The Extraordinary New World of the Participation Exemption
by Kuang-Chu "K.C." Chiang
BackgroundSection 245A, often described as providing the
participation exemption, was enacted in the Tax Cuts and Jobs Act to exempt repatriated foreign income from federal income tax by means of a 100 percent deduction of the dividends received.1 This new section has significantly affected many aspects of international taxation. One example is Treasury’s recent change to the section 956 regulations to coordinate with section 245A.
Section 956 generally requires income inclusion by a controlled foreign corporation’s U.S. shareholders (as defined in section 951(b)) if the CFC holds U.S. property and has undistributed earnings and profits that have not been previously taxed to the U.S. shareholders. Treasury finalized the regulations under section 956 (the final section 956 regulations)2 to maintain symmetry with the tax treatment that would have applied if there were an actual distribution. This “hypothetical distribution” method in the final
section 956 regulations involves multiple code sections that require careful analysis.3 But one point is clear: The income inclusion consequence under section 956 now depends, to a large extent, on whether and how section 245A applies.
New Paradigms
Indeed, with the other changes under the TCJA, such as the changes to sections 958(b) and 951(c) (the new CFC ownership rules), the issue of whether and how section 245A should apply plays an interesting role in many situations. The following is a simple example of the relevance of section 245A under the new CFC ownership rules.
Example 1: A U.S. person (USP) owns a 49 percent interest in a foreign partnership (FJV) with a foreign partner. FJV wholly owns a U.S. corporation (DC1) and a foreign corporation (FC1). FC1 wholly owns a foreign corporation FC2. FC1 and FC2 are not passive foreign investment companies and do not make distributions.
Under prior law, neither FC1 nor FC2 would be a CFC. Accordingly, USP and DC1 would not have income under section 951 from FC1 or FC2.
Under the new CFC ownership rules, FC1 and FC2 are now CFCs because they are treated as 100 percent owned by DC1. Still, DC1 is not required to recognize any income from FC1 or FC2 under section 951 or 951A because DC1 has no direct or indirect interest in FC1 and FC2.4
However, USP has a 49 percent indirect interest regarding FC1 and FC2.5 Because of the
Kuang-Chu “K.C.” Chiang is of counsel with Golenbock Eiseman Assor Bell & Peskoe LLP in New York.
In this article, Chiang reviews the proposed hybrid dividend regulations and the temporary regulations under section 245A.
1See Joint Committee on Taxation, “General Explanation of Public
Law 115-97,” JCS-1-18, at 348 (Dec. 2018).2T.D. 9859, finalizing REG-114540-18. Taxpayers may opt to apply the
regulations to tax years beginning after December 31, 2017. See reg. section 1.956-1(g)(4).
3In my prior article, Kuang-Chu “K.C.” Chiang, “Symmetry Lost:
Corollary of the Hypothetical Distribution,” Tax Notes, May 6, 2019, p. 825, the reduction required in section 956(a)(1)(B) should have been taken into account in the calculation of tentative section 956 amount. I hereby stand corrected.
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
2048 TAX NOTES FEDERAL, SEPTEMBER 23, 2019
CFC status of FC1 and FC2, USP may thus have income under sections 951(a)(1)(A) (subpart F income) and 951A (global intangible low-taxed income). Also, for purposes of sections 956 and 951(a)(1)(B), if FC1 or FC2 has any U.S. property and undistributed E&P, USP could have income depending in part on whether such undistributed E&P are previously taxed, and in part on whether section 245A deduction is available under the final section 956 regulations.
Section 245A deduction is available only to domestic C corporations,6 and only if other requirements are met. For example, a “hybrid dividend” is not eligible for section 245A deductions. As illustrated below, applying these rules may not always be straightforward.
Hypothetical Hybrid Dividends
As provided in the final section 956 regulations, if a domestic corporation is a U.S. shareholder and holds the CFC stock directly, the income resulting from sections 956 and 951(a)(1)(B) can be reduced by the amount of the deduction under section 245A that the domestic corporation would be allowed if the domestic corporation received as a hypothetical distribution from the CFC an amount equal to the tentative section 956 amount.7 If the U.S. shareholder owns the stock of the CFC indirectly, the hypothetical distribution is generally treated as if the U.S. shareholder directly owned the stock for purposes of determining section 245A deductions.8
To qualify under section 245A, however, a distribution cannot be a “hybrid dividend.”9 A hybrid dividend is the amount otherwise deductible under section 245A, for which the CFC received a foreign income tax deduction or other foreign income tax benefit.10 Treasury has proposed some general guidance regarding this hybrid dividend rule.11 Presumably, the hybrid dividend rule would also apply to a hypothetical
distribution for purposes of the final section 956 regulations to determine the availability of section 245A deductions. The following examples illustrate the result of applying the proposed guidance to hypothetical distributions.
Example 212: US1 holds both shares of stock of FX, which have an equal value. One share is treated as indebtedness for Country X tax purposes (Share A), and the other is treated as equity for Country X tax purposes (Share B). During year 1, under Country X tax law, FX accrues $80x of interest to US1 regarding Share A and is allowed a deduction for that amount. During year 2, FX is deemed under the final section 956 regulations to provide a hypothetical distribution of $60x to US1, $30x of which regarding each of Share A and Share B. For U.S. tax purposes, each of the $30x hypothetical distributions is treated as a dividend for which, but for section 245A(e), US1 would be allowed a deduction under section 245A. For Country X tax purposes, a $30x distribution regarding Share A would have represented a payment of interest for which a deduction was already allowed (and thus FX would not be allowed an additional deduction for the amount), and a $30x distribution regarding Share B would have been treated as a dividend (for which no deduction is allowed).
Based on the proposed guidance, it appears that the entire $60x hypothetical distribution received by US1 from FX during year 2 would have been a hybrid dividend.13 In particular, it appears that the $30x hypothetical distribution regarding Share B would be a hybrid dividend, even though there would have been no hybrid deductions allocated to Share B.14 Thus, it appears that US1 would not be allowed any section 245A deduction under the final section 956 regulations for the entire $60x hypothetical distribution.
Example 315: The facts are the same as in Example 2, except that for Country X tax purposes, Share A is treated as equity and under Country X tax law, FX would not be allowed a
6See section 245A(a); JCS-1-18, at 349.
7See reg. section 1.956-1(a)(2)(i).
8See reg. section 1.956-1(a)(2)(ii)(A)(1).
9See section 245A(e)(1).
10See section 245A(e)(4).
11See prop. reg. section 1.245A(e)-1.
12This example is a slightly modified version of the fact pattern in
prop. reg. section 1.245A(e)-1(g)(1)(i).13
See prop. reg. section 1.245A(e)-1(g)(1)(ii).14
See id.15
This example is a slightly modified version of the fact pattern in prop. reg. section 1.245A(e)-1(g)(1)(iv)(A).
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
TAX NOTES FEDERAL, SEPTEMBER 23, 2019 2049
deduction for the $30x deemed to be distributed in year 2 regarding Share A. However, FX has a branch in Country Z that gives rise to a taxable presence under Country Z tax law, and for Country Z tax purposes, Share A is treated as indebtedness and Share B is treated as equity. Also, during year 1, for Country Z tax purposes, FX accrues $80x of interest to US1 regarding Share A and is allowed an $80x interest deduction regarding its Country Z branch income. Moreover, for Country Z tax purposes, the $30x hypothetical distribution regarding Share A in year 2 would have represented a payment of interest for which a deduction was already allowed (and thus FX would not be allowed an additional deduction for the amount), and the $30x hypothetical distribution regarding Share B in year 2 would have been treated as a dividend (for which no deduction is allowed).
According to the proposed guidance, the $80x interest deduction allowed to FX under Country Z tax law is provided under a relevant foreign tax law regarding its Country Z branch income, and is therefore a hybrid deduction of FX for year 1.16 Thus, it appears that the entire $60x of the year 2 hypothetical distribution would be a hybrid dividend,17 and if so, no section 245A would be allowed regarding the $60x hypothetical distribution under the final section 956 regulations.
Tiered Structure
Notably, the final section 956 regulations also address the special case of applying the hybrid dividend rule to a hypothetical distribution in a tiered structure. Generally, sections 245A(a) through (d), 246(a), and 959 apply to the hypothetical distribution as if the U.S. shareholder directly owned (within the meaning of section 958(a)(1)(A)) the share.18 However, for section 245A(e) purposes, the hypothetical distribution is treated under the final section 956 regulations as if the distribution were made to the U.S. shareholder through each entity by reason of which the U.S. shareholder indirectly owns such
share and pro rata regarding the equity that gives rise to such indirect ownership.19 If any such hypothetical distribution is treated as made to a CFC and would be subject to the tiered hybrid dividend rule in section 245A(e)(2), the U.S. shareholder is treated as not being allowed a deduction under section 245A by reason of the hypothetical distribution.20
Example 421: US1 holds all the stock of FX, and FX holds all 100 shares of stock of FZ (the “FZ shares”), which have an equal value. The FZ shares are treated as equity for Country Z tax purposes. During year 2, FZ is deemed under the final section 956 regulations to provide a hypothetical distribution of $1,000x to FX regarding the FZ shares. The $1,000x distribution would have been treated as a dividend for U.S. and Country Z tax purposes and would not have been deductible for Country Z tax purposes. Under Country Z tax law, had FZ made the distribution of $1,000x to FX, FX would have been allowed a refundable tax credit of $187.5x, equivalent to a $937.5x deduction under Country Z tax law. Further, under Country Z tax law, FX would not have been subject to Country Z withholding tax (or any other tax) had the $1,000x been distributed by FZ to FX. If FX were a domestic corporation, FX would have been allowed a deduction under section 245A for the $1,000x but for section 245A(e).
Based on the proposed guidance, it appears that $937.5x of the $1,000x hypothetical distribution received by FX from FZ during year 2 would have been a tiered hybrid dividend.22 Thus, it appears that the $937.5x tiered hypothetical distribution would be treated as subject to section 245A(e)(2).23 Because this hypothetical distribution would be made to a CFC and would be subject to the tiered hybrid dividend rule in
20See reg. section 1.956-1(a)(2)(ii)(A)(3). Under section 245A(e)(2), if a
CFC receives a hybrid dividend from any other CFC, for purposes of section 951(a)(1)(A), the hybrid dividend would be treated as subpart F income to the receiving CFC, and the U.S. shareholder would have income equal to the shareholder’s pro rata share of such subpart F income. Presumably, under the final section 956 regulations, no such subpart F income need be deemed to arise under section 245A(e)(2).
21This example is a slightly modified version of the fact pattern in
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
2050 TAX NOTES FEDERAL, SEPTEMBER 23, 2019
section 245A(e)(2), it appears that US1 would not be allowed any section 245A deduction under the final section 956 regulations.
Example 524: The facts are the same as in Example 4, except that under Country Z tax law, had the $1,000x dividend been made by FZ to FX, the dividend would be subject to a 30 percent gross basis withholding tax, or $300x, and the $187.5x refundable tax credit would have been applied against and reduced the withholding tax to $112.5x.
According to the proposed guidance, it appears that the $187.5x refundable tax credit that would have been provided to FX would not be a hybrid deduction, because FX would have been subject to Country Z withholding tax of $300x on the $1,000x dividend, and such withholding tax would have been greater than the $187.5x credit.
The analysis in the foregoing could be increasingly overwhelming in some fact patterns, for example, if USP is a domestic partnership and one or more domestic corporations are partners.25
Temporary Regulations: The Extraordinary
Not satisfied with the already exceedingly complex limitations, Treasury promulgated temporary regulations under section 245A(g) that added even more limitations on the deduction under section 245A.26 The temporary section 245A(g) regs, expiring June 14, 2022, apply to distributions occurring after December 31, 2017.27
According to Treasury, section 245A was designed to operate residually, so that the section 245A deduction would generally apply only to the extent the CFC’s E&P were not first subject to subpart F income, GILTI, or the exclusions
provided in section 245A(c)(3) (and were not subject to section 965).28 In other words, Treasury believes section 245A was not intended to eliminate taxation regarding the foreign E&P of a CFC that are attributable to income of a type that is subject to taxation under the subpart F income or GILTI regimes.29 Treasury intends for the temporary section 245A(g) regs to limit the section 245A deduction in transactions that, in Treasury’s belief, facilitate the avoidance of the subpart F income or GILTI regimes or the new international tax framework adopted in the TCJA.30
As set forth in the temporary regulations, the ineligible amount of a dividend received by a domestic corporation from a CFC is not allowed the section 245A deduction.31 In general, the ineligible amount is the sum of (1) 50 percent of the portion of a dividend attributable to certain E&P resulting from transactions between related parties during a period after the measurement date under section 965(a)(2) and in which the corporation was a CFC but during which section 951A did not apply to it (referred to in the temporary regs as the extraordinary disposition amount), and (2) the extraordinary reduction amount.32
The extraordinary reduction amount applies only to a “controlling section 245A shareholder.”33 A controlling section 245A shareholder of a CFC is a domestic corporation that is a U.S. shareholder of the CFC and, taking into account ownership of the CFC by other specified persons (such as related persons), owns more than 50 percent of the stock of the CFC.34 A shareholder who would not otherwise be a controlling section 245A shareholder would be treated as one if the shareholder acts in concert with the controlling section 245A shareholder (for example, selling shares of the same CFC to the same buyer or buyers as part of the same plan as the controlling
24This example is a slightly modified version of the fact pattern in
prop. reg. section 1.245A(e)-1(g)(2)(iii).25
In that case, USP is generally required under the final section 956 regulations to aggregate the amounts of all the hypothetical section 245A deductions that would have been allowed to the domestic corporate partners had the corporations held the CFC directly, and then allocate the sections 956/951(a)(1)(B) inclusion based on the ratio of (1) the net hypothetical distribution income regarding the partner, divided by (2) the aggregate of the net hypothetical distribution income regarding all the partners of the domestic partnership. See reg. section 1.956-1(a)(2)(iii).
26T.D. 9865, 84 F.R. 28398-28424. T.D. 9865 also include certain
additional limitations on the applicability of section 954(c)(6) to foreign personal holding company income for certain dividends received by upper-tier CFCs from lower-tier CFCs.
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
TAX NOTES FEDERAL, SEPTEMBER 23, 2019 2051
section 245A shareholder’s).35 Subject to a de minimis rule, the extraordinary reduction amount of a controlling section 245A shareholder is generally the lesser of (1) the amount of the dividend, and (2) the sum of the shareholder’s pre-reduction pro rata share of the CFC’s subpart F income and tested income (as defined in section 951A(c)(2)(A)) for the tax year, reduced, but not below zero, by the prior extraordinary reduction amount.36 Generally, high-taxed kicked-out income under section 954(b)(4) is excluded from subpart F income37 and tested income,38 and the extraordinary reduction amount should also exclude such high-taxed kicked-out income.
The temporary regs include some interesting examples illustrating the powerful impact of these rules.
Example 639: At the beginning of CFC1’s tax year ending on December 31, year 2, US1 owns all of the single class of stock of CFC1, and CFC1 has no E&P described in section 959(c)(1) or (2). As of the end of year 2, CFC1 has $160x of GILTI and no other income, so that CFC1 has $160x of E&P for year 2. On October 19, year 2, US1 sells all of its CFC1 stock to US2 for $100x in a transaction in which US1 recognizes $90x of gain.
Under section 1248(a), the entire $90x of gain in Example 6 is included in US1’s gross income as a dividend and, under section 1248(j), the $90x is treated as a dividend for purposes of applying section 245A. However, under the temporary section 245A(g) regulations, no portion of the $90x is eligible for the deduction allowed under section 245A.40 The entire $90x dividend to US1 is treated as an extraordinary reduction amount regarding US1 because the dividend is at least equal to US1’s pre-reduction pro rata share of CFC1’s year 2 GILTI reduced by the amount of GILTI taken into account by US2.41
It is important to note that, even though the entire $90x could ultimately trace back to GILTI, US1 presumably would not be entitled to the 50 percent GILTI deduction under section 250(a)(1)(B) because, technically speaking, the $90x gain is not GILTI within the meaning of section 951A. Further, with the repeal of section 902, and without GILTI treatment, no foreign tax credit would seem to be available.42
A similar result would apply to subpart F income, as illustrated below.
Example 743: At the beginning of CFC1’s tax year ending December 31, year 2, US1 owns all of the single class of stock of CFC1. CFC1 generates $120x of subpart F income during its tax year ending on December 31, year 2. On October 1, year 2, CFC1 distributes a $120x dividend to US1. On October 19, year 2, US1 sells 100 percent of its stock of CFC1 to PRS, a domestic partnership, in a transaction in which no gain or loss is realized. PRS is owned 50 percent each by A, an individual who is a citizen of the United States, and B, a foreign individual who is not a U.S. tax resident. On December 1, year 2, US2 and FP, a foreign corporation, contribute property to CFC1; in exchange, each of US2 and FP receives 25 percent of the stock of CFC1. PRS owns the remaining 50 percent of the stock of CFC1.
On December 31, year 2, both PRS and US2 will be U.S. shareholders regarding CFC1. US2’s pro rata share of subpart F income is $30x (that is, 25 percent of CFC1’s subpart F income for the tax year).44 PRS’s pro rata share is $12x (after taking into account the reduction under section 951(a)(2)(B)), $6x of which is allocated to A.45 Under the temporary section 245A(g) regulations, the total amount taken into account by US2 and A ($36x) reduces US1’s pre-reduction pro rata share of CFC1’s subpart F income, to $84x ($120x - $36x).46 Thus, regarding the dividend of $120x paid to US1, the extraordinary reduction amount is $84x, that is, the lesser of the amount of the dividend received by US1 from CFC1 during year
35See id.
36See reg. section 1.245A-5T(e)(1).
37See sections 952(a)(2), 954(a), and 954(b)(4).
38See section 951A(c)(2)(A)(i)(III).
39The following example is a simplified version of the fact pattern in
reg. section 1.245A-5T(j)(4)(i).40
See reg. section 1.245-5T(j)(4)(ii)(C).41
See reg. section 1.245A-5T(j)(4)(ii)(B).
42See section 960(d).
43This example is a simplified version of the fact pattern in reg.
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
2052 TAX NOTES FEDERAL, SEPTEMBER 23, 2019
2, and US1’s pre-reduction pro rata share of CFC1’s subpart F income.47 US1 will have a section 245A deduction of $36x ($120x - $84x).48
The Short-Year Election
Perhaps realizing that serious concerns could arise, the temporary section 245A(g) regs preserve the section 245A deduction if the taxpayer makes an election to close the tax year of the CFC at the time of the sale and recognize subpart F income or GILTI for the short year.49
For instance, in Example 6, if US1 elects to close CFC1’s year 2 tax year as of the end of October 19, year 2, and has entered into a written, binding agreement with US2 that US1 will elect to close CFC1’s year 2 tax year, then US1 will take into account all of CFC1’s GILTI for the tax year beginning January 1, year 2, and ending October 19, year 2, and US2 will take into account the CFC1’s GILTI for the tax year beginning October 20, year 2, and ending December 31, year 2.50 In that case, no amount of the $90x gain will be considered an extraordinary reduction amount regarding US1 for purposes of applying the temporary section 245A(g) regs.51
The De Minimis Rule
The temporary section 245A(g) regulations also include another exception. Under the de minimis rule, no amount is considered an extraordinary reduction amount regarding a controlling section 245A shareholder if the sum of the CFC’s subpart F income and tested income for the year does not exceed the lesser of $50 million or 5 percent of the CFC’s total income for the tax year.52 Taxpayers should be mindful of the cliff effect of this de minimis rule.
Spinoff of CFC Stock
When a foreign business is acquiring a U.S.-based multinational group, it is not unusual that
the foreign buyer would want to spin the foreign subsidiaries out of the U.S.-based group to be owned by foreign entities. As a starting point, below is a basic analytical framework that assumes section 355 is otherwise satisfied regarding the distribution by the domestic corporation of the stock of existing CFCs to the foreign distributee corporation.53
First, the foreign distributee corporation should generally have no gain or dividend taxable in the United States regarding the distribution.54
For the distributing corporation, section 367(e)(1) and the regulations thereunder should apply to determine whether any gain should be recognized under the principles similar to the principles of section 367, overriding the nonrecognition treatment of section 355(c)(1). Under the section 367(e)(1) regulations, if a domestic corporation makes a distribution of stock or securities of a corporation that qualifies for nonrecognition under section 355 to a person who is not a qualified U.S. person, the distributing corporation generally recognizes a gain on the distribution.55 This gain, presumably treated as gain from a sale,56 should be recharacterized as dividend under section 1248(a) to the extent of the section 1248 amount of the CFC.57 In this instance, section 1248(f) presumably should be inapplicable because the nonrecognition treatment under sections 355(c)(1) and 311(a) is overridden.58 Also, to the extent a gain is
47See reg. section 1.245A-5T(j)(5)(ii)(D).
48See reg. section 1.245A-5T(j)(5)(ii)(E).
49See reg. section 1.245A-5T(e)(3)(i).
50See reg. section 1.245A-5T(j)(4)(iii).
51See id.
52See reg. section 1.245A-5T(e)(3)(ii).
53Section 7874 is likely not an issue under the circumstances, but that
should also be confirmed. See reg. section 1.7874-1(c).54
See reg. section 1.367(e)-1(b)(4).55
See reg. section 1.367(e)-1(b)(1). If the distributee is a partnership, the partners should generally be treated as distributees proportionately. See reg. section 1.367(e)-1(b)(2).
56See sections 355(c)(2) and 311(b)(1).
57See reg. section 1248(f)-2(e), Example 1, para. (ii)(A). See also LTR
9826025.58
Under section 1248(f), if a domestic corporation distributes stock of a CFC in a distribution to which section 311(a), 337, 355(c)(1), or 361(c)(1) applies, an amount equal to the excess of the fair market value of the stock over its adjusted basis in the hands of the domestic corporation will be treated as a dividend to the domestic corporation to the extent of the E&P of the CFC attributable to the stock during the period the stock was held by such domestic corporation while the foreign corporation was a CFC. See also reg. section 1248(f)-2(e), Example 1, para. (ii)(B).
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
TAX NOTES FEDERAL, SEPTEMBER 23, 2019 2053
recognized under section 367(e)(1), section 367(b) should not apply because the distributee in the section 355 distribution is a foreign distributee.59
Example 860: FP, a foreign corporation, owns 100 percent of the outstanding stock of DC, a domestic corporation. DC wholly owns CFC1. DC’s CFC1 stock has a $50x basis, $100x fair market value (therefore a gain of $50x), $25x of E&P attributable to it for purposes of section 1248, and a $25x section 1248 amount (computed as the lesser of $50x gain in the CFC1 stock and $25x of section 1248 E&P). DC distributes all of the CFC1 stock to FP in a distribution to which section 355 applies.
Based on the regulations, DC must recognize $50x gain on the distribution of CFC1 stock to FP under section 367(e)(1).61 Under section 1248(a), the $25x section 1248 amount is recharacterized as a dividend.62 Generally, in the case of a sale or exchange by a domestic corporation of stock in a foreign corporation held for one year or more, any amount received by the domestic corporation that is treated as a dividend under section 1248 will also be treated as a dividend for purposes of applying section 245A.63 Thus, to the extent section 245A is available, the domestic corporation would be able to reduce or even eliminate the tax consequences under section 367(e)(1). Further, because gain is recognized under section 367(e)(1), it appears that neither section 1248(f) nor section 367(b) should apply, albeit the gain to the extent treated as a dividend is reduced or eliminated by section 245A. This could make the spinoff an attractive approach.
However, in those transactions, other issues may still need to be considered in analyzing the application of section 245A. For example, it should be confirmed whether, under the temporary regs, the de minimis rule would apply and, if not, whether the CFC has subpart F income or tested income for the year that could give rise
to an extraordinary reduction amount. As noted above, the distributing corporation’s extraordinary reduction amount is the lesser of (1) the amount of the dividend, and (2) the sum of the shareholder’s pre-reduction pro rata share of the CFC’s subpart F income and tested income for the tax year, reduced, but not below zero, by the prior extraordinary reduction amount. A distributing corporation in a section 355 distribution is a controlling section 245A shareholder that is subject to this extraordinary reduction amount limitation because the distributing corporation owns more than 50 percent of the stock of the CFC. If the distributing corporation has extraordinary reduction amount and thus would lose the section 245A deduction under the temporary section 245A(g) regs, the distributing corporation should carefully evaluate the mitigating effect of a short-year election under those regulations.
It may also be unclear how the hybrid dividend rule would affect the section 245A deduction when a dividend is deemed to arise under section 1248 in the spinoff. Under the proposed hybrid dividend guidance, if a U.S. shareholder of the CFC transfers stock of the CFC, the U.S. shareholder’s hybrid deduction accounts regarding the stock of the CFC generally must be determined at the close of the transfer date.64 Section 245A deduction that is otherwise available would be reduced by the hybrid deduction accounts as of such date.65 Thus, if the distributing corporation distributes the stock of the CFC under section 355 and is required to include the section 1248 amount as if the stock were sold, it appears that the distributing corporation would be required to determine its hybrid deduction accounts regarding the distributed stock as of the close of the date of the distribution, and may be required to reduce the section 245A deduction as a result. As noted earlier, the determination of the hybrid deduction accounts could be difficult in some situations.
59See reg. section 1.367(b)-5(b)(2), (a)(2). If the distributee is a
partnership, the partners should generally be treated as distributees proportionately. See reg. section 1.367(b)-5(b)(4) and -2(k).
60This example is a modified version of Example 1 in reg. section
1.1248(f)-2(e).61
See reg. sections 1.367(e)-1(b)(1) and 1.1248(f)-2(e), Example 1, para. (ii)(A).
62See reg. section 1.1248(f)-2(e), Example 1, para. (ii)(A).
63See section 1248(j).
64See prop. reg. section 1.245A(e)-1(d)(5).
65See also New York State Bar Association Tax Section, “Report on
Proposed Regulations Under Sections 267A, 245A(e) and 1503(d),” Report No. 1411 at 79 (Feb. 26, 2019).
copyright in any public domain or third party content.
For more Tax Notes® Federal content, please visit www.taxnotes.com.
TAX PRACTICE
2054 TAX NOTES FEDERAL, SEPTEMBER 23, 2019
ConclusionThe participation exemption provided in
section 245A has drawn much attention to the benefits that are only available to corporate taxpayers. It may well open up planning opportunities that were unattainable under the prior law. But the effectiveness of the section 245A deduction could be significantly reduced or even eliminated under some circumstances. Until further guidance from Treasury, navigating around this new world can present intellectual and practical challenges even after only a few turns.
![Federal Income Tax - Basic Federal Income Tax, 1st Ed. - Westin - Law ...[1]](https://static.documents.pub/doc/80x56/577d34ae1a28ab3a6b8e9712/federal-income-tax-basic-federal-income-tax-1st-ed-westin-law-1.jpg)
