United States: IRS Paves The Way For Lenders To Obtain Guarantees And Collateral From (And 100% Stock Pledges Of) Foreign Subsidiaries


On Oct. 31, 2018, the Internal Revenue Service issued proposed regulations under Section 956 of the Internal Revenue Code that will eliminate the adverse tax consequences when a U.S. parent corporation (i) pledges more than two-thirds of the voting stock of a foreign subsidiary to secure the U.S. corporation's debt, (ii) causes a foreign subsidiary to pledge its assets to secure the U.S. corporation's debt or (iii) causes a foreign subsidiary to guarantee the U.S. corporation's debt.

Absent the applicability of the proposed regulations, such credit support generally would result in a taxable "deemed dividend" to the U.S. parent corporation borrower. The proposed regulations would, in most circumstances, eliminate any detrimental income inclusion to the U.S. parent corporation borrower based on a "dividends received deduction" under Section 245A of the Code. The proposed regulations apply only to U.S. borrowers that are corporations and not partnerships (or limited liability companies treated as partnerships for tax purposes), individuals, or entities disregarded as separate from their noncorporate owner. The proposed regulations address an inconsistency in tax treatment between actual dividends by a foreign subsidiary to its U.S. corporate parent and other transactions that would result in deemed dividends from that same foreign subsidiary to its U.S. corporate parent. As a result, the proposed regulations apply only to U.S. corporate shareholders that own 10 percent or more of the foreign subsidiary (by vote or value), and Section 956 continues to apply (as it did prior to the 2017 tax reform) with respect to all other shareholders. In addition, the relief provided by the proposed regulations applies only to the extent that the dividends received deduction under Section 245A would have applied if the deemed dividend were an actual dividend.

Section 956 and the Tax Cuts and Jobs Act of 2017

Section 956 was enacted to ensure that the offshore earnings of a controlled foreign corporation (a CFC) would be taxed when repatriated, either through a dividend or an effective repatriation substantially the equivalent of a dividend, such as through credit support provided by the CFC for a U.S. parent company's debt (a deemed dividend).

The Tax Cuts and Jobs Act of 2017 enacted a limited participation exemption system under which foreign source earnings of a foreign corporation repatriated to a U.S. corporate shareholder that owns 10 percent or more of the foreign corporation (by vote or value) as an actual dividend effectively would be exempt from U.S. federal income taxation through an offsetting dividends received deduction under Section 245A of the Code. However, this relief applies only to actual dividends and was not extended to deemed dividends under Section 956.

The proposed regulations extend the relief by providing that the amount of a Section 956 deemed dividend is reduced to the extent the U.S. corporate shareholder would have been allowed a dividends received deduction under Section 245A if it had received an actual dividend from the CFC in an amount equal to the deemed dividend under Section 956.1

To confirm the availability of the dividends received deduction under Section 245A, analysis of the detailed requirements of Section 245A will need to be undertaken.

Requirements Under Section 245A

Under Section 245A, the dividends received deduction is available only for the foreign-source portion of a dividend that is received by a U.S. corporate shareholder that owns 10 percent or more of the vote or value of the foreign corporation. The Section 245A deduction is not allowed (i) for any portion of the earnings and profits derived from U.S. sources; (ii) if the stock of the CFC is held by the U.S. corporate shareholder for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which such share becomes ex-dividend with respect to such dividend; (iii) if the U.S. corporate shareholder is under an obligation to make related payments with respect to positions in substantially similar or related property; or (iv) where the dividend paid by the CFC is a "hybrid" dividend for which the CFC received a deduction or other tax benefit with respect to certain foreign taxes. Section 245A contains additional requirements and limitations that need to be analyzed based on the facts and circumstances of each transaction.

Effective Date

The proposed regulations generally will be applicable to taxable years of a CFC beginning on or after the date of the publication of the regulations in final form; however, a taxpayer can rely on the proposed regulations for taxable years of a CFC beginning after 2017 if it and its related persons apply them consistently to all of their CFCs.


1 If Section 245A were to apply, a foreign tax credit would not be allowed for taxes paid or accrued by the CFC with respect to that dividend; thus, by equating a Section 956 inclusion to an actual dividend subject to the Section 245A dividends received deduction, it will no longer be possible for a U.S. corporate shareholder to affirmatively use Section 956 for foreign tax credit planning.

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.

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