Section 956 Proposed Regulations Released

| 11/15/2018
On Oct. 31, 2018, the U.S. Department of the Treasury and the IRS issued proposed regulations under IRC Section 956 that provide an exemption to U.S. corporate shareholders. Section 956 originally was enacted to tax U.S. shareholders of controlled foreign corporations (CFCs) when a CFC is considered to invest its current or accumulated earnings in U.S. property. Investments into U.S. property generally are taxable to the U.S. shareholder in the year of the investment. Under Section 956, U.S. property consists of tangible property located in the U.S., domestic corporation stock, and an obligation of a U.S. person as well as any right to the use in the U.S. of a patent or copyright; an invention, model, or design; a secret formula or process; or any other similar property right that is acquired or developed by the CFC for use in the United States.

The primary application of Section 956 was directed toward loans made from CFCs to U.S. shareholders and guarantees or collateral provided by a CFC in order for the U.S. shareholders to obtain loans. These “investments” were considered substantially equivalent to a dividend.

Under the Tax Cuts and Jobs Act, a participation exemption system was established that effectively eliminated the taxation of a dividend from a CFC to a corporate U.S. shareholder because the U.S. shareholder can take a dividends-received deduction (DRD) up to the amount of the dividend under Section 245A. A Section 956 inclusion, conversely, is not eligible for the DRD under Section 245A. As a result, the TCJA created a Section 956 inclusion, which is substantially equivalent to a dividend but would have treatment different from an actual dividend, which ultimately goes against the purpose of Section 956.

Treasury intended the proposed regulations to exclude corporate U.S. shareholders from the application of Section 956 to the extent necessary to maintain symmetry between the taxation of actual repatriations, which result in no additional U.S. tax, and the taxation of effective repatriations. To achieve this result, the proposed regulations direct the amount determined under Section 956 for a U.S. shareholder to be reduced to the extent that the U.S. shareholder would qualify for a Section 245A deduction if the U.S. shareholder had received an actual distribution from the CFC.

These changes are proposed to apply to taxable years of a CFC beginning on or after the date the final regulations are published. For the taxable years of a CFC beginning before the final regulations but after Dec. 31, 2017, however, a taxpayer may rely on the proposed regulations.

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Joe Callero
Brent Felten
Brent Felten
Partner, Washington National Tax