Treasury and IRS finalize DRD anti-abuse regulations with few changes

By Craig Hillier, J.D., Boston; Jose Murillo, CPA, Washington, D.C.; Joshua Ruland, J.D., Washington, D.C.; Allen Stenger, J.D., Washington, D.C.; and Carlos J. Vaca Valverde, J.D., Washington, D.C.

Editor: Susan Minasian Grais, CPA, J.D., LL.M.

On Aug. 21, 2020, Treasury and the IRS released final regulations under Sec. 245A (T.D. 9909) providing anti-abuse rules for extraordinary dispositions of assets and extraordinary reductions of dividends. These regulations finalize proposed regulations (REG-106282-18) and replace temporary regulations (T.D. 9865) that were issued in June 2019.

The final regulations are substantially similar to the proposed and temporary regulations, with a limited number of generally taxpayer-favorable changes at the margin. While the substantive rules did not change much, taxpayers should pay close attention to several new examples that illustrate the anti-abuse rules; one of them would extend the application of the extraordinary-disposition rules beyond "dispositions."

At the same time, Treasury and the IRS released new proposed regulations that would coordinate the final regulations with certain rules under Sec. 951A that effectively deny deductions arising from "disqualified basis" that is generated during the global intangible low-taxed income (GILTI) gap period, as defined below (see also "Reducing the Threat of Double Taxation From GILTI Gap Period Rules," in this issue).

Extraordinary dispositions

The final regulations continue to deny the Sec. 245A dividends-received deduction (DRD) for 50% of the dividends paid by specified 10%-owned foreign corporations (SFCs) to the extent attributable to earnings and profits (E&P) from extraordinary dispositions. An extraordinary disposition occurs when an SFC disposes of property to a related party outside its ordinary course of business and the disposition:

  • Occurs after Dec. 31, 2017, but before the close of a tax year to which the GILTI rules under Sec. 951A do not apply (the GILTI gap period); and
  • Would have resulted in tested income (or reduced tested income) if gain (or loss) were recognized outside the GILTI gap period.

Whether a disposition of tangible property is outside the SFC's ordinary course of business is a facts-and-circumstances determination. In contrast, dispositions of intangible property and dispositions undertaken with a principal purpose of generating E&P during the GILTI gap period are per se outside of the ordinary course of the SFC's business. The final regulations provide a new, limited exception to the per se rule for related-party, intangible-property transfers if the related acquirer is reasonably expected to resell the intangible property to an unrelated customer within one year.

Taxpayers must maintain extraordinary disposition accounts. A Sec. 245A shareholder's extraordinary disposition account for an SFC at any time equals the following: (shareholder's percentage, by value, of the SFC stock × the amount of the E&P resulting from extraordinary dispositions) − extraordinary disposition amounts (i.e., portion of dividends paid out of the extraordinary disposition account) already taken into account by the shareholder.

In a correction to an apparent oversight in the temporary regulations, the final regulations reduce a Sec. 245A shareholder's extraordinary disposition account for income inclusions under Sec. 956.

The final regulations retain the favorable ordering rule from the temporary regulations, in which a dividend is first considered paid out of non-extraordinary disposition E&P and is then considered paid out of the Sec. 245A shareholder's extraordinary disposition account. When determining non-extraordinary disposition E&P, the final regulations measure the Sec. 245A shareholder's share of the SFC's Sec. 959(c)(3) E&P based on the percentage of stock owned immediately before the distribution. As a result, when the Sec. 245A shareholder disposes of all its SFC stock (e.g., when a gain from the sale is recharacterized as a dividend under Sec. 1248), a portion of the dividend related to the sale may now be treated as distributed from non-extraordinary disposition E&P.

The final regulations include successor rules that are broader in some circumstances than the rules in the temporary regulations but narrower in others. In particular, the final regulations generally eliminate a Sec. 245A shareholder's extraordinary disposition account if (1) the shareholder transfers all its directly or indirectly owned stock in an SFC to persons that are not Sec. 245A shareholders, and (2) no related person is a Sec. 245A shareholder of the SFC after the transfer. In addition, the final regulations expand the successor rules for nonrecognition transactions, including certain Sec. 355 distributions, triangular asset reorganizations, and restructuring transactions described in Regs. Sec. 1.1248-8(a)(1). To address perceived abuses around issuances of SFC stock, the final regulations treat related domestic corporations (within the meaning of Sec. 267(b) or 707(b)) as a single domestic corporation for purposes of determining the extent to which a dividend is an extraordinary disposition amount or a tiered extraordinary disposition amount.

Extraordinary reductions

The final regulations continue to deny 100% of the Sec. 245A DRD for certain dividends paid in a tax year in which an extraordinary reduction occurs. An extraordinary reduction is a transaction in which either (1) a "controlling Sec. 245A shareholder" transfers more than 10% (by value) of its CFC stock (at least 5% of total CFC stock) or (2) the controlling Sec. 245A shareholder's overall ownership of the CFC changes more than 10% (by value) and at least 5 percentage points. A controlling Sec. 245A shareholder is a CFC shareholder that owns more than 50% of the CFC's stock, including through attribution.

The Sec. 245A DRD is denied to the extent that (1) the shareholder would have included Subpart F income or tested income had the transfer or other reduction in ownership not occurred (the U.S. shareholder's pre-reduction pro rata share), and (2) a different U.S. person who is a U.S. shareholder after the transfer does not take the amounts into account (the extraordinary reduction amount).

Election to close the CFC's tax year

The final regulations continue to provide an election for extraordinary reductions under which (1) the relevant CFC's tax year closes as of the extraordinary reduction's end date, and (2) the extraordinary reduction amount equals zero. Generally, this permits taxpayers to convert dividend income that is fully taxable by reason of the extraordinary-reduction rule into GILTI or Subpart F income, thereby allowing foreign tax credits and the Sec. 250 deduction.

The Sec. 245A shareholder must make the election with its tax return for the applicable tax year. The final regulations confirm that the election is bilateral; it must be made by both seller and buyer Sec. 245A shareholders. Before the election is made, each controlling Sec. 245A shareholder participating in the extraordinary reduction with an extraordinary reduction amount greater than zero, and each U.S. tax resident that is a U.S. shareholder of the CFC at the end of the day of the extraordinary reduction (including a person that becomes a U.S. shareholder of the CFC by reason of the extraordinary reduction), must enter into a binding agreement to close the CFC's tax year.

Denial of exclusion for related CFCs

The final regulations continue to deny the Sec. 954(c)(6) exception, in whole or in part, if a lower-tier CFC distributes a dividend to an upper-tier CFC and that distribution is attributable to a "tiered" extraordinary disposition amount or a "tiered" extraordinary reduction with respect to the lower-tier CFC.

Anti-abuse rule

The final regulations retain the general anti-abuse rule but modify it to be self-executing (as opposed to applying at the commissioner's discretion). As before, the anti-abuse rule provides for appropriate adjustments, including adjustments that would disregard a transaction or arrangement, if the taxpayer engages in the transaction or arrangement with a principal purpose of avoiding the purposes of the final regulations.

The final regulations include several new examples illustrating the application of the anti-abuse rule. In one of these examples, a CFC prepaid a royalty obligation to another related CFC during the GILTI gap period. Because a principal purpose of prepaying the royalty was to generate E&P during the GILTI gap period, the example concludes that the E&P amount is treated as extraordinary disposition E&P.

This example expands the scope of the extraordinary-disposition rules to transactions that do not involve "dispositions" of property. In this regard, the example is similar to Prop. Regs. Sec. 1.951A-2(c)(6), which would expand the disqualified-basis rule in the GILTI regulations to include "disqualified payments."

Applicability dates

The final regulations apply to tax periods ending on or after June 14, 2019, while Temp. Regs. Sec. 1.245A-5T continues to apply to distributions made after Dec. 31, 2017, to which the final regulations do not apply. Taxpayers may apply the final regulations retroactively, provided that they and all related parties apply them consistently.


Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C..

For additional information about these items, contact Ms. Grais at 202-327-8788 or

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.

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