A New Wrinkle in the U.S. Branch Versus Subsidiary Discussion
One of the many challenges our clients have been facing under the Tax Cuts & Jobs Act (the Act) has been evaluating their structures to determine the impact of revised attribution rules for the purpose of determining whether Controlled Foreign Corporation (CFCs) exist in their structure. By removing Internal Revenue Code Section 958(b)(4), the Act now requires “downward attribution” for the purpose of determining CFC status. In short, downward attribution causes shares of a foreign corporation that are actually owned by a non-U.S. person to be treated as constructively owned by a lower-tier U.S. entity (corporation, partnership, trust, or estate). Thus, whatever is owned by an upper-tier non-U.S. person is also deemed to be owned by the U.S. corporation (or certain other U.S. entities) below it.
While reevaluating structures under these rules in a post-Act era can be quite complex, the bottom line in many cases is quite simple. If any foreign person (e.g. a foreign parent company), owns 50 percent or more of the shares of a U.S. corporation (or an interest in a U.S. partnership, trust or estate), that will cause every foreign corporation that is more than 50 percent owned by the foreign person to be treated as a CFC, even though it actually has no U.S. shareholders. For example, imagine a foreign parent in Country X (HoldCo X) owns operating subsidiary corporations in Country Y (OpCo Y), Country Z (OpCo Z), and the United States (OpCo US). Under the old rules, OpCo Y and Z were not CFCs. However, now using downward attribution both entities will fall within the definition of CFCs since OpCo US will be deemed to constructively own OpCo Y and Z.[1]
The conversation on the situation above tends to result in the reaction, “Okay, so who cares?” In many cases, this response is well-merited. Despite the status of CFC, without any direct or indirect U.S. ownership, there are generally no adverse consequences of CFC status. The IRS has even indicated in Notice 2018-13 that it is unlikely CFC informational reporting (e.g., Form 5471) will be required where there is no direct or indirect U.S. shareholder that owns an interest in the CFC. So, in what situations do the new attribution rules really matter?
Perhaps the most dramatic and painful situation is where U.S. person actually owns at least 10 percent, but not more than 50 percent, of a foreign parent company that now owns one or more of these new “surprise CFCs.” While this U.S. person would have previously been outside the realm of the CFC and Subpart F regime, the new downward attribution rules have significantly changed the game, particularly considering the introduction of the Global Intangible Low Taxed Income (GILTI) regime. Layer GILTI in with the historic Subpart F regime, and this U.S. person, now a U.S. shareholder in newly anointed CFCs, may be running for the hills.
Another common problem is where a U.S. subsidiary in a foreign-based group actually owns any shares (50 percent or fewer) in a foreign subsidiary company. Here again, while the lower tier U.S. company would have previously been outside the realm of Subpart F (the U.S. CFC rules), the new downward attribution rules cause the lower tier foreign subsidiaries to be CFCs, requiring the U.S. subsidiary to be taxed on its pro-rata share of any Subpart F or GILTI income of the foreign subsidiaries.
If you’ve made it this far, you are now possibly asking how all this plays into a branch versus subsidiary discussion! While the branch/sub conversation in the past has usually danced around various differences relating to source of income, branch profits tax, and complex home-country and/or interest expense allocations; the new wrinkle is that introducing a U.S. subsidiary corporation in your foreign structure may cause other foreign corporations in the same structure to be treated as CFCs, while a U.S. branch may not.[2] Also, for structures that already have one or more lower-tier U.S. subsidiaries, these new downward attribution rules may make it desirable to convert the U.S. subsidiary(ies) to a U.S. branch. The impact of this decision in certain structures may not be present today (unless U.S. shareholders currently exist), but may have an impact on marketability of shares in the foreign parent company to certain U.S. suitors on a partial or full exit, particularly where the U.S. buyer is not purchasing the majority interest. Choose wisely!
Author: Kenneth Dettman
We’d love to get your thoughts: Is your current structure materially impacted by the new downward attribution rules and, if so, how are you managing the impact? Would your company re-think the branch versus subsidiary discussion in light of these new rules?
Please call or email us and let us know!
[1] Note while this scenario describes a scenario of “wholly-owned” entities, the same may be true in a structure where the U.S. corporation can be attributed greater than 50 percent any foreign entities in such structure.
[2] A U.S. branch is not a “person” for the purpose of defining a U.S. shareholder. This would even include a scenario with a wholly-owned U.S. limited liability company that is treated as a disregarded entity for U.S. tax purposes.
