The IRS has updated its practice unit on Partner’s Outside Basis. The overview is as follows:
The Tax Cuts and Jobs Act (TCJA) transitioned the United States from a primarily deferral-based international tax system to a participation exemption system coupled with immediate taxation of certain offshore earnings. This transition was implemented through several interlocking provisions of the Code – Sections 245A, 951A and 965. All three provisions have different effective dates and thus TCJA created periods in which some but not all of them apply. The new system also operates alongside the pre-Act subpart F regime that taxes certain offshore earnings using a longstanding rule for attributing pro rata shares of a foreign corporation’s earnings to its U.S. shareholders.
Section 245A allows an exemption for certain foreign income of a domestic corporation that is a U.S. Shareholder (within the meaning of IRC Section 951(b)) by means of a 100 percent dividends received deduction (“DRD”) for the foreign source portion of dividends received from “Specified 10-percent owned Foreign Corporations” (“SFCs”). The 100 percent DRD is only available to domestic C corporations that are neither real estate investment trusts nor regulated investment companies. The corporate shareholder must satisfy the one-year holding period requirement in Section 246(c).
Under this participation exemption system, Foreign Tax Credit (FTC) or Foreign Tax Deduction is not allowed for foreign taxes, including withholding taxes, paid or accrued with respect to any dividend that is benefiting from the 100% deduction.
Section 245A is effective for distributions made after December 31, 2017.
Section 245A DRD is generally intended to be available only with respect to distributions of residual untaxed foreign-source earnings and profits (E&P) remaining after application of Section 951 (subpart F income) and Section 951A (Global Intangible Low-Taxed Income (GILTI)).
IRS issued Treasury Regulations Section 1.245A-5 that limit the Section 245A DRD available for certain dividends received from current or former controlled foreign corporations (CFCs). The Treasury Regulations address situations where Section 245A could apply to distributions of E&P not previously taxed by the subpart F or GILTI regimes. These situations arise because of the different effective dates of Section 965 and Section 951A or change in ownership of a CFC.
These situations cause unanticipated interactions between Section 245A and the rules for including subpart F income and GILTI. The Treasury Regulations also limit the application of the Section 954(c)(6) exception with respect to certain dividends paid by a lowertier CFC to an upper-tier CFC. Under the Section 954(c)(6) exception, certain dividends paid to a CFC by a related CFC are excluded from Foreign Personal Holding Company Income (FPHCI) treatment and are not included in the distributee-CFC’s subpart F income as long as such dividends are not attributable or properly allocable to the distributor-CFC’s subpart F income or Effectively Connected Income (ECI).
IRS issued final regulations Section 1.245A(e)-1 special rules for hybrid dividends that address the implementation of Section 245A with respect to hybrid dividends. Section 245A(e) includes rules that disallow the Section 245A DRD with respect to hybrid dividends. If a U.S. shareholder receives a hybrid dividend, then the U.S. shareholder is not allowed the Section 245A DRD for that dividend and Section 245A(d) applies to disallow FTCs and Foreign Tax Credit deductions.
Download the full updated practice unit by clicking IRS Updates Practice Unit on Section 245A Dividends Received Deduction Overview (September 13, 2021).
Posted by Jessica Ji, Associate Editor, Wealth Strategies Journal.