(a) Allocation and apportionment of taxes to a separate category or categories of income—(1) In general—(i) Taxes related to a separate category of income. The amount of foreign taxes paid or accrued with respect to a separate category (as defined in §1.904-5(a)(4)(v)) of income (including U.S. source income within the separate category) includes only those taxes that are related to income in that separate category. Taxes are related to income if the income is included in the base upon which the tax is imposed. If, for example, foreign law exempts certain types of income from foreign taxes, or certain types of income are exempt from foreign tax under an income tax convention, then no taxes are considered to be related to such income for purposes of this paragraph. As another example, if foreign law provides for a specific rate of tax with respect to certain types of income (e.g., capital gains), or certain expenses, deductions, or credits are allowed under foreign law only with respect to a particular type of income, then such provisions shall be taken into account in determining the amount of foreign tax imposed on such income. Income included in the foreign tax base is calculated under foreign law, but characterized as income in a separate category under Federal income tax principles. For example, a foreign tax imposed on an amount realized on the disposition of controlled foreign corporation stock that is characterized as a capital gain under foreign law but as a dividend under section 1248 is generally assigned to the general category, not the passive category. A withholding tax (as defined in section 901(k)(1)(B)) is related to the income from which it is withheld. A tax that is imposed on a base that includes more than one separate category of income is considered to be imposed on income in all such categories, and, thus, the taxes are related to all such categories included within the foreign country or possession's taxable income base.

(ii) Apportionment of taxes related to more than one separate category. If a tax is related to more than one separate category, then, in order to determine the amount of the tax paid or accrued with respect to each separate category, the tax shall be apportioned on an annual basis among the separate categories on the basis of the following formula:

For purposes of apportioning foreign taxes among the separate categories, gross income is determined under the law of the foreign country or a possession of the United States to which the foreign income taxes have been paid or accrued. Gross income, as determined under foreign law, in the passive category shall first be reduced by any related person interest expense that is allocated to the income under the principles of section 954(b)(5) and §1.904-5(c)(2)(ii)(C) (adjusted gross passive income). Gross income in all separate categories (including adjusted gross passive income) is next reduced by deducting any expenses, losses, or other amounts that are deductible under foreign law that are specifically allocable to the gross amount of such income under the laws of that foreign country or possession. If expenses are not specifically allocated under foreign law then the expenses will be apportioned under the principles of foreign law but only after taking into account the reduction of passive income by the application of section 954(b)(5). Thus, for example, if foreign law provides that expenses will be apportioned on a gross income basis, the gross income amounts will be those amounts determined under foreign law except that, in the case of passive income, the amount will be adjusted gross passive income. If foreign law does not provide for the direct allocation or apportionment of expenses, losses, or other deductions to a particular category of income, then the principles of §§1.861-8 through 1.861-14T and section 954(b)(5) shall apply in allocating and apportioning such expenses, losses, or other deductions to gross income as determined under foreign law after reduction of passive income by the amount of related person interest allocated to passive income under section 954(b)(5) and §1.904-5(c)(2)(ii)(C). For example, the principles of §§1.861-8 through 1.861-14T apply to require definitely related expenses to be directly allocated to particular categories of gross income and provide the methods of apportioning expenses that are definitely related to more than one category of gross income or that are not definitely related to any particular category of gross income. For this purpose, the apportionment of expenses required to be made under §§1.861-8 through 1.861-14T need not be made on other than a separate company basis. The rules in this paragraph apply only for purposes of the apportionment of taxes among separate categories of income and do not affect the computation of a taxpayer's foreign tax credit limitation with respect to a specific category of income. If the taxpayer applies the principles of §§1.861-8 through 1.861-14T for purposes of allocating expenses at the level of the taxpayer (or at the level of the qualified business unit, foreign subsidiary, or other entity that paid or accrued the foreign taxes) under this paragraph (a)(1)(ii), such principles shall be applied (for such purposes) in the same manner as the taxpayer applies such principles in determining the income or earnings and profits for United States tax purposes of the taxpayer (or of the qualified business unit, foreign subsidiary, or other entity that paid or accrued the foreign taxes, as the case may be). For example, a taxpayer must use the modified gross income method under §1.861-9T when applying the principles of that section for purposes of this paragraph (a)(1)(ii) to determine the amount of a controlled foreign corporation's income, in each separate category, that is taxed by a foreign country, if the taxpayer applies the modified gross income method under §1.861-9T(f)(3) when applying §1.861-9T to determine the income and earnings and profits of the controlled foreign corporation for United States tax purposes.

(iii) Apportionment of taxes for purposes of applying the high-tax income test. If taxes have been allocated and apportioned to passive income under the rules of paragraph (a)(1) (i) or (ii) of this section, the taxes must further be apportioned to the groups of income described in §1.904-4(c) (3), (4) and (5) for purposes of determining if the group is high-taxed income. Taxes will be related to income in a particular group under the same rules as those in paragraph (a)(1) (i) and (ii) of this section except that those rules shall be applied by substituting the term “group” for the term “category.”

(iv) Base and timing differences. If, under the law of a foreign country or possession of the United States, a tax is imposed on a type of item that does not constitute income under Federal income tax principles (a base difference), such as gifts or life insurance proceeds, that tax is treated as imposed with respect to income in the separate category described in section 904(d)(2)(H)(i). If, under the law of a foreign country or possession of the United States, a tax is imposed on an item of income that constitutes income under Federal income tax principles but is not recognized for Federal income tax purposes in the current year (a timing difference), that tax is allocated and apportioned to the appropriate separate category or categories to which the tax would be allocated and apportioned if the income were recognized under Federal income tax principles in the year in which the tax was imposed. If the amount of an item of income as computed for foreign tax purposes is positive but is greater than the amount of income that is currently recognized for Federal income tax purposes, for example, due to a difference in depreciation conventions or the timing of recognition of gross income, or because of a permanent difference between U.S. and foreign tax law in the amount of deductions that are allowed to reduce gross income, the tax is allocated or apportioned to the separate category to which the income is assigned, and no portion of the tax is attributable to a base difference. In addition, a tax imposed on a distribution that is excluded from gross income under section 959(a) or section 959(b) is treated as attributable to a timing difference (and not a base difference) and is treated as tax imposed on the earnings and profits from which the distribution was paid.

(2) Special rules for foreign branches—(i) In general. Except as provided in this paragraph (a)(2), any foreign tax reflected on the books and records of a foreign branch under the principles of §1.987-2(b) is allocated and apportioned under the rules of paragraph (a)(1) of this section.

(ii) Disregarded reattribution transactions—(A) Foreign branch to foreign branch owner. In the case of a disregarded payment from a foreign branch to a foreign branch owner that is treated as a disregarded reattribution transaction that results in gross income being attributed to the foreign branch owner under §1.904-4(f)(2)(vi), any foreign tax imposed solely by reason of that transaction, such as a withholding tax imposed on a disregarded payment, is allocated and apportioned to the reattributed gross income.

(B) Foreign branch owner to foreign branch. In the case of a disregarded payment from a foreign branch owner to a foreign branch that is treated as a disregarded reattribution transaction that results in gross income being attributed to the foreign branch under §1.904-4(f)(2)(vi), any foreign tax imposed solely by reason of that transaction is allocated and apportioned to the reattributed gross income. In the case of a foreign branch owner that is a partnership, a foreign tax imposed solely by reason of a disregarded reattribution transaction that results in general category income being attributed to a foreign branch is allocated and apportioned to the partnership's general category income that is attributable to the foreign branch (as described in paragraph (b)(4)(ii) of this section).

(iii) Other disregarded payments—(A) Foreign branch to foreign branch owner. In the case of a disregarded payment from a foreign branch to a foreign branch owner that is not a disregarded reattribution transaction, foreign tax imposed solely by reason of that disregarded payment is allocated and apportioned to a separate category under paragraph (a)(1) of this section based on the nature of the item (determined under Federal income tax principles) that is included in the foreign tax base. For example, if a remittance of an appreciated asset results in gain recognition under foreign law, the tax imposed on that gain is treated as attributable to a timing difference with respect to recognition of the gain, and is allocated and apportioned to the separate category to which gain on a sale of that asset would have been assigned if it were recognized for Federal income tax purposes. However, a gross basis withholding tax on a remittance is attributable to a timing difference in taxation of the income out of which the remittance is made, and is allocated and apportioned to the separate category or categories to which a section 987 gain or loss would be assigned under §1.987-6(b).

(B) Foreign branch owner to foreign branch. In the case of a disregarded payment from a foreign branch owner that is a United States person to a foreign branch that is neither a disregarded reattribution transaction nor described in §1.904-4(f)(2)(vi)(C)(4), any foreign tax imposed solely by reason of the receipt of that disregarded payment is allocated and apportioned to the foreign branch category. In the case of a foreign branch owner that is a partnership, a foreign tax imposed solely by reason of the receipt of a disregarded payment by a foreign branch is allocated and apportioned to the partnership's general category income that is attributable to the foreign branch (as described in paragraph (b)(4)(ii) of this section).

(iv) Definitions. The following definitions apply for purposes of this paragraph (a)(2):

(A) Disregarded reattribution transaction. The term disregarded reattribution transaction means a disregarded payment or a transfer described in §1.904-4(f)(2)(vi)(D) to the extent that it results in an adjustment to the gross income attributable to the foreign branch under §1.904-4(f)(2)(vi)(A).

(B) The terms disregarded payment, foreign branch, foreign branch owner, and remittance have the same meaning given to those terms in §1.904-4(f)(3).

(3) Taxes imposed on high-taxed income. For rules on the treatment of taxes imposed on high-taxed income, see §1.904-4(c).

(b) Allocation and apportionment of deemed paid taxes and certain creditable foreign tax expenditures—(1) Taxes deemed paid under section 960(a) or (d). If a domestic corporation that is a United States shareholder includes any amount in gross income under section 951(a)(1)(A) or 951A(a), any foreign tax deemed paid with respect to such amount under section 960(a) or (d) is allocated to the separate category to which the inclusion is assigned.

(2) Taxes deemed paid under section 960(b)(1). If a domestic corporation that is a United States shareholder receives a distribution of previously taxed earnings and profits from a first-tier corporation that is excluded from the domestic corporation's income under section 959(a) and §1.959-1, any foreign tax deemed paid under section 960(b)(1) with respect to such distribution is allocated to the same separate category as the annual PTEP account and PTEP group (as defined in §1.960-3(c)) from which the distribution is made.

(3) Taxes deemed paid under section 960(b)(2). If a controlled foreign corporation receives a distribution of previously taxed earnings and profits from an immediately lower-tier corporation that is excluded from such controlled foreign corporation's gross income under section 959(b) and §1.959-2, any foreign tax deemed paid under section 960(b)(2) with respect to such distribution is allocated to the same separate category as the annual PTEP account and PTEP group (as defined in §1.960-3(c)) from which the distribution is made. See also §1.960-3(c)(2).

(4) Creditable foreign tax expenditures—(i) In general. Except as provided in paragraph (b)(4)(ii) of this section, creditable foreign tax expenditures (CFTEs) allocated to a partner under §1.704-1(b)(4)(viii)(a) are allocated for purposes of this section to the same separate category as the separate category to which the taxes were allocated in the hands of the partnership under the rules of paragraph (a) of this section.

(ii) Foreign branch category. CFTEs allocated to a partner in a partnership under §1.704-1(b)(4)(viii)(a) are allocated and apportioned to the foreign branch category of the partner to the extent that:

(A) The CFTEs are allocated and apportioned by the partnership under the rules of paragraph (a) of this section to the general category;

(B) In the hands of the partnership, the CFTEs are related to general category income attributable to a foreign branch (as described in §1.904-4(f)(2)) under the principles of paragraph (a) of this section; and

(C) The partner's distributive share of the income described in paragraph (b)(4)(ii)(B) of this section is foreign branch category income of the partner under §1.904-4(f)(1)(i)(B).

(c) [Reserved]

(d) Applicability dates. This section is applicable for taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

[T.D. 8214, 53 FR 27029, July 18, 1988, as amended by T.D. 8412, 57 FR 20652, May 14, 1992; T.D. 9141, 69 FR 43308, July 20, 2004; T.D. 9260, 71 FR 24533, Apr. 25, 2006; T.D. 9882, 84 FR 69098, Dec. 17, 2019]