Earlier today, the I.R.S. proposed regulations affecting a controlled foreign corporation (“C.F.C.”) and its U.S. Shareholders, as defined, when the C.F.C. makes an investment in U.S. Property.

A typical fact pattern that results in an investment in U.S. Property involves a C.F.C. that makes a loan to its U.S. Shareholder. This investment is taxable under Code §956, as if a dividend of a similar amount were paid. The purpose of the provision is to prevent tax avoidance by U.S. Shareholders merely by switching taxable dividends to tax-free loans.

Now that a U.S. corporation holding 10% of the shares of a foreign corporation can receive tax-free dividends by reason of the 100% dividends received deduction, the I.R.S. has determined that Code §956 should not be applied where a dividend would not be taxed.

Code §956 will continue to apply without modification to a U.S. Shareholder other than a corporation, such as an individuals or a trust, to ensure that an amount received from a C.F.C. that is substantially equivalent to a dividend will be treated in a manner that is similar to the receipt of an actual dividend. Thus, when a U.S. Shareholder is an individual, the imposition of tax under Code §956 will continue to apply. An election under Code §962 by an individual to be treated as a corporation for purposes of Subpart F Income will not prevent tax from being imposed under Code §956.

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