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Final Section 956 Regulations Open the Door to Foreign
Section 956 final regulations confirm those eligible for territorial dividend exemption can
benefit from foreign guarantee and collateral support without incurring US tax.
On May 23, 2019, the US Treasury and Internal Revenue Service (together, Treasury) published final
regulations (the Final Regulations) under Section 9561 that allow US corporate borrowers to obtain credit
support from non-US entities without incurring US tax, so long as certain conditions are met. The Final
Regulations generally adopt the proposed regulations published by Treasury on November 5, 2018 (the
The Final Regulations treat any deemed distribution resulting from the provision by foreign affiliates of
credit support to borrowings by US corporations in generally the same manner as actual cash
distributions, which US corporations in most circumstances can receive free of US tax under the
â€œterritorialâ€ dividend exemption regime enacted by the Tax Cuts and Jobs Act (the Act)2 in December
2017. As is also the case for the territorial dividend exemption, the relief provided by the Final
i. Limited to US corporations that own, directly, indirectly or constructively, 10% or more of the
stock of the relevant foreign corporations by vote or value (US corporate shareholders)
ii. Subject to a holding period and certain other limitations
The Final Regulations will generally apply to taxable years of foreign corporations beginning on or after
July 22, 2019, but taxpayers may apply the Final Regulations to taxable years beginning as early as
January 1, 2018, if all related parties apply them consistently.
The Act introduced a territorial dividend exemption regime â€” subject to a one-time transition tax on
accumulated pre-2018 foreign earnings â€” under which earnings of foreign subsidiaries of US corporate
parents can be repatriated without paying US tax, provided certain requirements are met. While a US
shareholder may pay some level of current tax on offshore earnings of foreign affiliates under either the
retained Subpart F rules or the new â€œglobal intangible low-taxed incomeâ€ (GILTI) rules introduced by the
Act, there is generally a 100% dividends received deduction (DRD) for the foreign-source portion of
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dividends received from a foreign corporation by a US corporate shareholder that meets the minimum
holding period of one year.
However, the Act retained Section 956, which generally subjects a US shareholder to a taxable income
inclusion (a Section 956 deemed dividend) for any previously untaxed offshore earnings of a foreign
subsidiary that is a â€œcontrolled foreign corporationâ€ (a CFC) when such CFC guarantees or provides
certain collateral support for debt of a related US borrower or makes loans to or other investments in a
US affiliate. The retention of Section 956 under the new territorial dividend exemption regime produced
an incongruous result â€” Section 956 deemed dividends remained potentially subject to tax, while actual
dividends paid to US corporate shareholders became exempt.
After the Act, some US borrowers have been able to offer CFC credit support without adverse US tax
consequences in light of their circumstances, including the application of the transition tax, which
generally eliminated pre-2018 untaxed earnings of CFCs, and other Act provisions, such as GILTI.
However, most US borrowings have retained â€œcustomary Section 956 carve-outs,â€ i.e., (i) exclusion of
CFCs from providing guarantees or pledging assets and (ii) limit on pledges of first-tier subsidiary CFC
stock to less than 662/3% of the total combined voting power of all classes of voting stock.
On November 5, 2018, Treasury published the Proposed Regulations in an attempt to remedy this
asymmetry, and the Final Regulations adopt the rules contained in the Proposed Regulations with very
ï‚· For analysis of the Proposed Regulations, read the Client Alert â€œNew Proposed Treasury Regulations
May Eliminate Adverse Tax Consequences on Use of Foreign Credit Support for US Corporate
Borrowingsâ€ (November 5, 2018)
ï‚· For analysis of the provisions of the Tax Cuts and Jobs Act, read the White Paper â€œUS Tax Reform
Key Business Impacts Analyzed, with Transactional Diagramsâ€ (January 10, 2018)
ï‚· For additional background and resources, visit the Latham & Watkins US Tax Reform Resource
Highlights of the Final Regulations
ï‚· A US corporate shareholderâ€™s Section 956 deemed dividend amount is reduced by the amount of the
DRD that the US corporate shareholder would have been allowed had it received an actual cash
distribution in the amount equal to such Section 956 deemed dividend from the CFC. This means that
a US corporate borrower will generally not be subject to a deemed dividend under Section 956, if:3
â€“ The US corporate borrower (or a US corporate affiliate of the borrower owning the CFC) satisfies
a one-year holding period requirement with respect to the CFC (which may also be satisfied
retrospectively, by continuing to own the CFC after the date of the deemed dividend)
â€“ The dividend is not a â€œhybrid dividendâ€ â€” generally, a dividend for which the CFC would have
received a deduction or other tax benefit with respect to taxes imposed by a foreign country had
the CFC paid an actual dividend
â€“ The dividend is foreign source â€” generally meaning that the CFC does not own a US business or
ï‚· A US corporate partner in a borrower that is a US partnership, or LLC treated as a partnership for US
tax purposes, will generally qualify for the same relief from the Section 956 deemed dividend
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treatment as a US corporate borrower described above, provided that the partner is a US corporate
shareholder with respect to the CFC.
ï‚· The DRD is not available to, and as such, relief from the Section 956 deemed dividend treatment
does not extend to:
â€“ A US shareholder that is an individual (owning a CFC directly or indirectly through a US
partnership or LLC treated as a partnership)
â€“ A REIT or RIC (owning a CFC directly or indirectly through a US partnership or LLC treated as a
ï‚· The Final Regulations apply to taxable years of a CFC beginning on or after July 22, 2019, but
taxpayers may apply the Final Regulations for all taxable years of a CFC beginning after December
31, 2017, provided all related parties apply them consistently.
Practical Implications for US Borrowers and Their Lenders
1. US corporate borrowers (and US partnership borrowers with US corporate shareholders as partners)
and their lenders now have certainty that deemed dividends resulting from the provision of foreign
credit support are treated in a manner generally comparable to the receipt of cash dividends from the
applicable CFCs and can structure their financings accordingly. The potential to provide additional
credit support adds flexibility to improve execution on financings.
2. A US corporate borrower (or a US partnership borrower with US corporate shareholders as partners)
that satisfies a one-year holding period requirement with respect to its CFCs should generally be able
to receive credit support from such CFCs without incurring US tax, assuming certain conditions are
met (see #5 below). In the case of an acquisition financing for a US corporate target with CFC
subsidiaries, the one-year holding period requirement in respect of the CFCs may be satisfied
through the US corporate targetâ€™s historical ownership of the CFCs.
3. US borrowers may consider a springing guarantee if the one-year holding period requirement is not
met at the time of closing the financing or if a CFC is newly acquired in the future.
4. A US partnership (including a US LLC treated as a partnership) borrower with individual or other US
non-corporate partners, or with US corporate partners who are not US corporate shareholders with
respect to the relevant CFCs, would continue to have deemed dividend concerns, and may need to
retain the customary Section 956 carve-outs.
5. Even for a US corporate borrower (or a US partnership borrower with US corporate shareholders as
partners) meeting the holding period requirement, due diligence is needed to ensure that:
a) No â€œhybrid dividendâ€ concern under foreign tax law exists
b) The deemed dividend would be foreign source based on activities and assets of the CFC
6. US corporate and partnership borrowers should conduct diligence to determine, as early as possible,
the extent of their Section 956 exposure, if any, so that parties can focus on and work toward
achieving the optimal credit support for efficient deal pricing.
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7. Local law restrictions, including corporate benefit doctrine and financial assistance considerations,
must still be taken into account for foreign guarantees or credit support.
8. Although the Final Regulations are not yet effective, taxpayers are given flexibility to apply them
before they become effective and, for certain taxpayers, applying the Final Regulations early may be
beneficial. However, in light of the related person consistency requirement noted above, taxpayers â€”
particularly taxpayers that are portfolio companies of private equity funds â€” should confirm that all
persons related to the portfolio company, to the extent relevant, apply the Final Regulations
9. A US corporate purchaser contemplating a direct purchase of stock in a CFC should conduct
diligence regarding whether such CFC has been providing credit support to a US obligor and, if so,
consider whether a Section 338(g) election should be made.
A Quick Guide for Assessing Section 956 Exposure
(assuming the borrower is a US entity with a 100%-owned foreign corporate subsidiary)
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If you have questions about this Client Alert, please contact one of the authors listed below or the Latham
lawyer with whom you normally consult:
Melissa S. Alwang [email protected] +1.212.906.1706 New York
Y. Bora Bozkurt [email protected] +1.212.906.4604 New York
Joseph M. Kronsnoble [email protected] +1.312.876.7657 Chicago
Jiyeon Lee-Lim [email protected] +1.212.906.1298 New York
Jocelyn F. Noll [email protected] +1.212.906.1616 New York
MichÃ¨le O. Penzer [email protected] +1.212.906.1245 New York
Elena Romanova [email protected] +1.212.906.1644 New York
Alfred Y. Xue [email protected] +1.212.906.1640 New York
Aaron M. Bernstein [email protected] +1.212.906.1820 New York
Amy L. Robertson [email protected] +1.212.906.4789 New York
You Might Also Be Interested In
Latham & Watkins US Tax Reform Resource Center
US Tax Reform: Key Business Impacts Analyzed, with Transactional Diagrams
New Proposed Treasury Regulations May Eliminate Adverse Tax Consequences on Use of Foreign
Credit Support for US Corporate Borrowings
Impact of Tax Reform on the Leveraged Loan Market
Following the BEAT: IRS Issues Proposed Regulations on Application of Base Erosion and Anti-Abuse
Latham & Watkins June 3, 2019 | Number 2509 | Page 6
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1 All references to â€œSectionâ€ are references to sections of the Internal Revenue Code of 1986, as amended.
2 Public Law No. 115-97 (Dec. 22, 2017). Shortly before final Congressional approval of the legislation, the Senate
parliamentarian struck the previously attached short title, the â€œTax Cuts and Jobs Act.â€ While the final legislation no longer bore
a short title, many commentators have continued to refer to it as the Tax Cuts and Jobs Act.
3 The Final Regulations add certain technical fixes to the Proposed Regulations, including an ordering rule, to ensure this result.