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IRS Issues Proposed Regulations Related to Investment of Earnings in U.S. Property – IRC Sec. 956

Nov 27, 2018

On October 31, 2018, the IRS issued proposed regulations addressing investment of earnings in U.S. property as it relates to controlled foreign corporations (“CFCs”). These regulations were to address certain questions arising from various changes in tax law from the Tax Cuts and Jobs Act (“TCJA”).

Prior to 1962, U.S. shareholders of a CFC were not subject to taxation on earnings from the CFC until repatriated. The Revenue Act of 1962 enacted a series of Internal Revenue Code provisions known as the Subpart F provisions to address this deferral, by allowing certain types of investments and transactions which create Subpart F income to be taxed currently even if not yet repatriated. IRC Sec. 956 was enacted alongside the subpart F regime to ensure that a CFC’s earnings not subject to immediate tax when earned would be taxed when repatriated, either through a dividend or an effective repatriation.

Recognizing that repatriation of foreign earnings was possible through means other than a taxable distribution, Congress determined that the investment by a CFC of its earnings in United States property, including obligations of a U.S. person, “is substantially the equivalent of a dividend.” Accordingly, Congress enacted IRC Sec. 956 as an anti-abuse measure to tax a CFC’s investment of earnings in United States property in the same manner as if it had distributed those earnings to the United States.  

As part of the TCJA, Congress enacted IRC Sec. 245A, commonly known as the participation exemption, to eliminate the additional U.S. tax on a dividend from specified foreign corporations.

The Treasury Department and the IRS have determined that as a result of the enactment of the participation exemption system, the current broad application of IRC Sec. 956 to corporate U.S. shareholders would be inconsistent with the purposes of IRC Sec. 956 and the scope of transactions it is intended to address.

Under the participation exemption system, earnings of a CFC that are repatriated to a corporate U.S. shareholder as a dividend are effectively exempt from U.S. tax. Typically, an IRC Sec. 956 inclusion is not eligible for the dividends received deduction under IRC Sec. 245A because it is not an actual dividend.

In order to achieve this result, the proposed regulations provide that the amount otherwise determined under IRC Sec. 956 with respect to a U.S. shareholder for a taxable year of a CFC is reduced to the extent that the U.S. shareholder would be allowed a deduction under IRC Sec. 245A if the U.S. shareholder had received a distribution from the CFC in an amount equal to the amount otherwise determined under IRC Sec. 956.  

The proposed regulations provide special rules with respect to indirect ownership. Due to the broad applicability of IRC Sec. 245A, in many cases a corporate U.S. shareholder will not have an IRC Sec. 956 inclusion as a result of a CFC holding U.S. property under the proposed regulations.

IRC Sec. 956 will continue to apply to U.S. shareholders who are not corporations, such as individuals. Even when an individual makes an IRC Sec. 962 election, which is an election to be treated as a corporation with respect to Subpart F income, IRC Sec. 245A does not apply.

The effective date is for CFC tax years beginning after December 31, 2017.


The proposed regulations would facilitate intercompany financing and other arrangements to allow the U.S. corporate shareholder to take advantage of earnings accumulated after TCJA where the requirements of IRC Sec. 245A are otherwise met.   There may be more flexibility in the terms of financing arrangements which previously had to be constructed to avoid the adverse tax consequences arising from IRC Sec. 956.  Taxpayers should review the terms of their financing arrangements, both third-party and intercompany, to analyze the impact.

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Charles Brezak

Charles Brezak is an International Tax Services Group Director with over 30 years experience advising clients on cross-border tax planning.

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