[Federal Register Volume 83, Number 214 (Monday, November 5, 2018)]
[Proposed Rules]
[Pages 55324-55329]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-24140]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-114540-18]
RIN 1545-BO88


Amount Determined Under Section 956 for Corporate United States 
Shareholders

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that reduce the 
amount determined under section 956 of the Internal Revenue Code with 
respect to certain domestic corporations. The proposed regulations 
affect certain domestic corporations that own (or are treated as 
owning) stock in foreign corporations.

DATES: Written or electronic comments and requests for a public hearing 
must be received by December 5, 2018.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-114540-18), Internal 
Revenue Service, Room 5203, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
114540-18), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-114540-18).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Rose E. Jenkins, (202) 317-6934; concerning submissions of comments or 
requests for a public hearing, Regina Johnson, (202) 317-6901 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

I. Section 956

    The Revenue Act of 1962 (the ``1962 Act''), Pub. L. 87-834, sec. 
12, 76 Stat. at 1006, enacted sections 951 and 956 as part of subpart F 
of part III, subchapter N, chapter 1 of the 1954 Internal Revenue Code 
(``subpart F''), as amended. Subpart F was enacted in order to limit 
the use of low-tax jurisdictions for the purposes of obtaining 
indefinite deferral of U.S. tax on certain earnings that would 
otherwise be subject to U.S. federal income tax. H.R. Rep. No. 1447 at 
57 (1962). Congress enacted subpart F in part to address taxpayers who 
had ``taken advantage of the multiplicity of foreign tax systems to 
avoid taxation by the United States on what could ordinarily be 
expected to be U.S. source income.'' Id. at 58.
    Before the 1962 Act, United States shareholders (as defined in 
section 951(b)) (``U.S. shareholders'') of controlled foreign 
corporations (as defined in section 957) (``CFCs'') were not subject to 
U.S. tax on earnings of the foreign corporations unless and until 
earnings of the foreign corporations were distributed to the 
shareholders as a dividend. S. Rep. No. 1881 at 78 (1962). The subpart 
F regime eliminated deferral for certain--generally passive or highly 
mobile--earnings of CFCs by subjecting those earnings to immediate U.S. 
taxation regardless of whether there was an actual distribution. Id. at 
80. Earnings that were not subject to immediate U.S. taxation under the 
subpart F regime were generally taxable only upon repatriation, as 
those earnings did not present the same concerns regarding indefinite 
tax deferral compared to earnings subject to subpart F.
    Section 956 was enacted alongside the subpart F regime in the 1962 
Act to ensure that a CFC's earnings not subject to immediate tax when 
earned (under the subpart F regime) would be taxed when repatriated, 
either through a dividend or an effective repatriation. Recognizing 
that repatriation of foreign earnings was possible through means other 
than a taxable distribution, Congress enacted section 956 ``to prevent 
the repatriation of income to the United States in a manner which does 
not subject it to U.S. taxation.'' H.R. Rep. No. 1447 at 58. Congress 
determined that the investment by a CFC of its earnings in United 
States property, including obligations of a U.S. person, ``is 
substantially the equivalent of a dividend.'' See S. Rep. No. 1881 at 
88 (1962). See also S. Rep. No. 94-938 at 226 (1976) (``[S]ince the 
investment . . . in the stock or debt obligations of a related U.S. 
person or its domestic affiliates makes funds available for use by the 
U.S. shareholders, it constitutes an effective repatriation of earnings 
which should be taxed.''). Accordingly, Congress enacted section 956 as 
an anti-abuse measure to tax a CFC's investment of earnings in United 
States property in the same manner as if it had distributed those 
earnings to the United States. See JCS-10-87 at 1081-82 (1987) (``In 
general, two kinds of transactions are repatriations that end deferral 
and trigger tax. First, an actual dividend payment ends deferral. . . . 
Second, in

[[Page 55325]]

the case of a controlled foreign corporation, an investment in U.S. 
property, such as a loan to the lender's U.S. parent or the purchase of 
U.S. real estate, is also a repatriation that ends deferral (Code sec. 
956).''). Failure to tax CFC investments in United States property 
would have allowed taxpayers to circumvent the U.S. system of deferral 
by effectively repatriating earnings without paying U.S. tax on the 
substantial equivalent of a taxable dividend. Section 956 was thus 
designed to ensure symmetry between the tax treatment of repatriations 
through dividends and effective repatriations. See generally Notice 
2014-52, 2014-42 I.R.B. 712 (``In the absence of section 956, a U.S. 
shareholder of a CFC could access the CFC's funds (untaxed earnings and 
profits) in a variety of ways other than by the payment of an actual 
taxable dividend, such that there would be no reason for the U.S. 
shareholder to incur the dividend tax. Section 956 eliminates this 
disincentive to pay a dividend by ensuring parity of treatment for 
different ways that CFC earnings can be made available for use in the 
United States or for use by the U.S. shareholder.'').
    Section 951(a)(1)(B) requires a U.S. shareholder of a CFC to 
include in gross income the amount determined under section 956 (the 
``section 956 amount'') with respect to the CFC to the extent not 
excluded from gross income under section 959(a)(2) (the inclusion, a 
``section 956 inclusion''). See sections 951(a)(1)(B), 959(a)(2), and 
959(f)(1). Section 951(b) defines a U.S. shareholder as a United States 
person that owns within the meaning of section 958(a), or is considered 
as owning by reason of the constructive ownership rules of section 
958(b), 10 percent or more of the voting power or value of a foreign 
corporation. A U.S. shareholder's section 956 amount with respect to a 
CFC for a taxable year is the lesser of (1) the excess (if any) of such 
shareholder's pro rata share of the average of the amounts of United 
States property held (directly or indirectly) by the CFC as of the 
close of each quarter of such taxable year, over the amount of earnings 
and profits described in section 959(c)(1)(A) with respect to such 
shareholder, or (2) such shareholder's pro rata share of the applicable 
earnings of the CFC. See section 956(a). Applicable earnings are 
defined as the sum of accumulated earnings and profits (not including 
deficits) described in section 316(a)(1) and current earnings and 
profits described in section 316(a)(2), reduced by distributions made 
during the year and earnings and profits described in section 
959(c)(1). See section 956(b)(1). Under section 956(c), United States 
property includes tangible property located in the United States, stock 
of a domestic corporation, an obligation of a United States person, and 
any right to use in the United States certain intangible property. 
Enacted as part of the Omnibus Budget Reconciliation Act of 1993, Pub. 
L. 103-66, sec. 13232(b), 107 Stat. 312, section 956(e) grants the 
Secretary of the Department of Treasury (the ``Secretary'') the 
authority to prescribe ``such regulations as may be necessary to carry 
out the purposes of this section, including regulations to prevent the 
avoidance of the provisions of this section through reorganizations or 
otherwise.''
    This regulatory authority is not limited to the adoption of anti-
avoidance rules, but rather permits the Secretary to ensure that the 
application of section 956 is consistent with the ``purposes of this 
section''--chief among them, to ensure symmetry between the treatment 
of actual dividends and payments which are ``substantially the 
equivalent of a dividend.'' S. Rep. No. 1881 at 88 (1962). Consistent 
with this understanding, the Department of Treasury (the ``Treasury 
Department'') and the IRS have exercised this regulatory authority to 
tailor the application of section 956 to the abuse that motivated its 
adoption, ensuring that the provision applies to the transactions 
Congress sought to tax, but does not extend to transactions the 
taxation of which would be inconsistent with the purpose of section 
956.\1\ For example, in 1964, shortly after section 956 was first 
enacted, the Treasury Department and the IRS issued regulations 
containing Treas. Reg. section 1.956-2(d)(2)(ii), providing that any 
debt collected within one year from the time incurred did not 
constitute an obligation that could be United States property. See T.D. 
6704, 29 FR 2599, 2603. This short-term loan exception was removed when 
the Treasury Department and the IRS issued regulations in 1988 
regarding the treatment of factoring receivables as United States 
property. See T.D. 8209, 53 FR 22163, 22169. A one-year debt exception 
would have been inconsistent with Congress's expansion of section 956 
in 1984 to reach factoring receivables, which are often outstanding for 
less than one year.
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    \1\ In addition to authorizing regulations by the Treasury 
Department and the IRS, Congress has acted on occasion to both 
expand and contract the scope of section 956 based on an evolving 
understanding of the potential means by which taxpayers could 
achieve the abusive results that gave rise to its enactment (that 
is, the tax-free effective repatriation of earnings through 
transactions that are economically equivalent to a taxable 
dividend). Thus, for example, Congress contracted the scope of 
section 956 in 1976, exempting investments in the stock of unrelated 
(tested using a 25 percent ownership threshold) U.S. corporations 
from the definition of United States property. See Pub. L. 94-455, 
sec. 1021, 90 Stat. 1520. Conversely, Congress expanded the scope of 
section 956 in the Deficit Reduction Act of 1984, Pub. L. 98-369, 
sec. 123(b), 98 Stat. 494, by adding certain factoring receivables 
as a type of United States property because it recognized that 
certain ``corporations based in the United States are using foreign 
subsidiaries to factor receivables as a device for repatriating 
foreign earnings tax-free.'' H.R. Rep. No. 98-432 at 1305 (1984).
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    Alongside the removal of the 1964 short-term loan exception in the 
1988 regulations, the Treasury Department and the IRS issued Notice 88-
108, 1988-2 C.B. 466, which indicated that regulations would be issued 
providing a narrower exception from the definition of obligation for 
purposes of section 956 for obligations collected within 30 days from 
the time incurred (the ``30-day rule''). However, the notice provided 
that the exception would not apply to a CFC that holds for 60 or more 
calendar days during the taxable year obligations which, without regard 
to the 30-day rule, would constitute United States property. The 30-day 
rule was expanded to 60 days in order to facilitate the flow of funds 
from foreign subsidiaries during a financial crisis beginning in 2008, 
which expansion was also extended to 2009 and 2010. See Notice 2008-91, 
2008-43 I.R.B. 1001; Notice 2009-10, 2009-5 I.R.B. 419; Notice 2010-12, 
2010-4 I.R.B. 326. The 30 day rule was ultimately adopted in final 
regulations issued on July 12, 2018, as Treas. Reg. section 1.956-
2(d)(2)(iv). See T.D. 9834, 83 FR 32524, 32537-38.
    Since 1964, Congress has modified section 956 several times without 
addressing Treasury's short-term debt exception; indeed, since then 
Congress adopted section 956(e) as a positive grant of regulatory 
authority in 1993, and explicitly validated the short-term debt 
exception in its legislative history. See H.R. Rep. 103-111 at 701 
(1993) (``The bill is not intended to change the measurement of U.S. 
property that may apply, for example, in the case of certain short-term 
obligations, as provided in IRS Notice 88-108 (1988-2 C.B. 445), 
interpreting present law.'').
    Conversely, the Treasury Department and the IRS have at times 
expanded the scope of section 956 by regulation to ensure that the 
provision reaches the type of transactions intended by Congress. See, 
e.g., T.D. 9402, 73 FR 35580, 35582 (adding rules modifying the basis 
of property transferred to a CFC in certain non-recognition 
transactions solely for the purposes of

[[Page 55326]]

section 956 and providing that ``[t]he purpose of this [rule] is to 
prevent the effective repatriation of earnings and profits of a 
controlled foreign corporation that acquires United States property in 
connection with an exchange to which this [rule] applies without a 
corresponding income inclusion under section 951(a)(1)(B) by claiming a 
basis in the United States property less than the amount of earnings 
and profits effectively repatriated''). See also T.D. 9834, 83 FR 
32524.

II. Adoption of Participation Exemption System

    On December 22, 2017, Congress enacted the Tax Cuts and Jobs Act, 
Public Law 115-97 (the ``Act''), which established a participation 
exemption system for the taxation of certain foreign income. Under 
section 245A(a), in the case of any dividend received from a specified 
10-percent owned foreign corporation by a domestic corporation which is 
a U.S. shareholder with respect to such foreign corporation, there is 
allowed as a deduction an amount equal to the foreign-source portion of 
such dividend. A specified 10-percent owned foreign corporation is 
defined in section 245A(b) as any foreign corporation (other than 
certain passive foreign investment companies) with respect to which a 
domestic corporation is a U.S. shareholder. Section 245A(g) grants the 
Secretary authority to prescribe such regulations or other guidance as 
may be necessary or appropriate to carry out the provisions of section 
245A, including regulations for the treatment of U.S. shareholders 
owning stock of a specified 10-percent owned foreign corporation 
through a partnership.
    Under section 246(c)(1) and (5), a domestic corporation that is a 
U.S. shareholder is not permitted a section 245A deduction in respect 
of any dividend on any share of stock of a specified 10-percent owned 
foreign corporation that the domestic corporation holds for 365 days or 
less during the 731-day period beginning on the date that is 365 days 
before the date on which the share becomes ex-dividend with respect to 
the dividend. Under section 246(c)(1)(B), a section 245A deduction is 
also not allowed to the extent the domestic corporation is under an 
obligation to make related payments with respect to positions in 
substantially similar or related property.

Explanation of Provisions

    The Treasury Department and the IRS have determined that as a 
result of the enactment of the participation exemption system, the 
current broad application of section 956 to corporate U.S. shareholders 
would be inconsistent with the purposes of section 956 and the scope of 
transactions it is intended to address. Congress determined that 
certain investments by a CFC of its earnings in United States property 
are ``substantially the equivalent of a dividend'' and enacted section 
956 to provide similar treatment for dividends and certain investments 
in United States property constituting effective repatriations. S. Rep. 
No. 1881 at 88. Before the Act, section 956 applied appropriately to 
domestic corporations because both dividends from, and investments in 
United States property by, CFCs were included in income by such 
domestic corporations. As noted, the purpose of section 956 is 
generally to create symmetry between the taxation of actual 
repatriations and the taxation of effective repatriations, by 
subjecting effective repatriations to tax in the same manner as actual 
repatriations. Under the participation exemption system, however, 
earnings of a CFC that are repatriated to a corporate U.S. shareholder 
as a dividend are typically effectively exempt from tax because the 
shareholder is generally afforded an equal and offsetting dividends 
received deduction under section 245A. A section 956 inclusion of a 
corporate U.S. shareholder, on the other hand, is not eligible for the 
dividends received deduction under section 245A (because it is not a 
dividend). As a result, the application of section 956 after the Act to 
corporate U.S. shareholders of CFCs that would qualify for section 245A 
deductions would result in disparate treatment of actual dividends and 
amounts ``substantially the equivalent of a dividend''--a result 
directly at odds with the manifest purpose of section 956.
    Accordingly, the proposed regulations continue the Treasury 
Department and the IRS's longstanding practice of conforming the 
application of section 956 to its purpose. The proposed regulations 
exclude corporate U.S. shareholders from the application of section 956 
to the extent necessary to maintain symmetry between the taxation of 
actual repatriations and the taxation of effective repatriations. In 
general, under section 245A and the proposed regulations, respectively, 
neither an actual dividend to a corporate U.S. shareholder, nor such a 
shareholder's amount determined under section 956, will result in 
additional U.S. tax.
    To achieve this result, the proposed regulations provide that the 
amount otherwise determined under section 956 with respect to a U.S. 
shareholder for a taxable year of a CFC is reduced to the extent that 
the U.S. shareholder would be allowed a deduction under section 245A if 
the U.S. shareholder had received a distribution from the CFC in an 
amount equal to the amount otherwise determined under section 956. The 
proposed regulations provide special rules with respect to indirect 
ownership. Due to the broad applicability of section 245A, in many 
cases a corporate U.S. shareholder will not have a section 956 
inclusion as a result of a CFC holding U.S. property under the proposed 
regulations.
    Section 956 will continue to apply without modification to U.S. 
shareholders other than corporate U.S. shareholders, such as 
individuals, to ensure that, consistent with the purposes of section 
956, amounts that are substantially the equivalent of a dividend will 
be treated similarly to actual dividends. This treatment will apply to 
individuals regardless of whether they make an election under section 
962. Because individuals are not eligible for a dividends received 
deduction under section 245A even if they make an election under 
section 962, the current application of section 956 to individuals is 
still necessary to ensure substantial equivalence between an actual 
repatriation and a deemed repatriation. Similarly, section 956 will 
continue to apply without reduction to regulated investment companies 
and real estate investment trusts because they are not allowed the 
dividends received deduction under section 245A. See sections 
852(b)(2)(C) and 857(b)(2)(A).
    In addition to carrying out the purposes of section 956, the 
proposed regulations would significantly reduce complexity, costs, and 
compliance burdens for corporate U.S. shareholders of CFCs. Absent the 
proposed regulations, corporate U.S. shareholders would need to 
continue to carefully monitor the application of section 956 to their 
operations, including provisions related to loans, guarantees, and 
pledges, to ensure that earnings were repatriated only through actual 
dividends, and therefore allowed a participation exemption, rather than 
through a deemed repatriation under section 956 subject to additional 
U.S. tax. Similarly, in the absence of the proposed regulations, a 
U.S.-parented group in many cases would need to engage in complex and 
costly restructuring upon the acquisition of a foreign corporation that 
owns domestic subsidiaries (since the foreign corporation becomes a CFC 
and the stock of its domestic subsidiaries represents United States 
property)

[[Page 55327]]

solely to avoid a section 956 inclusion. Absent the proposed 
regulations, section 956 could also serve as a ``trap for the unwary'' 
for domestic corporations that fail to recognize that, even though they 
are entitled to the deduction under section 245A for actual dividends, 
their section 956 inclusions would continue to be fully subject to U.S. 
tax.
    The proposed regulations also add, in proposed Sec.  1.956-1(g)(5), 
the effective date for Sec.  1.956-1(e)(6) that was inadvertently 
deleted in TD 9792, published in the Federal Register on November 3, 
2016 (81 FR 76497, as corrected at 81 FR 95470 and 95471).

Conforming Amendments

    The Treasury Department and the IRS intend to make conforming 
amendments to the examples throughout the regulations under section 956 
upon finalization of the proposed regulations.

Applicability Date

    These changes are proposed to apply to taxable years of a CFC 
beginning on or after the date of publication of the Treasury decision 
adopting these rules as final regulations in the Federal Register (the 
``finalization date''), and to taxable years of a U.S. shareholder in 
which or with which such taxable years of the CFC end. With respect to 
taxable years of a CFC beginning before the finalization date, a 
taxpayer may rely on the proposed regulations for taxable years of a 
CFC beginning after December 31, 2017, and for taxable years of a U.S. 
shareholder in which or with which such taxable years of the CFC end, 
provided that the taxpayer and United States persons that are related 
(within the meaning of section 267 or 707) to the taxpayer consistently 
apply the proposed regulations with respect to all CFCs in which they 
are U.S. shareholders.

Special Analyses

    The Administrator of the Office of Information and Regulatory 
Affairs (OIRA), Office of Management and Budget, has waived review of 
this proposed rule in accordance with section 6(a)(3)(A) of Executive 
Order 12866. OIRA will subsequently make a significance determination 
of the final rule, pursuant to section 3(f) of Executive Order (E.O.) 
12866 and the April 11, 2018, Memorandum of Agreement between the 
Department of Treasury and the Office of Management and Budget (OMB).
    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that this regulation, if adopted, will not have a 
significant economic impact on a substantial number of small entities, 
although some small entities that are domestic corporations could be 
affected by the regulation and comments are requested on the 
application of the regulation to domestic partnerships. However, even 
if a substantial number of small entities were to be affected by this 
regulation, the Treasury Department and the IRS estimate that the 
economic impact on such small entities would not be significant as the 
regulation is expected to marginally reduce compliance costs for 
smaller entities. This is because the Treasury Department and the IRS 
believe that the cost-saving benefits of the proposed regulations with 
respect to complex third-party borrowing arrangements, internal 
financial management structures, and restructurings of worldwide 
operations will generally be available only to large U.S. multinational 
corporations with 20 or more CFCs. The Treasury Department and the IRS 
believe that U.S. multinational corporations with less than 20 CFCs 
generally will not have the types of arrangements in place that would 
otherwise need to be structured and monitored to avoid section 956. The 
proposed regulations, if adopted, generally will not affect small 
entities that are not domestic corporations. The Treasury Department 
and the IRS invite comments on the impact of this rule on small 
entities.
    Pursuant to section 7805(f), this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small businesses.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The Treasury Department and the IRS request comments on all aspects of 
the proposed rules. In particular, comments are requested as to the 
appropriate application of the proposed regulations to U.S. 
shareholders that are domestic partnerships, which may have partners 
that are a combination of domestic corporations, U.S. individuals, or 
other persons. For example, one approach could be to reduce the amount 
otherwise determined under section 956 with respect to a domestic 
partnership to the extent that a domestic corporate partner would be 
entitled to a section 245A deduction if the partnership received the 
amount as a distribution. An alternative could be to determine a 
domestic partnership's section 956 amount and section 956 inclusion 
without regard to the status of its partners, but then provide that a 
corporate U.S. shareholder partner's distributive share of the section 
956 inclusion is not taxable. Comments are also requested with respect 
to the maintenance of previously taxed earnings and profits accounts 
under section 959 and basis adjustments under section 961. 
Additionally, comments are requested on the interaction between the 
proposed regulations and section 245A(e). All comments will be 
available at http://www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Joshua G. 
Rabon, formerly of the Office of Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.956-1 also issued under 26 U.S.C. 245A(g) and 956(e).
* * * * *
    Par. 2. Section 1.956-1 is amended by:
    1. Revising paragraph (a).
    2. In the first sentence of paragraph (g)(1), removing the language 
``Paragraph (a)'' and adding in its place ``Paragraph (a)(1)''.
    3. Adding paragraphs (g)(4) and (5).
    The revisions and additions read as follows:


Sec.  1.956-1  Shareholder's pro rata share of the average of the 
amounts of United States property held by a controlled foreign 
corporation.

    (a) Overview and scope--(1) In general. Subject to the provisions 
of

[[Page 55328]]

section 951(a) and the regulations thereunder, a United States 
shareholder of a controlled foreign corporation is required to include 
in gross income the amount determined under section 956 with respect to 
the shareholder for the taxable year but only to the extent not 
excluded from gross income under section 959(a)(2) and the regulations 
thereunder.
    (2) Reduction for certain United States shareholders--(i) In 
general. For a taxable year of a controlled foreign corporation, the 
amount determined under section 956 with respect to each share of stock 
of the controlled foreign corporation owned (within the meaning of 
section 958(a)) by a United States shareholder is the amount that would 
be determined under section 956 with respect to such share for the 
taxable year, absent the application of this paragraph (a)(2) for the 
taxable year (such amount, the tentative section 956 amount, and in the 
aggregate with respect to all shares owned (within the meaning of 
section 958(a)) by the United States shareholder, the aggregate 
tentative section 956 amount), reduced by the amount of the deduction 
under section 245A that the shareholder would be allowed if the 
shareholder received as a distribution from the controlled foreign 
corporation an amount equal to the tentative section 956 amount with 
respect to such share on the last day during the taxable year on which 
the foreign corporation is a controlled foreign corporation 
(hypothetical distribution).
    (ii) Determination of the amount of the deduction that would be 
allowed under section 245A with respect to a hypothetical distribution. 
For purposes of determining the amount of the deduction under section 
245A that a United States shareholder would be allowed with respect to 
a share of stock of a controlled foreign corporation by reason of a 
hypothetical distribution, the following rules apply--
    (A) If a United States shareholder owns a share of stock of a 
controlled foreign corporation indirectly (within the meaning of 
section 958(a)(2)), then--
    (1) Sections 245A(a) through (d), 246(a), and 959 apply to the 
hypothetical distribution as if the United States shareholder directly 
owned (within the meaning of section 958(a)(1)(A)) the share;
    (2) Section 245A(e) applies to the hypothetical distribution as if 
the distribution were made to the United States shareholder through 
each entity by reason of which the United States shareholder indirectly 
owns such share and pro rata with respect to the equity that gives rise 
to such indirect ownership;
    (3) To the extent that a distribution treated as made to a 
controlled foreign corporation pursuant to the hypothetical 
distribution by reason of paragraph (a)(2)(ii)(A)(2) of this section 
would be subject to section 245A(e)(2), the United States shareholder 
is treated as not being allowed a deduction under section 245A by 
reason of the hypothetical distribution; and
    (4) Section 246(c) applies to the hypothetical distribution by 
substituting the phrase ``owned (within the meaning of section 
958(a))'' for the term ``held'' each place it appears in section 
246(c); and
    (B) Section 246(c) applies to the hypothetical distribution by 
substituting ``the last day during the taxable year on which the 
foreign corporation is a controlled foreign corporation'' for the 
phrase ``the date on which such share becomes ex-dividend with respect 
to such dividend'' in section 246(c)(1)(A).
    (3) Examples. The following examples illustrate the application of 
paragraph (a)(2) of this section.
    (i) Example 1. (A) Facts. (1) USP, a domestic corporation, owns all 
of the single class of stock of CFC1, which is treated as equity for 
U.S. income tax purposes and under the laws of the jurisdiction in 
which CFC1 is organized and liable to tax as a resident. The stock of 
CFC1 consists of 100 shares, and USP satisfies the holding period 
requirement of section 246(c) (as modified by paragraph (a)(2)(ii)(B) 
of this section) with respect to each share of CFC1 stock. CFC1 owns 
all of the stock of USS, a domestic corporation. CFC1's adjusted basis 
in the stock of USS is $0x.
    (2) The functional currency of CFC1 is the U.S. dollar. CFC1 has 
$100x of undistributed earnings as defined in section 245A(c)(2), $90x 
of which constitute undistributed foreign earnings as defined in 
section 245A(c)(3), and $10x of which are described in section 
245(a)(5)(B) (that is, earnings attributable to a dividend that CFC1 
received from USS). CFC1 would not receive a deduction or other tax 
benefit with respect to any income, war profits, or excess profits 
taxes on a distribution. None of the earnings and profits of CFC1 are 
described in section 959(c)(1) or (2) or are earnings and profits 
attributable to income excluded from subpart F income under section 
952(b). CFC1's applicable earnings (as defined in section 956(b)(1)) 
are $100x. CFC1 also has held an obligation of USP with an adjusted 
basis of $120x on every day during the taxable year that was acquired 
while all of its stock was owned by USP.
    (B) Analysis. Because USP directly owns all of the stock of CFC1 at 
the end of CFC1's taxable year, USP's aggregate tentative section 956 
amount with respect to CFC1 is $100x, the lesser of USP's pro rata 
share of the average amounts of United States property held by CFC1 
($120x) and its pro rata share of CFC1's applicable earnings ($100x). 
Under paragraph (a)(2)(i) of this section, USP's section 956 amount 
with respect to CFC1 is its aggregate tentative section 956 amount with 
respect to CFC1 reduced by the deduction under section 245A that USP 
would be allowed if USP received an amount equal to its aggregate 
tentative section 956 amount as a distribution with respect to the CFC1 
stock. With respect to the tentative distribution from CFC1 to USP, USP 
would be allowed a $90x deduction under section 245A with respect to 
the foreign-source portion of the $100x hypothetical distribution (that 
is, an amount of the dividend that bears the same ratio to the dividend 
as the $90x of undistributed foreign earnings bears to the $100x of 
undistributed earnings). Accordingly, USP's section 956 amount with 
respect to CFC1 is $10x, its aggregate tentative section 956 amount 
($100x) with respect to CFC1 reduced by the amount of the deduction 
that USP would have been allowed under section 245A with respect to the 
hypothetical distribution ($90x).
    (ii) Example 2. (A) Facts. The facts are the same as in paragraph 
(A) of Example 1 in paragraph (a)(3)(i) of this section, except that 
all $100x of CFC1's undistributed earnings are described in section 
959(c)(2).
    (B) Analysis. As in paragraph (B) of Example 1 in this paragraph 
(a)(3)(i) of this section, USP's aggregate tentative section 956 amount 
with respect to CFC1 is $100x, the lesser of USP's pro rata share of 
the average amounts of United States property held by CFC1 ($120x) and 
its pro rata share of CFC1's applicable earnings ($100x). However, 
paragraph (a)(2) of this section does not reduce USP's section 956 
amount, because USP would not be allowed any deduction under section 
245A with respect to the $100x hypothetical distribution by reason of 
section 959(a) and (d). Accordingly, USP's section 956 amount is $100x. 
However, under sections 959(a)(2) and 959(f)(1), USP's inclusion under 
section 951(a)(1)(B) with respect to CFC1 is $0, because USP's section 
956 amount with respect to CFC1 does not exceed the earnings and 
profits of CFC1 described in section 959(c)(2) with respect to USP. The 
$100x of earnings and profits of CFC1

[[Page 55329]]

described in section 959(c)(2) are reclassified as earnings and profits 
described in section 959(c)(1).
    (iii) Example 3. (A) Facts. (1) USP, a domestic corporation, owns 
all of the single class of stock of CFC1, and has held such stock for 
five years. CFC1 has held 70% of the single class of stock of CFC2 for 
three years. The other 30% of the CFC2 stock has been held by a foreign 
individual unrelated to USP or CFC1 since CFC2's formation. All of the 
stock of each of CFC1 and CFC2 is treated as equity for U.S. income tax 
purposes and under the laws of the jurisdiction in which each 
respective corporation is organized and liable to tax as a resident. 
CFC2 has a calendar taxable year. On December 1, Year 1, CFC1 acquires 
the remaining 30% of the stock of CFC2 for cash. On June 30, Year 2, 
CFC1 sells to a third party the 30% of CFC2 stock acquired in Year 1 at 
no gain. CFC2 made no distributions during Year 1.
    (2) The functional currency of CFC1 and CFC2 is the U.S. dollar. 
CFC2 has $120x of undistributed earnings as defined in section 
245A(c)(2), all of which constitute undistributed foreign earnings. 
Neither CFC1 nor CFC2 would receive a deduction or other tax benefit 
with respect to any income, war profits, or excess profits taxes on a 
distribution. None of the earnings and profits of CFC2 are described in 
section 959(c)(1) or (2) or are earnings and profits attributable to 
income excluded from subpart F income under section 952(b). CFC2's 
applicable earnings (as defined in section 956(b)(1)) are $120x. CFC2 
has held an obligation of USP with an adjusted basis of $100x on every 
day of Year 1 that was acquired while USP owned all of the stock of 
CFC1 and CFC1 held 70% of the single class of stock of CFC2.
    (B) Analysis. Because USP indirectly owns (within the meaning of 
section 958(a)) all of the stock of CFC2 at the end of Year 1, USP's 
aggregate tentative section 956 amount with respect to CFC2 for Year 1 
is $100x, the lesser of USP's pro rata share of the average amounts of 
United States property held by CFC2 ($100x) and its pro rata share of 
CFC2's applicable earnings ($120x). Under paragraph (a)(2)(i) of this 
section, USP's section 956 amount with respect to CFC2 for Year 1 is 
its aggregate tentative section 956 amount with respect to CFC2 reduced 
by the deduction under section 245A that USP would be allowed if USP 
received an amount equal to its aggregate tentative section 956 amount 
as a distribution with respect to the CFC2 stock that USP owns 
indirectly within the meaning of section 958(a)(2). For purposes of 
determining the consequences of this hypothetical distribution, under 
paragraph (a)(2)(ii)(A)(1) of this section, USP is treated as owning 
the CFC2 stock directly. In addition, under paragraph (a)(2)(ii)(A)(4) 
of this section, the holding period requirement of section 246(c) is 
applied by reference to the period during which USP owned (within the 
meaning of section 958(a)) the stock of CFC2. Therefore, with respect 
to the hypothetical distribution from CFC2 to USP, USP would satisfy 
the holding period requirement under section 246(c) with respect to the 
70% of the CFC2 stock that USP indirectly owned for three years through 
CFC1, but not with respect to the 30% of the CFC2 stock that USP 
indirectly owned through CFC1 for a period of less than 365 days. 
Accordingly, USP's section 956 amount with respect to CFC2 for Year 1 
is $30x, its aggregate tentative section 956 amount ($100x) reduced by 
the amount of the deduction that USP would have been allowed under 
section 245A with respect to the hypothetical distribution ($70x).
* * * * *
    (g) * * *
    (4) Paragraphs (a)(2) and (3) of this section apply to taxable 
years of controlled foreign corporations beginning on or after the date 
of publication of the Treasury decision adopting paragraphs (a)(2) and 
(3) of this section as final regulations in the Federal Register, and 
to taxable years of a United States shareholder in which or with which 
such taxable years of the controlled foreign corporation end.
    (5) Paragraph (e)(6) of this section applies to property acquired 
in exchanges occurring on or after June 24, 2011.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-24140 Filed 11-1-18; 4:15 pm]
 BILLING CODE 4830-01-P