November 1, 2018 / North America
Among all the oddities of the Tax Cuts and Jobs Act of 2017 (TCJA), Congress’s preservation of Section 956 for corporate taxpayers has been among the most head-scratching. Earlier this week, the IRS acknowledged taxpayers’ concerns and issued proposed regulations that would substantially neuter this legacy provision.
Sec. 956 was an anti-abuse mechanism under the pre-TCJA deferral regime, under which the earnings of controlled foreign corporations (CFCs) were generally taxable only when distributed to a U.S. shareholder. In order to prevent taxpayers from accessing those earnings tax-free by other means, Sec. 956 treats a CFC’s investment in U.S. property similarly to a “deemed” dividend to its U.S. shareholders. For example, a loan by a CFC to its U.S. shareholder from previously untaxed earnings would cause those earnings to be included in the income of the U.S. shareholder.
The TCJA enacted Sec. 245A as part of a new participation exemption regime, allowing U.S. corporations a full dividends received deduction (DRD) for dividends paid by a 10 percent-owned foreign corporation. However, the TCJA did not repeal Sec. 956 for corporate shareholders (although the first draft of the House Bill did). Therefore, a disconnect exists between U.S. taxpayers who access earnings of CFCs by way of dividend and those who do so via investments in U.S. property. The U.S. corporation receiving a dividend from a CFC pays no tax; the U.S. corporation receiving a loan from its CFC pays 21 percent tax (assuming the CFC has sufficient untaxed E&P and insufficient previously taxed income to shield the inclusion).