Today’s post is a followup to the (last post), about a US citizen who owns shares of a fiscal year foreign corporation that is subject to the new deemed repatriation rule of section 965. Here is the setup:
I am a US citizen reporting on a calendar year. I have a foreign corporation with a fiscal year ending June 30. When am I subject to the repatriation tax? What is the rate of tax?
In the last post, I wrote that this corporation may be subject to section 898, which forces certain CFCs to conform to its shareholder(s) tax year. For example, if a US citizen is the sole shareholder of a foreign corporation, then the foreign corporation is forced to use the calendar year, even if it keeps account on a fiscal year. In this situation, the US citizen has income under section 965 in 2017 instead of 2018.
Several responses to the newsletter points to a proposed regulation that provides an exception to the conformity rule:
A specified foreign corporation is not required to conform its taxable year to the required year so long as its United States shareholders do not have any amount includible in gross income pursuant to section 951(a) and do not receive any actual or deemed distributions attributable to amounts described in section 553 with respect to that corporation. Prop. Treas. Reg. §1.898-1(c)(1).
What this exemption says is that if no US shareholder of a foreign corporation has ever included income from the foreign corporation as a result of subpart F rules or foreign personal holding company rules, then the foreign corporation does not need to conform to the US shareholder(s) tax year.
Under this proposed regulation, and assuming the foreign corporation never had subpart F income and never was a foreign personal holding company, the foreign corporation would have a tax year equal to its fiscal accounting period. This means the US citizen has income under section 965 in calendar year 2018, not 2017.
A proposed regulation is a substantial authority construing a statute. Usually you can rely on its being correct and avoid negligence and substantial understatement penalties. Reg. §1.6662-4(d)(3)(iii). The exception, of course, is if there is stronger authority indicating that the proposed regulation is not correct (for example, the Code, a temporary regulation, or a final regulation).
Section 898(c)(1) says this:
The required year is–
(A) the majority U.S. shareholder year, or
(B) if there is no majority U.S. shareholder year, the taxable year prescribed under regulations.
The statutory language here is quite clear: If there is a majority US shareholder year, then that is the tax year. If there is not one, then follow the regulations. By the text of the statute, the IRS lacks regulatory authority to prescribe a tax year when there is a majority US shareholder year.
But remember the normal rules for the tax year under section 441(b)
For purposes of this subtitle, the term “taxable year” means–
(1) the taxpayer’s annual accounting period, if it is a calendar year or fiscal year;
The statutory language here is quite clear as well: If the taxpayer has a fiscal year accounting period, then the accounting period is the tax year.
It is normal for an administrative agency’s regulations to resolve conflicting statutory commands. So our readers probably are correct, and my last post was not: We can rely on the proposed regulation and use the fiscal year, leading to deemed repatriation in 2018.
What happens if a section 898 corporation uses a fiscal year for several years, then a US shareholder has inclusion of income? The proposed regulation tells us the solution:
Once any United States shareholder of that specified foreign corporation has any amount includible in gross income pursuant to section 951(a) or receives any actual or deemed distributions attributable to amounts described in section 553 with respect to that corporation, then the specified foreign corporation must comply with section 898 and §§1.898-3 and 1.898-4 beginning with its first taxable year subsequent to the taxable year to which that shareholder’s income is attributable. Prop. Reg. §1.898-1(c)(1).
In our hypothetical, the first year in which subpart F inclusion under section 951(a) happens is the fiscal year ending 2018-06-30, because section 965’s deemed repatriation works by increasing subpart F income. IRC §§965(a), 951(a).
For the first subsequent taxable year, the foreign corporation must conform to its majority US shareholder year. This means it will have a short tax year from 2018-07-01 to 2018-12-31, then use the calendar year starting 2019.
The IRS can change the rules with another proposed regulation, but at least for now, we would expect a switch to the calendar year.
Disclaimer: This article is not legal or tax advice. You cannot use it to avoid penalties or for promotional purposes. Hire help.