The IRS recently released Memorandum 202436010 (dated July 31, 2024), denying the application of Section 245A of the Internal Revenue Code to dividends received by a Controlled Foreign Corporation (“CFC”).
Section 245A, introduced by the Tax Cuts and Jobs Act of 2017, allows a domestic corporation, which is a U.S. Shareholder of a distributing foreign corporation, a 100% dividend received deduction (“DRD”) for the foreign-source portion of dividends received from specified 10% owned foreign corporations (“SFCs”). The code section defines a specified 10% owned foreign corporation to include any foreign corporation which has a domestic corporation as a “U.S. Shareholder.” A “U.S. shareholder” is defined in Section 951(b) as a U.S. person who owns 10% or more of the vote of value in a foreign corporation.
The conference report for the TCJA included a footnote to the term “domestic corporations” suggesting that a CFC might be eligible for the Section 245A DRD.
Including a controlled foreign corporation treated as a domestic corporation for purposes of computing the taxable income thereof. See Treas. Reg. sec. 1.9522(b)(1). Therefore, a CFC receiving a dividend from a 10-percent owned foreign corporation that constitutes subpart F income may be eligible for the DRD with respect to such income.
This footnote suggested that a CFC may be eligible for the Section 245A DRD by implying that dividends received by a CFC from another foreign corporation could qualify for the DRD, provided certain conditions were met.
The memorandum outlines the following scenario involving three entities – USP is a domestic corporation, and FC1 and FC2 are foreign corporations. FC1 is a foreign corporation wholly owned by USP and qualifies as a CFC. FC2 is a foreign corporation that is 45% owned by FC1, with the remaining 55% owned by an unrelated foreign person. FC2 qualifies as an SFC but not a CFC. FC1 receives a dividend from FC2 (the “FC2 Dividend”). The issue was whether FC1 could claim the Section 245A DRD for the FC2 Dividend if FC1 were treated as a domestic corporation.
The IRS concluded through the plain language in Section 245A, FC1 is not entitled to the Section 245A DRD for the FC2 Dividend because Section 245A(a) explicitly states that the DRD is available only to a “domestic corporation.” The IRS stated that the use of the term “domestic corporation” in Section 245A(a) is deliberate and contrasts with other sections of the Internal Revenue Code, such as Sections 243(a) and 245(a), which do not specify that the corporation must be domestic. Since FC1 is a foreign corporation, it does not meet this requirement.
In addition, the IRS stated that Section 245A requires that the domestic corporation receiving the dividend be a U.S. Shareholder with respect to the SFC distributing the dividend. FC1, being a foreign corporation, does not qualify as a United States shareholder.
Regarding the footnote in the Congressional TJCA conference reports, the IRS Chief Counsel memorandum clarifies that the interpretation that Congress intended to allow CFCs to apply 245A is inconsistent with the statutory language of Section 245A.The IRS’ position in the Chief Counsel memorandum highlights that the legislative intent, as reflected in the plain language of the statute, was to limit the Section 245A DRD to domestic corporations.
While IRS Chief Counsel memorandums are not binding on taxpayers and cannot be cited as precedent, they can be used to gain an understanding of the IRS’ position on tax issues. Tax practitioners and multinational corporations should take note of this guidance when planning cross-border dividend distributions and repatriation strategies.
Author: Calvin Yung | [email protected]
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