On September 21, 2020, the IRS released for publication final regulations (T.D. 9908) relating to the modification of section 958(b) by the Tax Cuts and Jobs Act (“TCJA”). These regulations affect U.S. persons that have ownership interest in, or that make or receive payments to or from, certain foreign corporations.
By way of background, section 958(b)(4) prevented “downward attribution” of stock owned by a foreign person to a U.S. person. Thus, if a foreign person owned stock of a foreign corporation and a U.S. corporation, then the U.S. corporation was prevented from being attributed ownership of the stock of the foreign corporation. However, the TCJA repealed section 958(b)(4) resulting in stock of a foreign corporation owned by a foreign person to be subject to “downward attribution” to a U.S. person under section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 (which is relevant to determining whether the foreign corporation is a controlled foreign corporation (“CFC”)). The repeal of section 958(b)(4) had the result of significantly expanding the number of foreign corporations that would be treated as CFCs (which, among other things, would have increased compliance and reporting burdens for many foreign corporations and their shareholders). In October 2019, the IRS published proposed regulations (REG-104223-18) related to the repeal of section 958(b)(4) and provided guidance under Rev. Proc. 2019-40, which included (i) safe harbor rules for determining that a foreign corporation is not a CFC if the U.S. person does not have actual knowledge plus other conditions, safe harbor rules for using alternative information in order to determine subpart F or GILTI inclusion amount, and using alternative information for determining section 965 amounts; (ii) penalty relief under section 6038 and 6662, and (iii) certain reporting requirements on Form 5471.
These final regulations adopt the proposed regulations and provide the following:
- Section 267 – Deduction for certain payments to foreign related persons: under section 267(a)(3)(B)(i), any item payable to a related CFC is deductible by the payor to the extent that an amount attributable to the item is includible in the gross income of a U.S. person who owns stock in such CFC (“CFC payee rule”). Under the proposed regulations, an amount (other than interest) that is income of a related foreign person and exempt from U.S. taxation pursuant to a treaty obligation of the U.S. was exempt from the CFC payee rule if the related foreign person is a CFC that did not have any U.S. shareholders that owned stock in such CFC (“section 958(a) U.S. shareholder”). The final regulations expanded the exception from the CFC payee rule 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. shareholder.
- Comments were provided on sections 881(c), 1248, and 6049. However, the IRS decided not to adopt such comments. Regarding the proposed regulations modification of a CFC for purposes of section 1297(e) to disregard “downward attribution” from foreign persons, the IRS published other proposed regulations (REG-105474-18) and decided to finalize proposed section 1.1297-1(d)(1)(iii)(A).
Additionally, the IRS also released a notice of proposed rulemaking (REG-110059-20) that modifies the regulations under section 367(a) regarding the direct or indirect transfer of stock or securities of a domestic corporation by a U.S person (as defined in section 7701(a)(30)) to a foreign corporation to ensure the attribution rules are applied consistently following the TCJA’s repeal of section 958(b)(4). The IRS have decided not to modify the constructive ownership rules as they apply to the condition set forth in section 1.367(a)-3(c)(1)(iii) (either the U.S. person is not a 5% transferee shareholder or must enter into a gain recognition agreement). The continued application of the “downward attribution” for purposes of section 1.367(a)-3(c)(1)(iii) results in a consistent application of the gain recognition agreement provision for outbound transfers of stock or securities of domestic and foreign corporations. Therefore, the proposed regulations revise section 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), or (C) to treat a U.S. person as owning stock that is owned by a foreign person, for all purposes of section 1.367(a)-3(c) other than for purposes of determining whether a U.S. person is a 5% transferee shareholder under section 1.367(a)-3(c)(1)(iii).
Finally, taxpayers should be mindful that these tax rules are complex and special care should be taken to understand both the benefits and collateral consequences that can arise from the application of these tax rules.