The IRS released proposed regulations (REG-104223-18
) on Oct. 1 addressing a number of unintended consequences brought about by the repeal of Section 958(b)(4) by the Tax Cuts and Jobs Act (TCJA). It also concurrently released a revenue procedure (Rev. Proc. 2019-40
) to help certain U.S. taxpayers determine whether a foreign corporation is a controlled foreign corporation (CFC) and calculate their Subpart F inclusions and global intangible low-taxed income (GILTI) inclusion amounts. The revenue procedure provides a number of safe harbors aimed at taxpayers that have limited ability to obtain detailed information regarding certain corporate foreign investments.
Section 958(b)(4) was repealed by TCJA in an effort to narrowly target "de-control" transactions in which a foreign parent of a U.S. shareholder with a CFC sheds the CFC status by acquiring the CFC’s stock. But in effect, the full repeal of Section 958(b)(4) without additional statutory limits significantly expanded the scope of the downward attribution rules beyond what was intended.
The proposed regulations were released under Sections 267, 332, 367, 672, 706, 863, 904, 958, 1297, and 6049. They provide taxpayers relief in certain situations but also propose to end various taxpayer-favorable outcomes resulting from the repeal of “downward attribution.” Taxpayers may rely on the proposed regulations with respect to any applicable period before the date they are published as final regulations in the Federal Register.
Notably, the proposed regulations do not provide broad relief for U.S. income inclusions of minority U.S. owners of foreign corporations that became CFCs solely because of downward attribution. Additionally, the rules do not address all known issues. For example, no relief is provided to investors that would have otherwise satisfied the requirements of the portfolio interest exemption but for the fact that the foreign corporation receiving the interest became a CFC because of downward attribution from non-U.S. persons.
While the rules generally provide relief for foreign-owned multinationals, some U.S. multinationals may be impacted. Taxpayers affected by the repeal of Section 958(b)(4) should assess how the proposed rules may influence them. The ability to adopt the rules for prior years may also provide opportunities to consider refund claims, but can have financial statement implications.
Section 958 provides rules for determining stock ownership for purposes of Sections 951-964. This includes the determinations of CFC and U.S. shareholder status, which are crucial to the Subpart F and GILTI regime, among other things.
Section 958(b) provides that, for purposes of certain sections and with certain modifications, the constructive ownership rules of Section 318 apply when determining stock ownership. Section 318(a)(3) provides rules for attribution to partnerships, estates, trusts, and corporations from owners (commonly referred to as “downward attribution”).
The application of the downward attribution rules was limited in scope by former Section 958(b)(4), which was repealed in TCJA. Section 958(b)(4) had prevented the attribution of stock owned by a non-U.S. person to a U.S. person. Now, stock owned (directly, indirectly, or constructively) by a foreign person may be subject to downward attribution to a U.S. person.
The TCJA’s legislative history collectively indicates that Congress only intended a partial repeal of Section 958(b)(4). According to the final conference report, the amendment was meant to narrowly target “de-control” transactions in which the foreign parent corporation of a U.S. shareholder of a CFC causes the foreign corporation to lose its CFC status by acquiring more than 50% of the foreign corporation's stock in exchange for the contribution of cash or property. However, the amended Section 958 does not include any reference to any control or relatedness requirement, or any other indication that the repeal is anything less than a full repeal of Section 958(b)(4).
To address the various, presumably, unintended consequences of Section 958(b)(4) repeal, the proposed regulations generally modify the definition of a CFC for select purposes to either disregard downward attribution from foreign persons or provide exemptions to certain rules when an entity becomes a CFC solely because of downward attribution from non-U.S. persons. The proposed regulations address both favorable and unfavorable outcomes experienced by taxpayers. The following provides highlights of the proposed changes:
Grant Thornton Insight: The relief provided under Section 267 appears narrower than some had expected. It is limited to amounts exempt from taxation pursuant to a treaty obligation. This likely does not capture other categories of payments that are not exempt from taxation as a result of a treaty obligation. Notably, the preamble to the proposed regulations indicates that the IRS intends to update other provisions in Treas. Reg. Sec. 1.267(a)-3 to take into account previous statutory changes to Section 267(a)(3) in future guidance.
- Section 267(A)(3)(B)(i) provides that an item paid to a CFC is deductible by the payor only to the extent that it is includible in the gross income of a Section 958(a) U.S. shareholder. The proposed regulations provide that an amount (other than interest) that is income of a related foreign person with respect to which the related foreign person is exempt from U.S. taxation on the amount owed pursuant to a treaty obligation of the United States is exempt from the application of Section 267(a)(3)(B)(i) if the related foreign person is a CFC that does not have any Section 958(a) U.S. shareholders.
- Section 332(d)(3) provides that exchange treatment under Section 331 applies if the distributee of a distribution in complete liquidation of an applicable holding company is a CFC. For purposes of applying Section 332(d)(3), the proposed regulations revert the definition of a CFC to the one in effect immediately before the repeal of Section 958(b)(4)).
- Treas. Reg. Sec. 1.367(a)-(8)(k)(14) provides a gain recognition agreement triggering event exception if, immediately after the disposition, the U.S. transferor meets certain requirements, including the U.S. transferor retaining a direct or indirect interest in the transferred stock or securities. The proposed regulations revise this rule to apply Section 958(b) without regard to the repeal of Section 958(b)(4).
- Section 672(f)(3)(A) provides special rules that provides, except as otherwise provided by regulations, CFCs are treated as domestic corporations for purposes of Section 672(f)(1). The proposed regulations provide that the only CFCs taken into account for purposes of Section 672(f) are those that are CFCs without regard to downward attribution from foreign persons.
- Section 706 provides rules for determining the taxable year of a partnership and its partners. Under the Section 706 regulations, certain foreign partners’ interests are disregarded when making this determination, but CFCs are not treated as foreign partners. The proposed regulations modify the rule to provide that CFCs that exist solely by reason of downward attribution would not be treated as CFCs for purposes of the Section 706 regulations. Thus in many instances, CFCs without a Section 958(a) US shareholder that is a partner in a partnership will continue to be disregarded when determining the taxable year of partnership.
- Under Section 863, space and ocean income and international communications income is generally US sourced if derived by a U.S. person and foreign source if derived by a foreign person. However, income derived by a CFC may be treated as U.S. source income, in whole or in part, in certain circumstances. As a result of the repeal of 958(b)(4) the sourcing rules applicable to CFCs were extended to foreign corporations that became CFCs following repeal. The proposed regulations revise this rule to provide that CFC status is determined without regard to downward attribution from a foreign person (consistent with Notice 2018-13).
- Section 904(d)(3) provides an active rents and royalties exception for certain amounts received by a CFC. The proposed regulations limit the application of these and certain related rules to foreign corporations that are CFCs without regard to downward attribution from foreign persons.
- Under Section 1297(e)(2), if a foreign corporation is a CFC and is not publicly traded, adjusted basis (rather than value) of the assets must be used when determining whether the average percentage of the corporation’s assets that produce passive income is at least 50%. The proposed regulations modify the definition of a CFC for purposes of Section 1297(e) to disregard downward attribution from foreign persons.
- The regulations under Chapter 61 generally provide that the scope of payments or transactions subject to Form 1099 reporting depends, in part, on whether or not the payor is a U.S. payor, which generally includes United States persons and their foreign branches, as well as CFCs. The proposed regulations provides that a U.S. payor include only a CFC that is a CFC without regard to downward attribution from a foreign person.
Revenue Procedure 2019-40
Rev. Proc. 2019-40 grants certain administrative relief and safe harbor guidance for complying with various tax reporting and information reporting requirements related to the repeal of Section 958 (b)(4). As a result of the repeal, U.S. persons that were not previously treated as U.S. shareholders may become U.S. shareholders. Furthermore, foreign corporations that were not previously treated as CFCs may become CFCs. Once becoming a CFC, taxpayers may be faced with income inclusions and reporting requirements related to Sections 951 and 951A (Subpart F and GILTI) with limited information available to compute and report these amounts.
The revenue procedure offers administrative relief and safe harbor guidance in a number of areas consisting of:
- A safe harbor for determining that a foreign corporation is not a CFC where facts are not known through actual knowledge and other conditions are met.
- A safe harbor approach allowing for the use of alternative information in order to compute GILTI and Subpart F income under Sections 952 and 964, where the information is not readily available. Under this safe harbor, alternative information, as defined in the guidance, includes audited or unaudited GAAP, IFRS, or local accounting financial statements.
- A safe harbor allowing for the use of alternative information in order to compute Section 965 inclusion amounts for specified foreign corporations, where the information is not readily available. Under this safe harbor, alternative information, as defined in the guidance, includes audited or unaudited GAAP, IFRS, or local accounting financial statements.
- An exception that reduces or eliminates the Form 5471 reporting requirements for certain minority US shareholders and certain constructive owners of CFC’s.
- Penalty relief under Sections 6038 and 6662 is provided where alternative information is used.
The revenue procedure allows taxpayers to use the safe harbors with respect to the last taxable year of a foreign corporation beginning before Jan. 1, 2018, and each subsequent taxable year.
Grant Thornton Insight: Rev. Proc. 2019-40 offers relief and guidance related to the information reporting and computation related to CFC status and Section 965, 951, and 951A income inclusions. Streamlined reporting is also allowed on Form 5471 and penalties are abated if alternative information is used and the conditions are met. For both prior and current years, consideration should be given to using alternative information and whether amended returns should be filed for the past.
The proposed rules generally provide relief for foreign-owned multinationals, but may impact U.S. multinationals in certain situations. Taxpayers impacted by the repeal of Section 958(b)(4) should assess how the proposed rules would affect them. The ability to adopt the rules for prior years also may provide opportunities to consider refund claims.
The ability to adopt the regulations retroactively also carries financial statement implications. A company with a reporting period (annual or interim) ending after Oct. 1 will need to evaluate whether the regulations constitute new information which causes a change in judgment with respect to the recognition and measurement of unrecognized tax benefits for financial statement.
For more information contact:
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Partner, Washington National Tax Office
+1 202 861 4104
Senior Manager, Washington National Tax Office
+1 202 521 1509
Managing Director, Washington National Tax Office
+1 202 521 1543
Mike Del Medico
Manager, Washington National Tax Office
+ 1 202 521 1522
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