Proposed regulations address CFC pro-rata share rules in consolidated groups

December 2022

In brief

Treasury and the IRS on December 9 released proposed regulations (REG-113839-22) that would amend the regulations under Section 1502 to treat members of a consolidated group as a single US shareholder when ownership of CFC stock changes among group members during a tax year and a CFC makes a distribution described in Section 959(b). The regulations affect the determination of a US shareholder’s pro rata share of subpart F income or tested income with regard to the entire group’s stock ownership for purposes of Section 951(a)(2)(B).

The proposed regulations would treat all members of the consolidated group as a single US shareholder for purposes of Section 951(a)(2)(B). The preamble states that this rule would clearly reflect the US tax liability of the consolidated group and prevent avoidance of tax liability with respect to a CFC. 

The proposed regulations would apply to tax years for which the original consolidated federal income tax return is due (without extensions) after the date final regulations are published in the Federal Register. Thus, if the proposed regulations are published as final in the Federal Register before April 15, 2023, they would apply to consolidated tax years ending on or after December 31, 2022.

Observation: When finalized, these regulations could impact transactions that occurred during 2022 prior to the date on which the proposed regulations were issued.

In detail

Sections 951(a)(2)(B), 951A(a), and 959(b)

Section 951(a)(1) generally requires a US shareholder of a controlled foreign corporation (CFC) to include in gross income its pro rata share of subpart F income of the CFC if the shareholder owns stock on the last day of the corporation’s tax year in which it was a CFC. The pro rata share is determined by reference to a hypothetical distribution of the gross income of the corporation as if the corporation distributed all of its earnings each year. Section 951(a)(2)(B) provides for a reduction to a US shareholder’s pro rata share of subpart F income by the amount of dividends made by a CFC to another person, but the reduction is limited to a pro rata amount that corresponds to the portion of the year that the shareholder did not own the stock.

The calculation of a US shareholder’s GILTI inclusion is determined under Section 951A(a) in the same manner as the US shareholder’s pro rata share of a CFC’s subpart F income, with some modifications. Under Section 959(b), the earnings and profits associated with a distribution by a lower-tier CFC representing income that previously was taxed, although a dividend, is not again included in gross income of the recipient CFC.


Subpart F, enacted as part of the Revenue Act of 1962, is an anti-deferral regime designed to discourage passive activity in foreign jurisdictions by preventing US taxpayers from shifting highly mobile income to low-taxed jurisdictions. Section 951(a) generally requires a US shareholder to include earnings and profits attributable to Subpart F income of a CFC on a current basis by reference to a hypothetical distribution of a CFC's earnings. Section 951(a)(2)(B) provides for adjustments that limit the earnings to an amount that takes into account earnings related to a prior owner's holding period that were distributed as a dividend during the relevant year to the other shareholder.

More than 50 years later, with the enactment of the Tax Cuts and Jobs Act of 2017, Congress added to the Internal Revenue Code the global intangible low-taxed income regime (GILTI). The GILTI rules are an anti-base-erosion measure intended to discourage US taxpayers from shifting profits from the United States to low-tax or no-tax foreign jurisdictions. The participation exemption under Section 245A — introduced as part of the 2017 Act alongside the repeal of the indirect foreign tax credit with respect to dividends under Section 902 — allows US shareholders of CFCs to receive a 100% dividends-received deduction on the foreign-source portion of dividends received from specified 10% foreign corporations, subject to a one-year holding period requirement. Amounts from certain types of transactions, such as gain from the sale of CFC stock or gain from the sale of a CFC in a multi-tiered corporate structure, are included in income as dividends under the tax code and may qualify for the dividends-received deduction. 

On June 18, 2019, Treasury and the IRS published temporary regulations aimed at preserving the ‘structure of the statutory scheme’ with respect to subpart F, GILTI, and Section 245A. Reg. sec. 1.245A-5 limits the participation exemption for dividends from earnings attributable to an extraordinary disposition, which otherwise would lead to potential tax-free repatriation of earnings that may not previously have been subject to US taxation. 

In the notice of final temporary rulemaking prescribing Temp. Reg. sec. 1.245A-5, Treasury and the IRS emphasized that “[t]he transition tax, the subpart F and GILTI regimes, and the participation exemption under Section 245A together form a comprehensive and closely integrated set of tax rules with respect to the earnings of foreign corporations with requisite levels of U.S. ownership. These related provisions must be read and interpreted together in order to ensure that each provision functions as part of a coherent whole, as intended.” 

Reg. sec. 1.245A-5 also contains rules relating to extraordinary reduction transactions that implicated the pro rata share reduction rule under Section 951(a)(2)(B). The regulations thus prevent US shareholders from claiming dividends-received deductions under Section 245A(a) (or exemptions from subpart F income under the dividend look-through rules of Section 954(c)(6)) for dividends that reduce a US shareholder’s pro rata share of subpart F income or tested income of a CFC through dividends.

Proposed regulations

The new proposed regulations would amend Reg. sec. 1.1502-80 to modify the application of Sections 951(a)(2)(B), 951A(a), and 959(b). Specifically, Prop. Reg. sec. 1.1502-80(j) addresses the outcomes claimed under the foregoing provisions and would require the US tax liability of consolidated groups to be determined by treating all group members as a single US shareholder for purposes of analyzing a Section 959(b) distribution under Section 951(a)(2)(B). 

The proposed regulations note that, in addition to the proposed regulations, other authorities or common-law doctrines may apply to recast a transaction or otherwise affect the tax treatment of a transaction. 

A distribution that is a dividend from a lower-tier CFC to an upper-tier CFC is excluded from subpart F income and tested income by reason of Section 959(b), and under the proposed regulations any subsequent transfer of stock ownership within the consolidated group would not result in the new owner reducing its pro rata share of the CFC’s subpart F income or tested income. This would occur because the new owner would be treated as the same shareholder as the original owner for purposes of applying Section 951(a)(2)(B), such that the second owner would be treated as owning the CFC stock for the entire ownership period. Thus, the US shareholder’s pro rata share of a distributing CFC’s subpart F and tested income would not be reduced by reason of a Section 959(b) distribution. Accordingly, the aggregate inclusion amount with respect to a CFC would not change when a different group member owns the stock on the last day of the tax year. 

Observation:  Treasury and the IRS have taken a targeted approach in addressing their concerns with the interaction of Section 959(b) and the pro-rata share rules under Section 951(a)(2)(B). The proposed regulations would apply to transactions involving the interaction of Sections 959(b) and 951(a)(2)(B) in the consolidated group setting. The preamble to the proposed regulations notes that Treasury and the IRS are continuing to study the interaction of Sections 951(a)(2)(B) and 959(b), and may issue additional guidance relating to those provisions, including guidance to prevent abuse. The preamble notes that such guidance may be retroactive.

Observation:  The proposed regulations would not extend the single-shareholder approach under Section 951(a)(2) to other contexts. For example, when there is a transfer of direct or indirect ownership of a CFC, there have been questions about the extent to which a US shareholder can claim the benefits of a tested loss of the CFC attributable to the pre-ownership change period. Extending the single-shareholder approach to tested losses would address this concern.

Observation:  The preamble to the proposed regulations mentions that no inference should be made with respect to the application of the intercompany transaction rules of Reg. sec. 1.1502-13 to transfers of CFCs between members of a consolidated group. Thus, even prior to the effective date of final regulations, taxpayers should consider whether the intercompany transaction rules could impact the application of Section 951(a)(2)(B) when an intercompany transfer of CFC stock is preceded by a Section 959(b) distribution.

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Ed Geils

Ed Geils

Global and US Tax Knowledge Management Leader, PwC US

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