In the Revenue Reconciliation Act of 1993, Congress expanded the antideferral regime of subpart F by amending the ordering rules of Sec. 959, Exclusion from Gross Income of Previously Taxed Earnings and Profits. The new ordering rules can have a significant effect on year-end planning for controlled foreign corporations (CFCs), as CFC shareholders can unwittingly trigger double income recognition in the year of a distribution.
New Sec. 959(f)(2) requires current-year distributions, and their effects on earnings and profits (E&P), previously taxed income (PTI) and any other item, to be taken into account before the determination of income includible under Sec. 951(A)(1)(B) and (C) - otherwise known, respectively, as Sec. 956 (Investment of Earnings in U.S. Property) and Sec. 956A (Earnings Invested in Excess Passive Assets) inclusions. The subpart F inclusions provided for under Sec. 951(a)(1)(A) continue to be taken into account before distributions. The amendment applies to CFC tax years beginning after Sept. 30, 1993, and to the tax years of their U.S. shareholders in which or with which such CFCs' tax years end. Prior to the amendment, a CFC would determine the character of distributions after all current-year income inclusions (if any) had been determined under Sec. 951(a).
Generally stated, the amendment prevents a CFC from classifying a current-year Sec. 956 or 956A inclusion as PTI for purposes of current-year distributions. The new rules may thus accelerate the recognition of income when a CFC has current Sec. 956 and 956A inclusions and makes an actual distribution to its U.S. shareholders. The following example illustrates the effects of the new ordering rules.
Example: CFC, in year 1, generates $200 in non-subpart F operating income ("good income") and makes an investment in U.S. property of $100. In the same year, CFC distributes $100 to its U.S. parent, P. Under old law, P recognized $100 of income from CFC in year 1, while under new law P recognizes $200. Old law: Sec. 956 is applied before the character of the distribution is determined. Thus, P has...