Notice 2005-38 clarifies critical issues.

A. Introduction

Added by the American Jobs Creation Act of 2004, section 965 of the Internal Revenue Code permits U.S. corporations to elect a one-time 85-percent dividends-received deduction for cash dividends received from controlled foreign corporations (CFCs). The election is subject to a number of limitations. Only cash dividends in excess of the average amount paid over a three-year base period are eligible for the deduction. There is an overall ceiling on eligible dividends equal to the greater of $500 million or the amount shown as permanently reinvested outside of the United States on the U.S. shareholder's applicable financial statement. The ceiling amount is reduced by the amount of any increase in CFC related-party indebtedness between the date of the enactment of section 965 and the end of the taxpayer's section 965 election year. Finally, the deduction is available only for dividends earmarked for reinvestment in the United States pursuant to a qualifying dividend reinvestment plan (DRIP).

In Notice 2005-10, the Internal Revenue Service refined the definition of "cash dividends" and provided guidance concerning the types of investments in the United States for which repatriated funds may be used. Although helpful, this first Notice did not address several key questions. As a result, many taxpayers have been unable to decide whether to take advantage of the provision.

The two principal uncertainties were the status of the section 78 gross-up amount attributable to the deductible portion of a section 965 dividend (1) and the effect of mergers and acquisitions, during and prior to the section 965 election year, on both the base-period dividend and APB 23 ceiling amounts. Many taxpayers found it impossible to evaluate the new law in the absence of guidance on these issues.

Issued by the IRS on May 10, 2005, Notice 2005-38 is the much-anticipated second round of guidance on the mechanics of the section 965 temporary dividends-received deduction. The Notice resolves the section 78 issue and addresses the effect of various merger and acquisition transactions on the base-period amount, the ceiling on eligible dividends, and the related-party indebtedness rules. Notice 2005-38 also addresses other miscellaneous, but important, issues, including the disallowance of expenses related to the deductible portion of the eligible dividend, and the application of the alternative minimum tax in the year of election. At least one more round of guidance is expected in the summer of 2005, covering issues relating to the foreign tax credit and expense allocation.

B. Clarification of Section 78 Gross-up and Other Issues

1. Section 78 gross-up. Section 9 of Notice 2005-38 provides guidance on several areas of great interest to taxpayers. First, and most important, the Notice provides that "[s]ection 78 does not apply to any tax which is not allowable as a credit under section 901 by reason of section 965(d)," thus effectively adopting the approach taken in the pending Technical Corrections Bill. (2) It is somewhat unorthodox for the Treasury Department to promulgate guidance contradicting a provision of the Code, but apparently the urgency of providing taxpayers with guidance, combined with assurances from congressional tax-writers that the pending technical correction legislation reflects their original intent, (3) were considered to provide sufficient justification.

2. Directly allocable expenses. Another issue addressed in the pending Technical Corrections Bill is the extent to which expenses must be allocated to the deductible portion of a section 965 dividend. Section 965(d)(2) provides that "[n]o deduction shall be allowed for expenses properly allocated and apportioned to the deductible portion...." The bill would amend section 965(d) "by striking 'properly allocated and apportioned' and inserting 'directly allocable.'"

Again, Notice 2005-38 adopts the pending technical correction: "The disallowance of expenses in section 965(d)(2) applies only to expenses that are "directly allocable" to the deductible portion...." While helpful, this language leaves open how to determine which expenses are directly allocable for this purpose. (4) Further guidance is anticipated on this point.

3. AMT taxpayers. Section 965(e)(1)(B) provides that any tax imposed on the nondeductible portion of a CFC dividend will not be treated as a regular corporate income tax for purposes of determining the recipient's alternative minimum tax. The statute arguably requires that AMT taxpayers must pay both regular tax and AMT on the nondeductible portion of section 965 dividends, raising the cash tax cost from 5.25 percent to 8.25percent. IRS representatives, however, previously stated that they did not agree with this interpretation, and the Notice provides that AMT taxpayers will not be subject to the AMT with respect to any portion of section 965 dividends. (5)

4. Election by DRIP. A domestic reinvestment plan may provide for the investment in the United States of an amount that is less than the entire amount of cash dividends that are otherwise eligible for the section 965(a) DRD. In such a case, the section 965(a) DRD applies only to the amount of eligible dividends that are reinvested pursuant to the plan (assuming that all the other requirements under section 965 are satisfied). This language suggests that taxpayers may elect which eligible dividends will be subject to the section 965 DRD by specifically identifying dividends in their DRIP and making no provision for reinvestment of other eligible dividends.

5. Cross-chain section 304 transactions. Section 9.04 clarifies that a CFC dividend received as a result of a cross-chain section 304 transaction will qualify as an eligible dividend, ending any concern that the dividend recipient's lack of direct ownership in the acquiring entity might prevent the dividend from qualifying for the DRD. (6)

6. Dividends to disregarded entities. Section 9.06 clarifies the circumstances in which a CFC cash dividend to a foreign disregarded subsidiary of a U.S. shareholder qualifies as a cash dividend to the U.S. shareholder. Notice 2005-10 provided that receipt of cash by a disregarded entity does not constitute receipt of the cash by the U.S. shareholder that owned the disregarded entity unless the disregarded entity in turn distributed the cash to the U.S. shareholder. This is a significant issue for taxpayers that would be subject to foreign withholding tax on dividends paid by the disregarded entity. Notice 2005-38 significantly narrows this rule, providing that the disregarded entity need not distribute the cash so long as the U.S. shareholder receives the cash and has no legal obligation to repay the cash to the disregarded entity. This allows disregarded entities to repatriate cash via repayment of shareholder loans or purchases of assets, thereby avoiding the imposition of foreign withholding tax, 85 percent of which will never be creditable.

C. Effect of M&A Transactions on a Domestic Reinvestment Plan

Section 4 of Notice 2005-10 provides that a DRIP must describe planned investments in reasonable detail and specificity, state the total amount that will be invested for each principal investment in the United States, and describe the time period over which the investment will be made. A DRIP may encompass more than one cash dividend from one or more CFCs, or the taxpayer may adopt separate DRIPs to apply to different cash dividends received during the election year. Alternative investments may be provided. Notice 2005-10 does not require that a DRIP state from which specific CFCs the cash dividends will be received, or which U.S. shareholder will receive such dividends, nor does it require segregation or tracing of funds. (7)

Section 8 of Notice 2005-38 takes a flexible approach in addressing how a DRIP may be satisfied following a change to the consolidated group during or after the year of election. Section 8 also specifies which company is responsible for fulfilling the reporting and administrative requirements outlined in Notice 2005-10 when such a change occurs.

1. Electing Consolidated Group--Member Entering or Exiting. Section 8 provides that a member entering or exiting a consolidated group on or after the first day of the consolidated group's election year can fulfill the investment obligation of the consolidated group. This rule applies "regardless of the amount of cash or property held by the former member or new member at the time it leaves or joins the consolidated group."

Based on this permissive language, a consolidated group could sell the stock of one of its members on the first day of its election year, even before the election was approved and the cash dividend received, and the exiting member could still fulfill the investment obligation of its former group. The exiting member could fulfill the investment obligation of its former group whether it receives cash dividends from its CFCs before it exits the group, after it exits the group, or not at all. In fact, even if the exiting member is not a U.S. shareholder to one or more CFCs, it is still permitted to fulfill the investment obligation of its former group.

Similarly, a new member that joins the consolidated group during or after the consolidated group's election year may fulfill the investment obligation of the consolidated group. Because there is no requirement that the taxpayer trace or segregate the cash dividends received from CFCs, the new member may fulfill the acquiring group's investment obligation with the proceeds of cash distributions from CFCs that it owned prior to joining the consolidated group, with the proceeds of cash dividends from CFCs of the consolidated group that it is joining, or with proceeds from other sources, such as its own domestic operations.

Notice 2005-38 provides that when a former member of the consolidated group fulfills the investment obligation of the consolidated group, in whole or in part, the consolidated group remains responsible for the reporting and administrative requirements of Notice 2005-10. If the consolidated group does not continue to exist following the departure of the member, the common parent (or a successor agent) of the group retains the reporting and administrative requirements.

2. Electing corporation or consolidated group joins another consolidated group. Notice 2005-38 also provides that an electing taxpayer may rely on another corporation to fulfill its investment obligation, as long as the electing taxpayer and the investing corporation are members of the same consolidated group at the time the investment occurs. This applies to a stand-alone corporation that makes the election and becomes a member of a consolidated group during or after the election year. It also applies to a consolidated group that makes the election and becomes part of another consolidated group during or after the election year. In either of these cases, a member of the acquiring consolidated group is permitted to fulfill the investment obligation of the new member, and it may do so with funds that can not be traced to the cash distributions received from CFCs of the new member. When an electing corporation joins a consolidated group, the consolidated group becomes responsible for the reporting and administrative requirements of the new member. (8)

3. Asset acquisitions. Notice 2005-38 provides that a corporation (or any member of its consolidated group) that acquires the assets of a transferor in a transaction described in section 381(a) may fulfill the investment obligation of the transferor. Conversely, a transferee that acquires assets in a taxable transaction may not fulfill the investment obligation of the transferor.

4. Designation of permitted investment activity. The entrance or exit of a member to or from a consolidated group, or the acquisition of the assets of an electing corporation, may result in a single corporation being required or permitted to fulfill investment obligations under more than one DRIP. A single investment by such corporation cannot be double-counted to satisfy the obligations under multiple DRIPs. A single corporation, however, may make one investment to satisfy one DRIP and another investment to satisfy a different DRIP.

The corporation may designate which investment plan a particular investment satisfies. In the absence of such designation, the Notice provides ordering rules for determining which DRIP is deemed to be satisfied first. Under these rules, the investment is deemed to first satisfy the investing corporation's own plan for its earliest election year; second, the investment is deemed to satisfy the investing corporation's own plan for any subsequent election year; and third, the investment is deemed to satisfy the plan of any other corporation, in the order the corporation became required or permitted to make such investments. (9)

D. Taxable Year to Which Section 965 Applies

Section 5 of Notice 2005-38 provides rules determining the taxable year to which section 965 applies when a member enters or exits a consolidated group. Section 5 generally requires matching the corporation or consolidated group making an election to cash dividends received from CFCs while the entering or exiting member is a member.

1. Electing consolidated group--member entering or exiting. Unless it exits the group on the last day of the group's taxable year, a member exiting a consolidated group will have a short taxable year (the "initial short year"). If the exiting member then joins a new group, it will have a second short taxable year that ends on the last day of the new group's taxable year (the "next short year" or "second short year"). Alternatively, the exiting member may become a stand-alone corporation, in which case the next short year will end on the last day of the taxable year chosen by the stand-alone corporation. The taxable year of the new group or the taxable year chosen by the stand-alone corporation, may end on the same or a different month-end than that of the old group.

Section 5 provides general principles that apply when a member enters or exits a consolidated group. First, an eligible year may include a short taxable year. Second, the election of an eligible year by the parent company of a consolidated group applies to each member of the group, but only for the portion of the eligible year during which such member is a member of the group. Finally, a cash dividend received from a CFC during the portion of the eligible year when the recipient is a member of an electing group may qualify as a dividend eligible for the section 965(a) deduction of the electing group.

2. Exiting a consolidated group. If a consolidated group makes a section 965 election, and a member of the group exits the group during the election year, cash dividends received by the exiting member during its initial short year ending within the group's election year are eligible for the group's election. Conversely, dividends received by the exiting member after the member exits the group would not qualify for the section 965(a) election of the group. (10)

3. Entering a new consolidated group. When a member exits a consolidated group, it may enter a new consolidated group. Cash dividends received by the new member from its CFCs during the new consolidated group's election year generally may qualify for the section 965(a) election of the new group. This rule applies whether the new consolidated group's election year includes the next short year of the new member or is the next succeeding taxable year of the new consolidated group. (11) This rule also applies if, instead of a member of the old group being acquired by a new group, the entire old group is acquired by a new group. (12)

4. Member exiting a group but net joining a new group. If a member (US1) exits a consolidated group, but does not enter a new group, cash dividends received by it during its initial short year may qualify for the section 965(a) election of the old group, and cash dividends received by it during its next short year may qualify for its own section 965(a) election. In this case, however, the length of the initial short year plus the next short year cannot exceed 12 months. For instance, the old consolidated group may make an election for its taxable year ending December 31, 2004. US1 may exit the old group on November 15, 2004, and not become a member of an existing new group. (US1 may become a stand-alone corporation, or may become the parent of a new consolidated group.) If US1's new taxable year-end is December 31, cash dividends received in the second short year starting on November 16, 2004, and ending December 31, 2004, will qualify for US1's own section 965(a) election. If US1's taxable year ends June 30, 2005, however, cash dividends received during the second short year starting November 16, 2004, and ending June 30, 2005, will not qualify for the section 965(a) election, because the length of the initial short year plus the second short year exceeds 12 months. US1 also would not be permitted to make the section 965 election for a year succeeding its second short year (for instance, the taxable year ending December 31, 2005). (13)

It is possible that dividends received from US1's CFCs would qualify for a section 965(a) election in three separate taxable years. For example, on November 15, 2004, US1 may exit a consolidated group that has made an election for its taxable year ending December 31, 2004. Cash dividends received by US1 from its CFCs in US1's initial short year beginning January 1, 2004, and ending November 15, 2004, may qualify for the section 965(a) election of its former group. Cash dividends received during US1's second short year beginning November 16, 2004, and ending December 31, 2004, (while US1 is a stand-alone corporation) may qualify for US1's own section 965(a)election. And, if US1 then becomes a member of another consolidated group on May 1, 2005, cash dividends received from US1's CFCs during its taxable year beginning May 1, 2005, and ending December 31, 2005, may qualify for the new group's section 965(a) election for its taxable year ending December 31, 2005. (14)

5. Acquisition of target resulting in single short election year. There are situations where the acquisition of a target results in a single short election year for the target. This situation would arise where the acquiring corporation has made an election for a taxable year that ends prior to the acquisition of the target. For instance, an acquiring corporation or group may make an election for its taxable year ending December 31, 2004. On June 30, 2005, it may acquire the common parent of a target group that plans to make the election for its taxable year ending December 31, 2005. The target group's short taxable year ending June 30, 2005, is an eligible year during which cash dividends received from the target group's CFCs may qualify for the target group's section 965(a) election. Cash dividends received from the target group's CFCs after June 30. 2005, however, will not qualify for the section 965(a) election of the target group, because it has become part of a group for which the election period has passed. Thus, the target group's election year consists only of a single short taxable year. (15)

6. Effect of reverse acquisition. The reverse acquisition rules of Treas. Reg. [section] 1.1502-75(d)(3) apply when an acquiring corporation (A) for any member of a group of which A is the common parent) acquires either (1) the stock of a second corporation (T), or (2) substantially all of the assets of T, in exchange for stock of A. If, immediately after the acquisition, the stockholders of T own more than 50 percent of the fair market value of the outstanding stock of A, then the A group is treated as ceasing to exist, and the T group is treated as continuing to exist, with A displacing T as the common parent of the group. When a reverse acquisition occurs, A and members of the A group have a short taxable year ending on the acquisition date. A and members of the A group then change to the taxable year of the T group. Notice 2005-38 provides that when a reverse acquisition occurs, the taxable year of the continuing group (the T group) governs its available eligible years and the terminating group (A) members are subject to the rules for members leaving and entering groups, with the common T parent treated as becoming a subsidiary of the continuing T group. (16)

E. Overview of General Principles Concerning Base Period and Ceiling Amounts

Section 3 of Notice 2005-38 provides general guidance for determining the base-period amount, while section 4 provides general principles for determining the ceiling on the eligible dividend.

1. Determining the base-period amount. Under section 965(b)(2), the base-period amount for each base-period year is the sum of cash and non-cash dividends from CFCs, section 956 inclusions, and distributions of previously taxed income that would be includible in the U.S. shareholder's taxable income but for section 959(a), excluding PTI attributable to base-period section 956 inclusions. (17) A deduction under section 965 is only available for cash distributions in excess of the annual average, during the base-period years, of the base-period amount. The base-period years are the three taxable years out of the five most recent taxable years ending on or before June 30, 2003 (1998-2002 for a calendar year taxpayer), determined by disregarding the years with the highest and lowest base-period amounts.

Section 3 of Notice 2005-38 provides that a U.S. shareholder determines its base-period inclusions and its base-period amount with respect to CFCs for which it was a U.S. shareholder at any time during its base period.

For a consolidated group, base-period inclusions are first determined for each group member and then aggregated on a consolidated group basis. Only then is the average base-period amount determined for the three taxable years out of the five most recent taxable years beginning on or before June 30, 2003, disregarding the years with the highest and lowest inclusions. The Notice thus rejects the alternative approach of determining the average base-period amount on a member-by-member basis (i.e., by discarding the years with the highest and lowest inclusions on a member-by-member basis). (18)

A short taxable year may be a base-period year. If so, there is no need to annualize or otherwise adjust the amount of inclusions for purposes of calculating the base-period inclusion. This provision is potentially beneficial for a corporation that has a twelve-month period that includes a short year and a stub year, for instance because of a change during the year in its ultimate owner. Base-period inclusions for the twelve-month period are effectively divided between two taxable years, potentially lowering the average base-period amount.

A foreign currency distribution of previously taxed income that constitutes a base-period inclusion is converted to U.S. dollars at the spot rate on the date of the distribution.

2. The section 965(b)(1) ceiling. Section 965(b)(1) provides a "ceiling" on the amount of cash dividends eligible for the 85-percent dividends-received deduction. This ceiling is the greater of $500,000 or the amount shown as permanently reinvested outside of the United States on the applicable financial statement. For this purpose, the Notice clarifies that notes and other documents that form an integral part of the financial statement are treated as part of the applicable financial statement, but that workpapers or other materials underlying or supporting the statement are not considered part of the statement.

If the applicable financial statement does not show an amount permanently reinvested outside of the United States, but shows a specific amount of tax liability attributable to such earnings, then the ceiling is the amount of such tax liability divided by .35. (19)

If a financial statement is an applicable financial statement for more than one U.S. shareholder, the portion of the APB 23 limitation allocated to each U.S. shareholder is the amount from the separate company financial statements (or supporting workpapers) of such U.S. shareholder that were prepared in connection with determining the amount shown on the applicable financial statement that included such U.S. shareholder. (20) For this purpose, all members of a consolidated group are treated as a single U.S. shareholder.

F. Adjustments to Base-Period Amount

1. Background. Section 965(c)(2)(C) provides that rules similar to sections 41(f)(3)(A) and (B) are to apply in determining the base-period amount following mergers, acquisitions, or dispositions, and further provides that in the case of a tax-free spin-off, the base-period amount is to be allocated between the distributing and the controlled corporations in proportion to their respective interests as U.S. shareholders of a controlled foreign corporation immediately after such distribution. Commentators proposed a variety of approaches for adjusting base-period amounts to reflect mergers and acquisitions during and after the five base-period years. (21) Perhaps the principal uncertainty was whether base-period dividend amounts should attach to CFCs or to U.S. shareholders--i.e., whether a U.S. corporation that sold or acquired a CFC during or after its five base-period years would have to adjust its base-period amount to reflect dividends paid by the CFC.

2. General rule. Notice 2005-38 provides that base-period inclusions are tax attributes particular to a U.S. shareholder as of the date these amounts are fixed. Because these amounts are not treated as tax attributes particular to a CFC, they are unaffected by an acquisition or disposition of a CFC. Instead, if a U.S. corporation (USP) acquires or disposes of another U.S. corporation (US1) that is a U.S. shareholder of a CFC, USP must adjust its base-period inclusions to reflect the base-period inclusions attributable to US1. Base-period adjustments are required for asset acquisitions or dispositions only in the case of tax-free transactions in which the acquiring corporation inherits the tax attributes of the transferor corporation pursuant to section 381.

Members of a consolidated group are treated as a single U.S. shareholder for purposes of determining the group's base-period amount. (22) Accordingly, when a member exits or enters a U.S. consolidated group, the selling group reduces its base-period inclusions by the amount attributable to a departed member, and the acquiring group correspondingly increases its base-period inclusions to account for the entrance of the new member. Thus, if USP sells the stock of US1 to an unrelated foreign person on December 31, 2003, the USP group reduces its base-period inclusions attributable to US1. Because US1 files a separate return after it leaves the USP consolidated group, it must take into account its individual base-period inclusions should it make an election under section 965. (23)

The required adjustments to an acquirer's base-period inclusions are accomplished by adding to the acquirer's base-period inclusions all base-period inclusions for the five taxable years in the relevant base period for any acquired corporation or group. Such inclusions are aggregated for taxable years one through five without regard to whether either the acquiring or acquired groups have short or full taxable years during the base period.

3. Transactions before the end of the acquirer's base period. If a U.S. corporation or group joins the acquiring group before the end of the acquiring group's base period, the acquiring group inherits a base-period inclusion history for the acquired U.S. shareholder or group for each of the taxable years in the acquiring group's base period that end on or before the date of the acquisition. Thus. if US1 is acquired from the USP group by the USB group during USB's base period, US1's post-acquisition base-period years will include its short year ending on the date of its acquisition, and its immediately following short year ending with the USB group's next taxable year-end. (24)

4. Transactions after the acquirer's base period. If a U.S. corporation is acquired after the end of the acquiring group's base period, the acquired U.S. shareholder's base-period inclusions in its last five taxable years ending on or before June 30, 2003 are aggregated with the acquiring group's base-period inclusions in its five base-period taxable years, on a year-by-year basis.

5. Special rule: Transactions during selling group's section 965 election year. When a U.S. shareholder ceases to be a member of a selling group during the taxable year for which the selling group elects the benefits of section 965, the selling group's base-period inclusions are not reduced by amounts attributable to the departing U.S. shareholder. Nevertheless, the acquiring group increases its base-period inclusions by the inclusions attributable to the acquired U.S. shareholder. This surprising result is illustrated by the following example:

   On February 15, 2005, USP sells the stock of US1
   to an unrelated foreign person, FP. US1 files a
   separate return for the taxable years following
   such sale. On February 16, 2005, US1 is no longer
   a member of the USP consolidated group as a
   result of the sale of the US1 stock to FP. Because
   the transaction occurs within the USP election
   year, the USP group does not reduce its base-period
   inclusions ... attributable to US1. Further,
   US1 still takes into account its individual base-period
   inclusions ... should it make an election
   with respect to section 965(a) in its short taxable
   year following the acquisition (February 16, 2005
   through December 31, 2005). (25)

This rule will result in double counting of base-period inclusions, with a corresponding increase in the base-period amount that must be distributed before the section 965 DRD may be claimed. (26) This negative consequence, however, is coupled with a taxpayer friendly rule (discussed below) providing that when a U.S. shareholder ceases to be a member of a selling group during the taxable year for which the selling group elects the benefits of section 965, the selling group's APB 23 amount is likewise not reduced by amounts attributable to the departing U.S. corporation, even though that amount is also available to the departing corporation.

6. Adjustments for base-period tax-free spin-offs. If stock in a U.S. corporation is distributed in a tax-free spin-off during the distributing company's base period, and either distributing or controlled is a U.S. shareholder of a CFC, base-period inclusions that were received by distributing or controlled from a CFC prior to the spin-off of controlled are allocated based on the fair market values of distributing's and controlled's interests in such CFC immediately after the spin-off. If controlled is a newly formed corporation, (e.g., in a divisive D transaction), any base-period inclusions received by either distributing or controlled from such CFC are allocated by treating controlled as having been in existence for the same period that distributing has been in existence.

The same rules apply if controlled is a member of a consolidated group and is distributed outside the group in a spin-off. The base-period inclusions of the consolidated group with respect to each of the group's CFCs before the applicable base-period spin-off are allocated between the members of the distributing group and the controlled group and any controlled subsidiaries that thereafter file a consolidated return in proportion to the fair market values of the distributing group's and the controlled group's respective interests in each CFC owned by the distributing group and the controlled group immediately after the applicable base-period spin-off.

Base-period inclusions allocated to the distributing group and the controlled group are further allocated within such groups in proportion to the fair market value of such members' respective interests in each CFC immediately after the applicable base-period spin-off.

Tax-free spin-offs occurring after the end of the distributing corporation's base period are subject to the rule applicable to any other disposition of a subsidiary after the end of the distributing company's base period.

7. Practical implications. Most taxpayers will prefer to use high taxed dividends to satisfy their base-period amount, and elect the benefits of section 965 only for low-taxed dividends, in order to minimize loss of foreign tax credits. A mistake in computing the base-period amount thus can have disastrous consequences, resulting in either unanticipated tax on low-taxed CFC dividends unexpectedly treated as fully taxable base-period dividends, or the opportunity cost of applying the section 965 DRD to high-taxed dividends. Thus, taxpayers must undertake a thorough analysis of acquisitions, dispositions, and spin-offs dating back to the beginning of their first base-period year, which could be as far back as 1998. This may involve requests to sellers for pre-closing dividend information relating to stock purchases that occurred years ago. In addition, taxpayers in the midst of domestic stock acquisitions or dispositions (27) will have to add to their due diligence list a review of the potential section 965 consequences of such transactions.

G. Adjustments to APB 23 Amount and $500 Million Limitation

1. General rule. As with base-period inclusions, Notice 2005-38 provides that APB 23 limitation is treated as a tax attribute particular to a U.S. shareholder as of the date it is fixed under section 965(b). Accordingly, acquisitions or dispositions of a CFC do not require adjustment to a U.S. shareholder's APB 23 limitation. Because APB 23 limitation is measured by reference to the taxpayer's most recently audited financial statement certified on or before June 30, 2003, only transactions in which a U.S. corporation is acquired or disposed of after the acquirer or disposer's APB 23 limitation determination date require adjustment. Thus, if a U.S. shareholder joins a consolidated group before the acquiring group's APB 23 determination date, the U.S. shareholder's membership in the new group will be taken into account when determining the acquiring group's APB 23 limitation, and no adjustment to the acquiring group's APB 23 limitation is required.

2. Transactions after the selling group's APB 23 determination date. If a member of a consolidated group is sold after the selling group's APB 23 determination date, but before the beginning of the selling group's section 965 election year, the selling group reduces its APB 23 limitation to account for the APB 23 limitation that goes with the departed U.S. shareholder.

3. Transactions before the selling group's APB 23 determination date but after buyer's APB 23 determination date. If a U.S. shareholder ceases to be a member of a consolidated group before the selling group's APB 23 determination date, there is no reduction in the selling group's APB 23 limitation to reflect the departure because the selling group's APB 23 limitation will reflect such disposition. If the departing U.S. shareholder is acquired by another consolidated group with an APB 23 determination date falling after the acquisition, however, the acquiring consolidated group's APB 23 limitation is increased by the amount of reduction to the selling group's APB 23 limitation that would have been required if the selling group's APB 23 determination date had been the date of the acquisition.

4. Transactions during selling group's section 965 election year. There is no reduction in the selling consolidated group's APB 23 amount if the departure from the group occurs during the selling group's section 965 election year. As a result, a calendar-year consolidated group with a determination date of June 30, 2003, that elects the benefits of section 965 for its year ending December 31, 2005, must reduce its APB 23 limitation only for dispositions of members occurring between June 30, 2003, and December 31, 2004.

5. The $500 million limitation. Each section 52(a) group is limited to one $500 million limitation. A section 52(a) group includes all corporations that are members of a controlled group of corporations within the meaning of section 1563(a), substituting "more than 50 percent" for "at least 80 percent" throughout section 1563(a)(1), and making the determination without regard to sections 1563(a)(4) (certain insurance companies) and (e)(3)(C) (stock owned by employee trust).

Each qualified member of a section 52(a) group is allocated a portion of the group's single $500 million limitation if it is a qualified member on the last day of the election year of the qualified member with the last election year to end (the "apportionment date"). Limitation so allocated is particular to each corporation and cannot be surrendered from one group member to another, except by a transaction whereby the "surrendering" group leaves the group before the group's apportionment date, as discussed below. (28)

A "qualified member" is either: (1) a domestic corporation that files a separate tax return and is a member of a section 52(a) group; or (2) a consolidated group that is part of a section 52(a) group. Accordingly, if a consolidated group is not a part of a section 52(a) group, it has its own $500 limitation, and, if a consolidated group is part of a section 52(a) group, the portion of the $500 million allocated to the consolidated group is not further allocated among the members of the consolidated group.

The $500 million limitation is allocated among the qualified members of a section 52(a) group on the group's apportionment date in proportion to the current and accumulated earnings and profits (excluding PTI) of all CFCs owned by each qualified member. The amount of non-PTI earnings and profits of a CFC owned by a qualified member is the amount of earnings and profits of such CFC appropriately reported on the last Form 5471 filed by such qualified member on or before the apportionment date, translated into U.S. dollars at the average exchange rate for the CFC's taxable year. The use of the qualifier "appropriately reported" suggests that the IRS will not be bound by the amount of earnings and profits shown on the Form 5471. Accordingly, taxpayers may wish to take extra care in reviewing the relevant Forms 5471 before determining the section 965 limitation available to members of a section 52(a) group.

The portion of a section 52(a) group's $500 million limitation allocated to each member of the group applies for such member's election years ending while it is a qualified member of the group, including taxable years that end before the apportionment date. (29)

The $500 million limitation is allocated only among corporations or consolidated groups that are qualified members of the section 52(a) group on the apportionment date. Thus, if a corporation or consolidated group ceases to be a qualified member of a section 52(a) group before the group's apportionment date, the former member does not retain any of the group's $500 million limitation after it leaves the group. (30) If a corporation or consolidated group ceases to be a qualified member of a section 52(a) group before the end of its own section 965 election year, however, that corporation or group is entitled to its own $500 million limitation, unless it becomes part of a different section 52(a) group on or before that group's apportionment date. In that case, it may be allocated a portion of its new group's limitation, but the entering corporation's separate $500 million limitation is not added to the group's existing limitation. (31)

6. Overlap of $500 million and APB 23 limitation allocations. The rules for allocating the APB 23 limitation and $500 million limitation apply in any situation in which a member of a section 52(a) group also has an APB 23 limitation amount. In such a case, the taxpayer is entitled to whichever amount is larger. (32)

7. Allocations of APB 23 limitation for spin-off of a U.S. shareholder --pre-APB 23 determination date spin-offs. If a spin-off occurs before the APB 23 determination dates of both distributing and controlled parties, no adjustment is required, and the APB 23 amount for each of the distributing and controlled corporations or consolidated groups is determined as of its APB 23 determination date.

8. Allocations of APB 23 limitation for base-period spin-off of a U.S. shareholder--post-APB 23 determination date. If a controlled corporation is distributed outside the consolidated group in a tax-free spin-off after the APB 23 determination date and during the base period of the distributing consolidated group, the APB 23 limitation that is attributable to each CFC owned by the consolidated group before the spin-off is allocated between the distributing group and the controlled group in proportion to the fair market values of the distributing group's and the controlled group's respective interests in each CFC owned by the distributing group and the controlled group immediately after the applicable base-period spin-off. This rule applies whether or not CFCs were transferred to the controlled corporation prior to the spin-off, as in a divisive D spin-off transaction. The APB 23 limitation allocated to the distributing group and the controlled group is further allocated among the members of such groups in proportion to the fair market values of such members' respective interests in each CFC immediately after the applicable base-period spin-off.

9. Post-base period spin-offs. Spin-offs occurring after the APB 23 determination date and the base period of the distributing corporation are subject to the normal rules for allocating APB 23 limitation. Accordingly, any APB 23 limitation attributable to the controlled corporation's CFCs will remain with the distributing group. If the spin-off occurs in the distributing group's section 965 election year, however, the APB 23 limitation attributable to the controlled corporation's CFCs will be available to both the controlled and distributing corporations.

10. Planning opportunities. Notice 2005-38 is welcome because it provides explicit rules for determining a taxpayer's base-period amount and APB 23/$500 million repatriation ceiling amount. Because the principal policy objective underlying section 965 was to encourage cash repatriation of undistributed CFC earnings--and because of the need to produce guidance that can reasonably be applied and administered--Notice 2005-38 adopts a "rough justice" approach that may create planning opportunities. (33) In public appearances following the issuance of Notice 2005-38, IRS representatives have acknowledged the planning opportunities provided by the Notice, but averred that the short remaining time for implementing planning makes it unlikely taxpayers will be able to take advantage of these opportunities. (34)

11. Practical implications. The rough justice approach adopted in Notice 2005-38 can result in traps for the unwary as well as planning opportunities. It is critical that section 965 dividends are matched up accurately with section 965 capacity. Accordingly, taxpayers should review stock acquisitions and dispositions closing after the last audited financials issued before June 30, 2003, to determine the effect of these transactions on the APB 23 and $500 million limitations. In addition, this will be an added due diligence item for pending stock deals.

H. Increase in Related-Party Indebtedness

1. General rules. The maximum amount of cash dividends eligible for the section 965 DRD under the rules set out above is reduced dollar-for-dollar by any increase in the amount of indebtedness of the electing group's CFCs to related persons as of the last day of the Election Period (the final measurement date) over the amount of such indebtedness as of October 3, 2004. (35) This rule is intended to prevent taxpayers from claiming the benefits of section 965 for CFC dividends paid out of funds that were already in the United States. (36) All of the electing group's CFCs are treated as one CFC for purposes of applying this limitation, and indebtedness of one CFC to a related CFC is ignored. (37)

The Notice provides an exception to the related-party indebtedness rule that is not found in the statute. Under the Notice, a U.S. shareholder considers the indebtedness of its CFC to related persons only if the U.S. shareholder itself is a related person with respect to such CFC. For example, if a 60-percent U.S. shareholder lends money to the CFC, the other 40-percent U.S. shareholder is unaffected. For this purpose, relatedness is tested on the initial measurement date to determine the amount of related-party indebtedness on such date and likewise on the final measurement date for purposes of the amount of related-party indebtedness on such date.

As generally expected, Notice 2005-38 defines "indebtedness" by reference to existing debt/equity tests. It also provides that CFC indebtedness to related persons is measured on a gross basis without offset for any indebtedness for the related person to the CFC. This obviously puts a premium on cleaning up offsetting intercompany debt accounts before the last day of a section 965 election year.

Commentators complained that it would be difficult for many taxpayers to determine their related-party debt as of October 3, 2004, and suggested using September 30, 2004, the nearest month-end. Thankfully, Notice 2005-38 permits calendar-year and fiscal-year taxpayers to elect as their initial measurement date either October 3, 2004, or September 30, 2004. Taxpayers that used a 52-53 week taxable year may elect the close of the last day of the taxpayer's fiscal-year month ending nearest October 3, 2004, as their initial measurement date. (28)

Many commentators noted that intra-company trade payables fluctuate significantly over time as a result of business and economic factors. Therefore, fluctuations in CFC trade payables to related U.S. companies do not serve as an appropriate measure of whether CFC dividends are funded by U.S. cash. The Treasury Department and IRS agreed, and Notice 2005-38 provides that "the term 'indebtedness' does not include indebtedness arising in the ordinary course of a business from sales, leases, or the rendition of services provided to or for a CFC by a related person, provided that such indebtedness is actually paid within 183 days." (39) The exclusion of related-party trade payables will be welcomed by most taxpayers. It is unfortunate, however, that a similar rule was not provided for financial institutions.

Although not provided in Notice 2005-38, IRS representatives have said some limited netting will be permitted in determining whether trade payables have been outstanding for more than 183 days. This point is critical because many taxpayers settle payables by offset rather than cash settlement. In such cases, apparently the IRS will accept only an enforceable legal right to offset. Additional guidance would be helpful on this point. (40)

Another issue raised by commentators is the application of the related-party debt rules to "sandwich structures" in which a foreign parent owns a U.S. corporation that in turn owns CFCs. Technically, CFC debt to the foreign parent would count as related party debt, but an increase in such debt hardly indicates the use of U.S. cash to fund CFC dividends to the United States. Nevertheless, Notice 2005-38 provides that CFC debt to an ultimate foreign parent that is not a CFC must be taken into account in applying the related-party debt test. (41)

Commentators also noted that guidance was needed regarding situations in which CFC indebtedness was denominated in a currency other than the dollar. Notice 2005-38 provides that the initial measurement date related-party indebtedness and the final measurement date related-party indebtedness of a U.S. shareholder are determined in U.S. dollars. The amount of any indebtedness on both the initial and final measurement dates is translated into U.S. dollars using the spot rate on the initial measurement date. This rule ensures that a taxpayer's ability to take advantage of section 965 will not be reduced (or increased) solely by changes in currency exchange rates between the initial measurement date and the final measurement date. (42) It is not entirely clear whether this rule is limited to situations in which a foreign currency denominated debt remained outstanding from the initial measurement date through the final measurement date (Case 1), or whether it would also apply to a situation in which foreign currency denominated debt that was outstanding on the initial measurement date was repaid prior to the final measurement date, and a like amount of foreign currency debt was then put in place before the final measurement date (Case 2).

The logic of the rule suggests that it should apply only in Case 1. If CFC 1 owes USP 100 on the initial measurement date, when 100 = $100, repays that debt on the day after the initial measurement date, and then borrows

100 from USP the day before the final measurement date, when 100=$130, CFC1 would in effect have increased the amount of its related-party borrowings. Limiting the rule to Case 1 situations, however, would impose a significant compliance burden and result in unfair results in many situations, such as where CFC1 owes USP 100 on the initial measurement date and regularly repays some or all of that debt as its cash-flow permits, with subsequent borrowing from USP when necessary to meet its cash needs, resulting in CFC1 still owing 100 to USP on USP's final measurement date.

2. Allocations of related-party indebtedness. As in the case of base-period amounts and APB 23 limitation, ordinary business restructuring transactions may require adjustments to a taxpayer's beginning or ending related-party indebtedness. If a U.S. shareholder of one or more CFCs ceases to be a U.S. shareholder or a related person with respect to a CFC on a date after its initial measurement date (generally, September 30, 2004) and before its final measurement date (the last day of its section 965 election year), the U.S. shareholder's related-party indebtedness as of the initial measurement date is reduced by any initial measurement date related-party indebtedness attributable to that CFC. No reduction is required, however, to the extent debt of the CFC that was outstanding on the initial measurement date was repaid either before or as a result of the transaction through which the U.S. shareholder ceased to be a U.S. shareholder or a related person with respect to the CFC. This rule is necessary to prevent double counting--because the intercompany debt outstanding on the initial payment debt has been repaid, the U.S. shareholder should be entitled to lend that same amount to another CFC without suffering an increase in its related-party debt.

As a corollary to the rule requiring U.S. shareholders that dispose of CFCs to reduce their initial measurement date related-party debt amount, a U.S. shareholder that acquires a CFC and associated CFC debt (43) after its initial measurement debt is permitted to increase its initial measurement date related-party debt amount. Thus, if, after its initial measurement date but before its last measurement date, a U.S. corporation becomes a U.S. shareholder and a related person with respect to a CFC, and that U.S. corporation remains a U.S. shareholder and a related person with respect to such CFC on its last measurement date, such U.S. corporation increases its initial measurement date RPI by the amount of related-party indebtedness of the individual CFC immediately after the transaction. Again, to avoid double counting, however, no increase is permitted for any indebtedness arising in connection with or as a result of the transaction. New debt issued in connection with the acquisition of a CFC represents CFC indebtedness arising after the initial measurement date and should not increase the acquirer's initial related-party debt amount.

If more than one U.S. shareholder is a related person with respect to a CFC, any increase in the CFC's related-party indebtedness is allocated among such U.S. shareholders. The increase is allocated on a dollar-for-dollar basis to cash dividends received by U.S. shareholders otherwise eligible for the section 965(a) DRD in the order that those dividends are received. If the dividends are received by more than one U.S. shareholder on the same day, each U.S. shareholder takes into account the remaining amount of the increase in such CFC's related-party indebtedness based on the relative amount of cash dividends received on that day. The overall reduction in dividends of all U.S. shareholders eligible for the section 965(a) DRD under this rule may not exceed the total increase in related-party indebtedness under section 965(b)(3). The effect of this rule is to provide an election to affected taxpayers for allocating related party debt, as illustrated in Example 9 of section 7.08.

3. Practical implications. Taxpayers wishing to repatriate under section 965 should review post-September 30, 2004, stock acquisitions and dispositions to determine their effect on related-party indebtedness. Moreover, due diligence lists must be expanded to assess the related-party indebtedness implications of current and pending stock deals closing before the end of either party's election year. The exclusion of trade payables from the related-party indebtedness test may offer opportunities to use payment terms to help fund section 965 cash dividends. As previously noted, taxpayers facing a reduction in their section 965 capacity should clean up cross-debt prior to the close of their election year, given that gross, not net, intercompany debt is taken into account. Finally, taxpayers may wish to consider checking the box on CFCs that are indebted to related persons, as the debt will no longer be taken into account as debt of a CFC. Careful consideration must obviously be given to the collateral tax consequences of such an election.

I. Reporting; Transition Rules

Section 10 of Notice 2005-38 requires taxpayers to prepare and maintain a description of any transaction that results in an adjustment to base-period inclusions or APB 23 amounts, an adjustment to the initial measurement date related-party indebtedness, or an investment obligation that is satisfied by a U.S. shareholder that is not a member of the electing consolidated group at the time it makes the investment. The taxpayer must also prepare and maintain a list of investments that may satisfy more than one DRIP, its designation of which DRIP is satisfied by such investment; and a list of domestic corporations that have participated in more than one election year. The taxpayer is required to make such records available to the Commissioner within 30 days of a request.

A taxpayer that has approved a DRIP prior to May 10, 2005, may amend such plan to take into account the guidance provided in Notice 2005-38, even if the dividend to which the DRIP relates has already been paid. The DRIP must be modified no later than July 11, 2005, with subsequent approval by the taxpayer's president or chief executive officer, and the board of directors.

Notice 2005-38 also permits a taxpayer that has filed a tax return prior to May 10, 2005, to amend such return to elect the fair market value method for valuing the assets of a business entity that is acquired pursuant to a DRIP. Under Notice 2005-10, section 5.06, the acquisition of a 10-percent or more interest in a domestic or foreign business entity, including a corporation or partnership, is a permitted investment to the extent that an acquisition of the entity's assets directly would be a permitted investment. Amounts spent to acquire a business entity are to be allocated between permitted and non-permitted investments based on the relative value of assets that, if acquired directly, would be permitted vs. non-permitted investments. In determining asset values, Notice 2005-10 required that taxpayers use the same method they used for the apportionment of interest expense (tax book value, alternative tax book value, or fair market value). Notice 2005-38, section 9.05 modifies this requirement by allowing taxpayers to elect the fair market value method for valuing the assets, even if they use the tax book value or alternative tax book value method for interest expense apportionment. Because this is a change from the previously issued guidance, taxpayers are permitted to file an amended return to make the election on or before December 31, 2005.

(1) See Natan Leyva, Applying the New Section 965 Deduction: Limitations and Considerations, 8 Practical International/US Tax Strategies No. 19 (October 2004).

(2) Section 7(E) of the Tax Technical Corrections Act of 2004 would add a new section 965(d)(4): "COORDINATION WITH SECTION 78.--Section 78 shall not apply to any tax which is not allowable as a credit under section 901 by reason of this subsection."

(3) See the March 17, 2005, Letter to the Deputy Assistant Secretary of Treasury for Regulatory Affairs from the Chairmen of the Senate Finance and House Ways and Means Committees. which concludes by saying "We trust this letter provides sufficient clarification so that appropriate guidance may be issued reflecting our intention."

(4) Notice 2005-38, [section] 9.01. Senators Gordon Smith (R-OR) and Charles Grassley (R-IA) discussed the scope of expenses disallowed under section 965(d)(2) during Senate debate on the 2004 tax law. 150 CONG. REC. S10976 (Oct. 9, 2004). The senators agreed that such expenses did not include general and administrative costs not directly relating to generating the repatriated funds, or such indirect costs as R&D expenses, state and local income taxes, sales and marketing costs, depreciation, and amortization. The senators considered "directly allocable" expenses to include stewardship costs and legal and accounting fees directly related to the repatriated funds. Treas. Reg. [section] 1.861-8(b)(2) provides that an expense is definitely related to a class of gross income if it "is incurred as a result of, or incident to an activity or in connection with property from which such class of gross income is derived." See Baker & McKenzie Comments on Dividends Received Deduction Provision of Jobs Act, TAX NOTES TODAY, January 13, 2005 (2005 TNT 9-17) (discussion of the types of expenses that should and should not be disallowed under section 965(d)(2)).

(5) Notice 2005-38, [section] 9.01 ("For purposes of calculating alternative minimum tax for the election year under section 55(a) in accordance with section 965(e)(1)(B), the taxpayer's regular tax described in section 55(c) and tentative minimum tax determined under section 55(b)(1)(B) do not include tax attributable to nondeductible CFC dividends.").

(6) "If stock of an acquiring CFC is deemed to be issued to another CFC pursuant to section 304(a)(1), the acquiring CFC is treated as being in a chain of ownership described in section 958(a) for purposes of applying section 965(a)(2)." Id. [section] 9.04.

(7) See Phillip A. Stoffregen, Steven R. Lainoff, and Elizabeth Satkoski, Bringing It Home: Summary and Analysis of the Repatriation Provision of the American Jobs Creation Act, 57 TAX EXECUTIVE 45 (January-February 2005), discussing Notice 2005-10's guidance regarding the drafting and implementation of a DRIP.

(8) Id. [section] 8.06, Example 2.

(9) The application of this rule is clear when an electing stand-alone corporation joins a consolidated group; investments by the new member would first satisfy its own plan and then the plan of its new group. The rule is somewhat ambiguous, however, in the context of a corporation that exits one consolidated group and becomes a member of another. It is unclear whether the investment obligation of the member's former group is considered an investment obligation under the member's "own plan."

(10) Cash dividends received by a member from its CFCs prior to the member exiting the group qualify for the section 965(a) election of the group even if the member leaves the group prior to October 22. 2004. For example, a consolidated group may make an election under section 965 for its taxable year ending December 31, 2004. A member (US1) may exit the consolidated group on August 30, 2004. Cash dividends received by US1 during its initial short year beginning January 1, 2004 and ending August 30, 2004 may qualify for the section 965(a) election of the group, even though technically US1's short taxable year ending August 30 is not its last taxable year beginning before October 22, 2004.

(11) Notice 2005-38, [section] 5.03, Example 1.

(12) Id. [section] 5.03, Example 5.

(13) Id. [section] 5.03. Example 2.

(14) Id. [section] 5.03, Examples 3 & 4.

(15) Id. [section] 5.03, Example 3.

(16) Id. [section] 5.03, Example 4.

(17) It is not entirely clear under section 965(b)(2) whether the exclusion of distributions of previously taxed income related to a prior year section 956 inclusion applies only to section 956 inclusions during the base period or to section 956 inclusions during any prior taxable year. Both the statute and the congressional record are ambiguous on this point. See ABA Tax Section Seeks Guidance on Temporary Dividends Received Deduction, TAX NOTES TODAY, April 22, 2005 (2005 TNT 77-36), which interprets section 965(b)(2) to exclude from the base-period amount PTI distributions related to a section 956 inclusion in any prior taxable year.

(18) This alternative approach would potentially produce different results than the aggregate approach, as illustrated by the example in Notice 2005-38, [section] 3(e).

(19) Commentators have noted that taxpayers reporting the tax liability attributable to permanently reinvested earnings were at a disadvantage under this calculation because the tax liability reported was generally net of foreign tax credits that would be available to offset U.S. tax liability if such earnings were distributed. It is unclear whether Congress will address this issue in a technical corrections bill. Notice 2005-38 simply follows existing statutory language.

(20) Supporting workpapers are relevant for this inquiry, even though they are not treated as part of an applicable financial statement. Notice 2005-38, [sub section] 4.04 & 4.01.

(21) See NYSBA Comments on Dividends Received Deduction, TAX NOTES TODAY, March 22, 2005 (2005 TNT 54-18), noting that the general principle of section 41(f) (holding that the attributes go with the trade or business that generated them) leaves open the question of whether the various section 965 attributes attach to the CFC, the direct U.S. shareholder in the CFC, or the consolidated group of which the direct U.S. shareholder is a member. The NYSBA concluded that it was more consistent with the structure of section 965 to transfer section 965 attributes only when the U.S. shareholder holding the CFC stock is transferred. But see Phillip A. Stoffregen, Steven R. Lainoff & Elizabeth Satkoski, Bringing It Home: Summary and Analysis of the Repatriation Provision of the American Jobs Creation Act, 57 TAX EXECUTIVE 45 (January-February 2005), suggesting that the M&A rule should apply only upon the acquisition or disposition of CFC stock. Other commentators have suggested the rule would apply upon a transfer of assets by a CFC. Peter Blessing, Bringing It All Back Home: Repatriations Under the American Jobs Creation Act of 2004, TAX NOTES TODAY, November 16, 2004 (2004 TNT 221-33). See also ABA Tax Section Seeks Guidance on Temporary Dividends Received Deduction, TAX NOTES TODAY, April 22, 2005 (2005 TNT 77-36).

(22) I.R.C. [section] 965(c)(5)(A).

(23) Notice 2005-38, [section] 6.01(d), Example 1.

(24) Id.[section] 6.01, Examples 7 & 8.

(25) Id. [section] 6.01(d), Example 1.

(26) It may be that this rule was adopted to prevent taxpayers from selling domestic subsidiaries before the end of their election year in order to reduce their base-period dividend amount.

(27) This also includes tax-free asset acquisitions in which tax attributes are inherited pursuant to section 381.

(28) U.S. Officials Answer Questions Raised by Dividend Repatriation Merger Notice, TAX ANALYSTS, Doc 2005-11474.

(29) See Notice 2005-38, [section] 4.05, Example.

(30) It is unclear how to determine how these rules apply if a section 52(a) group breaks into two unrelated groups before the group apportionment date (i.e., which is treated as having left the group). See U.S. Officials Answer Questions Raised by Dividend Repatriation Merger Notice, TAX ANALYSTS, Doc 2005-11474.

(31) Notice 2005-38 [section] 6.02, Examples 1 & 2.

(32) Id. [section] 6.01(d) Example 1, Alternative Facts.

(33) In contrast, the NYSBA suggested the following: "In considering the issues raised by Extraordinary Transactions and potential solutions to those issues, we think it should be a goal that the taxpayers involved in an Extraordinary Transaction, taken together, neither lose anything nor gain anything as a result of the Extraordinary Transaction. We believe that the purposes of Section 965 will be best served if the rules enable and require taxpayers to preserve their Section 965 attributes (both the ones that benefit a taxpayer as well as the ones that are a detriment). We believe that this is consistent with the principles of Section 41(f) and is appropriate as a policy matter. The rules should not expose the government to the risk of being whip-sawed--for example, where attributes that benefit taxpayers could be duplicated or attributes that are detrimental to taxpayers are inappropriately eliminated." NYSBA Comments on Dividend Received Deduction, TAX NOTES TODAY, March 22, 2005 (2005 TNT 54-18). Such an approach would have been significantly more complex than the rules adopted in Notice 2005-38.

(34) U.S. Officials Answer Questions Raised by Dividend Repatriation Merger Notice, TAX ANALYSTS, Doc 2005-11474.

(35) I.R.C. [section] 965(b)(3).

(36) On this same point, the Notice confirms that "a related party guarantee of CFC indebtedness is not considered to be an indirect financing of a cash dividend for purposes of section 965(b)(3), provided that the CFC is treated as the obligor on the indebtedness for Federal income tax purposes. See Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972), cert. denied, 409 U.S. 1076 (1972)." Notice 2005-38 [section] 7.04(b).

(37) Notice 2005-38 reserves on the question whether and under what circumstances CFC indebtedness to a partnership can constitute related-party debt.

(38) Notice 2005-38, [section] 7.01(b)(vi).

(39) Id., [section] 7.02(b).

(40) U.S. Officials Answer Questions Raised by Dividend Repatriation Merger Notice, TAx ANALYSTS, Doc 2005-11474.

(41) Notice 2005-38, [section] 7.08, Example 8.

(42) Id. [sub section] 7.07 & 7.08, Example 7.

(43) For example, USB purchases US1 from USP at a time when US1 wholly owns CFC1, and holds debt issued by CFC1. Id., [section] 7.08, Example 3.