Worthless-stock losses in foreign subsidiaries did not "occur in" the COVID disaster area, so no section 165(i) disaster-loss election

Plain-English summary

A U.S. consolidated corporate group had a subsidiary that owned three foreign corporations (CFCs). Through entity-classification elections and a reorganization, each CFC was deemed to liquidate, and the subsidiary claimed large worthless-stock deductions on the group's return. The group elected to treat those losses as "disaster losses" under section 165(i), tied to the nationwide COVID-19 emergency, which is a federally declared disaster covering every state. That election let the group carry the losses back to earlier tax years that had higher corporate rates, producing a bigger benefit. Chief Counsel (International) advised that a section 165(i) loss must both occur in the disaster area and be attributable to the disaster, and addressed only the "occur in" requirement. It concluded that a loss on stock of a foreign corporation is located by looking at the corporation's own business metrics (assets, customers, employees, revenue), not the shareholder's residence or the place of the deemed sale. Because none of the CFCs had substantially all of their business in the U.S. COVID disaster area, the losses did not occur there and do not qualify as section 165(i) disaster losses. The memorandum is deliberately narrow: it does not decide worthlessness, attributability, or whether the restructuring steps were valid, and it flags substance-over-form and section 269 concerns for the examination team.

Ruling snapshot

• Question: Did the worthless-stock losses on the foreign CFCs "occur in" a federally declared disaster area under section 165(i)(1) and Treas. Reg. § 1.165-11(b)(3)?
• Outcome: Advice (Chief Counsel concluded the losses did not occur in the disaster area and do not qualify under section 165(i))
• Key authorities: IRC § 165(i), (g), (a); Treas. Reg. § 1.165-11; IRC § 865 and Treas. Reg. § 1.865-2; IRC § 269

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service

memorandum

Number: 202325007
Release Date: 6/23/2023
CC:INTL:B05:JSDeuth Third Party Communication: None
POSTU-101813-23 Date of Communication: Not Applicable

UILC: 165.07-00

date: March 22, 2023

to: Mary K. Black
(Large Business & International)

from: Peter H. Blessing
Associate Chief Counsel (International)

subject: Application of Section 165(i) With Respect to Stock in a Controlled Foreign
Corporation

This memorandum responds to your request for assistance regarding application of
section 165(i) to losses sustained with respect to stock of three controlled foreign
corporations ("CFCs"). This memorandum is limited in scope and does not address
related issues such as whether the taxpayer is permitted to take a stock loss, whether a
stock loss can be taken as a disaster loss eligible for the section 165(i) election,
whether a stock loss can be attributable to a federally declared disaster, or whether the
taxpayer's CFCs' entity classifications were appropriate under U.S. tax principles. This
advice may not be used or cited as precedent.

ISSUE

Whether losses sustained by ---------------------------------------- ("Subsidiary") in three
controlled foreign corporations – -------------------- ("Country 1 CFC"), --------------------------
---------------------------- ("Country 2 CFC"), and ------------------------------------ ("Country 3
CFC") (collectively, the "CFCs") – of which Subsidiary was the sole shareholder,
"occur[red] in" a federally declared disaster area for purposes of meeting the
requirements of section 165(i)(1) and Treas. Reg. §1.165-11(b)(3).1

1 Unless otherwise indicated, all references to "section" are to the Internal Revenue Code of 1986, as
amended (the "Code"), and all references to "Treas. Reg. §" are to the Treasury regulations promulgated
thereunder.

CONCLUSION

The losses sustained by Subsidiary with respect to stock in the CFCs did not occur in a
federally declared disaster area within the meaning of section 165(i)(1) and Treas. Reg.
§1.165-11(b)(3), and, therefore, the losses do not qualify as disaster losses under
section 165(i).2

FACTUAL BACKGROUND

On March 13, 2020, President Trump declared that the COVID-19 outbreak in the
United States constituted a nationwide emergency pursuant to the Robert T. Stafford
Disaster Relief and Emergency Assistance Act, 42 U.S.C. 5121-5207 (the "Stafford
Act").3 Specifically, the declaration letter provided:

    I have determined that the ongoing Coronavirus Disease 2019 (COVID-19)
    pandemic is of sufficient severity and magnitude to warrant an emergency
    determination under section 501(b) of the Robert T. Stafford Disaster Relief and
    Emergency Assistance Act, 42 U.S.C. 5121-5207 (the "Stafford Act").

    ...

    Therefore, as an initial step, I hereby determine, under section 501(b) of the
    Stafford Act, that an emergency exists nationwide. In accordance with this
    determination, the Federal Emergency Management Agency may provide, as
    appropriate, assistance pursuant to section 502 and 503 of the Stafford Act for
    emergency protective measures not authorized under other Federal statutes.

    ...

    In addition, after careful consideration, I believe that the disaster is of such
    severity and magnitude nationwide that requests for a declaration of a major
    disaster as set forth in section 401(a) of the Stafford Act may be appropriate.

For purposes of this memorandum, the declaration is referred to as the "COVID
Declaration" and the emergency is referred to as the "COVID National Emergency."

2 This memorandum does not address whether the losses sustained by Subsidiary with respect to the
CFCs were "attributable to" the federally declared disaster within the meaning of section 165(i)(1) and
Treas. Reg. §1.165-11(b)(3), which is an additional requirement for the losses in this case to qualify under
section 165(i), regardless of where they occurred.

3 Letter from Donald J. Trump, President of the United States, to Acting Secretary Wolf, Secretary
Mnuchin, Secretary Azar, and Administrator Gaynor (Mar. 13, 2020),
https://trumpwhitehouse.archives.gov/briefings-statements/letter-president-donald-j-trump-emergency-
determination-stafford-act/.

After the COVID Declaration, President Trump approved requests for major disaster
declarations under the authority of the Stafford Act with respect to all fifty states, District
of Columbia, U.S. Virgin Islands, Commonwealth of Puerto Rico, American Samoa,
Northern Mariana Islands, Guam, and a number of tribes, beginning from January 20,
2020 (the "COVID Disaster Area").4 The COVID National Emergency with respect to
each COVID Disaster Area remains effective until terminated by notice of publication in
the Federal Register.5

FACTS

--------------------------------, a ------------- corporation that is ------------------------------------------
----------------------, is the common parent of an affiliated group of corporations filing a
consolidated U.S. federal income tax return (the "Taxpayer"). The Taxpayer's taxable
year is the calendar year. Taxpayer's -------------------- taxable years are under
examination. The Taxpayer is headquartered in ------------------.

The Taxpayer is in the --------------------------------------------, with ----------- in the United
States, ----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------, and -------------. In
addition to ------------------, the Taxpayer also operates ------------------------- within its -------
-------------------------------------------------. Before the COVID pandemic, the Taxpayer
operated ----------------- in the United States and ---------------------------------------. The
Taxpayer leased all of its ---------------------------------. None of the CFCs' operations in ---
------------------ derived material revenue from customers in the United States.

In -------, the Taxpayer undertook a restructuring plan "---------------------------------------------

---------------------------------------------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------" One of the
Taxpayer's wholly owned subsidiaries, Subsidiary, was the sole shareholder of the

4 Federal Emergency Management Agency, COVID-19 Disaster Declarations,
https://www.fema.gov/coronavirus/disaster-declarations (last visited March 22, 2023). These FEMA
notices are published in the Federal Register. See, e.g., New Jersey; Major Disaster and Related
Determinations, 85 Fed. Reg. 20,700 (Apr. 14, 2020); New Mexico; Major Disaster and Related
Determinations, 85 Fed. Reg. 26, 701 (May 5, 2020); and Ohio; Major Disaster and Related
Determinations, 85 Fed. Reg. 26,702 (May 5, 2020).

5 See 44 C.F.R. §206.32(f), which provides that federal assistance under the Stafford Act may be
approved if the damage or hardship giving rise to a Presidential declaration of a major disaster or
emergency took place during the "incident period or was in anticipation of that incident." "The incident
period will be established by FEMA in the FEMA-State Agreement and published in the Federal Register."
Id.

CFCs that were part of the Taxpayer's ------- restructuring. In -------, Subsidiary was a
domestic eligible entity treated as an association taxable as a corporation.

The Taxpayer's tax returns and related filings for the years under examination, plus
information submitted in response to Exam's questions, indicate that the -------
restructuring involved the following entities and transactions:

1. As of --------------------------, Country 1 CFC was a limited liability company
   organized under the laws of the ---------------------- that was a disregarded entity
   for U.S. federal income tax purposes and was 100 percent owned by Subsidiary.
   On --------------------------, -----------------------------------, a ------ corporation for U.S.
   federal income tax purposes, contributed assets to Country 1 CFC in exchange
   for membership interests therein. On --------------------------, ------------------------------
   -------------------, a disregarded entity for U.S. federal income tax purposes whose
   sole owner was Subsidiary, contributed assets to Country 1 CFC in exchange for
   membership interests therein. As of --------------------------, Country 1 CFC's
   default entity classification for U.S. federal income tax purposes was as a
   partnership. Country 1 CFC was a holding company for the Taxpayer's ------------
   ------------- and -------- operations.

    In -----------------, Country 1 CFC filed an IRS Form 8832 to change its entity
    classification from a foreign eligible entity that was classified as a partnership to a
    foreign eligible entity treated as an association taxable as a corporation, effective
    ---------------------.6 Pursuant to the restructuring plan, -------------------------------------
    ----------------------------------------------------------------------------------------------------------
    contributed its interest in Country 1 CFC to Subsidiary on -------------------------------
    --------------------------------------------------------------------------------------------------------, in
    an exchange governed by section 351. As a result, Subsidiary was the sole
    shareholder of Country 1 CFC as of ---------------------------. Country 1 CFC then
    reorganized as a ------------- limited liability company effective --------------------------
    -------, with Subsidiary as its sole owner. Pursuant to Treas. Reg. §301.7701-
    3(b)(1)(ii), Country 1 CFC was treated as a domestic eligible entity that was
    disregarded as separate from its owner as of ---------------------------. This change
    in entity classification resulted in a deemed liquidation of Country 1 CFC under
    Treas. Reg. §301.7701-3(g)(1)(iii).

    Subsidiary claimed a worthless securities deduction under sections 165(a) and
    (g) in the amount of $----------------- in respect of its shares of stock in Country 1

6 This election was filed in ----------------- and, therefore, was filed late to make the requested change
effective as of . See Treas. Reg. §301.7701-3(c)(1)(iii). Late election relief was sought by the
Taxpayer and granted under IRS Revenue Procedure 2009-41. Gain Recognition Agreements, pursuant
to Treas. Reg. §1.367(a)-8, were filed with the Taxpayer's ------- tax return, reflecting built-in gain of
$ . Exam may wish to consider whether there was a correct representation as to
reasonable cause, and whether hindsight was used.

     CFC immediately before its deemed liquidation.7 Subsidiary elected to claim this
     deduction on the Taxpayer's ------- consolidated U.S. federal income tax return
     pursuant to section 165(i)(1).8

2. Country 2 CFC was a corporation organized under the laws of the -------------------
   --------- and was 100 percent owned by Subsidiary. Country 2 CFC was a holding
   company for the Taxpayer's operations in ----------------------------------------------------
   ----------------------------------------------------.

     Country 2 CFC timely filed an IRS Form 8832 to change its entity classification
     from a foreign eligible entity treated as an association taxable as a corporation to
     a foreign eligible entity that is disregarded as separate from its owner, effective --
     ---------------------. This change in entity classification resulted in a deemed
     liquidation of Country 2 CFC pursuant to Treas. Reg. §301.7701-3(g)(1)(iii).

     Subsidiary claimed a worthless securities deduction under sections 165(a) and
     (g) in the amount of $--------------- in respect of its shares of stock in Country 2

7 The Taxpayer explained that it determined insolvency of each of the CFCs as of the date that all of the
CFCs were deemed liquidated for U.S. federal income tax purposes and because the CFCs no longer
existed after those dates, they were not expected to have any potential future value. Compare I.R.S.
Rev. Rul. 2003-125, 2003-2 C.B. 1243 (2003).

8 Exam should consider whether the steps involved here, including Country 1 CFC's election in --------------
------ to change its entity classification to a corporation (claimed to be retroactive to ) followed
a month later in ----------------------- by the corporation's liquidation in order to claim recognition of a loss in
the deemed newly issued shares, appropriately results in a loss deduction. In addition to considering
whether the Revenue Procedure predicates for the approximately retroactive entity classification
election were correctly represented in the request for late election relief, various articulations of the
substance over form doctrine appear relevant, including step transaction principles (collapsing steps),
transitory corporation principles (permitting disregard of a transitory corporation), and circularity principles
(permitting a contribution of property into a corporation and related distribution of the property by the
corporation to be disregarded), as well as disregard of a corporation that, even if not transitory, serves no
non-federal income tax function. See, e.g., Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff'd
sub nom. Gregory v. Helvering, 293 U.S. 465 (1935); Hay v. Comm'r, 2 T.C. 460 (1943), aff'd, 145 F.2d
1001 (4th Cir. 1944), cert. den., 324 U.S. 863 (1945); Portland Manufacturing Co. v. Comm'r, 35 AFTR 2d
75-1439 (9th Cir. 1975); Asiatic Petroleum Co. Ltd. v. Comm'r, 79 F.2d 234 (2d Cir. 1935), cert. den., 296
U.S. 645 (1935); Haberman Farms, Inc. v. United States, 305 U.S. 787 (8th Cir. 1962); Packard v.
Comm'r, 85 T.C. 397 (1985); West Coast Marketing v. Comm'r, 46 T.C. 32 (1966); Casco Products Corp.
v. Comm'r, 49 T.C. 32 (1967); Custom Chrome Inc. v. Comm'r, T.C. Memo. 1998-317. (For purposes of
applying these concepts, we believe the date the reclassification election was filed rather than the
effective date of the change is relevant.) We note that there appears to have been no commercial
purpose for the change in classification to a corporation (i.e., deemed formation of a corporation) beyond
what was already met by the foreign partnership, and such formation appears to have been part of a plan
intended solely to have a form of entity to subsequently (on conversion to an LLC, which had the effect of
circumventing the Treas. Reg. §301.7701-3(c)(1)(iv) 60-month limitation on elective changes in entity
classification) claim recognition of a loss without disposing of the loss property to an unrelated party, and
a loss ordinary in character under section 165(g)(3), as well as the claimed benefit of section 165(i). (Any
duplication of loss should be prevented under section 362(e)(2).) Under these circumstances, section
269 also should be considered (deductions may be disallowed if resulting from certain acquisitions or
liquidations with a principal purpose of evading or avoiding tax).

     CFC immediately before its deemed liquidation.9 Subsidiary elected to claim this
     deduction on the Taxpayer's ------- consolidated U.S. federal income tax return
     pursuant to section 165(i)(1).

3. Country 3 CFC was a ---------------------------------------------- organized under the
   laws of ------------- and was 100 percent owned by Subsidiary. Country 3 CFC
   operated ------------------------------------------------- throughout ------------- before the
   COVID pandemic.

     Country 3 CFC timely filed an IRS Form 8832 to change its entity classification
     from a foreign eligible entity treated as an association taxable as a corporation to
     a foreign eligible entity that is disregarded as separate from its owner, effective --
     ---------------------. This change in entity classification resulted in a deemed
     liquidation of Country 3 CFC pursuant to Treas. Reg. §301.7701-3(g)(1)(iii).

     Subsidiary claimed a worthless securities deduction under sections 165(a) and
     (g) in the amount of $--------------- in respect of its shares of stock in Country 3
     CFC immediately before its deemed liquidation.10 Subsidiary elected to claim
     this deduction on the Taxpayer's ------- consolidated U.S. federal income tax
     return pursuant to section 165(i)(1).

The total worthless securities deductions that Subsidiary claimed on the Taxpayer's -----
------- consolidated U.S. federal income tax return in respect of the CFCs is $---------------
------------------.11 Claiming these loss deductions, pursuant to section 165(i)(1), in -------
allowed the Taxpayer to carry back such losses to prior tax years and, as a result,
trigger beneficial tax consequences.12

The COVID National Emergency was in effect when the Taxpayer implemented the
transactions described above.

Before the COVID pandemic, the Taxpayer was "---------------------------------------------------

-----------------------------------------------------------------------------------------------------" It closed

9 Supra note 7.

10 Supra note 7.

11 The Taxpayer also claimed $----------------- of operating losses with respect to other related entities on
its consolidated U.S. federal income tax return pursuant to section 165(i)(1). The Taxpayer filed IRS
Form 8886 (Reportable Transaction Disclosure Statement) with its ------- consolidated U.S. federal
income tax return disclosing the losses it carried back pursuant to section 165(i)(1).

12 See sections 172(b)(1)(D) and 172(b)(2)(C) (allowing net operating losses arising in tax years
beginning after December 31, 2017, and before January 1, 2021, to be carried back five years without
limitation on the amount thereof to 80 percent of taxable income); section 11(b) (replacing the 35 percent
rate on corporations with a 21 percent rate effective for taxable years beginning after December 31, 2017,
thereby increasing the value of the Taxpayer's net operating losses for years before 2018).

its ----------- in the United States ------------------------ to comply with government
mandates imposed in the respective jurisdictions on --------------------- (in the case of its
U.S. -----------) and --------------------- (in the case of its --------------------------------).

Because of decreased cash flow resulting from having to close its -----------, the
Taxpayer "------------------------------------------------------------------------------------------------------
--------------------------------------------------------" Without the Taxpayer's financial support,
the CFCs became insolvent, causing Subsidiary to conclude that its respective equity
investment in such CFCs became worthless. Specifically, the CFCs "------------------------

----------------------------------------------------------------------------------"

The Taxpayer treated the worthless securities losses claimed with respect to the CFCs
as disaster losses under section 165(i) because "---------------------------------------------------

--------------------------------------------------------------------------------------------------------------"

LAW

Section 165(a) provides generally for a deduction of any loss sustained during the
taxable year and not compensated by insurance or otherwise. Treas. Reg. §1.165-1(a).

No deduction is allowed under section 165(a) solely on account of a decline in the value
of stock owned by the taxpayer when the decline is due to a fluctuation in the market
price of the stock or to another similar cause, except if the stock loss is recognized
pursuant to Treas. Reg. §1.1002-1 upon the sale or exchange of stock or as provided
for pursuant to Treas. Reg. §1.165-5 with respect to worthless stock. Treas. Reg.
§1.165-4(a).

Section 165(g) provides that if any security, including a share of stock (or right to
subscribe for, or to receive, a share of stock) in a corporation, which is a capital asset
becomes worthless during the taxable year, the loss resulting therefrom is treated, for
purposes of subtitle A, as a loss from the sale or exchange, on the last day of the
taxable year, of a capital asset. Sec. 165(g)(1) and (2). Treas. Reg. §1.165-5 provides
additional details regarding section 165(g), including treatment of ordinary and capital
losses, treatment of worthless securities of an affiliated corporation, and abandonment
of securities.

Section 165(i)(1) provides that, notwithstanding section 165(a), any loss occurring in a
disaster area and attributable to a federally declared disaster may, at the election of the
taxpayer, be taken into account for the taxable year immediately preceding the taxable
year in which the disaster occurred. See also Treas. Reg. §1.165-11(a) (noting that the
loss must be "sustained"). Section 165(i)(2) provides that, if an election is made under
section 165(i), the casualty resulting in the loss shall be treated for purposes of Title 26
as having occurred in the taxable year for which the deduction is claimed. The loss
otherwise must be allowable as a deduction for the disaster year under section 165(a)
and Treas. Reg. §§1.165-1 through 1.165-10. Treas. Reg. §1.165-11(b)(3).

Section 165(h), the predecessor to section 165(i), was enacted in 1962 in response to a
massive severe storm that struck the Atlantic seaboard causing damage to life and
property. 108 Cong. Rec. 4146 (Mar. 14, 1962). The Congressional record indicates
that section 165(h) was enacted to provide relief from tax liability of those "adversely
affected who have lost their entire life savings through the destruction of their homes,
their places of business, or the livestock on their farms." Id. (statement of Senator John
J. Williams). Section 165(h) was redesignated as section 165(i) in 1982. Tax Equity
and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, §203(a).13

For purposes of section 165(i), the term "federally declared disaster" means any
disaster subsequently determined by the President of the United States to warrant
assistance by the federal government under the Stafford Act. Sec. 165(i)(5)(A); Treas.
Reg. §1.165-11(b)(1). The COVID National Emergency constitutes a "federally
declared disaster" within the meaning of section 165(i)(5)(A). The term "disaster area"
means the area so determined to warrant assistance by the federal government. Sec.
165(i)(5)(B). The COVID Disaster Area constitutes a "disaster area" within the meaning
of section 165(i)(5)(B).

Treas. Reg. §1.165-11(c) provides that an election made pursuant to section 165(i) for a
disaster loss attributable to a particular disaster applies to the entire loss sustained by
the taxpayer from that disaster during the disaster year.

ANALYSIS

To qualify as a disaster loss within the meaning of section 165(i), the loss must both
occur in a disaster area and be attributable to a federally declared disaster. Regardless
of whether the losses sustained by Subsidiary are attributable to a federally declared
disaster, they did not occur in the COVID Disaster Area. Therefore, the losses
sustained by Subsidiary with respect to its stock in the CFCs do not qualify as disaster
losses within the meaning of section 165(i).

To qualify for the election under section 165(i)(1), the loss must occur "in" the COVID
Disaster Area. No authority is directly on point clarifying where a loss sustained with
respect to stock in a foreign corporation occurs under section 165(i). Previous disasters
that could have given rise to an accelerated deduction under section 165(i) were
triggered by an event, such as a hurricane, flood, or drought, that resulted in a discrete
geographic disaster zone (including specific county level designations).14 This is

13 Congress amended section 165(i) multiple times after 1982 to conform defined terms to other changes
in law.
14 See, e.g., FM-5433-NM, available at, https://www.fema.gov/disaster/5433, designating Lincoln County
as a disaster area in connection with the New Mexico Nogal Canyon Fire. See also, e.g., Stevens v.
Comm'r, T.C. Memo. 1984-365 (1984) (drought); Radding v. Comm'r, T.C. Memo. 1988-250 (1988)
(landslide); Novack v. Comm'r, T.C. Memo. 1989-538 (1989) (flood); Gordon v. U.S., 1995 WL 429248
(N.D. Calif. July 3, 1995) (earthquake); Tudyman v. Comm'r, T.C. Memo. 1996-215 (1996) (earthquake);
and Rower v. Comm'r, T.C. Memo. 1998-117 (1998) (earthquake).

consistent with Congress's intent that section 165(i) should provide relief by alleviating
the financial impact of damages resulting from a physical disaster that is geographically
confined. See 108 Cong. Rec. 4146 (Mar. 14, 1962).

The Taxpayer states that "----------------------------------------------------------------------------------
------------------------------------------------------------------------------------" The rules under
Subchapter N, Part 1, for determining the source of stock losses, however, do not
provide a framework for locating a loss sustained with respect to stock in a foreign
corporation for purposes of section 165(i). The source rules are motivated by various
concerns meaningfully different than the concern motivating the requirement of section
165(i) that the loss occur in a disaster area. For example, the section 865(a) and Treas.
Reg. §1.865-2 source rules for gain or loss on the disposition of stock generally focus
on facts relevant to the recognition event (the disposition itself). The requirement that
the loss occur in a disaster area, on the other hand, appears motivated by a concern
that the economic decrease in the value of property giving rise to the loss must have a
nexus to the location of the disaster.

A more reasonable approach to locating where a loss with respect to stock in a foreign
corporation economically arose would be to look to certain business metrics applicable
to the foreign corporation.15 This memorandum addresses this approach below, and
contrasts it with an approach based on whether selling shareholders are "United States
residents" or "nonresidents," as those terms are used in section 865(a), or an approach
looking to the place of sale, or an approach based on the place where the foreign
corporation is headquartered.

An approach looking to business metrics would reflect the location of the economic loss.
Business metrics that might be applicable to a foreign corporation for purposes of
analyzing the location of a loss with respect to stock in the foreign corporation include
income producing assets, customers, employees, or revenue streams. An appropriate
standard by analogy to physical assets would be to require that substantially all of the
applicable metrics occur in the COVID Disaster Area for the loss sustained to be

15 An example of the section 865 sourcing rules relying on the location of economic activity can be found
in section 865(f), which sources gain from a U.S. resident's sale of foreign affiliate stock based (in part)
on whether the foreign affiliate is in the active conduct of a trade or business in a foreign country. This
test generally is consistent with the "business metrics" approach discussed in this Memorandum. See
also The Black & Decker Corp. v. Comm'r, T.C. Memo. 1991-557 (1991) (applying the "geographical situs
test" to treat the taxpayer's worthless stock loss under section 165(g)(3) as foreign source income
because the loss sustained grew out of an activity and use of property in the foreign country). See also
Treas. Reg. §1.954-2(b)(4)(x) (for purposes of subpart F's "same country" rules, the location of stock of a
controlled foreign corporation is determined by reference to underlying assets).

considered to occur in a disaster area.16 The "substantially all" standard has been used
in other instances when, for U.S. federal income tax purposes, a tax consequence is
dependent on locating a business, property, or services within a specific zone. In one
instance, the new markets tax credit under section 45D considers "substantially all" as
satisfied if at least 85 percent of the taxpayer's investment is directly traceable to
qualified low-income community investments.17 However, that standard is not
dispositive for purposes of section 165(i).

Applying the "substantially all" approach to the Taxpayer's circumstances, none of the
CFCs derived substantially all of their revenues from U.S. customers. Other possible
metrics, such as income producing assets, employees, and revenue streams, all were
located or occurred outside the United States. As such, this approach would not result
in the losses sustained by Subsidiary being treated as occurring in the COVID Disaster
Area.

In contrast to looking at business metrics, section 865(a) and Treas. Reg. §1.865-2 are
predicated on a single event of a disposition, rather than the location of the underlying
cause of loss. For a variety of reasons, including ease of administration, these rules, as
noted above, generally focus on the residence of the seller. Even so, exceptions apply,
including that, in the case of a CFC, as here, a hybrid rule may apply to treat part of the
gain characterized as a dividend under section 1248 and sourced accordingly.18 This
hybrid treatment, as well as other specific rules in section 865, illustrates the residual,
default aspect of the section 865(a) and Treas. Reg. §1.865-2 rules, as opposed to
being rules based on substantive principles.

It follows that determining whether a loss sustained with respect to stock in a foreign
corporation occurred in the COVID Disaster Area based on the residence of the
shareholder is inappropriate. The location of the occurrence of the loss is conceptually
different than the location of the shareholder's residence, and the latter has no direct
bearing on location of the foreign corporation's operations. For example, this approach
would locate a loss sustained with respect to stock in a corporation within the United
States if the shareholder were a U.S. resident, despite all other applicable business

16 This approach is consistent with past judicial application of section 165(i) requiring the affected property
to be located in the disaster area. See, e.g., Kohn v. Comm'r, T.C. Memo. 2017-159, 39 (2017) ("The
President determined that in 1993 St. Charles County, where petitioners' docks were located, suffered a
natural disaster warranting assistance under the Disaster Relief and Emergency Assistance Act.")
(emphasis added); Cziraki v. Comm'r, T.C. Memo. 1998-439, *1 (1998) ("The area in which properties A
and B are situated was declared a Federal disaster area for the period January 5 through March 20,
1993.") (emphasis added).
17 See Treas. Reg. §1.45D-1(c)(5). See also, e.g., Treas. Reg. §§1.108(i)-2(b)(6)(i)(B); 1.250(b)-5(c)(7);
1.1400L(b)-1(c)(3) (Liberty Zones, since repealed); Treas. Reg. §§1.1400Z2(d)-1(d)(2), 1.1400Z2(d)-
2(d)(4)(ii); and Notice 2006-77, 2006-2 C.B. 590 (Sept. 1, 2006) (Gulf Opportunity Zone; since repealed).
(These regulations illustrate a range of thresholds that have been used for purposes of determining
"substantially all" in certain contexts).
18 Further, a recapture rule in respect of prior dividends applies under Treas. Reg. §1.865-2.

metrics of the corporation being located outside the United States; and conversely,
would locate a loss sustained with respect to stock of a corporation outside the United
States (denying section 165(i) relief) if the shareholder were a U.S. citizen having a tax
home abroad (or other nonresident as defined in section 865) despite all applicable
business metrics of the corporation being in the United States.

Locating a loss sustained with respect to stock in a foreign corporation for purposes of
section 165(i) based on the location of the place of sale or disposition is inappropriate
for reasons similar to those discussed relating to the residence of the shareholder.19
Moreover, in the case of the CFCs, the location of the sale of stock can be unclear,
such as when, as here, the deemed liquidations occurred by reason of a tax election or,
in the case of Country 1 CFC, a reorganization. Such a formalistic approach to locating
a loss sustained for purposes of section 165(i) is inconsistent with the motivation behind
section 165(i) that the disaster caused the economic decrease in value of property
giving rise to the loss.

Locating a loss sustained with respect to stock in a foreign corporation for purposes of
section 165(i) based on the place where the foreign corporation is headquartered also
would not necessarily appropriately target the tax relief intended by Congress.
Whereas Congress intended section 165(i) to provide relief to those directly impacted
by a particular disaster, locating a loss on the basis of where a foreign corporation is
headquartered would not necessarily relate to the geographic location of the foreign
corporation's business operations. For example, it would not be appropriate to grant
relief under section 165(i) to a shareholder who owns stock in a foreign corporation that
only is headquartered within the United States, but whose operations and/or revenue
streams are located outside the United States.

For these reasons, the losses sustained by Subsidiary with respect to stock of the CFCs
did not occur in the COVID Disaster Area for purposes of section 165(i). As such, these
losses do not qualify as disaster losses within the meaning of section 165(i).

SCOPE AND CASE DEVELOPMENT

This memorandum addresses only whether losses with respect to stock in a foreign
corporation occurred in the COVID Disaster Area for purposes of meeting the
requirements of section 165(i). Specifically, this memorandum does not consider the
additional requirement of whether the losses sustained by Subsidiary with respect to
stock of the CFCs were attributable to a federally declared disaster within the meaning
of section 165(i)(1) and Treas. Reg. §1.165-11(b)(3). No opinion is expressed or
implied concerning whether a loss with respect to stock (either domestic or foreign) may
qualify as a disaster loss under section 165(i). This memorandum also does not
address whether the stock of the CFCs was worthless for purposes of section 165(g).
Finally, this memorandum does not conclude as to whether the steps involved to

19 See Hay v. Comm'r, supra, 2 T.C. 460, 471 (gain on liquidation sourced by reference to where the
corporation conducted "all its business" rather than where "a technical bill of sale" was executed).

change Country 1 CFC's entity classification were appropriate under U.S. tax principles.
Exam may wish to pursue one or more of these issues.

Please call (202) 317-6938 if you have any further questions.