Taxpayers With Possible Code Sec. 956 Inclusions Should Consider Implications Of New Law

Author: Remy Farag, J.D., LL.M., RIA editorial staff

Taxpayers with structures that planned for a Code Sec. 956 inclusion from lower-tier controlled foreign corporations (CFCs) that anticipated not paying significant residual U.S. tax should quickly assess how the enactment of the "Education Jobs and Medicaid Assistance Act" (P.L. 111-226) affects their tax positions.

Background. A Code Sec. 951(a)(1)(B) inclusion is generally the income inclusion of a U.S. shareholder of a CFC arising from the CFC's investment in U.S. property. Under current law, a U.S. company's deemed paid taxes from a Code Sec. 951(a)(1)(B) from a lower-tier CFC comes directly from the CFC to the U.S. company without affecting the earnings and taxes of upper tier CFCs). This is often referred to as the Code Sec. 956 hopscotch rule. As an example, this provision is often applicable to financing transactions where U.S. borrowers have their foreign subsidiaries act as guarantors to secure financing and some (or all) of the CFC's pledged assets includes U.S. property.

New Code Sec. 960(c). Under the new law, Code Sec. 960 is modified to provide a new rule for determining the deemed paid foreign income tax associated with a Code Sec. 951(a)(1)(B) inclusion. For acquisitions of U.S. property afterDecember 31, 2010, the new law prevents taxpayers from maximizing their foreign tax credits by selectively repatriating income from high-taxed foreign subsidiaries while continuing to defer U.S. tax on income of low-taxed foreign subsidiaries. If there is an amount included in the gross income of a domestic corporation under Code Sec. 951(a)(1)(B) attributable to the earnings and profits of a foreign corporation which is a member of a qualified group with respect to the domestic corporation, then the amount of any foreign income tax deemed to have been paid during the tax year by the domestic corporation under Code Sec. 902 by reason of Code Sec. 960(a) with respect to such gross income inclusion can't exceed the amount of foreign taxes that would be deemed paid if cash in an amount equal to the amount of the inclusion in gross income were distributed as a series of distributions (determined without regard to any foreign tax which would be imposed on an actual distribution) through the chain of ownership which begins with the foreign corporation and ends with the domestic corporation.

It should be noted that taxpayers may still be able to take advantage of the Code Sec. 956 hopscotch rule after December 31, 2010, with respect to their Code Sec. 951(a)(1)(B) inclusions if the U.S. property was acquired by the CFC prior to January 1, 2011, although the Joint Committee on Taxation's report advises that this provision is likely subject to certain limitations.