Page 556 - TaxAdviser_2022

TAX CLINIC

of U.S. property held both directly of their pro rata share of net income and while the U.S. shareholder owned the
and indirectly by the CFC. A Sec. 956 losses from all CFCs to determine the “net CFC shares.
income inclusion is similar to Subpart tested income” amount that would be sub- Sec. 245A(e) disallows the
F income in that it does not require a ject to U.S. taxation under Sec. 951A(c). dividends-received deduction under
CFC to actually make a distribution out A U.S. shareholder’s GILTI inclusion Sec. 245A(a) for any hybrid dividend
of its E&P to the U.S. shareholder for for the tax reporting year is the excess of received by a U.S. shareholder of a
an income inclusion to occur, but rather, the U.S. shareholder’s pro rata share of CFC. Moreover, Sec. 245A(e) treats
it is treated as a deemed dividend inclu- net CFC tested income of all CFCs that hybrid dividends between CFCs with
sion. The Sec. 956 anti-deferral regime the U.S. shareholder owns, over its 10% a common U.S. shareholder as Subpart
is aimed at preventing the deferral of normal return on its tangible assets. F income. Note that Sec. 245A(e) de-
untaxed E&P in a CFC that is effec- Again, a U.S. shareholder’s net CFC fines a “hybrid dividend” as an amount
tively repatriated to the United States in tested income is its aggregate pro rata received from a CFC for which a
the form of investment in U.S. property, share of tested income from all of its deduction would be allowed under Sec.
subjecting any amounts to taxation in CFCs minus the aggregate pro rata 245A(a) and for which the CFC re-
the current year. Income inclusions by share of tested loss from all CFCs ceived a deduction or other tax benefit
U.S. shareholders under Sec. 956 rep- (but not less than zero). Net deemed in a foreign country. A common exam-
resent the CFC’s adjusted basis in the tangible income return (net DTIR) is ple of a hybrid dividend is a convertible
U.S. property, decreased by the liabilities defined as 10% of the U.S. shareholder’s preferred equity certificate (CPEC),
attached to that property. pro rata share of aggregate qualified which is a financial instrument used in
Like Subpart F income, Sec. 956 business asset investment (QBAI) of its connection with Luxembourg financ-
income is limited under Sec. 956(a)(2) CFCs, less specified interest expense. ing structures. For Luxembourg tax
to the applicable E&P of the CFC. Sec. A CFC’s QBAI is its average quar- purposes, the CPEC is treated as debt,
956 income does not apply to E&P that terly tax basis in depreciable tangible and, therefore, the payment is deduct-
has already been taxed in the United property used in a trade or business ible for local country purposes. For U.S.
States if those same earnings have (tracked using the alternative deprecia- tax purposes, the CPEC is treated as
already been included by a U.S. share- tion system method) for the production equity or dividend income and there-
holder and taxed by the United States of tested income (see Sec. 951A(d)). fore would qualify for the Sec. 245A
(PTEP), as described in Sec. 959(a). It It is important to note that a U.S. foreign dividends-received deduction.
is important to note that Sec. 956 is ef- shareholder’s GILTI inclusion is not However, Sec. 245A(e) disallows the
fectively inapplicable for CFCs that have Subpart F income, and, unlike Subpart Sec. 245A deduction and treats the
U.S. shareholders that are C corporations. F income, GILTI is not subject to a dividend as Subpart F income for U.S.
GILTI: As mentioned earlier, the CFC’s E&P. tax purposes.
TCJA enacted the Sec. 951A GILTI Other inclusions under Sec. 1248
rules, an anti-deferral tax regime intend- and Sec. 245A: While less common, Using Schedules J and P in
ed to prevent U.S. shareholders in CFCs there are notable ways in which a U.S. connection with foreign income
from shifting profits from the United shareholder may be required to include inclusions
States to low-tax jurisdictions through into U.S. taxable income the gain rec- This discussion now turns to Schedules
the transfer of mobile income from in- ognized on the sale of CFC stock that J and P of Form 5471. These forms are
tangible property. Rather than explicitly is recharacterized as dividend income. used to track the accumulated E&P as
identifying what intangible income is, Specifically, Sec. 1248(a) states that if well as the PTEP of a CFC on a year-
the GILTI provisions approximate the a U.S. shareholder sells or exchanges by-year basis. Incorrectly tracking the
intangible income of a CFC by assum- stock in a foreign corporation that was various types of E&P and PTEP gen-
ing a 10% rate of return on the CFC’s a CFC at any time during a five-year erated by a CFC each year could have
tangible assets (see Sec. 951A(b)(2)), period ending on the date of the sale severe tax consequences to a taxpayer as
and any income in excess of that “normal or exchange, then the gain recognized certain events occur throughout the life
return” on assets is effectively treated as on the sale or exchange of the stock of a CFC. E&P and PTEP are used
intangible income. is partly or wholly recharacterized as in the classification of distributions
Unlike Subpart F income, the in- a dividend to the extent of the E&P from a CFC to U.S. shareholders as
clusion of which is determined at the of the CFC stock sold. The amount dividends, return of capital, and capital
CFC level, the GILTI rules require U.S. recharacterized as a dividend is limited gains distributions, in accordance with
shareholders to evaluate the aggregate to the extent of the E&P of the CFC the Sec. 301(c) ordering rules.

14 November 2022 The Tax Adviser