CFC downward attributions get safe harbors

By Paul Bonner

U.S. persons who own stock in controlled foreign corporations (CFCs) may be able to benefit from safe harbors for determining CFC status and resulting income inclusions under a revenue procedure (Rev. Proc. 2019-40) the IRS issued Tuesday.

At the same time, the IRS issued proposed regulations (REG-104223-18) concerning ownership attribution for determining the status of corporations as CFCs and their U.S. shareholders.

Under Sec. 957(a), a CFC is any foreign corporation of which U.S. shareholders own or are considered to own more than 50% of the voting power or value of its stock on any day during the corporation’s tax year.

The guidance is prompted by the repeal of Sec. 958(b)(4) under the law known as the Tax Cuts and Jobs Act, P.L. 115-97, the IRS explained in an accompanying news release (IR-2019-162).

Before its repeal, under the rules for constructive ownership of stock, Sec. 958(b)(4) excluded U.S. persons from constructively owning stock in a CFC by application of Sec. 318(a)(3)(A), (B), or (C), which each attribute ownership of stock directly or indirectly for or by a partner, beneficiary, or controlling stockholder to the respective partnership, estate, trust, or corporation and thence to other partners, beneficiaries, or shareholders. The repeal of Sec. 958(b)(4) can cause stock of a foreign corporation to now be attributed to a U.S. person under Sec. 318(a)(3) (referred to as “downward attribution”).

Thus, a U.S. person may now be treated as a U.S. shareholder of a CFC who was not formerly, and foreign corporations that were not previously treated as a CFC may be so treated. The Code change is effective for the last tax year of foreign corporations beginning before Jan. 1, 2018, and subsequently.

Ownership of stock in CFCs, in turn, may require taxpayers to include in gross income amounts under Secs. 951 (Subpart F) and 951A (global intangible low-taxed income, or GILTI). In issuing the relief, the IRS stated it recognized that taxpayers so affected might not be able to obtain information to accurately determine these income amounts or whether foreign corporations in which they now are considered to own stock are in fact CFCs.

Safe harbor for determining CFC status

Therefore, for foreign corporations that are not U.S.-controlled CFCs, the IRS will accept a U.S. person’s determination that a corporation is not a CFC under Sec. 957(a) if the following conditions are satisfied:

  • The U.S. person has no actual knowledge, statements received, and/or reliable publicly available information sufficient to determine that the Sec. 957 ownership requirements are met.
  • If the U.S. person directly owns stock of, or an interest in, a foreign entity (a top-tier entity), the U.S. person inquires of the top-tier entity whether it meets the Sec. 957 ownership requirements; whether, how, and to what extent the top-tier entity directly or indirectly owns stock of one or more foreign corporations; and whether, how, and to what extent the top-tier entity owns directly or indirectly stock of, or an interest in, one or more domestic entities.

In addition, Rev. Proc. 2019-40 provides safe harbors for using “alternative information” to determine amounts necessary for calculating Subpart F and/or GILTI inclusions, such as the CFC’s gross and taxable income, qualified business asset investment under Sec. 951A(d), specified interest expense, and earnings and profits.

Alternative information

Alternative information is defined in the revenue procedure as the following, each item of which qualifies only if the preceding item is not readily available:

  • Audited separate-entity financial statements prepared in accordance with U.S. GAAP;
  • Audited separate-entity financial statements prepared on the basis of IFRS;
  • Audited separate-entity financial statements prepared on the basis of the local-country GAAP;
  • Unaudited separate-entity financial statements prepared on each of the above bases, in the same order;
  • Separate-entity records used by the foreign corporation for tax reporting; or
  • Separate-entity records used by the foreign corporation for internal management controls or regulatory or other similar purposes.

Safe harbor for using alternative information

The IRS generally will accept the use by an unrelated Sec. 958(a) U.S. shareholder of alternative information in the case of foreign-controlled CFCs with respect to which there is no related Sec. 958(a) shareholder, if the information required under Regs. Secs. 1.952-2(a), (b), and (c)(2) and Sec. 964 and its regulations is not readily available to the unrelated Sec. 958(a) U.S. shareholder. The IRS intends to revise the instructions for Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, to that effect.

In addition, alternative information may be used to calculate a Subpart F inclusion by reason of Sec. 965 (transition tax) or a deduction under Sec. 965(c) (participation exemption), under conditions specified in the revenue procedure.

Penalty and Form 5471 filing relief

The revenue procedure also provides relief from penalties under Sec. 6038 for failure to report certain information required on Form 5471 and Sec. 6662 upon application of the safe harbors consistent with the revenue procedure and taxpayers’ acting in good faith with reasonable cause.

Finally, the revenue procedure notes that the IRS intends to further limit Form 5471 filing requirements, in addition to exceptions it announced earlier in Notice 2018-13.

The revenue procedure applies with respect to the last tax year of a foreign corporation beginning before Jan. 1, 2018, and subsequently, and with respect to the tax years of U.S. shareholders in which or with which these tax years of foreign corporations end.

Proposed regulations

The proposed regulations would amend a number of existing regulations (including regulations under Secs. 267, 332, and 1297) to ensure, in appropriate circumstances, that the operation of various rules is consistent with their application before the repeal of Sec. 958(b)(4).

Paul Bonner ( is a JofA senior editor.

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