The IRS issued proposed regulations (REG-114540-18) on Wednesday providing that Sec. 956, which requires an income inclusion by U.S. shareholders of controlled foreign corporations (CFCs) that invest in U.S. property, should not apply to corporate shareholders.

Under the participation exemption system introduced by P.L. 115-97, known as the Tax Cuts and Jobs Act, earnings of a CFC that are repatriated to a corporate U.S. shareholder as a dividend are typically effectively exempt from tax because the shareholder is permitted to take an equal and offsetting dividends-received deduction under Sec. 245A. A corporate U.S. shareholder’s Sec. 956 inclusion is not eligible for the Sec. 245A dividends-received deduction because it is not a dividend. As a result, continuing to have Sec. 956 apply to corporate U.S. shareholders of CFCs that qualify for Sec. 245A deductions would result in actual dividends and amounts that are “substantially the equivalent of a dividend” being treated differently, which the IRS says is at odds with Sec. 956’s manifest purpose.

To treat them similarly, the proposed regulations would provide that the amount otherwise determined under Sec. 956 for a CFC’s tax year is reduced to the extent that the U.S. shareholder would be allowed a Sec. 245A dividends-received deduction if the U.S. shareholder had received a distribution from the CFC in an amount equal to the amount otherwise determined under Sec. 956. The proposed regulations provide special rules for indirect ownership of CFCs.

The IRS noted that individual taxpayers, regulated investment companies, and real estate investment trusts are still subject to Sec. 956 because none of them qualify for the Sec. 245A dividends-received deduction.

These changes are proposed to apply to tax years of a CFC beginning on or after the date they are published as final regulations in the Federal Register, and to tax years of a U.S. shareholder in which or with which such tax years of the CFC end. For tax years of a CFC beginning before the date the regulations are finalized, a taxpayer may rely on the proposed regulations for tax years of a CFC beginning after Dec. 31, 2017, and for tax years of a U.S. shareholder in which or with which such tax years of the CFC end, provided that the taxpayer and U.S. persons that are related (within the meaning of Sec. 267 or 707) to the taxpayer consistently apply the proposed regulations for all CFCs in which they are U.S. shareholders.

The IRS requests comments on the proposed rules within 30 days after they are published in the Federal Register.

— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a Tax Adviser senior editor.