23 June 2025 United States | Senate Finance Committee version of tax reconciliation bill adds new international proposals, modifies other proposals in House-passed bill
On June 16, 2025, the Senate Finance Committee released a draft reconciliation bill containing numerous tax provisions, including extensions of many 2017 Tax Cuts and Jobs Act (TCJA) provisions expiring at the end of 2025. This draft follows the House Bill, which was passed May 22, 2025. While the House Bill did not contain significant changes to the international tax rules (other than proposed Section 899), the Senate Bill makes many notable changes to these international rules. For detailed discussions on the House Bill (along with the House Ways and Means Committee's earlier draft), please refer to Tax Alert 2025-1143, dated May 28, 2025 and Tax Alert 2025-1075, dated May 16, 2025.
The bill would also modify the headings of the GILTI and FDII provisions and, correspondingly, the acronyms by which these regimes are known. GILTI would change to "net CFC tested income" (NCTI); FDII would change to "foreign-derived deduction eligible income" (FDDEI). For ease of discussion, this Alert uses the current-law acronyms. IRC Section 163(j). The Senate Bill would permanently add back depreciation, amortization and depletion when determining (ATI) (i.e., reversion to EBITDA). However, in an unexpected change, all inclusions under subpart F, GILTI or IRC Section 78 would be fully excluded from ATI. In addition, certain capitalized interest expense would be treated as interest expense subject to the IRC Section 163(j) limitation. BEAT. The Senate Bill would increase the BEAT rate from 10% to 14% and would decrease the base erosion percentage threshold from 3% to 2%. It would also add a base erosion payment exception for those payments subject to "sufficient foreign tax." Proposed Section 899. The Senate Bill would significantly modify the House Bill's version of proposed Section 899 by:
Under IRC Section 951A, a US shareholder of a CFC must include GILTI in gross income. GILTI is the excess of a US shareholder's net CFC tested income over its net deemed tangible income return (NDTIR). In determining a CFC's tested income (which is taken into account when computing a US shareholder's net CFC tested income), certain types of income (for instance, income effectively connected with a US trade or business and subpart F income) are excluded. The NDTIR is the excess of 10% of the US shareholder's pro rata share of the QBAI of each CFC, reduced by certain interest expense. For tax years beginning before January 1, 2026, IRC Section 250 permits a domestic corporation to deduct 50% of its GILTI, including the corresponding deemed-paid foreign taxes treated as a dividend under IRC Section 78. Unlike the full 21% corporate tax rate applied to subpart F income, the IRC Section 250 deduction results in a 10.5% effective federal corporate tax rate on GILTI. For tax years beginning after December 31, 2025, the GILTI deduction rate decreases to 37.5%. Against this 10.5% effective corporate tax rate, IRC Section 960(d) provides that certain US shareholders are deemed to pay (and may therefore credit, subject to limitations) 80% of the foreign income taxes that are paid by the CFC and properly attributable to its tested income. Taken together, the 50% IRC Section 250 deduction and 80% deemed paid credit allowance mean that a taxpayer with a foreign effective tax rate of at least 13.125% would not generally expect to pay residual US tax on its GILTI inclusion (setting aside taxpayer-level expense apportionment that reduces a taxpayer's foreign tax credit limitation). We refer to this rate at which no residual US tax on GILTI would apply as the "Crossover Rate." To determine its GILTI foreign tax credit limitation, a US shareholder of a CFC must allocate and apportion certain deductions to its GILTI inclusion. Interest expense is generally apportionable based on the relative values of the taxpayer's assets in each foreign tax credit limitation category. Because CFC stock is often treated as an asset in the GILTI category, interest expense (among other expenses) is often apportioned to the GILTI category, thus reducing a taxpayer's ability to claim GILTI foreign tax credits. The Senate Bill proposes to permanently reduce the IRC Section 250 deduction from 50% to 40%, resulting in a 12.6% effective federal corporate tax rate on GILTI. The House Bill would reduce the GILTI deduction rate to 48.2%. The Senate bill proposes additional changes to GILTI that were not present in the House Bill. Specifically, the current 80% deemed-paid allowance under IRC Section 960(d) for foreign income taxes deemed paid on GILTI inclusions would increase to 90%, bringing the Crossover Rate under the Senate proposal to 14%. It would also eliminate the NDTIR for QBAI. For purposes of the IRC Section 904(a) foreign tax credit limitation, the Senate Bill would limit the deductions allocable to GILTI inclusions to (i) the IRC Section 250 deduction for both GILTI and its associated IRC Section 78 gross-up; (ii) certain deductible taxes allocable to GILTI inclusions; and (3) any other deductions that are "directly allocable" to GILTI inclusions. Expenses that otherwise would have been allocated or apportioned to the GILTI foreign tax credit category would instead be allocated to US-source income. The Senate Bill omits a House proposal that would exclude from tested income certain services income earned in the Virgin Islands or effectively connected with a trade or business in the Virgin Islands. The provisions modifying the IRC Section 250 GILTI deduction and the apportionment of deductions to the GILTI category for IRC Section 904(a) purposes would be effective for tax years beginning after December 31, 2025. The provisions on eliminating the NDTIR and increasing the deemed-paid allowance to 90% for foreign tax credits in the GILTI category would be effective for (i) foreign corporations' tax years beginning after December 31, 2025, and (ii) US shareholders' tax years in which or with which the foreign corporations' tax years end. The Senate Bill's GILTI Crossover Rate of 14% would be higher than the existing rate (13.125%) or the rate under the House Bill (13.335%) but would still be less than the Crossover Rate that would apply to tax years beginning after December 31, 2025, absent legislative action (16.406%). The proposed changes to expense apportionment appear intended to prevent, at a minimum, the allocation and apportionment of most interest expense to the GILTI category. Interest expense is often the largest expense apportioned to the GILTI category under current law (other than the IRC Section 250 deduction), so the reallocation of interest expense from GILTI to US-source income could significantly increase taxpayers' GILTI foreign tax credit limitation. For tax years beginning before January 1, 2026, IRC Section 250 generally allows a domestic corporation to deduct 37.5% of the corporation's FDII, which results in an effective federal corporate tax rate of 13.125% on FDII. This deduction would decrease for tax years beginning after December 31, 2025, to 21.875%, which would cause the effective corporate tax rate on FDII to increase to 16.406%. A domestic corporation currently determines its FDII in a tax year under a formula. The corporation first determines its gross deduction eligible income (gross DEI) for the year by excluding from its total gross income certain enumerated categories of income, such as subpart F and GILTI inclusions, financial services income, certain dividends and foreign branch income. Gross DEI is then reduced by the deductions that are "properly allocable" to that income to arrive at the corporation's DEI. The corporation then determines its deemed intangible income by reducing its DEI by its deemed tangible income return (DTIR), which is 10% of the domestic corporation's QBAI. Finally, the corporation's FDII is the amount that bears the same ratio to deemed intangible income as the ratio of (i) the foreign-derived portion of the corporation's DEI (FDDEI) to (ii) its DEI. The Senate Bill would permanently reduce the 37.5% IRC Section 250 FDII deduction rate to 33.34%, resulting in an effective tax rate of approximately 14%. The House Bill would decrease the FDII deduction to 36.5%. Unlike the House Bill, the Senate Bill proposes to eliminate the DTIR, which would increase the overall FDII deduction in many circumstances. The Senate Bill would modify the definition of DEI to exclude two new categories of income: (i) Income or gain from the sale or disposition (including a deemed disposition) of property giving rise to rents or royalties; and (ii) certain passive income, including income that would be foreign personal holding company income if earned by a CFC and amounts includible in gross income under IRC Section 1293 by passive foreign investment companies (PFICs) for which a qualified electing fund election has been made. Both exclusions would be determined without regard to the high-tax kickout (HTKO) rules, meaning income that would be passive but for the HTKO rules could be excluded from DEI even if not ultimately treated as passive category income for foreign tax credit purposes. These items of income would no longer be eligible for the FDII deduction. Similar to the GILTI proposals, the Senate Bill would limit the deductions allocable to DEI to those that are "directly related" to gross DEI (as opposed to the current "properly allocable" rule). The reduction to the IRC Section 250 FDII deduction rate, the elimination of the DTIR and the limitation on deductions allocable to DEI would be effective for tax years beginning after December 31, 2025. The exclusion from DEI of income from the sale of property that gives rise to rents or royalties would apply to sales or other dispositions occurring after June 16, 2025. Similarly, the exclusion of certain passive income from DEI would apply to income attributable to amounts received or accrued after June 16, 2025. Like GILTI, the Senate Bill would increase the FDII effective tax rate to 14% from the currently effective rate of 13.125%. This rate would, however, be less than the rate that would apply under current law to tax years beginning after December 31, 2025 (16.406%). The exclusion of new types of income from DEI with an immediate effective date could catch taxpayers by surprise and impact the anticipated US tax consequences of pending transactions (e.g., dispositions of certain businesses with intellectual property). Further, taxpayers may need to undertake a new analysis of whether current FDII-eligible transactions meet exceptions to foreign personal holding income and thus remain FDII-eligible, such as determining whether royalties meet the exception for active royalties. The reduction in the expenses apportioned to DEI should generally increase the FDII deduction and is likely to be welcomed by taxpayers. However, it is not clear what expenses could fall within the scope of the new "directly related" standard in the proposed statute. Further guidance may be needed to clarify the types of expenses that are not intended to be allocated or apportioned to FDII (e.g., interest, stewardship, and research and experimentation expenses). The removal of the DTIR for QBAI could provide a significant benefit for companies with significant tangible property in the US. IRC Section 163(j) limits the business interest expense that may be deducted in a tax year to the sum of (i) the taxpayer's business interest income, (ii) 30% of the taxpayer's adjusted taxable income (ATI), and (iii) the taxpayer's floor plan financing interest. For tax years beginning before January 1, 2022, a taxpayer's ATI was based on earnings before interest, taxes, depreciation and amortization (EBITDA). Thereafter, a taxpayer's ATI has been computed after depreciation, amortization and depletion (EBIT). A U.S. shareholder of a CFC may, in certain circumstances, include a portion of its GILTI, subpart F income and section 78 inclusions in its ATI. Under the final IRC Section 163(j) regulations, IRC Section 163(j) generally applies after provisions that subject business interest expense to disallowance, deferral, capitalization or other limitation. As a result, capitalized interest expense is not treated as business interest expense for purposes of IRC Section 163(j). The Senate Bill would amend IRC Section 163(j) to provide that ATI is computed before any deduction allowable for depreciation, amortization or depletion (i.e., based on EBITDA). Unlike the House Bill, the Senate Bill would make this rule permanent. The Senate Bill would also adjust ATI by excluding CFC income inclusions under IRC Sections 78, 951(a) and 951A. The Senate Bill would also modify interest deductibility under IRC Section 163(j) by generally applying the IRC Section 163(j) limitation before interest capitalization provisions, thus subjecting business interest expense that might otherwise be capitalized to the IRC Section 163(j) limitation (with certain exceptions). The Senate Bill's changes to ATI determination would be retroactively effective for all tax years beginning after December 31, 2024. Under the House Bill, ATI would be determined based on EBITDA for only five years, through tax years beginning before January 1, 2030. The provisions on CFC income inclusions and interest capitalization coordination would be effective for tax years beginning after December 31, 2025. The exclusion of GILTI, subpart F and section 78 gross-up inclusions from ATI is surprising. U.S. shareholders of CFCs, however, would no longer benefit from CFC income inclusions in determining ATI, for tax years beginning after December 31, 2025. On the other hand, taxpayers whose interest expense is currently limited under the IRC Section 163(j) could benefit significantly from the permanent reinstatement of the EBITDA-based limitation for ATI. For tax years beginning before January 1, 2026, an applicable taxpayer must pay a "base erosion minimum tax amount" (BEMTA) in an amount equal to the excess (if any) of 10% of an applicable taxpayer's modified taxable income over its regular tax liability. A taxpayer's regular tax liability for this purpose is reduced by some tax credits, but not all. An applicable taxpayer that is a member of an affiliated group that includes a bank (as defined in IRC Section 581), or securities dealer registered under Section 15(a) of the Securities Exchange Act of 1934 is subject to a tax rate on its modified taxable income that is one percentage point higher than the generally applicable tax rate. For tax years beginning after December 31, 2025, the BEAT rate increases from 10% to 12.5% (or 13.5% for members of affiliated groups that include a bank or registered securities dealer). The regular tax liability decreases (and the BEMTA therefore increases) by the sum of all the taxpayer's income tax credits for the tax year. The Senate Bill would introduce important changes to the BEAT rules, including modifications to certain rates and the definition of base erosion payments. First, the Senate Bill would increase the BEAT rate from 10% to 14%. This rate would apply to all taxpayers, including members of an affiliated group that includes a bank or registered securities dealer. This proposal differs from the House Bill, which proposed raising the BEAT rate to 10.1% (or 11.1% for members of affiliated groups that include a bank or registered securities dealer). For determining whether a taxpayer is an applicable taxpayer, the Senate Bill would decrease the base erosion percentage in IRC Section 59A(e)(1)(C) from 3% to 2%. This same rate would apply to banks or registered securities dealers. Rules to determine an applicable taxpayer's modified taxable income would also change. Like the House Bill, the Senate Bill would eliminate the post-2025 scheduled change that would reduce regular tax liability (and increase the BEMTA) by the sum of all the taxpayer's income tax credits for the tax year. The Senate Bill introduces a new exception for base erosion payments subject to "sufficient foreign tax." Under this exception, an amount paid or accrued to a related foreign person would not be treated as a base erosion payment if the taxpayer were to establish to the satisfaction of the Secretary that the amount is subject to an effective foreign income tax rate (determined in accordance with the principles of IRC Section 904(d)(2)(F)) that exceeds 90% of the highest rate in effect under IRC Section 11 (i.e., 18.9%, which is 90% of the current 21% corporate income tax rate). The Senate Bill also directs the Secretary to issue regulations or other guidance to carry out the purposes of proposed IRC Section 59A(i), including rules for determining the effective foreign income tax rate and recharacterizing transactions among multiple parties. The Senate Bill would also include a new provision that would treat certain capitalized interest expenses as base erosion payments. Specifically, interest that is paid or accrued to a related foreign person and capitalized under any provision of Chapter 1 would be treated as a base erosion payment. An exception would apply for interest that is subject to mandatory capitalization under IRC Section 263(g) or IRC Section 263A(f). The Senate Bill would also amend IRC 59A(c)(2) to treat as a base erosion tax benefit (i) any depreciation or amortization deduction for property to which such interest payment is capitalized and (ii) any reduction in gross receipts from that property (to the extent attributable to the interest payment). The addition of a new exception to the BEAT regime for income subject to a sufficient foreign income tax represents a welcome development for taxpayers. However, the other BEAT changes proposed by the Senate Bill (i.e., the reduction in the base erosion percentage test to 2% coupled with treating certain capitalized interest expenses as base erosion payments) would likely subject more taxpayers to BEAT. Taxpayers that are subject to BEAT would also incur higher tax costs as a result of the rate increase from 10% to 14%. Finally, taxpayers that are "applicable corporations" will also have to evaluate the Senate Bill's BEAT changes in the context of proposed Section 899. The Senate Bill retains proposed Section 899, which was included with the House Bill, albeit with some key changes. Under the Senate Bill, proposed Section 899 would now target "applicable persons" of "offending foreign countries" (the House Bill referred to "discriminatory foreign countries") that have an "unfair foreign tax." The Senate Bill maintains the definition of an "applicable person"; in contrast to the House Bill, it defines a "publicly held corporation" as a corporation where at least 80% of its stock (by vote and value) is regularly traded on a national securities exchange registered under Section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) (e.g., Nasdaq Stock Market or New York Stock Exchange), or any established securities market that meets similar regulatory requirements as determined by the Secretary. The Senate Bill would revise the definition of an "unfair foreign tax" to include an "extraterritorial tax" and a "discriminatory tax." Unlike the House Bill, which defined an unfair foreign tax to expressly include a diverted profits tax (DPT), in addition to a UTPR and DST, the Senate Bill does not explicitly include a DPT in the definition of an "unfair foreign tax"; the Secretary is authorized, however, to determine other taxes that are a "discriminatory tax." In a significant change from the House Bill, the Senate Bill would increase "specified rates of tax" only for applicable persons with a connection to countries with an extraterritorial tax (e.g., a UTPR). Thus, the rate increase would not apply to countries that only have a "discriminatory tax" like a DST. The Senate Bill retains the House Bill's definition of a "specified rate of tax." It would apply the increased tax rate to certain taxes, such as taxes on FDAP income and ECI of foreign corporations, if the tax were "otherwise applicable" to an applicable person but "not imposed by reason of an exemption or exception, or [imposed] at a rate of tax equal to zero." Thus, for these "otherwise applicable" taxes, the Senate Bill would appear to override any exemptions, exceptions or zero rates provided elsewhere, including under an applicable US income tax treaty. Unlike the House Bill, the Senate Bill explicitly provides an exception from proposed Section 899 for:
The Senate Bill generally maintains the House Bill's list of withholding tax rates subject to increase, while also adding a reference to the withholding tax rate under IRC Section 1443(b), which applies to income of certain foreign organizations described in IRC Section 4948. Like the House Bill, the Senate Bill also explicitly prevents IRC Section 892(a)(1) from applying to an applicable person that is a government of an offending foreign country. The Senate Bill, however, would modify the cap on the rate increase to 15 percentage points above the otherwise applicable rate. This is a notable change from the House Bill, which generally allowed an increase up to a 20 percentage points over the statutory rate. Moreover, the Senate Bill would modify the definition of "applicable date," which is relevant for determining the applicable number of percentage points. Under the Senate Bill, the "applicable date" would be the first day of the first calendar year beginning on or after the latest of (i) one year after the enactment of proposed Section 899 (compared to 90 days in the House Bill), (ii) 180 days after the enactment of the unfair foreign tax that results in the foreign country's treatment as an offending foreign country, or (iii) the first date that the unfair foreign tax begins to apply. The Senate Bill maintains rules that would expand the application of BEAT to certain corporations, although it includes key changes compared to the House Bill, with potentially far-reaching effects. First, the Senate Bill explicitly defines an "applicable corporation" as any domestic corporation (excluding publicly held corporations, as defined under proposed Section 899(b)(3)) if more than 50% of the total vote or value of its stock is owned directly or indirectly by one or more applicable persons. The term also includes any US branch of a foreign corporation (also excluding publicly held corporations) if that corporation is an applicable person with respect to any offending foreign country. Then, for purposes of determining whether such applicable corporation is an applicable taxpayer, the Senate Bill, similar to the House Bill, would treat an applicable corporation as meeting the average annual gross receipts test under IRC Section 59A(e)(1)(B). The Senate Bill would, however, reduce the 2% base erosion percentage threshold of IRC Section 59A(e)(1)(C) to a 0.5% threshold (unlike the House Bill, which deemed the corporation to have met that test). Unlike the House Bill, the Senate Bill provides rules coordinating proposed Section 899 and IRC Section 891. The Senate Bill would slightly modify the wording of current IRC Section 891 and define the terms "extraterritorial tax" and "discriminatory tax" by referencing the definitions in proposed Section 899(d). Additionally, a coordination rule would preclude a rate increase under proposed Section 899 from applying during any period a rate increase is in effect under IRC Section 891. A Tax Alert with a more detailed discussion of the Senate Bill's changes to proposed Section 899 is forthcoming. Compared to the House Bill, the Senate Bill would delay the application of proposed Section 899 by one year. Specifically, increases in the rates of taxes, other than withholding taxes and modifications to BEAT, would apply to each tax year beginning on or after the latest of:
The Senate Bill would also retain the House Bill's blending rules for determining the applicable number of percentage points when multiple tax rate increases are in effect during a taxpayer's tax year, which could be relevant for fiscal-year taxpayers. Like the House Bill, increases in withholding tax rates would apply for each calendar year beginning during the period the person is an applicable person., Under the modified definition of "applicable date" (described previously), however, the increased withholding tax rates would not apply until January 1, 2027. The Senate Bill retains the rule for determining the applicable number of percentage points for withholding taxes based on the payment or disposition date (as applicable). The Senate Bill also generally retains the safe harbors included in the House Bill. For calendar-year taxpayers, delaying Section 899's application by one year would mean that the provision would not apply until tax years beginning after December 31, 2026. Withholding agents also would not be required to withhold at higher amounts until January 1, 2027. The omission of the House Bill's changes to the temporary safe harbor for withholding, however, means that relief from penalties and interest only applies for failures to withhold occurring before January 1, 2027 — even though the associated rate increases would not take effect until that date. The Senate Bill's adjustment to cap the rate increase under proposed Section 899 to 15 percentage points above the otherwise applicable rate is a welcome change when compared to the House Bill, which proposed a cap of 20 percentage points over the statutory rate. For example, the House Bill could have resulted in tax rates reaching 50% (30% plus 20 percentage points) for FDAP income. The Senate Bill would narrow the potential scope of proposed Section 899 by imposing tax rate increases only on those applicable persons that are connected to a jurisdiction imposing an "extraterritorial tax" such as a UTPR. Even though the Section 899 rate increases would apply solely to countries imposing extraterritorial taxes, however, the IRC Section 891 coordination rule indicates that increased rates under IRC Section 891 might apply in certain cases — in other words, IRC Section 891 remains relevant, suggesting that the Senate intends it to stand "side by side" with proposed Section 899. The Senate Bill's exceptions to proposed Section 899 could introduce uncertainty regarding the continued availability of other statutory exemptions not explicitly enumerated in Section 899. This is particularly relevant given that the Senate Bill appears to override exemptions and exceptions, as well as zero rates of tax, in the context of certain withholding taxes, taxes on FDAP income and taxes on ECI of corporations. Some of this uncertainty could be mitigated, however, as the Secretary would be authorized to designate additional exceptions to proposed Section 899 for amounts "similar" to those excepted in the Senate Bill. Regarding BEAT, the Senate Bill largely aligns with the House proposal. However, it retains the base erosion percentage test — albeit with a reduced threshold of 0.5% — and would not impose an additional rate increase, as the BEAT rate is already scheduled to rise to 14% under broader proposed amendments to IRC Section 59A. As was the case with the House proposal, the expansion of the BEAT rules under the Senate's version of Section 899 could have far-reaching implications for many US corporations with some degree of direct or indirect foreign ownership, including US corporations that, to date, have not had BEAT exposure because they do not meet the gross receipts and base erosion percentage tests under current IRC Section 59A. Under IRC Section 954(c)(6), dividends, interest, rents and royalties received or accrued by a CFC from a related CFC are generally not treated as foreign personal holding company income, provided certain requirements are met. The provision currently applies to tax years of foreign corporations beginning before January 1, 2026. The Senate Bill proposes to make permanent the look-through exception for foreign personal holding company income under IRC Section 954(c)(6). This provision would be effective for tax years of foreign corporations beginning after December 31, 2025, and to US shareholders' tax years in which or with which the foreign corporations' tax years end. Gains, profits and income from the sale or exchange of inventory that is produced by a taxpayer are treated as US- or foreign-source income based solely on whether the production activities with respect to the inventory occur within or outside the United States. Thus, income from the sale or exchange of inventory produced by the taxpayer in the United States would be treated as US-source income regardless of whether it was sold through a foreign branch. For the purposes of the foreign tax credit limitation, the Senate Bill would treat as foreign-source taxable income up to 50% of the income from inventory property that is:
The proposal helps address concerns of taxpayers that incur foreign tax on sales or distribution activities through foreign branches (including disregarded entities) but cannot credit those foreign taxes because all income from the sale is treated as US-source income under current law (because the property is produced in the US). Guidance may be needed to determine how much income from the sale is attributable to the foreign office or fixed place of business (and thus foreign-source income) and not attributable to US production activities. IRC Section 898 generally requires a CFC to use the tax year of its majority US shareholder. IRC Section 898(c)(2), however, permits a CFC to elect a tax year beginning one month earlier than the majority US shareholder's year. The Senate Bill would repeal the one-month deferral election. A transition rule would require a CFC's first tax year beginning after November 30, 2025, to end at the same time as the first "required" year (generally that of its majority US shareholder) ending after that date. Therefore, CFCs with a tax year ending November 30, 2025, and a one-month deferral election would automatically have a short tax year ending December 31, 2025. The Senate Bill would explicitly authorize the Secretary to issue guidance on allocating foreign taxes between the short year and the succeeding tax year. This provision would be effective for tax years of specified foreign corporations beginning after November 30, 2025. If the proposed effective date were maintained, many calendar-year taxpayers would have a one-month CFC short period from December 1, 2025 to December 31, 2025. Absent a special allocation of foreign taxes (which the Senate Bill would authorize Treasury to provide), taxpayers with a foreign tax year ending December 31, 2025 could accrue 12 months of foreign taxes in the CFC's one-month transition year, which could create risk that the taxes would not be eligible for a foreign tax credit. If one or more US shareholders owns directly or indirectly under IRC Section 958(a), or constructively under IRC Section 958(b), more than 50% of the stock (by vote or value) of a foreign corporation, that foreign corporation is a CFC. A US shareholder of a foreign corporation is a US person that owns, under IRC Section 958(a) and IRC Section 958(b), 10% or more of the shares (by vote or value) of the foreign corporation. IRC Section 958(b) applies the constructive ownership rules of IRC Section 318(a), including the downward ownership attribution rules of IRC Section 318(a)(3). If a shareholder owns 50% or more of the shares of a corporation by value, the downward attribution rules of IRC Section 318(a)(3) treat any other stock owned by the shareholder as owned by that corporation. The rules also treat stock owned by a partner as owned by the partnership. IRC Section 958(b)(4) previously prevented downward attribution of stock owned by a foreign person to a US person before its repeal by the Tax Cuts and Jobs Act of 2017 (TCJA). The TCJA repealed IRC Section 958(b)(4), effective for a foreign corporation's last tax year beginning before January 1, 2018. IRC Section 958(b)(4)'s repeal caused many foreign corporations that previously were not CFCs to become CFCs without any change in ownership. The Senate Bill proposes to reinstate IRC Section 958(b)(4), thus limiting downward attribution of stock ownership when applying the constructive ownership rules. This would cause many foreign corporations that became CFCs with the repeal of IRC Section 958(b)(4) to no longer be treated as CFCs. However, the Senate Bill would also introduce a new IRC Section 951B, which would apply downward attribution from foreign persons in certain cases and apply the subpart F and GILTI inclusion rules to a "foreign controlled US shareholder" (FCUSS) of a "foreign controlled foreign corporation" (FCFC) as if the former were a US shareholder and the latter were a CFC. An FCUSS is a US person that would be a US shareholder of a foreign corporation if (i) downward attribution from foreign persons applied, and (ii) the definition of US shareholder were applied with a threshold of more than 50% rather than a threshold of 10% or more. An FCFC is a foreign corporation that is not a CFC but would be a CFC if (i) the definition of CFC applied to FCUSS instead of US shareholders, and (ii) downward attribution from foreign persons applied. The Senate Bill would authorize Treasury to treat an FCUSS as a US shareholder and an FCFC as a CFC for purposes other than subpart F and GILTI, such as reporting requirements or coordinating the treatment of FCFCs with the PFIC rules. This provision would be effective for foreign corporations' tax years beginning after December 31, 2025, and for US shareholders' tax years in which or with which the foreign corporations' tax years end. The reinstatement of IRC Section 958(b)(4) would likely be a welcome change for many taxpayers — especially members of foreign-parented multinational groups — as it would eliminate CFC status for many foreign corporations that are not controlled, directly or indirectly, by US shareholders. However, the introduction of the new IRC Section 951B inclusion rule would increase complexity and prevent a complete return to a pre-TCJA state. For example, a wholly owned US subsidiary (USSUB) of a foreign corporation may own 20% of a foreign corporation (FSUB) that is otherwise wholly owned by a foreign parent that does not have any direct or indirect US shareholders (i.e., USSUB and FSUB are brother-sister but for the USSUB's 20% ownership in FSUB). Before the TCJA, FSUB would not have been a CFC, and USSUB would not have had subpart F inclusions with respect to its 20% interest. Under new IRC Section 951B, FSUB would not be a CFC but would be a FCFC, requiring USSUB to include subpart F and NCTI from FSUB based on its 20% ownership interest (consistent with the inclusions required under current law). If a foreign corporation is a CFC at any time during the foreign corporation's tax year, a US shareholder in the foreign corporation on the last day of the year on which the foreign corporation is a CFC (the Last Relevant Day) must include in gross income the US shareholder's pro-rata share of the CFC's subpart F income for the year. A US shareholder's pro-rata share is determined by first proportionally allocating subpart F income to the US shareholder based on its share of a hypothetical distribution treated as made by the CFC on the Last Relevant Day. Next, if the US shareholder does not own its CFC stock all year, the allocation is reduced by certain dividends received by another person on that stock. First, it would remove the Last-Relevant-Day rule. Instead, each US shareholder owning stock in a foreign corporation at any time during a year in which the foreign corporation is a CFC would include in gross income its pro rata share of the CFC's subpart F income. Thus, Subpart F income inclusions would no longer be limited to the US shareholders on the Last Relevant Day. Second, a US shareholder's pro-rata share would be determined under a new, more flexible standard based on the portion of the CFC's subpart F income that is "attributable to" the CFC stock owned by the US shareholder and the period of the CFC year during which all of the following are true - (i) the US shareholder owned the stock; (ii) the shareholder was a US shareholder; and (iii) the corporation was a CFC. Third, the Senate Bill would grant Treasury broad authority for IRC Section 951(a) purposes, including to (i) provide rules and methods for determining a US shareholder's pro-rata share, taking into account all facts and circumstances; (ii) provide for the determination of a US shareholder's pro-rata share in a tiered entity; and (iii) allow taxpayers to elect to close a CFC's tax year upon a direct or indirect transfer of the CFC's stock. This provision would be effective for foreign corporations' tax years beginning after December 31, 2025, and to US shareholders' tax years in which or with which the foreign corporations' tax years end. The Senate Bill addresses concerns that a transfer of CFC stock could result in subpart F income or tested income attributable to a US shareholder's ownership of stock of the CFC escaping taxation. It would supplant regulations like Treas. Reg. Section 1.245A-5(e), which address similar concerns by denying an IRC Section 245A(a) deduction for certain dividends viewed as attributable to such income. The Senate Bill would eschew the mechanical approach of existing IRC Section 951(a) and prior proposed legislation in favor of a new "attributable to" standard. It would thus go further than proposals in Representative Brady's Tax Technical and Clerical Corrections Act Discussion Draft from 2019, which would have turned off the Last-Relevant-Day rule only where certain dividends viewed as attributable to subpart F income or tested income would give rise to an IRC Section 245A(a) deduction (or, in tiered structures, an exclusion from subpart F income under IRC Section 954). Because the Senate Bill does not contain explicit rules for attributing income to CFC stock, Treasury regulations will be needed to fill computational gaps and ensure consistent methods (including in tiered structures or structures involving multiple classes of stock or other interests).
Document ID: 2025-1330 | ||||||
