CFCs — Sections 959-965 and 1248 (Portfolio 930)

Tax Management Portfolio, CFCs — Sections 959–965 and 1248, describes the various rules that apply to the repatriation of the earnings and profits of a controlled foreign corporation (CFC) under Subpart F of the Internal Revenue Code.

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Subpart F is designed to tax the U.S. shareholder of a CFC on the shareholder's pro rata share of the corporation's Subpart F income, even when that income remains in corporate solution. In order to avoid double taxation of Subpart F income when it is repatriated to the shareholder, Subpart F contains a number of provisions dealing with previously taxed income, adjustments to the basis of CFC stock, the foreign tax credit, and disposition of stock in a CFC.

This Portfolio provides a detailed discussion of those provisions. Under §959, a shareholder of a CFC is permitted to exclude from income distributions of earnings and profits that were previously included in the shareholder's income. This exclusion applies to actual distributions, as well as deemed distributions resulting from investments in U.S. property. Section 960 allows the U.S. corporate shareholder of a CFC to claim foreign tax credits for any foreign taxes deemed paid by the CFC on Subpart F amounts that are included in the income of the U.S. shareholder. Section 961 provides for adjustments to a U.S. shareholder's basis in the stock of a CFC.

In general, the shareholder receives an increase in basis equal to the CFC earnings that are includible in the shareholder's income, and basis is decreased by the amount of any distributions to the shareholder that are excluded from income as previously taxed. Section 962 provides that individual U.S. shareholders of a CFC may elect to be taxed at the corporate rates on Subpart F income and thereby qualify for the deemed paid foreign tax credits of §960. Section 964 contains rules for the determination of a CFC's earnings and profits, which is critical to the determination of Subpart F income taxable to U.S. shareholders. Section 965 provides a temporary 85% dividends received deduction for certain dividends received from CFCs.

Finally, §1248 provides special rules for the sale of CFC stock by a U.S. shareholder. These rules have the effect of recharacterizing capital gain as ordinary income to the extent of the shareholder's pro rata portion of the accumulated earnings and profits that have not been taxed under Subpart F.


CFCs — Sections 959–965 and 1248 was authored by the following experts.
Lowell D. Yoder

Lowell D. Yoder, B.A. (1979, with highest distinction) and J.D. (1982, magna cum laude), University of Illinois; Order of the Coif; Law Review Editor; Law Clerk, The Honorable James M. Sprouse, Federal Court of Appeals for the Fourth Circuit; frequent lecturer on international tax topics; author of numerous articles on international taxation; Fellow of the American College of Tax Counsel; Editor-in-Chief of the Journal of Taxation of Global Transactions; member of the Tax Management International Journal Advisory Board and member of Editorial Board of the Journal of International Taxation; Chairman of the University of Chicago Law School's Federal Tax Conference Planning Committee and Advisory Board member of the George Washington University Annual Institute on International Taxation; Adjunct Professor of Law at the Northwestern University School of Law; Regional V.P. of the International Fiscal Association and Co-Chair of the ABA FAUST Committee on CFCs and PFICs. Mr. Yoder also is the author of 926 T.M., CFCs — General Overview; 6220 T.M., CFCs — Foreign Personal Holding Company Income; and 928 T.M., CFCs — Foreign Base Company Income (Other than FPHCI).

Larry R. Kemm

Larry R. Kemm, B.S. (1984), University of Missouri – Kansas City; J.D. (1992, summa cum laude), Indiana University School of Law; Associate Editor, Indiana Law Review; Certified Public Accountant (Texas); Board Certified, Tax Law, Texas Board of Legal Specialization (1997–2002); past Chair, Controlled Group Subcommittee, ABA Tax Section, Affiliated and Related Corporations Committee; frequent speaker on international tax subjects at various institutes and seminars; Regional Vice-President, Treasurer and member of Steering Committee, Midwest Region, International Fiscal Association; former tax partner, McDermott Will & Emery LLP, Chicago, Illinois; admitted to practice, Florida, Texas, Illinois, U.S. Tax Court, and U.S. District Court for the Northern District of Texas.

Table of Contents

Detailed Analysis

I. Introduction

II. Exclusion from Gross Income of Previously Taxed Earnings and Profits

A. Introduction

1. General

2. Legislative Background

3. Basic Rules

B. Definition of Previously Taxed Income

1. General

2. Section 951(a) Amounts

3. Section 1248 Amounts

a. General

b. Section 964(e) Amounts

4. PFIC/QEF Amounts

C. Exclusion from Gross Income of United States Persons

1. General

2. Actual Distributions

a. General Taxation

b. Exclusion for PTI

c. Basis Adjustment

3. Deemed Distributions

a. General

b. Investments in U.S. Property

(1) Section 956 Amount

(2) Exclusion for PTI

c. Investments in Excess Passive Assets

(1) Section 956A Amount

(2) Exclusion for PTI

4. Qualifying Shareholders

a. U.S. Shareholder Including § 951(a) Amounts

b. Successor in Interest

D. Exclusion from Gross Income of Certain Foreign Shareholders

1. General

2. Exclusion Rule

3. Non-U.S. Shareholder Ownership

4. Successor in Interest

E. Allocation of Distributions

1. General Rules

2. Categories of Earnings and Profits

a. Description of Categories

(1) Section 959(c)(1) Account

(2) Section 959(c)(2) Account

(3) Section 959(c)(3) Account

b. Reductions of Categories

(1) Actual Distributions

(2) Investments in U.S. Property

(3) Distributions of Property in Kind

c. Election to Combine Categories

d. Deficits in Earnings and Profits

3. Actual Distributions

a. General Rules

b. Current Year Subpart F Income

c. Current Year Investments in U.S. Property

d. Sale of CFC Stock

(1) Section 951(a)(1) Inclusions

(2) Current Year § 1248 Dividend

e. Distributions Through Tiers of CFCs

(1) PTI Character Maintained

(2) Reduction for Foreign Taxes on Distributions

(3) Foreign Tax Credits

4. Investments in U.S. Property

a. General Rules

b. Section 956 Amount

c. Subpart F Income PTI

d. Distributions

e. Sale of CFC Stock

5. Section 1248

6. Detailed Example

F. Exchange Gain and Loss

1. Distributions of PTI to U.S. Shareholder

2. Deemed Distributions of PTI

3. Distributions of PTI to CFC

G. Excluded Distributions of PTI Not Treated as Dividends

1. General Rule

2. Reduction in Earnings and Profits

3. Exception to Non-Dividend Treatment

H. Shareholder Limitations

1. U.S. Shareholder Including § 951(a) Amounts

2. Successor in Interest

a. General Rule

b. Information Requirements

3. Non-Pro-Rata Distributions

4. Cross-Chain § 304 Distributions

a. General Rules

b. Previously Taxed Income

III. Section 960 Deemed Paid Foreign Tax Credits

A. Introduction

B. General Application of Foreign Tax Credit Rules to CFCs

1. Direct Foreign Tax Credit

2. Indirect Foreign Tax Credit

a. General

b. Gross Up

3. Foreign Tax Credit Limitation

a. General

b. Source of Income

c. Foreign Tax Credit Limitation Categories

(1) General

(2) Look-Through Rules

(a) General

(b) Dividends, Interest, Rents and Royalties Received from a CFC

(c) Subpart F Inclusions

(d) Special Rules

C. Basic § 960 Rules

D. Subpart F Inclusions

1. Subpart F Inclusions

2. Qualified Group

E. Ownership Requirements

1. General

2. First-Tier CFC

3. Lower-Tier CFCs

F. Computation of the Amount of Foreign Taxes Deemed Paid

1. General Rules

a. The Numerator: Deemed Dividend

b. The Denominator: Post-1986 Undistributed Earnings

c. The Multiplicand: Post-1986 Foreign Income Taxes

d. Implementation of the Pools

2. Lower-Tier CFCs

G. Distributions of Previously Taxed Income

1. Prevention of Double Crediting

a. General

b. Section 960(a)(2)

2. Credit for Taxes Paid on Intercorporate Distributions of PTI

a. General

b. Exception to Gross-Up Rule

c. Calculations as Income Is Distributed Through a Chain of CFCs

d. Taxation of Intercorporate Dividends at Different Tax Rates

3. Increase in Foreign Tax Credit Limitation Under § 960(b)

a. General

b. The Excess Limitation Account

c. Denial of Deduction for Foreign Taxes

d. Overpayments Resulting from Increase in Limitation for Taxable Year of Exclusion

IV. Adjustments to Basis of CFC Stock and Other Property

A. Introduction

1. General Rules

2. Purpose of Rules

B. Relevant Property

C. Increase in Basis

1. General Rule

2. Section 962 Election

D. Reduction in Basis

1. General Rule

2. Limited to Actual Distributions

3. Amount in Excess of Basis

4. Section 962 Election

E. Basis in Lower-Tier CFCs

V. Election by Individuals to Be Subject to Tax at Corporate Rates

A. Introduction

1. General Rules

2. Purpose of Rules

B. Determination of Tax

1. General Rules

2. Application of § 11

3. Allowance of Foreign Tax Credit

C. Treatment of Actual Distributions

1. General Rule

2. Successor in Interest

D. Effect on Stock Basis

E. Section 962 Election

1. Who May Elect

2. Time and Manner of Making Election

3. Effect of Election

F. Advantages and Disadvantages of Election

1. General

2. Interaction with § 1(h)(11)

VI. CFC Earnings and Profits

A. Introduction

1. General Rules

2. Application

B. Taxable Year

C. Computation Methods: § 964 Regulations

1. General Rules

2. Foreign Profit and Loss Statement

3. U.S. Accounting Principles Adjustments

4. Tax Accounting Standards Adjustments

a. Accounting Methods

b. Inventories

c. Depreciation

d. Elections

e. Action Not Required Until Significant

f. Time of Election

g. Foreign Currency Transactions and Translations

5. Sensitive Payments

D. Blocked Earnings and Profits

1. General

2. Foreign Law Restrictions

3. End of Deferral

E. Miscellaneous Considerations

1. Other Events That Affect Earnings and Profits

2. Interrelationship of § § 902 and 964

VII. Gain from Sale or Exchange of CFC Stock

A. Introduction

1. General

2. Legislative Background

3. Basic Rules

4. Beneficial Result Under § 1248

B. Shareholders and Corporations Subject to § 1248

1. General

2. United States Person

a. Domestic Person

b. 10% Ownership

3. Controlled Foreign Corporation

4. Five-Year Rule

5. Captive Insurance Companies

6. Application to Certain Domestic Corporations

a. General

b. "Formed or Availed of"

c. Application

d. Suspension of Rule

C. Transactions Subject to § 1248

1. General

2. Sale or Exchange

a. General

b. Section 338 Election

3. Taxable Redemption and Liquidation Distributions by Foreign Corporation

a. General

b. Redemptions

c. Liquidations

4. Nonrecognition Transfers and Deemed Sales by Domestic Corporations

a. General

b. Prior Law

c. Deemed Sales

d. Nonrecognition Transactions

(1) Nonrecognition Transactions Included

(2) Nonrecognition Transactions Excluded

5. Taxable Organization and Reorganization Transactions

a. Section 367

b. Section 351 Boot

6. Exchange by Shareholder of Domestic Corporation

D. Transactions Not Subject to § 1248

1. Nonrecognition Transactions

2. Section 303 Distributions

3. Dividends and Ordinary Income

E. Tax Consequences Under § 1248

1. Amount of Gain or Loss

a. General

b. Nonrecognition Transactions and Indirect Transfers

c. PTI Exchange Gain or Loss

2. Timing of Recognition

a. General

b. Installment Method

c. Consolidated Returns

3. Character of Gain or Loss

a. General

b. Gain Recharacterized as Dividend

c. Amount Recharacterized

4. Source of Gain

5. Foreign Tax Credits

6. Section 1248 Previously Taxed Income

a. General

b. Effect of § 338 Election

F. Determination of CFC's Earnings and Profits

1. General

2. Calculation of Earnings and Profits

a. Distributions

b. Section 338

3. Post-1962 Earnings and Profits While a CFC

4. Exclusions from Earnings and Profits

a. Subpart F Amounts

b. Foreign Personal Holding Company Income

c. Passive Foreign Investment Company Income

d. Foreign Investment Company Income

e. FSC Foreign Trade Income

f. Effectively Connected Income

g. Less Developed Country Corporation's Earnings and Profits (Prior Law)

5. Earnings and Profits Attributable to Shares Sold

a. General

b. Ownership Change During Year

6. Earnings and Profits of Lower-Tier Foreign Corporations

a. Scope of Application

b. Pro Rata Share

G. Determination of Earnings and Profits Attributable to Stock

1. General Rule

2. Simple Case Method

a. Conditions to Application

b. Block of Stock

c. Earnings and Profits Taken into Account

d. Pro Rata Allocation

3. Complex Case Method

a. When Applicable

b. Block of Stock

c. Earnings and Profits Taken into Account

d. Pro Rata Allocation

4. Substantiation of Earnings and Profits

H. Section 1248 Deemed Paid Credits

1. Availability of Credits

a. General Rules

b. Sale of Domestic Corporation

c. Section 338

2. Ten Percent Ownership

3. Gross-Up

4. Lower-Tier Foreign Corporations

5. Transferee Shareholder

I. Section 1248 Previously Taxed Income

J. Limitation on Tax Applicable to Individuals

1. Limitation Computation

a. Section 1248(a) Tax

b. Hypothetical Corporate Tax

c. Hypothetical Shareholder Tax

d. Amount of Limitation

2. Substantiation

3. Interplay with Taxation of Qualified Foreign Corporation Dividends

K. Coordination with Other Rules

1. Earnings and Profits Reductions

2. Amounts Otherwise Treated as Ordinary Income

L. Extension of § 1248 to Lower-Tier CFCs

M. Section 338

N. Partnerships

1. Partnership Sale of CFC Shares

a. General

b. Individuals

2. Sale of Interest in Partnership

VIII. Temporary 85% DRD for CFC Dividends

A. General

B. Election Year

C. Dividends Received by Corporate U.S. Shareholders from CFCs

D. Eligible Cash Dividends Received During Election Year

1. Cash

2. Dividend

3. Previously Taxed Income

a. Eligible Amounts

b. Ordering Rules

4. Intermediary Pass-Through Entities

a. General Distribution Requirement

b. Ordering Rules

5. Amount of Cash Dividend

a. Functional Currency Distributions

b. No Reduction for Expenses

E. Computation of Amount of Qualifying Dividends

1. The Floor

a. General

b. Base Period Inclusions

c. Base Period Years

2. The Ceiling

a. Amount Eligible for DRD

b. Financial Statement

c. Application

3. Reduction for Increase in Related Party Indebtedness

a. General

b. Measurement Dates

c. Definition of Indebtedness

d. Substance over Form Principles

e. Calculating Related Party Indebtedness

4. Identification Rules

F. Investment Requirements

1. Permitted Investments

a. Code

b. Notice 2005-10

c. General Principles

2. Investment Plan

3. Reporting and Safe Harbor

a. General

b. Safe Harbor

G. Acquisitions, Dispositions and Spin-Offs

1. Base Period Amount and APB 23 Limitation

a. General

b. U.S. Shareholder Changes Consolidated Group

c. Determination of Attributes

2. Additional M& A Rules

a. Cash Dividends

b. Domestic Reinvestment Plan

c. Related Party Indebtedness

H. Tax Computational Rules

1. 85% DRD

2. Net Operating Losses

3. Foreign Tax Credits

a. Deductible Portion of Qualifying Dividends

b. Nondeductible CFC Dividends

c. Identification of Qualifying Dividends: Source, Baskets and Deemed Paid Credits

d. Allocation and Apportionment of Expenses

4. Disallowance of Expenses

5. Alternative Minimum Tax

Working Papers

Working Papers

Table of Worksheets

Other Sources

Worksheet 1 Revenue Act of 1962, Report of the Senate Finance Committee August 16, 1962 (enactment of § 1248)

Worksheet 2 General Explanation of the Tax Reform Act of 1976 (H.R. 10612, 94th Cong., P.L. 94-455) prepared by the Joint Committee on Taxation December 29, 1976 (amendment of § 956)

Worksheet 3 Taxpayer Relief Act of 1997 (H.R. 2014, 105th Cong., P.L. 105-34) Conference Report, H.R. Conf. Rep. No. 105-220, July 31, 1997 (amendment of § § 902, 904, 951, 952, 961, and 964)

Worksheet 4 American Jobs Creation Act of 2004 (H.R. 4520, P.L. 108-357), Conference Report, October 7, 2004 (enactment of § 965)

Worksheet 5 General Explanation of Tax Legislation Enacted in the 108th Congress Joint Committee on Taxation, May 2005 (enactment of § 965)

Worksheet 6 Notice 2005-10, 2005-6 I.R.B. 474

Worksheet 7 Notice 2005-38, 2005-22 I.R.B. 1100

Worksheet 8 Notice 2005-64, 2005-36 I.R.B. 471

Worksheet 9 Form 8895, One-Time Dividends Received Deduction for Certain Cash Dividends from Controlled Foreign Corporations

Worksheet 10 Section 962 Election to Be Taxed at Corporate Rates




Treasury Regulations:

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Treasury Rulings