On October 31, 2018, the Treasury Department and Internal Revenue Service released proposed regulations under Section 956 to reduce inclusions by domestic corporations under Section 956. These proposed regulations provide consistency between the deemed repatriation rules under Section 956 and the new participation exemption for domestic corporations contained in Section 245A, which was enacted as part of the Tax Cuts and Jobs Act (P.L. 115-97).
Section 956, in conjunction with Section 951(a)(1)(B), generally requires a deemed repatriation of the earnings and profits of a "controlled foreign corporation" ("CFC") to a "United States shareholder" if such CFC holds "United States property," which includes, among other property, stock of a domestic corporation or a debt obligation of a U.S. person. If certain holding period and other requirements are satisfied, new Section 245A allows a domestic corporation that is a "United States shareholder" of a CFC to claim a 100% dividends received deduction on dividends received from such CFC.
Importantly, a deemed repatriation under Section 956 is not technically considered a dividend for U.S. federal income tax purposes, so any such deemed repatriation is not eligible for the 100% dividends received deduction under Section 245A. As a result, a domestic corporation could be subject to additional U.S. federal income tax on a deemed repatriation from a CFC under Section 956 even though an actual dividend distribution received from such CFC would be exempt from U.S. federal income tax because of Section 245A. These proposed regulations fix this disparate treatment by reducing the Section 956 inclusion amount for a domestic corporation with respect to a CFC by the amount that would have been exempted from U.S. federal income because of Section 245A if such domestic corporation had instead received an actual dividend distribution from such CFC.
Financing transactions involving domestic corporations are directly impacted by these proposed regulations. Because a guarantee of a domestic corporation's debt by a CFC or the pledge of all of the stock of a CFC with respect to debt of a domestic corporation could cause a CFC to be considered to hold "United States property" for purposes of Section 956, credit and loan agreements for loans to domestic corporations often exclude CFCs from serving as guarantors and limit the pledge of stock of CFCs to less than 66 2/3% of the voting stock of first-tier CFCs. Although each specific situation should still be analyzed by tax counsel to ensure there is not a Section 956 or other tax issue, this change to Section 956 should allow more flexibility on these points and, therefore, could result in the expansion of the guarantor group to include CFCs and the collateral base to include additional stock and assets of CFCs when loans are made to domestic corporations.
Taxpayers generally are allowed to rely on these proposed regulations prior to the issuance of final regulations.
Should you have any questions about the impact these proposed regulations may have on your financing transactions or other areas of your business, please contact any of the authors of this update.
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