Freeman Law frequently advises international business ventures. International operations often give rise to unique (and sometimes unanticipated) compliance obligations and complex reporting requirements. Recent tax reform rules and regulations have imposed a number of new requirements. The IRS and Treasury Department have elaborated on these new rules through proposed regulations and other guidance. This post provides a short introduction to the TCJA’s changes to the definition of U.S. shareholder, a definition that impacts Subpart F taxation, GILTI taxation, and the section 965 transition tax, among other provisions.
The definition of U.S. shareholder affects multinational corporations and their shareholders. The TCJA’s amendments to the definition of U.S. shareholder, which effectively change important stock attribution rules, can, in some circumstances, expand the reach of the section 965 transition tax, as certain amendments were given retroactive effect.
Before the TCJA, section 951(b) defined a U.S. shareholder of a foreign corporation as a United States person (“U.S. person”) that holds at least 10 percent of the total combined voting power of all classes of stock entitled to vote in a foreign corporation. Prior to the TCJA, the application of this definition was limited to Subpart F of subtitle A, chapter 1, subchapter N, part III of the Internal Revenue Code. The definition was determined exclusively by looking to voting power.
The TCJA amended this definition, however, to also include a U.S. person that holds at least 10 percent of the total value of shares of all classes of stock of the foreign corporation. The amendment also eliminated the requirement that a foreign corporation be a CFC for an uninterrupted period of 30 days or more in order to give rise to an inclusion under section 951(a)(1) (the “30-day requirement”).
The Impact on the Definition of a CFC
Section 957 defines a Controlled Foreign Corporation as a foreign corporation that is more than 50% owned (directly, indirectly or constructively) by U.S. persons who are U.S. shareholders. Section 951(b) defines a U.S. shareholder as a U.S. person who owns (directly, indirectly, or constructively) 10% of a voting stock or (as added under the TCJA) 10% of the total value of shares of a foreign corporation. This expanded definition is effective for tax years of foreign corporations beginning after December 31, 2017.
Section 958(b) provides that, with certain exceptions and modifications, the section 318(a) constructive ownership rules apply to determine whether a foreign corporation is a CFC and whether a U.S. person is a “U.S. shareholder” under section 951(b). Notably, under the TCJA, section 958(b)(4) was repealed in order to allow attribution of stock from a non-U.S. person to a U.S. person. This amendment—which represents a major change—was made effective retroactively, effective the first day of the last tax year that began before January 1, 2018.
While the change impacts which taxpayers fall under the definition of “U.S. shareholder” and which foreign corporations are treated as CFC’s, the new attribution rule does not necessarily cause the CFC’s foreign earnings to be taxed to a U.S. shareholder. Section 951(a)(2) still provides that a U.S. shareholder is only required to include in gross income its share of the CFC’s Subpart F income to the extent that it directly or indirectly owns stock in the CFC (leaving out constructive ownership).
Taxpayers should be aware that section 6038 of the Internal Revenue Code and Treasury regulations may impose Form 5471 reporting obligations on U.S. persons with interests in a CFC or other foreign corporations. Taxpayers that fail to comply with these reporting obligations may face penalties monetary penalties of $10,000 per form, as well as an extended statute of limitations pursuant to section 6501(c)(8)(A). Taxpayers with interests in foreign corporations may also have other or separate reporting obligations, such as Form 8938, 8621 or other forms.