The IRS Office of Chief Counsel issued memorandum ILM 202436010 on July 31, 2024, to the acting director of cross-border activities in the Large Business and International Division explaining that a CFC is not entitled to a DRD under Section 245A. The memorandum’s position is that a Section 245A DRD is not allowed for dividends received by a CFC from a 10%-owned non-CFC foreign corporation. The memorandum is not binding precedent that may be used or relied on by taxpayers, but it does reflect the IRS’ current thinking on the issue.
Background
Section 245A(a), enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA), permits a DRD on the foreign-sourced dividends received by a domestic corporation from a specified 10%-owned foreign corporation (SFC). Many taxpayers interpret Section 245A(a) as permitting both domestic corporations and CFCs to claim a DRD on dividends received from an SFC. The interpretation is primarily based on U.S. tax principles that generally treat a CFC as if it were a domestic corporation when computing inclusions under the IRC’s antideferral tax regime or subpart F. Furthermore, a footnote to the conference report for the TCJA expressly states that Section 245A would be applicable in the computation of an income inclusion under the subpart F rules.
Foreign corporations and non-U.S. shareholders ineligible for Section 245A DRD
The memorandum addresses the issue in the context of a fact pattern in which a domestic corporation’s wholly owned CFC (FC1) receives a dividend from a 45%-owned lower tier foreign corporation (FC2). The IRS concludes that FC1 is not allowed a DRD under Section 245A(a) for the dividend received from FC2 because FC1 is neither a domestic corporation nor a U.S. shareholder with respect to FC2. The memorandum focuses on the plain language of Section 245A and distinguishes it from other DRD provisions, such as Sections 243 and 245, which extend deductions to foreign corporations.
The IRS rebuts potential arguments that the meaning of Section 245A(a) could be interpreted in the context of the language of Section 245A(e)(2) and Section 964(e)(4), which also were enacted under the TCJA. Section 245A(e)(2) provides an anti-abuse rule applicable to a hybrid dividend between CFCs that is deductible to the payer under local tax law. A hybrid dividend is defined as an amount received from a CFC “for which a deduction would be allowed under [Section 245A(a)]” but for the anti-abuse rule under Section 245A(e). The IRS maintains that no inference can be drawn from Section 245A(e)(2) in the absence of an express statutory provision with respect to nonhybrid dividends from an SFC. Similarly, with respect to Section 964(e)(4), which treats gain recharacterized as a dividend under Section 1248 in a way that coordinates with the rules of Section 245A DRD, the IRS maintains that the statutory provisions do not carry any implications for actual dividends received by a CFC from an SFC.
The memorandum contains a potentially contradictory view of the legislative history of the TCJA and its conference report. A footnote of the conference report indicates that the phrase “domestic corporations” in Section 245A includes a CFC “treated as a domestic corporation for purposes of computing the taxable income thereof. See Treasury Regulation Section 1.952-2(b)(1). Therefore, a CFC receiving a dividend from a 10%-owned foreign corporation that constitutes subpart F income may be eligible for the DRD with respect to such income.” Despite this language, the memorandum states that the plain language of Section 245A, which provides that the provision applies to a domestic corporation, should be observed when it is clear and unambiguous.
Crowe observation
While acknowledging the legislative intent to allow a Section 245A DRD to CFCs, the IRS maintains that the intent does not influence the interpretation of Section 245A unless expressly provided in the statute. Though IRS representatives have said that Loper Bright Enterprises v. Raimondo, which overruled deference to agency regulations, will not change the way it writes regulations, strict adherence to the statutory language without taking into account language in the conference report could indicate how the IRS views its authority in a post-Loper Bright world.
Interestingly, the memorandum asserts the legislative intent, when enacting Section 245A, misapplies Treasury Regulation Section 1.952-2, which was promulgated to provide guidance with reference to the subpart F rules enacted by that same legislative body. In explaining the rule to treat a foreign corporation as a domestic corporation for purposes of computing subpart F income under Treasury Regulation Section 1.952-2, the memorandum states that the regulatory guidance cannot change a statute that limits a deduction to U.S. shareholders. In support of this conclusion, the memorandum cites Treasury Regulation Section 1.952-2(c)(1), which provides that a foreign corporation is not treated as a U.S. shareholder for purposes of that regulation.
Looking ahead
While the memorandum is nonprecedential guidance to IRS personnel and nonbinding on taxpayers, it provides insight into how the IRS will treat the issue if it is encountered on audit. Taxpayers that own a CFC holding a minority interest in a non-CFC foreign corporation should be mindful of potential challenges from the IRS when claiming a DRD under Section 245A(a) on the dividends from these foreign corporations and consider the risks. Taxpayers should review their offshore structures and consult with tax advisers to consider whether to restructure their organization to meet operational and business goals while mitigating risk on audit.
