The new U.S. tax law (Pub. L. No. 115-97) modifies the stock attribution rules under section 958(b) that apply for purposes of the anti-deferral rules of subpart F of the U.S. Internal Revenue Code, including determining whether a person (corporation or otherwise) is a “U.S. Shareholder” of a controlled foreign corporation (“CFC”), and whether a foreign corporation is a CFC.
Specifically, the new tax law repealed statutory language that had prevented “downward attribution” of stock ownership, from a foreign person to a related U.S. person.
In general, a U.S. person is U.S. Shareholder for subpart F purposes when it owns at least 10% of a CFC. Prior to tax reform, the U.S. Shareholder determination was made on the basis of voting power.
The new tax law expanded the definition of U.S. Shareholder to include a U.S. person that owns at least 10% of the value of the CFC. The new “vote or value” U.S. Shareholder definition applies to tax years beginning after December 31, 2017, and a foreign corporation is a CFC when it is more than 50% owned by U.S. Shareholders. For this purpose, ownership is determined under the attribution rules of sections 958(a) and 958(b).
Section 958(b) generally adopts the constructive ownership rules in section 318 (with certain modifications) to attribute foreign stock ownership of one person to a related person. Before the new tax law was enacted, section 958(b)(4) turned off the downward attribution rules in 318(a)(3) such that, for example, a U.S. corporation was not considered to own stock that was owned by its foreign parent. By removing section 958(b)(4), the new statute now requires “downward attribution” from a foreign person to a related U.S. person.
As a result of expanding the section 958(b) constructive ownership rules, the number of U.S. Shareholders and, therefore the number of CFCs, will increase. The diagram below illustrates this change.
As noted in the diagram, before the repeal of section 958(b)(4), Foreign Parent’s ownership of Foreign Sub was not attributed to US Sub. However, under current section 958(b), Foreign Parent’s ownership in Foreign Sub is attributed to US Sub. Thus, Foreign Sub is a CFC in which US Sub is a U.S. Shareholder.
The section 958(b) rules do not apply, however, for purposes of determining the amount that a U.S. Shareholder includes in income under the subpart F provisions, including the new global intangible low-taxed income (GILTI) rules. As a result, notwithstanding its U.S. Shareholder status, US Sub would not be subject to tax under the subpart F regime (including GILTI) with respect to Foreign Sub because it does not own—directly or indirectly under the section 958(a) attribution rules—any interest in Foreign Sub.
The repeal of section 958(b)(4) is applicable to the last tax year of foreign corporations beginning before January 1, 2018, and each subsequent tax year, and to tax years of U.S. Shareholders in which or with which such taxable years of foreign corporations end.
As a result of its effective date, the repeal of section 958(b)(4) has immediate consequences for purposes of the mandatory repatriation provisions as well as U.S. Shareholder information filing obligations for the 2017 tax year.
Specified foreign corporation status for mandatory repatriation
In general, the mandatory repatriation rules apply to U.S. Shareholders of “specified foreign corporations” (SFCs) that have post-1986 earnings and profits (“post-86 E&P”). For this purpose, an SFC is a CFC or a foreign corporation with at least one domestic corporation that is a U.S. Shareholder. The repeal of section 958(b)(4) must be taken into account in determining whether a foreign corporation is a CFC, and whether a domestic corporation is a U.S. Shareholder for SFC purposes.
The diagram below illustrates the effect that the downward attribution rules (which apply as a result of the repeal of section 958(b)(4)) have on increasing the number of U.S. persons subject to the mandatory repatriation regime:
In this diagram, US Sub directly owns 9% of Foreign Sub, and, under revised section 958(b), constructively owns the remaining 91% of Foreign Sub as a result of “downward attribution” of Foreign Parent’s ownership of Foreign Sub. Thus, US Sub is treated as wholly owning Foreign Sub, and Foreign Sub is an SFC.
As a result, US Sub would have to include in income its pro rata share of Foreign Sub’s post-86 E&P pursuant to the mandatory repatriation rules, although the amount of US Sub’s mandatory repatriation inclusion would be based solely on its direct and indirect ownership (9%) of Foreign Sub, and only take into account E&P earned by Foreign Sub during periods that Foreign Sub was an SFC.
Note that foreign income taxes paid or accrued by Foreign Sub would not be attributed to US Sub’s mandatory repatriation inclusion because US Sub own less than 10% of Foreign Sub’s voting stock (as determined under the relevant rules).
Additional Form 5471 filings
Generally speaking, U.S. Shareholders of CFCs are required to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, to report entity level information for each of their CFCs. The U.S. persons required to file, and the extent of information they are required to provide on the form, varies based on the person’s filing “category.”
As relevant here, a U.S. Shareholder (that is, a U.S. person that owns at least 10% of the CFC) is a Category 5 filer that is required to file a Form 5471. Furthermore, constructive ownership rules apply for purposes of determining whether a U.S. person owns a CFC for Category 5 filing purposes. Accordingly, starting with the last tax year that begins before January 1, 2018, the new downward attribution rules may result in a U.S. person needing to file a Form 5471, as a Category 5 filer.
Significantly, in Notice 2018-13, the IRS signaled an intention to limit the scope of Category 5 filings necessitated by the new downward attribution rules, and echoed that intention in the preamble to the proposed regulations under section 965. Taken together, the guidance relieves a U.S. person that is a U.S. Shareholder of a CFC from the Category 5 filing obligation if:
Under this limitation, in the diagram below, US Sub has no Form 5471 filing obligation for Foreign Sub unless US Shareholder—which would indirectly wholly own Foreign Sub—exists, or US Investor exists and owns at least 10% of Foreign Sub.
Taxpayers can rely on the description of this new exception, which is expected to be included in the upcoming revised Form 5471 instructions, for their 2017 filings. Notwithstanding this exception, due to its limited nature, the repeal of section 958(b)(4) is still expected to drastically increase the number of taxpayers required to file Form 5471.
To alleviate redundant filings, a joint ownership exception generally allows one U.S. person to file a joint information return on behalf of other persons required to file the same information for the same CFC. Under this exception, only one Form 5471 for a CFC may need to be filed by a consolidated group even when there are more than one Category 5 U.S. Shareholder of the CFC under the newly expanded section 958(b) constructive ownership rules.
When a U.S. person files a Form 5471 on behalf of a person that is not in its consolidated return group, the person relying on the exception must attach to its return a statement that identifies the filer and provides certain other information.
Unless and until the government provides otherwise, taxpayers are advised to review their structure charts to determine whether the downward attribution rule imposes Category 5 filing obligations on U.S. persons that historically have not been treated as U.S. Shareholders of CFCs. The Category 5 filing obligation can apply even when a U.S. Shareholder is not otherwise subject to tax under the subpart F rules with respect to the CFC.
For more information contact a tax professional with KPMG’s Washington National Tax practice:
Ron Dabrowski | +1 202 533 4274 | email@example.com
Barbara Rasch | +1 213 533 3382 | firstname.lastname@example.org
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