This article applies to owner of Controlled Foreign Corporations that are receiving dividends under the dividend exclusion rules of IRC Section 245A. It focuses on relief for some of the negative consequences of the extraordinary disposition rules. Owners of CFCs that may be taking dividends from the CFC should review these rules with their advisors before taking such distributions.

Abstract: When applied together, the extraordinary disposition rule for controlled foreign corporation dividends and the disqualified basis rule sometimes give rise to excess taxation of certain shareholders and related parties. This article describes relief for some taxpayers in the form of final regs that address the matter.

When applied together, the extraordinary disposition rule for controlled foreign corporation (CFC) dividends and the disqualified basis rule under Internal Revenue Code Section 951A sometimes give rise to excess taxation of a Sec. 245A shareholder or a Sec. 245A shareholder and related party. Providing welcome relief, the IRS recently issued an advance copy of final regs that address the matter.

A Helpful Determination

The final regs adopt the existing proposed regs with one important modification. Under the proposed regs, there is a rule that reduces disqualified basis in certain cases (the “DQB reduction rule”). It generally applies when, regarding a Sec. 245A shareholder, extraordinary disposition earnings and profits (E&P) become subject to U.S. tax by reason of the application of the extraordinary disposition rule to a distribution of the extraordinary disposition E&P.

Generally, the DQB reduction rule provides that basis attributable to gain to which the extraordinary disposition E&P are also attributable is no longer disqualified basis. The preamble to the proposed regs noted that the IRS was studying whether the DQB reduction rule should also apply by reason of a prior extraordinary disposition amount described in the regulations. The preamble requested comments on this matter, but none were received.

Such a prior extraordinary disposition amount generally represents extraordinary disposition E&P that have become subject to U.S. tax, regarding a Sec. 245A shareholder, other than by direct application of the extraordinary disposition rule. One example is extraordinary disposition E&P that give rise to an income inclusion to the Sec. 245A shareholder by reason of Sec. 951(a)(1)(B) and Sec. 956(a).

Under the extraordinary disposition rule, the application of the other provision to the extraordinary disposition E&P reduces the application of the extraordinary disposition rule because, otherwise, the E&P (or an amount of other E&P) could be taxed as to the Sec. 245A shareholder both by reason of the other provision and the extraordinary disposition rule. This reduction to the application of the extraordinary disposition rule will generally result in an extraordinary disposition being subject to a single level of U.S. tax.

The IRS has determined that the DQB reduction rule should also apply by reason of a prior extraordinary disposition amount described in the regulations. Therefore, the final regs provide a rule to this effect. Absent such an approach, gain to which extraordinary disposition E&P and disqualified basis are attributable could, in effect, be taxed both by reason of the disqualified basis rule and a provision other than the extraordinary disposition rule.

Immediate Applicability

The final regs apply to tax years of foreign corporations beginning on or after December 1, 2020, and to tax years of Sec. 245A shareholders in which or with which such tax years of foreign corporations end. In addition, taxpayers may generally choose to apply the final regs to tax years beginning before December 1, 2020. Contact your CPA for answers to questions and additional information.

Contact Us

Our dedicated and experienced international tax team understand how not being compliant can affect you. For more information on this topic or any other subjects, contact us today! Interested in receiving these blogs directly to your inbox? Signup for our newsletter and international tax blogs here!