Treasury Issues Temporary Regulations on the Section 245A Dividends Received Deduction and the Section 954(c)(6) Exception

On June 18, 2019, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued temporary regulations under Section 245A that limit the dividends received deduction available for certain dividends received from current or former controlled foreign corporations (CFCs). The temporary regulations also limit the applicability of the exception to foreign personal holding company income in Section 954(c)(6) for certain dividends received by upper-tier CFCs from lower-tier CFCs. Temporary regulations under Section 6038 were also issued to facilitate administration of certain rules in the temporary regulations. The temporary regulations affect certain U.S. persons that are domestic corporations that receive certain dividends from current or former CFCs or are U.S. shareholders of upper-tier CFCs that receive certain dividends from lower-tier CFCs.

 

Details

Treasury states in the preamble to the temporary regulations that the temporary regulations limit the availability of the Section 245A deduction and the Section 954(c)(6) exception in specific and narrow cases where the deduction or exception, respectively, effectively eliminates Subpart F income or income subject to tax under Section 951A from the U.S. tax system. Specifically, the temporary regulations address transactions that have the effect of avoiding tax under Section 965, 951A, or 951 by inappropriately converting income that should have been subject to U.S. tax into nontaxed income. The temporary regulations also include rules under Section 6038 to facilitate administration of certain rules in the temporary regulations. The temporary regulations do not include general rules relating to dividends eligible for the Section 245A deduction; Treasury notes in the preamble to the temporary regulations that those rules will be included in separate guidance.
 
In the case of a dividend received by a domestic corporation from a specified 10-percent owned foreign corporation (SFC, as defined in Section 245A(b)), the temporary regulations disallow the Section 245A deduction on the portion of a dividend constituting an “ineligible amount.”^[1]
 
In general, the ineligible amount is the sum of: (i) 50 percent of the portion of a dividend attributable to certain earnings and profits resulting from transactions between related parties, during a period after the measurement date under Section 965(a)(2) and in which the SFC was a CFC but during which Section 951A did not apply to it (referred to as the extraordinary disposition amount); and (ii) the portion of a dividend attributable to certain earnings and profits generated during any taxable year ending after December 31, 2017, in which the domestic corporation reduces its ownership of the CFC (referred to as the extraordinary reduction amount).
 
The disallowance of the Section 245A deduction with respect to a distribution from a CFC that constitutes an extraordinary reduction amount applies only to a controlling Section 245A shareholder, i.e., a Section 245A shareholder that owns more than 50 percent (by vote or value) of the stock of the CFC taking into account stock owned by related parties with respect to the Section 245A shareholder and other persons acting in concert with the Section 245A shareholder to undertake an extraordinary reduction. For definitions and additional details, see §1.245A-5T.
 
The temporary regulations also prevent the Section 954(c)(6) exception from applying in certain cases where a dividend from a lower-tier CFC to an upper-tier CFC would be an extraordinary disposition amount if distributed directly to the Section 245A shareholders of the lower-tier CFC.^[2]
 
The temporary regulations include various definitions, exceptions, and special rules implementing the disallowance of the Section 245A deduction and the limitation for amounts eligible for the Section 954(c)(6) exception not discussed in this tax alert. For additional details, see the temporary regulations.
 
The rules in the temporary regulations relating to eligibility of distributions for the Section 245A deduction apply to distributions occurring after December 31, 2017. The rules in the temporary regulations relating to the eligibility of dividends for the Section 954(c)(6) exception also apply to distributions occurring after December 31, 2017, subject to the transition rule in §1.245A-5T(f)(3) for determining tiered extraordinary reduction amounts.^[3]
 

BDO Insight

The temporary regulations are intended to prevent U.S. shareholders from avoiding U.S. tax on Subpart F income or income subject to tax under Section 951A. Please contact a BDO international tax specialist if you require assistance in understanding and applying the temporary regulations.
 

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[1] See §1.245A-5T(b).
[2] See §1.245A-5T(d).
[3] See §§1.245A-5T(k), 1.954(c)(6)-1T(b), and 1.6038-2T(m).