Final Regulations: Single-Entity Treatment of Consolidated Groups
Well, that didn’t take long …
On February 22, 2023, the IRS issued final rules regarding single-entity treatment of consolidated groups that treat members of a consolidated group as a single U.S. shareholder in certain cases for purposes of Section 951(a)(2)(B) of the Internal Revenue Code. These rules were published in the Federal Register on February 23. The final regulations adopt the proposed regulations (without modifications) that were released on December 9, 2022 and published on December 14. As the background of the final regulations states, “No comments were received from the public in response to the notice of proposed rulemaking. No public hearing was requested or held. This Treasury Decision adopts the proposed regulations as final regulations without modification.”
The final regulations apply to taxable years for which the original consolidated return is due (without extensions) after February 23, 2023. In other words, taxpayers with a calendar year-end for 2022 will have to apply these rules for their return due April 15, 2023.
Below is information from the previous FORsights™ article, “Proposed Regulations: Single-Entity Treatment of Consolidated Groups,” related to the proposed regulations, including examples of the rules.
Background & Purpose
On December 9, 2022, the IRS released proposed regulations regarding single-entity treatment of consolidated groups that treat members of a consolidated group as a single U.S. shareholder in certain cases for purposes of §951(a)(2)(B) of the Internal Revenue Code (published December 14, 2022). The proposed regulations affect consolidated groups that own stock of foreign corporations.
By way of background, §951(a)(2)(B) reduces a portion of an acquiring U.S. shareholder’s pro rata share of a controlled foreign corporation’s (CFC’s) Subpart F or tested income by the amount of a dividend the CFC paid to the former shareholder earlier in the acquisition year. While §959(d) provides that a §959(a) distribution of previously taxed earnings and profits (PTEP) paid to a U.S. shareholder is not a dividend, there is no similar rule providing that a §959(b) CFC-to-CFC distribution of PTEP is not a dividend. Thus, some taxpayers have taken the position that a §959(b) distribution of PTEP by a lower-tier CFC to its upper-tier CFC parent company is a dividend that can invoke a §951(a)(2)(B) reduction in Subpart F or tested income when there is a subsequent transfer by the upper-tier CFC of its stock of the lower-tier CFC to a new U.S. shareholder or to a foreign subsidiary of a new U.S. shareholder.
According to the proposed regulations’ explanation of provisions, “the Treasury Department and the IRS are aware that some consolidated groups are taking the position that the group’s aggregate inclusions under sections 951(a)(1)(A) and 951A(a) are reduced by changing the location of ownership of stock of a CFC within the group.” Moreover, Treasury is aware of the “substantial amount of PTEP in the U.S. tax system following the enactment of §951A and §965,” which is resulting in an increase in these types of transactions.
Furthermore, the proposed regulations do not address the issue of whether a §959(b) CFC-to-CFC PTEP distribution should be treated as a dividend to which §951(a)(2)(B) applies but shut down the ability to effectuate a §951(a)(2)(B) reduction through a CFC-to-CFC PTEP distribution followed by an intercompany transfer of CFC stock by treating members of a consolidated filing group as one shareholder.
Purpose & Examples
The proposed regulations provide two examples to help taxpayers understand the proposed rules. However, diving into the purpose of the rules will help illustrate the intent of the examples. In general, §959(b) excludes dividends from a lower-tier CFC from Subpart F and tested income. Disregarding the proposed regulations, if a dividend was distributed from a lower-tier CFC to an upper-tier CFC, and then the lower-tier CFC subsequently contributed to another member of the U.S. consolidated group (that is, the new U.S. shareholder) before the end of the year, the distribution would result in the new owner reducing its pro rata share of the CFC’s Subpart F and tested income under §959(b) and reducing the days owned by the consolidating parent by those days of only the new U.S. shareholder.
However, these rules would prevent that reduction by treating members as a single U.S. shareholder and, therefore, would result in the aggregate amount not changing with respect to the Subpart F or tested income of the other member of the consolidated group (that is, the new U.S. shareholder) by disregarding the dividend amount under §959(b) and by not impacting the number of days (the numerator) for days owned by the previous member for purposes of the §951(a)(2)(B) fraction. Simply put, Subpart F and tested income would not change as a result of the above transactions. Below are examples directly from the proposed regulations and for purposes of the examples, P owns M1 and M2 and they are all part of the U.S. consolidated group.
“Example 1 – Intercompany transfer of stock of a controlled foreign corporation (A) Facts. Throughout Year 1, M1 directly owns all the stock of CFC1, which directly owns all the stock of CFC2. In Year 1, CFC2 has $100x of subpart F income (as defined in §952). M1’s pro rata share of CFC2’s subpart F income for Year 1 is $100x, which M1 includes in its gross income under §951(a)(1)(A). In Year 2, CFC2 has $80x of subpart F income and distributes $80x to CFC1 (the CFC2 Distribution). §959(b) applies to the entire CFC2 Distribution. On December 29, Year 2, M1 transfers all of its CFC1 stock to M2 in an exchange described in §351(a). As a result, on December 31, Year 2 (the last day of Year 2 on which CFC2 is a controlled foreign corporation), M2 owns 100% of the stock of CFC1, which owns 100% of the stock of CFC2.
(B) Analysis. Under paragraph (j)(1) of this section, in determining the amount described in §951(a)(2)(B) that is attributable to the CFC2 Distribution, all members of the P group are treated as a single United States shareholder for purposes of determining the part of Year 2 during which such shareholder did not own the stock of CFC2. Thus, the ratio of the number of days in Year 2 that such United States shareholder did not own the stock of CFC2 to the total number of days in Year 2 is 0/365. The amount described in §951(a)(2)(B) is $0, M2’s pro rata share of CFC2’s subpart F income for Year 2 is $80x ($80x - $0), and M2 must include $80x in its gross income under §951(a)(1)(A).
Example 2 – Transfer of stock of a controlled foreign corporation between controlled foreign corporations (A) Facts. The facts are the same as the facts of Example 1, except that M1 does not transfer its CFC1 stock to M2. Additionally, throughout Year 1 and from January 1, Year 2, to December 29, Year 2, M2 directly owns all 90 shares of the only class of stock of CFC3. Further, on December 29, Year 2, CFC3 acquires all the CFC2 stock from CFC1 in exchange for 10 newly issued shares of the same class of CFC3 stock in a transaction described in §368(a)(1)(B). As a result, on December 31, Year 2, M1 owns 10% of the stock of CFC2, and M2 owns 90% of the stock of CFC2.
(B) Analysis. Under paragraph (j)(1) of this section, in determining the amount described in §951(a)(2)(B) that is attributable to the portion of the CFC2 Distribution with respect to each of the CFC2 stock that M1 owns on December 31, Year 2, and the CFC2 stock that M2 owns on that day, all members of the P group are treated as a single United States shareholder for purposes of determining the part of Year 2 during which such shareholder did not own such stock. In each case, the ratio of the number of days in Year 2 that such United States shareholder did not own such stock to the total number of days in Year 2 is 0/365, and the amount described in §951(a)(2)(B) is $0. M1’s and M2’s pro rata shares of CFC2’s subpart F income for Year 2 are $8x ($8x - $0) and $72x ($72x - $0), respectively, and M1 and M2 must include $8x and $72x in gross income under §951(a)(1)(A), respectively.”
Treasury and the IRS are continuing to coordinate PTEP rules with §951(a) and §951(A) and the impact of intercompany transactions along with other regulations impacting CFCs. In addition, the proposed regulations refer to other code sections where non-PTEP dividend distributions take place and have language around impacts of other authorities or common law doctrines that may apply to recast a transaction or otherwise affect the tax treatment of a transaction.
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