The sourcing of income and losses is used when (1) U.S. resident companies determine their foreign tax credit limitations and (2) foreign taxpayers determine their U.S. taxable income. Internal Revenue Code section 865 provisions on how gains should be sourced were enacted in 1986; however, with the exception of certain rulings on bank losses, the IRS has not provided rules for sourcing losses.
Section 865 generally bases the sourcing of gains from sales of personal property, including stock, on the taxpayer's residence. One exception applies when the sale is made through a branch office. For U.S. residents, gains from sales made through a foreign office generally are considered foreign source gains if they are subject to at least 10% foreign income tax. Another exception allows gains from sales of foreign affiliate stock by a U.S. resident to be considered foreign sourced if the sales occur in a foreign country where the affiliate's business generates more than half of its gross income.
Proposed regulations section 1.8652(a) provides sourcing rules for losses from affiliate stock sales that generally mirror the gains rules. However, a U.S. resident's losses attributable to a foreign office would be foreign sourced if a gain would have been taxable by a foreign country where the highest marginal tax rate is at least 10%.
The provision's dividend recapture rule would require allocation of a loss to the same income source as well as the same foreign tax credit limitation category as any dividend inclusion within 24 months of the loss sale. This recapture rule would not apply if the sum of all recapture amounts was less than 10% of the realized loss. The loss rules generally do not incorporate the special rule for gains from sales of foreign affiliate stock. However, a consistency rule would require a loss recognized on the sale of an 80%-owned foreign affiliate to reduce foreign source passive income if, within the past five years, the seller had recognized gain on the sale of a foreign affiliate sourced under the foreign affiliate stock rule. The five-year lookback would apply only to gains recognized after September 6, 1996.
Observation: The proposed regulations generally mirror the rules for gains from sales of affiliate stock and prevent potential whipsawing that could occur if, for example, losses from a sale of a block of affiliate stock could not be netted against gains from a sale of another block of the same stock. They also are favorable for U.S. multinationals because they generally result in U.S. source losses, which do not reduce the foreign tax credit limitation.
--Kenneth Kral, CPA, international tax partner; Jack Serota, Esq., international tax manager; and Sophie Young, international tax associate, Price Waterhouse, New York City.
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|Publication:||Journal of Accountancy|
|Article Type:||Brief Article|
|Date:||Jan 1, 1997|
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