The Treasury and IRS recently released guidance that could reduce certain U.S. shareholder’s foreign information reporting burden. Proposed regulations (REG-104223-18) would alter the impact of certain provisions of the Tax Cuts and Jobs Act (TCJA) (i.e., the so-called downward attribution rules) that generally expand scope of taxpayers who have income tax paying and reporting obligations under the controlled foreign corporation (CFC) rules of the Internal Revenue Code (Code). Revenue Procedure 2019-40 provides relief by allowing taxpayers to use alternative documentation to support their determinations with respect CFCs they may own.
Prior to repeal by the TCJA, section 958(b)(4) of the Code prevented the attribution of shares owned by a foreign corporation to a U.S. corporation also owned by that foreign corporation. After repeal, a U.S. corporation may be treated as owning shares owned by its foreign parent by attribution. This so-called ‘downward attribution’ rule may results in CFC status for foreign corporations attributed to the U.S. corporation. As a result, any U.S. shareholder of the foreign subsidiary may be subject to increased U.S. tax and reporting requirements including shareholders who own the CFC only by attribution. Such shareholders may not have any significant ability to obtain information needed to comply with any of the significant reporting obligations that apply to CFCs. Tax professionals have argued that Congress did not intend for the repeal of section 958(b)(4) to have such a broad impact and that such treatment is contrary to the key premise of the CFC rules: that only U.S. taxpayers, either individually or with other U.S. taxpayers, who in fact control a foreign entity should have additional reporting and tax obligations.
Under the new guidance, the IRS and Treasury have provided U.S. taxpayers with several safe harbor rules effectively limiting, but not always entirely eliminating, the reporting burden caused by the repeal of section 958(b)(4). The Revenue Procedure allows U.S. persons to make their own determination as to whether a foreign corporation is a CFC or not, provided that they have made a reasonable attempt to secure the information necessary to make such determination and they have no actual knowledge that the foreign corporation is a CFC. Under the Revenue Procedure, if it is determined that the foreign corporation is a CFC then additional safe harbors are available which may allow U.S. taxpayers to: (1) use alternative, non U.S. GAAP, financial records, (2) avoid certain penalties under sections 6038 and 6662, and (3) file Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) with fewer required sections, or in some situations eliminate the Form 5471 filing requirement. The Revenue Procedure also announced corresponding amendments to the instructions for Form 5471.
The Proposed Regulations provide additional taxpayer relief by modifying numerous existing rules and regulations affected by the repeal of section 958(b)(4). The Proposed rules would modify existing rules under other provisions of the Code that depend on CFC status by restricting application of the repeal if necessary to ensure that such other provisions operate as originally intended. The Proposed Regulations address provisions under section 267 (deductions for payments to related parties), section 332 (liquidations of certain companies), section 367(a) (gain recognition agreement triggering events), section 904 (look-through rules and active rents and royalties exception), section 958 (determination of stock ownership), section 1297 (passive foreign investment company (PFIC) asset test), section 863 (space and telecommunication income) and section 6049 (Chapter 61 reporting requirements).
The Proposed Regulations and the Revenue Procedure are generally effective for tax years beginning on or after Oct. 1, 2019 but taxpayers may generally apply the Proposed regulations to the last taxable year of a foreign corporation beginning before Jan. 1, 2018. As a result, taxpayers who treated foreign corporations as CFCs because of the repeal of section 958(b)(4) may wish to examine previously filed returns to determine whether the Proposed Regulations may have a beneficial impact.
Taxpayers with foreign corporations in their broader affiliated group should consult their tax advisors as soon as possible. These new rules may impact filing decisions for the upcoming Oct. 15th filing deadline.