International Tax Considerations for Distributions From Foreign Corporations

At a glance:

• The Main Takeaway: U.S. taxpayers who are repatriating cash from foreign operations must appropriately consider complex federal international tax requirements.
• Impact on Your Business: There are important considerations taxpayers should think through before starting the repatriation process to ensure they don’t have an unexpected material tax consequence.
• Next Steps: Enlist the help of an international tax expert to navigate the repatriation process and ensure you don’t make any mistakes.

Schedule a consultation with Aprio today.

The full story:

At some point, taxpayers in the United States may need to repatriate cash from foreign operations — whether it is due to COVID-19, general business purposes (i.e., mergers and acquisitions, capital expenditures, debt servicing, etc.), or other operational liquidity and cash flow needs.

There are some key federal international tax issues that taxpayers need to consider before they start the repatriation process. Let’s dive into some of the most pertinent considerations below.

Characterize relevant earnings and profits and the distribution

When a wholly owned foreign corporation — also known as a controlled foreign corporation (CFC) — makes a distribution to its U.S. shareholder, it needs to determine the nature and character of that distribution. To do so, it should determine if the CFC has any earnings and profits (E&P), as well as the character of the E&P. Assuming an amount of E&P exists, a distribution is generally sourced from the CFC in the following order:

1. Previously taxed E&P (PTEP);
2. Not previously taxed E&P (non-PTEP);
3. Return of capital; and finally,
4. Capital gain.

Distributions of PTEP

PTEP refers to the E&P of a CFC attributable to income that has already been included in the gross income of a U.S. shareholder. Generally, PTEP distributions to a CFC’s U.S. shareholder are excluded from the shareholder’s gross income, avoiding double taxation. In addition, upon a distribution of PTEP, a U.S. shareholder must reduce its basis in its CFC stock by the amount of that distribution. To the extent a PTEP distribution exceeds stock basis, the excess amount is treated as a gain from the sale or exchange of property (i.e., a capital gain). Consequently, a U.S. shareholder should ensure that it has sufficient basis in its CFC stock prior to a PTEP distribution.

Further, a U.S. shareholder will typically recognize a foreign currency exchange gain or loss on a PTEP distribution. A foreign currency gain or loss with respect to a PTEP distribution is attributable to the movement in exchange rates from the date the PTEP was included in the U.S. shareholder’s gross income and the date of the distribution. The foreign exchange gain or loss is recognized by the U.S. shareholder as ordinary income.

Distributions of non-PTEP

Non-PTEP refers to the E&P of a CFC that has not been included in a U.S. shareholder’s gross income. To the extent that the distribution is treated as a distribution of non-PTEP, corporate U.S. shareholders may be eligible for a 100%-dividends-received deduction if they meet all requirements (i.e., a one-year holding period with respect to stock). This deduction is not available to individual shareholders and subchapter S corporations. Individual U.S. shareholders should determine if they qualify for favorable qualified dividends tax rates on a distribution of non-PTEP.

Return of capital distributions and recognition of capital gain

A distribution from a CFC characterized as a return of capital is not a taxable event to the recipient U.S. shareholder. However, a U.S. shareholder should proceed with caution to the extent it holds various blocks of stock in the CFC at a different average basis per share. While the U.S. shareholder may have an aggregate basis in its stock in an amount greater than the amount of the distribution, low average basis stock blocks can result in unexpected capital gain recognition (as noted below).

If a distribution exceeds the amount of non-PTEP and the U.S. shareholder’s basis in its CFC stock, the excess is recognized by the U.S. shareholder as a capital gain.

Foreign withholding taxes

In many instances, distributions received by U.S. shareholders from CFCs may not be subject to federal income tax, but the foreign withholding tax consequences of any distribution should be considered as well. In many cases, the U.S. may have an in-force tax treaty with the CFC’s country of residence, which could reduce or otherwise eliminate the amount of a foreign withholding tax on a distribution. Even in the event of a foreign withholding tax, a U.S. shareholder should determine if, and to what extent, those foreign withholding taxes are creditable against its U.S. federal income tax liability.

The bottom line

Of course, further complexities can arise outside the scope of what we have covered in this article. Businesses should potentially account for situations in which a distribution is made by a first-tier CFC which holds lower-tier CFCs, is made through a chain of CFCs to a U.S. shareholder, or is made from a branch held by the U.S. shareholder. Finally, businesses should also consider the state and local tax impact of any repatriation.

Related Resources

• About Aprio’s International Services
• IRS Final Regulations on Foreign Tax Credits: New Compliance Headaches
• Top 5 Things You Need to Know About the Business Interest Deduction Limitation and Controlled Foreign Corporations

If you have questions or need assistance while navigating this process, contact Aprio today.