Proposed Sec. 956 regulations: Planning and pitfalls

By David Little, CPA, J.D., M.Acc., MIBS, and Wilson Brakefield, J.D., LL.M., MBA, Atlanta

Editor: Kevin D. Anderson, CPA, J.D.

On Oct. 31, 2018, Treasury and the IRS issued proposed regulations under Sec. 956, on the investment of earnings in United States property (REG-114540-18). An unexpected and generally welcome surprise by many U.S. multinationals, the proposed Sec. 956 regulations have the potential to dramatically alter a basic component of U.S. international tax. This discussion addresses the proposed changes to the operation of Sec. 956, potential planning opportunities under the proposed regulations, and certain outstanding issues.

Sec. 956: Investment of earnings in U.S. property

The Revenue Act of 1962, P.L. 87-834, introduced Sec. 956 to U.S. federal income taxation. This long-standing regime generally subjected certain U.S. shareholders (as defined in Sec. 951(b)) of controlled foreign corporations (CFCs) (as defined in Sec. 957) to current federal income taxation on a CFC's specified income or investments. Sec. 956 is intended to prevent a U.S. shareholder from achieving tax deferral on income that is deemed to have been effectively repatriated to the United States.

Under Sec. 951(a)(1)(B), a U.S. shareholder of a CFC is generally required to include in his or her gross income the Sec. 956 amount (to the extent it is not excluded under Sec. 959(a)(2)) for the tax year. The Sec. 956 amount is generally equal to the lesser of:

  • The U.S. shareholder's pro rata share of the quarterly average of "United States property" (U.S. property) held by the CFC over the course of the year minus the Sec. 959(c)(1)(A) earnings and profits (E&P) with respect to the shareholder;or
  • The U.S. shareholder's pro rata share of the "applicable earnings" of the CFC.

The term U.S. property is generally defined in Sec. 956(c)(1) to include tangible property located in the United States, stock of a U.S. corporation, an obligation of a U.S. person, or the right to use intangibles in the United States that are acquired or developed by the CFC for use in the United States.

The chart "FC to USP Loan Transaction" (below) shows the operation of these rules prior to the enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, and the proposed regulations. For this example, assume all entities are calendar-year taxpayers and USP, a domestic C corporation, has owned FC, a foreign corporation, for more than one year. FC makes a loan to USP on Jan. 1, in the amount of 100x. FC has no prior-year E&P, and during the course of the year, FC generates 200x of E&P that is entirely foreign-source, none of which generates Subpart F income. FC has 0x of Sec. 959(c)(1)(A) previously taxed income (PTI).

FC to USP loan transaction

USP's Sec. 956 amount is equal to the lesser of (1) its pro rata share of the loan to USP (100x) minus the Sec. 959(c)(1)(A) PTI (0x), or (2) its pro rata share of applicable earnings (200x). Therefore, USP would generally have to include 100x in its gross income for the year. This Sec. 956 inclusion amount creates 100x of Sec. 959(c)(1)(A) PTI that can be used to offset USP's inclusion amount in later years, assuming those earnings are not distributed byFC.

Proposed regs. under Sec. 956

The proposed regulations can provide a very different result for qualifying taxpayers. Conceptually, the proposed regulations attempt to align the treatment of certain CFC investments in U.S. property that are "substantially the equivalent of a dividend" with CFC dividend distributions under new Sec. 245A. Mechanically, the proposed regulations operate by first calculating the Sec. 956 amount (as described above) and then reducing the Sec. 956 amount by the dividends-received deduction (DRD) the U.S. shareholder would have received on a hypothetical dividend from the CFC under Sec. 245A.

Sec. 245A generally provides a domestic corporation that is a U.S. shareholder of a "specified 10-percent owned foreign corporation" a full DRD on the foreign-source portion of dividends received from that foreign corporation. The term "specified 10-percent owned foreign corporation" is defined as any foreign corporation (other than a passive foreign investment company, or PFIC) with respect to which any domestic corporation is a U.S. shareholder of that foreign corporation. To qualify for the Sec. 245A DRD, the U.S. shareholder must typically be classified as a domestic C corporation (that is, neither a regulated investment company nor a real estate investment trust) and meet the holding period requirements in Sec. 246(c)(5) (generally one year). Numerous exceptions to Sec. 245A exist, including hybrid dividends (as defined in Sec. 245A(e)(4)), dividends from PFICs, and the domestic-source portion (as defined in Sec. 245(a)(5)) of dividends from specified 10%-owned foreign corporations. Importantly, the Sec. 245A DRD is not available to entities that are not classified as domestic C corporations for U.S. federal income tax purposes.

The same example in the chart, with identical facts, is now used to show the operation of the proposed Sec. 956 regulations.

Prior to the proposed regulations, the Sec. 956 amount for USP would have been 100x. However, under the proposed regulations, assuming USP qualifies for the Sec. 245A DRD, the Sec. 956 amount is reduced by the amount that would otherwise be deducted under Sec. 245A had FC paid an actual dividend to USP (100x). Therefore, after application of the proposed regulations, USP does not have a Sec. 956 inclusion amount for the tax year.

Planning opportunities under the proposed regs.

The proposed regulations present several planning opportunities for domestic corporations that are eligible for the Sec. 245A DRD. Planning opportunities are particularly plentiful in the areas of intercompany finance.

Prior to the proposed regulations, a U.S. shareholder could have an inclusion of the Sec. 956 amount if a CFC made an applicable loan to the U.S. shareholder. As in the hypothetical, the loan was treated as an effective repatriation of funds similar to a dividend from the CFC to the U.S. shareholder. As outlined above, assuming the U.S. shareholder qualifies for the Sec. 245A DRD, the proposed regulations would no longer require an inclusion of the Sec. 956 amount for the U.S. shareholder in that case. This may allow for easier access to overseas funds and the potential for improved cash management capabilities.

Another opportunity arises in the case of financing strategies and the pledging of CFC stock. Prior to the promulgation of the proposed regulations, if a U.S. shareholder pledged at least 66.67% of the voting stock of a CFC in a loan agreement and made certain negative covenants, the CFC was generally deemed to have held an obligation of a U.S. person and there could be a resulting inclusion of the Sec. 956 amount. The proposed regulations would remove this limitation on pledged CFC stock for eligible taxpayers (as described above), and there should not be a Sec. 956 inclusion. This could allow the U.S. taxpayer to improve its borrowing opportunities and lower its cost of capital. Some lenders are already well-aware of the proposed regulations and have been in discussions with their borrowers regarding expanded security options.

Additionally, in certain limited circumstances, qualifying taxpayers with supply chain flexibility and treaty protection may consider that tangible property located in the United States might no longer result in an inclusion of the Sec. 956 amount. If there are legal, commercial, or customs benefits for a CFC keeping tangible property in the United States, U.S. corporations may be able to streamline their supply chains in certain circumstances.

It is important to note, however, that deemed paid foreign tax credits (FTCs) under Sec. 960(a) are no longer available for any FTCs associated with inclusions of the Sec. 956 amount. Prop. Regs. Sec. 1.960-2(b)(1) specifically excludes deemed paid FTCs under Sec. 960(a) for an inclusion under Sec. 951(a)(1)(B).

Outstanding issues

One issue that is not fully addressed in the proposed regulations is whether domestic C corporations that own CFCs through domestic partnerships are eligible for the treatment described above. The proposed regulations provide two options for treatment to domestic C corporations in this type of scenario. One option would be to reduce the Sec. 956 inclusion amount at the domestic partnership level to the extent the domestic C corporation would be eligible for the Sec. 245A DRD if the partnership received the amount as a dividend from the CFC. Another option would be to determine the domestic partnership's Sec. 956 inclusion amount on a stand-alone basis and then provide that the domestic C corporation's distributive share of the domestic partnership's Sec. 956 inclusion amount is not taxable.

Effective date

The proposed regulations apply to CFCs whose tax years begin on or after the date that the proposed regulations are finalized. However, taxpayers may rely on the proposed regulations for CFC tax years beginning after Dec. 31, 2017, and before the final Sec. 956 regulations are published, provided that taxpayers and related U.S. persons consistently apply the principles of the proposed regulations to all of their CFCs.

Final thoughts

Overall, the proposed regulations provide a new approach to Sec. 956 for qualifying domestic C corporations. This new approach could provide eligible U.S. multinationals with easier access to overseas funds, improved cash management capabilities, and lower borrowing costs. In some cases, it may be necessary for these U.S. multinationals to evaluate their structures, especially in the case of hybrid instruments (such as convertible preferred equity certificates, or CPECs) that could prevent the application of Sec. 245A and thus the proposed Sec. 956 regulations. Consideration should be given, however, to any related implications that may arise as a result of Sec. 956 planning, such as impacts to the Sec. 59A base-erosion and anti-abuse tax, Sec. 163(j), and state tax implications.


Kevin D. Anderson, CPA, J.D., is a partner, National Tax Office, with BDO USA LLP in Washington, D.C.

For additional information about these items, contact Mr. Anderson at 202-644-5413 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.