AMENDMENTS RELATED TO TITLE XII OF THE REFORM ACT.

SEC. 1012. AMENDMENTS RELATED TO TITLE XII OF THE REFORM ACT. (a) Amendments Related to Section 1201 of the Reform Act.— (1) (A) Subparagraph (O of section 904(d)(2) of the 1986 Code is amended to read as follows: “(C) Financial services income.— “(i) In general.— Except as otherwise provided in this subparagraph, the term ‘financial services income’ means any income which is received or accrued by any person predominantly engaged in the active conduct of a banking, insurance, financing, or similar business, and which is— “(I) described in clause (ii), 102 STAT. 3494 “(II) passive income (determined without regard to subclause (I) of subparagraph (A)(iii)), or “(III) export financing interest which (but for subparagraph (B)(ii)) would be high withholding tax interest. “(ii) General description of financial services income.— Income is described in this clause if such income is— “(I) derived in the active conduct of a banking, financing, or similar business, “(II) derived from the investment by an insurance company of its unearned premiums or reserves ordinary and necessary for the proper conduct of its insurance business, or “(III) of a kind which would be insurance income as defined in section 953(a) determined without regard to those provisions of paragraph (1)(A) of such section which limit insurance income to income from countries other than the country in which the corporation was created or organized, “(iii) Exceptions.— The term ’financial services income’ does not include— “(I) any high withholding tax interest, “(II) any dividend from a noncontrolled section 902 corporation, and “(III) any export financing interest not described in clause (i)(III).” (B) Clause (i) of section 864(d)(5)(A) of the 1986 Code is amended by striking out “(C)(iii)” and inserting in lieu thereof “(C)(iii)(III)”. (2) Subparagraph (D) of section 904(d)(2) of the 1986 Code is amended by adding at the end thereof the following new sentence: “Such term does not include any dividend from a noncontrolled section 902 corporation and does not include any financial services income.” (3) Paragraph (3) of section 904(d) of the 1986 Code is amended by adding at the end thereof the following new subparagraph: “(H) Exception for certain high withholding tax interest.— This paragraph shall Dot apply to any amount which— “(i) without regard to this paragraph, is high withholding tax interest (including any amount treated as high withholding tax interest under paragraph (2)(B)(iii)), and “(ii) would (but for this subparagraph) be treated as financial services income under this paragraph. The amount to which this paragraph does not apply by reason of the preceding sentence shall not exceed the interest or equivalent income of the controlled foreign corporation taken into account in determining financial services income without regard to this subparagraph.” (4) Subparagraph (E) of section 904(d)(3) of the 1986 Code is amended— (A) by striking out the first sentence and inserting in lieu thereof the following: “If a controlled foreign corporation meets the requirements of section 954(b)(3)(A) (relating to de minimis rule) for any taxable year, for purposes of this 102 STAT. 3495paragraph, none of its foreign base company income (as defined in section 954(a) without regard to section 954(bX5J) and none of its gross insurance income (as defined in section 954(b)(3)(C)) for such taxable year shall be treated as income in a separate category, except that this sentence shall not apply to any income which (without regard to this sentence) would be treated as financial services income.”, and (B) by striking out “income (other than high withholding tax interest and dividends from a noncontrolled section 902 corporation)” and inserting in lieu thereof “passive income”. (5) Paragraph (2) of section 1201(e) of the Reform Act is amended by adding at the end thereof the following new subparagraph: “(J) Treatment of affiliated group filing consolidated return.—For purposes of this paragraph, all members of an affiliated group of corporations filing a consolidated return shall be treated as 1 corporation.” (6) Subparagraph (A) of section 904(d)(2) of the 1986 Code is amended— (A) by striking out “The term” in clause (ii) and inserting in lieu thereof “Except as provided in clause (iii), the term , and (B) by adding at the end thereof the following new clause: “(iv) Clarification of application of section 864(d) (6).—In determining whether any income is of a kind which would be foreign personal holding company income, the rules of section 864(d)(6) shall apply only in the case of income of a controlled foreign corporation.” (7) Subparagraph (F) of section 904(d)(3) of the 1986 Code is amended to read as follows: “(F) Separate category.— For purposes of this paragraph— “(i) In general.—Except as provided in clause (ii), the term ‘separate category’ means any category of income described in subparagraph (A), (B), (C), (D), or (E) of paragraph (1), “(ii) Coordination with high-taxed income provisions.— “(I) In determining whether any income of a controlled foreign corporation is in a separate category, subclause (III) of paragraph (2)(A)(iii) shall not apply. “(II) Any income of the taxpayer which is treated as income in a separate category under this paragraph shall be so treated notwithstanding any provision of paragraph (2); except that the determination of whether any amount is high-taxed income shall be made after the application of this paragraph.” (8) Clause (iii) of section 904(d)(2)(B) of the 1986 Code is amended to read as follows: “(iii) Regulations.— The Secretary may by regulations provide that— “(I) amounts (not otherwise high withholding tax interest) shall be treated as high withholding tax 102 STAT. 3496interest where necessary to prevent avoidance of the purposes of this subparagraph, and “(II) a tax shall not be treated as a withholding tax or other tax imposed on a gross basis if such tax is in the nature of a prepayment of a tax imposed on a net basis.” (9) Clause (ii) of section 904(d)(2)(D of the 1986 Code is amended by striking out “except to the extent that” and all that follows down through “and” at the end thereof and inserting in lieu thereof the following: “except that— “(I) such taxes shall be treated as paid or accrued with respect to shipping income to the extent the taxpayer establishes to the satisfaction of the Secretary that such taxes were paid or accrued with respect to such income, “(II) in the case of a person described in subparagraph (C)(i), such taxes shall be treated as paid or accrued with respect to financial services income to the extent the taxpayer establishes to the satisfaction of the Secretary that such taxes were paid or accrued with respect to such income, and “(III) such taxes shall be treated as paid or accrued with respect to high withholding tax interest to the extent the taxpayer establishes to the satisfaction of the Secretary that such taxes were paid or accrued with respect to such income, and”. (10) Clause (i) of section 904(d)(2)(E) of the 1986 Code is amended by striking out “during which it was a controlled foreign corporation” and inserting in lieu thereof “during which it was a controlled foreign corporation and except as provided in regulations, the taxpayer was a United States shareholder in such corporation”. (11) Subparagraph (E) of section 904(d)(1) of the 1986 Code is amended by striking out “dividends” and inserting in lieu thereof “in the case of a corporation, dividends”. (b) Amendment Related to Section 1202 of the Reform Act.— (1) Paragraph (7) of section 902(c) of the 1986 Code is amended— (A) by striking out “secton 960” and inserting in lieu thereof “section 960”, and (B) by striking out “this section” the second place it appears and inserting in lieu thereof “this section and section 960”. (2) Paragraph (1) of section 902(c) of the 1986 Code is amended by striking out “sections 964 and 986” and inserting in lieu thereof “sections 964(a) and 986”. (3) For purposes of sections 902 and 960 of the 1986 Code, the increase in earnings and profits of any foreign corporation under section 1023(e)(3)(C) of the Reform Act shall be taken into account ratably over the 10-year period beginning with the corporation’s first taxable year beginning after December 31, 1986. (4) Paragraph (3) of section 404A(d) of the 1986 Code is amended by striking out “the amount determined” and inserting in lieu thereof “except as provided in regulations, the amount determined”. 102 STAT. 3497 (c) Amendment Related to Section 1203 of the Reform Act.—Paragraph (5) of section 904(f) of the 1986 Code is amended by adding at the end thereof the following new subparagraph: “(F) Dispositions.—If any separate limitation loss for any taxable year is allocated against any separate limitation income for such taxable year, except to the extent provided in regulations, rules similar to the rules of paragraph (3) shall apply to any disposition of property if gain from such disposition would be in the income category with respect to which there was such separate limitation loss.” (d) Amendments Related to Section 1211 of the Reform Act.— (1) Subsection (d) of section 865 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(4) Coordination with subsection (c) .— “(A) Gain not in excess of depreciation adjustments sourced under subsection (c).—Notwithstanding paragraph (1), any gain from the sale of an intangible shall be sourced under subsection (c) to the extent such gain does not exceed the depreciation adjustments with respect to such intangible. “(B) Subsection (c) (2) not to apply to intangibles.—Paragraph (2) of subsection (c) shall not apply to any gain from the sale of an intangible.” (2) Subparagraph (A) of section 865(e)(1) of the 1986 Code is amended by striking out “(d), or (f)” and inserting in lieu thereof “(d)(1)(B) or (3), or (f)”. (3) (A) Clause (ii) of section 865(g)(1)(A) of the 1986 Code is amended by striking out “partnership,”. (B) Subsection (h) of section 865 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(5) Treatment of partnerships.—In the case of a partner-ship, except as provided in regulations, this section shall be applied at the partner level.” (4) Subsection (f) of section 865 of the 1986 Code is amended to read as follows: “(f) Stock of Affiliates.—If— “(1) a United States resident sells stock in an affiliate which is a foreign corporation, “(2) such sale occurs in a foreign country in which such affiliate is engaged in the active conduct of a trade or business, and “(3) more than 50 percent of the gross income of such affiliate for the 3-year period ending with the close of such affiliate’s taxable year immediately preceding the year in which the sale occurred was derived from the active conduct of a trade or business in such foreign country, any gain from such sale shall be sourced outside the United States. For purposes of paragraphs (2) and (3), the United States resident may elect to treat an affiliate and all other corporations which are wholly owned (directly or indirectly) by the affiliate as one corporation.” (5) Effective with respect to taxable years beginning after December 31, 1987, subparagraph (B) of section 865(e)(2) of the 1986 Code is amended to read as follows: “(B) Exception.—Subparagraph (A) shall not apply to any sale of inventory property which is sold for use, disposition, or consumption outside the United States if an office 102 STAT. 3498or other fixed place of business of the taxpayer in a foreign country materially participated in the sale.” (6) (A) Subsection (g) of section 865 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(3) Special rule for certain stock sales by residents of puerto rico.—Paragraph (2) shall not apply to the sale by an individual who was a bona fide resident of Puerto Rico during the entire taxable year of stock in a corporation if— “(A) such corporation is engaged in the active conduct of a trade or business in Puerto Rico, and “(B) more than 50 percent of its gross income for the 3-year period ending with the close of such corporation’s taxable year immediately preceding the year in which such sale occurred was derived from the active conduct of a trade or business in Puerto Rico. For purposes of the preceding sentence, the taxpayer may elect to treat a corporation and all other corporations which are wholly owned (directly or indirectly) by such corporation as one corporation.” (B) Subsection (i) of section 865 of the 1986 Code is amended by striking out “and” at the end of paragraph (1), by striking out the period at the end of paragraph (2) and inserting in lieu thereof ”, and”, and by adding at the end thereof the following new paragraph: “(3) providing that, subject to such conditions (which may include provisions comparable to section 877) as may be provided in such regulations, subsections (e)(1)(B) and (g)(2) shall not apply for purposes of sections 931,933, and 936.” (7) Subparagraph (B) of section 864(c)(4) of the 1986 Code is amended by striking out “or” at the end of clause (i), by striking out the period at the end of clause (ii) and inserting in lieu thereof “; or”, and by adding at the end thereof the following new clause: “(iii) is derived from the sale or exchange (outside the United States) through such office or other fixed place of business of personal property described in section 1221(1), except that this clause shall not apply if the property is sold or exchanged for use, consumption, or disposition outside the United States and an office or other fixed place of business of the taxpayer in a foreign country participated materially in such sale.” (8) Section 865 of the 1986 Code is amended by redesignating subsections (h), (i), and (j) as subsections (i), (j), and (k), respectively, and by inserting after subsection (g) the following new subsection: “(h) Treatment of Gains From Sale of Certain Stock or Intangibles and From Certain Liquidations.— “(1) In general.— In the case of gain to which this subsection applies— “(A) such gain shall be sourced outside the United States, but “(B) subsections (a), (b), and (c) of section 904 and sections 902, 907, and 960 shall be applied separately with respect to such gain. “(2) Gain to which subsection applies.—This subsection shall apply to— 102 STAT. 3499 “(A) Gain from sale of certain stock or intangibles.— Any gain— “(i) which is from the sale of stock in a foreign corporation or an intangible (as defined in subsection (d)(2)) and which would otherwise be sourced in the United States under this section, “(ii) which, under a treaty obligation of the United States (applied without regard to this section), would be sourced outside the United States, and “(iii) with respect to which the taxpayer chooses the benefits of this subsection. “(B) Gain from liquidation in possession.— Any gain which is derived from the receipt of any distribution in liquidation of a corporation— “(i) which is organized in a possession of the United States, and “(ii) more than 50 percent of the gross income of which during the 3-taxable year period ending with the close of the taxable year immediately preceding the taxable year in which the distribution is received is from the active conduct of a trade or business in such possession.” (9) Subparagraph (A) of section 865(e)(1) of the 1986 Code is amended by striking out “outside the United States” the first place it appears and inserting in lieu thereof “in a foreign country”. (10) Subparagraph (B) of section 864(c)(4) of the 1986 Code is amended— (A) by striking out “(including any gain or loss realized on the sale or exchange of such property)” in clause (i), and (B) by striking out “, or gain or loss from the sale or exchange of stock or notes, bonds, or other evidences of indebtedness” in clause (ii). (11) Clause (i) of section 865(g)(1)(A) of the 1986 Code is amended to read as follows— “(i) any individual who— “(I) is a United States citizen or a resident alien and does not have a tax home (as defined in section 911(d)(3)) in a foreign country, or “(II) is a nonresident alien and has a tax home (as so defined) in the United States, and”. (12) Paragraph (2) of section 865(d) of the 1986 Code is amended by inserting “franchise,” after “trade brand,”. (e) Amendments Related to Section 1212 of the Reform Act.— (1) (A) Paragraph (3) of section 883(c) of the 1986 Code is amended to read as follows: “(3) Special rules for publicly traded corporations.— “(A) Exception.—Paragraph (1) shall not apply to any corporation which is organized in a foreign country meeting the requirements of paragraph (1) or (2) of subsection (a) (as the case may be) and the stock of which is primarily and regularly traded on an established securities market in such foreign country, another foreign country meeting the requirements of such paragraph, or the United States. “(B) Treatment of stock owned by publicly traded corporation.—Any stock in another corporation which is owned (directly or indirectly) by a corporation meeting the 102 STAT. 3500requirements of subparagraph (A) shall be treated as owned by individuals who are residents of the foreign country in which the corporation meeting the requirements of subparagraph (A) is organized.” (B) Paragraph (1) of section 883(c) of the 1986 Code is amended— (i) by striking out “Paragraphs (1) and (2) of subsection (aX’ and inserting in lieu thereof “Paragraph (1) or (2) of subsection (a) (as the case may be)”, and (ii) by striking out “such paragraphs (1) and (2)” and inserting in lieu thereof “such paragraph”. (2) (A) Paragraphs (1) and (2) of section 883(a) of the 1986 Code are each amended by striking out “to citizens of the United States and”. (B) Paragraphs (1) and (2) of section 872(b) of the 1986 Code are each amended by striking out “to citizens of the United States and to corporations organized in the United States” and inserting in lieu thereof “to individual residents of the United States”. (3) (A) The section heading for section 863 of the 1986 Code is amended to read as follows: “SEC. 863. SPECIAL RULES FOR DETERMINING SOURCE.” (B) The table of sections for part I of subchapter N of chapter 1 of the 1986 Code is amended by striking out the item relating to section 863 and inserting in lieu thereof the following: “Sec. 863. Special rules for determining source.” (4) Subsection (c) of section 862 is hereby repealed. (5) Paragraphs (1) and (2) of section 872(b) of the 1986 Code and paragraphs (1) and (2) of section 883(a) of the 1986 Code are each amended by striking out “operation” and inserting in lieu thereof “international operation”. (6) Paragraph (1) of section 887(b) of the 1986 Code is amended— (A) by striking out “under section 863(c)” and inserting in lieu thereof “under section 863(c)(2)”, and (B) by adding at the end thereof the following new sentence: “To the extent provided in regulations, such term does not include any income of a kind to which an exemption under paragraph (1) or (2) of section 883(a) would not apply” (f) Amendment Related to Section 1213 of the Reform Act.—Paragraph (2) of section 863(e) of the 1986 Code is amended by striking out “foreign country” each place it appears and inserting in lieu thereof “foreign country (or possession of the United States)”. (g) Amendments Related to Section 1214 of the Reform Act.— (1) (A) Paragraph (1) of section 1214(d) of the Reform Act is amended to read as follows: “(1) In general.—The amendments made by this section shall apply to payments made in a taxable year of the payor beginning after December 31, 1986.” (B) A taxpayer may elect not to have the amendment made by subparagraph (A) apply and to have section 1214(d)(1) of the Reform Act apply as in effect before such amendment Such election shall be made at such time and in such manner as the Secretary of the Treasury or his delegate may prescribe. 102 STAT. 3501 (2) Subparagraph (B) of section 1214(d)(2) of the Reform Act is amended by striking out “section 904(d)(2)(G)” and inserting in lieu thereof ”section 904(d)(2)(H)”. (3) Subparagraph (B) of section 861(c)(1) of the 1986 Code is amended— (A) by striking out “subchapter)” in clause (i) and inserting in lieu thereof “subchapter) or, in the case of a corporation, is attributable to income so derived by a subsidiary of such corporation”, (B) by striking out “or chain of subsidiaries of such corporation” in clause (ii), and (C) by adding at the end thereof the following new sentence: “For purposes of this subparagraph, the term ‘subsidiary’ means any corporation in which the corporation referred to in this subparagraph owns (directly or indirectly) stock meeting the requirements of section 1504(a)(2) (determined by substituting ‘50 percent’ for ‘80 percent’ each place it appears).” (4) Paragraph (1) of section 2105(b) of the 1986 Code is amended by striking out “section 861(c), if any interest thereon would be treated by reason of section 861(a)(1)(A) as income from sources without the United States” and inserting in lieu thereof “section 871(i)(3), if any interest thereon would not be subject to tax by reason of section 871(i)(1)”. (5) Paragraph (2) of section 864(c) of the 1986 Code is amended by striking out the last sentence. (6) Paragraph (3) of section 907(c) of the 1986 Code is amended: (A) by striking out subparagraph (B) and redesignating subparagraphs (CD and (D) as subparagraphs (B) and (C), respectively, and (B) by striking out “and dividends described in subparagraph (B)”. (7) Subsection (a) of section 1442 of the 1986 Code is amended— (A) by striking out “and the references in” and inserting in lieu thereof “the references in”, and (B) by inserting before the period at the end thereof the following: “, and the reference in section 1441(c)(10) to section 871(i)(2) shall be treated as referring to section 881(d)”. (h) Amendments Related to Section 1215 of the Reform Act.— (1) Paragraph (4) of section 864(e) of the 1986 Code is amended to read as follows: “(4) Basis of stock in nonaffiliated iopercent owned corporations adjusted for earnings and profits changes.— “(A) In general.— For purposes of allocating and apportioning expenses on the basis of assets, the adjusted basis of any stock in a nonaffiliated 10-percent owned corporation shall be— “(i) increased by the amount of the earnings and profits of such corporation attributable to such stock and accumulated during the period the taxpayer held such stock, or “(ii) reduced (but not below zero) by any deficit in earnings and profits of such corporation attributable to such stock for such period. 102 STAT. 3502 “(B) Nonaffiliated 10-percent owned corporation.— For purposes of this paragraph, the term ‘nonaffiliated 10-percent owned corporation’ means any corporation if— “(i) such corporation is not included in the taxpayer’s affiliated group, and “(ii) members of such affiliated group own 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote. “(C) Earnings and profits of lower tier corporations taken into account.— “(i) In general.—If, by reason of holding stock in a nonaffiliated 10-percent owned corporation, the tax-payer is treated under clause (iii) as owning stock in another corporation with respect to which the stock ownership requirements of clause (ii) are met, the adjustment under subparagraph (A) shall include an adjustment for the amount of the earnings and profits (or deficit therein) of such other corporation which are attributable to the stock the taxpayer is so treated as owning and to the period during which the taxpayer is treated as owning such stock. “(ii) Stock ownership requirements.—The stock ownership requirements of this clause are met with respect to any corporation if members of the taxpayer’s affiliated group own (directly or through the application of clause (iii)) 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote. “(iii) Stock owned through entities.—For purposes of this subparagraph, stock owned (directly or in-directly) by a corporation, partnership, or trust shall be treated as being owned proportionately by its share-holders, partners, or beneficiaries. Stock considered to be owned by a person by reason of the application of the preceding sentence, shall, for purposes of applying such sentence, be treated as actually owned by such person. “(D) Coordination with subpart f, etc.—For purposes of this paragraph, proper adjustment shall be made to the earnings and profits of any corporation to take into account any earnings and profits included in gross income under section 951 or under any other provision of this title and reflected in the adjusted basis of the stock.” (2) (A) Paragraph (1) of section 864(e) of the 1986 Code is amended by striking out “from sources outside the United States”. (B) Subsection (h) of section 936 of the 1986 Code is amended by redesignating paragraph (7) as paragraph (8) and by inserting after paragraph (6) the following new paragraph: “(7) Section 864;(e)(1) not to apply.— This subsection shall be applied as if section 864(e)(1) (relating to treatment of affiliated groups) had not been enacted.” (C) The heading for part I of aubchapter N of chapter 1 of the 1986 Code is amended to read as follows: 102 STAT. 3503 “PART I—SOURCE RULES AND OTHER GENERAL RULES RELATING TO FOREIGN INCOME”. (D) The table of parts for subchapter N of chapter 1 of the 1986 Code is amended by striking out the item relating to part I and inserting in lieu thereof the following: “Part I. Source rules and other general rules relating to foreign income.” (3) Paragraph (3) of section 864(e) of the 1986 Code is amended by striking out the last sentence and inserting in lieu thereof the following: “A similar rule shall apply in the case of the portion of any dividend (other than a qualifying dividend as defined in section 243(b)) equal to the deduction allowable under section 243 or 245(a) with respect to such dividend and in the case of a like portion of any stock the dividends on which would be so deductible and would not be qualifying dividends (as so defined).” (4) (A) Paragraph (5) of section 864(e) of the 1986 Code is amended by adding at the end thereof the following new subparagraph: “(D) Treatment of bank holding companies.— To the extent provided in regulations— “(i) a bank holding company (within the meaning of section 2(a) of the Bank Holding Company Act of 1956), and “(ii) any subsidiary of a financial institution described in section 581 or 591 or of any bank holding company if such subsidiary is predominantly engaged (directly or indirectly) in the active conduct of a banking, financing, or similar business, shall be treated as a corporation described in subparagraph (C).>” (B) Subparagraph (B) of section 864(e)(5) of the 1986 Code is amended by adding at the end thereof the following new sentence: “This subparagraph shall not apply for purposes of paragraph (6).” (5) Paragraph (6) of section 864(e) of the 1986 Code is amended by striking out “directly allocable and apportioned” and inserting in lieu thereof “directly allocable or apportioned”. (6) (A) Paragraph (7) of section 864(e) of the 1986 Code is amended by striking out “and” at the end of subparagraph (B), by striking out the period at the end of subparagraph (C) and inserting in lieu thereof a comma, and by adding at the end thereof the following new subparagraphs: “(D) for direct allocation of interest expense in the case of indebtedness resulting in a disallowance under section 246A, “(E) for appropriate adjustments in the application of paragraph (3) in the case of an insurance company, and “(F) that this subsection shall not apply for purposes of any provision of this subchapter to the extent the Secretary determines that the application of this subsection for such purposes would not be appropriate.” (B) Subsection (e) of section 864 of the 1986 Code is amended by striking out “(except as provided in regulations)” in the material preceding paragraph (1). 102 STAT. 3504 (7) Paragraph (2) of section 1215(c) of the Reform Act is amended to read as follows: “(2) Transitional rules.— “(A) General phase-in.— “(i) In general—In the case of the 1st 3 taxable years of the taxpayer beginning after December 31, 1986, the amendments made by this section shall not apply to interest expenses paid or accrued by the tax-payer during the taxable year with respect to an aggregate amount of indebtedness which does not exceed the general phase-in amount. “(ii) General phase-in amount.—Except as provided in clause (iii), the general phase-in amount for purposes of clause (i) is the applicable percentage (determined under the following table) of the aggregate amount of indebtedness of the taxpayer outstanding on November 16, 1985: “In the case of the The applicable percentage is: 1st taxable year 75 2nd taxable year 50 3rd taxable year 25 “(iii) Lower limit where taxpayer reduces indebtedness.—For purposes of applying this subparagraph to interest expenses attributable to any month, the general phase-in amount shall in no event exceed the lowest amount of indebtedness of the taxpayer outstanding as of the close of any preceding month beginning after November 16, 1985. To the extent provided in regulations, the average amount of indebtedness outstanding during any month shall be used (in lieu of the amount outstanding as of the close of such month) for purposes of the preceding sentence. “(B) Consolidation rule not to apply to certain interest— “(i) In general.— In the case of the 1st 5 taxable years of the taxpayer beginning after December 31, 1986— “(I) subparagraph (A) shall not apply for purposes of paragraph (1) of section 864(e) of the Internal Revenue Code of 1986 (as added by this section), but “(II) such paragraph (1) shall not apply to interest expenses paid or accrued by the taxpayer during the taxable year with respect to an aggregate amount of indebtedness which does not exceed the special phase-in amount. “(ii) Special phase-in amount.— The special phase-in amount for purposes of clause (i) is the sum of— “(I) the general phase-in amount as determined for purposes of subparagraph (A), “(II) the 5-year phase-in amount, and “(III) the 4-year phase-in amount. For purposes of applying this subparagraph to interest expense attributable to any month, the special phase-in amount shall in no event exceed the limitation determined under subparagraph (A)(iii). 102 STAT. 3505 “(iii) 5-year phase-in amount.— The 5-year phase-in amount is the lesser of— “(I) the applicable percentage (determined under the following table for purposes of this subclause) of the 5-year debt amount, or “(II) the applicable percentage (determined under the following table for purposes of this subclause) of the 5-year debt amount reduced by paydowns: “In the case of the: The applicable percentage for purposes of subclause (I) is: The applicable percentage for purposes of subclause (II) is: 1st taxable year 8⅓ 10 2nd taxable year 16⅔ 25 3rd taxable year 25 50 4th taxable year 33⅓ 100 5th taxable year 16⅔ 100. “(iv) 4-year phase-in amount.— The 4-year phase-in amount is the lesser of— “(I) the applicable percentage (determined under the following table for purposes of this subclause) of the 4-year debt amount, or “(II) the applicable percentage (determined under the following table for purposes of this subclause) of the 4-year debt amount reduced by paydowns to the extent such paydowns exceed the 5-year debt amount: “In the case of the: The applicable percentage for purposes of subclause (I) is: The applicable percentage for purposes of subclause (II) is: 1st taxable year 5 6¼ 2nd taxable year 10 16⅔ 3rd taxable year 15 37½ 4th taxable year 20 100 5th taxable year 0 0. “(v) 5-year debt amount.— The term ‘5-year debt amount’ means the excess (if any) of— “(I) the amount of the outstanding indebtedness of the taxpayer on May 29, 1985, over “(II) the amount of the outstanding indebtedness of the taxpayer as of the close of December 31, 1983. The 5-year debt amount shall not exceed the aggregate amount of indebtedness of the taxpayer outstanding on November 16, 1985. “(vi) 4-year debt amount.— The term ‘4-year debt amount’ means the excess (if any) of— “(I) the amount referred to in clause (v)(II), over “(II) the amount of the outstanding indebtedness of the taxpayer as of the close of December 31, 1982. The 4-year debt amount shall not exceed the aggregate amount of indebtedness of the taxpayer outstanding on November 16, 1985, reduced by the 5-year debt amount. 102 STAT. 3506 “(vii) Paydowns.—For purposes of applying this subparagraph to interest expenses attributable to any month, the term ‘paydowns’ means the excess (if any) of— “(I) the aggregate amount of indebtedness of the taxpayer outstanding on November 16, 1985, over “(II) the lowest amount of indebtedness of the taxpayer outstanding as of the close of any preceding month beginning after November 16, 1985 (or, to the extent provided in regulations under subparagraph (A)(iii), the average amount of indebtedness outstanding during any such month). “(C) Coordination of subparagraphs (a) and (b).— In applying subparagraph (B), there shall first be taken into account indebtedness to which subparagraph (A) applies. “(D) Special rules.— “(i) In the case of the 1st 9 taxable years of the taxpayer beginning after December 31, 1986, the amendments made by this section shall not apply to interest expenses paid or accrued by the taxpayer during the taxable year with respect to an aggregate amount of indebtedness which does not exceed the applicable percentage (determined under the following table) of the indebtedness described in clause (iii) or (iv): “In the case of the: The applicable percentage is: 1st taxable year 90 2nd taxable year 80 3rd taxable year 70 4th taxable year 60 5th taxable year 50 6th taxable year 40 7th taxable year 30 8th taxable year 20 9th taxable year 10. “(ii) The provisions of this subparagraph shall apply in lieu of the provisions of subparagraphs (A) and (B). “(iii) Indebtedness outstanding on may 29, 1985.—Indebtedness is described in this clause if it is indebtedness (which was outstanding on May 29, 1985) of a corporation incorporated on June 13, 1917, which has its principal place of business in Bartlesville, Oklahoma. “(iv) Indebtedness outstanding on may 29, 1935.—Indebtedness is described in this clause if it is indebtedness (which was outstanding on May 29, 1985) of a member of an affiliated group (as defined in section 1504(a)), the common parent of which was incorporated on August 26, 1926, and has its principal place of business in Harrison, New York. “(E) Treatment of affiliated group.—For purposes of this paragraph, all members of the same affiliated group of corporations (as defined in section 864(e)(5)(A) of the Internal Revenue Code of 1986, as added by this section) shall be treated as 1 taxpayer whether or not such members filed a consolidated return. “(F) Election to have paragraph not apply.—A tax-payer may elect (at such time and in such manner as the 102 STAT. 3507Secretary of the Treasury or his delegate may prescribe) to have this paragraph not apply. In the case of members of the same affiliated group (as so defined), such an election may be made only if each member consents to such election.” (i) Amendments Related to Section 1221 of the Reform Act.— (1) (A) Subparagraph (C) of section 953(c)(3) of the 1986 Code is amended by adding at the end thereof the following new sentence: “An election under this subparagraph made for any taxable year shall not be effective if the corporation (or any predecessor thereof) was a disqualified corporation for the tax-able year for which the election was made or for any prior taxable year beginning after 1986.” (B) Clause (i) of section 953(c)(3)(1) of the 1986 Code is amended to read as follows: “(i) Period during which election in effect.— “(I) In general.—Except as provided in subclause (II), any election under subparagraph (C) shall apply to the taxable year for which made and all subsequent taxable years unless revoked with the consent of the Secretary. “(II) Termination.—If a foreign corporation which made an election under subparagraph (C) for any taxable year is a disqualified corporation for any subsequent taxable year, such election shall not apply to any taxable year beginning after such subsequent taxable year.” (C) Paragraph (3) of section 953(c) of the 1986 Code is amended by adding at the end thereof the following new subparagraph: “(E) Disqualified corporation.—For purposes of this paragraph the term ‘disqualified corporation’ means, with respect to any taxable year, any foreign corporation which is a controlled foreign corporation for an uninterrupted period of 30 days or more during such taxable year (determined without regard to this subsection) but only if a United States shareholder (determined without regard to this subsection) owns (within the meaning of section 958(a)) stock in such corporation at some time during such taxable year.” (2) (A) Paragraph (1) of section 953(c) of the 1986 Code is amended by striking out “and” at the end of subparagraph (A), by striking out the period at the end of subparagraph (B) and inserting in lieu thereof “, and”, and by adding at the end thereof the following new subparagraph: “(C) the pro rata share referred to in section 951(a)(1)(A)(i) shall be determined under paragraph (5) of this subsection.” (B) Subsection (c) of section 953 of the 1986 Code is amended by redesignating paragraph (5) as paragraph (6) and by inserting after paragraph (4) the following new paragraph: “(5) Determination of pro rata share.— “(A) In general.— The pro rata share determined under this paragraph for any United States shareholder is the lesser of— “(i) the amount which would be determined under paragraph (2) of section 951(a) if— 102 STAT. 3508 (I) only related person insurance income were taken into account, “(II) stock owned (within the meaning of section 958(a)) by United States shareholders on the last day of the taxable year were the only stock in the foreign corporation, and “(III) only distributions received by United States shareholders were taken into account under subparagraph (B) of such paragraph (2), or “(ii) the amount which would be determined under paragraph (2) of section 951(a) if the entire earnings and profits of the foreign corporation for the taxable year were subpart F income. “(B) Coordination with other provisions—The Secretary shall prescribe regulations providing for such modifications to the provisions of this subpart as may be necessary or appropriate by reason of subparagraph (A).” (3) (A) Paragraph (2) of section 953(c) of the 1986 Code is amended by striking out “with respect to which the primary insured is” and inserting in lieu thereof “with respect to which the person (directly or indirectly) insured is”. (B) Subparagraph (A) of section 953(c)(3) of the 1986 Code is amended— (i) by striking out “persons who are the primary insured” and inserting in lieu thereof “persons who are (directly or indirectly) insured”, and (ii) by striking out “to any such primary insured” and inserting in lieu thereof “to any such person”. (C) The amendments made by this paragraph to the extent such amendments add the phrase “(directly or indirectly)” shall apply only to taxable years beginning after December 31, 1987. (4) (A) Subsection (c) of section 953 of the 1986 Code (as amended by paragraph (2)) is amended by redesignating paragraph (6) as paragraph (7) and by inserting after paragraph (5) the following new paragraph: “(6) Related person.— For purposes of this subsection— “(A) In general.—Except as provided in subparagraph (B), the term ‘related person’ has the meaning given such term by section 954(d)(3). “(B) Treatment of certain liability insurance policies.—In the case of any policy of insurance covering liability arising from services performed as a director, officer, or employee of a corporation or as a partner or employee of a partnership, the person performing such services and the entity for which such services are performed shall be treat-ed as related persons.” (B) Paragraphs (2) and (3)(A) of section 953(c) of the 1986 Code are each amended by striking out “(within the meaning of section 954(d)(3))”. (5) Paragraph (2) of section 953(c) of the 1986 Code is amended by striking out “insurance income attributable” and inserting in lieu thereof “insurance income (within the meaning of subsection (a)) attributable”. (6) For purposes of applying section 952(c)(1)(A) of the 1986 Code, the earnings and profits of any corporation shall be determined without regard to any increase in earnings and profits under section 1023(e)(3)(C) of the Reform Act. 102 STAT. 3509 (7) Subsection (b) of section 953 of the 1986 Code is amended— (A) by striking out paragraph (1) and redesignating paragraphs (2), (3), and (4) as paragraphs (1), (2), and (3), respectively, (B) by striking out subparagraph (A) of paragraph (1) (as so redesignated) and inserting in lieu thereof the following: “(A) The small life insurance company deduction.”, and (C) by striking out “(other than those taken into account under paragraph (3))” in paragraph (3) (as so redesignated). (8) Subparagraph (B) of section 953(c)(3) of the 1986 Code is amended— (A) by striking out “related person insurance income” and inserting in lieu thereof “related person insurance income (determined on a gross basis)”, and (B) by striking out “its insurance income” and inserting in lieu thereof “its insurance income (as so determined)”. (9) Subclause (II) of section 953(c)(3)(C)(i) of the 1986 Code is amended— (A) by striking out “all benefits” and inserting in lieu thereof “all benefits (other than with respect to section 884)”, and (B) by striking out “under any income tax treaty” and inserting in lieu thereof “granted by the United States under any treaty”. (10) Paragraph (7) of section 861(a) of the 1986 Code is amended to read as follows: “(7) Amounts received as underwriting income (as defined in section 832(b)(3)) derived from the issuing (or reinsuring) of any insurance or annuity contract— “(A) in connection with property in, liability arising out of an activity in, or in connection with the lives or health of residents of, the United States, or “(B) in connection with risks not described in subparagraph (A) as a result of any arrangement whereby another corporation receives a substantially equal amount of premiums or other consideration in respect to issuing (or reinsuring) any insurance or annuity contract in connection with property in, liability arising out of activity in, or in connection with the lives or health of residents of, the United States.” (11) Subparagraph (A) of section 955(a)(2) of the 1986 Code is amended by striking out “beginning before 1987” and inserting in lieu thereof “beginning before 1987 (to the extent such amount exceeds the sum of the decreases in qualified investments determined under this paragraph for prior taxable years beginning after 1986)”. (12) Paragraphs (6) and (7) of section 954(b) of the 1986 Code are each amended by striking out “(determined without regard to the exclusion under paragraph (2) of this subsection)”. (13) (A) Subparagraph (O of section 1221(g)(3) of the Reform Act is amended— (i) by striking out “July 9” and inserting in lieu thereof “June 9”, and (ii) by striking out “March 31, 1982” and inserting in lieu thereof “November 3, 1981”. (B) Subparagraph (D) of section 1221(g)(3) of the Reform Act is amended— 102 STAT. 3510 (i) by striking out “as of August 16, 1986, under a reinsurance contract in effect on such date” and inserting in lieu thereof “under a reinsurance contract”, (ii) by striking out “the preceding sentence” and inserting in lieu thereof “this subparagraph”, and (iii) by adding at the end thereof the following: “For purposes of this paragraph, the amount of qualified reinsurance income shall not exceed the amount of insurance income from reinsurance contracts for calendar year 1985. In the case of controlled foreign corporations described in subparagraph (C)(ii), the preceding sentence shall not apply and the qualified reinsurance income of any such corporation shall not exceed such corporation’s proportionate share of $27,000,000 (determined on the basis of respective amounts of qualified reinsurance income determined with-out regard to this subparagraph).” (14) (A) Paragraph (3) of section 954(d) of the 1986 Code is amended by striking out “50 percent or more” each place it appears and inserting in lieu thereof “more than 50 percent”. (B) Clause (ii) of section 861(c)(2)(B) of the 1986 Code is amended to read as follows: “(ii) such section shall be applied by substituting TO percent or more’ for ‘more than 50 percent’ each place it appears.” (15) Subsection (b) of section 951 of the 1986 Code is amended by striking out “section 957(d)” and inserting in lieu thereof “section 957(c)”. (16) Subsection (c) of section 952 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(3) Special rule for determining earnings and profits.—For purposes of this subsection, earnings and profits of any controlled foreign corporation shall be determined without regard to paragraphs (4), (5), and (6) of section 312(n). Under regulations, the preceding sentence shall not apply to the extent it would increase earnings and profits by an amount which was previously distributed by the controlled foreign corporation.” (17) Subparagraph (A) of section 881(c)(4) of the 1986 Code is amended by striking out clauses (ii), (iii), (iv), and (v) and inserting in lieu thereof the following: “(ii) Paragraph (4) of section 954(b) (relating to exception for certain income subject to high foreign taxes). “(iii) Clause (i) of section 954(c)(3)(A) (relating to certain income received from related persons).” (18) Subparagraph (B) of section 954(c)(1) of the 1986 Code is amended by striking out “or” at the end of clause (i), by redesignating clause (ii) as clause (iii), and by inserting after clause (i) the following new clause: “(ii) which is an interest in a trust, partnership, or REMIC, or”. (19) (A) Subsection (a) of section 6046 of the 1986 Code is amended by striking out “and” at the end of paragraph (2), by redesignating paragraph (3) as paragraph (4), and by inserting after paragraph (2) the following new paragraph: (3) each person (not described in paragraph (2)) who, at any time after January 1, 1987, is treated as a United States share-holder under section 953(c) with respect to a foreign corporation, and”. 102 STAT. 3511 (B) Subsection (b) of section 6046 of the 1986 Code is amended by striking out “subsection (a)(2)” and inserting in lieu thereof “paragraph (2) or (3) of subsection (a)”. (C) Subsection (a) of section 6046 of the 1986 Code is amended by adding at the end thereof the following new sentence: “In the case of a foreign corporation with respect to which any person is treated as a United States shareholder under section 953(c), paragraph (1) shall be treated as including a reference to each United States person who is an officer or director of such corporation.” (20) Subparagraph (B) of section 954(c)(1) of the 1986 Code is amended by striking out the last sentence and inserting in lieu thereof the following: “In the case of any regular dealer in property, gains and losses from the sale or exchange of any such property or arising out of bona fide hedging transactions reasonably necessary to the conduct of the business of being a dealer in such property shall not be taken into account under this subparagraph. Gains and losses from the sale or exchange of any property which, in the hands of the controlled foreign corporation, is property described in section 1221(1) also shall not be taken into account under this subparagraph.” (21) Subsection (c) of section 953 (as amended by this subsection) is amended by striking out paragraph (7) and inserting in lieu thereof the following: “(7) Coordination with section 1248.— For purposes of section 1248, if any person is (or would be but for paragraph (3)) treated under paragraph (1) as a United States shareholder with respect to any foreign corporation which would be taxed under subchapter L if it were a domestic corporation and which is (or would be but for paragraph (3)) treated under paragraph (1) as a controlled foreign corporation— “(A) such person shall be treated as meeting the stock ownership requirements of section 1248(a)(2) with respect to such foreign corporation, and “(B) such foreign corporation shall be treated as a controlled foreign corporation. “(8) Regulations.— The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subsection, including— “(A) regulations preventing the avoidance of this subsection through cross insurance arrangements or otherwise, and “(B) regulations which may provide that a person will not be treated as a United States shareholder under paragraph (1) with respect to any foreign corporation if neither such person (nor any related person to such person) is (directly or indirectly) insured under any policy of insurance or reinsurance issued by such foreign corporation.” (22) Subclause (1(I) of section 952(c)(1)(B)(iii) of the 1986 Code is amended by striking out “insurance income” and inserting in lieu thereof “insurance income or foreign personal holding company income,”. (23) Clause (iii) of section 952(c)(1)(B) of the 1986 Code is amended by redesignating subclauses (III) and (IV) as subclauses (V) and (VI), respectively, and by inserting after subclause (II) the following new subclauses: 102 STAT. 3512 “(III) foreign base company sales income, “(IV) foreign base company services income,”. (24) Clause (ii) of section 952(c)(1)(B) of the 1986 Code is amended by adding at the end thereof the following new sentence: “In determining the deficit attributable to qualified activities described in clause (iii)(III) or (IV), deficits in earnings and profits (to the extent not previously taken into account under this section) for taxable years beginning after 1962 and before 1987 also shall be taken into account. In the case of the qualified activity described in clause (iii)(II), the rule of the preceding sentence shall apply, except that ‘1982’ shall be substituted for ‘1962’.” (25) (A) Paragraph (1) of section 952(c) of the 1986 Code is amended by adding at the end thereof the following new subparagraph: “(C) Certain deficits of member of the same chain of corporations may be taken into account.— “(i) In general.—A controlled foreign corporation may elect to reduce the amount of its subpart F income for any taxable year which is attributable to any qualified activity by the amount of any deficit in earnings and profits of a qualified chain member for a taxable year ending with (or within) the taxable year of such controlled foreign corporation to the extent such deficit is attributable to such activity. To the extent any deficit reduces subpart F income under the preceding sentence, such deficit shall not be taken into account under subparagraph (B). “(ii) Qualified chain member.— For purposes of this subparagraph, the term ‘qualified chain member’ means, with respect to any controlled foreign corporation, any other corporation which is created or organized under the laws of the same foreign country as the controlled foreign corporation but only if— “(I) all the stock of such other corporation (other than directors’ qualifying shares) is owned at all times during the taxable year in which the deficit arose (directly or through 1 or more corporations other than the common parent) by such controlled foreign corporation, or “(II) all the stock of such controlled foreign corporation (other than directors’ qualifying shares) is owned at all times during the taxable year in which the deficit arose (directly or through 1 or more corporations other than the common parent) by such other corporation. “(iii) Coordination.—This subparagraph shall be applied after subparagraphs (A) and (B). (B) Subparagraph (B) of section 954(c)(3) of the 1986 Code is amended by inserting before the period at the end thereof the following: “or creates (or increases) a deficit which under section 952(c) may reduce the subpart F income of the payor or another controlled foreign corporation”. (j) Amendment Related to Section 1224 of the Reform Act.—Paragraph (2) of section 901(g) of the 1986 Code and section 936(d)(3)(B) of the 1986 Code are each amended by striking out “section 957(c)” and inserting in lieu thereof “section 957(c) (as in102 STAT. 3513 effect on the day before the date of the enactment of the Tax Reform Act of 1986)”. (k) Amendment Related to Section 1225 of the Reform Act.—Subsection (c) of section 1225 of the Reform Act is amended by striking out “March 1, 1986” and inserting in lieu thereof “January 1, 1986”. (l) Amendments Related to Section 1226 of the Reform Act.— (1) Subsection (a) of section 246A of the 1986 Code is amended by striking out the last sentence. (2) (A) Paragraph (8) of section 245 of the 1986 Code is amended to read as follows: (2) Disallowance of foreign tax credit.—No credit shall be allowed under section 901 for any taxes paid or accrued (or treated as paid or accrued) with respect to the United States source portion of any dividend received by a corporation from a qualified 1 O-percent-owned foreign corporation.” (B) Subsection (a) of section 245 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(10) Coordination with treaties.—If— “(A) any portion of a dividend received by a corporation from a qualified 1 O-percent-owned foreign corporation would be treated as from sources in the United States under paragraph (9), “(B) under a treaty obligation of the United States (applied without regard to this subsection), such portion would be treated as arising from sources outside the United States, and “(C) the taxpayer chooses the benefits of this paragraph, this subsection shall not apply to such dividend (but subsections (a), (b), and (c) of section 904 and sections 902, 907, and 960 shall be applied separately with respect to such portion of such dividend).” (3) Subsection (a) of section 245 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(11) Coordination with section 1248.—For purposes of this subsection, the term ‘dividend’ does not include any amount treated as a dividend under section 1248.” (m) Amendments Related to Section 1228 of the Reform Act.— (1) Subsection (a) of section 1228 of the Reform Act is amended by striking out “and” at the end of paragraph (3), and by striking out paragraph (4) and inserting in lieu thereof the following: “(4) the transfer, sale, exchange, or other disposition is part of a single integrated plan, whereby the stock of the corporation described in paragraph (1) becomes owned directly by the 2 corporations specifically referred to in subsection (b) or by such 2 corporations and by 1 or both of their jointly owned direct subsidiaries, “(5) within 20 days after each transfer, sale, exchange, or other disposition, the person making such transfer, sale, ex-change, or other disposition notifies the Internal Revenue Service of the transaction, the date of the transaction, the basis of the stock involved, the holding period for such stock, and such other information as the Internal Revenue Service may require, and 102 STAT. 3514 “(6) the integrated plan is completed before the date 4 years after the date of the enactment of the Technical and Miscellaneous Revenue Act of 1988. In the case of any underpayment attributable to a failure to meet any requirement of this subsection, the period during which such underpayment may be assessed shall in no event expire before the date 5 years after the date of the enactment of the Technical and Miscellaneous Revenue Act of 1988.” (2) Subsection (c) of section 1228 of the Reform Act is hereby repealed. (n) Amendments Related to Section 1231 of the Reform Act.— (1) Subparagraph (A) of section 1231(g)(2) of the Reform Act is amended by adding at the end thereof the following new sentence: “In the case of any transfer (or License) which is not to a foreign person, the preceding sentence shall be applied by substituting ‘August 16, 1986’ for ‘November 16, 1985. (2) Subparagraph (B) of section 1231(g)(2) of the Reform Act is amended by striking out “was made” and inserting in lieu thereof “, if any, was made”. (3) Subsection (g) of section 1231 of the Reform Act is amended by adding at the end thereof the following new paragraph: “(5) Transitional rule for increase in gross income test.— “(A) In general.— If— “(i) a corporation fails to meet the requirements of subparagraph (B) of section 936(a)(2) of the Internal Revenue Code of 1986 (as amended by subsection (d)(1)) for any taxable year beginning in 1987 or 1988, “(ii) such corporation would have met the requirements of such subparagraph (B) if such subparagraph had been applied without regard to the amendment made by subsection (d)(1), and “(iii) 75 percent or more of the gross income of such corporation for such taxable year (or, in the case of a taxable year beginning in 1988, for the period consisting of such taxable year and the preceding taxable year) was derived from the active conduct of a trade or business within a possession of the United States, such corporation shall nevertheless be treated as meeting the requirements of such subparagraph (B) for such taxable year if it elects to reduce the amount of the qualified possession source investment income for the taxable year by the amount of the shortfall determined under subparagraph (B) of this paragraph. “(B) Determination of shortfall.— The shortfall determined under this subparagraph for any taxable year is an amount equal to the excess of— “(i) 75 percent of the gross income of the corporation for the 3-year period (or part thereof) referred to in section 936(a)(2)(A) of such Code, over “(ii) the amount of the gross income of such corporation for such period (or part thereof) which was derived from the active conduct of a trade or business within a possession of the United States. “(C) Special rule.—Any income attributable to the investment of the amount not treated as qualified possession source investment income under subparagraph (A) 102 STAT. 3515shall not be treated as qualified possession source investment income for any taxable year.” (4) Subparagraph (B) of section 1231(a)(1) of the Reform Act is amended by striking out “at the end thereof and inserting in lieu thereof “at the end of the material relating to payment of cost sharing”. (5) (A) Clause (ii) of section 936(d)(4)(A) of the 1986 Code is amended to read as follows: “(ii) in accordance with a specific authorization granted by the Commissioner of Financial Institutions of Puerto Rico pursuant to regulations issued by such Commissioner.” (B) Clauses (i) and (ii) of section 936(d)(4)(C) of the 1986 Code are each amended by striking out “the Secretary of the Treasury of Puerto Rico” and inserting in lieu thereof “the Commissioner of Financial Institutions of Puerto Rico”. (o) Amendment Related to Section 1234 of the Reform Act.—Subsection (d) of section 6039E of the 1986 Code is amended by adding at the end thereof the following new sentence: “Nothing in the preceding sentence shall be construed to require the disclosure of information which is subject to section 245A of the Immigration and Nationality Act (as in effect on the date of the enactment of this sentence).” (p) Amendments Related to Section 1235 of the Reform Act.— (1) Paragraph (1) of section 1291(d) of the 1986 Code is amended to read as follows: “(1) In general.— This section shall not apply with respect to any distribution paid by a passive foreign investment company, or any disposition of stock in a passive foreign investment company, if such company is a qualified electing fund for each of its taxable years— “(A) which begins after December 31, 1986, and for which such company is a passive foreign investment company, and “(B) which includes any portion of the taxpayer’s holding period.” (2) Subsection (c) of section 1296 of the 1986 Code is amended by striking out “owns at least” and inserting in lieu thereof “owns (directly or indirectly) at least”. (3) Paragraph (3) of section 1291(b) of the 1986 Code is amended by striking out “and” at the end of subparagraph (D), by striking out the period at the end of subparagraph (E) and inserting in lieu thereof ”, and”, and by adding at the end thereof the following new subparagraph: “(F) proper adjustment shall be made for amounts not includible in gross income by reason of section 551(d), 959(a), or 1293(c).” (4) Paragraph (2) of section 1294(c) of the 1986 Code is amended— (A) by striking out “is disposed of in subparagraph (A) and inserting in lieu thereof “is transferred”, (B) by striking out “such disposition or cessation” each place it appears and inserting in lieu thereof “such transfer or cessation”, and (C) by striking out “Dispositions” in the paragraph heading and inserting in lieu thereof “Transfers”. (5) Paragraph (1) of section 1296(b) of the 1986 Code is amended to read as follows: 102 STAT. 3516 “(1) In general.—Except as provided in paragraph (2), the term ‘passive income’ means any income which is of a kind which would be foreign personal holding company income as defined in section 954(c).” (6) (A) Subsection (f) of section 1291 of the 1986 Code is amended to read as follows: “(f) Recognition of Gain.—To the extent provided in regulations, in the case of any transfer of stock in a passive foreign investment company where (but for this subsection) there is not full recognition of gain, the excess (if any) of— “(1) the fair market value of such stock, over “(2) its adjusted basis, shall be treated as gain from the sale or exchange of such stock and shall be recognized notwithstanding any provision of law. Proper adjustment shall be made to the basis of any such stock for gain recognized under the preceding sentence.” (B) Subsection (e) of section 1291 of the 1986 Code is amended by striking out “Rules similar” and inserting in lieu thereof “Except to the extent inconsistent with the regulations prescribed under subsection (f), rules similar”. (7) (A) Paragraphs (4) and (5) of section 1291(a) of the 1986 Code are hereby repealed. (B) Section 1291 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(g) Coordination With Foreign Tax Credit Rules.— “(1) In general.— If there are creditable foreign taxes with respect to any distribution in respect of stock in a passive foreign investment company— “(A) the amount of such distribution shall be determined for purposes of this section with regard to section 78, “(B) the excess distribution taxes shall be allocated rat-ably to each day in the taxpayer’s holding period for the stock, and “(C) to the extent— “(i) that such excess distribution taxes are allocated to a taxable year referred to in subsection (a)(1)(B), such taxes shall be taken into account under section 901 for the current year, and “(ii) that such excess distribution taxes are allocated to any other taxable year, such taxes shall reduce (subject to the principles of section 904(d) and not below zero) the increase in tax determined under subsection (c)(2) for such taxable year by reason of such distribution (but such taxes shall not be taken into account under section 901). “(2) Definitions.— For purposes of this subsection— “(A) Creditable foreign taxes.— The term ‘creditable foreign taxes’ means, with respect to any distribution— “(i) any foreign taxes deemed paid under section 902 with respect to such distribution, and “(ii) any withholding tax imposed with respect to such distribution, but only if the taxpayer chooses the benefits of section 901 and such taxes are creditable under section 901 (determined without regard to paragraph (1)(C)(ii)). “(B) Excess distribution taxes.—The term ‘excess distribution taxes’ means, with respect to any distribution, the 102 STAT. 3517portion of the creditable foreign taxes with respect to such distribution which is attributable (on a pro rata basis) to the portion of such distribution which is an excess distribution. “(C) Section 1248 gain.—The rules of this subsection also shall apply in the case of any gain which but for this section would be includible in gross income as a dividend under section 1248”. (B) Section 1294 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(g) Cross Reference.— “For provisions providing for interest for the period of the extension under this section, see section 6601.” (9) Paragraph (2) of section 1291(e) of the 1986 Code is amended by striking out “not” the second place it appears. (10) (A) Subsection (a) of section 1297 of the 1986 Code is amended by redesignating paragraph (4) as paragraph (5) and by inserting after paragraph (3) the following new paragraph: “(4) Options.—To the extent provided in regulations, if any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be consideró! as an option to acquire such stock.” (B) Paragraph (5) of section 1297(a) of the 1986 Code (as redesignated by subparagraph (A)) is amended by striking out “paragraph (2) or (3)” and inserting in lieu thereof “paragraph (2), (3), or (4)”. (11) Paragraph (3) of section 904(d) of the 1986 Code is amended by adding at the end thereof the following new subparagraph: “(I) Look-thru applies to passive foreign investment company inclusion.—If— “(i) a passive foreign investment company is a controlled foreign corporation, and “(ii) the taxpayer is a United States shareholder in such controlled foreign corporation, any amount included in gross income under section 1293 shall be treated as income in a separate category to the extent such amount is attributable to income in such category.” (12) Clause (ii) of section 1291(a)(1)(B) of the 1986 Code is amended to read as follows: “(ii) any period in the taxpayer’s holding period before the 1st day of the 1st taxable year of the company which begins after December 31, 1986, and for which it was a passive foreign investment company, and”. (13) Subparagraph (A) of section 1291(b)(2) of the 1986 Code is amended by adding at the end thereof the following new sentence: “For purposes of clause (ii), any excess distribution received during such 3-year period shall be taken into account only to the extent it was included in gross income under subsection (a)(1)(B).” (14) Subparagraph (A) of section 1291(a)(3) of the 1986 Code is amended by striking out “in the case of an excess distribution”102 STAT. 3518 and inserting in lieu thereof “for purposes of applying this section to an excess distribution”. (15) Subsection (b) of section 1293 of the 1986 Code is amended by adding at the end thereof the following new sentence: “To the extent provided in regulations, if the fund establishes to the satisfaction of the Secretary that it uses a shorter period than the taxable year to determine shareholders’ interests in the earnings of such fund, pro rata shares may be determined by using such shorter period,” (16) Subparagraph (B) of section 1296(b)(2) of the 1986 Code is amended by striking out “by a corporation which” and inserting in lieu thereof “by a corporation which is predominantly engaged in an insurance business and which”. (17) Paragraph (5) of section 1297(b) of the 1986 Code is amended to read as follows: “(5) Application of part where held by other entity.— “(A) In general.— Under regulations, in any case in which a United States person is treated as owning stock in a passive foreign investment company by reason of subsection (a)— “(i) any disposition by the United States person or the person owning such stock which results in the United States person being treated as no longer owning such stock, or “(ii) any disposition of property in respect of such stock to the person holding such stock, shall be treated as a disposition to, the United States person with respect to the stock in the passive foreign investment company. “(B) Amount treated in same manner as previously taxed income.—Rules similar to the rules of section 959(b) shall apply to any amount described in subparagraph (A) and to any amount included in gross income under section 1293(a) (or which would have been so included but for section 951(f)) in respect of stock which the taxpayer is treated as owning under subsection (a).” (18) Subsection (e) of section 1293 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(3) Determination of earnings and profits.—The earnings and profits of any qualified electing fund shall be determined without regard to paragraphs (4), (5), and (6) of section 312(n). Under regulations, the preceding sentence shall not apply to the extent it would increase earnings and profits by an amount which was previously distributed by the qualified electing fund.” (19) Subsection (d) of section 1248 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(7) Amounts included in gross income under section 1293.—Earnings and profits of the foreign corporation attributable to any amount previously included in the gross income of such person under section 1293 with respect to the stock sold or exchanged, but only to the extent the inclusion of such amount did not result in an exclusion of an amount under section 1293(c).” (20) Paragraph (6) of section 1297(b) of the 1986 Code is amended by striking out “If a” and inserting in lieu thereof “Except as provided in regulations, if a”. 102 STAT. 3519 (21) Section 1246 of the 1986 Code is amended by redesignating the subsection relating to information with respect to certain foreign investment companies as subsection (f), by re-designating the subsection relating to coordination with section 1248 as subsection (g), and by redesignating the subsection relating to cross reference as subsection (h). (22) Subparagraph (A) of section 1297(b)(3) of the 1986 Code is amended to read as follows: “(A) neither such corporation (nor any predecessor) was a passive foreign investment company for any prior taxable year,”. (23) Subsection (c) of section 1293 of the 1986 Code is amended by striking out “shall be treated as a distribution which is not a dividend” and inserting in lieu thereof “shall be treated, for purposes of this chapter, as a distribution which is not a dividend; except that such distribution shall immediately reduce earnings and profits”. (24) Subsection (b) of section 1297 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(8) Treatment of certain foreign corporations owning stock in 25-percent owned domestic corporation.— “(A) In general.— If— “(i) a foreign corporation is subject to the tax imposed by section 531 (or waives any benefit under any treaty which would otherwise prevent the imposition of such tax), and “(ii) such foreign corporation owns at least 25 percent (by value) of the stock of a domestic corporation, for purposes of determining whether such foreign corporation is a passive foreign investment company, any qualified stock held by such domestic corporation shall be treated as an asset which does not produce passive income (and is not held for the production of passive income) and any amount included in gross income with respect to such stock shall not be treated as passive Income. “(B) Qualified stock.—For purposes of subparagraph (A), the term ‘qualified stock’ means any stock in a C corporation which is a domestic corporation and which Is not a regulated investment company or real estate investment trust.” (25) Section 1294 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(f) Treatment of Loans to Shareholder.—For purposes of this section and section 1293, any loan by a qualified electing fund (directly or indirectly) to a shareholder of such fund shall be treated as a distribution to such shareholder. (26) (A) Paragraph (2) of section 1296(b) of the 1986 Code is amended by striking out “or” at the end of subparagraph (A), by striking out the period at the end of subparagraph (B) and inserting in lieu thereof “, or”, and by adding at the end thereof the following: “(C) which is interest, a dividend, or a rent or royalty, which is received or accrued from a related person (within the meaning of section 954(d)(3)) to the extent such amount is properly allocable (under regulations prescribed by the Secretary) to income of such related person which is not passive income. 102 STAT. 3520For purposes of subparagraph (C), the term ‘related person’ has the meaning given such term by section 954(d)(3) determined by substituting ‘foreign corporation’ for ‘controlled foreign corporation’ each place it appears in section 954(d)(3).” (B) The paragraph heading for paragraph (2) of section 1296(b) of the 1986 Code is amended by striking out “Exception for certain banks and insurance companies” and inserting in lieu thereof “Exceptions”. (27) Subsection (a) of section 1296 of the 1986 Code is amended by adding at the end thereof the following new sentences: “A foreign corporation may elect to have the determination under paragraph (2) based on the adjusted bases of its assets in lieu of their value. Such an election, once made, may be revoked only with the consent of the Secretary.” (28) Paragraph (2) of section 1291(d) of the 1986 Code is amended by striking out subparagraph (B) and inserting in lieu thereof the following: “(B) Additional election for shareholder of controlled foreign corporations.— “(i) In general.— If— “(I) a passive foreign investment company be-comes a qualified electing fund for a taxable year which begins after December 31, 1986, “(II) the taxpayer holds stock in such company on the first day of such taxable year, and “(III) such company is a controlled foreign corporation (as defined in section 957(a)), the taxpayer may elect to include in gross income as a dividend received on such first day an amount equal to the portion of the post-1986 earnings and profits of such company attributable (under regulations prescribed by the Secretary) to the stock in such company held by the taxpayer on such first day. The amount treated as a dividend under the preceding sentence shall be treated as an excess distribution and shall be allocated under subsection (a)(1)(A) only to days during periods taken into account in determining the post-1986 earnings and profits so attributable. “(ii) Post-1986 earnings and profits.—For purposes of clause (i), the term ‘post-1986 earnings and profits’ means earnings and profits which were accumulated in taxable years of such company beginning after December 31, 1986, and during the period or periods the stock was held by the taxpayer while the company was a passive foreign investment company. “(iii) Coordination with section 959(e).—For purposes of section 959(e), any amount included in gross income under this subparagraph shall be treated as included in gross income under section 1248(a). “(C) Adjustments.— In the case of any stock to which subparagraph (A) or (B) applies— “(i) the adjusted basis of such stock shall be increased by the gain recognized under subparagraph (A) or the amount treated as a dividend under subparagraph (B), as the case may be, and 102 STAT. 3521 “(ii) the taxpayer’s holding period in such stock shall be treated as beginning on the first day referred to in such subparagraph.” (29) (A) Clause (ii) of section 904(d)(2)(A) of the 1986 Code is amended by striking out “or section 1293” and inserting in lieu thereof “or, except as provided in subparagraph (E)(iii) or paragraph (3)(1), section 1293”. (B) Subparagraph (E) of section 904(d)(2) of the 1986 Code is amended by adding at the end thereof the following new clause: “(iii) Treatment of inclusions under section 1293.—If any foreign corporation is a non-controlled section 902 corporation with respect to the taxpayer, any inclusion under section 1293 with respect to such corporation shall be treated as a dividend from such corporation.” (30) Clause (ii) of section 864(b)(2)(A) of the 1986 Code is amended by striking out “section 542(c)(7)” and inserting in lieu thereof “section 542(c)(7), 542(c)(10),”. (31) Paragraph (i) of section 1291(c) of the 1986 Code is amended by adding at the end thereof the following new sentence: “Any increase in the tax imposed by this chapter for the current year under subsection (a) to the extent attributable to the amount referred to in subparagraph (B) shall be treated as interest paid under section 6601 on the due date for the current year.” (32) Section 1293 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(g) Other Special Rules.— “(1) Exception for certain income.— For purposes of deter-mining the amount included in the gross income of any person under this section, the ordinary earnings and net capital gain of a qualified electing fund shall not include any item of income received by such fund if— “(A) such fund is a controlled foreign corporation (as defined in section 957(a)) and such person is a United States shareholder (as defined in section 951(b)) in such fund, and “(B) such person establishes to the satisfaction of the Secretary that— “(i) such income was subject to an effective rate of income tax imposed by a foreign country greater than 90 percent of the maximum rate of tax specified in section 11, or “(ii) such income is— “(I) from sources within the United States, “(II) effectively connected with the conduct by the qualified electing fund of a trade or business in the United States, and “(III) not exempt from taxation (or subject to a reduced rate of tax) pursuant to a treaty obligation of the United States. “(2) Prevention of double inclusion.—The Secretary shall prescribe such adjustment to the provisions of this section as may be necessary to prevent the same item of income of a qualified electing fund from being included in the gross income of a United States person more than once.” (33) Paragraph (3) of section 1291(b) of th® 1986 Code (as amended by paragraph (3)) is amended by striking out “and” at the end of subparagraph (E), by striking out the period at the 102 STAT. 3522end of subparagraph (F) and inserting in lieu thereof “, and”, and by adding at the end thereof the following new subparagraph: “(G) if a charitable deduction was allowable under section 642(c) to a trust for any distribution of its income, proper adjustments shall be made for the deduction so allowable to the extent allocable to distributions or gain in respect of stock in a passive foreign investment company.” (34) Paragraph (2) of section 1294(c) of the 1986 Code is amended by adding at the end thereof the following new sentence: “To the extent provided in regulations, the preceding sentence shall not apply in the case of a transfer in a trans-action with respect to which gain or loss is not recognized (in whole or in part), and the transferee in such transaction shall succeed to the treatment under this section of the transferor.” (35) Section 1297 of the 1986 Code is amended by redesignating subsection (c) as subsection (d) and by inserting after subsection (b) the following new subsection: “(c) Treatment of Stock Held by Pooled Income Fund.—If stock in a passive foreign investment company is owned (or treated as owned under subsection (a)) by a pooled income fund (as defined in section 642(c)(5)) and no portion of any gain from a disposition of such stock may be allocated to income under the terms of the governing instrument of such fund— “(1) section 1291 shall not apply to any gain on a disposition of such stock by such fund if (without regard to section 1291) a deduction would be allowable with respect to such gain under section 642(c)(3), “(2) section 1293 shall not apply with respect to such stock, and “(3) in determining whether section 1291 applies to any distribution in respect of such stock, subsection (d) of section 1291 shall not apply.” (36) Paragraph (1) of section 1297(b) of the 1986 Code is amended by striking out “passive foreign investment corporation” and inserting in lieu thereof “passive foreign investment company”. (37) (A) Paragraph (2) of section 1295(b) of the 1986 Code is amended by adding at the end thereof the following new sentence: “To the extent provided in regulations, such an election may be made later than as required by the preceding sentence in cases where the company failed to make a timely election because it reasonably believed it was not a passive foreign investment company.” (B) The period during which an election under section 1295(b) of the 1986 Code may be made shall in no event expire before the date 60 days after the date of enactment of this Act. (q) Amendments Related to Section 1241 of the Act.— (1) (A) Subparagraph (B) of section 884(b)(2) of the 1986 Code is amended to read as follows: “(B) Limitation.— “(i) In general.—The increase under subparagraph (A) for any taxable year shall not exceed the accumulated effectively connected earnings and profits as of the close of the preceding taxable year. “(ii) Accumulated effectively connected earnings and profits.— For purposes of clause (i), the term 102 STAT. 3523‘accumulated effectively connected earnings and profits’ means the excess of— “(I) the aggregate effectively connected earnings and profits for preceding taxable years beginning after December 31, 1986, over “(II) the aggregate dividend equivalent amounts determined for such preceding taxable years.” (B) For purposes of applying section 884 of the 1986 Code, the earnings and profits of any corporation shall be determined without regard to any increase in earnings and profits under sections 1023(e)(3)(C) and 1021(e)(2)(C) of the Reform Act or arising from section 823(b)(4)(C) of the 1986 Code. (2) (A) Paragraph (1) of section 884(e) of the 1986 Code is amended to read as follows: “(1) Limitation on treaty exemption.— No treaty between the United States and a foreign country shall exempt any foreign corporation from the tax imposed by subsection (a) (or reduce the amount thereof) unless— “(A) such treaty is an income tax treaty, and “(B) such foreign corporation is a qualified resident of such foreign country.”. (B) Paragraph (3) of section 884(e) of the 1986 Code is amended to read as follows: “(3) Coordination with withholding tax.— “(A) In general.—If a foreign corporation is subject to the tax imposed by subsection (a) for any taxable year (determined after the application of any treaty), no tax shall be imposed by section 871(a), 881(a), 1441, or 1442 on any dividends paid by such corporation out of its earnings and profits for such taxable year. “(B) Limitation on certain treaty benefits.— If— “(i) any dividend described in section 861(a)(2)(B) is received by a foreign corporation, and “(ii) subparagraph (A) does not apply to such dividend, rules similar to the rules of subparagraphs (A) and (B) of subsection (f)(3) shall apply to such dividend.” (C) Subsection (f) of section 884 of the 1986 Code is amended— (i) by striking out the 2nd sentence of paragraph (1), and (ii) by adding at the end thereof the following new paragraph: “(3) Coordination with treaties.— “(A) Payor must be qualified resident.— In the case of any interest described in paragraph (1) which is paid or accrued by a foreign corporation, no benefit under any treaty between the United States and the foreign country of which such corporation is a resident shall apply unless— “(i) such treaty is an income tax treaty, and “(ii) such foreign corporation is a qualified resident of such foreign country. “(B) Recipient must be qualified resident.— In the case of any interest described in paragraph (1) which is received or accrued by any corporation, no benefit under any treaty between the United States and the foreign country of which such corporation is a resident shall apply unless— “(i) such treaty is an income tax treaty, and 102 STAT. 3524 “(ii) such foreign corporation is a qualified resident of such foreign country.” (3) Paragraph (1) of section 884(f) of the 1986 Code is amended— (A) by striking out “sections 871, 881, 1441, and 1442” and inserting in lieu thereof “this subtitle”, and (B) by adding at the end thereof the following new sentence: “To the extent provided in regulations, subparagraph (A) shall not apply to interest in excess of the amounts reasonably expected to be deductible under section 882 in computing the effectively connected taxable income of such foreign corporation.” (4) Paragraph (4) of section 884(e) of the 1986 Code is amended by redesignating subparagraph (C) as subparagraph (D) and by inserting after subparagraph (B) the following new subparagraph: “(C) Corporations owned by publicly traded domestic corporations.— A foreign corporation which is a resident of a foreign country shall be treated as a qualified resident of such foreign country if— “(i) such corporation is wholly owned (directly or indirectly) by a domestic corporation, and “(ii) the stock of such domestic corporation is primarily and regularly traded on an established securities market in the United States.” (5) Subparagraph (A) of section 884(e)(4) of the 1986 Code is amended— (A) by striking out “more than 50 percent” in clause (i) and inserting in lieu thereof “50 percent or more”, and (B) by striking out “or the United States” in clause (ii) and inserting in lieu thereof “or citizens or residents of the United States”. (6) Subsection (e) of section 884 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(5) Exception for international organizations.—This section shall not apply to an international organization (as defined in section 7701(a)(18)).” (7) Subparagraph (B) of section 861(a)(2) of the 1986 Code is amended by striking out “other than under section 884(d)(2)” each place it appears and inserting in lieu thereof “other than income described in section 884(d)(2)”. (8) Paragraph (2) of section 26(b) of the 1986 Code is amended by striking out “and” at the end of subparagraph (J), by striking out the period at the end of subparagraph (K) and inserting in lieu thereof “, and”, and by adding at the end thereof the following new subparagraph: “(L) section 884 (relating to branch profits tax).” (9) Section 861 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(f) Cross Reference.— “For treatment of interest paid by the branch of a foreign corporation, see section 884(f).” (10) The paragraph (6) of section 906(b) of the 1986 Code which was added by section 1241(c) of the Reform Act is redesignated as paragraph (7). 102 STAT. 3525 (11) Subsection (c) of section 2104 of the 1986 Code is amended by striking out “section 861(a)(1)(B), section 861(a)(1)(G), or section 861(a)(1)(H)” and inserting in lieu thereof “subparagraph (A), (C), or (D) of section 861(a)(1)”. (12) Subparagraph (A) of section 9O4(g)(9) of the 1986 Code is amended by striking out “861(a)(1)(B)” and inserting in lieu thereof “861(a)(1)(A)” (13) (A) Paragraph (1) of section 4373 of the 1986 Code is amended to read as follows: “(1) Effectively connected items.—Any amount which is effectively connected with the conduct of a trade or business within the United States unless such amount is exempt from the application of section 882(a) pursuant to a treaty obligation of the United States.” (B) The amendment made by subparagraph (A) shall apply with respect to premiums paid after the date 30 days after the date of the enactment of this Act. (14) Paragraph (1) of section 884(f) of the 1986 Code is amended by inserting “(or having gross income treated as effectively connected with the conduct of a trade or business in the United States)” after “United States” in the material preceding subparagraph (A) thereof. (15) Section 861(a)(2)(O of the 1986 Code is amended by striking out “section 243(d)” and inserting in lieu thereof “section 243(e)”. (r) Amendments Related to Section 1242 of the Reform Act.— (1) Paragraph (7) of section 864(c) of the 1986 Code is amended to read as follows: “(7) Treatment of certain property transactions.— For purposes of this title, if— “(A) any property ceases to be used or held for use in connection with the conduct of a trade or business within the United States, and “(B) such property is disposed of within 10 years after such cessation, the determination of whether any income or gain attributable to such disposition is taxable under section 871(b) or 882 (as the case may be) shall be made as if such sale or exchange occurred immediately before such cessation and without regard to the requirement that the taxpayer be engaged in a trade or business within the United States during the taxable year for which such income or gain is taken into account.” (2) Paragraph (6) of section 864(c) of the 1986 Code is amended to read as follows: “(6) Treatment of certain deferred payments, etc.— For purposes of this title, in the case of any income or gain of a nonresident alien individual or a foreign corporation which— “(A) is taken into account for any taxable year, but “(B) is attributable to a sale or exchange of property or the performance of services (or any other transaction) in any other taxable year, the determination of whether such income or gain is taxable under section 871(b) or 882 (as the case may be) shall be made as if such income or gain were taken into account in such other taxable year and without regard to the requirement that the taxpayer be engaged in a trade or business within the United States during the taxable year referred to in subparagraph (A).” 102 STAT. 3526 (s) Amendments Related to Section 1246 of the Reform Act.— (1) (A) Section 1446 of the 1986 Code is amended to read as follows: “SEC. 1446. WITHHOLDING TAX ON FOREIGN PARTNERS’ SHARE OF EFFECTIVELY CONNECTED INCOME. “(a) General Rule.—If— “(1) a partnership has effectively connected taxable income for any taxable year, and “(2) any portion of such income is allocable under section 704 to a foreign partner, such partnership shall pay a withholding tax under this section at such time and in such manner as the Secretary shall by regulations prescribe. “(b) Amount of Withholding Tax.— “(1) In general.—The amount of the withholding tax payable by any partnership under subsection (a) shall be equal to the applicable percentage of the effectively connected taxable income of the partnership which is allocable under section 704 to foreign partners. “(2) Applicable percentage.—For purposes of paragraph (1), the term ‘applicable percentage’ means— “(A) the highest rate of tax specified in section 1 in the case of the portion of the effectively connected taxable income which is allocable under section 704 to foreign partners who are not corporations, and “(B) the highest rate of tax specified in section 11(b) in the case of the portion of the effectively connected taxable income which is allocable under section 704 to foreign partners which are corporations. “(c) Effectively Connected Taxable Income.—For purposes of this section, the term ‘effectively connected taxable income’ means the taxable income of the partnership which is effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States computed with the following adjustments: “(1) Paragraph (1) of section 703(a) shall not apply. “(2) The partnership shall be allowed a deduction for depletion with respect to oil and gas wells but the amount of such deduction shall be determined without regard to sections 613 and 613A. “(3) There shall not be taken into account any item of income, gain, loss, or deduction to the extent allocable under section 704 to any partner who is not a foreign partner. “(d) Treatment of Foreign Partners.— “(1) Allowance of credit.—Each foreign partner of a partnership shall be allowed a credit under section 33 for such partner’s share of the withholding tax paid by the partnership under this section. Such credit shall be allowed for the partner’s taxable year in which (or with which) the partnership taxable year (for which such tax was paid) ends. “(2) Credit treated as distributed to partner.—A foreign partner’s share of any withholding tax paid by the partnership under this section shall be treated as distributed to such partner by such partnership on the last day of the partnership’s taxable year (for which such tax was paid). 102 STAT. 3527 “(e) Foreign Partner.—For purposes of this section, the term “foreign partner” means any partner who is not a United States person. “(f) Regulations.—The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this section, including regulations providing for the application of this section in the case of publicly traded partnerships.” (B) Paragraph (2) of section 6401(b) of the 1986 Code is amended by striking out the last sentence and inserting in lieu thereof the following: “The preceding sentence shall not apply to any credit so allowed by reason of section 1446.” (C) The table of sections for subchapter A of chapter 3 of the 1986 Code is amended by striking out the item relating to section 1446 and inserting in lieu thereof the following: “Sec. 1446. Withholding of tax on foreign partners’ share of effectively connected income.”. (D) The amendments made by this paragraph shall apply to taxable years beginning after December 31, 1987. No amount shall be required to be deducted and withheld under section 1446 of the 1986 Code (as in effect before the amendment made by subparagraph (A)). (2) (A) Subsection (a) of section 872 of the 1986 Code is amended by striking out “the case of a nonresident alien individual” and inserting in lieu thereof “the case of a non-resident alien individual, except where the context clearly indicates otherwise”. (B) Subsection (b) of section 882 of the 1986 Code is amended by striking out “the case of a foreign corporation” and inserting in lieu thereof “the case of a foreign corporation, except where the context clearly indicates otherwise”. (t) Amendments Related to Section 1247 of the Reform Act.— (1) Subparagraph (A) of section 892(a)(2) of the 1986 Code is amended by striking out “or” at the end of clause (i), by striking out the period at the end of clause (ii) and inserting in lieu thereof “, or”, and by adding at the end thereof the following new clause: “(iii) derived from the disposition of any interest in a controlled commercial entity.” (2) Clause (ii) of section 892(a)(2)(A) of the 1986 Code is amended to read as follows: “(ii) received by a controlled commercial entity or received (directly or indirectly) from a controlled commercial entity.” (3) Subsection (a) of section 892 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(3) Treatment as resident.—For purposes of this title, a foreign government shall be treated as a corporate resident of its country. A foreign government shall be so treated for purposes of any income tax treaty obligation of the United States if such government grants equivalent treatment to the Government of the United States.” (4) Section 893 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(c) Limitation on Exclusion.—Subsection (a) shall not apply to— 102 STAT. 3528 “(1) any employee of a controlled commercial entity (as defined in section 892(a)(2)(B)), or “(2) any employee of a foreign government whose services are primarily in connection with a commercial activity (whether within or outside the United States) of the foreign government.” (u) Amendment Related to Section 1249 of the Reform Act.—Subsection (d) of section 1503 of the 1986 Code is amended by adding at the end thereof the following new paragraphs: “(3) Treatment of losses of separate business units.—To the extent provided in regulations, any loss of a separate unit of a domestic corporation shall be subject to the limitations of this subsection in the same manner as if such unit were a wholly owned subsidiary of such corporation. “(4) Income on assets acquired after the loss.—The Secretary shall prescribe such regulations as may be necessary or appropriate to prevent the avoidance of the purposes of this subsection by contributing assets to the corporation with the dual consolidated loss after such loss was sustained.” (v) Amendments Related to Section 1261 of the Reform Act.— (1) (A) So much of section 986 of the 1986 Code as precedes subsection (c) thereof is amended to read as follows: “SEC. 986. DETERMINATION OF FOREIGN TAXES AND FOREIGN CORPORATION’S EARNINGS AND PROFITS. “(a) Foreign Taxes.— (1) In general.— For purposes of determining the amount of the foreign tax credit— “(A) any foreign income taxes shall be translated into dollars using the exchange rates as of the time such taxes were paid to the foreign country or possession of the United States, and “(B) any adjustment to the amount of foreign income taxes shall be translated into dollars using— “(i) except as provided in clause (ii), the exchange rate as of the time when such adjustment is paid to the foreign country or possession, or “(ii) in the case of any refund or credit of foreign income taxes, using the exchange rate as of the time of original payment of such foreign income taxes. (2) Foreign income taxes.—For purposes of paragraph (1), ‘foreign income taxes’ means any income, war profits, or excess profits taxes paid to any foreign country or to any possession of the United States. “(b) Earnings and Profits and Distributions.—For purposes of determining the tax under this subtitle— (1) ) of any shareholder of any foreign corporation, the earnings and profits of such corporation shall be determined in the corporation’s functional currency, and (2) in the case of any United States person, the earnings and profits determined under paragraph (1) (when distributed, deemed distributed, or otherwise taken into account under this subtitle) shall (if necessary) be translated into dollars using the appropriate exchange rate.” (B) Section 987 of the 1986 Code is amended by inserting “and” at the end of paragraph (2), by striking out “, and” at the end of paragraph (3) and inserting in lieu thereof a period, and by striking out paragraph (4). 102 STAT. 3529 (C) The table of sections for subpart J of part III of subchapter N of chapter 1 is amended by striking out the item relating to section 986 and inserting in lieu thereof the following: “Sec. 986. Determination of foreign taxes and foreign corporation’s earnings and profits.” (2) (A) Subsection (c) of section 988 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(5) Special rules where taxpayer takes or makes delivery.— If the taxpayer takes or makes delivery in connection with any section 988 transaction described in paragraph (l)(B)(iii), any gain or loss (determined as if the taxpayer sold the contract, option, or instrument on the date on which he took or made delivery for its fair market value on such date) shall be recognized in the same manner as if such contract, option, or instrument were so sold.”; (B) The amendment made by subparagraph (A) shall not apply in any case in which the taxpayer takes or makes delivery before June 11, 1987. (3) (A) Subsection (b) of section 988 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(3) Special rule for certain contracts, etc.—In the case of any section 988 transaction described in subsection (c)(1)(B)(i), any gain or loss from such transaction shall be treated as foreign currency gain or loss (as the case may be).” (B) Subclause ®) of section 988(c)(1)(C)(i) of the 1986 Code is amended to read as follows: “(II) any gain or loss from such transaction shall be treated as foreign currency gain or loss (as the case may be).” (C) Paragraph (2) of section 988(c) of the 1986 Code is amended by inserting “or” at the end of subparagraph (A), by striking out “, or” at the end of subparagraph (B) and inserting in lieu thereof a period, and by striking out subparagraph (C). (D) Paragraph (3) of section 988(c) of the 1986 Code is amended to read as follows: (3) Payment date.—The term ‘payment date’ means the date on which the payment is made or received.” (4) The first sentence of paragraph (1) of section 988(d) is amended by striking out “this section” and inserting in lieu thereof “this subtitle”. (5) Subsection (b) of section 989 of the 1986 Code is amended— (A) by striking out “951(a)” in paragraph (3) and inserting in lieu thereof “951(a)(1)(A)”, and (B) by adding at the end thereof the following new sentence: “For purposes of the preceding sentence, any amount included in income under section 951(a)(1)(B) shall be treated as an actual distribution made on the last day of the taxable year for which such amount was so included.” (6) Clause (iii) of section 988(c)(1)(B) of the 1986 Code is amended to read as follows: “(iii) Entering into or acquiring any forward con-tract, futures contract, option, or similar financial instrument unless such instrument would be marked to 102 STAT. 3530market under section 1256 if held on the last day of the taxable year.” (7) Subparagraph (B) of section 988(a)(3) of the 1986 Code is amended by adding at the end thereof the following new clause: “(iii) Special rule for partnerships.—To the extent provided in regulations, in the case of a partnership, the determination of residence shall be made at the partner level.” (8) Clause (i) of section 988(a)(3)(B) of the 1986 Code is amended by adding at the end thereof the following new sentence: “If an individual does not have a tax home (as so defined), the residence of such individual shall be the United States if such individual is a United States citizen or a resident alien and shall be a country other than the United States if such individual is not a United States citizen or a resident alien.” (9) Section 903 of the 1986 Code is amended by striking out “this subpart” and inserting in lieu thereof “this part”. (w) Amendments Related to Section 1274 of the Reform Act.— (1) Subsection (e) of section 932 of the 1986 Code is amended to read as follows: “(e) Special Rule for Applying Section to Tax Imposed in Virgin Islands.—In applying this section for purposes of determining income tax liability incurred to the Virgin Islands, the provisions of this section shall not be affected by the provisions of Federal law referred to in section 934(a).” (2) Paragraph (4) of section 932(c) of the 1986 Code is amended to read as follows: “(4) Residents of the virgin islands.—In the case of an individual— “(A) who is a bona fide resident of the Virgin Islands at the close of the taxable year, “(B) who, on his return of income tax to the Virgin Islands, reports income from all sources and identifies the source of each item shown on such return, and “(C) who fully pays his tax liability referred to in section 934(a) to the Virgin Islands with respect to such income, for purposes of calculating income tax liability to the United States, gross income shall not include any amount included in gross income on such return, and allocable deductions and credits shall not be taken into account.” (3) Paragraph (2) of section 932(c) of the 1986 Code is amended by striking out “his income tax return” and inserting in lieu thereof “an income tax return”. (4) Subsection (c) of section 1274 of the Reform Act is amended by striking out “this title” and inserting in lieu thereof “the Internal Revenue Code of 1986”. (x) Amendment Related to Section 1275 of the Reform Act.—Section 1444 of the 1986 Code is amended by striking out “(as modified by section 934A)”. (y) Amendment Related to Section 1276 of the Reform Act.—Subsection (a) of section 7654 of the 1986 Code is amended by striking out “an individual to which” and inserting in lieu thereof “an individual to whom”. (z) Amendment Related to Section 1277 of the Reform Act.— (1) Section 1277 of the Reform Act is amended by adding at the end thereof the following new subsection: 102 STAT. 3531 “(f) Exemption From Withholding.—Notwithstanding subsection (b), the modification of section 884 of the Internal Revenue Code of 1986 by reason of the amendment to section 881 of such Code by section 1273(b)(1) of this Act shall apply to taxable years beginning after December 31, 1986.” (2) Subsection (e) of section 1277 of the Reform Act is amended by striking out “The preceding sentence” and inserting in lieu thereof “Notwithstanding subsection (b), the preceding sentence”. (aa) Coordination With Treaties.— (1) Treaty obligations.— (A) Subsection (d) of section 7852 of the 1986 Code is amended to read as follows: “(d) Treaty Obligations.— “(1) In general.—For purposes of determining the relation-ship between a provision of a treaty and any law of the United States affecting revenue, neither the treaty nor the law shall have preferential status by reason of its being a treaty or law. “(2) Savings clause for 1954 treaties.— No provision of this title (as in effect without regard to any amendment thereto enacted after August 16, 1954) shall apply in any case where its application would be contrary to any treaty obligation of the United States in effect on August 16, 1954.” (B) Section 7852(d)(1) of the 1986 Code, as added by subparagraph (A), shall apply to any taxable period with respect to which the time for assessment of any deficiency has not expired by reason of any law or rule of law before the date of the enactment of this Act. (2) Certain amendments to apply notwithstanding treaties.— The following amendments made by the Reform Act shall apply notwithstanding any treaty obligation of the United States in effect on the date of the enactment of the Reform Act: (A) The amendments made by section 1201 of the Reform Act. (B) The amendments made by title VII of the Reform Act to the extent such amendments relate to the alternative minimum tax foreign tax credit. (3) Certain amendments not to apply to the extent inconsistent with treaties.— The following amendments made by the Reform Act shall not apply to the extent the application of such amendments would be contrary to any treaty obligation of the United States in effect on the date of the enactment of the Reform Act: (A) The amendments made by section 1211 of the Reform Act to the extent— (i) such amendments apply in the case of an individual treated as a resident of a foreign country under a treaty obligation of the United States as so in effect, or (ii) such amendments relate to income of a non-resident from the sale or exchange of inventory property which would otherwise be sourced under section 8(e)(2) of the 1986 Code. (B) The amendments made by section 1212(a) of the Reform Act; except for purposes of determining the amount of the foreign tax credit. (C) The amendments made by subsections (b) and (c) of section 1212 of the Reform Act. 102 STAT. 3532 (D) The amendments made by section 1214 of the Reform Act; except for purposes of determining the amount of the foreign tax credit. (E) The amendment made by section 1241(a) of the Reform Act to the extent that, under a treaty obligation of the United States, interest described in section 884(f)(1)(A) of the 1986 Code (as added by such amendment) which is in excess of amounts deducted would be treated as other than United States source. (F) The amendment made by section 1241(b)(2)(A) of the Reform Act. (G) The amendment made by section 1241(a) of the Reform Act to the extent such amendment relates to section 884(f)(1)(B) of the 1986 Code. (H) The amendments made by section 1242 of the Reform Act to the extent they relate to paragraph (7) of section 864(c) of the 1986 Code. (I) The amendment made by section 1247(a) of the Reform Act. (J) The amendments made by section 123 of the Reform Act. (4) Treatment of technical corrections.—For purposes of paragraphs (2) and (3), any amendment made by this title shall be treated as if it had been included in the provision of the Reform Act to which such amendment relates. (5) Reporting of certain treaty-based return positions.— (A) Subchapter B of chapter 61 of the 1986 Code is amended by redesignating section 6114 as section 6115 and by inserting after section 6113 the following new section: “SEC. 6114. TREATY-BASED RETURN POSITIONS. “(a) In General.—Each taxpayer who, with respect to any tax imposed by this title, takes the position that a treaty of the United States overrules (or otherwise modifies) an internal revenue law of the United States shall disclose (in such manner as the Secretary may prescribe) such position— “(1) on the return of tax for such tax (or any statement attached to such return), or “(2) if no return of tax is required to be filed, in such form as the Secretary may prescribe. “(b) Waiver Authority.—The Secretary may by regulations waive the requirements of subsection (a) with respect to classes of cases for which the Secretary determines that the waiver will not impede the assessment and collection of tax.” (B) Part I of subchapter B of chapter 68 of the 1986 Code is amended by adding at the end thereof the following new section: “SEC. 6712. FAILURE TO DISCLOSE TREATY-BASED RETURN POSITIONS. “(a) General Rule.—If a taxpayer fails to meet the requirements of section 6114, there is hereby imposed a penalty equal to $1,000 ($10,000 in the case of a C corporation) on each such failure. “(b) Authority to Waive.—The Secretary may waive all or any part of the penalty provided by this section on a showing by the taxpayer that there was reasonable cause for the failure and that the taxpayer acted in good faith. 102 STAT. 3533 “(c) Penalty in Addition to Other Penalties.—The penalty imposed by this section shall be in addition to any other penalty imposed by law.” (C) (i) The table of sections for subchapter B of chapter 61 of the 1986 Code is amended by striking out the item relating to section 6114 and inserting in lieu thereof the following: “Sec. 6114. Treaty-baaed return positions. “Sec. 6115. Cross reference.” (ii) The table of sections for part I of subchapter B of chapter 68 of the 1986 Code is amended by adding at the end thereof the following new item: “Sec. 6712. Failure to disclose treaty-based return positions.” (D) The amendments made by this paragraph shall apply to taxable periods the due date for filing returns for which (with-out extension) occurs after December 31, 1988. (6) Subsection (a) of section 894 of the 1986 Code is amended to read as follows: “(a) Treaty Provisions.— “(1) In general.—The provisions of this title shall be applied to any taxpayer with due regard to any treaty obligation of the United States which applies to such taxpayer. “(2) Cross reference.— “For relationship between treaties and this title, see section 7852(d).” (bb) Miscellaneous Foreign Technical Corrections.— (1) Provisions relating to foreign personal holding companies.— (A) Subsection (0 of section 551 of the 1986 Code is amended— (i) by amending paragraph (1) to read as follows: “(1) a foreign partnership or an estate or trust which is a foreign estate or trust, or”, and (ii) by striking out the last sentence and inserting in lieu thereof the following: “In any case to which the preceding sentence applies, the Secretary may by regulations provide that rules similar to the rules of section 1297(b)(5) shall apply, and provide for such other adjustments in the application of this subchapter as may be necessary to carry out the purposes of this subsection.” (B) Subsection (a) of section 551 of the 1986 Code is amended by striking out “(other than estates or trusts the gross income of which under this subtitle includes only income from sources within the United States)” and inserting in lieu thereof “(other than foreign estates or trusts)”. (C) Subsection (c) of section 552 of the 1986 Code is amended to read as follows: “(c) Look-Thru for Certain Dividends and Interest.— “(1) In general.—For purposes of this part, any related person dividend or interest shall be treated as foreign personal holding company income only to the extent such dividend or interest is attributable (determined under rules similar to the rules of subparagraphs (C) and (D) of section 904(d)(3)) to income of the related person which would be foreign personal holding company income. 102 STAT. 3534 “(2) Related person dividend or interest.— For purposes of paragraph (1), the term ‘related person dividend or interest’ means any dividend or interest which— “(A) is described in subparagraph (A) of section 954(c)(3), and “(B) is received from a related person which is not a foreign personal holding company (determined without regard to this subsection). For purposes of the preceding sentence, the term ‘related person’ has the meaning given such term by section 954(d)(3) (determined by substituting ‘foreign personal holding company’ for ‘controlled foreign corporation’ each place it appears).” (D) The amendments made by this paragraph shall apply to taxable years of foreign corporations beginning after December 31, 1986. (2) Treatment of certain payments outside the united states.— (A) Subparagraph (A) of section 3405(d)(13) of the 1986 Code is amended by striking out “the United States” and inserting in lieu thereof “the United States and any possession of the United States”. (B) Clause (i) of section 3405(d)(13)(B) of the 1986 Code is amended to read as follows: “(i) a United States citizen or a resident alien of the United States, or”. (C) The heading of paragraph (13) of section 3405(d) of the 1986 Code is amended by striking out “united states” and inserting in lieu thereof “united states or its possessions”. (D) Hie amendments made by this paragraph shall apply to distributions made after the date of the enactment of this Act. (3) Clarification of disclosure under certain agreements.— (A) Paragraph (4) of section 6103(k) of the 1986 Code is amended— (i) by striking out “or other convention” and inserting in lieu thereof “or other convention or bilateral agreement”, and (ii) by striking out “such convention” and inserting in lieu thereof “such convention or bilateral agreement”. (B) Subparagraph (A) of section 6103(b)(5) of the 1986 Code is amended by striking out “the Commonwealth of the Northern Mariana Islands, the Republic of the Marshall Islands, the Federated States of Micronesia, and the Republic of Palau” and inserting in lieu thereof “and the Commonwealth of the Northern Mariana Islands”. (C) The amendments made by this paragraph shall take effect on the date of the enactment of the Tax Reform Act of 1986. (4) Coordination of treaties with section 904 (g).— (A) Subsection (g) of section 904 of the 1986 Code is amended by redesignating paragraph (10) as paragraph (11) and by inserting after paragraph (9) the following new paragraph: “(10) Coordination with treaties.— 102 STAT. 3535 “(A) In general.—If— “(i) any amount derived from a United States-owned foreign corporation would be treated as derived from sources within the United States under this subsection by reason of an item of income of such United States owned foreign corporation, “(ii) under a treaty obligation of the United States (applied without regard to this subsection and by treating any amount included in gross income under section 951(a)(1) as a dividend), such amount would be treated as arising from sources outside the United States, and “(iii) the taxpayer chooses the benefits of this paragraph, this subsection shall not apply to such amount to the extent attributable to such item of income (but subsections (a), (b), and (c) of this section and sections 902, 907, and 960 shall be applied separately with respect to such amount to the extent so attributable). “(B) Special rule.—Amounts included in gross income under section 951(a)(1) shall be treated as a dividend under subparagraph (A)(ii) only if dividends paid by each corporation (the stock in which is taken into account in determining whether the shareholder is a United States shareholder in the United States-owned foreign corporation), if paid to the United States shareholder, would be treated under a treaty obligation of the United States as arising from sources outside the United States (applied without regard to this subsection).” (B) The amendment made by subparagraph (A) shall take effect as if included in the amendment made by section 121 of the Tax Reform Act of 1984. (5) Treatment of election under section 338.— (A) In general—Subsection (h) of section 338 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(16) Coordination with foreign tax credit provisions.—Except as provided in regulations, this section shall not apply for purposes of determining the source or character of any item for purposes of subpart A of part HI of subchapter N of this chapter (relating to foreign tax credit). The preceding sentence shall not apply to any gain to the extent such gain is includible in gross income as a dividend under section 1248 (determined without regard to any deemed sale under this section by a foreign corporation).” (B) Effective date.—The amendment made by subparagraph (A) shall apply to qualified stock purchases (as defined in section 338(d)(3) of the 1986 Code) after March 31, 1988, except that, in the case of an election under section 338(h)(10) of the 1986 Code, such amendment shall apply to qualified stock purchases (as so defined) after June 10, 1987. (6) Treatment of tax-exempt shareholders of a disc.— (A) Section 995 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(g) Treatment of Tax-Exempt Shareholders.—If any organization described in subsection (a)(2) or (b)(2) of section 511 is a share-holder in a DISC— 102 STAT. 3536 “(1) any amount deemed distributed to such shareholder under subsection (b), “(2) any actual distribution to such shareholder which under section 996 is treated as out of accumulated DISC income, and “(3) any gain which is treated as a dividend under subsection (c), shall be treated as derived from the conduct of an unrelated trade or business (and the modifications of section 512(b) shall not apply). The rules of the preceding sentence shall apply also for purposes of determining any such shareholder’s DISC-related deferred tax liability under subsection (f).” (B) The amendment made by subparagraph (A) shall apply to taxable years beginning after December 31, 1987. (7) Treatment of certain amounts previously taxed under section 1248.— (A) In general.—Subsection (e) of section 959 of the 1986 Code is amended by striking out “such person under” and inserting in lieu thereof “such person (or, in any case to which section 1248(e) applies, of the domestic corporation referred to in section 1248(e)(2)) under”. (B) Effective date.—The amendment made by subparagraph (A) shall apply in the case of transactions to which section 1248(e) of the 1986 Code applies and which occur after December 31, 1986. (8) Treatment of shared fsc’s.— (A) In general.—Section 927 of the 1986 Code is amended by adding at the end thereof the following new subsection: “(g) Treatment of Shared FSC’s.— “(1) In general.—Except as provided in paragraph (2), each separate account referred to in paragraph (3) maintained by a shared FSC shall be treated as a separate corporation for purposes of this subpart. “(2) Certain requirements applied at shared fsc level.— Paragraph (1) shall not apply— “(A) for purposes of— “(i) subparagraphs (A), (B), (D), and (E) of section 922(a)(1), “(ii) paragraph (2) of section 922(a), “(iii) subsections (b), (c), and (e) of section 924, and “(iv) subsection (f) of this section, and “(B) for such other purposes as the Secretary may by regulations prescribed. “(3) Shared fsc.—For purposes of this subsection, the term ‘shared FSC’ means any corporation if— “(A) such corporation maintains a separate account for transactions with each shareholder (and persons related to such shareholder), “(B) distributions to each shareholder are based on the amounts in the separate account maintained with respect to such shareholder, and “(C) such corporation meets such other requirements as the Secretary may by regulations prescribe.” (B) The amendment made by subparagraph (A) shall apply as if included in the provision of the Tax Reform Act of 1984 to which it relates. 102 STAT. 3537 (9) Clarification of dividends received deduction for dividends from a FSC.— (A) Subsection (c) of section 245 of the 1986 Code is amended to read as follows: “(c) Certain Dividends Received From FSC.— “(1) In general.— In the case of a domestic corporation, there shall be allowed as a deduction an amount equal to— “(A) 100 percent of any dividend received from another corporation which is distributed out of earnings and profits attributable to foreign trade income for a period during which such other corporation was a FSC, and “(B) 70 percent (80 percent in the case of dividends from a 20-percent owned corporation as defined in section 243(c)(2)) of any dividend received from another corporation which is distributed out of earnings and profits attributable to effectively connected income received or accrued by such other corporation while such other corporation was a FSC. “(2) Exception for certain dividends.— Paragraph (1) shall not apply to any dividend which is distributed out of earnings and profits attributable to foreign trade income which— “(A) is section 923(a)(2) nonexempt income (within the meaning of section 927(d)(6)), or “(B) would not, but for section 923(a)(4), be treated as exempt foreign trade income. “(3) No deduction under subsection (a) or (b).—No deduction shall be allowable under subsection (a) or (b) with respect to any dividend which is distributed out of earnings and profits of a corporation accumulated while such corporation was a FSC. “(4) Definitions.— For purposes of this subsection— “(A) Foreign trade income; exempt foreign trade income.—The terms ‘foreign trade income’ and ‘exempt foreign trade income’ have the respective meanings given such terms by section 923. “(B) Effectively connected income.—The term ‘effectively connected income’ means any income which is effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States and is subject to tax under this chapter. Such term shall not include any foreign trade income.” (B) The amendment made by subparagraph (A) shall apply as if included in the provision of the Tax Reform Act of 1984 to which it relates.