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Final Regulations Issued Under IRC Section 956

Jun 21, 2019

The IRS has issued final regulations under IRC Sec. 956 which are intended to align the deemed income inclusion under IRC Sec. 956 with the newly enacted IRC Sec. 245A dividends received deduction (“DRD”), also known as the participation exemption. The final regulations were issued and became effective on May 23, 2019 (in some cases the regulations will be effective for taxable years beginning after December 31, 2017).

IRC Sec. 245A, newly enacted under the 2017 Tax Cuts and Jobs Act (“TCJA”), provides that earnings of a controlled foreign corporation (“CFC”) that are repatriated to a qualified corporate U.S. shareholder as a dividend are effectively exempt from tax because the shareholder is permitted to take an equal and offsetting DRD.


U.S. shareholders (ownership of 10% or more as defined in IRC Sec. 958(b)) of CFCs (as defined in IRC Sec. 957) are subject to current federal income taxation on certain CFC investments under IRC Sec. 956. The amount of income included under IRC Sec. 956 is generally equal to the lesser of:

  1. The U.S. shareholder's pro rata share of the quarterly average of United States property (“U.S. property”) held by the CFC over the course of the year minus the IRC Sec. 959(c)(1)(A) earnings and profits (“E&P”) with respect to the shareholder; or
  2. The U.S. shareholder's pro rata share of the "applicable earnings" of the CFC.

Final Regulations

Under the final regulations, the amount of income inclusion determined under IRC Sec. 956 (“Tentative Sec. 956 Amount”) will be reduced for U.S. corporate shareholders to the extent the shareholder would be eligible for a DRD under IRC Sec. 245A as if the shareholder had received an equal amount of an actual dividend from the CFC (“Hypothetical Distribution”). A U.S. shareholder is eligible for the deduction if the U.S. shareholder meets a one-year holding period requirement under IRC Sec. 246(c)(5). The holding period must be met for each share of stock.

IRC Sec. 956 will continue to adversely apply to individuals who are U.S. shareholders of a CFC, regulated investments company or real estate investment trust. For U.S. partnerships with U.S. corporate partners, the Tentative Sec. 956 Amount is reduced to the extent the U.S. corporate partner is allowed the deduction by application of IRC Sec. 245A. See Treas. Reg. Sec. 1.956-1(a)(2)(i) and (iii).

For CFCs with previously taxed earnings and profits (“PTEP”), the Hypothetical Distribution would be first attributable to any IRC Sec. 959(c)(2) PTEP (e.g., Subpart F inclusions) and then to the CFC’s untaxed earnings and profits under IRC Sec. 959(c)(3). These ordering rules will apply even if the CFC had PTEP from IRC Sec. 956 inclusions. Notwithstanding the complexity, it is anticipated these new ordering rules will generally be favorable to taxpayers.

One of the major benefits under the final IRC Sec. 956 regulations is that U.S. corporate shareholders will generally be able to pledge the stock and/or assets of their CFCs to support their borrowings without adverse deemed dividend tax consequences. In addition, there is more flexibility now for CFCs to serve as the guarantor for the U.S. parent’s borrowings.

In summary, the final regulations appear to provide a more favorable outcome for U.S. corporate shareholders of CFCs. U.S. shareholders of a CFC should continue checking whether IRC Sec. 956 rules apply to them or not. Clients should consult their tax advisors before making any financial decision involving loans, guarantees or pledging stock and/or assets

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