Treasury Releases Final and Proposed Regulations on Downward Attribution

Summary Relating to Modification of Section 958(b)

On September 22, 2020, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) published in the Federal Register final regulations relating to the modification of Section 958(b) of the Internal Revenue Code by the Tax Cuts and Jobs Act (TCJA) (the Final Regulations). The Final Regulations—which finalize proposed regulations published on October 2, 2019—affect U.S. persons that have ownership interests in, or that make or receive payments to or from, certain foreign corporations.
 
On the same date, Treasury published in the Federal Register proposed regulations (the 2020 Proposed Regulations) relating to the modification of Section 958(b) by the TCJA. The 2020 Proposed Regulations modify the ownership attribution rules applicable to outbound transfers of stock or securities of a domestic corporation under Section 367(a). The 2020 Proposed Regulations also narrow the scope of foreign corporations that are treated as controlled foreign corporations (CFCs) for purposes of the look-through rule under Section 954(c)(6). The 2020 Proposed Regulations affect U.S. persons that transfer stock or securities of a domestic corporation to a foreign corporation that are subject to Section 367(a), and U.S. shareholders of foreign corporations.

Details

1. The Final Regulations  

On October 2, 2019, Treasury published proposed regulations (REG-104223-18) relating to the repeal of Section 958(b)(4) by the TCJA, in the Federal Register (84 FR 52398) (the 2019 Proposed Regulations). Additional guidance related to the repeal of Section 958(b)(4), including relief from certain information reporting requirements and safe harbors for determining whether a foreign corporation is a CFC and for determining certain items of a CFC (such as taxable income and earnings and profits) based on alternative information, was issued in Rev. Proc. 2019-40. For a summary of the 2019 Proposed Regulations and Rev. Proc. 2019-40, see our October 2019 tax alert.
 
The Final Regulations adopt the 2019 Proposed Regulations with certain modifications. In the preamble to the Final Regulations, Treasury largely rejects comments received on the 2019 Proposed Regulations but does make a key modification with respect to proposed Section 267 regulations. In particular, the exception from the CFC payee rule in proposed §1.267(a)-3(c)(4) is expanded in the Final Regulations to apply to all amounts payable to a related foreign person that is a CFC that does not have any Section 958(a) U.S. shareholders.^[1] As a result, the foreign payee rule in Section 267(a)(3)(A) and the regulations under that section will apply to those payments exempt from the application of the CFC payee rule. However, the CFC payee rule continues to apply to a CFC that has a Section 958(a) shareholder even if the foreign corporation is a CFC due solely to the repeal of Section 958(b)(4).
 
The Final Regulations generally apply on or after October 1, 2019. For taxable years before taxable years covered by the regulations, a taxpayer may generally apply the rules in the Final Regulations to the last taxable year of a foreign corporation beginning before January 1, 2018, and each subsequent taxable year of the foreign corporation, and to taxable years of U.S. shareholders in which or with which such taxable years of the foreign corporation end, provided that the taxpayer and U.S. persons that are related (within the meaning of Section 267 or 707) to the taxpayer consistently apply the relevant rule with respect to all foreign corporations.^[2] Moreover, although §1.958-2 applies to taxable years of foreign corporations ending on or after October 1, 2019, and taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end, the same result applies before such date due to the effective date of the repeal of Section 958(b)(4).

2. The 2020 Proposed Regulations  

Treasury states in the preamble to the 2020 Proposed Regulations that it has determined that, for purposes of applying §1.367(a)-3(c)(1)(i), (ii) and (iv), a U.S. person’s constructive ownership interest should not include an interest that is treated as owned as a result of downward attribution from a foreign person as it would inappropriately treat the U.S. person as owning an interest it would not have owned under the rules in effect when those regulations were promulgated. The Treasury further states that the constructive ownership rules as they apply to the condition set forth in §1.367(a)-3(c)(1)(iii) (which requires that either the U.S. person is not a 5% transferee shareholder or the U.S. person must enter into a gain recognition agreement) should not be modified, and thus will continue to take into account downward attribution. The continued application of downward attribution for purposes of §1.367(a)-3(c)(1)(iii) results in a consistent application of the gain recognition agreement provisions for outbound transfers of stock or securities of domestic and foreign corporations. Therefore, the 2020 Proposed Regulations revise §1.367(a)-3(c)(4)(iv) to apply the attribution rules of Section 318, as modified by Section 958(b) but without applying Section 318(a)(3)(A), (B) and (C) to treat a U.S. person as owning stock that is owned by a foreign person for all purposes of §1.367(a)-3(c) other than for purposes of determining whether a U.S. person is a 5% transferee shareholder under §1.367(a)-3(c)(1)(iii).
 
The 2020 Proposed Regulations also limit the application of the Section 954(c)(6) look-through rule to amounts received or accrued from foreign corporations that are CFCs without applying Section 318(a)(3)(A), (B) and (C) to treat a U.S. person as owning stock that is owned by a foreign person.
 
The regulations under Section 367(a) are proposed to apply to transfers made on or after September 21, 2020.
 
Subject to special rules for certain entity classification elections and changes in taxable years, the regulations under Section 954(c)(6) are proposed to apply to payments or accruals of dividends, interest, rents and royalties made by a foreign corporation during taxable years of the foreign corporation ending on or after September 21, 2020, and to taxable years of U.S. shareholders in which or with which such taxable years of the foreign corporation end.
 
The 2020 Proposed Regulations further provide that taxpayers may choose to apply the rules under Section 367 or 954(c)(6), once filed as final regulations in the Federal Register, to the last taxable year of a foreign corporation beginning before January 1, 2018, and each subsequent taxable year of the foreign corporation, subject to a consistency requirement.^[3]
 
Finally, a taxpayer may rely on the 2020 Proposed Regulations under Section 367 or 954(c)(6) with respect to any taxable year before the date that these regulations are published as final regulations in the Federal Register, provided that the taxpayer and persons that are related (within the meaning of Section 267 or 707) to the taxpayer consistently rely on the proposed regulations under Section 367 or 954(c)(6), respectively, with respect to all foreign corporations.