Section 245A of the Internal Revenue Code of 1986 (the "Code") effectively exempts U.S. corporations from U.S. Federal income tax on dividends received from certain foreign subsidiaries. It allows a deduction equal to the amount of the dividend received. Code §245A applies only where certain conditions are met and only with respect to dividends received "by a domestic corporation which is a United States shareholder."

Nevertheless, Code §245A can also apply to dividends received by a controlled foreign corporation from a qualifying participation in a lower-tier foreign corporation. The question presented in that fact pattern is how Code §245A is applied.

  • Is the controlled foreign corporation entitled to claim the deduction as dividends are received?
  • Or is a U.S. corporation that is a U.S. Shareholder with regard to both the distributing and the recipient corporation foreign corporations entitled to claim the deduction at the time Subpart F income is reported in its U.S. tax return?

Significantly different results may apply depending on the answer. Interestingly, the differences affect U.S. taxpayers other than the corporation that is a U.S. Shareholder.


Code §245A was added to the Code as part of the Tax Cuts and Jobs Act of 2017 (the "T.C.J.A.").1 It is effective for distributions made after December 31, 2017.

Prior to the T.C.J.A., the U.S. international tax system was largely a worldwide system of taxation. Except as provided under Subpart F, active business income of foreign subsidiaries was taxed only upon repatriation, i.e., when distributed to the U.S. corporate shareholder.2

The imposition of U.S. tax on repatriated income of foreign subsidiaries placed U.S. multinational corporations at a disadvantage compared with foreign corporations based in countries that employed a territorial system of taxation dividend income received from foreign subsidiaries.3 Examples include the U.K. and other G-7 counntries. This was especially true because the nominal U.S. corporate tax rate was very high relative to the corporate tax rates in other countries, reaching 35% at the time.4

In 2017, Congress decided to eliminate the taxation of repatriated income of foreign subsidiaries and to reduce the corporate income tax rate to 21%. The main purpose was to allow U.S. multinationals to better compete against foreign multinationals.5 This is when Code §245A came into play, effective in 2018.


Code §245A provides that, in the case of any dividend received from a 10%-owned foreign corporation by a U.S. corporation that is a U.S. Shareholder, the U.S. corporation is allowed a deduction in an amount equal to the foreign-source portion of the dividend (also known as a dividend-received deduction or a "D.R.D."). As a result of the D.R.D., the dividend income is fully offset, resulting in a nil rate of U.S. Federal corporate income tax.

An important point to bear in mind is that, where the distributing corporation is a controlled foreign corporation ("C.F.C.") as defined in Code §957(a), some of its income might already have been taxed in the U.S. under the U.S. anti-deferral regimes in advance of any distribution ("Previously Taxed Income").6 To prevent the same income from being taxed a second time, the Code provides that Previously Taxed Income is not to be taken into account for U.S. Federal tax purposes when actually distributed to the U.S. Shareholder.7 Accordingly, ordering rules published by the I.R.S. provide that any amount distributed by a C.F.C. will first be considered as being made out of Previously Taxed Income.8 Only the remainder of the dividend amount, if any, will be potentially subject to Code §245A D.R.D.

For the D.R.D. to apply, the following five conditions must be met:

  • The dividend must be received from a "specified 10-percent owned foreign corporation" (a "Specified Foreign Corporation" or "S.F.C."). An S.F.C. is a foreign corporation if at least one of its shareholders is a corporation that is "U.S. Shareholder."9 A corporation is "U.S. Shareholder" if it was formed in the U.S. and it owns, either directly or indirectly, or is considered as owning under special attribution rules, shares representing10% or more of the voting power or value of the distributing corporation.10
  • The dividend must be received by a domestic corporation that is a "U.S. Shareholder" with respect to the distributing corporation.
  • The U.S. Shareholder must meet a minimum holding-period requirement of more than 365 days during a two-year period beginning one year before the ex-dividend date.11
  • The dividend must be a foreign source dividend, determined by reference to the undistributed foreign earnings of the Specified Corporation.12
  • The dividend must not be any of the following: (i) a hybrid dividend,13 (ii) a purging distribution by a passive foreign investment company ("P.F.I.C.") generally made as a condition of becoming a "pedigreed Q.E.F.,14 (iii) any other distribution from a P.F.I.C."15 that is not a C.F.C.,16 and (iv) an extraordinary disposition amount during the taxable year preceding application of the D.R.D.17

In this article, we focus on the second requirement listed above, according to which the dividend must be received by a domestic corporation.

As explained below, the D.R.D. should also apply if the dividend is received by a C.F.C. owned by a domestic corporation, provided the domestic corporation is U.S. Shareholder with respect to the distributing corporation and all other requirements listed above are met.

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1. Pub. L. No. 115-97, §14101(a).

2. In contrast to active business income, passive income of foreign subsidiaries has been taxed by the U.S. shareholder on an annual basis under the Subpart F regime or the P.F.I.C. regime where the foreign corporation is treated as a Qualified Electing Fund. Both sets of rules are beyond the scope of this article.

3. S. Comm. on the Budget, 115th Cong., Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Prt. No. 115-20, at 358 (Comm. Print 2017).

4. Of course, corporations with sophisticated tax departments were tasked to manage the effective rate.

5. S. Comm. on the Budget, 115th Cong., Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Prt. No. 115-20, at 358 (Comm. Print 2017)

6. Mainly, the Subpart F regime governed by Code §§951 to 965 and the G.I.L.T.I. regime under Code §951A. The G.I.L.T.I. regime became effective as of 2018.

7. Code §959(a).

8. I.R.S. Notice 2019-01.

9. Code §245A(b).

10. Code §951(b)

11. Code §246(c)(5).

12. As defined in Code §245A(c). A deduction for the U.S. portion of the dividend, if any, is available under Code §245, in full or in part, depending on the circumstances and provided certain conditions are met.

13. Code §245A(e).

14. Code §245A(f).

15. Defined in Code §1297.

16. Defined in Code §957(a).

17. Treas. Regs. §1.245A-5

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.