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Code §245a – Sometimes Things Are More Than They Appear – Shareholders


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Section 245A of the Internal Revenue Code of 1986 (the
“Code”) effectively exempts U.S. corporations from U.S.
Federal income tax on dividends received from certain foreign
subsidiaries. It allows a deduction equal to the amount of the
dividend received. Code §245A applies only where certain
conditions are met and only with respect to dividends received
“by a domestic corporation which is a United States

Nevertheless, Code §245A can also apply to dividends
received by a controlled foreign corporation from a qualifying
participation in a lower-tier foreign corporation. The question
presented in that fact pattern is how Code §245A is

  • Is the controlled foreign corporation entitled to claim the
    deduction as dividends are received?

  • Or is a U.S. corporation that is a U.S. Shareholder with regard
    to both the distributing and the recipient corporation foreign
    corporations entitled to claim the deduction at the time Subpart F
    income is reported in its U.S. tax return?

Significantly different results may apply depending on the
answer. Interestingly, the differences affect U.S. taxpayers other
than the corporation that is a U.S. Shareholder.


Code §245A was added to the Code as part of the Tax Cuts
and Jobs Act of 2017 (the “T.C.J.A.”).1 It is
effective for distributions made after December 31, 2017.

Prior to the T.C.J.A., the U.S. international tax system was
largely a worldwide system of taxation. Except as provided under
Subpart F, active business income of foreign subsidiaries was taxed
only upon repatriation, i.e., when distributed to the U.S.
corporate shareholder.2

The imposition of U.S. tax on repatriated income of foreign
subsidiaries placed U.S. multinational corporations at a
disadvantage compared with foreign corporations based in
countries that employed a territorial system of taxation dividend
income received from foreign subsidiaries.3 Examples
include the U.K. and other G-7 counntries. This was especially true
because the nominal U.S. corporate tax rate was very high relative
to the corporate tax rates in other countries, reaching 35% at the

In 2017, Congress decided to eliminate the taxation of
repatriated income of foreign subsidiaries and to reduce the
corporate income tax rate to 21%. The main purpose was to allow
U.S. multinationals to better compete against foreign
multinationals.5 This is when Code §245A came into
play, effective in 2018.


Code §245A provides that, in the case of any dividend
received from a 10%-owned foreign corporation by a U.S. corporation
that is a U.S. Shareholder, the U.S. corporation is allowed a
deduction in an amount equal to the foreign-source portion of the
dividend (also known as a dividend-received deduction or a
“D.R.D.”). As a result of the D.R.D., the dividend income
is fully offset, resulting in a nil rate of U.S. Federal corporate
income tax.

An important point to bear in mind is that, where the
distributing corporation is a controlled foreign corporation
(“C.F.C.”) as defined in Code §957(a), some of its
income might already have been taxed in the U.S. under the U.S.
anti-deferral regimes in advance of any distribution
(“Previously Taxed Income”).6 To prevent the
same income from being taxed a second time, the Code provides that
Previously Taxed Income is not to be taken into account for U.S.
Federal tax purposes when actually distributed to the U.S.
Shareholder.7 Accordingly, ordering rules published by
the I.R.S. provide that any amount distributed by a C.F.C. will
first be considered as being made out of Previously Taxed
Income.8 Only the remainder of the dividend amount, if
any, will be potentially subject to Code §245A D.R.D.

For the D.R.D. to apply, the following five conditions must be

  • The dividend must be received from a “specified 10-percent
    owned foreign corporation” (a “Specified Foreign
    Corporation” or “S.F.C.”). An S.F.C. is a foreign
    corporation if at least one of its shareholders is a corporation
    that is “U.S. Shareholder.”9 A corporation is
    “U.S. Shareholder” if it was formed in the U.S. and it
    owns, either directly or indirectly, or is considered as owning
    under special attribution rules, shares representing10% or more of
    the voting power or value of the distributing

  • The dividend must be received by a domestic corporation that is
    a “U.S. Shareholder” with respect to the distributing

  • The U.S. Shareholder must meet a minimum holding-period
    requirement of more than 365 days during a two-year period
    beginning one year before the ex-dividend date.11

  • The dividend must be a foreign source dividend, determined by
    reference to the undistributed foreign earnings of the Specified

  • The dividend must not be any of the following: (i) a hybrid
    dividend,13 (ii) a purging distribution by a passive
    foreign investment company (“P.F.I.C.”) generally made as
    a condition of becoming a “pedigreed Q.E.F.,14
    (iii) any other distribution from a P.F.I.C.”15
    that is not a C.F.C.,16 and (iv) an extraordinary
    disposition amount during the taxable year preceding application of
    the D.R.D.17

In this article, we focus on the second requirement listed
above, according to which the dividend must be received by a
domestic corporation.

As explained below, the D.R.D. should also apply if the dividend
is received by a C.F.C. owned by a domestic corporation, provided
the domestic corporation is U.S. Shareholder with respect to the
distributing corporation and all other requirements listed above
are met.

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1. Pub. L. No. 115-97, §14101(a).

2. In contrast to active business income, passive
income of foreign subsidiaries has been taxed by the U.S.
shareholder on an annual basis under the Subpart F regime or the
P.F.I.C. regime where the foreign corporation is treated as a
Qualified Electing Fund. Both sets of rules are beyond the scope of
this article.

3. S. Comm. on the Budget, 115th Cong., Reconciliation
Recommendations Pursuant to H. Con. Res. 71, S. Prt. No. 115-20, at
358 (Comm. Print 2017).

4. Of course, corporations with sophisticated tax
departments were tasked to manage the effective rate.

5. S. Comm. on the Budget, 115th Cong.,
Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Prt.
No. 115-20, at 358 (Comm. Print 2017)

6. Mainly, the Subpart F regime governed by Code
§§951 to 965 and the G.I.L.T.I. regime under Code
§951A. The G.I.L.T.I. regime became effective as of 2018.

7. Code §959(a).

8. I.R.S. Notice 2019-01.

9. Code §245A(b).

10. Code §951(b)

11. Code §246(c)(5).

12. As defined in Code §245A(c). A deduction for the
U.S. portion of the dividend, if any, is available under Code
§245, in full or in part, depending on the circumstances and
provided certain conditions are met.

13. Code §245A(e).

14. Code §245A(f).

15. Defined in Code §1297.

16. Defined in Code §957(a).

17. Treas. Regs. §1.245A-5

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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