The US Treasury has finalized regulations (Regulations) affecting the US tax treatment of guarantees by "controlled foreign corporations" (CFCs) of debt of certain US corporate shareholders and pledges of CFC stock in support of such debt. These regulations likely will allow CFCs of many US corporate parent borrowers to guarantee the parent's debt and similarly permit a US parent to pledge more than 2/3 of the voting stock of its CFCs, without incurring a taxable "deemed dividend" under section 956 of the US Internal Revenue Code (Code).
The US historically has taken the view that a CFC's providing credit support for obligations of its US shareholders has the economic effect of repatriating offshore earnings. On that basis, prior to the Regulations, a CFC's guarantee of a loan to its US parent or the US parent's pledge of more than 66 2/3% of the CFC's voting stock in support of its debt could result in a taxable "deemed dividend" inclusion under section 956 of the Code in the amount of the loan. To address this concern, credit agreements with US obligors often contained a US guarantee limitation excluding CFC subsidiaries as guarantors and excluding pledges of more than 66 2/3% of CFC voting stock.
The US generally taxes its residents on their worldwide income. As a result of the 2017 US Tax Cuts and Jobs Act's shift to a partial territorial tax system, however, an actual dividend from a CFC (or certain other 10-percent owned foreign corporations) to its US corporate parent is no longer taxable to the US parent under certain circumstances. This exemption generally is not available to US shareholders that are not corporations. The Regulations attempt to achieve parity between the US tax treatment of actual dividends from a CFC and deemed dividend inclusions arising from a CFC guarantee or stock pledge. Very generally, the Regulations exempt from US tax a deemed dividend to the extent that an actual dividend would have been exempted. The Regulations also address US shareholders of a CFC that are US partnerships and that have US corporations as partners. The rules provide generally that a deemed dividend inclusion would be exempted by reference to the US corporate partner.
The rules are set to apply prospectively to taxable years of CFCs beginning on or after July 22, 2019, and to taxable years of a US shareholder in which or with which such taxable years of the CFCs end. However, subject to certain requirements, US shareholders may apply the rules currently (and, in fact, retroactively to taxable years of CFCs beginning after December 31, 2017, and to taxable years of a US shareholder in which or with which such taxable years of the CFCs end).
Although finalization of the Regulations provides more certainty on the law, obligors may continue to seek limitations on guarantees and credit support from CFCs. Such requests may need to be addressed on a case by case basis.
