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Controlled Foreign Corporations — Section 956 (Portfolio 929)

Product Code: TPOR43
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Controlled Foreign Corporations — Section 956 analyzes the federal income tax consequences under §956 of the Internal Revenue Code of investments of earnings in United States property by controlled foreign corporations. Written by Ewing W. Madole, Esq., PricewaterhouseCoopers LLP, this Portfolio discusses the circumstances under which such investments will result in the taxation to the company's U.S. shareholders of a pro rata portion of the company's earnings and profits, and it explains the rules governing the computation of such income inclusion.

This Portfolio describes the possibility of unexpected results from the operation of the §956 rules, and it suggests planning possibilities to avoid potential pitfalls or to take advantage of possible windfalls.

Among the matters discussed are the definition of the term “United States property” and the exceptions thereto; calculations of the amount of a controlled foreign corporation's earnings invested in U.S. property; the effect of distributions on such calculations; special rules regarding the taxation of U.S. shareholders, including the applicable foreign tax credit rules; and tax planning opportunities.

Controlled Foreign Corporations — Section 956 allows you to benefit from:

  • Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
  • Invaluable practice documents including tables, charts and lists
  • Plain-English guidance from world-class experts
  • Real-world and in-depth analysis that lets you explore various options
  • Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more.
  • Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the Foreign Income Portfolios Library, a comprehensive series containing more than 90 Portfolios, which covers critical transactions and issues in international taxation. This highly-regarded resource service offers commentary on a wide range of foreign income topics including: Foreign Tax Credit, Business Operations in more than 40 foreign countries, Branch ProfitsTax, Source of Income Rules, Subpart F (Controlled Foreign Corporations), Foreign Partnerships and Partners, Transfer Pricing, and more.


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Detailed Analysis

I. Introduction

A. Purpose of Section 956

1. 1993 Legislation

2. Summary

3. Repeal of Section 956A

B. General Structure of Section 956

1. End-of-Quarter "Snapshot" Rule

2. Taxation of Investment in U.S. Property

3. Foreign Tax Credit

4. Pre-1963 Earnings May Be Taxed

5. Distribution to U.S. Shareholders

6. Definitions of "U.S. Shareholder" and "CFC"

7. Reinvestment by CFC of its Earnings Outside the United States

C. Constitutionality of Section 956

D. Coordination with Other Anti-Deferral Provisions

1. Subpart F Income

2. FPHC Rules

3. Foreign Investment Company (FIC) Provisions

4. PFIC Provisions

5. Excess Passive Assets Rules for Pre-1997 Years

E. Substance-Over-Form Doctrine

1. Anti-Abuse Rule

a. Use of Another CFC

(1) Wholly Owned Second-Tier CFC

(2) Affiliated CFC

(3) Third-Tier or Lower-Tier CFC

b. Use of a Trust

c. "Nominees"

d. Use of a Partnership

2. Conduit Arrangements

a. Aiken Industries

b. IRS Interpretation of Aiken

3. End-of-Quarter Divesting of U.S. Property

II. "United States Property" - Definitions and Exceptions

A. Overview

1. Definition of United States Property

2. Statutory Exceptions

3. Statement Required if Exception Applies

B. Calculation of Amount of U.S. Property "Held" by the CFC

1. "Adjusted Basis" of U.S. Property

2. Liabilities to Which U.S. Property Is Subject

a. General Rule

b. Liability in Excess of Basis

c. "Artificial Liabilities"

d. Reduction of Liability

e. Statement Required

3. Combined Effects of Depreciation and Amortization of Related Liability

C. Tax-Free Exchanges of Pre-1963 Property

D. Tangible Property Located in the United States

1. General Rule

2. Property Purchased for Export

a. Exemption for "Export Trade Assets"

b. Property for "Use in Foreign Countries"

c. Time Limit to Keep Export Property in the United States

3. Property Imported into the United States

4. Property in Transit Through the United States

5. Property Used in International Transportation

6. Property Used on the U.S. Continental Shelf

7. Insurance Reserves

8. "Money"

9. Earnings and Profits Derived from Effectively Connected Income

10. Export-Related Property of an FSC

E. Stock of a Domestic Corporation

1. General Rule

2. Exception for Unrelated Domestic Corporations

3. Investment in Foreign Corporations

4. Equity Investments in Non-Corporations

5. Investment of Insurance Reserves

6. Earnings and Profits Derived from Effectively Connected Income

F. Obligations of U.S. Persons

1. General Rules

a. Definition of "Obligation"

b. Definition of "United States Person"

2. Exceptions to Section 956(c)(1)(C)

a. Obligations of Unrelated Corporations

b. Obligations Collected, or Maturing Within 30 Days

(1) Pre-1993 Act Rules (One-Year Rule)

(2) Post-1993 Act Rules

c. Obligations Connected with the Sale or Processing of Property

(1) Period During Which Obligation May Be Outstanding

(2) Exception Limited to Sale and Processing Transactions

(3) Partially Excessive Obligations May Taint Entire Obligation

(4) FIFO Rule for Trade Receivables

d. Obligations Connected with Providing Services

e. Bank Deposits

f. Conduit Financing Arrangements

g. Money and U.S. Government Obligations

h. Obligations of States and Municipalities

i. Insurance Company Reserves

j. Involuntary Conversion of Non-U.S. Property

k. Earnings and Profits Derived from Effectively Connected Income

l. Other Exceptions

3. U.S. Persons Not Excepted by Section 956(c)(2)(F)

4. Pledges and Guarantees by a CFC

a. General Rule of Section 956(d)

b. Pledge by U.S. Shareholder of CFC Stock

5. Loans Involving a CFC and a U.S. Parent - Special Problems

a. U.S. Parent and CFC Both Guarantee a Third Party's Debt

b. U.S. Parent Acts as "Clearing House" for CFC Accounts

c. Loan to Foreign Affiliate to Finance Acquisition of U.S. Property

d. CFC Helps U.S. Parent Borrow Funds Abroad

e. Back-to-Back Loans

f. Conduit Financing Arrangements

g. Cross-Collateralization

h. U.S. Withholding Tax on Intercompany Loans

i. Swap Transaction Recharacterized as a Loan

6. Miscellaneous

a. Futures Contracts

b. Section 1504(d) Contiguous Country Corporations

c. Warrants and Options

G. Intangible Property Used in the United States

1. General Rule

2. Adjusted Basis of the Property Right

H. Income from Factoring Trade Receivables

I. Exception for Certain Assets Acquired by Securities or Commodities Dealers in Ordinary Course

III. Exceptions for Earnings Already Taxed Under the Internal Revenue Code

A. General

B. Exceptions for Effectively Connected Income

1. General Rule

2. Discharge of Pre-1963 Liabilities

3. Only Post-1962 Effectively Connected Income Qualifies

4. Distributions by a CFC Traced First to Other Earnings

C. Exception for Subpart F Income

D. Exception for FPHC Income

IV. Subpart F Exceptions That Are Not Available for Section 956 Purposes

A. General

B. Section 952(c) Rules

C. Section 954(b)(4) Rule

D. The "70-5" Rule

V. Calculations of Amount of Section 951(a)(1)(B) Gross Income

Introductory Material

A. Pre-1993 Act

1. Basic Principles

B. Post-1993 Act

1. Basic Principles

2. Calculation Where No Prior Year U.S. Property

3. Effect of Section 959(c)(1) PTI Adjustment

4. Effect of Earnings and Profits Deficits

5. Effect of Fluctuations in Amount of U.S. Property

6. Previously Taxed Subpart F Income

7. Previously Taxed FPHC Income

8. Coordination of Section 955 and Section 956 Calculations

VI. Effect of Distributions to Shareholders on Section 956 Calculations

Introductory Material

A. General Rule of Section 959(a)

B. Effect of Distributions on Section 956 PTI Account

1. Summary of Rules

2. Comprehensive Example

C. Effect of In-Kind Distributions

VII. Taxation of U.S. Shareholders - Special Rules

A. Introduction

B. Acquisition of CFC Stock During the Year

C. Non-CFC Status During Part of the Year

D. Earnings and Profits and Foreign Tax Credit

1. Dollar-Based CFC, No Foreign Income Tax

2. Foreign Currency-Based CFC, No Foreign Income Tax

3. Foreign Currency-Based CFC, Subject to Foreign Income Tax

4. Foreign Currency-Based CFC with Pre-1987 Earnings and Profits

5. Subsequent Distributions by the CFC

E. Adjustment of Basis of CFC Stock

F. "Hopscotch" Rule

G. Section 1248 Dispositions

VIII. Planning Opportunities

A. General

B. Foreign Tax Credit Planning

1. General

2. "Hopscotch Rule"

C. Unrealized Foreign Exchange Losses

D. Foreign Tax Credit for Pre-1963 Earnings

E. "Double Dip" Effect of Section 959(a)(1) Rule

IX. Compliance Considerations

A. Form 5471

B. Statements Attached to U.S. Shareholder's Return

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Working Papers

Table of Worksheets

Other Sources

Worksheet 1 H.R. Rep. No. 1447, 87th Cong., 2d Sess. pp. 57-60; 63-66 (1962)

Worksheet 2 S. Rep. No. 1881, 87th Cong., 2d Sess. pp. 78-81; 87-88 (1962)

Worksheet 3 Conf. Rep. No. 2508, 87th Cong., 2d Sess. pp. 29-30 and 33 (1962)

Worksheet 4 H.R. Rep. No. 658, 94th Cong., 2nd Sess., pp. 216-218 (1976)

Worksheet 5 S. Rep. No. 938, 94th Cong., 2nd Sess., pp. 225-228 (1976)

Worksheet 6 S. Rep. No. 36 (Selected Excerpts), 103d Cong., 1st Sess. (1993).

Worksheet 7 Conf. Rep. No. 213 (Selected Excerpts), 103d Cong., 1st Sess. (1993).

Worksheet 8 IRS Handbook International Audit Guidelines Handbook Chapter 13-Controlled Foreign Corporations (excerpt)

Worksheet 9 Exclusions from Definition of U.S. Property

Worksheet 10 Reduction of Adjusted Basis of U.S. Property Subject to Liabilities

Worksheet 11 Exclusion for Income Previously Taxed to Predecessor-in-Interest

Worksheet 12 Sample § 956 Calculations




Treasury Regulations:

Committee Reports:

Treasury Rulings:

Field Service Advice Memoranda:






















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Thomas St. G. Bissell
Thomas St.G. Bissell, B.A., Harvard College (1964); LL.B., Columbia Law School (1967); LL.M. in Taxation, New York University (1971); Member, New York Bar; Certified Public Accountant, State of New Jersey; Member, Tax Management International Advisory Board, American Bar Association, American Institute of Certified Public Accountants, International Fiscal Association, Canadian Tax Foundation; former Attorney-Advisor, Office of International Tax Counsel, US Treasury Department, Washington, D.C.; retired tax partner, Coopers & Lybrand LLP; author of numerous articles in professional tax publications. 
Ewing W. Madole
Ewing W. Madole, B.A., M.B.A. Mississippi State University (1973, 1975); J.D., Columbia University School of Law (1985); LL.M. in Taxation, New York University (1990); Member of the New York Bar; Certified Public Accountant, Tennessee (1977).