On May 23, 2019, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued final regulations (TD 9859) (the Final Regulations) modifying the application of section 956 of the Internal Revenue Code of 1986, as amended (the Code), which taxes US shareholders with respect to certain investments in US property by a controlled foreign corporation (CFC). The Final Regulations conform the application of section 956 to the section 245A dividend exemption system implemented by Public Law 115-97, commonly known as the Tax Cuts and Jobs Act (the TCJA). The Final Regulations adopt the proposed regulations (REG-114540-18) (the Proposed Regulations) issued by the Treasury and the IRS in 2018 with minimal changes. Please see our prior legal alert on the Proposed Regulations, Legal Alert: Deemed participation better than no participation? Proposed regulations expand tax-free treatment to section 956 inclusions of certain shareholders, for a detailed discussion on the Proposed Regulations and related matters.

  • The Final Regulations generally reduce the taxable section 956 inclusions of corporate US shareholders by reducing the amount otherwise determined under section 956 (the tentative section 956 amount) by an amount equal to the dividends-received deduction (DRD) under section 245A that would be available with respect to a hypothetical distribution.
  • Under section 245A and the Final Regulations, neither an actual dividend to a corporate US shareholder nor such a shareholder’s tentative section 956 amount will generally result in additional US tax, subject to several important exceptions.
  • The Final Regulations include a new ordering rule that ensures that the taxable inclusion under section 956 will properly be reduced to conform to the section 245A deduction that would have been available with respect to a hypothetical distribution.
  • The Final Regulations also provide a special rule that applies to a US shareholder that is a domestic partnership that has domestic partners.
  • Symmetry between the treatment of actual dividends and section 956 inclusions for corporate US shareholders removes many (but not all) potential traps for the unwary.

New ordering rule for allocation of hypothetical distribution

The Final Regulations include a new ordering rule for hypothetical distributions that addresses an unintended consequence under the Proposed Regulations. Under the Proposed Regulations, the taxpayer’s amount determined under section 956 is calculated by reducing its tentative section 956 amount by an amount equal to the DRD that would be available under section 245A with respect to a hypothetical distribution. The apparent problem under the Proposed Regulations stems from the interaction of section 956 and the previously taxed earnings and profits (E&P) rules under section 959. Under those rules, an actual distribution is sourced first to previously taxed E&P that are described in section 959(c)(1) (as a result of an investment in US property in a prior year). The portion of the hypothetical distribution allocated to the prior-year section 959(c)(1) E&P would not qualify for a section 245A deduction because section 245A does not apply to distributions of previously taxed E&P. As a result, under the Proposed Regulations, the taxable section 956 inclusion for the year might have exceeded the amount that would have been subject to tax on an actual distribution.

The Final Regulations include a new ordering rule that specifically addresses this issue, consistent with section 959(f)(1). Under this rule, a hypothetical distribution is treated as attributable first to E&P described in section 959(c)(2), and then to E&P described in section 959(c)(3). By not treating any portion of the hypothetical distribution as attributable to section 959(c)(1) E&P, this rule aligns the E&P subject to the hypothetical distribution to the E&P that would make up the section 956 amount, avoiding the potential mismatch possible under the Proposed Regulations.

Special rule for domestic partnerships and their partners

The Final Regulations also add a rule that addresses US shareholders that own stock of a CFC through a domestic partnership. Under this rule, 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 domestic partnership’s inclusion under sections 951(a)(1)(B) and 956 is allocated to the partners in the same proportion as net income would result to the partners upon a hypothetical distribution.

Implications for US corporate taxpayers

Symmetry between the taxation of actual repatriations and the taxation of effective repatriations should significantly reduce complexity, costs, and compliance burdens for many corporate US shareholders.

Eversheds Sutherland Observation: Corporate US shareholders should continue to be mindful of section 956; however, because it can still apply to them in certain situations, such as when the 12-month holding period applicable to section 245A is not satisfied or there is hybrid equity in the chain, even though no hybrid dividend is actually distributed. This can also occur when a portion of the hypothetical dividend would be from US sources.

The comfort generally provided by the Proposed Regulations makes these limited situations where section 956 continues to apply to a corporate US shareholder an even greater potential trap for the unwary, precisely because section 956 will rarely be a relevant consideration for these taxpayers.


The Final Regulations apply to tax years of a CFC beginning on or after July 22, 2019, and to tax years of a US shareholder in which or with which such tax years of the CFC end. However, taxpayers may apply the Final Regulations for tax years of a CFC beginning after December 31, 2017, and for the tax years of a US shareholder in which or with which such tax years of the CFC end, provided that the taxpayer and the US persons that are related (within the meaning of sections 267 or 707) to the taxpayer consistently apply the Final Regulations for all CFCs of which they are US shareholders for tax years of the CFCs beginning after December 31, 2017.

Eversheds Sutherland Observation: Notwithstanding the May 23, 2019, applicability date described in the preamble to the Final Regulations, the Office of Management and Budget’s Office of Information and Regulatory Affairs determined that the final regulations constitute a major rule for purposes of the Congressional Review Act, which means that Congress has 60 days from the date of Federal Register publication to review the regulations; accordingly, the text of the Final Regulations refers to the July 22, 2019, applicability date referenced above.