Advising International Business Ventures: Tax Reform’s Section 245A Participation Exemption Regime

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Jason B. Freeman

Jason B. Freeman

Managing Member

214.984.3410
jason@freemanlaw.com

Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine , a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

Advising International Business Ventures: Tax Reform’s Section 245A Participation Exemption Regime

Freeman Law frequently advises international business ventures. International operations often give rise to unique (and sometimes unanticipated) compliance obligations and complex reporting requirements. Recent tax reform rules and regulations have imposed a number of new requirements.  The IRS and Treasury Department have elaborated on these new rules through proposed regulations and other guidance.  This post focuses on, and provides a short introduction to, the new section 245A Participation Exemption System.

The Tax Cuts and Jobs Act, Pub. L. 115- 97 (2017) (“the TCJA”) enacted new section 245A, which provides for the new Participation Exemption System and a dividends received deduction (“DRD”) for certain foreign-source income—a central part of the new international tax regime.  Section 245A is an integral part of the TCJA’s changes to the international tax regime, which largely adopt a quasi-territorial tax system for foreign-source income earned by foreign subsidiaries of certain domestic corporations.

The TCJA’s “participation exemption” under Section 245A generally exempts a dividend received by a 10%-or-greater U.S. corporate shareholder of a foreign subsidiary from tax.  More technically, under new section 245A(a), a domestic corporation that is a U.S. shareholder of, and that receives a dividend from, a “specified 10-percent owned foreign corporation” is allowed as a deduction equal to the foreign-source portion of that dividend. A “specified 10-percent owned foreign corporation” is defined in section 245A(b) as any foreign corporation (other than certain passive foreign investment companies) with respect to which a domestic corporation is a U.S. shareholder.

Section 245A’s “participation exemption” is a key feature in the TCJA’s new international tax regime.  It applies where the domestic corporate shareholder owns directly, indirectly, or by attribution, 10% or more of the voting power or value of the foreign corporation.  (It does not, however, apply with respect to a foreign corporation that is a passive foreign investment company (“PFIC”) that is not a controlled foreign corporation (“CFC”).).

The “foreign-source portion” of a dividend is the amount that bears the same ratio to the dividend as the “undistributed foreign earnings” bear to the “undistributed earnings” of the “specified 10-percent owned foreign corporation.”  Undistributed foreign earnings are undistributed earnings that are not effectively connected with the conduct of a trade or business within the United States (“ECI”) or dividends received from a domestic corporation that is at least 80% owned, directly or indirectly, by the specified 10-percent owned foreign corporation.

Hybrid dividends, Holding-Period Requirements, and Contractual Arrangements that Diminish Risk of Loss.  The participation exemption is not available with respect to “hybrid” dividends, and is generally not available unless the domestic corporation has held the stock for more than 365 days during the 731-day period that begins 365 days before the ex-dividend date.  The period during which the taxpayer held certain contractual arrangements that diminish the taxpayer’s risk of loss with respect to the foreign subsidiary’s stock, including an option to sell, short sale, granting an option to buy substantially similar stock or securities, or other events prescribed under regulations, do not count towards this holding period.

 

Representation in Tax Audits & Appeals

Need assistance in managing the audit process? Freeman Law’s team of attorneys and dual-credentialed attorney-CPAs regularly represents taxpayers before the IRS and Texas Comptroller. Our team also provides tax return-related representations and helps taxpayers navigate state tax laws. Our Firm offers value-driven services and provides practical solutions to complex issues. Schedule a consultation or call (214) 984-3410 to discuss our tax representation services.

 

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