Foreign sales corporation general rules. (a) Exclusion--(1) Classifications of income. The extent to which income of a FSC (any further reference to a FSC in this section shall include a small FSC unless indicated otherwise) is subject to the corporate income tax of section 11, or, in the alternative, section 1201(a), is dependent upon the allocation of the FSC's income to the following five categories: (i) Exempt foreign trade income determined under section 923 and Sec. 1.923-1T; (ii) Non-exempt foreign trade income determined with regard to the administrative pricing rules of section 925(a)(1) or (2); (iii) Non-exempt foreign trade income determined without regard to the administrative pricing rules of section 925(a)(1) or (2) (section 923(a)(2) non-exempt income as defined in section 927(d)(6)); (iv) Investment income and carrying charges; and (v) Other non-foreign trade income. (2) Source and characterization of FSC income--(i) Exempt foreign trade income. The exempt foreign trade income of a FSC determined under section 923 and Sec. 1.923-1T is treated as foreign source income which is not effectively connected with a United States trade or business. See Sec. 1.923-1T(a) for the definition of foreign trade income and Sec. 1.923-1T(b) for the definition of exempt foreign trade income. (ii) Non-exempt foreign trade income determined with regard to the administrative pricing rules. The FSC's non-exempt foreign trade income with respect to a transaction or group of transactions will be treated as United States source income which is effectively connected with the FSC's trade or business which is conducted through its permanent establishment within the United States if either of the administrative pricing rules of section 925(a)(1) or (2) is used to determine the FSC's foreign trade income from a transaction or group of transactions. See Sec. 1.923-1T(b) for the definition of non-exempt foreign trade income. (iii) Non-exempt foreign trade income determined without regard to the administrative pricing rules. The source and taxation of the FSC's non-exempt foreign trade income not classified in paragraph (a)(2)(ii) of this section will be determined under the appropriate sections of the Internal Revenue Code and the regulations under those sections. This type of income (section 923(a)(2) non-exempt income) includes both income that is not effectively connected with the conduct of a trade or business in the United States and income that is effectively connected. (iv) Investment income and carrying charges. All of the FSC's investment income and carrying charges will be treated as income which is effectively connected with the FSC's trade or business which is conducted through its permanent establishment within the United States. The source of that income will be determined under the appropriate sections of the Internal Revenue Code and the regulations under those sections. See Sec. 1.921-2(f) (Q & A9) for definition of investment income and carrying charges. (v) Non-foreign trade income (other than investment income and carrying charges). The source and taxation of the FSC's non-foreign trade income (other than investment income and carrying charges) will be determined under the appropriate sections of the Internal Revenue Code and the regulations under those sections. (b) Allocation and apportionment of deductions. Expenses, losses and deductions incurred by the FSC shall be allocated and apportioned under the rules set forth in Sec. 1.861-8 to the FSC's foreign trade income and to the FSC's [[Page 43]] non-foreign trade income. Any deductions incurred by the FSC on a transaction, or group of transactions, which are allocated and apportioned to the FSC's foreign trade income from that transaction, or group of transactions, shall be allocated on a proportionate basis between exempt foreign trade income and non-exempt foreign trade income. (c) Net operating losses and capital losses--(1) General rule. (i) If a FSC for any taxable year incurs a deficit in earnings and profits attributable to foreign trade income determined without regard to the administrative pricing rules of section 925(a)(1) or (2), that deficit shall be applied to reduce current earnings and profits, if any, attributable to-- (A) First, exempt foreign trade income determined with regard to the administrative pricing rules, (B) Second, non-exempt foreign trade income determined with regard to the administrative pricing rules, (C) Third, investment income and carrying charges, and (D) Fourth, other non-foreign trade income. (ii) If a FSC for any taxable year incurs a deficit in earnings and profits attributable to non-foreign trade income (other than investment income, carrying charges and net capital losses), that deficit shall be applied to reduce current earnings and profits, if any, attributable to-- (A) First, investment income and carrying charges, (B) Second, exempt foreign trade income determined with regard to the administrative pricing rules, (C) Third, exempt foreign trade income determined without regard to the administrative pricing rules, (D) Fourth, non-exempt foreign trade income determined with regard to the administrative pricing rules, and (E) Fifth, section 923(a)(2) non-exempt income. (iii) If a FSC for any taxable year incurs a deficit in earnings and profits attributable to investment income and carrying charges, that deficit shall be applied to reduce current earnings and profits, if any, attributable to-- (A) First, non-foreign trade income other than capital gains, (B) Second, exempt foreign trade income determined with regard to the administrative pricing rules, (C) Third, exempt foreign trade income determined without regard to the administrative pricing rules, (D) Fourth, non-exempt foreign trade income determined with regard to the administrative pricing rules, and (E) Fifth, section 923(a)(2) non-exempt income. (iv) Net capital losses will be available for carryback or carryover pursuant to paragraph (c)(2) of this section. (v) Because the no-loss rules provide that a related supplier may always compensate the FSC for its expenses either as part of the commission payment or as part of the transfer price if the administrative pricing rules are used (see Sec. 1.925(a)-1T(e)(1)(i)), a FSC will not have a deficit in its earnings and profits relating to foreign trade income determined with regard to the administrative pricing rules. To determine the amount of any division of earnings and profits for the purpose of determining under Sec. 1.926(a)-1T (a) and (b) the treatment and order of distributions, the portion of a deficit in earnings and profits chargeable under this paragraph to such division prior to such distribution shall be determined in a manner consistent with the rules in Sec. 1.316-2(b) for determining the amount of earnings and profits available on the date of any distribution. (2) Carryback or carryover of net operating losses and capital losses to other taxable years of a FSC (or former FSC). (i) The amount of the deduction for the taxable year under section 172 for a net operating loss carryback or carryover, or under section 1212 for a capital loss carryback or carryover, shall be determined in the same manner as if the FSC were a foreign corporation which had not elected to be treated as a FSC. Thus, the amount of the deduction will be the same whether or not the corporation was a FSC in the year of the loss or in the year to which the loss is carried. (ii) Any carryback or carryover of a FSC's (or former FSC's) net operating loss which is attributable to transactions which give rise to foreign trade income shall be charged-- [[Page 44]] (A) First, to earnings and profits attributable to exempt foreign trade income which is determined without regard to the administrative pricing rules, (B) Second, to earnings and profits attributable to section 923(a)(2) non-exempt income, (C) Third, to earnings and profits attributable to exempt foreign trade income determined with regard to the administrative pricing rules, (D) Fourth, to earnings and profits attributable to non-exempt foreign trade income determined with regard to the administrative pricing rules, (E) Fifth, to earnings and profits attributable to investment income and carrying charges (other than capital gain income), and (F) Sixth, to earnings and profits attributable to non-foreign trade income (other than investment income, carrying charges and capital gain income). (iii) Any carryback or carryover of a FSC's (or former FSC's) net operating loss which is attributable to non-foreign trade income (other than capital gain income) shall be charged-- (A) First, to earnings and profits attributable to non-foreign trade income (other than investment income, carrying charges and capital gain income), (B) Second, to earnings and profits attributable to investment income and carrying charges, (C) Third, to earnings and profits attributable to exempt foreign trade income determined with regard to the administrative pricing rules, (D) Fourth, to earnings and profits attributable to non-exempt foreign trade income determined with regard to the administrative pricing rules, (E) Fifth, to earnings and profits attributable to exempt foreign trade income which is determined without regard to the administrative pricing rules, and (F) Sixth, to earnings and profits attributable to section 923(a)(2) non-exempt income. (iv) Any carryback or carryover of a net operating loss to a year in which the corporation was (or is) a FSC from a taxable year in which the corporation was not a FSC shall be applied in a manner consistent with subdivision (iii) of this paragraph. (d) Credits against tax--(1) General rule. Notwithstanding any other provision of chapter 1, subtitle A, a FSC is allowed under section 921(c) as credits against tax only the following credits: (i) The foreign tax credit, section 27(a); (ii) The credit for tax withheld at source on foreign corporations, section 33; and (iii) The certain uses of gasoline and special fuels credit, section 34. (2) Foreign tax credit. (i) The direct foreign tax credit of section 901(b)(4) as determined under section 906 for income, war profits, and excess profits taxes (or taxes in lieu thereof) paid or accrued to any foreign country or possession of the United States is allowed a FSC only to the extent that those taxes are attributable to the FSC's foreign source non-foreign trade income which is effectively connected with its conduct of a trade or business within the United States. See section 906(b)(5). (ii) The foreign tax credit for domestic corporate shareholders in foreign corporations (the deemed paid credit) provided under section 901(a) as determined under section 902 is allowed for income, war profits, and excess profits taxes deemed paid or accrued by a FSC (or former FSC) only to the extent those taxes are deemed paid or accrued with respect to the FSC's (or former FSC's) section 923(a)(2) non-exempt income and its non-foreign trade income. (iii) The foreign tax credit allowed by sections 901 and 903 for tax withheld at source is allowed only to the extent the dividends paid to the FSC's (or former FSC's) shareholder are attributable to the FSC's (or former FSC's) section 923(a)(2) non-exempt income and its non- foreign trade income. (3) Foreign tax credit limitation. (i) For purposes of computation of the direct foreign tax credit of section 901(b)(4) as determined under section 906, the separate limitation of section 904(d)(1)(C) for the FSC's taxable income attributable to its foreign trade income will apply. The direct foreign tax credit is not allowed to a FSC with regard to taxes it paid which are attributable to its foreign trade income. Since the foreign tax credit is not allowed for that type of income, the effect of the separate limitation is to remove the FSC's [[Page 45]] foreign trade income from the numerator of the fraction used to compute the FSC's overall foreign tax credit limitation. (ii) A separate limitation under section 904(d)(1)(D) is provided for distributions from a FSC (or former FSC) that arise through operation of the deemed paid credit of section 902 and are attributable to foreign trade income earned during the period when the distributing corporation was a FSC. This limitation is computed by multiplying the FSC's shareholder's tentative United States tax by a fraction the numerator of which is the foreign source dividend (determined with regard to section 78) attributable to the foreign trade income less dividends received deductions and other expenses allocated and apportioned under Sec. 1.861-8 allowed to the shareholder and the denominator of which is the shareholder's worldwide income. The effect of this separate limitation is to remove dividends attributable to the FSC's foreign trade income from the numerator of the fraction used to compute the overall foreign tax credit limitation of the FSC's shareholder. (iii) The separate limitation under section 904(d)(1)(D) also applies to the foreign tax credit allowed to a FSC shareholder by sections 901 and 903 for tax withheld at source on dividends paid by the FSC. The numerator of this fraction is the part of the dividend attributable to the FSC's foreign trade income and the denominator is the shareholder's worldwide income. The effect of this separate limitation is to remove dividends attributable to foreign trade income of a FSC (or former FSC) from the numerator of the fraction used to compute the overall foreign tax credit limitation of the FSC's shareholder. (e) Deduction for foreign income, war profits and excess profits taxes. Under section 275(a)(4)(B), income, war profits and excess profits taxes imposed by a foreign country or possession of the United States may not be deducted by a FSC to the extent those taxes are paid or accrued with respect to its foreign trade income. (f) Payment of estimated tax. Every FSC which is subject to tax under section 11 or 1201(a) and section 882 must make payment of its estimated tax in accordance with section 6154 and the regulations under that section. In determining the amount of the estimated tax, the FSC must treat the tax imposed by section 881 as though it were a tax imposed by section 11. See section 6154(g). (g) Accumulated earnings, personal holding company and foreign personal holding company. The provisions covering the accumulated earnings tax (sections 531 through 537), personal holding companies (sections 541 through 547) and foreign personal holding companies (sections 551 through 558) apply to FSCs to the extent they would apply to foreign corporations that are not FSCs. (h) Subpart F income and increase of earnings invested in U.S. property. For the mandatory inclusion in the gross income of the U.S. shareholders of the subpart F income and of the increase in earnings invested in U.S. property of a FSC, see sections 951 through 964 and the regulations under those sections. However, the foreign trade income (other than section 923(a)(2) non-exempt income) and, generally, the investment income and carrying charges of a FSC and any deductions which are allocated and apportioned to those classes of income, are not taken into account under sections 951 through 964. See sections 951(e) and 952(b). (i) Certain accumulations of earnings and profits. For the inclusion in the gross income of U.S. persons as a dividend on the gain recognized on certain sales or exchanges of stock in a FSC, to the extent of certain earnings and profits attributable to the stock which were accumulated while the FSC was a controlled foreign corporation, see section 1248 and the regulations under that section. However, section 1248 and the regulations under that section do not apply to a FSC's earnings and profits attributable to foreign trade income, see section 1248(d)(6). (j) Limitations on certain multiple tax benefits. The provisions of section 1561, Limitations on Certain Multiple Tax Benefits in the Case of Certain Controlled Corporations, and section 1563, Definitions and Special Rules, and the [[Page 46]] regulations under those sections apply to a FSC and its controlled group. [T.D. 8126, 52 FR 6435, Mar. 3, 1987]