In depth

Section 245A, which was enacted as part of the Tax Cuts and Jobs Act (TCJA) in 2017, allows US parent companies to deduct a 100-percent foreign-source portion of dividends from certain foreign corporations in which they own at least 10 percent (hereinafter referred to as "SFCs") and satisfy certain other requirements. In the Letter Ruling, the IRS addressed a taxpayer-specific fact pattern involving a domestic corporation ("Parent") that indirectly owned a foreign subsidiary ("Foreign Sub 1"). Foreign Sub 1, in turn, owned another foreign subsidiary ("Foreign Sub 2") as well as several controlled foreign corporations (CFCs). Foreign Sub 1 incurred a loss as a result of a business divestiture and had a corresponding E&P deficit. Subsequently, Foreign Sub 2 liquidated into Foreign Sub 1, which was subject to section 332 ("Foreign Sub 2 Liquidation"). Under section 381(c)(2)(B) and Reg. § 1.367(b)-7(e)(2)(iii), in the case of a section 381 transaction such as a section 332 liquidation, an E&P deficit in one of the parties to the transaction can be used only to offset E&P accumulated after the date of transaction (a "hovering deficit"). The taxpayer sought a ruling on the following proposed transactions undertaken pursuant to a "single, integrated plan":

1. The CFCs owned by Foreign Sub 1 will pay dividends to Foreign Sub 1; and
2. Foreign Sub 1 will pay a dividend to the US group, including Parent.

The IRS explained that, under the Reg. § 1.367(b)-7 rules, any hovering deficit offsets only post-transaction earnings accumulated by the foreign surviving corporation in the same separate category of E&P to which the relevant portion of the hovering deficit is attributable, and therefore post-transaction earnings do not include E&P that are earned after the section 381 transaction but distributed or deemed distributed in the same year they are earned. Based on the taxpayer's facts as well as the taxpayer's representations, the IRS ruled that the Foreign Sub 1 hovering deficit is not taken into account in computing Foreign Sub 1's undistributed earnings, and, therefore, its undistributed foreign earnings, for purposes of section 245A.

Conclusion

The Letter Ruling's conclusion is a taxpayer-favorable result and reflects the technical application of the hovering deficit rules. Although private letter rulings are nonprecedential, taxpayers with similar facts nevertheless can take some comfort from the IRS's confirmation of the application of the hovering deficit rules in the section 245A context.¹ Critically, however, one of the representations made by the taxpayer was that the Foreign Sub 2 Liquidation was not related to, nor was it part of a plan including, the proposed transactions.

1 In Hanover Bank v. Commissioner, the Supreme Court stated, "[a]lthough the petitioners are not entitled to rely upon unpublished private rulings which were not issued specifically to them, such rulings do reveal the interpretation put upon the statute by the agency charged with the responsibility of administering the revenue laws." 369 U.S. 672, 686 (1962).