Home > News & Seminars > Articles & Alerts > 2007 Articles & Alerts > Earnings and Profits Attributable to CFC Stock
Originally published in Canadian Tax Highlights, Volume 15, Number 8, August 2007. Reprinted with permission.
IRS final regs of July 27, 2007 under Code section 1248 provide guidance for determining earnings and profits (E & P) attributable to the stock of a controlled foreign corporation (CFC) in certain non-recognition transactions, and they clarify the section 1248 treatment of a foreign partnership's sale of CFC stock. The final regs modify somewhat the proposed regs of June 2, 2006 and are generally effective after July 29, 2007.
A foreign corporation is a CFC if US shareholders own more than 50 percent of the stock's votes or value on any day during the corporation's tax year. A US shareholder is a US person that owns--directly, indirectly, or by attribution--at least 10 percent of the forco's total combined voting power. Under Code section 1248, if a US person sells or exchanges CFC stock, the gain is generally recharacterized as a dividend if the person owns at least 10 percent of the forco's combined voting power at any time when forco was a CFC during the five years ending on the date of sale. Under Code section 964(e)(1), a CFC that sells or exchanges forco stock must generally recognize any gain as a dividend as it would under section 1248(a) if it were a US person.
The final regs clarify (where the proposed regs did not) the attribution of E & P to non-exchanging shareholders in certain non-recognition transactions. Language from the proposed regs' preamble is incorporated into the final regs: generally, the E & P attributable to an acquiring corporation's stock held by a non-exchanging shareholder immediately before a restructuring transaction will continue to be attributable to the stock, but E & P attributable to the acquired corporation's stock and accumulated before the restructuring will not be attributed to the non-exchanging shareholder's stock in the acquiring corporation.
The proposed regs treated a foreign partnership's sale or exchange of CFC stock as a sale or exchange by the partners of their proportionate share of the stock, and applied Code section 1248(a) to tiers of foreign partnerships; however, it was unclear whether section 1248 applied to a partner's sale of its interest in a partnership that held corporate stock. The final regs clarify that section 1248 does not apply: the sale or exchange of the partnership interest generates ordinary income under Code sections 751(a) and 751(c) if attributable to stock in a forco described in section 1248, and thus the operation of section 1248 is pre-empted (section 1248(g)(2)(B)). The final regs thus clarify that a foreign partnership is treated as an aggregate only when it sells or exchanges corporate stock (Treas. reg. section 1.1248-1(a)(4)); a partner may apply that aggregate rule to open years, provided that it does so consistently in all such years, by treating its distributive share of gain attributable to a sale of CFC shares as recognized on the sale or exchange of a forco's stock under section 1248(a).
The final regs also clarify the application of Treas. reg. section 1.1248-8: the CFC definition now includes a corporation described in either Code section 953(c)(1)(B) (certain captive insurance companies) or Code section 957. A new example in Treas. reg. section 1.367(b)-4(d) clarifies that E & P attributable to certain lower-tier subs are not taken into account in determining the E & P attributable to transactions described in Treas. reg. section 1.367(b)-3--for example, when a USco acquires a Canco's assets in a section 332 liquidation or an asset acquisition under section 368(a)(1).
The final regulations provide needed clarification for some tax consequences under Code sections 1248 and 367 that may affect a US shareholder that sells its stock in a Canco CFC or engages in certain non-recognition transactions involving the CFC. A US partner in a Canadian partnership that sells a CFC interest (held directly or through tiers of partnerships) may also be affected.
Hodgson Russ LLP, Buffalo