IRS and Department of Treasury Issue Regulations on Controlled Foreign Corporations

On November 2nd, 2016, the Internal Revenue Service and the U.S. Department of the Treasury finalized regulations on properties owned by foreign controlled corporations and foreign partnerships in order to cut down on tax avoidance. A final subpart F regulation addressed sections 954 and 956.

A controlled foreign corporation is a corporate entity that is registered and conducts business in a different place then the residency of the controlling shareholders. These corporations are majority-owned by U.S. shareholders.

This new regulation stems from the temporary rule passed on September 1st, 2015. The final subpart F regulation makes it difficult for foreign corporate and partnership structures, which own U.S. property to avoid paying taxes.

According to the IRS, foreign companies were created to evade tax laws, treating the property as an indirect U.S. investment. The permanent regulation expands the rules to include foreign partnerships controlled by such corporations, based on an IRS memorandum. Before this final ruling came in to effect, foreign partnerships were not subject to rules and laws that made it necessary for them to pay taxes.

The permanent changes to law Section 956 of the Internal Revenue Code, deals with taxes on controlled foreign subsidiaries of U.S. corporations. In recent years, the IRS found the past ruling, prior to 2015, only applied to enterprises funded through capital contributions or debt. The IRS felt it gave way to tax avoidance schemes by U.S. taxpayers.

The IRS memorandum writes of a bigger issue of tax avoidance from entities. The IRS and the Treasury Department believe that the anti-avoidance rule should not be limited to fundings by debt or equity but should apply to all fundings whose main purpose is to avoid the new rulings written in section 956.

U.S. tax law implemented in the 1960’s made provisions to prevent U.S. residents from using controlled foreign corporations to avoid taxes on U.S. investments. Prior to 2015, it did not extend to investments by partnerships backed by controlled foreign corporations. Controlled foreign corporations have used partnerships as a proxy to invest in U.S. assets, based on the memorandum.

Regulations from the 2015 rule assign property ownership to controlled foreign corporations based on their liquidation value percentage in a partnership that invest in U.S. property.

The regulations set forth on Wednesday, set the rules for obligations, pledges and securities exchange between U.S. residents and controlled foreign corporations, which were first set in 1988.

Link to US tax code § 956.

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Maria Moller