IRS Chief Counsel memo denies dividends-received deduction for CFCs

In brief

What happened?

The IRS on September 6 published memorandum 202436010 (the Memo) from the IRS Office of Chief Counsel, dated July 31, 2024, which addresses the application of Section 245A(a) to dividends received by a controlled foreign corporation (CFC).  

Why is it relevant?

The Memo argues that Section 245A(a) does not allow a deduction to a foreign corporation that receives a dividend from another foreign corporation, noting that the text of Section 245A(a) explicitly requires the recipient of the dividend to be a domestic corporation that is a United States shareholder. The Memo emphasizes that the statutory language of Section 245A(a) is clear and unambiguous in requiring that the recipient of the dividend be a domestic corporation and that taxpayers should avoid interpretations that render any part of the statute unnecessary.  

The Memo expresses the position of the IRS with respect to the application of Section 245A(a). The advice is not binding on taxpayers and may not be used or cited as precedent. 

Actions to consider

Taxpayers who own minority positions in non-CFC foreign corporations through a CFC and who have relied on the Section 245A(a) deduction with respect to dividends should expect challenges from the IRS. These taxpayers should consider their options, including potentially restructuring their investments in order to avoid the issue raised in the Memo.  

Legislative History 

Conference Report and footnote 1486 

The Memo explores the legislative history of the Tax Cuts and Jobs Act (TJCA) and its conference report (Conference Report). The Conference Report states, in footnote 1486, that a domestic corporation for purposes of Section 245A includes a CFC treated as a domestic corporation for purposes of calculating its taxable income citing to Reg. 1.952-2(b)(1). Specifically, footnote 1486 provides the following clarity on Congress’s intended interpretation of the term “domestic corporation”: “Including a [CFC] treated as a domestic corporation for purposes of computing the taxable income thereof. See Reg. 1.952- 2(b)(1). Therefore, a CFC receiving a dividend from a 10-percent owned foreign corporation that constitutes subpart F income may be eligible for the DRD with respect to such income." The Memo states that footnote 1486 does not alter its conclusion that Section 245A is not available in the case of dividends received by a CFC, asserting instead that the statute's plain language should be followed. 

Observation: The IRS asserts in the Memo that statutory 'plain meaning' must control, notwithstanding its own regulation providing for a different result, legislative history indicating that Congress intended that different result, a regulatory grant in Section 245A(g), strong policy considerations, and the overall statutory framework. It is difficult to reconcile the analysis in the Memo with the arguments put forth by the IRS in Varian Medical Systems Inc. and Subsidiaries v. Commissioner, 163 T.C. No. 4, in which the IRS asserted that the plain meaning of the statute should not control because it was inconsistent with Congressional intent and the overall purpose of the statute.  

Observation: Congress does not often cross-reference a Treasury Regulation when enacting legislation, but such instances have occurred in the past. Moreover, Congress is presumed to know the law, including the regulations promulgated by the Department of Treasury under its delegated authority and having the force of law (see United States v. Bailey, 34 U.S. 238 (1835)). Indeed, the statement provided for in footnote 1486 merely confirms that the relevant analysis as to whether a CFC should receive a Section 245A DRD when a dividend is received from another CFC or, in this case, a non-CFC SFC, commences with an examination of Section 954(b)(5), which permits deductions in arriving at a CFC’s subpart F income (as Treasury and the IRS have interpreted under Reg. 1.952-2(b) and -2(c) to be done as if the CFC is a domestic corporation).

The Memo further examines footnote 1486’s citation to Reg. 1.952-2(b)(1) in support of the assertion that a CFC is allowed a Section 245A DRD for purposes of determining subpart F income. The Memo provides that while Reg. 1.952-2(a)(1) and (b)(1) treat a foreign corporation as a domestic corporation for calculating gross and taxable income to determine subpart F income, Reg. 1.952-2(b)(1) does not permit a foreign corporation to claim the Section 245A DRD, as it cannot change the requirement that the recipient must be a domestic corporation and a United States shareholder. The Memo emphasizes that the special rules in Reg. 1.952-2(c)(1) provide that the CFC is not treated as a United States shareholder because subchapter N, which includes the definition of a United States shareholder, does not apply for purposes of the regulation unless explicitly stated. Therefore, the IRS concludes that even if the CFC were treated as a domestic corporation under the regulations, the CFC would not meet the requirement in Section 245A(a) to also be a United States shareholder. 

Observation: As noted, the Memo is not binding on taxpayers and may not be used or cited as precedent. Taxpayers should consider the analysis in the Memo, as well as the relevant statutory language and legislative history, in determining the potential applicability of Section 245A at the CFC level, bearing in mind that the IRS may choose to challenge taxpayer approaches that are at odds with the analysis in the Memo.  

While the IRS may disagree with Congress’ interpretation of Reg. 1.952-2(b), it nevertheless appears clear, given the inclusion of footnote 1486 in the Conference Report, that Congress intended that CFCs should be allowed a Section 245A DRD on dividends from SFCs in the same manner as if the CFC is a domestic corporation. This is consistent with the broader policy framework of the TCJA, which allows a Section 245A DRD for dividends received directly from SFCs (not only CFCs, as was the case with prior legislative proposals), and which allows the Section 245A DRD as the sole mechanism of mitigating double taxation on the distributed earnings (in lieu of former Section 902).