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provides rules for identifying which deductions are properly
allocable to foreign base company income" under the authority of
section 954(b)(5).
A taxpayer first allocates deductions to the appropriate
class of gross income and then apportions those deductions within
the class of gross income (defined as "the gross income to which
a specific deduction is definitely related") between the
statutory grouping (in this case, subpart F income) and the
residual grouping (in this case, non-subpart F income). Sec.
1.861-8(a)(2), (3), and (4), Income Tax Regs. If a deduction is
not related to a specific class of gross income, it will be
treated as relating to all gross income and will be allocated
ratably by gross income. Sec. 1.861-8(b)(1), (5), Income Tax
Regs. Once a particular deduction has been allocated to a class
of gross income, it must be apportioned within that class between
the "statutory" and "residual" groupings of income. The
regulations stress that allocation and apportionment reflect the
"factual relationship" between the deductions and the gross
income. Sec. 1.861-8(a)(2),(b)(1), and (c)(1), Income Tax Regs.
In addition, there are special rules for interest
deductions. Because money is fungible, and a taxpayer has a
great deal of flexibility in the use of borrowed funds, interest
expense is normally allocated "to all the gross income which the
income producing activities and properties of the taxpayer
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