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IRS Form 5471
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IRC §951A Exists to Solve a Problem Created by IRC §245A

Portrait of Phil Hodgen

Phil Hodgen

Attorney, Principal


Today, Let's ask a "Why?" question and make sense of why IRC §951A exists.

TCJA's impact: a myriad of details and confusion

IRC §951A arrived in late 2017 and caught everyone's attention. A new tax! Everything in CFC-land became vastly more complicated.

The Tax Cuts and Jobs Act promised a new, modern, efficient "territorial" tax system.

Yet we practitioners quickly determined that the whole mess -- "Global Intangible Low-Taxed Income" and the collateral damage to earnings and profits tracking, foreign tax credits, etc. etc. -- was . . . well, let's not use potty-mouth words, now, Phil.

But did we ever stop to think about why IRC §951A exists?

No. We just put our heads down and got to work, trying to make sense of the myriads of details and requirements imposed by the new law.

Second-order effects

Sometimes, though, it helps to understand motivations. Why does Congress pass the laws that we wrangle with?

Understand motives, and you understand actions. You may not like the actions, but you can understand them.

Congress did not write the TCJA with IRC §951A as its centerpiece – with the primary purpose of generating tax revenue.

Congress wrote IRC §951A to solve a problem created elsewhere in the TCJA, by IRC §245A's dividend-received deduction.

Congress created an incentive for U.S. multinationals to move assets and business operations abroad -- "base erosion", as the tax wonks call it. IRC §951A is one of several Code sections enacted to discourage base erosion behavior by taxpayers.

The old "worldwide" tax system: incentives

Until 2017 and the Tax Cuts and Jobs Act, we had a "worldwide" tax system for corporations. U.S. corporations were taxed on profits of foreign subsidiaries, with a foreign tax credit. Tax on foreign profits was deferred until the profits were repatriated. (Ignore Subpart F for the purposes of this discussion).

Charlie Munger famously bangs on about incentives.

Well, tax law creates incentives.

The old pre-TCJA worldwide system did two things:

  1. U.S. multinationals had an incentive to defer repatriation of profits. It's a present value/future value game: the present value of a tax liability paid 20 years from now is $peanuts.
  2. Corporate inversions became a thing. U.S. corporations would reorganize to become foreign corporations.

Furthermore, the worldwide tax system put U.S. multinationals at a competitive disadvantage compared to their foreign multinational peers, who operated under territorial tax systems in their home countries.

There were a variety of piecemeal efforts to solve these problems. None were terribly successful.

The new "territorial" tax system

The old system ("worldwide" taxation) was residence-based. U.S. corporations were taxed on worldwide income of their foreign subsidiaries. The big game we played was "When is it taxable?"

The new system we live with now is a "territorial" system. It is source-based. If the foreign corporation's source of income is from outside the United States, the income is not taxable at all, even when paid by dividend to the U.S. shareholder. The answer to "when?" is "never".

That's the Platonic ideal of how a territorial tax system works.

Our incarnation of a territorial tax system (like almost every other country's) is a hacky mess of rules that take us ever further from God's grace and the Platonic ideal. Tax policy wonks (of which I am assuredly not one) call this a "hybrid" territorial tax system. Fine. We will live with the imperfect.

Go with the general idea that fundamentally we have a territorial tax system with a myriad of hacks to reduce taxpayer exploits to an acceptable level.

IRC §951A is one of those hacks.

How Congress created the territorial tax system

Here is the direct linkage between tax policy and legislation. The wonks, staffers, and bureaucrats spout off about "territorial tax systems" but how did they actually do it?

By enacting IRC §245A.

IRC §245A(a) In general. In the case of any dividend received from a specified 10-percent owned foreign corporation by a domestic corporation which is a United States shareholder with respect to such foreign corporation, there shall be allowed as a deduction an amount equal to the foreign-source portion of such dividend.

Emphasis added.

A dividend is a distribution received from the earnings and profits of a corporation. IRC §316(a).

Assume a CFC distributes all of its earnings and profits to a domestic corporation shareholder. The U.S. corporation receiving the dividend would have no taxable income because the dividend income is offset by a dividend-received deduction.


ParentCo owns 100% of ForeignSub. ForeignSub has $1,000 of foreign source current year earnings and profits from active business operations.

ForeignSub makes a distribution of $1,000 to its sole shareholder, ParentCo. The distribution is a dividend because it is a distribution of earnings and profits to the shareholder. ParentCo has dividend income of $1,000.

However, IRC §245A grants ParentCo a dividend-received deduction of $1,000. Therefore, ParentCo’s taxable income is $0, and it has $1,000 cash in the bank.

The territorial tax system encourages "base erosion"

The territorial tax system creates an incentive for U.S. multinationals to move income-producing assets and business activities offshore, to a foreign subsidiary, to achieve that magic zero taxable income number.

  • A dollar of foreign-source profit earned by a U.S. corporation is subject to income tax at 21%.
  • A dollar of foreign-source profit earned by that U.S. corporation's a foreign subsidiary would be taxed at 0% because of the dividend-received deduction.

Moving assets and business operations (hint: jobs) out of the United States means that the stuff readily available in the United States to be taxed -- the "tax base" -- is eroded by the flow of assets and jobs overseas.

"Base erosion" is what Congress calls it. And something, says Congress, must be done to prevent base erosion. (Meaning, in plain terms, moving assets and moving business processes to jurisdictions outside the United States where they are out of reach of the U.S. tax system).

Enter IRC §951A.

By raising the tax rate on foreign profits to an effective rate greater than 0%, there is less incentive to move assets abroad and erode the tax base.

Put another way: the bigger the difference between the U.S. income tax on foreign profits earned by foreign corporations and U.S. income tax on foreign profits by domestic corporations, the less likely domestic corporations are to commit acts of base erosion.

IRC §951A makes some foreign-source profits of CFCs taxable at 0%, and some foreign-source profits taxable at 21%. (Yes I know that IRC §250(a) functionally cuts that tax rate in half. We're talking about why IRC §951A exists at all--not the effect of its application on the tax liability of the U.S. shareholder).

IRC §951A make base erosion behavior less profitable for taxpayers.

How IRC §951A discourages base erosion

The territorial tax system (as created by the dividend received deduction of IRC §245A) creates the incentive to move assets outside the United States to create tax-free income. See Diagram 1, above.

IRC §951A makes the CFC's earnings and profits partly taxable.

A CFC's net income is run through several filters, and a remainder amount is classified as "tested income". IRC §951A(c)(2)(A). In my example, let's arbitrarily assume the CFC has $3,000 of tested income.

Tested income is then further divided into two parts. IRC §951A(b)(1).

  • Global Intangible Low-Taxed Income; and
  • Net Deemed Tangible Income Return.

The method for allocating tested income between the two parts is an arbitrary exercise of basic arithmetic. Compute Net Deemed Tangible Income Return using the formula in IRC §951A(b)(2) and subtract the result from tested income. The remainder is Global Intangible Low-Taxed Income.

In my example let's pretend that the result of the math is $1,000 of Net Deemed Tangible Income Return and $2,000 of Global Intangible Low-Taxed Income.

All $3,000 of tested income is paid as a dividend to the U.S. shareholder.

The $1,000 portion of the dividend income that is allocable to Net Deemed Tangible Income Return is offset by the IRC §245A dividend-received deduction, so the U.S. shareholder has zero taxable income attributable to the $1,000 foreign profit that generated the dividend income. Net Deemed Tangible Income Return is not included in gross income of the U.S. shareholder directly.

The $2,000 portion of tested income that is Global Intangible Low-Taxed Income is included in the gross income of the U.S. shareholder. IRC §951A(a). That creates an income tax liability.

Then the $2,000 portion of the $3,000 dividend that is allocable to Gross Intangible Low-Taxed Income is received but excluded from gross income of the U.S. shareholder by IRC §959.

End result: $3,000 cash received by the U.S. shareholder, and only $2,000 of gross income subject to tax.

These two elements of the CFC's tested income (let's use the technical equivalent "earnings and profits" to make the idea clear) are subjected to tax treatment under the two systems.

  • Global Intangible Low-Taxed Income is taxed using the "worldwide" tax system we have always known and loved. The CFC's earnings and profits (of which Global Intangible Low-Taxed Income is a part) are included in the U.S. shareholder's gross income by IRC §951A(a), creating tax liability at the shareholder level.
  • Net Deemed Tangible Income Return is taxed using the philosophy of the "territorial" tax system. The earnings and profits from this component of the CFC's income are not included in the gross income of the U.S. shareholder by IRC §951A(a), and the dividend income received by the shareholder is offset by a 100% dividend-received deduction. IRC §245A(a).

That second part – the treatment of Net Deemed Tangible Income Return – delivers on the promise of the territorial tax system. The CFC's foreign-source income that is totally and forever exempt from U.S. income taxation when distributed to the U.S. shareholder.

The first part – the Global Intangible Low-Taxed Income – is the disincentive designed to discourage taxpayers from engaging in random acts of base erosion.


So that is how tax policy implemented:

  1. See a problem: U.S. multinationals are noncompetitive against their peers because of U.S. tax policy, and undesirable multinational behavior (leaving foreign profits offshore) needs to be corrected.
  2. Have a clever idea. Decide to solve the problem with a brand new tax philosophy: territorial taxation. All the cool kids (other countries) are doing it, so USA should, too. (Here's your first clue that the train is going off the rails; cf. N. N. Taleb and his concept of "Lindy".)
  3. Pass a law. Put the territorial taxation system into practice with a dividend-received deduction at IRC §245A.
  4. Oops -- collateral damage. As you're doing this, realize that you solved those problems but created a new problem: the base erosion problem.
  5. Anti-oops. Solve the base erosion problem by implementing IRC §951A.

There are plenty of other anti-oops provisions that were passed in the TCJA -- FDII, BEAT, damage control to the foreign tax credit rules, etc.

Moral of the story: when you're solving a tax problem and you're getting confused by the details, zoom out. Find the original cause of the problem (in our case, IRC §245A). Then you will be able to see how your details fit into the big picture.

For the longest time I loathed IRC §951A because it made no sense. I perceived it as a pure money grab by Congress: "we want moar taxes". I thought IRC §965's transition tax as the initial motivator and IRC §951A as the continuation of that tax grab was the real reason that we got the international tax law changes in the TCJA.

And using that lens I couldn't make sense of it. I was just a blind monkey doing math that Congress told me to do, the way they told me to do it.

Once I zoomed out and saw IRC §951A as a "finger in the dike" move by Congress to solve a future revenue leak caused by base erosion, it started to make more sense.

I still don't like IRC §951A and its gratuitous and arbitrary complexity, but I understand it now.