INTRODUCTION
In Chief Counsel Advice ("C.C.A.") Memo. 202436010, the I.R.S. concluded that the dividends-received deduction ("D.R.D.") under Code §245A is not available to controlled foreign corporations ("C.F.C.'s"). The I.R.S.'s position drew heavily on the plain language of the relevant statute. The emphasis on the statute's plain language is not a new legal principle, but the timing of the memorandum is interesting given it was released a few months after Loper Bright Enterprises v. Raimondo,1 a landmark Supreme Court case decided in June 2024. Loper Bright struck down the long-standing Chevron doctrine,2 under which courts were directed to defer to a Federal agency's reasonable interpretation of ambiguous statutory provisions. In Loper Bright, the Supreme Court reasserted the judiciary's responsibility to interpret the law and held that the Chevron doctrine gave too much interpretive power to Federal agencies. In the tax context, this has led practitioners to speculate about Loper Bright's effect on Treasury Regulations. The speculation is partly fueled by a lack of clarity on what tests and standards will be used under Loper Bright to determine the validity of regulations promulgated by Federal agencies.
D.R.D.
As the name suggests, a D.R.D. is a deduction that a corporate shareholder can claim when receiving dividends if certain conditions are met. The general purpose behind the D.R.D. is to reduce the tax burden on income that is being shifted from one corporation to another but is staying within corporate solution. The Code §245A D.R.D. applies to the foreign-source portion of a dividend received by a U.S. corporate shareholder from a foreign corporation. To qualify for the deduction, the recipient must hold at least 10% of the distributing corporation's shares measured either by vote or by value.3 Additionally, the recipient must have held the stock for more than 365 days in the two-year period beginning one year before the ex-dividend date.4 If the recipient qualifies for the Code §245A requirements, the D.R.D. provides a deduction equal to 100% of the foreign-source portion of the dividend.
This D.R.D. was enacted in 2017 as part of the U.S.'s partial shift to a territorial tax system.
By the statute's plain language, the Code §245A D.R.D. is available only to domestic corporations. However, practitioners have found several clues that this D.R.D. should also be available to C.F.C.'s that receive a dividend from a 10%-owned foreign corporation. A C.F.C. is a foreign corporation in which more than 50% of the corporation's stock, measured by vote or by value, is owned by U.S. shareholders each of whom own at least 10% of the corporation's stock, measured by vote or by value.5
Because computation of income can yield different results under U.S. rules compared to foreign rules, Treas. Reg. §1.952-2 requires that a C.F.C. calculate its income for U.S. income tax purposes by using U.S. rules. Notably, a C.F.C. is directed to calculate its gross income and taxable income as though it were a domestic corporation. Certain exceptions and special rules are laid out, such as those relating to insurance income, but Code §245A is not among those exclusions.
Other statutory rules might infer the availability of the D.R.D. Paragraph (e)(2) of Code §245A applies to a C.F.C. that receives a hybrid dividend from its foreign subsidiary that is also a C.F.C. with respect to the upper-tier C.F.C.'s U.S. shareholders. The upper-tier C.F.C. is not entitled to claim the D.R.D. to offset Subpart F income. As a result, a U.S. shareholder holding directly or indirectly a ≥10% interest in the upper-tier C.F.C. is taxed in the U.S. on its share of the Subpart F income of that C.F.C.
Notably, a hybrid dividend is a dividend for which a Code §245A D.R.D. would be allowed but for paragraph (e) and for which the lower-tier C.F.C. payor received a deduction or other tax benefit in a foreign country.6 An example of a hybrid dividend is an amount paid by a corporation that the U.S. views as a dividend for a shareholder, but the foreign country of residence of the payor views as a deductible expense, such as interest paid on a debt instrument.7
This definition of hybrid dividend implies a dividend that would, in principle, be eligible for the Code §245A D.R.D. were it not for paragraph (e). Paragraph (e)(2) indicates that a C.F.C. can receive a Code §245A-eligible-dividend. If a C.F.C. can never claim the Code §245A D.R.D., the hybrid dividend rule would be superfluous as no dividend received by a C.F.C. could ever qualify for the D.R.D., whether hybrid or not hybrid.
Code §964(e)(4) also deals with structures involving a C.F.C. owning a foreign subsidiary. This provision applies where a C.F.C. sells stock in the foreign subsidiary and, under rules similar to Code §1248, is required to treat the gain as a dividend to the extent of the earnings and profits of the foreign subsidiary.8 This deemed dividend is also included in the C.F.C.'s U.S. shareholders' income as Subpart F income. However, a U.S. shareholder who would have been eligible to claim the Code §245A D.R.D. had the shareholder received an actual dividend can apply the Code §245A D.R.D. to this Subpart F inclusion. Therefore, the C.F.C. is effectively allowed a Code §245A D.R.D. on the deemed dividend. It would seem logical to allow the D.R.D. for actual dividends. However, the language is limited to such deemed dividends and does not extend to actual dividends.
LEGISLATIVE HISTORY
The legislative history behind Code §245A is ambiguous. A footnote in the House of Representative's Conference Report,9 describing U.S. corporations eligible for the Code §245A D.R.D., supports the availability of the D.R.D. for C.F.C.'s:
[U.S. corporations eligible for the §245A D.R.D. include] a controlled foreign corporation treated as a domestic corporation for purposes of computing the taxable income thereof. See Treas. Reg. Sec. 1.952- 2(b)(1). Therefore, a C.F.C. receiving a dividend from a 10-percent owned foreign corporation that constitutes subpart F income may be eligible for the D.R.D. with respect to such income.
The Joint Committee on Taxation's Bluebook, which explains the new law after its enactment, offers a different viewpoint:
A corporate U.S. shareholder of a C.F.C. receiving a dividend from a 10-percent owned foreign corporation shall be allowed a D.R.D. with respect to the subpart F inclusion attributable to such dividend in the same manner as a dividend would be allowed under section 245A.10
The Bluebook thus suggests that while Congress intended to extend Code §964(e) (4) treatment to actual dividends received by a C.F.C., and therefore mimic the effect of a Code §245A D.R.D., Congress's intent did not go as far as to actually allow the D.R.D. to the C.F.C
THE I.R.S. POSITION
C.C.A. 202436010 holds that the statute's unambiguous language means that "the analysis of the issue ends there* * *." It further states:
In fact, the reading of section 245A(a) to allow a section 245A D.R.D. for a C.F.C. would render the use of the word "domestic" in the statute surplusage, and under a "cardinal principle of statutory construction," statutes are to be interpreted to give effect to every word of the statute.11 The use of the word "domestic" in section 245A(a) contrasts with the language of sections 243(a) and 245(a), each of which allows a deduction for a dividend received by a "corporation" without specifying that the corporation needed to be domestic. Thus, unlike section 245A(a), sections 243(a) and 245(a) provide dividends received deductions to both domestic and foreign corporations. Had Congress wanted to provide a section 245A D.R.D. to both domestic and foreign corporations, it could have used language analogous to sections 243 and 245. Instead, section 245A(a) specifically requires a domestic corporation that is a United States shareholder, and that word must be given its plain meaning.
The C.C.A. also considers and rejects the specific arguments above. It argues, relying on regulatory definitions, that the Subpart F inclusion required under Code §245A(e)(2) does not imply that the D.R.D. would otherwise apply. Instead, it suggests that this provision operates by treating the C.F.C. as a domestic corporation for this purpose and then determining whether the D.R.D. would be available to the deemed domestic corporation. Arguably, however, the I.R.S.'s regulatory interpretation of Code §245A(e)(2) also departs from statutory language, as the statute's plain language does not treat a C.F.C. as a domestic corporation for purposes of defining a hybrid dividend.
VARIAN
The first court case to discuss the impact of Loper Bright in a tax context was Varian Medical Systems v. Commr.,12 where the Tax Court examined another issue related to the Code §245A D.R.D.: the interaction of the D.R.D. with the Code §78 gross-up. The Code §78 gross-up applies to a U.S. corporation that claims a foreign tax credit for foreign taxes paid by certain 10%-owned foreign subsidiaries. It requires such a corporation to treat as a dividend the amount of foreign tax paid by the C.F.C. with respect to the included income. Without the gross-up, a taxpayer could effectively claim a double benefit of a foreign tax credit and a deduction for foreign tax paid. However, Code §78 states that the grossed-up amount is not treated as a dividend for purposes of Code §245 D.R.D.13 In other words, the gross-up dividend cannot be reduced or eliminated by a Code §245 D.R.D. When Code §245A was enacted, this rule's scope was extended to cover the Code 245A D.R.D.
However, there was a timing issue as to effective dates of the provisions in play in the case. Code §245A applies to distributions made after December 31, 2017. The revised version of Code §78, which takes into account the Code §245A D.R.D., applies to tax years beginning after December 31, 2017. For a calendar-year taxpayer, both provisions applied to the 2018 tax year, and there was no timing mismatch. But for a fiscal-year taxpayer, revised Code §78 seemed not to apply until its new tax year began in 2018. This meant that the Code §245A D.R.D. was theoretically applicable to the gross-up until the new tax year began sometime in 2018.
That was the taxpayer's situation and its position in Varian. The taxpayer's tax year began on September 29, 2017. This meant that its first tax year to which revised Code §78 applied to – i.e., the first tax year beginning after December 31, 2017 – did not begin until September 29, 2018. But since Code §245A D.R.D. is available for all post-2017 distributions without regard to the tax year, the taxpayer applied the D.R.D. to its gross-up for its 2017–18 tax year.
The I.R.S. argued that the Code §245A D.R.D. only applies to actual dividends distributed out of a corporation's earnings and profits. The court found several objections to this. No such limitation exists in the statutory language, and the definition of "dividend" implies that when a dividend is deemed made, it is also deemed to be distributed, satisfying the I.R.S.'s purported requirement. The I.R.S. pointed out that some other Code provisions that create deemed dividends, such as Code §1248,14 specify that Code §245A applies to the deemed dividend. This would imply that by default, Code §245A does not apply to deemed dividends. But the court explained that Code §78, unlike those other provisions, creates a deemed dividend "for purposes of this title [i.e., the Code]." It concluded:
Saying that an amount will be treated in a particular manner "for purposes of this title" (i.e., the Code) is equivalent to listing every section in the Code and saying that the amount will be so treated for purposes of each section. Thus, Congress did not need to say more to bring a section 78 dividend within the scope of section 245A
After rejecting the definitional argument of the I.R.S., the court turned to the I.R.S.'s regulatory argument. In 2019, the I.R.S., having taken note of the mismatch issue with Code §§245A and 78, amended Treas. Reg. §1.78-1(a) to read as follows:
A section 78 dividend is treated as a dividend for all purposes of the Code, except that it is not treated as a dividend for purposes of section 245 or 245A, and does not increase the earnings and profits of the domestic corporation or decrease the earnings and profits of the foreign corporation.
This regulation disallows the application of the Code §245A D.R.D. to a gross-up. But it also contradicts the statute. For the court, that was a non-starter:
But, as we have already observed, the plain text of the statutes provides for the deduction. As the Supreme Court has said, "self-serving regulations never 'justify departing from the statute's clear text.'" Niz-Chavez v. Garland, 593 U.S. 155, 141 S. Ct. 1474, 1485, 209 L. Ed. 2d 433 (2021) (quoting Pereira v. Sessions, 585 U.S. 198, 138 S. Ct. 2105, 2118, 201 L. Ed. 2d 433 (2018)); see also Util. Air Regul. Grp. v. EPA, 573 U.S. 302, 328, 134 S. Ct. 2427, 189 L. Ed. 2d 372 (2014) ("[T]he need to rewrite clear provisions of the statute should have alerted [the Government] that it had taken a wrong interpretive turn."); Koshland v. Helvering, 298 U.S. 441, 447, 56 S. Ct. 767, 80 L. Ed. 1268, 1936-1 C.B. 219 (1936) ("[W]here . . . the provisions of the act are unambiguous, and its directions specific, there is no power to amend it by regulation."); Abdo v. Commissioner, No. 5514- 20, 162 T.C., slip op. at 21 (Apr. 2, 2024) (reviewed) ("Respondent's regulation . . . cannot change the result dictated by an unambiguous statute." (citing Niz-Chavez, 141 S. Ct. at 1485)).
IMPACT OF LOPER BRIGHT?
Although the I.R.S. adopted its Varian position before Loper Bright was decided, the court asked the I.R.S. for its views on the impact of Loper Bright on the case. But it seems unlikely that it made a difference. The statutes here were unambiguous with respect to their effective dates. The court noted that "even under Chevron, '[i]f the intent of Congress is clear, that is the end of the matter,' [Chevron, 467 U.S. at 842,]* * 15
Therefore, Varian did not provide much clarity regarding the impact of Loper Bright. But under the Loper Bright framework, courts may place greater emphasis on uncovering the unambiguous meaning of a statute. Loper Bright holds that "statutes, no matter how impenetrable, do – in fact, must – have a single, best meaning." The single, best meaning here was easy to find. That will not necessarily be the case with other statutes.
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Footnotes
1 603 U.S. 369 (2024).
2 Named after Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).
3 Code §951(b).
4 Code §246(c)(5).
5 Code §§957(a), 951(b).
6 Code §245A(e)(4).
7 For this purpose, any limitation on the deduction claimed for the payment is irrelevant.
8 Code §1248 recharacterizes certain sales of foreign corporate stock by U.S. shareholders as dividends.
9 H.R. Rep. No. 115-466 (2917).
10 But the Bluebook notes that a "technical correction may be necessary to reflect this intent."
11 Citing Williams v. Taylor, 529 U.S. 362 (2000).
12 163 T.C. No. 4 (2024).
13 This D.R.D. is similar to the Code §245A D.R.D. but applies to the U.S.-source portion of the dividend rather than the foreign-source portion.
14 Code §1248 recharacterizes gain on the sale of C.F.C. stock as a dividend to the extent of untaxed E&P in the C.F.C.
15 Citing Loper Bright
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