On October 31, the U.S. Internal Revenue Service (IRS) and the Department of the Treasury (Treasury) released proposed regulations (Proposed Regulations) excluding corporate U.S. shareholders from the application of Section 956 of the Internal Revenue Code of 1986, as amended (Code),1 to the extent necessary to maintain symmetry between the taxation of actual repatriations and the taxation of deemed repatriations. In many circumstances, this change will allow U.S. corporate borrowers with valuable foreign subsidiaries to provide significantly more credit support to their lenders than is currently market practice in the U.S. credit market.


Section 956 deems a repatriating distribution to occur to certain U.S. shareholders each year if the assets of a controlled foreign corporation (CFC) or a foreign partnership (collectively, Applicable Foreign Subsidiaries) serve at any time as credit enhancement for borrowing by its U.S. parent. The amount of the deemed distribution is limited to the amount outstanding under the borrowing. To avoid this result, it is customary in the market for a U.S. borrower to limit the credit support made available to its lenders by

not providing guarantees by any first-tier Applicable Foreign Subsidiaries or any domestic holding companies that own Applicable Foreign Subsidiaries (FSHCOs) limiting pledges of the U.S. borrower’s equity interest in its foreign subsidiaries to 65 percent of the voting equity in the borrower’s first-tier Applicable Foreign Subsidiary not providing credit support from any direct or indirect subsidiaries of first-tier Applicable Foreign Subsidiaries

The 2017 tax reform legislation known as the Tax Cuts and Jobs Act (Tax Act) substantially changed how the U.S. taxes the income of and distributions from Applicable Foreign Subsidiaries. As part of those changes, Section 245A now provides that a U.S. parent corporation generally is entitled to a 100% deduction for any actual distribution from a specified 10-percent-owned foreign corporation. However, the deemed distribution rules under Section 956 described above were not repealed as part of the Tax Act. As a result, the tax law created an asymmetry in which an actual cash distribution from certain foreign subsidiaries to their U.S. corporate parent would be tax-free to the U.S. corporate parent, but a deemed distribution under Section 956 from those same foreign subsidiaries to their U.S. corporate parent would be fully taxable. The Proposed Regulations are intended to bring parity between actual and deemed distributions.

Summary of the Proposed Regulations

 Reduction (but not elimination) of the Section 956 amount. The Proposed Regulations would not repeal Section 956 (only Congress could do so). Instead, they would reduce the amount of the Section 956 deemed distribution treated as received by a U.S. shareholder by the amount that such U.S. shareholder would be able to deduct under Section 245A if the deemed distribution were treated as an actual distribution by the CFC. Because Section 245A provides a 100% deduction for actual dividends, the Section 956 amount can in many circumstances be reduced to zero. However, in other circumstances, Section 956 will continue to apply (see below for practical implications for borrowers). Effective dates. The Proposed Regulations will be effective when published in their final form. However, a U.S. corporation is permitted, but not required, to rely on the Proposed Regulations, generally with respect to taxable years of a CFC of such U.S. corporation beginning after December 31, 2017, until they are finalized. To do so, the U.S. corporation, and certain of its affiliates, must consistently apply the Proposed Regulations with respect to all of their CFCs.

Practical Implications

Borrowing by U.S. corporate groups. Suppose X, a U.S. corporate parent, has a 100%-owned Applicable Foreign Subsidiary. Suppose further that Applicable Foreign Subsidiary had $200 of earnings and profits not otherwise subject to U.S. tax. Applicable Foreign Subsidiary operates in Dubai (i.e., no corporate tax). X borrows from B, a federally chartered bank, $100 under a credit agreement, which provides that Applicable Foreign Subsidiary shall guarantee the borrowing for the benefit of B. X has no foreign operations or sales other than through Applicable Foreign Subsidiary. As a result, there are no available foreign tax credits.

Under old law (i.e., prior to 1/1/2018), a distribution by Applicable Foreign Subsidiary of $100 would have resulted in a $35 tax to U.S. corporate parent ($100 dividend times 35% corporate tax). The guarantee by Applicable Foreign Subsidiary in the example would have resulted in the same $35 tax to the U.S. corporate parent (i.e., guarantee triggers deemed distribution from Applicable Foreign Subsidiary to U.S. corporate parent in the amount of the loan, all of which is out of earnings and profits). Under the new law (including the Proposed Regulations), Applicable Foreign Subsidiary’s actual distribution of $100 would result in no tax to U.S. corporate parent because of new Section 245A (i.e., $100 of foreign dividend income minus a deduction of $100 (100% of $100)). Similarly, because of the Proposed Regulations, Applicable Foreign Subsidiary’s deemed distribution under Section 956 as a result of the guarantee in favor of B would be zero (i.e., $100 deemed dividend minus $100 (100% of $100)). Thus, as this example shows, solely as a U.S. tax matter, U.S. corporate groups with significant foreign subsidiaries may no longer be opposed to providing credit support from their foreign subsidiaries in respect of borrowings by the U.S. corporate parent. However, this was a simplified example. The determination and calculations in a particular case can be complicated (e.g., multiple tiers of foreign subsidiaries, foreign tax credit calculations, earnings and profits calculations) and would need to be undertaken early in the transaction structuring process. As a result of these complications, whether the lending market will move in this direction remains to be seen.

Foreign subsidiaries owned by domestic partnerships, real estate investment trusts (REITs) and regulated investment companies (RICs). The new Proposed Regulations provide relief only to U.S. corporate borrowers. A U.S. borrower that is either a partnership (including many LLCs) for tax purposes (e.g., a domestic private equity fund partnership or a family investment partnership), a REIT or a RIC, which borrows and wishes to provide credit support by a CFC, will not benefit from the new Proposed Regulations because Section 245A limits the 100% deduction to “domestic corporations,” and the Proposed Regulations make the Section 245A deduction available only to the extent such deduction would be available in the case of an actual distribution. Thus, in such cases, the current market practice will likely continue unchanged. 956 still applicable for some corporate borrowers. While the Proposed Regulations provide relief to corporate borrowers that may now be able to provide more security to their lenders without suffering adverse tax consequences, borrowers should be aware that under certain circumstances Section 956 and the adverse tax consequences related to it may still apply. For example, Section 956 might still apply where the foreign subsidiary has income that is effectively connected with a U.S. trade or business, where dividends to the domestic parent are deductible under foreign law or where the foreign subsidiary stock was held for 365 days or less within a two-year period. Changes to market practice only on advice of tax advisers. In light of the foregoing and the technical nature of the Proposed Regulations, borrowers should deviate from established market practice in respect of credit support by foreign subsidiaries only after obtaining advice from their respective tax advisers.