Treasury Issues Final and Concurrent Proposed Regulations Relating to the Section 245A Deduction
Treasury Issues Final and Concurrent Proposed Regulations Relating to the Section 245A Deduction
On August 27, 2020, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) published in the Federal Register final regulations that limit the deduction for certain dividends received by U.S. persons from foreign corporations under Section 245A and the exception to subpart F income under Section 954(c)(6) for certain dividends received by controlled foreign corporations (CFCs). Treasury also published final regulations under Section 6038 regarding information reporting to facilitate administration of the final regulations.
On the same date, Treasury published in the Federal Register proposed regulations under Sections 245A and 951A that coordinate the extraordinary disposition rule under Section 245A with the disqualified basis rule under Section 951A. Treasury also published proposed regulations under Section 6038 regarding information reporting to facilitate administration of the proposed regulations. The proposed regulations affect corporations that are subject to the extraordinary disposition rule and the disqualified basis rule.
Section 245A generally provides a 100 percent deduction to domestic corporations for certain dividends received from foreign corporations after December 31, 2017.
On June 18, 2019, Treasury published temporary regulations (TD 9865) under Sections 245A, 954(c)(6) and 6038 in the Federal Register (84 FR 28398, as corrected at 84 FR 38866). These temporary regulations limit the Section 245A deduction and the Section 954(c)(6) exception with respect to distributions supported by certain earnings and profits (E&P) not subject to the integrated international tax regime created by the Tax Cuts and Jobs Act. On the same date, Treasury published a notice of proposed rulemaking (REG-106282-18) in the Federal Register (84 FR 28426, as corrected at 84 FR 38892) by cross-reference to the temporary regulations (together with the temporary regulations, the 2019 regulations).
In general, the 2019 regulations include rules that limit the amount eligible for the Section 245A dividends received deduction and the amount eligible for the Section 954(c)(6) exception by 50 percent of the extraordinary disposition amount or tiered extraordinary disposition amount, respectively (together, the extraordinary disposition rule). In addition, the 2019 regulations include rules that disallow the Section 245A deduction for the portion of a dividend attributable to certain E&P 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). For a summary discussion of the 2019 regulations, see our July 2019 Tax Alert.
1. Final Regulations
The final regulations finalize the proposed regulations with certain revisions and remove the temporary regulations.
The final regulations provide additional guidance with respect to:
- Exceptions to extraordinary dispositions, including an exception for certain intangible property transfers;
- Extraordinary disposition accounts, including rules for measuring the Section 245A shareholder’s share of E&P described in Section 959(c)(3);
- Prior extraordinary disposition amounts, including a new type of prior extraordinary disposition amount and rules that consider certain income inclusions under Section 956;
- Successor rules for extraordinary disposition accounts, including rules dealing with nonrecognition;
- Tiered extraordinary disposition amounts, including rules that continue to limit the application of the Section 954(c)(6) exception with respect to certain dividends attributable to extraordinary disposition E&P from a lower tier CFC to an upper tier CFC;
- Extraordinary reductions, including additional guidance with respect to the bilateral election to close the CFC tax year; and
- The anti-abuse rule, which provides that the Commissioner may make appropriate adjustments to any amounts determined under Reg. §1.245A-5 if a transaction is entered into with a principal purpose of avoiding the purposes of such section, including new examples.
Treasury also states in the preamble to the final regulations that it is studying the extent to which nimble dividends should qualify for the Section 245A deduction generally and may address this issue in future guidance under Section 245A.
The final regulations apply to tax periods ending on or after June 14, 2019, the date the proposed regulations were filed with the Federal Register. In a case where both the temporary regulations and the final regulations could apply, only the final regulations apply. Distributions made after December 31, 2017, and before the final regulations apply, continue to be subject to the rules set forth in the temporary regulations. However, a taxpayer may choose to apply the final regulations to distributions made during this period, provided that the taxpayer and all related parties consistently apply the final regulations in their entirety.
For additional details, see the final regulations.
2. Proposed Regulations
On June 21, 2019, Treasury published in the Federal Register final regulations (TD 9866, 84 FR 29288) under Section 951A (the GILTI final regulations). The GILTI final regulations include a rule providing that a deduction or loss attributable to basis created by reason of a transfer of property from a CFC to a related person during the disqualified period (disqualified basis) is allocated and apportioned solely to residual CFC gross income (the disqualified basis rule). For a summary discussion of the GILTI final regulations, see our June 2019 Tax Alert.
The new proposed regulations include a coordination mechanism that reduces disqualified basis (the DQB reduction rule), and another that reduces an extraordinary disposition account (the EDA reduction rule) in certain cases where the extraordinary disposition rule and the disqualified basis rule could give rise to excess taxation as to a Section 245A shareholder (or as to the Section 245A shareholder and a related party).
The DQB reduction rule provides that when an extraordinary disposition account of a Section 245A shareholder gives rise to an extraordinary disposition amount or tiered extraordinary disposition amount, the disqualified bases of certain items of specified property are reduced by the same amount solely for purposes of Reg. §1.951A-2(c)(5). This rule is intended to ensure that as the extraordinary disposition rule applies to cause gain to which extraordinary disposition E&P are attributable to in effect be subject to U.S. tax, the disqualified basis rule generally does not apply to the basis of an item of specified property attributable to that gain (because that basis is no longer generated at no U.S. tax cost) and, accordingly, items of deduction or loss attributable to that basis become eligible to offset income subject to U.S. tax. The proposed regulations include timing rules for determining and reducing disqualified basis.
The EDA reduction rule provides that when items of deduction or loss attributable to disqualified basis of an item of specified property are allocated and apportioned to residual CFC gross income of a CFC and have the effect of reducing certain E&P of the CFC that could otherwise potentially qualify for the Section 245A deduction when distributed, the extraordinary disposition account to which the specified property corresponds is reduced by up to the same amount. This rule is generally intended to ensure that as the application of the disqualified basis rule results in income of the CFC being indirectly taxed to a Section 245A shareholder (or a related party that is a domestic corporation, a domestic affiliate) and a reduction in the E&P of the CFC available to be distributed to the Section 245A shareholder and any domestic affiliates as a dividend to which the Section 245A deduction could be available if distributed, the extraordinary disposition rule no longer applies to E&P attributable to gain to which the disqualified basis is also attributable. The proposed regulations include timing rules for reducing an extraordinary disposition account.
The proposed regulations provide two versions of both the DBQ reduction rule and the EDA reduction rule. The first version (proposed §1.245A-7) may be applied to simple cases, and the second version (proposed §1.245A-8) applies to complex cases.
The version for simple cases may be applied when two conditions are satisfied, because those conditions eliminate the need for certain additional rules under the version for complex cases. The first condition provides requirements related to the seller specified 10 percent-owned foreign corporation (an SFC) with respect to which there is an extraordinary disposition account. The second condition provides requirements related to an item of specified property for which an extraordinary disposition occurred and the buyer CFC holding the item. Also, the version of the rules for simple cases is not available if the Section 245A shareholder’s extraordinary disposition account with respect to an SFC has been adjusted pursuant to the successor rules of Reg. §1.245A-5(c)(4).
The versions of the DQB reduction rule and EDA reduction rule for complex cases use the same architecture as the versions of the rules for simple cases but provide additional rules to address scenarios in which the conditions provided in proposed Reg. §1.245A-6(b) are not satisfied.
The proposed regulations also provide guidance with respect to rules coordinating the extraordinary disposition rule with the disqualified payment rule in proposed Reg. §1.951A-2, currency translation rules, an anti-avoidance rule providing that appropriate adjustments are made if a transaction or arrangement is engaged in with a principal purpose of avoiding the purposes of these proposed regulations, and rules that permit a taxpayer to revoke the disqualified basis elimination election in §1.951A-3(h)(2)(ii)(B)(3) during a transition period.
The proposed regulations are proposed to apply to taxable years of foreign corporations beginning on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register (the finalization date), and to taxable years of a U.S. person in which or with which such taxable years of foreign corporations end. For taxable years beginning before the finalization date, a taxpayer may apply the rules set forth in the final regulations, provided the taxpayer and all related parties consistently apply the rules to those taxable years.
For additional details, see the proposed regulations.