The Tax Cuts and Jobs Act of 2017 ushered in a host of tax provisions you may have heard of, including the Repatriation Tax,[1] GILTI,[2] and Base Erosion[3] taxes.  But, there are some little-known changes that may make a big difference on the 2017 tax return.

In this post, I will talk about two specific changes: (1) the expanded definition of United States (U.S.) shareholder[4] and (2) downward attribution of stock ownership for determining whether a foreign corporation is a controlled foreign corporation (CFC).[5]

Let’s start with the change to the definition of a U.S. shareholder.

Under the old law, a U.S. shareholder was a U.S. person who owns either directly, indirectly, or constructively 10% of the voting stock of a CFC.

Under the new law, a U.S. shareholder is now a U.S. person who owns either directly, indirectly, or constructively 10% of the stock of a CFC, by vote or by value.

Let’s look at an example of how this will change things.

Facts:

Assume Foreign Corporation 1 (FC1) has two classes of stock for vote and value.

Assume Taxpayer X, a non-U.S. person, owns 95% of the voting stock of FC1 and 5% of the total value of FC1.

Assume Taxpayer Y, a U.S. person, owns 5% of the voting stock of FC1 and 95% of the total value of FC1.

Assume that neither person is related by blood or marriage.

Result Old Rules – Not a CFC

Under the old rules, Taxpayer Y is not a U.S. shareholder because Taxpayer Y owns less than 10% of the voting stock.  Since there are no other U.S. shareholders, FC1 is not a CFC.

Result New Rules – CFC

Under the new rules, Taxpayer Y is a U.S. shareholder because Taxpayer Y owns 95% of the total value of FC1.  This would also make FC1 a CFC.

Now let’s assume the same facts with one twist, let’s make FC1 a Passive Foreign Investment Company (PFIC) in the prior year.  The result under the new rules is still the same.  But what about the rule, “once a PFIC, always a PFIC?”  In order to make the transition, the PFIC would need to conduct a purge election.[6]  Then, in the following year, it can be treated as a CFC.

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Let’s move on to our second topic, the change in attribution rules.

This is a change that will affect a lot of taxpayers.  It has drawn attention in the tax practitioner community since the bill was passed and subsequent IRS notices[7] were issued.  The American Institute of Certified Public Accountants (AICPA) has gone so far as to issue a letter[8] to the IRS about the topic.  Without going into the specific code sections of 958 and 318, the new law now allows downward attribution of ownership from a foreign person to a U.S. person.

What does this mean?  Let’s look at an example:

Facts:

FC2 is a foreign corporation in the United Kingdom (UK).  FC2 is owned by Taxpayer Z, a UK national with no ties to the United States (i.e., a nonresident alien).  FC2 has two wholly-owned subsidiaries, FC3 and U.S. Domestic Corporation 1 (DC1).  FC3 is a foreign corporation in Ireland.  DC1 is a U.S. C corporation in Delaware.

Old Law Result

Under the old law, DC1 would not have constructive ownership (under the foreign corporation attribution rules) of FC2 or FC3.  Therefore, the worst-case scenario is that DC1 would need to file Form 1120 along with the international informational report, Form 5472.

New Law Result

Under the new law, DC1 would be treated as having constructive ownership of both the UK parent (FC2) and Irish subsidiary (FC3).  This would make the parent and Irish subsidiary CFCs.

Usually, when a U.S. corporation has constructive ownership of a CFC, it must pick up any Subpart F income (deferral items) in its current income.  Under the new law, since DC1 has no direct ownership in FC2 or FC3, there is no Subpart F inclusion.

Technically, if a U.S. corporation has constructive ownership in a CFC, it must also file Form 5471, to report ownership of a foreign corporation, but recent IRS Notice 2018-13[9] also provided an exception for filing the form under this scenario so long as there were no other U.S. shareholders who owned stock directly or indirectly in the Irish or UK entities.

Please note that Notice 2018-13 applies to tax year 2017 and may not be applicable to future tax years.  While there is no immediate impact to most multinationals that have this setup, changes to the ownership structure (as illustrated below) produce a different result that is quite tangible.

Facts:

Let’s change the facts slightly and assume that the FC2 owns 90% and DC1 owns 10% of FC3.

Now under the new law, because DC1 has direct ownership in a foreign company, it would be subject to Subpart F, the Repatriation Tax, and filing requirements under Form 5471.

It would also be subject to GILTI & FDII[10] (applies in 2018) because it has a 10% ownership interest in a foreign company.

In summary, the Tax Cuts and Jobs Act of 2017 added many changes to international tax.  Unlike most of the changes to individuals and domestic corporations, some of these changes apply to 2017 and should be thoroughly considered before filing the annual return.

Disclaimer: This blog does not constitute tax advice. Seek advice from a tax professional to address your specific needs.

 


[1] IRC 965(c).  Legal Information Institute.  Cornell.edu. https://www.law.cornell.edu/uscode/text/26/965 (accessed February 12, 2018).

[2] IRC 951A.  Legal Information Institute.  Cornell.edu. https://www.law.cornell.edu/uscode/text/26/951A (accessed February 12, 2018).

[3] IRC 59A. Legal Information Institute.  Cornell.edu.  https://www.law.cornell.edu/uscode/text/26/59A (accessed February 12, 2018).

[4] IRC 951(b). Legal Information Institute.  Cornell.edu. https://www.law.cornell.edu/uscode/text/26/951 (accessed February 12, 2018).

[5] IRC 958(b). Legal Information Institute.  Cornell.edu. https://www.law.cornell.edu/uscode/text/26/958 (accessed February 12, 2018).

[6] 26 CFR 1.1297-3 – https://www.law.cornell.edu/cfr/text/26/1.1297-3 (accessed February 12, 2018).

[7] “Additional Guidance Under Section 965 and Guidance Under Sections 863 and 6038 in Connection with the Repeal of Section 958(b)(4).”   U.S. Treasury.  Notice 2018-13.  IRS.gov. https://www.irs.gov/pub/irs-drop/n-18-13.pdf (accessed February 12, 2018).

[8] “Request for Penalty Relief for First-Time Filers of Form 5471.”  Letter from Anette Nellen, Chair of AICPA Tax Executive Committee to Leni Perkins, Office of Associate Chief Counsel (International), dated February 8, 2018. AICPA.org.  https://www.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/20180208-aicpa-request-for-penalty-relief-for-first-time-5471-filers.pdf (accessed February 12, 2018).

[9] “Additional Guidance Under Section 965 and Guidance Under Sections 863 and 6038 in Connection with the Repeal of Section 958(b)(4).”   U.S. Treasury.  Notice 2018-13.  IRS.gov. https://www.irs.gov/pub/irs-drop/n-18-13.pdf (accessed February 12, 2018).

[10] IRC 250(a)(1)(A).  Legal Information Institute.  Cornell.edu. https://www.law.cornell.edu/uscode/text/26/250 (accessed February 12, 2018).