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The Senate amendment provides a ``financial institution group'' election that expands the bank group rules of present law (sec. 864(e)(5)(B)-(D)), but modifies the House bill by providing that this election is a one-time election as opposed to an annual election, and by providing that the election is only available to the extent that a worldwide affiliated group election has been made. Thus,

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   Under the Senate amendment, at the election of the common parent of the affiliated group that has made the election to apply the worldwide affiliated group rules, those rules can be applied separately to a subgroup of the worldwide affiliated group that consists of (1) all corporations that are part of the present-law bank group and (2) all ``financial corporations.'' For this purpose, the Senate amendment follows the House bill by providing that a corporation is a financial corporation if at least 80 percent of its gross income is ``financial services income'' (as described in section 904(d)(2)(C)(ii) and the regulations thereunder).\69\ The Senate amendment modifies the House bill, however, by requiring that such income be derived from transactions with unrelated persons. \69\ See Treas. Reg. sec. 1.904-4(e)(2).

   Under the Senate amendment, the financial institution group rules, if elected, apply to all members of the worldwide affiliated group that are financial corporations within the meaning of the provision. The election must be made for the first taxable year beginning after December 31, 2004, in which a worldwide affiliated group includes a financial corporation that would qualify as part of the expanded financial institution group (other than a corporation that would qualify as part of the present-law bank group). Once made, the election applies to the financial institution group for the taxable year and all subsequent taxable years. In addition, the Senate amendment provides anti-abuse rules under which certain transfers from one member of a financial institution group to a member of the worldwide affiliated group outside of the financial institution group are treated as reducing the amount of indebtedness of the separate financial institution group.

   Effective date

   The provision in the Senate amendment is effective for taxable years beginning after December 31, 2004.

   The conference agreement generally follows the House bill with the following modifications.

   Worldwide affiliated group election

   The conference agreement modifies the present-law interest ex pense al location ru les by providing a one-time election under which the taxable income of the domestic members of an affiliated group from sources outside the United States generally would be determined by allocating and apportioning interest ex pense of the domestic members of a worldwide affiliated group on a worldwide-group basis. The election provides taxpayers with the option either to apply fungibility principles on a worldwide basis or to continue to apply present law. The conference agreement makes no changes to the present-law interest ex pense al location ru les; all aspects of the provision apply only to the extent that a worldwide affiliated group election is made.

   Under the conference agreement, if an affiliated group makes the worldwide affiliated group election, subject to certain modifications and exceptions, the taxable income of the domestic members of the worldwide affiliated group from sources outside the United States is determined by allocating and apportioning the interest ex pense of those domestic members to foreign-source income in an amount equal to the excess (if any) of (1) the worldwide affiliated group's worldwide interest ex pense mu ltiplied by the ratio which the foreign assets of the worldwide affiliated group bears to the total assets of the worldwide affiliated group, over (2) the interest ex pense in curred by a foreign member of the group (and taken into account for allocation pu rposes) to the extent that such interest wo uld be allocated to foreign sources if the provision's principles were applied separately to the foreign members of the group. While this approach is generally the same as that under the House bill, the conference agreement follows the Senate amendment by providing the actual allocation an d apportionment formula in the statute.

   For purposes of the new elective rules based on worldwide fungibility, the worldwide affiliated group means all corporations in an affiliated group (as that term is defined under present law for interest ex pense al location pu rposes) \70\ as well as any foreign corporations with respect to which domestic members of the affiliated group own stock meeting the ownership requirements for treatment as a controlled foreign corporation under section 957(a). For this purpose, the conference agreement modifies the House bill to permit limited constructive ownership rules (as described in section 958(b)) to apply. The conferees, however, believe that certain constructive ownership rules such as option attribution and ``to-corporation'' attribution (sec. 318(a)(3) and (4)) does not provide sufficient economic ownership to justify inclusion in the worldwide affiliated group. The conference agreement therefore disregards these types of constructive ownership. Hence, if more than 50 percent of the total combined voting power or the total value of the stock of a foreign corporation is owned (directly, indirectly, or, in certain circumstances, constructively) by domestic members of the affiliated group that are U.S. shareholders (i.e., that own 10 percent or more of the total combined voting power of the stock of such foreign corporation), then such foreign corporation is included in an electing worldwide affiliated group. \70\ The conference agreement expands the present-law definition of an affiliated group for interest ex pense al location pu rposes with respect to an electing worldwide affiliated group to include certain insurance companies that are generally excluded from an affiliated group under section 1504(b)(2) (without regard to whether such companies are covered by an election under section 1504(c)(2)). As is the case under present law, the affiliated group includes section 936 corporations.

   With respect to foreign corporations included in a worldwide affiliated group, the conference agreement follows the House bill in providing that only a pro rata portion of such foreign corporation's interest ex pense an d assets is treated as attributable to the worldwide affiliated group and taken into account for purposes of determining the allocation an d apportionment of interest ex pense. T he pro rata portion is determined by the ratio of the value of the stock of the foreign corporation owned (within the meaning of section 958(a)) by domestic members of the worldwide affiliated group (regardless of whether the foreign corporation qualifies as more than 50-percent owned because of either vote or value) to the total value of the stock of such foreign corporation.

   Under the conference agreement, the worldwide affiliated group election is to be made by the common parent of the affiliated group. It must be made for the first taxable year beginning after December 31, 2001 (the effective date under the conference agreement), in which a worldwide affiliated group exists that includes at least one foreign corporation that meets the requirements for inclusion in a worldwide affiliated group. Once made, the election applies to the common parent and all other members of the worldwide affiliated group for the taxable year for which the election was made and all subsequent taxable years.

   Additional elections

   The conference agreement modifies the annual elections provided in the House bill as follows. To the extent that a worldwide affiliated group elects to apply the new worldwide fungibility principle, the conference agreement provides two additional elections that are exceptions to the ``one-taxpayer'' rule described above: (1) the ``subsidiary group'' election, and (2) the ``financial institution group'' election.

   Subsidiary group election

   Under the subsidiary group election, at the election of the common parent of the affiliated group, certain interest ex pense at tributable to qualified indebtedness incurred by a domestic member of the affiliated group (other than the common parent) is allocated and apportioned by treating the borrower and its direct and indirect subsidiaries as a separate group (in which the borrower would be treated as the common parent). The conference agreement modifies the House bill by providing that election is only available to the extent that the affiliated group has elected the worldwide fungibility rules, and those rules apply to the qualified indebtedness of the members of that separate electing subsidiary group. For this purpose, qualified indebtedness generally means any borrowing from unrelated parties that is not guaranteed or in any other way supported by any corporation within the same worldwide affiliated group (other than a member of the subsidiary group) of the borrower.

   If the common parent of the worldwide affiliated group makes the election with respect to a domestic member of an affiliated group, the subsidiary group election applies to all direct and indirect subsidiaries of that member. The conference agreement modifies the House bill to provide that the election, once made, applies to the taxable year and the four succeeding taxable years (unless revoked with the consent of the Treasury Secretary). The conferees are concerned with certain potentials for abuse and believe that a five-year period is a reasonable duration for which the subsidiary group election should apply. In addition, as under the House bill, no member of an electing subsidiary group can be treated as a member of another electing subsidiary group. Therefore, a separate subsidiary group election cannot be made with respect to lower-tier subsidiaries in an electing subsidiary group.

   The conference agreement follows the House bill by providing that, if the subsidiary group election is made, an ``equalization'' rule applies under which interest ex pense (i f any) incurred by domestic members of the worldwide affiliated group with respect to indebtedness that is not qualified indebtedness of an electing subsidiary group is allocated first to foreign- source income to the extent necessary to achieve (if possible) the allocation an d apportionment of interest ex pense to foreign-source income that would have resulted had the subsidiary group election not been made. In addition, the conference agreement provides anti-abuse rules under which certain transfers from one member of a subsidiary group to a member of the affiliated group outside of the subsidiary group would be recharacterized as reducing the amount of qualified indebtedness, except as otherwise provided by the Treasury Secretary.

   Financial institution group election

   The conference agreement generally follows the Senate amendment with respect to

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   For purposes of the financial institution group election, the conference agreement provides that a corporation is a financial corporation if at least 80 percent of its gross income is (1) ``financial services income'' (as described in section 904(d)(2)(C)(ii) and the regulations thereunder), \71\ that is derived from transactions with unrelated persons or (2) dividends or financial services income derived directly or indirectly from related corporations that satisfy the 80-percent test by deriving financial services income from transactions with unrelated persons. \72\ For this purpose, the conferees intend that certain ordering rules and netting rules with respect to amounts paid or accrued to and amounts received or accrued from related persons, similar to those provided in Treas. Reg. sec. 1.904-5(k), will apply. The conferees also intend that, for this purpose, gross income will not include gain from the disposition of the stock of a corporation that is related to the transferor prior to such disposition. \73\ In addition, the conference agreement provides an anti-abuse rule under which items of income or gain from a transaction a principal purpose of which is to qualify a corporation as a financial corporation under these rules are disregarded. \71\ See Treas. Reg. sec. 1.904-4(e)(2). \72\ As is the case under the House bill, the conference agreement provides that certain bank holding companies that would qualify as part of the present-law bank group are also considered to be financial corporations. \73\ See Treas. Reg. sec. 1.904-4(e)(3)(i).

   Under the conference agreement, the financial institution group rules, if elected, apply to all members of the worldwide affiliated group that are financial corporations within the meaning of the provision. If a financial institution group election has been made, a member of the worldwide affiliated group that is part of the financial institution group cannot also be a member of a separate subsidiary group. The election must be made for the first taxable year beginning after December 31, 2001, in which a worldwide affiliated group includes a corporation that qualifies as a financial corporation. Once made, the election applies to the financial institution group for the taxable year and all subsequent taxable years. Therefore, if a financial institution group election is in place, a corporation that qualifies as a financial corporation for a taxable year will be included in the financial institution group for that year notwithstanding that it may not have qualified in prior years for which the election was in place. Similarly, a corporation that was a financial corporation in the first year in which an election was made will be included in the financial institution group for all subsequent years, but only to the extent that such corporation qualifies as a financial corporation for a given year. In addition, the conference agreement provides anti-abuse rules similar to those that apply in connection with the subsidiary group election.

   The conference agreement follows the House bill and the Senate amendment in granting the Treasury Secretary authority to prescribe rules to carry out the purposes of the provision. Such authority includes, among other things, the authority to provide for direct allocation of interest ex pense in appropriate circumstances. The conferees intend that this authority to provide for direct allocation of interest ex pense in cludes, for example, circumstances in which interest ex pense is incurred by foreign corporations in order to circumvent the purposes of the provision.

   The provision in the conference agreement is effective for taxable years beginning after December 31, 2001.

   U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. The amount of foreign tax credits that may be claimed in a year is subject to a limitation that prevents taxpayers from using foreign tax credits to offset U.S. tax on U.S.-source income. Separate limitations are applied to specific categories of income.

   Special foreign tax credit limitations apply in the case of dividends received from a foreign corporation in which the taxpayer owns at least 10 percent of the stock by vote and which is not a controlled foreign corporation (a so-called ``10/50 company''). \74\ Dividends paid by a 10/50 company in taxable years beginning before January 1, 2003, are subject to a separate foreign tax credit limitation for each 10/50 company. Dividends paid by a 10/50 company that is not a passive foreign investment company in taxable years beginning after December 31, 2002, out of earnings and profits accumulated in taxable years beginning before January 1, 2003, are subject to a single foreign tax credit limitation for all 10/50 companies (other than passive foreign investment companies). Dividends paid by a 10/50 company that is a passive foreign investment company out of earnings and profits accumulated in taxable years beginning before January 1, 2003, continue to be subject to a separate foreign tax credit limitation for each such 10/50 company. Dividends paid by a 10/50 company in taxable years beginning after December 31, 2002, out of earnings and profits accumulated in taxable years after December 31, 2002, are treated as income in a foreign tax credit limitation category in proportion to the ratio of the earnings and profits attributable to income in such foreign tax credit limitation category to the total earnings and profits (a so-called ``look-through'' approach). For these purposes, distributions are treated as made from the most recently accumulated earnings and profits. Regulatory authority is granted to provide rules regarding the treatment of distributions out of earnings and profits for periods prior to the taxpayer's acquisition of such stock. \74\ A controlled foreign corporation in which the taxpayer owns at least 10 percent of the stock by vote is treated as a 10/50 company with respect to any distribution out of earnings and profits for periods when it was not a controlled foreign corporation.

   The House bill simplifies the application of the foreign tax credit limitation by applying the look-through approach to all dividends paid by a 10/50 company, regardless of the year in which the earnings and profits out of which the dividend is paid were accumulated. The House bill eliminates the single-basket limitation approach for dividends from such companies for foreign tax credit limitation purposes.

   The House bill provides a transition rule under which pre-effective date foreign tax credits associated with a 10/50 company separate limitation category can be carried forward into post-effective date years. Under the House bill, look-through principles similar to those applicable to post-effective date dividends from a 10/50 company apply to determine the appropriate foreign tax credit limitation category or categories with respect to the foreign tax credit carryforward.

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