Treasury Issues Guidance and Proposed Regulations Relating to the Repeal of Section 958(b)(4)

Summary

On October 1, 2019, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued Rev. Proc. 2019-40. The Revenue Procedure provides guidance related to the repeal of Section 958(b)(4) to certain U.S. persons that own stock in certain foreign corporations.
 
Also, on October 2, 2019, Treasury published in the Federal Register proposed regulations relating to the repeal of Section 958(b)(4). The proposed regulations affect U.S. persons that have ownership interests in or that make or receive payments to or from certain foreign corporations.

 

Background

Section 958 provides rules for determining stock ownership of a foreign corporation for purposes of Sections 951 through 965.  Section 958(b) provides, in relevant part, that Section 318(a), relating to the constructive ownership of stock, applies, subject to certain modifications, to the extent that the effect is to treat any U.S. person as a U.S. shareholder within the meaning of Section 951(b) or to treat a foreign corporation as a controlled foreign corporation (CFC) under Section 957. Effective for the last tax year of foreign corporations beginning before January 1, 2018, and each subsequent year of such foreign corporations, and for the tax years of U.S. shareholders in which or with which such tax years of foreign corporations end, the Tax Cuts and Jobs Act of 2017 (TCJA) repealed Section 958(b)(4). 
 
As in effect prior to repeal, Section 958(b)(4) provided that subparagraphs (A), (B), and (C) of Section 318(a)(3) were not to be applied so as to consider a U.S. person as owning stock that is owned by a person who is not a U.S. person. The subparagraphs of Section 318(a)(3) generally attribute stock owned by a person to a partnership, estate, trust, or corporation in which such person has an interest.
 
Due to the repeal of Section 958(b)(4), stock of a foreign corporation owned by a foreign person can be attributed to a U.S. person under Section 318(a)(3) for purposes of determining whether a U.S. person is a U.S. shareholder of the foreign corporation and, therefore, whether the foreign corporation is a CFC. In other words, because of the repeal of Section 958(b)(4), Section 958(b) now provides for downward attribution from a foreign person to a U.S. person in circumstances in which Section 958(b), before the TCJA, did not so provide. As a result, U.S. persons that were not previously treated as U.S. shareholders may be treated as U.S. shareholders, and foreign corporations that were not previously treated as CFCs may be treated as CFCs.

 

Rev. Proc. 2019-40

Due to the repeal of Section 958(b)(4), a U.S. shareholder with respect to a foreign corporation may not be able to determine that the foreign corporation is a CFC without knowledge regarding the investments of unrelated persons. As it may not be possible for the U.S. shareholder to obtain information necessary to determine whether the foreign corporation is a CFC, the Revenue Procedure limits the inquiries required by U.S. persons to determine whether certain foreign corporations are CFCs. In the Revenue Procedure, the IRS states that it will accept a U.S. person’s determination that a foreign corporation does not meet the Section 957 ownership requirements and, therefore, that the foreign corporation is not a CFC with respect to the U.S. person if certain conditions described in the Revenue Procedure are satisfied.^[1]
 
The Revenue Procedure also allows certain unrelated minority U.S. shareholders to rely on specified financial statement information to calculate their subpart F and GILTI inclusions, along with amounts included under Section 951 by reason of Section 965 or a deduction under Section 965(c), and satisfy reporting requirements with respect to certain CFCs if more detailed tax information is not available when certain conditions are satisfied. It also provides penalty relief to taxpayers in the specified circumstances.^[2]
 
In addition, the IRS announced that it intends to amend the instructions for Form 5471 to reduce the amount of information that certain unrelated minority U.S. shareholders of the CFC are required to provide. It will also limit the filing requirements of U.S. shareholders who only constructively own stock of the CFC solely due to downward attribution from another person.^[3]
 
The Revenue Procedure also includes examples illustrating the rules described in the Revenue Procedure.^[4]
 
Unless otherwise provided in future guidance, taxpayers may apply sections 4, 5, 6, and 7 of the Revenue Procedure with respect to the last taxable year of a foreign corporation beginning before January 1, 2018, and each subsequent taxable year of such a foreign corporation, and with respect to the taxable years of U.S. shareholders in which or with which such taxable years of such foreign corporation end. 
 
Taxpayers may apply the rules described in sections 5, 6, and 8 of the Revenue Procedure, before the instructions to the Form 5471 are modified, for the last taxable year of a foreign corporation beginning before January 1, 2018, and each subsequent taxable year of the foreign corporation, and with respect to the taxable years of U.S. shareholders in which or with which such taxable years of the foreign corporation end.
 
For additional details, see Rev. Proc. 2019-40.

 

Proposed Regulations

Some of the key items included in the proposed regulations are summarized below.

1. The proposed regulations provide that an amount, other than interest, that is income of a related foreign person with respect to which the related foreign person is exempt from U.S. taxation on the amount owed pursuant to a treaty obligation of the United States is exempt from the application of Section 267(a)(3)(B)(i) if the related foreign person is a CFC that does not have any Section 958(a) U.S. shareholders.^[5]
2. The proposed regulations prevent a CFC that does not have any Section 958(a) U.S. shareholders from avoiding U.S. tax under Section 332(d)(3) by modifying the definition of a CFC so as to use the definition of a CFC in effect immediately before the repeal of Section 958(b)(4) for purposes of applying Section 332(d)(3).^[6]
3. The proposed regulations revise §1.367(a)-8(k)(14) to apply Section 958(b) without regard to the repeal of Section 958(b)(4).^[7]
4. To prevent the tax-free accumulation of income in a trust for the benefit of U.S. persons that would otherwise result in tax-free distributions from the trust to the U.S. beneficiaries, the proposed regulations provide that the only CFCs taken into account for purposes of Section 672(f) are those that are CFCs without regard to downward attribution from foreign persons.^[8]
5. The proposed regulations exclude from the definition of “foreign partner” only CFCs with respect to which a U.S. shareholder owns stock within the meaning of Section 958(a) for purposes of determining a partnership taxable year.^[9]
6. The proposed regulations provide that whether a foreign corporation is a CFC for purposes of the rules under Sections 863(d) and (e) treating space and ocean income and international communications income as U.S. source income in whole or in part is determined without regard to downward attribution from a foreign person.^[10]
7. The regulations under Section 904 are revised to limit the application of the affiliated group rules in the Section 904 active rents and royalties exception and the financial services income rule, as well as the CFC look-through rule, to foreign corporations that are CFCs without regard to downward attribution from foreign persons. Further, the CFC look-through rule, as proposed to be revised at 83 FR 63200 (December 7, 2018), is further revised to apply only to U.S. shareholders that are U.S. shareholders without regard to downward attribution from foreign persons.^[11]
8. The proposed regulations modify the definition of a CFC for purposes of Section 1297(e) to disregard downward attribution from foreign persons.^[12]
9. To mitigate the increased Form 1099 reporting by foreign corporations that may have no direct or indirect owners that are U.S. persons, proposed §1.6049-5(c)(5)(i)(C) provides that a U.S. payor includes only a CFC that is a CFC without regard to downward attribution from a foreign person.

For additional details and applicability dates, see the proposed regulations.
 

BDO Insight

Rev. Proc. 2019-40 provides welcome, albeit limited, relief for certain taxpayers that may be subject to substantial compliance burdens resulting from the repeal of Section 958(b)(4). The proposed regulations are generally intended to ensure that the operation of certain rules is consistent with their application before the TCJA’s repeal of Section 958(b)(4). Please contact a BDO international tax specialist if you would like more information regarding the content of this tax alert.
 

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[1] See Section 4.02 of the Revenue Procedure for additional details.
[2] See Sections 5.02, 6.02 and 7.02 of the Revenue Procedure for additional details.
[3] See Section 8 of the Revenue Procedure for additional details. The Revenue Procedure also states that the IRS intends to revise the instructions for Form 5471 to provide that a category 5 filer is not required to file a Form 5471 with respect to a “foreign-controlled CFC” if it is an “unrelated constructive U.S. shareholder” with respect to the “foreign-controlled CFC.” See Section 3 of the Revenue Procedure for definitions.
[4] See Section 9 of the Revenue Procedure for additional details.
[5] Proposed §1.267(a)-3(c)(4). The proposed regulations also amend §1.267(a)-3(c)(2) and remove the rules currently in §1.267(a)-3(c)(4) to reflect the changes to Section 267 in Pub. L. 108-357. In the preamble to the proposed regulations, Treasury stated the intention to update other provisions in §1.267(a)-3 to take into account the changes made to Section 267(a)(3) by Pub. L. 108- 357 in future guidance.
[6] See proposed §1.332-8(a).
[7] See proposed §1.367(a)-8(k)(14)(ii).
[8] See proposed §1.672(f)-2(a). A reference to foreign personal holding companies in §1.672(f)-2(a) is also deleted, consistent with the repeal of the foreign personal holding company regime by Section 413(a) of the American Jobs Creation Act of 2004, Pub. L. 108-357. Id.
[9] See proposed §1.706-1(b)(6)(ii). As in proposed §1.672(f)-2(a), the reference to foreign personal holding companies is also deleted. See id.
[10] See proposed §§1.863-8(b)(2)(ii) and 1.863-9(b)(2)(ii).
[11] See proposed §1.904-5(a)(4)(i) and (vi) (providing definitions that apply for purposes of §§1.904-4 and 1.904-5, pursuant to §§1.904-4(a) and 1.904-5(a)(4) as proposed to be revised at 83 FR 63200 (December 7, 2018)).
[12] See proposed §1.1297-1(d)(1)(iii)(A).