Regulations from the U.S. Treasury Department and IRS are published in today's edition of the Federal Register. The final regulations (T.D. 9908) and a related notice of proposed rulemaking (REG-110059-20) concern the repeal of section 958(b)(4).
The 2017 U.S. tax law (Pub. L. No. 115-97, enacted December 22, 2017, that is often referred to as the “Tax Cuts and Jobs Act” (TCJA)) modified the stock attribution rules under section 958(b) that apply for subpart F purposes, including determining whether a person is a U.S. Shareholder under section 951(b) (“U.S. Shareholder”) of a controlled foreign corporation (“CFC”), and whether a foreign corporation is a CFC. Specifically, the TCJA repealed the statutory rule under section 958(b)(4) that had prevented “downward attribution” of stock from a foreign person to a U.S. person under section 318(a)(3), effective beginning with the last tax year of foreign corporations that began before January 1, 2018.
The repeal of section 958(b)(4) by the TJCA increased the number of U.S. persons that are U.S. Shareholders and, therefore, the number of foreign corporations that are CFCs. U.S. Shareholders are required to include amounts in income under the provisions of subpart F, including the global intangible low-taxed income (“GILTI”) rules, based on the CFC's income, but only if they own stock in the CFC directly or indirectly under section 958(a) which, unlike constructive ownership under section 958(b), is determined without regard to downward attribution.
A number of rules outside of subpart F cross-reference the subpart F definition of CFC, which is determined under the section 958 constructive ownership rules, or directly reference the section 958(b) constructive ownership rules. The change to the section 958(b) constructive ownership rules impacted these rules by expanding or contracting their applicability in a manner not contemplated when the underlying rules were enacted. Treasury published proposed regulations on October 2, 2019 (“2019 proposed regulations”) that modified the section 958 ownership regulations as well as nine regulations outside of subpart F that were affected by the section 958(b)(4) repeal, generally by providing that the downward attribution rules are not taken into account for a particular provision, or otherwise by revising the rule to more closely align with its application prior to the repeal of section 958(b)(4). For a detailed discussion of the 2019 proposed regulations read: TaxNewsFlash
The final regulations finalize nine of the 10 rules in the 2019 proposed regulations. The final regulations do not finalize the passive foreign investment company (“PFIC”) proposed rule because Treasury intends to finalize the proposed rule in connection with finalizing PFIC proposed regulations issued on July 11, 2019 (REG-105474-18).
Treasury modified the rule in the 2019 proposed regulations that addressed the application of section 267(a)(3)(B).
Tax professionals view the final regulation as a welcomed change from the 2019 proposed regulation, which was relatively narrow. The application of the 2019 proposed rule to CFCs that were not exempt from tax under a treaty but nonetheless not subject to U.S. withholding tax (for instance, foreign source non-effectively connected amounts) was difficult to justify from a policy perspective. Unlike certain of the other rules in the final regulations, the application of the section 267(a)(3)(B) rule depends on whether any U.S. Shareholders own any stock in the CFC under section 958(a), rather than on whether the foreign corporation is a CFC without regard to downward attribution from foreign entities.
The following rules in the 2019 proposed regulations were modified without any substantive changes:
The final regulations revise the definition of CFC in seven rules to be consistent with the definition prior to the repeal of section 958(b)(4).
As relevant, the final regulations apply to tax years of foreign corporations or shareholders ending on or after October 1, 2019, or to relevant transactions (payments accrued, distributions in complete liquidation, transfers, or payments made) that occur on or after October 1, 2019. In addition, a particular proposed regulation can be applied to certain earlier tax years, generally determined by reference to the last tax year of a foreign corporation that begins before January 1, 2018, provided that the taxpayer and related persons consistently apply the rule.
The proposed regulations revise regulations under section 367(a) and add a new regulation under section 954(c)(6) that addresses the repeal of section 958(b)(4) for purposes of each provision, consistent with the rules in the 2019 proposed regulations.
i. 50% or less of the voting power and value of the transferee foreign corporation must be received in the aggregate by U.S. transferors
ii. 50% or less of the voting power and value of the transferee foreign corporation must be owned in the aggregate, immediately after the transfer by U.S. persons that are either officers or directors of the U.S. target company or that are 5% target shareholders
iii. Either the U.S. person must not be a 5% transferee shareholder or, if the U.S. person is a 5% transferee shareholder, the U.S. person must enter into a GRA, and
iv. The active trade or business test must be satisfied
For this purpose, the section 958(b) ownership rules are applied for purposes to determine ownership or the receipt of stock, securities or other property. The proposed regulations provide that the requirements in (i), (ii), and (iv) are determined without regard to downward attribution from foreign entities to U.S. persons. The proposed requirement further provides that the requirement in (iii) does take into account downward attribution from foreign entities to U.S. persons. Treasury noted in the preamble that allowing downward attribution from foreign entities for (iii) is consistent with an existing rule under which a U.S. transferor that transfers foreign stock in an outbound transfer must enter into a GRA if immediately after the transfer it owns, taking into account section 958(b), at least 5% of the transferee corporation.
Although the preamble refers to interest payments between related CFCs (resulting in subpart F income instead of tested income), the more significant impact may come from the interaction of the proposed rule to CFC-to-CFC dividends and section 245A. Prior to the proposed regulations, a dividend paid to a CFC from a related CFC could be excluded from the CFC’s subpart F income under section 954(c)(6) as well as being excluded from tested income under section 951A(c)(2)(A)(i)(IV), with the result that earnings and profits in the recipient CFC would be eligible for a dividend received deduction (“DRD”) under section 245A when distributed to a U.S. shareholder. Under the proposed regulations, when applicable, unless the recipient CFC can exclude the dividend under another exception (such as the related-party dividend rule in section 954(c)(3)) a dividend from a related CFC will be included in the CFC’s subpart F income, thus eliminating the availability of the section 245A DRD.
The proposed regulations under section 367(a) apply to transfers occurring on or after September 21, 2020, and the proposed regulations under section 954(c)(6) apply to payments or accruals of dividends, interest, rents, and royalties made by a foreign corporation during tax years of foreign corporations ending on or after September 21, 2020. In addition, each of the proposed regulations can be applied to certain earlier tax years, generally determined by reference to the last tax year of the relevant foreign corporation that begins before January 1, 2018, provided that the taxpayer and related persons (as determined under section 267 or 707) consistently apply the proposed regulation.
Comments or requests for a public hearing on the proposed regulations must be submitted by November 20, 2020.
For more information, contact a tax professional with KPMG’s Washington National Tax practice:
Barbara Rasch | +1 213 533 3382 | firstname.lastname@example.org
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