Restrictions on the deductibility of U.K. branch losses.

Sec. 1503(d) limits the deductibility of dual consolidated losses, i.e., losses used, through tax consolidation, to offset income in both the United States and a foreign country. The dual consolidated loss rules apply to domestic corporations that are dual resident corporations (DRC). A separate return limitation year (SRLY) rule is imposed on U.S. group use of DRC losses even when such losses may not be used for foreign group relief purposes.

A domestic corporation is a DRC if its worldwide income is subject to a foreign country's income tax or it is subject to a foreing country's income tax on a residence, not a source, basis. However, a foreign branch of a domestic corporation may be treated as a DRC under the separate unit rules of Sec. 1503(d)(3) even if the branch is taxed only on a source basis.

A branch is defined as an integral business operation, evidenced by various factors including (but not limited to) the existence of separate books and records and a foreign office or fixed place of business used by employees or officers of the U.S. company in conducting foreign activities.

A foreign branch taxed on a source or similar basis is treated as a DRC if its losses can be used by or transferred under foreign law to another person in any other year by any means (e.g., by carryover, merger or incorporation of the DRC into a domestic corporation of that foreign jurisdiction). This affects the typical U.K. branch that is controlled and managed in the United States. Under U.K. tax law, losses sustained by such a U.K. branch carry over to a new corporation on incorporation of the branch.

Temp. Regs. Sec. 1.1503-2T(d)(3) provides that DRC classification does not apply if the U.S. taxpayer certifies on its tax return, under penalties of perjury, that a loss has not offset income that otherwise would have been taxed by a foreign country. For returns filed without an attached certification for tax years ending before Dec. 31, 1989, the certifications should have been attached to the return for the first tax year ending on or after Dec. 31, 1989. Also, the taxpayer must agree to recapture any such losses and pay an interest charge if post-1986 branch losses are thereafter used by any person under foreign law.

The recapture rules provide that, if in any year, any portion of the branch loss is used under foreign law "by any means to offset the income of any other person," the total loss shall be recaptured and reported as income on the tax return of the U.S. company (or its affiliated group). Such income is reported in the year in which the loss is used in whole or part by a foreign transferee. A Sec. 6601 interest charge applies to the recapture year U.S. tax, computed by reference to the U.S. benefit of the loss in previous years by the U.S. company (or its affiliated group).

Sec. 1503(d) and the temporary regulations also apply to domestic corporations that are managed and controlled in the United Kingdom and to U.K. corporations classified as partnerships for U.S. tax purposes.