Final Section 956 Regulations Follow Approach of Proposed Regulations—with Two Helpful Modifications

June 14, 2019

Final regulations applicable to controlled foreign corporations and their US shareholders, issued by the US Treasury under Code Section 956, generally follow previously proposed regulations but introduce two modifications: a new earnings and profits ordering rule and a rule regarding the treatment of domestic partnerships with corporate partners.

The US Department of Treasury released final regulations (the Final Regulations) under Section 956 of the Internal Revenue Code of 1986, as amended, on May 22. The Final Regulations generally follow the approach taken in the proposed regulations (the Proposed Regulations) that were published on November 5, 2018.

The Proposed Regulations provided that the amount of a Section 956 deemed income inclusion that would otherwise be taken into account by a corporate US parent of a controlled foreign corporation (CFC) subsidiary will be reduced by the amount of the dividends received reduction that would be available to the corporate US parent under Section 245A if the earnings that would be included under Section 956 were instead actually distributed by the CFC as a dividend. In a prior LawFlash, we discussed the operation of this basic rule, as well as limitations on its applicability. As a general matter, the Final Regulations should continue to have the impact on typical financing transactions that we discussed in our prior LawFlash (subject to the limitations noted therein).

While the Final Regulations generally follow the Proposed Regulations, they introduce two helpful modifications.

Earnings and Profits Ordering Rule

Commentary to the Proposed Regulations pointed out that due to the operation of the ordering rules in Section 959(c), the hypothetical distribution contemplated by the Proposed Regulations would have been allocated first to any prior year earnings and profits that were attributable to previously taxed income related to prior Section 956 inclusions (thereby leading to a lower hypothetical Section 245A dividends received deduction). As a result of the interaction of this ordering rule with the basic computational mechanism in the Proposed Regulations, the hypothetical distribution might not result in a reduction of the otherwise includible Section 956 amount. The Final Regulations address this technical issue by including a special ordering rule that allocates the hypothetical distribution first to earnings and profits attributable to previously taxed Subpart F income and then to untaxed earnings and profits. The impact of this special ordering rule is to maximize the reduction of the otherwise includible Section 956 amount.

Treatment of Domestic Partnerships with Corporate Partners

As we noted in our prior LawFlash, the IRS had requested comments concerning how the Proposed Regulations should apply to US shareholders of CFCs that are domestic partnerships and that have a combination of domestic corporations and other persons as partners. In the case of a domestic partnership, the Final Regulations look to the aggregate amount of Section 245A dividends received deductions that domestic corporate partners in that partnership (including indirect domestic corporate partners through a chain of upper-tier partnerships) would be allowed with respect to their share of the hypothetical distribution received by the domestic partnership. The domestic partnership may reduce its Section 956 inclusion by that aggregate amount of Section 245A dividends received deductions that would be allowed to the direct and indirect domestic corporate partners. The amount of the remaining Section 956 inclusion, after giving effect to such reduction, is allocated among the partners in proportion to the respective amounts of income that they would be required to include as a result of the hypothetical distribution (after reduction for any Section 245A dividends received deductions allowable to them).

Effective Date

The Final Regulations apply to taxable years of a CFC beginning on or after July 22, 2019, and to taxable years of a US shareholder in which or with which such CFC taxable years end. A taxpayer may choose to apply the Final Regulations to such tax years beginning after December 31, 2017, so long as the taxpayer and US persons related to the taxpayer apply the Final Regulations to all CFCs of which they are US shareholders for taxable years of the CFCs beginning after December 31, 2017.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Daniel A. Nelson

Mike Liu
Josh Richardson

New York
Kenneth S. Kail
Richard S. Zarin

San Francisco
Barton W.S. Bassett
Greg Hartker

Washington, DC
Scott Farmer