By way of background, the 2017 tax act introduced new Code § 245A, which, in general, provides a deduction for the foreign source portion of a dividend received by a U.S. “C” corporation from a foreign corporation, provided the shareholder owns at least 10 percent (by vote or value) of the foreign corporation and certain holding period and other requirements are met.
However, to the surprise of market participants and practitioners, Code § 956, which taxes certain investments in U.S. property by controlled foreign corporations (CFCs) as deemed dividends to their 10 percent U.S. shareholders, was retained, resulting in disparate treatment between actual dividends from CFCs (which generally can now be received tax-free by U.S. corporate parents under Code § 245A) and deemed dividends, which remained taxable. For purposes of Code § 956, a guarantee by a CFC of an obligation (such as a loan or other debt obligation) of a related U.S. person is considered an investment in U.S. property, that can trigger a deemed dividend. Similarly, a pledge of more than two thirds of the voting stock of a CFC can trigger a deemed dividend. General market practice has been to recognize the deemed dividend issue and provide exceptions for credit support from CFCs and CFC Holdcos in financing transactions.
Here are five things you need to know about the Proposed Regulations.
- Possible Current Reliance—The Proposed Regulations are proposed to be effective for taxable years of a CFC beginning on or after the date a Treasury decision adopting the rules as final is published in the Federal Register, and to taxable years of a 10 percent U.S. shareholder in which or with which such taxable years of the CFC end. However, with respect to taxable years of a CFC beginning before the finalization date, a taxpayer may rely on the Proposed Regulations for taxable years of a CFC beginning after December 31, 2017, and for taxable years of a 10 percent U.S. shareholder in which or with which such taxable years of the CFC end, provided that the taxpayer and related U.S. persons to the taxpayer consistently apply the Proposed Regulations with respect to all CFCs in which they are 10 percent U.S. Shareholders. Taxpayers that would like to rely on the Proposed Regulations before they are finalized should make sure that related U.S. persons will be applying the Proposed Regulations consistently to all their CFCs.
- Loan Agreements—Market practice concerning credit support from CFCs and CFC Holdcos of U.S. corporate-parented groups likely will evolve given the Proposed Regulations. It may be expected that lenders may begin to require credit support from CFCs where Code § 245A would be applicable. It also may be anticipated that there will be discussions on whether Code § 245A would be applicable based on the particular facts and circumstances of the U.S. parent and its foreign subsidiaries. Current loan agreements may require CFCs to become guarantors if there would be no material adverse tax consequences.
- Corporate Restructurings—The Proposed Regulations may alleviate the “deemed dividend” issues that arise from sandwich structures (i.e., where a U.S. parent owns a foreign subsidiary that, in turn, owns a U.S. subsidiary) or that arise from a CFC owning other U.S. property (such as U.S. intangibles) that can trigger a deemed dividend. Corporations facings these types of Code § 956 issues should examine whether the Proposed Regulations can save them from having to undergo a costly restructuring.
- Not all Taxpayers May Benefit—Under the Proposed Regulations, only taxpayers that would benefit from a Code § 245A deduction with respect to an actual dividend would benefit. This means that C corporations that own less than 10 percent of the foreign corporation or that do not meet the holding period requirements, regulated investment companies, real estate investment trusts, S corporations, and individuals still would be subject to tax on deemed dividends under Code § 956.
- Not All Taxpayers May Want to Benefit—Taxpayers that otherwise could rely on the Proposed Regulations may, in certain circumstances, not want to apply the rules of the Proposed Regulations until finalized.