PLR 202304008: Taxpayer Does Not Have Section 961(b)(2) Gain for Mid-Year Distributions
Introduction to Section 961 and Mid-Year Distributions
For years, there has been a longstanding question under the subpart F rules on whether a controlled foreign corporation’s (“CFC”) mid-year earnings could be taken into account in determining section 961 basis adjustments with respect to a mid-year distribution of current year earnings to a U.S. shareholder. If a CFC distributed earnings in excess of its U.S. shareholder’s section 961(a) basis in the CFC, the distribution would trigger gain under section 961(b)(2). As a result, U.S. parented groups with CFCs were limited in the amount of current year earnings that could be distributed to avoid triggering non-economic section 961(b)(2) gain as a result of basis adjustments. In PLR 202304008, the IRS confirmed that, at least in the case of the taxpayer that submitted the PLR, mid-year earnings could be taken into account when determining a section 961(b) basis reduction. The ruling is consistent with how many international tax practitioners viewed these rules. Below, we discuss the basics of section 961 as well as the facts and ruling of PLR 202304008.
Section 961 Basis Adjustments
In a U.S. parented group with CFCs, the rules under sections 951-965 (i.e., subpart F), require each U.S. shareholder of a CFC to currently include in income its pro rata share of the CFC’s subpart F income for the tax year. Thus, when a CFC generates earnings, the U.S. shareholder of that CFC must include its pro rata share of such amounts in income. A related and important component of these rules is that under section 961(a), a U.S. shareholder is required to increase its basis in the stock of the CFC by the amount that the U.S. shareholder is required to include in income under section 951(a) with respect to such CFC stock. Similarly, under section 961(b), if a U.S. shareholder receives an amount which is excluded from gross income under section 959(a) (i.e., previously taxed earnings and profits (“PTEP”)), the U.S. shareholder is required to reduce its adjusted basis in the stock of the CFC. Typically, this involves a distribution of PTEP.