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INTRODUCTION
Deconsolidation is a mechanism that has been used by taxpayers to improve their tax positions. There are three common situations in which the deconsolidation of certain corporations may be beneficial. First, it may be beneficial to deconsolidate a corporation having either U.S. source or foreign source losses. For a consolidated group, foreign tax credits are based on the total foreign source income for the group. Therefore, if a member of a consolidated group has U.S. or foreign source losses, these losses will offset the foreign source income of other members of the group, resulting in less foreign source income and, consequently, a lower foreign tax credit limitation.
Second, it may be beneficial to deconsolidate a corporation that is expected to generate a substantial amount of foreign source income if the consolidated group has had foreign losses that have offset U.S. source income. Under Sec 904(f),(1) where a group's foreign losses have offset U.S. income, the group's future foreign source income will need to be recharacterized as U.S. source income. If such company remains part of the consolidated group, a portion of its future foreign source income will be recharacterized as U.S. source income, thereby reducing the amount of foreign source income and the foreign tax credit limitation.
Finally, for purposes of allocating a group's interest expense under 864, where a company has a large amount of foreign income, the deconsolidation of such company may help to increase the ratio of U.S. to foreign assets. This would result in more of the group's interest being allocated to U.S. source income. For this situation, the Service has adopted Regs. Sec 1.861-11T, under the authority of Sec 864(e), to prevent the manipulation of interest expense between U.S. and foreign source income.
In 1989, Congress enacted Sec 904(i) to prevent the use of deconsolidation to enhance available foreign tax credits for related corporations.(2) Section 904(i) applies to corporations that would be members of an affiliated group under 1504 but for the ownership of includible corporations by entities that are not includible corporations, or the inapplicability of certain constructive ownership rules. Section 904(i) also applies to corporations that are part of the same affiliated group under Sec 1504 but do not file a consolidated return. Section 904(i) granted...