Proposed Rules Bring Limited Relief From Downward Attribution

| 6/13/2019
On May 17, the U.S. Department of the Treasury and the IRS released proposed regulations under IRC Section 954(d)(3), which provides rules for determining if a person is related to a controlled foreign corporation (CFC). The proposed regulations would affect U.S. persons with direct or indirect ownership interests in certain foreign corporations.


The 2017 tax overhaul under the Tax Cuts and Jobs Act (TCJA) repealed IRC Section 958(b)(4). This provision was written to prevent the ownership of stock by a foreign shareholder from being attributed downward to a domestic subsidiary and, consequently, creating CFC status based on constructive ownership attributed to a domestic brother-sister corporation. With the repeal of Section 958(b)(4), the stock attribution rules now permit the downward attribution of shareholder stock held by a foreign shareholder to a U.S. person. For example, pre-TCJA, if a foreign parent owned 51% of a foreign subsidiary and a U.S. subsidiary (of the foreign parent) owned the remaining 49%, the foreign subsidiary would not be a CFC because Section 958(b)(4) prevented the U.S. subsidiary from being attributed ownership of the foreign parent’s 51% interest. As a result of the repeal of this limitation, under the facts already described, the U.S. subsidiary would be treated, for purposes of determining U.S. shareholder and CFC status, as owning all of the foreign parent’s stock in the foreign subsidiary, causing the foreign subsidiary to be a CFC.

Proposed regulations

Section 954(d)(3) provides that transactions with related parties under Subpart F of the code rely on the same ownership rules to define related parties. However, Treasury and the IRS were concerned that the application of the constructive ownership rules, incorporated into Section 1.954-1(f) by reference to Section 958, could produce some unintended results when defining a related person for purposes of Section 954(d)(3). For example, if two unrelated domestic corporations each own interests in a partnership, under the constructive ownership rules of Section 318(a)(3)(A), the partnership would be treated as owning any stock of CFCs that are owned directly or indirectly by the unrelated domestic corporations. As such, the partnership would be treated as controlling any CFC in which the domestic corporations owned 50% or more of the stock, regardless of the size of the domestic corporation’s ownership interest in the partnership. Therefore, a CFC of one of the domestic corporations would be treated as related to a CFC of the other domestic corporation, creating Subpart F income between two marginally related corporations or allowing marginally related corporations to qualify for an exception to Subpart F income received as a payment from a related CFC. According to the preamble of the proposed regulations, Treasury and the IRS do not believe that either of these results is appropriate when domestic corporations each own 50% or less of the partnership.

In order to address the concerns described, the proposed regulations revise Section 1.954-1(f) to provide that the rules of Section 318(a)(3) and Section 1.958-2(d) do not apply for purposes of Section 954(d)(3) and Section 1.954-1(f). In the example provided earlier, the partnership and other domestic corporation would not be treated as controlling any CFC of either domestic corporation for purposes of determining related-party transactions. However, the proposed revision would not prevent a corporation or partnership from being treated as controlled by the same person that controls the CFC, but the partnership no longer would be treated as owning the stock of the related-party CFC as a result of downward attribution from a domestic corporation for purposes of Section 954(d).

The proposed regulations also provide that the option attribution rule in Section 318(a)(4), which treats a person who has the option to acquire stock, equity interest, or other similar interest as owning the stock for purposes of the related-person definition, will not apply if the principal purpose is to treat that person as a related person with respect to a CFC.

Requests for comments and an opportunity to testify at a hearing are due July 19. With the repeal of Section 958(b)(4), implemented through these proposed regulations, the scope of entities subject to global intangible low-taxed income and other Subpart F applications would be broadened, and ownership structures will need to be analyzed to determine the impact these new rules might have.

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Laurie Cameron
Brent Felten
Brent Felten
Partner, Washington National Tax