United States: Recent Tax Court Decision In Crestek – A Cautionary Tale For U.S. Companies With Foreign Subsidiaries

In a ruling with tax implications for U.S. corporations with foreign subsidiaries, the U.S. Tax Court has held that transactions between a U.S. parent company and its controlled foreign corporations constitute "United States property" and must be included in the parent company's gross income. The decision in Crestek v. Commissioner (July 27, 2017) illustrates several common fact patterns in which certain tax code Section 956 problems can arise and serves as a reminder of issues that should not be overlooked in ongoing cash management and financial transactions between a U.S. affiliate and its CFCs. 

A planning objective that may be very important​ for a U.S. corporation (or other controlling U.S. shareholder) with foreign subsidiaries is deferral of U.S. tax on the un-repatriated earnings of those subsidiaries. Where such subsidiaries are CFCs as defined in Section 957 of the code, deferral can be terminated and U.S. tax immediately come due not only because of actual cash distribution but by deemed dividends resulting from inclusions of subpart F income or investments in United States property under Section 956 of the Code.

In Crestek, the Tax Court upheld the IRS' assessment of tax (and accuracy related penalties) arising from several Section 956 U.S. property investments made by the taxpayer's CFCs. The case involves several common sources of Section 956 problems involving CFCs in practice. Specifically, the U.S. parent was required to include a deemed dividend out of its CFCs' earnings as a result of the following transactions: (1) intercompany loans by the CFCs to U.S. affiliates from advances of cash; (2) a guarantee by a locally resident CFC to a foreign bank that made a loan to the U.S. entity; and (3) accounts payable owing from a U.S. affiliate to two different CFCs from purchase of manufactured inventory. With one exception, the court rejected the taxpayer's arguments for why Section 956 did not apply.

Statute of Limitations – When Can a Section 956 Issue Be Assessed?

At the threshold, the taxpayer argued that the IRS was too late in assessing the tax under the applicable statute of limitations. This argument had two parts. First, as to one of the two taxable years at issue (2008 and 2009), the IRS mailed the statutory notice of deficiency after the normal three-year statute of limitations in Section 6501(a) had expired. Second, some of the Section 956 investments had been made many years before the year at issue, in some cases as early as 2001. The taxpayer argued that tax attributable to such Section 956 investments should have been assessed in the earlier years when the Section 956 investments were first made. 

On the first question, the Tax Court found the IRS's notice of assessment to be timely under the sometimes-overlooked six-year statute of limitations for omissions from gross income attributable to inclusions under Section 951(a). See Section 6501(e)(1)(C). Under this provision, which was added as part of the 2004 JOBS Act,1 if the taxpayer omits an item from gross income under Section 951(a), the IRS has six years from the tax return filing date to assess the tax. Note that this special rule applicable to Subpart F applies regardless of the amount of the omission, or whether it exceeds 25 percent of gross income. 

On the second argument, in an earlier case involving a previous version of Section 956, McCulloch Corp. v. Commissioner, TC Memo 1984-422, the Tax Court had ruled that the statute of limitations barred the IRS from assessing a deficiency with respect to a Section 956 investment made in a prior, closed taxable year. Under the statute at that time, the Section 956 inclusion was determined based on the increase in CFC's earnings invested in U.S. property as compared to the preceding year. 

By contrast, under the current version of Section 956, which was at issue in Crestek, the Section 956 inclusion is determined as the lesser of (1) the excess of the Section 956 investment over previously taxed earnings under Section 956 and (2) the CFC's "applicable earnings." In Crestek, since the Section 956 investments from earlier years had never been actually included in gross income of the U.S. shareholder, there was no previously taxed income to shelter the Section 956 investment. Since the taxpayer had not "picked up" the Section 956 investment in a prior year, it was fully includible in the later years audited by the IRS. Under this rationale, an unreported Section 956 investment effectively has no statute of limitations so long as it is outstanding. Coupled with the six-year statute of limitations for assessment under Section 6501(e)(1)(C), Section 956 issues may have a long or indefinite shelf life. 

While not at issue in the case, note that if an amount representing the PTI is distributed after the initial Section 956 investment, that Section 956 investment can be taxed again to the U.S. shareholder of the CFC. This also can "extend" the shelf life of a Section 956 investment.

Intercompany Loans

With respect to the intercompany loans made by CFCs to a U.S. affiliate for cash, the taxpayer argued that the loans had been effectively "discharged" due to the debtor's failure to make payments. However, the court found this assertion to be unsupported. Also, as noted by the court, discharge of the loans payable would have constituted a taxable income from cancellation of indebtedness under Section 61(a)(12).2

Guarantee of Shareholder Debt

Section 956 issues can potentially arise in the context of third-party borrowing supported by a CFC's guarantee or other credit support. 

In Crestek, one of the taxpayer's U.S. affiliates borrowed from a bank in Malaysia. As a condition of loan, one of the CFCs in Malaysia guaranteed the repayment of the debt directly. The shareholder also pledged that CFC's shares to the bank as collateral and entered certain agreements restricting the CFC's disposition of its assets in the nature of negative covenants. 

This pledge and guarantee seemed to fall squarely within the scope of the pledge and guarantee rules of Section 956(d) and Treas. Reg. 1.956-2(c). Under those rules, the pledging CFC was deemed to hold a Section 956 investment equal to the U.S. shareholder's entire unpaid principal balance of the loan.3

To avoid this unfortunate result, the taxpayer argued that Section 956's guarantee rule should be limited in some fashion to the pledging CFC's wherewithal to support the guarantee. Specifically, the taxpayer argued that the pledging CFC lacked sufficient net assets to support the guarantee, which accordingly had no value to the lender. In support, the taxpayer cited an example from the 1979 proposed regulations under Section 956 that suggests that the guaranteeing CFC's asset base might be relevant.4

The Tax Court rejected this argument. It found a lack of facts to support the taxpayer's argument that the pledging CFC's were insufficient to support the guarantee. The court also said that having an in-country company guarantee repayment to the Malaysia bank may well have had value to the bank, which was making the loan to a foreign, non-Malaysian borrower. In addition, the Tax Court's discussion suggested that, even if proven, the limited asset base of the guaranteeing CFC may not be relevant. 

Under the latter analysis, a CFC making a guarantee will have an inclusion that may outweigh the benefit of the guarantee to the lender (or secondarily the taxpayer) in obtaining the loan. This is unlike a direct loan or other Section 956 investment where the inclusion equals the amount of earnings invested in U.S. property. Since the cost of a CFC guarantee to the taxpayer may outweigh the benefit from it, the case serves as a reminder to avoid CFC guarantees and limit pledges to the amounts permitted in the regulations.

Trade Receivables – When Do They Become Stale?

Lastly, in yet another recurring fact pattern, the Tax Court addressed Section 956 investments attributable to a U.S. affiliate's unpaid trade receivable balances owing to two CFCs arising from purchase of inventory manufactured by the CFCs. Trade receivables from inventory and services transactions between CFCs and U.S. group members are common. While Section 956(c)(2)(C) contains an exception to Section 956 treatment for certain accounts receivable, the Crestek case illustrates that taxpayers can inadvertently fall out of this exception if such receivables are not properly managed. 

In Crestek, the issue arose in two different fact patterns.

In the first fact pattern, an account receivable owing from a U.S. affiliate to the CFC remained outstanding several years after the CFC's manufacture and sale of goods to the parent ceased. The CFC extending credit had, in fact, ceased its manufacturing operations in a prior year. The Tax Court ruled for the IRS as a matter of law that this account was not "ordinary and necessary" to the two affiliates' trade or business. As stated by the court, the receivable had "lost any connection to ongoing commercial transactions" and "was not 'ordinary and necessary' because [the affiliates] were no longer engaged in a trade or business with each other." 149 T.C. No. 5, at *14.

Similar issues could arise in other fact patterns where a trade receivable ages too far or is transferred between entities. In those situations, at what point does an ordinary and necessary trade receivable "lose its connection" to the trade or business activities of the CFC? 

Secondly, the court addressed a trade receivable in place between the U.S. affiliate and CFC pursuant to an ongoing relationship of purchasing and selling goods to the U.S. affiliate. The receivables balance from the U.S. to the CFC steadily increased over the years at issue. The CFC also incurred accounts payable to the parent from purchases of raw materials, but these payables the CFC promptly settled. 

As to this balance, the court expressed some doubts that the receivables might be "excessive," but held that the application of ordinary and necessary was a factual issue for trial. 


The Crestek case addresses several garden variety Section 956 issues that can frequently come up in practice. While the court's decision does not break any new ground in analysis of these issues, it nonetheless illustrates some of the fact patterns in which these issues can arise and thus serves as a useful reminder of Section 956 traps to be monitored and avoided in ongoing cash management between a U.S. shareholder and its CFCs.     


1 Before the JOBS Act, the lengthened six-year statute of limitations applied only to inclusions under the foreign personal holding company rules (Section 552(a)).  Along with repealing the FPHC rules, Congress amended the six-year statute of limitations to also apply to subpart F.  Crestek appears to be the first case or other authority applying this easily forgotten statute of limitations provision.

2 Alternatively, given that any such discharge would have arisen in a corporate-shareholder relationship, it is more likely that the discharge would have been taxed as a dividend under Section 301.  However, the court did not reach the characterization of such a debt discharge as COD income versus a constructive dividend.

3 Additionally, in one chief counsel advice, ILM 201436047 (Sept. 8, 2014), the IRS advised that the guaranteed "principal balance" also includes any accrued but unpaid interest on the loan.

4 The reference to the guaranteeing CFC's assets was removed from the corresponding example in the Final Regulations.  Compare Treas. Reg. Section 1.956-2(c)(3), Example 3 with Prop. Reg. 1.956-2(c)(3), Example 3, 44 Fed. Reg. 23883 (Apr. 23, 1979) (stating that book value of guaranteeing CFC's assets exceeded the principal balance of the loan).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
7 Jan 2019, Other, California, United States

Learn how to effectively take an HR department paperless while protecting company information and complying with ‘personnel file’ disclosure laws.

21 Jan 2019, Speaking Engagement, California, United States

Now entering its fifth year, the Pocket Gamer Connects events series has grown to become the biggest and most influential mobile games conference in the west as well as th​e biggest games event overall in the UK and Helsinki.

28 Jan 2019, Other, California, United States

Legalweek New York is the week in which various segments of the legal industry gather to explore the Business and Regulatory Trends, Technology and Talent drivers impacting the industry.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions