skip to main content

June 12, 2019

Stroock Special Bulletin

By: Jonathan D. Canfield, Alex Cota, Alon M. Goldberger, Michelle M. Jewett, Brett Lawrence, Jeffrey D. Uffner, Marni M. Isaacson, Daniel Martinez

On May 22, 2019, the Department of the Treasury and the Internal Revenue Service (“IRS”) issued final regulations (the “Final Regulations”)[1] that implement the previously issued proposed regulations (“Proposed Regulations”).[2] The Final Regulations do not differ substantively from the Proposed Regulations, but they do add some additional clarification with respect to treatment of partnerships and the treatment of previously taxed earnings and profits.


Section 956[3] may impose a U.S. tax in situations in which offshore earnings are not distributed, but are used in a manner that was perceived as an effective repatriation. Section 956 generally requires a “U.S. shareholder” (i.e. a U.S. individual or entity that owns 10% or more of the stock of a controlled foreign corporation (“CFC”)[4] by vote or value) to include in its income an amount equal to its share of any increase in the CFC’s investment in U.S. property during the applicable taxable year (other than previously taxed earnings and profits of the CFC) even if the CFC makes no distributions in such year. For this purpose, U.S. property generally includes: (i) tangible property located in the United States; (ii) stock of a domestic corporation; (iii) a debt obligation of a U.S. obligor; or (iv) a right to use certain intellectual property in the United States. Notably, a CFC’s guarantee of debt of a U.S. shareholder and a pledge of stock of a CFC by a U.S. shareholder representing more than 66 2/3% of the voting stock of such CFC generally is treated as an investment in U.S. property.

In order to prevent U.S. shareholders of CFCs from recognizing significant tax liability in connection with a deemed dividend, credit agreements and other financing documents for loans to U.S. borrowers with subsidiaries that are CFCs often exclude such CFCs from serving as guarantors and limit the pledge of stock of such CFCs to less than 66 2/3% of the voting stock of first-tier CFCs (and in many cases similarly exclude stock of U.S. subsidiary corporations where substantially all of the assets of such corporations are shares of one or more CFCs).

When Congress enacted the Tax Cuts and Jobs Act (“TCJA”)[5] at the end of 2017, it created a participation exemption with respect to the taxation of certain dividends from foreign corporations under Section 245A. Specifically, Section 245A generally permits a U.S. corporate shareholder of a CFC to claim a 100% deduction with respect to dividends received from the CFC (the “245A Deduction”). However, the 245A Deduction does not technically apply to Section 956 deemed dividends because such inclusions do not represent actual distributions. The original purpose of Section 956 was to equalize the treatment of such deemed repatriations and actual repatriations, by subjecting both to immediate taxation. However by exempting only a dividend that is actually paid from U.S. tax, the 245A Deduction would treat a deemed dividend from a CFC disparately.

The Final Regulations

The Treasury Department and the IRS determined that as a result of the enactment of the participation exemption system, the application of Section 956 to deemed dividends attributable to corporate U.S. shareholders should be modified. The Final Regulations in effect provide for a hypothetical 245A Deduction to maintain harmony between the taxation of actual and effective repatriations. The Final Regulations accomplish this harmony by creating a concept of “tentative Section 956 amount” (i.e. deemed dividend amount), and treating such tentative Section 956 amount as an actual distribution for purposes of determining the 245A Deduction. Such 245A Deduction then is used to reduce the Section 956 inclusion. Therefore, both actual dividends and deemed distributions pursuant to Section 956 would in most circumstances be tax-free to U.S. corporate shareholders.

The Final Regulations clarify the treatment of partnerships (including limited liability companies and limited partnerships that are treated as partnerships for U.S. tax purposes) which have U.S. corporations as partners. The tentative Section 956 amount with respect to a domestic partnership is reduced to the extent that one or more domestic corporate partners would be entitled to a Section 245A deduction if the partnership received such amount as a distribution. Any remaining amount of the partnership’s Section 956 inclusion amount is allocated to the partners in the same proportion as net income upon a hypothetical distribution.

Additionally, the Final Regulations address receipt of a Section 956 deemed dividend from a CFC that has previously taxed earnings and profits[6] and non-previously taxed earnings and profits. Because a CFC may have some earnings and profits that were previously taxed and some earnings and profits that were not previously taxed, elaborate ordering rules are required for purposes of determining the source of a particular distribution to avoid double taxation. A dividend distribution is treated as being allocated first to earnings and profits described in Section 959(c)(1) (previously taxed Section 956 earnings and profits), then to earnings and profits described in Section 959(c)(2) (previously taxed Subpart F earnings and profits), then to earnings and profits described in Section 959(c)(3) (non-taxed earnings and profits). In contrast, Section 956 deemed dividends are treated as being allocated first to earnings and profits described in Section 959(c)(2) and then to earnings and profits described in Section 959(c)(3). Thus, for example, prior to the enactment of the Final Regulations, if a CFC had earnings and profits described in Section 959(c)(1) but not in Section 959(c)(2), an actual dividend distribution would not be taxable to the extent of such Section 959(c)(1) earnings and profits, and would not result in a Section 245A deduction. In contrast, a Section 956 deemed dividend would be allocated to non-taxed earnings and profits described in 959(c)(3), would be taxable to the U.S. shareholders, and would not qualify for the hypothetical 245A deduction. The Final Regulations address this issue by including an ordering rule for hypothetical distributions that matches the ordering rule for Section 956 deemed dividends and treats a hypothetical distribution as attributable first to earnings and profits described in Section 959(c)(2), then to earnings and profits described in Section 959(c)(3).

The Final Regulations become effective on July 22, 2019, and apply to taxable years of a CFC beginning on or after May 23, 2019, and to taxable years of a U.S. shareholder in which such taxable years of the CFC end. Taxpayers are also entitled to rely on the Final Regulations (or, with respect to period prior to the issuance of the Final Regulations, the Proposed Regulations) for taxable years of a CFC beginning after December 31, 2017, and for taxable years of a U.S. shareholder in which or with which such taxable year of the CFC end, provided that the taxpayer and its related U.S. persons consistently apply the Final Regulations with respect to all CFCs in which they are U.S. shareholders for taxable years of the CFCs beginning after December 31, 2017.

Implications for Financing Transactions

Lenders should evaluate whether to require U.S. corporate borrowers to pledge all of the voting and non-voting stock of their first-tier CFCs (and the subsidiaries of those CFCs) and to have those CFCs (and their subsidiaries) guarantee the debt obligations of the U.S. corporate borrowers because the adverse U.S. tax consequences of doing so may (and frequently will) not apply. In addition, U.S. corporate borrowers may seek to provide credit support from their CFCs (and their subsidiaries) to improve the terms of the financing, or to increase the amount those borrowers may borrow.

Following the issuance of the Proposed Regulations, there had been some concern that even though the Proposed Regulations could be relied upon until final Treasury Regulations were enacted, there could be changes in the final Treasury Regulations that would limit or adversely affect the favorable positions of the Proposed Regulations. As a result, some U.S. borrowers had continued to insist on restrictions on pledges and guarantees of their debt obligations by their CFCs or on savings provisions that provided that if final Treasury Regulations were issued and contained material adverse changes from the Proposed Regulations, such customary restrictions on CFC pledges and guarantees would apply. Now that the Final Regulations have been issued, in most circumstances, U.S. corporate borrowers should have certainty that such limitations are no longer necessary from a U.S. federal income tax perspective.

However, because there are some situations in which a U.S. corporate shareholder cannot claim a dividends received deduction, credit agreements may have to provide a carve-out of credit support by CFCs in certain circumstances. In addition, there may be limitations on CFCs providing certain types of credit support as a result of restrictions under local law or non-U.S. tax considerations.

With respect to existing credit agreements, lenders and borrowers should review the foreign collateral requirements, particularly with respect to the provisions that provide that CFC stock pledges and CFC subsidiary guarantees will be limited only to the extent such pledges or guarantees would cause an adverse tax consequence or other similar credit support limitations. If Section 956 no longer imposes an adverse tax consequence, U.S. corporate borrowers and their CFCs would be required to provide additional pledges or guarantees.

It is also important to note that, because of other provisions of the TCJA such as the GILTI and FDII tax regimes, some U.S. shareholders of foreign subsidiaries are converting those subsidiaries from corporations into partnerships or disregarded entities for U.S tax purposes. In those cases, the CFC impediments to guarantees and pledges would no longer apply.

Lenders to U.S. borrowers that own CFCs with material value should consider how to approach the guarantee and collateral requirements for future loans in light of the Final Regulations, potential augmentation of their guarantee and collateral packages under existing credit facilities, and non-tax considerations that are relevant to the foregoing. Similarly, in the context of the negotiation of a workout or restructuring of an existing credit facility, parties may want to consider their ability to obtain additional credit support in the form of guarantees by, and pledges of the equity interests of, foreign entities that are CFCs. It is likely that the Final Regulations will materially change common collateral packages for loans made to U.S. borrowers with foreign subsidiaries and lenders and borrowers are well advised to analyze the consequences for new and existing loans.


For More Information:

Jonathan D. Canfield

Alex Cota

Alon M. Goldberger

Michelle M. Jewett

Brett Lawrence

Jeffrey D. Uffner

Marni M. Isaacson

Daniel Martinez

[1] 84 FR 23716.

[2] REG-114540-18. For a description of the Proposed Regulations, see Stroock Special Bulletin, “Additional Credit Support: How Changes to the ‘Deemed Dividend’ Tax Regime Should Shape Your Thinking on Financing/Collateral Arrangements,” November 12, 2018, available at

[3] References in this Special Bulletin to “Sections” refer to sections of the Code unless otherwise specified.

[4] A CFC is any foreign corporation if more than 50 percent of (i) the total combined voting power of all classes of stock of such foreign corporation entitled to vote or (ii) the total value of the stock of such foreign corporation is owned, or is treated as owned through the application of certain constructive ownership rules, by U.S. shareholders on any day during the taxable year of such foreign corporation.

[5] P.L. 115-97.

[6] Previously taxed earnings and profits are earnings and profits of a foreign corporation attributable to amounts which are, or have been, included in the gross income of a United States shareholder under Section 951(a) or Section 1248(a). Because previously taxed earnings and profits already have been taxed in the U.S., distributions of previously taxed earnings and profits to a U.S. shareholder generally are not included in its gross income.

Related Services