Multinationals Can Limit the Effect of a Pivotal Tax Rule Repeal

Multinational businesses have had to figure out if they’re affected by modifications to the downward attribution rules caused by the repeal of Section 958(b)(4) in the Tax Cuts and Jobs Act of 2017. These rules deem that any stock owned by an individual or a corporation are also owned by partnerships, corporations, trusts, and estates in which the stock owner has a certain interest.

There are steps businesses can take if they’re subject to downward attribution in years for which they’ve already filed returns, or if they’re planning new investment structures to prevent downward attribution and the triggering of controlled foreign corporation stock reporting requirements.

To determine whether they’re subject to downward attribution, multinationals should review the entire global structure of parents and subsidiaries; identify the full legal ownership of the entire structure, with a focus on the tax residency of the upper-tier investors; and evaluate the structures in the lower tiers to see if they meet the requirements for attribution.

Triggering Attribution Rules

The rules that govern this area of taxation are complex and can affect a variety of cross-border business structures. The following example provides one of the most basic fact patterns that became subject to downward attribution rules under Section 958 with the enactment of the TCJA:

• A foreign parent company has an ownership group that includes a US owner that holds at least 10% of its stock.
• The foreign parent company owns 100% of a US subsidiary, treated as a C corporation, and 100% of a foreign subsidiary operating outside of the US.

Consider that this structure was in place before the TCJA took effect and continues in effect through tax year 2022. Before the TCJA, no one in this structure was required to report holding controlled foreign corporation stock to the IRS.

Once the TCJA removed the exemption for downward attribution in this situation, both the 10% owner of the foreign parent and the US subsidiary of the foreign parent are deemed to hold controlling interests in the foreign subsidiary. Both of these entities are then required to file Form 5471. Each is required to file the form annually, and the penalty for failure to file the form is $10,000 per year.

If they missed each year starting in 2018 and running through 2022, they’re exposed to a maximum of $50,000 each in failure-to-file penalties. On top of the additional filing requirements (and penalties for missed filings), US investors holding a 10% stake in the foreign parent could incur additional US tax liabilities if they’re subject to anti-deferral rules in the US law under global intangible low-taxed income and Subpart F provisions.

One could argue in favor of possible “reasonable cause” relief for these penalties. However, given the lack of a technical correction in the intervening years and the efforts by the IRS to revise relevant forms to recognize these categories of attribution, affected taxpayers should work with their advisers to comply with the rules as enacted in 2017 and petition for reasonable relief from the penalties where possible.

Preventing Downward Attribution

There are options for existing businesses looking to modify their structure to operate in a manner not subject to downward attribution, and for new businesses looking to organize in a structure that operates outside of these requirements.

Use a US branch instead of a subsidiary corporation. One way to avoid triggering downward attribution is to structure the foreign parent’s operations in the US as a branch instead of a subsidiary. Where the structure makes sense for a business, it can remove one of the dominoes that can lead to the unintended global reporting obligation quagmire that can arise from downward attribution.

Existing businesses that want to modify their structure to end downward attribution could be subject to US taxation on the conversion of a C corporation subsidiary to a branch, but that cost can be factored into the decision-making process.

Rely on US check-the-box rules. For new entities looking to create a structure that prevents downward attribution from the start, the check-the-box options available to foreign subsidiaries of the foreign parent can help manage this filing obligation. Existing foreign subsidiaries of the foreign parent that make new check-the-box elections to opt out of controlled foreign corporation treatment could trigger tax consequences for US shareholders.

However, there’s one noteworthy precaution. Given the current business climate in which private equity groups make so many investments by purchasing significant percentages of an entity, any purchase by a US investor of more than 10% of a foreign parent company could trigger downward attribution and controlled foreign corporation reporting requirements for all of that parent’s foreign subsidiaries.

These rules effectively add another box to check in the due diligence process—will this investment trigger downward attribution rules? The investment may still be worth it, but compliance costs need to be factored into the purchase price.

It’s become clear since the downward attribution rules expanded that every taxpayer’s unique facts and circumstances must be considered when developing a solution. If you think that your business may be subject to these rules, discuss the issue with your tax adviser before taking additional steps.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Steve Schnepel is an international tax partner at Plante Moran who assists publicly and privately held businesses with all their cross-border tax needs

Randall Janiczek is also an international tax partner at Plante Moran who advises multinational and internationally active clients about minimizing their global tax liability.

We’d love to hear your smart, original take: Write for us.