Today, the Treasury Department (Treasury) released final regulations (T.D. 10026); Final Regulations) that partially implement the proposed dual consolidated loss (DCL) regulations issued in August 2024. The regulations finalize (1) the disregarded payment loss (DPL) rules, which require income inclusions with respect to certain disregarded payments that are deductible under foreign tax law, and (2) an anti-avoidance rule. Changes were made to the deemed ordering rule for determining the foreign uses of DCLs and DPLs.

Several components of the proposed DCL regulations were not finalized, such as the elimination of the "inclusions on stock" rule (other than for portfolio investments) and the interaction of the DCL rules with the intercompany transaction rules under Treas. Reg. Section 1.1502-13. Treasury indicated that it intends to address these remaining items in future guidance.

The DPL rules generally require a domestic owner of certain foreign entities to recognize income equal to a "disregarded payment loss," which is generally the net loss attributable to disregarded payments of interest or royalties that are deductible under foreign income tax law. In a change from the proposed DCL regulations, following the inclusion of the DPL in income, a suspended deduction is established, which domestic owners may claim in future years to the extent of disregarded payment income.

The DPL rules, as well as the changes to the deemed ordering rule, will apply to tax years beginning on or after January 1, 2026 - a significant delay from the proposed effective date of tax years beginning on or after August 6, 2024. The anti-abuse rule, however, applies to DCLs incurred in tax years ending on or after August 6, 2024, and to DPLs in tax years beginning on or after January 1, 2026.

Additionally, this guidance extends transition relief regarding the interaction of the DCL rules with Pillar 2. The Preamble to these regulations indicates that the final DCL regulations will apply the DCL rules without taking into account qualified domestic minimum top-up taxes and top-up taxes collected under an income inclusion rule or undertaxed profits rule in tax years beginning before August 31, 2025. Taxpayers may rely on this transition relief until final regulations addressing the Pillar 2 interaction are published. The proposed anti-abuse rule limiting this transition relief was not addressed in this guidance.

A detailed Tax Alert is forthcoming.