U.S. taxpayers continue to analyze and adapt to the new international taxation regimes introduced by the Tax Cuts and Jobs Act (TCJA), including the Section 965 inclusion, global intangible low-taxed income (GILTI), foreign derived intangible income (FDII), and the base erosion anti-abuse tax (BEAT).
While the U.S. Department of the Treasury and the IRS have been working on clarifying the new tax rules and the related compliance requirements and addressing comments from taxpayers and practitioners, guidance has not been provided on a number of the TCJA provisions. One of the TCJA provisions that might become an unpleasant surprise for some taxpayers is the change in the downward attribution rules of Section 958(b).
Before the TCJA, Section 958(b)(4) provided that U.S. taxpayers could not be attributed ownership in a foreign corporation if their ownership resulted from first attributing ownership in a foreign corporation to its foreign parent and then attributing the same ownership interest to a U.S. subsidiary of the foreign corporate parent (under Section 318(a)(3)). The TCJA repealed Section 958(b)(4) but provided no exceptions for the unintended results of the downward attribution.
As a result of the repeal of Section 958(b)(4), many taxpayers might find that they have become U.S. shareholders of controlled foreign corporations (CFCs) and, consequently, subject to taxation under Section 965 and GILTI. A CFC is a foreign corporation that is more than 50 percent owned by 10 percent shareholders (by vote or value) that are U.S. persons (certain U.S. individuals, corporations, trusts, estates, and partnerships). For example, if a foreign corporate parent company (FP) has a U.S. wholly owned subsidiary (U.S. Sub) and a foreign wholly owned subsidiary (F Sub), U.S. Sub will be attributed 100 percent of the ownership of F Sub under the new Section 958(b) attribution rules, and F Sub will be treated as a CFC. If FP has no direct or indirect 10 percent U.S. shareholders under Section 958(a) (Section 958(a) shareholders), the CFC status of F Sub should not result in U.S. Sub or any constructive 10 percent shareholder of F Sub under Section 958(b) having to include any income from F Sub under deemed inclusion rules such as Section 965 and GILTI.
However, if FP does have a Section 958(a) shareholder, the Section 958(a) shareholder will be treated as a U.S. shareholder of a CFC and will be subject to all the rules of income inclusion applicable to U.S. shareholders of a CFC. Specifically, under the TCJA, the U.S. shareholder will be subject to the Section 965 one-time toll charge on F Sub’s undistributed earnings. In addition, the U.S. shareholder will be subject to U.S. taxation on its share of GILTI income from F Sub. Finally, the Subpart F and Section 956 income inclusion rules also will apply to the U.S. shareholder. In no event, however, will a U.S. shareholder that is a U.S. shareholder solely by virtue of constructive ownership rules under Section 958(b) have a deemed inclusion under the provisions already described.
The example of the new downward attribution rules in the previous paragraph appears to show an unintended result of the TCJA. According to the act’s accompanying conference report, the downward attribution rules were not intended to “cause a foreign corporation to be treated as a controlled foreign corporation with respect to a U.S. shareholder as a result of attribution of ownership under [S]ection 318(a)(3) to a U.S. person that is not a related person (within the meaning of [S]ection 954(d)(3)) to such U.S. shareholder as a result of the repeal of [S]ection 958(b)(4).”
The legislative intent of the downward attribution rules was to target certain transactions that shifted the ownership of a foreign corporation to a common foreign parent entity to avoid the CFC status for the foreign corporation. It is clear from the example provided that downward attribution was not the intended result of the repeal of Section 958(b)(4), and it is possible that this situation will be addressed in future technical corrections legislation. Unfortunately, the current law does not provide any exceptions to exclude the example provided earlier from the downward attribution rules.
The downward attribution rules are effective for the last taxable year of foreign corporations beginning before Jan. 1, 2018, and each subsequent year of such foreign corporations as well as for the taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end. In preparation for the 2018 tax filing season, taxpayers should consult their tax advisers to consider the potential applicability of the downward attribution rules.
While the U.S. Department of the Treasury and the IRS have been working on clarifying the new tax rules and the related compliance requirements and addressing comments from taxpayers and practitioners, guidance has not been provided on a number of the TCJA provisions. One of the TCJA provisions that might become an unpleasant surprise for some taxpayers is the change in the downward attribution rules of Section 958(b).
Before the TCJA, Section 958(b)(4) provided that U.S. taxpayers could not be attributed ownership in a foreign corporation if their ownership resulted from first attributing ownership in a foreign corporation to its foreign parent and then attributing the same ownership interest to a U.S. subsidiary of the foreign corporate parent (under Section 318(a)(3)). The TCJA repealed Section 958(b)(4) but provided no exceptions for the unintended results of the downward attribution.
As a result of the repeal of Section 958(b)(4), many taxpayers might find that they have become U.S. shareholders of controlled foreign corporations (CFCs) and, consequently, subject to taxation under Section 965 and GILTI. A CFC is a foreign corporation that is more than 50 percent owned by 10 percent shareholders (by vote or value) that are U.S. persons (certain U.S. individuals, corporations, trusts, estates, and partnerships). For example, if a foreign corporate parent company (FP) has a U.S. wholly owned subsidiary (U.S. Sub) and a foreign wholly owned subsidiary (F Sub), U.S. Sub will be attributed 100 percent of the ownership of F Sub under the new Section 958(b) attribution rules, and F Sub will be treated as a CFC. If FP has no direct or indirect 10 percent U.S. shareholders under Section 958(a) (Section 958(a) shareholders), the CFC status of F Sub should not result in U.S. Sub or any constructive 10 percent shareholder of F Sub under Section 958(b) having to include any income from F Sub under deemed inclusion rules such as Section 965 and GILTI.
However, if FP does have a Section 958(a) shareholder, the Section 958(a) shareholder will be treated as a U.S. shareholder of a CFC and will be subject to all the rules of income inclusion applicable to U.S. shareholders of a CFC. Specifically, under the TCJA, the U.S. shareholder will be subject to the Section 965 one-time toll charge on F Sub’s undistributed earnings. In addition, the U.S. shareholder will be subject to U.S. taxation on its share of GILTI income from F Sub. Finally, the Subpart F and Section 956 income inclusion rules also will apply to the U.S. shareholder. In no event, however, will a U.S. shareholder that is a U.S. shareholder solely by virtue of constructive ownership rules under Section 958(b) have a deemed inclusion under the provisions already described.
The example of the new downward attribution rules in the previous paragraph appears to show an unintended result of the TCJA. According to the act’s accompanying conference report, the downward attribution rules were not intended to “cause a foreign corporation to be treated as a controlled foreign corporation with respect to a U.S. shareholder as a result of attribution of ownership under [S]ection 318(a)(3) to a U.S. person that is not a related person (within the meaning of [S]ection 954(d)(3)) to such U.S. shareholder as a result of the repeal of [S]ection 958(b)(4).”
The legislative intent of the downward attribution rules was to target certain transactions that shifted the ownership of a foreign corporation to a common foreign parent entity to avoid the CFC status for the foreign corporation. It is clear from the example provided that downward attribution was not the intended result of the repeal of Section 958(b)(4), and it is possible that this situation will be addressed in future technical corrections legislation. Unfortunately, the current law does not provide any exceptions to exclude the example provided earlier from the downward attribution rules.
The downward attribution rules are effective for the last taxable year of foreign corporations beginning before Jan. 1, 2018, and each subsequent year of such foreign corporations as well as for the taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end. In preparation for the 2018 tax filing season, taxpayers should consult their tax advisers to consider the potential applicability of the downward attribution rules.