Look out for Sec. 956 inclusions.

Author:Pasmanik, Philip T.


* Be aware of the types of U.S. property that can give rise to Sec. 956 deemed income inclusions.

* Besides direct ownership of U.S. property, a controlled foreign corporation (CFC) might have indirect ownership as a partner of a partnership.

* Learn how a domestic corporation can benefit from a deemed foreign tax credit for foreign taxes paid by a foreign corporation of which the domestic corporation owns 10% or more of the voting stock.

Sec. 956 results in an income inclusion to a U.S. shareholder of a controlled foreign corporation (CFC) that invests in U.S. property. Sec. 956 works as a two-edged sword that can be effectively used by both the IRS and a taxpayer. For the IRS it provides a tool for taxing U.S. shareholders on a CFC's earnings even when the CFC does not distribute the earnings to its shareholders. Sec. 956 generally applies where a CFC makes certain investments in US. property.

Conversely, a U.S. shareholder may, through tax planning, cause a CFC to make such an investment. This investment may implicate Sec. 956, which may permit the U.S. person to claim a credit for foreign taxes paid by the CFC to offset the tax generated by the income inclusion.

Taxpayers who are not aware of this provision or who do not plan carefully to avoid the traps may find themselves in unexpected tax situations and subject to IRS challenges. So a caution to the unwary--be aware of Sec. 956. It is one of the more complex aspects of CFC tax law.

This article is intended to provide an introduction to Sec. 956 inclusions and is not all-inclusive with respect to the technical aspects of the statute and regulations.


Sec. 951 requires certain U.S. shareholders of CFCs to include in gross income the amount of the CFC's earnings invested in U.S. property, but only to the extent such earnings have not been previously included in a U.S. shareholder's income under Sec. 951(a). (1) A CFC is any foreign corporation of which more than 50% of the total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of its shares is owned by U.S. shareholders. Pursuant to Sec. 951(b), a U.S. shareholder is a U.S. person who owns, actually or constructively, 10% or more of the total combined voting power of all classes of voting stock of the foreign corporation. (2) A further discussion of Subpart F inclusions under Sec. 951 is beyond the scope of this article.

The amount of a deemed income inclusion pursuant to Sec. 956, with respect to any U.S. shareholder, is the lesser of:

* The excess, if any, of the U.S. shareholder's pro rata share of the average of the amounts of U.S. property held, directly or indirectly, by the CFC as of the close of each quarter of such tax year, over the amounts of earnings and profits previously included pursuant to Sec. 956; or

* The U.S. shareholder's pro rata share of the CFC's current and accumulated earnings and profits (but not reduced by a deficit in accumulated earnings and profits), reduced by distributions during the year and any amounts previously included under Sec. 951(a)(1)(B). (3)

Example: USP owns all of the stock of CFC, which is a calendar-year taxpayer. During 2016, CFC has $100 of Subpart F income and $150 of earnings and profits (and no previously taxed income (PTI) from prior years). CFC makes an investment in U.S. property during January 2012 in the amount of $125. Under the Subpart F provisions, only $100 of the $150 of the earnings and profits would be includible in income, which causes the investment in U.S. property to be reduced by $100, resulting in an additional inclusion of $25.

What is U.S. property?

"U.S. property" means any property acquired after Dec. 31, 1962, that is:

* Tangible property located in the United States;

* Stock of a domestic corporation;

* An obligation of a U.S. person (including certain pledges or guarantees of such obligations); and

* Any right to use in the United States a patent or copyright; an invention, model, or design; a secret formula or process; or any other similar property right that the CFC acquires or develops for use in the United States. (4)

U.S. property for this purpose does not include: (5)

* U.S. government obligations, money, or deposits with:

** (1) Any bank (defined by Section 2(c) of the Bank Holding Company Act of 1956 (12 U.S.C. [section]1841(c)), without regard to subparagraphs (C) and (G) of 12 U.S.C. [section]1841(c)(2); or

** (2) A corporation not described in (1) above that is more than 80% owned, directly or indirectly, by vote or value, by a bank holding company. (6)

* Property located in the United States and purchased there for export to, or use in, foreign countries. (7)

* Any obligation of a U.S. person arising in connection with the sale or processing of property if the obligation's outstanding amount during the tax year never exceeds the amount that...

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