Preparing a Dual Consolidated Loss Statement

A dual consolidated loss (DCL) is a net operating loss from a corporate entity that could potentially offset taxable income in both the United States and a foreign country. U.S. tax law, under Internal Revenue Code Section 1503(d), prevents this “double-dipping” to ensure a single economic loss is deducted in only one jurisdiction. The regulations establish a default prohibition on using such losses in the U.S. but provide specific exceptions. These exceptions allow for the loss to be claimed, but they come with detailed reporting and compliance obligations.

Understanding Dual Consolidated Losses

The rules governing dual consolidated losses start with a broad prohibition. A DCL cannot be used to reduce the taxable income of any member of a U.S. consolidated group unless the taxpayer elects to follow a specific procedure. The regulations target losses from two types of entities: dual resident corporations and separate units.

A dual resident corporation (DRC) is a domestic corporation that is also subject to the income tax of a foreign country on its worldwide income or on a residence basis. From the perspective of the U.S., it is a domestic entity, but another country may treat it as a local resident. This dual status creates the potential for any net operating loss it incurs to be claimed against income in both jurisdictions.

The regulations also apply to a “separate unit” of a domestic corporation, which is treated as a distinct entity for these purposes. Examples include a foreign branch of a U.S. corporation, an interest in a partnership, or an interest in a hybrid entity. A hybrid entity is treated as fiscally transparent for U.S. tax purposes but as a separate corporation under foreign law. The income or loss of these units is calculated as if the unit were a separate domestic corporation.

When a DRC or a separate unit generates a net operating loss for a taxable year, that loss is defined as a dual consolidated loss. This classification subjects the loss to the limitation on its use within a U.S. consolidated tax return.

The Domestic Use Election and Agreement

While the general rule prohibits using a dual consolidated loss to offset U.S. taxable income, an exception exists. Taxpayers can use the loss on their U.S. return by making a “domestic use election.” This election allows for the immediate deduction of the DCL but comes with binding commitments formalized in a statement attached to the tax return.

The domestic use election is an agreement where the taxpayer certifies that the DCL has not been, and will not be, used to offset the income of any other person under a foreign country’s income tax laws. By making the election, the U.S. consolidated group agrees to be bound by these terms for a specified period. The statement filed with the tax return serves as the official record of this choice and its associated obligations.

Required Information for the DCL Statement

The domestic use election is formalized through a custom statement attached to the income tax return, not a standard IRS form. As mandated by Treasury Regulation §1.1503(d), the statement must be clearly labeled at the top with a title such as “Domestic Use Agreement and Election Under Section 1.1503(d)-6.” This heading identifies the document’s purpose for tax authorities.

The body of the statement must identify all parties involved. This includes the name, address, and taxpayer identification number of the domestic consolidated group. It must also identify the dual resident corporation or separate unit(s) that incurred the DCL, providing their names and U.S. taxpayer identification numbers.

The statement must specify the amount of the dual consolidated loss to which the agreement applies. The document must also include the taxpayer’s explicit agreement to comply with all provisions of the regulations. This includes a declaration that the loss has not been and will not be put to a “foreign use” and an acknowledgment of the recapture rules that apply if a triggering event occurs.

Filing and Annual Certification Requirements

The initial domestic use statement must be attached to the timely filed U.S. federal income tax return for the year the dual consolidated loss is incurred. This timing is precise, as filing with an amended return is not permitted. This submission formalizes the election and allows the consolidated group to deduct the DCL for that year.

Compliance obligations continue after the initial filing, as the taxpayer must file an annual certification for each subsequent year within the certification period. This new statement, labeled “Annual Domestic Use Certification,” must be attached to the tax return for each of those years. The certification period lasts until the DCL is fully absorbed or a triggering event occurs.

In the annual certification, the taxpayer must certify that the DCL was not used in a prohibited manner under foreign law during the preceding year. This ongoing requirement ensures continuous compliance and keeps the domestic use election in good standing.

Triggering Events and Loss Recapture

A “triggering event” is an occurrence that violates the domestic use agreement, leading to the recapture of the previously deducted dual consolidated loss. One of the most direct triggering events is the “foreign use” of the DCL. This happens if any portion of the loss is used to offset the income of another entity under foreign tax law.

Other triggering events relate to changes in corporate structure. For example, if the dual resident corporation or the separate unit disaffiliates from the U.S. consolidated group that made the election, it is a triggering event. The sale or disposition of 50% or more of the separate unit’s assets can also trigger recapture.

When a triggering event occurs, the taxpayer must “recapture” the entire amount of the DCL. This is done by including the full amount of the previously deducted loss in the consolidated group’s gross income on its tax return for the year of the trigger. This action effectively reverses the tax benefit that was originally claimed.

In addition to the income inclusion, the taxpayer must pay an interest charge. This interest is computed on the tax liability that results from the recapture, calculated as if that tax had been due in the year the DCL was originally deducted. This charge compensates the government for the time value of the money it was owed.