patrickbland, jd, mba, llm

Earnings Invested in “U.S. Property” – §956

• Generally—

1. Impact of 956—if any CFC loaned its acc earnings that were not SubF income to its US SH, effective repatriation of the earnings to the US had occurred, and consequently, the transaction should be treated as a constructive dividend.

• Underlying theory – because the US SH had use of the money loaned to it, it could reasonably be treated as if it had received the funds as a dividend even though it had an unconditional obligation to replay the principal of the loan. Also note, this result is obtained if the earnings of the CFC were used to buy stock of the US SH.
• Constructive Dividend Treatment—§956’s sweep is far broader than the treat of loans to, and equity investments in, the US shareholder as constructive dividends. Indeed, constructive dividend treatment under §951(a)(1)(B) and §956 extends to a broad range of investments in “U.S. Property” by the CFC that may represent no benefit to the US SH.
• Basic thrust of §956 is clear, mechanics are complex.
  
  
• Example: One 1/1/x1, DC, a US corp, formed a wholly owned foreign sub, FC, which is a CFC. FC engaged in a foreign business that generated $100k of net income during last year (its first year of operation), none of which was SubF income w/in the meaning of §952. One 2/1/x1, FC made a bona fide loan of $10k to DC and such loan remained outstanding at the end of year 1. The loan from FC to DC is treated as investment of FC’s earnings in US property (w/in the meaning of §956(c)(1)(C) and (c)(2)). Consequently, under §951(a)(1)(B) and §956, DC must include $10k in gross income as if FC had distributed that amount to DC as a constructive dividend. The same result would obtain if, on 2/1/x1, FC had paid $10k to purchase stock in DC. See §956(c)(1)(B) and 956(c)(2).
  
  

1. Amount Includible in U.S. SH’s income as a result of CFC’s investment in U.S. property §956(a)—LESSER OF:

• (1) The excess (if any) of
  • (i) the US SH’s pro rata share of average amounts of U.S. property held directly or indirectly by the CFC as of the close of each quarter of the taxable year, OVER
  • (ii) the amount of E&P attributable to amounts that previously resulted in an inclusion for investment of earnings in U.S. Property (or that would have if they ahd not been previously taxed as SubF income) w/r/t the US SH
  • OR
  • (2) the US Sh’s pro rata share of the “applicable earnings” of the CFC.
    
    

1. Determination Date—a CFC must determine the amount invested in US Property based on the average at the END OF EACH QUARTER. As a result, it has become more difficult to arrange short-term financing on U.S. activities from a CFC without generating Subpart F constructive dividends.

• Special Rules –

1. “Applicable Earnings” §956(b)(1)—SUM OF:

• = (1) E&P accumulated in prior tax years + (2) E&P for current tax year.
  • This amt is REDUCED by (1) distributions made during the year; and (2) accumulated E&P previously included in the gross income of US SHs on account of investments of the earnings in US Property

1. Special Rules—§956(b)(2); §956(b)(3)

• §956(b)(2)—“U.S. Property” Acquired BEFORE the 1^st Day the Corporation became a CFC—US Property items are disregarded in determining the investment of earnings in U.S. property.
  • LIMITATION: Total amt of property disregarded MAY NOT EXCEED the portion of the applicable earnings of the CFC accumulated during periods before that first day.
  • §956(b)93)—Special rule if Corporation ceases to be a CFC

1. Prevent Double Taxation—an amount of earnings invested in US Property is NOT taxable under §951(a)(1)(B) and §956 to the extent that it is attributable to E&P previously taxed under SubF. See §959(a).

• “U.S. Property”—956(c)

1. laundry list in 956(c)(1) with exceptions from “U.S. Property” in 956(c)(2)
2. ISSUE: what constitutes a “Bank?”—the 2004 JOBS Act clarified and narrowed the definition of banking business for purposes of §956(c)(2)(A). See 956(c)(2)(A).

• Treatment of Pledges and Guarantees by CFC and for Pledges of Stock by U.S. Shareholders—§956(d)

1. §956(d) may treat a CFC as holding the obligation of a US person if the corporation is a pledgor or guarantor of the obligation.
2. The government has attempted to use §956(d) to treat a CFC as owning an obligation of its US Shareholder if the US SH pledges stock possessing a significant portion of the total voting power of the corporation as security for the obligation and if certain other circumstances are present.
3. See §1.956-2 – Definition of United States Property—

• (c) Treatment of Pledges and Guarantees—
  • (1) General Rule
  • (2) Indirect pledge or guarantee
  • Indirect Ownership of U.S. Property Through a PARTNERSHIP—

1. ISSUE: How does 956 apply when a CFC is a partner in a partnership which owns property that would constitute U.S. property if held directly by the CFC?
2. See Rev Rule 90-112 (p. 545 of textbook)

• ISSUE: Does a CFC hold “U.S. Property” w/in the meaning of §956 when it is a partner in a partnership that owns real property located in the United States?
• HOLDING: Real property located in the U.S. that is owned by a partnership in which a CFC is a partner CONSTITUTES “U.S. Property” held by the CFC for purposes of §956(c).