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 ------------------------------------------------------------------------                                               A %  B %  C %   D %   E %------------------------------------------------------------------------M Corporation's interest:  Direct interest............................   60  (60%x80%)+20% direct interest..............  ...   68  (60%x80%)+20% indirect interest............  ...  ...   68  (68%x80%)..................................  ...  ...  ...   54.4  (68%x50%)+(68%x50%)........................  ...  ...  ...  .....   68N Corporation's interest:  Direct interest............................   30  (30%x80%)..................................  ...   24  (30%x80%)..................................  ...  ...   24  (24%x80%)..................................  ...  ...  ...   19.2  (24%x50%)+(24%x50%)........................  ...  ...  ...  .....   24R Corporation's interest:  Direct interest............................   10  (10%x80%)..................................  ...    8  (10%x80%)..................................  ...  ...    8  (8%x80%)...................................  ...  ...  ...    6.4  (8%x50%)+(8%x50%)..........................  ...  ...  ...  .....    8                                              --------------------------    Total interests to which consolidation     100  100  100     80  100     applies.................................------------------------------------------------------------------------

(b) Effect of consolidation—(1) Determination of subpart F income, export trade income, etc. An election under paragraph (a) of this section to consolidate export trade corporations in a chain of such corporations shall have no effect on the determination of the character of income as subpart F income or on the determination of export trade income, export trade income which constitutes foreign base company income, or earnings and profits of the individual export trade corporations in the chain. Thus, the consolidation of export trade corporations under this section shall not have the effect of reducing earnings and profits of such corporations or of changing the characterization of income from that which is, for example, foreign base company income to that which is not. The application of this paragraph may be illustrated by the following example:

Example.  Corporation A, incorporated under the laws of foreign country X, and corporation B, incorporated under the laws of foreign country Y, are both wholly owned subsidiaries of domestic corporation M. Corporations A and B both qualify under section 971(a) as export trade corporations. Corporation A purchases personal property produced in the United States from an unrelated person and sells the property to B Corporation for use outside of country X. Corporation B resells the property to an unrelated person for use in foreign country Z. Corporations A and B each derive foreign base company sales income described in §1.954–3 from the purchase and sale transactions. Consolidation of Corporations A and B under this section does not result in the two transactions being treated as one transaction which is a purchase of property from an unrelated person and a sale of property to an unrelated person or the nonrecognition of gain on the sale of export property by A Corporation to B Corporation.

(2) Determination of amount by which consolidated subpart F income is reduced—(i) In general. In determining the amount by which the subpart F income of each export trade corporation includible in a consolidation of export trade corporations shall be reduced as provided in section 970(a) and paragraph (b)(1) of §1.970–1 for any taxable year of consolidation, the limitations provided by section 970(a) and paragraph (b)(2) of §1.970–1 on such amount for each such export trade corporation shall be determined on the basis of such corporation's separate share of—

(a) Amounts included in the total export promotion expense,

(b) The total gross receipts from the sale, installation, operation, maintenance, or use of property in respect of which each such corporation derives such export trade income as is properly allocable to the export trade income which constitutes foreign base company income, and

(c) The total increase in investments in export trade assets,

of all export trade corporations to which the consolidation applies for the taxable year.

(ii) Limitations not effective. If for any taxable year each of the limitations under paragraph (b)(2) of §1.970–1, determined on a consolidated basis, equals or exceeds the total export trade income which constitutes foreign base company income of all corporations includible in the consolidation of export trade corporations, the subpart F income of each includible corporation shall be reduced under section 970(a) for such year by its separate export trade income which constitutes foreign base company income.

(iii) Limitation effective. If for any taxable year one of the limitations under paragraph (b)(2) of §1.970–1, determined on a consolidated basis, is less than the total export trade income which constitutes foreign base company income of all corporations includible in the consolidation of export trade corporations, the amount by which the subpart F income of each includible corporation shall be reduced under section 970(a) for such year shall be an amount which bears the same ratio to the amount by which the subpart F income may be reduced on a consolidated basis as the export trade income which constitutes foreign base company income of each includible corporation bears to the total export trade income which constitutes foreign base company income of all export trade corporations includible in the consolidation of export trade corporations.

(iv) Illustration. The application of this subparagraph may be illustrated by the following example:

Example.  (a) Domestic corporation M owns 100 percent of the only class of stock of controlled foreign corporation A, which, in turn, owns 100 percent of the only class of stock of controlled foreign corporation B. All corporations use the calendar year as the taxable year, and corporations A and B are export trade corporations throughout the period here involved. Corporation M elects under this section to consolidate corporations A and B for the entire period here involved. Corporation M elects under paragraph (a)(2) of §1.970–2 for 1963 to determine both A Corporation's and B Corporation's investments in export trade assets as of the close of the 75th day after the close of such corporations' taxable year.

(b) The following amounts are applicable to corporations A and B for 1964:

 ------------------------------------------------------------------------                                                Corporation  Corporation                                                     A            B------------------------------------------------------------------------Subpart F income..............................      $100         $200Export trade income which constitutes foreign         25           75 base company income..........................Other export trade income.....................        10           15Export promotion expenses allocable to export         10           80 trade income which constitutes foreign base company income...............................Gross receipts from the sale of property in          400          600 respect of which export trade income which constitutes foreign base company income is derived......................................Increase in investments in export trade assets        35          120 for period beginning with March 16, 1964, and ending with March 16, 1965...................------------------------------------------------------------------------
  (c) The amount by which subpart F income of corporations A and B is reduced for 1964 on a separate-company basis without regard to section 972 may be determined as set forth in items (i) through (vii) below, and the results of the consolidation of corporations A and B for 1964 are set forth in items (viii) through (x). Assuming an alternative case in which for 1964 the facts are the same as set forth in paragraphs (a) and (b) of this example except that B Corporation incurs export promotion expenses of $50 (rather than $80) which are allocable to the export trade income which constitutes foreign base company income, the results of the consolidation of corporations A and B for such year (a case where one of the limitations under paragraph (b)(2) of §1.970–1 is effective) are set forth in items (xi) through (xiii):
 ------------------------------------------------------------------------                                            A            B                                       Corporation  Corporation   Total                                           (1)          (2)        (3)------------------------------------------------------------------------(i) Subpart F income.................       $100         $200       $300                                      ==================================(ii) Export trade income which                25           75        100 constitutes foreign base company income..............................(iii) Other export trade income......         10           15         25                                      ----------------------------------(iv) Total export trade income.......         35           90        125                                      ==================================(v) Limitations under § 1.970- 1(b)(2):  (a) Increase in export trade assets   limitation:    ($35x$25/$35)....................         25    ...........  .......    ($120x$75/$90)...................  ...........        100    .......    ([$35+$120]x$100/ $125)..........  ...........  ...........      124  (b) Gross receipts limitation:    (10% of $400)....................         40    ...........  .......    (10% of $600)....................  ...........         60    .......    (10% of $1,000)..................  ...........  ...........      100  (c) Export promotion expenses   limitation:    (150% of $10)....................         15    ...........  .......    (150% of $80)....................  ...........        120    .......    (150% of $90)....................  ...........  ...........      135  (d) Export promotion expenses   limitation (alternative case):    (150% of $10)....................         15    ...........  .......    (150% of $50)....................  ...........         75    .......    (150% of $60)....................  ...........  ...........       90                                      ----------------------------------(vi) Reduction in subpart F income on         15           60         75 a separate company basis determined without regard to section 972 (item (ii), but not to exceed smallest of items (v) (a), (b), and (c), in columns (1) and (2))................                                      ----------------------------------(vii) Subpart F income as reduced on          85          140        225 a separate company basis (item (i) minus item (vi))....................                                      ==================================(viii) Reduction in subpart F income   ...........  ...........      100 on a consolidated basis determined under section 972 (item (ii), but not to exceed smallest of items (v) (a), (b), and (c), in column (3))...                                      ----------------------------------(ix) Apportionment of reduction in            25           75        100 subpart F income (item (ii))........(x) Subpart F income as reduced on a          75          125        200 consolidated basis (item (i) minus item (ix))..........................                                      ==================================                            Alternative Case(xi) Reduction in subpart F income on  ...........  ...........        9 a consolidated basis determined under section 972 (item (ii) but not to exceed smallest of items (v) (a), (b), and (d), in column (3))........                                                                --------(xii) Apportionment of reduction in       $22.50 subpart F income (item (xi) times [item (ii) of column (1) over item (ii) of column (3)] and item (xi) times [item (ii) of column (2) over item (ii) of column (3)]); ($90 x $25/$100)...........................  ($90 x $75/$100)...................  ...........     $67.50         90                                                   ---------------------(xiii) Subpart F income as reduced on      77.50       132.50        210 a consolidated basis (item (i) minus item (xii)).........................------------------------------------------------------------------------

(3) Determination of pro rata share of consolidated withdrawal of previously excluded export trade income—(i) In general. If, for any taxable year, there is a decrease in investments in export trade assets under section 970(b) and paragraph (c)(1) of §1.970–1, determined on a consolidated basis, of export trade corporations includible in a consolidated chain of such corporations, each United States shareholder who has elected under paragraph (a) of this section to consolidate his interest in such chain of corporations shall include in his gross income, under section 951(a)(1)(A)(ii) and the regulations thereunder as an amount to which section 955 (as in effect before the enactment of the Tax Reduction Act of 1975) applies, his pro rata share of the amount of such consolidated decrease in investments but only to the extent such pro rata share does not exceed the lesser of the limitations provided by section 970(b) and paragraph (c)(2) of §1.970–1 with respect to such shareholder determined on a consolidated basis. The consolidated decrease in investments and the consolidated limitations shall be determined by aggregating the applicable amounts determined under paragraph (c) of §1.970–1 with respect to such shareholder's interest in each corporation includible in the consolidation.

(ii) Allocation of pro rata share of consolidated decrease in investments in export trade assets. For purposes of determining the amount referred to in paragraph (c)(2)(i)(b)(3) of §1.970–1 for a subsequent taxable year, a United States shareholder's pro rata share of a consolidated decrease in investments determined under subdivision (i) of this subparagraph for the current taxable year shall be allocated to such shareholder's interest in each of the export trade corporations includible in the consolidation in that ratio which—

(a) The net amount determined under paragraph (c)(2)(i)(b) of §1.970–1 with respect to such shareholder's interest in such corporation for all prior taxable years (whether or not a taxable year occurring during the period of consolidation) bears to

(b) The total of the net amounts determined under paragraph (c)(2)(i) (b) of §1.970–1 with respect to such shareholder's interests in all export trade corporations includible in such consolidation for all prior taxable years (whether or not a taxable year occurring during the period of consolidation).

(iii) Illustration. The application of this subparagraph may be illustrated by the following example:

Example.  (a) Domestic corporation M owns 60 percent of the only class of stock of controlled foreign corporation A, which, in turn, owns 100 percent of the only class of stock of controlled foreign corporation B. All corporations use the calendar year as a taxable year, and corporations A and B are export trade corporations throughout the period here involved. Corporation M elects to consolidate corporations A and B for the entire period here involved.

(b) The following amounts are applicable to corporations A and B for 1964:

 ------------------------------------------------------------------------                                                            Consolidated                                              A (1)  B (2)       (3)------------------------------------------------------------------------(i) Consolidated decrease in investments in   .....  .....       $100 export trade assets (determined before application of § 1.970-1(c)(2)).......(ii) M Corporation's pro rata share of        .....  .....         60 consolidated decrease (60%)................(iii) M Corporation's pro rata share of        $120    $90        210 earnings and profits for 1963 and 1964 (§ 1.970-1(c) (2)(i)(a)...............(iv) M Corporation's pro rata share of net      180     60        240 amount determined under § 1.970- 1(c)(2)(i)(b) for 1963.....................(v) Amount includible in M Corporation's      .....  .....         60 gross income for 1964 (smallest of items (ii), (iii), and (iv) in column (3)).......------------------------------------------------------------------------

Corporation M must include $60 in its gross income for 1964 under section 951(a)(1)(A)(ii) by reason of the application of section 970(b) as its pro rata share of the consolidated decrease in investments in export trade assets; and, for purposes of determining the amount under paragraph (c)(2)(i)(b)(3) of §1.970–1 with respect to M Corporation's interest in each of corporations A and B for a subsequent taxable year, such consolidated decrease for 1964 is allocated as follows: to M Corporation's interest in A Corporation, $45 ($60 times $180/$240); and to its interest in B Corporation, $15 ($60 times $60/$240).

  (c) The following amounts are applicable to corporations A and B for 1965:
 ------------------------------------------------------------------------                                                            Consolidated                                         A(1)       B(2)         (3)------------------------------------------------------------------------(i) Consolidated decrease in          .........  .........         $150 investments in export trade assets (determined before application of § 1.970-1(c)(2))..............(ii) M Corporation's pro rata share   .........  .........           90 of consolidated decrease (60%).....(iii) M Corporation's pro rata share       $100      ($20)           80 of earnings and profits (and deficits in earnings and profits) for 1963, 1964, and 1965 (§ 1.970-1(c)(2)(i)(a))...............(iv) M Corporation's pro rata share of the net amount determined under § 1.970-1(c)(2)(i)(b) for 1963 and 1964...........................  ($180-$45)........................        135  ($60-$15).........................  .........         45    Total...........................  .........  .........          180(v) Amount includible in M            .........  .........           80 Corporation's gross income for 1965 (smallest of items (ii), (iii), and (iv) in column (3))................------------------------------------------------------------------------

Corporation M must include $80 in its gross income for 1965 under section 951(a)(1)(A)(ii) by reason of the application of section 970(b) as its pro rata share of the consolidated decrease in investments in export trade assets; and, for purposes of determining the amount under paragraph (c)(2)(i)(b)(3) of §1.970–1 with respect to M Corporation's interest in each of corporations A and B for a subsequent taxable year, such consolidated decrease for 1965 is allocated as follows: to M Corporation's interest in A Corporation, $60 ($80 times $135/$180); and to its interest in B Corporation, $20 ($80 times $45/$180).

  (d) The following amounts are applicable to corporations A and B for 1966:
 ------------------------------------------------------------------------                                                            Consolidated                                               A(1)   B(2)       (3)------------------------------------------------------------------------(i) Consolidated decrease in investments in   .....  .....       $200 export trade assets (determined before application of § 1.970-1(c)(2)).......(ii) M Corporation's pro rata share of        .....  .....        120 consolidated decrease (60%)................(iii) M Corporation's pro rata share of        $120    $50        170 earnings and profits (and deficits in earnings and profits) for 1963, 1964, 1965, and 1966 (§ 1.970-1(c)(2)(i)(a))......(iv) M Corporation's pro rata share of the net amount determined under § 1.970- 1(c)(2)(i)(b) for 1963, 1964, and 1965.....  ($180 minus [$45+$60])....................     75  ($60-[$15+$20])...........................  .....     25    Total...................................  .....  .....        100(v) Amount includible in M Corporation's      .....  .....        100 gross income for 1966 (smallest of items (ii), (iii), and (iv) in column (3)).......------------------------------------------------------------------------

Corporation M must include $100 in its gross income for 1966 under section 951(a)(1)(A)(ii) by reason of the application of section 970(b) as its pro rata share of the consolidated decrease in investments in export trade assets; and, for purposes of determining the amount under paragraph (c)(2)(i)(b)(3) of §1.970–1 with respect to M Corporation's interest in each of corporations A and B for a subsequent taxable year, such consolidated decrease for 1966 is allocated as follows: to M Corporation's interest in A Corporation, $75 ($100 times $75/$100); and to its interest in B Corporation, $25 ($100 times $25/$100).

[T.D. 6754, 29 FR 12714, Sept. 9, 1964, as amended by T.D. 7893, 48 FR 22512, May 19, 1983]

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