245A (Participation Exemption) Temporary Regulations Eliminating Deduction for Some Foreign Corporation Dividends to U.S. Taxpayers

On Friday, June 14, 2019, the Internal Revenue Service issued temporary regulations for the new participation exemption (245A) regime. The new regulations eliminate the deduction for certain dividends received by U.S. taxpayers from foreign controlled corporations.

Background

The Tax Cuts and Jobs Act (TCJA) instituted, under Section 245A, a new participation exemption regime for U.S. C-corporation taxpayers. In short, the new regime exempts from federal income tax dividends received by U.S. C-corporations from foreign corporations in which the U.S. taxpayer has held at least a 10% stake (vote or value) for longer than one year prior to the dividend payment. This new exemption for foreign-sourced dividends became effective January 1, 2018, regardless of the fiscal or tax year of the foreign corporation making such dividend.

In conjunction with this new rule, the TCJA also enacted a new GILTI regime, and a toll charge mechanism regime. These two new rules disallow deferral by U.S. taxpayers of certain income earned by controlled foreign corporations. That being said, these two new regimes could interact with the Section 245A regime differently than intended, in cases where the foreign corporation issuing such dividends does not have a calendar tax year.

Lastly, while not part of the TCJA, a pre-existing anti-deferral rule exists, colloquially called the “Subpart F” regime. This regime, like the two new regimes, also works to disallow deferral by U.S. taxpayers of certain income earned by controlled foreign corporations. This rule has been in effect since 1962.

Highlights of New Temporary Section 245A Regulations

Mismatches of the effective dates of each of these rules (Section 245A, the toll charge regime, the GILTI regime, and the Subpart F regime) have the unintended effect of enabling sophisticated U.S. taxpayers and their tax advisors to structure certain arrangements and inter-company transactions between January 1, 2018 (the effective date of the new Section 245A participation exemption regime), and the end of the tax year (for any controlled foreign corporation not having a calendar tax year) to avoid picking up income that would otherwise have been included under the pre-existing Subpart F rules, or under the new GILTI or toll tax rules.

The new Section 245A temporary regulations look to remedy this issue through a complex calculation that disallows the Section 245A dividend-received deduction on certain dividends issued between January 1, 2018, and the tax year-end of the controlled foreign corporation, when the dividend, aggregated with other transactions, is a component of a strategy that reduces or eliminates that U.S. taxpayer’s Subpart F income inclusion for the tax year.

Marcum’s international tax advisors will keep you posted on this regulation and additional interpretations of the new regulation.