Repeal of Downward Attribution Rules Creating More CFCs

Feb 28, 2020

The Tax Cuts and Jobs Act (TCJA) of 2017 modified the stock attribution rules for determining if a foreign corporation is a controlled foreign corporation (CFC)1 by repealing the downward attribution rules under Section 958(b)(4).2 The reason for repealing the provision was to have more companies that undertook “inversion” transactions classified as CFCs so their U.S. shareholders3 would be subject to inclusions under the U.S. anti-deferral subpart F provisions per Section 951(a) and global intangible low-taxed income (GILTI) per Section 951A.

For example, assume a foreign parent is 10% owned by one U.S. person and 90% by foreign persons. The foreign parent owns 100% of a U.S. corporation and 100% of a foreign subsidiary. With the repeal of Section 958(b)(4), the U.S. corporation is deemed to own by attribution the foreign subsidiary, which is, therefore, a CFC. The parent company’s U.S. shareholder must include and report its subpart F and GILTI income from the foreign subsidiary and comply with U.S. filing requirements. Prior to the repeal, the foreign subsidiary would not be considered a CFC, and the U.S. shareholder would not have to address subpart F or have U.S. tax filing requirements. 

Ways to “fix” this structure may include either filing a U.S. entity classification election to treat the foreign subsidiary as a disregarded entity or converting the U.S. corporation to a Delaware LLC, which defaults to being treated as a disregarded entity. Either way, the corporation causing the problem is being eliminated. However, due care and a full tax analysis need to be performed to make sure conversions can be done and do not cause adverse tax results.

Treasury and the IRS issued Revenue Procedure 2019-40 and proposed regulations to provide some relief. Revenue Procedure 2019-40 provides three safe-harbor rules, addresses the applicability of certain penalties, and revises the requirements for certain U.S. shareholders to report as Category 5 filers on Form 5471. 

The three safe-harbor rules are generally limited to U.S. shareholders of “foreign-controlled CFCs”4 that would not be CFCs without the repeal of Section 958(b)(4). Also, the U.S. person does not have actual knowledge that the entity is a CFC, a statement that the entity is a CFC, or reliable publicly available information that the entity is a CFC.

If the U.S. person directly owns an interest in a foreign entity the safe harbor applies only if the U.S. person makes the following inquiries of the top-tier entity: 

  • Whether the top-tier entity is a CFC
  • Whether, how, and to what extent the top-tier entity directly owns stock in any other foreign corporation
  • Whether, how, and to what extent the top-tier entity owns an indirect interest in a U.S. domestic corporation

Revenue Procedure 2019-40 acknowledges the difficulty that U.S. shareholders of foreign-controlled CFCs may have in obtaining the necessary information to properly report and calculate its subpart F and GILTI inclusions for Form 5471. In general, a U.S. shareholder would not be able to compel a CFC that it does not control to provide it with information to meet U.S. filing requirements, and the information may not be available publicly. 

In this circumstance, there is a safe-harbor list for use of alternative information, starting with various types of separate entity5 audited financial statements and separate entity internal records. You cannot pick and choose here. It is a top-down approach, and you cannot pick a lower-tier record when a higher-level record is available. The alternative information cannot be used for determining deemed paid foreign tax credits for subpart F or GILTI inclusions.

Not filing a complete or proper Form 5471 can result in a $10,000 penalty. Revenue Procedure 2019-40 provides penalty relief, but it is unclear if the statute of limitations’ tolling provision under Section 6501(c)(8) is affected for filing an accurate Form 5471. Further guidance is expected. 

The takeaway is that the repeal of Section 958(b)(4) is having a ripple effect on taxpayers and is causing foreign entities that were not CFCs before the TCJA to become CFCs, thereby causing subpart F and GILTI inclusions and enhanced Form 5471 reporting requirements that are difficult to comply with. The situation must be reviewed carefully and addressed accordingly.  

1 A CFC is defined as a foreign corporation that has U.S. shareholders that own more than 50% of the vote or value (whichever is greater) of the foreign corporation at any time during the taxable year. 
2 Repeal is effective for tax years beginning with the last tax year of foreign corporations that began before Jan. 1, 2018. For calendar-year corporations, this created a retroactive repeal effective Jan. 1, 2017. 
3 A U.S. shareholder is a U.S. person who owns 10% or more of the vote or value of a foreign corporation.
4 U.S.-controlled CFCs are not provided relief under the safe harbor because they are CFCs prior to the Section 958(b)(4) repeal. 
5 The foreign-controlled CFC cannot have any other U.S. shareholders for this safe harbor to apply. 

Andrew M. Bernard Jr., CPA, is a managing director for Andersen in Philadelphia and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at
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