On September 6, 2024, the Internal Revenue Service (IRS) Office of Associate Chief Counsel (International) released an advice memorandum (202436010) to the Large Business & International Division (LB&I) concluding that section 245A does not allow a deduction for a dividend received by a controlled foreign corporation (CFC) from a "specified 10-percent owned foreign corporation" (SFC). Although the guidance is not binding, the memorandum represents the first written explanation of Chief Counsel's position on this issue, more than five years after Treasury and the IRS announced they were studying "whether, and to what extent, proposed regulations should be issued that provide that dividends received by a CFC are eligible for a section 245A deduction." 

Multinational taxpayers that have applied the section 245A deduction in this context of lower-tier dividends received by CFCs should expect enhanced scrutiny in current and future LB&I examinations. Although the interpretation offered by the advice memorandum is vulnerable to challenge, taxpayers should consider whether restructuring is nevertheless advisable, at least in circumstances in which a U.S. shareholder can become the direct owner of a minority interest in an SFC without incremental tax cost.

The memorandum provides the stylized example of a U.S. parent corporation that wholly owns a CFC (FC1), which in turn owns 45 percent of an SFC (FC2). FC1 receives a dividend from FC2. Section 245A(a) generally allows a deduction (the section 245A DRD) for the foreign-source portion of a dividend received from an SFC "by a domestic corporation which is a United States shareholder with respect to such [SFC]." The memorandum assumes that, if FC1 were a domestic corporation, section 245A would allow a 100 percent deduction. However, "[b]ecause FC1 is neither a domestic corporation nor a United States shareholder with respect to FC2," the "plain meaning" of section 245A(a) prohibits any deduction. 

Although the memorandum asserts that "the analysis of the issue ends" with the "plain language of section 245A(a)," the memorandum seeks to defuse known counterarguments. First, the memorandum analyzes related provisions enacted in tandem with section 245A(a) – specifically section 245A(e)(4) and section 964(e)(4) – and concludes the language of those rules does not imply that section 245A extends to dividends received by CFCs. 

Second, the memorandum considers legislative history from the Tax Cuts and Jobs Act (TCJA). For purposes of the section 245A dividends received deduction (DRD), the TCJA Conference Report stated that a "domestic corporation" includes any CFC that is treated as a domestic corporation for purposes of computing its taxable income, as provided in longstanding regulations under section 952. The Conference Report concludes in footnote 1486 that "a CFC receiving a dividend from a 10-percent owned foreign corporation that constitutes subpart F income may be eligible for the DRD with respect to such income." Notwithstanding these direct statements, the memorandum contends that the Conference Report "cannot reasonably be read as an authoritative distinct expression of congressional intent to allow the section 245A DRD for a CFC[.]" 

The memorandum bypasses the Conference Report by concluding that the position not only contradicts "an express statutory limitation of a deduction to only domestic corporations," but also "appears to rest on a misapplication" of the section 952 regulations. The memorandum observes that the rules of subchapter N of Chapter 1 of the Internal Revenue Code do not apply for purposes of the section 952 regulations at issue, unless "otherwise distinctly expressed." Because subchapter N contains the definition of a "United States shareholder," the memorandum concludes that the section 952 regulations cannot apply to treat the CFC as a U.S. shareholder, which is a prerequisite for the application of the section 245A DRD.

Not content to restrict itself to the bold conclusion that Congress misapprehended pre-TCJA law, the memorandum also asserts that the "interpretation… asserted by" Congress in the Conference Report would inevitably permit "untenable results," such as allowing foreign corporations to join U.S. consolidated groups and permitting foreign corporations to claim deductions under section 250. The memorandum's invocation of the classic slippery slope fallacy is a useful reminder that the litigating position articulated in the advice memorandum warrants careful scrutiny. 

For more information, please contact:

Layla J. Asali, lasali@milchev.com, 202-626-5866

Jeffrey M. Tebbs, jtebbs@milchev.com, 202-626-1480

Katherine Lewis, klewis@milchev.com, 202-626-5894

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