The dual-consolidated-loss trap.

• Author: O'Connell, Frank J., Jr.

The adoption of the "check-the-box" rules in Regs. Sec. 301.7701-3 has significantly enhanced the tax-planning strategies available to U.S. corporations doing business abroad. This is particularly true for S corporations not eligible to claim indirect foreign tax credits (FTCs) under Sec. 902 on dividends received from their foreign subsidiaries. A check-the-box election to treat a foreign subsidiary as a passthrough entity allows the S corporation (and its shareholders) to claim a direct FTC, under Sec. 901, for the foreign taxes paid by the foreign subsidiary. Moreover, treating the foreign subsidiary as a passthrough entity enables the U.S. corporate shareholder to deduct any losses incurred by the foreign subsidiary against the corporation's domestic taxable income. However, a C or S corporation seeking to claim such foreign losses against its U.S. income must be aware of the special requirements imposed by the dual-consolidated-loss (DCL) rules, which may limit a U.S. corporate shareholder's ability to claim such losses.

The DCL rules in Sec. 1503(d) generally prevent a dual-resident corporation (DRC) from offsetting a DCL against the income of a domestic affiliate (as defined in Sec. 1504(d)). A DRC is any domestic corporation subject to tax in a foreign country either on a worldwide or residence basis. A DCL is a net operating loss (NOL) incurred by the DRC, unless the loss cannot offset, or be carried back or forward to offset, by any means, the income of any other person under the laws of a foreign country. Sec. 1503(d)(3) treats a "separate unit" of a U.S. corporation, such as a branch or a partnership, as if it were a wholly owned subsidiary and, therefore, deemed affiliated with the U.S. corporation under Sec. 1504(d). Thus, the DCL rules may apply to losses incurred by a foreign branch of a U.S. corporation.

Regs. Sec. 1.1503-2(c)(5)(ii) provides two exceptions to the definition of a DCL. One exception is for losses incurred in a foreign country whose income tax laws do not allow such losses to offset income of any other person or entity in the same tax year the loss is incurred, and do not allow such loss to be carried over or back to be used, by any means, to offset the income of any other person in other tax years. The term "by any means" can be construed to mean that the other person whose income might be offset under foreign law by the DCL does not have to exist in the year of the loss, if there is the possibility of a...