On Feb. 23, 2023, the U.S. Department of the Treasury and the IRS released final regulations that treat members of a consolidated group as a single U.S. shareholder for purposes of applying Section 951(a)(2)(B) when a controlled foreign corporation (CFC) makes a distribution of previously taxed earnings and profits (PTEP) described in Section 959(b). The final regulations adopt the proposed regulations published on Dec. 14, 2022, including two illustrative examples, without modification.
The final regulations were a response to concerns that taxpayers might treat each member of a consolidated group as a separate U.S. shareholder when applying the rules in Section 951(a)(2)(B). The final regulations apply to tax years for which the original consolidated return is due (without extensions) after Feb. 23, 2023. Accordingly, consolidated groups with a calendar tax year will be required to comply with the final regulations for their 2022 tax year.
Crowe observation
Though these regulations are prospective, Treasury and the IRS are considering whether there is a need for retroactive anti-abuse guidance related to the interaction of Sections 951(a)(2)(B) and 959(b). This potential guidance is something for taxpayers to keep an eye on for the future.
Section 951(a)(1) generally requires a U.S. shareholder of a CFC to include in its gross income its pro rata share of Subpart F income of the CFC if the shareholder owns stock on the last day of the CFC’s taxable year. A U.S. shareholder’s global intangible low-taxed income inclusion is calculated in a similar manner under Section 951A(a)(1).
Section 951(a)(2)(B) provides for a reduction of a U.S. shareholder’s share of the CFC’s Subpart F income and tested income by the amount of dividend distributions that any other person receives with respect to the CFC stock. The reduction under Section 951(a)(2)(B) is limited to a pro rata amount that corresponds to the number of days during the taxable year of the CFC that the U.S. shareholder did not own stock in the CFC.
Under Section 959(b), a dividend distribution of PTEP from a lower tier CFC to an upper tier CFC is excluded from the recipient CFC’s Subpart F and tested income for purposes of Section 951(a).
Prior to the final regulations, a consolidated group was not expressly disallowed to treat each consolidated group member as a separate U.S. shareholder for purposes of Section 951(a)(2)(B). Without such an express disallowance, Treasury and the IRS were concerned that a group could use Section 959(b) PTEP distributions to reduce its aggregate Subpart F income and tested income inclusion amount. For example, when a CFC indirectly owned by a consolidated group member remits a Section 959(b) PTEP distribution to an upper tier CFC, and the ownership of the lower tier CFC is transferred to another member of the group late in the CFC tax year, arguably the acquiring member could be allowed to reduce its share of the lower tier CFC’s Subpart F income and tested income by reason of Section 951(a)(2)(B).
The final regulations under Treasury Regulation Section 1.1502-80(j) address these situations by treating members of the consolidated group as a single entity in determining a U.S. shareholder’s pro rata share of the CFC’s Subpart F income or tested income for purposes of Section 951(a)(2)(B) when a Section 959(b) distribution is followed by a transfer of ownership in the distributing CFC stock. To clearly reflect the consolidated group’s U.S. tax liability on its aggregate inclusions under Sections 951(a)(1)(A) and 951A(a), Section 1.1502-80(j) treats the entire consolidated group as a single entity for purposes of applying Section 951(a)(2)(B), treating an acquiring member as owning the distributing CFC stock for the entire CFC tax year. Therefore, the group’s aggregate inclusion amount of Subpart F income and tested income with respect to the CFC would not be reduced under Section 951(a)(2)(B) by any amount of a Section 959(b) distribution, which is followed by a transfer of the CFC stock within the group.
While the regulations technically are prospective, calendar year consolidated groups and consolidated groups with a fiscal or short year end after October 2022 are subject to these new rules. Taxpayers should consult with their tax adviser to consider how these regulations might affect them.
