Locke Lord QuickStudy: IRS Issues Proposed Regulations under Section 956, Potentially Impacting Certain Multinational Debt Structures

As a part of the recent Tax Cuts and Jobs Act, Congress enacted new Section 245A of the Code, which generally permits U.S. corporations owning 10% or more of a foreign corporation to take a 100% dividends received deduction on foreign-sourced dividends received from such subsidiaries. Section 245A includes a number of other requirements for and exceptions to its application. Following the enactment of Section 245A, questions developed regarding the continuing appropriateness of Section 956 and its broad deemed-dividend approach.

While clearly a reply to these concerns, it is important to note that the proposed regulations are not a repeal of Section 956. Rather, the perceived overly-broad application of Section 956, to the extent disruptive of the desired parity between actual and deemed dividends, is more precisely targeted by these regulations. To achieve the desired result, the proposed regulations provide that the amount otherwise determined under Section 956 is reduced to the extent that an actual dividend of the same amount would result in a Section 245A deduction. Section 956 will thus continue to apply without modification in instances where a Section 245A deduction would not be available.

The proposed regulations do not take effect until they are finalized; however, taxpayers may rely on the proposed regulations for tax years beginning before the date the regulations are so finalized and after December 31, 2017. 

The proposed regulations may provide U.S. corporate borrowers and their lenders with additional flexibility in structuring collateral and guarantee arrangements by allowing them to provide for the grant of a security interest in all assets of CFCs, a pledge of 100% of the voting stock of CFCs, or CFC guarantees without triggering an additional tax under Section 956. Importantly, however, these regulations fully incorporate the limitations applicable to the Section 245A provisions, which could limit or eliminate the effect of the changes made by the proposed regulations (including limitations requiring certain holding periods pertinent to the ownership by the US parent of foreign subsidiary stock). Thus, the potential impact of the proposed regulations to a particular borrower or transaction will ultimately turn on the borrower group’s eligibility for the Section 245A dividends received deduction under the applicable facts (some of which might not be known at the time of the lending).

In addition, because the regulations are only in proposed form, and taxpayers are permitted by the regulations to rely on them only for years beginning before the regulations are finalized, potential future changes to these regulations should be considered before committing to long-term arrangements relying on their terms. Borrowers and lenders considering implementing lending arrangements without imposing the CFC limitations (or considering revising existing lending arrangements to eliminate the CFC limitations) should carefully consider the impact under the proposed regulations of the specific Section 245A requirements and exceptions as applied to the borrower group, as well as the potential for future revisions to such regulations. In addition, borrowers under current agreements that provide that the CFC limitations would be imposed only to the extent that they create adverse tax consequences should review the impact of the proposed regulations to determine whether the new rules eliminate any such adverse tax consequences, and thus give rise to the need to provide additional security and guarantees under the agreement.

As always, non-tax limitations, including local-law issues and costs in obtaining effective guarantees or collateral, should also be considered. Obtaining enforceable guarantees and security interests under foreign laws necessitates retaining foreign counsel and in many jurisdictions the remedies available to a secured lender are less advantageous than those available under U.S. laws.