December 12th, 2025

The international tax law reforms enacted into law by the TCJA 2017, Pub. L. No. 115-97, and as further preserved and made permanent in the recent One Big Beautiful Bill Act (OBBBA), Pub. L. No. 119-24, reflected the adoption of a territorial-based system for the cross-border income taxation of U.S. companies, including U.S. subsidiaries of foreign corporations. The package of international tax legislation in TCJA 2017 was intended by Congress to remove prior incentives for U.S. corporations to make substantial investments overseas in conducting active business operations. The incentive to invest in the U.S. to conduct active businesses here was enacted into law but at the same time Congress greatly expanded the width and operation of the Subpart F rules under the Code to accelerate US income tax on current period net taxable income derived from active foreign business operations that generated foreign source income that previously was outside the scope of Subpart F. In putting into place this territorial-based system Congress also enacted a "participation exemption" for U.S. shareholders that are domestic corporations owning 10% or more of the stock of a specified foreign corporation (SFC).

These and other international tax reforms introduced in TCJA 2017 were made permanent or otherwise kept in place in the recent One Big Beautiful Bill Act (OBBBA) enacted and signed into law on July 5, 2025. For a summary on the relevant statutory cross border tax provisions involved see August, "One Big Beautiful Bill Act Enacted into Law: Initial Observations on Business and International Tax Provisions", Corporate Taxation (WG&L) Sep/Oct 2025. This post highlights the tax-free dividend rule for U.S. domestic corporations owning stock in a "specified foreign corporation".

Please note that this post in only a summary of the provision which intersects with various other provisions in the Code, including international tax provisions, which renders this provision attractive to enter but difficult to "open the door". This post highlights the "attractiveness" of Section 245A.

Repatriation of Foreign Accumulated Earnings and Profits: Section 965

TCJA 2017 required, however, that a U.S. shareholder's share of CFC foreign accumulated earnings and profits from 1986 through 2017 be included in taxable income in 2017 under Section 965. The included income would be subject to a lower rate of 15.5% for cash or cash equivalent and 8% for other assets of the CFC regardless of whether actual distributions were received. A U.S. shareholder could elect to pay its resulting tax liability on a deferred, rear-end loaded, basis over an eight-year period under Section 965(h). The Supreme Court upheld the constitutionality of the TCJA 2017's repatriation income tax on foreign accumulated earnings and profits under Section 965 in Moore, 602 U.S. 572 (2024), aff'g 36 F.4th 930 (2022), aff'g 2000 WL 6799022 (W.D. Wash. 2020).

US Version of The Corporate "Participation Exemption": Section 245A

Participation Exemption Enjoyed by Foreign Companies in Country of Residence. TCJA 2017 permits certain U.S. corporations owning 10% or more of the stock of a foreign subsidiary to qualify for 100% dividends received deduction (DRD) for dividends sourced from foreign income other than derived by a passive foreign investment company (PFIC) as defined in Section 1297. Countries which have long provided resident holding companies a participation exemption from domestic income taxation of repatriated earnings of a controlled subsidiary include: (1) Austria; (2) Belgium; (3) Ireland; (4) Luxembourg; (5) Malta; (6) Netherlands; (7) Norway; (8) Portugal; (9) Italy; (10) Sweden; and (11) the United Kingdom. Ireland may also enact a dividend participation exemption. In the House Report to TCJA 2017 it was stated that other jurisdictions' enacting a participation exemption for its resident companies work to the prejudice of American workers and companies. The United States is one of the few industrialized nations having a worldwide system of taxation and prior to the TCJA 2017 its corporate income tax rate was among the highest among OECD member countries. The TCJA 2017 House Report continues by noting that this favorable treatment for repatriation of earnings by foreign based companies "provides perverse incentives to keep funds offshore" and defer income tax on foreign based earnings by US corporations until repatriated. The Ways and Means Committee was of the view that a territorial system with anti-base erosion safeguards, plus a lower (21% flat from 35%) corporate income tax rate, would make American workers and companies more competitive and reduce the motivation to defer foreign earnings and profits from U.S. taxation. Of course, Section 951A (global low-tax intangible income) or GILTI (as now amended and change in name to "net FCF tested income") may prevent the deferral of CFCs having active foreign business income that was not otherwise captured under Subpart F and Section 951(a)(1). HR Rep. No. 409, 115th Cong., 1st Sess. 372 (2017). But see Collins, Junge and Zemil "How Congress Ensured Section 245A Applies to 10/50 Dividends to CFCs", Tax Notes (12/12/2024).

A Closer and More Technical Look at Section 245A. The participation exemption is set forth in Section 245A. Section 245A(a), in general, provides where a U.S. domestic corporation (USCorp) receives a dividend sourced from foreign earnings and profits, from a "specified 10% owned foreign corporation (SFCorp) per Section 245A(b), the USCorp is allowed a deduction equal to 100% of such dividend (SFCorp DRD). However, there are limitations and exceptions to this attractive outcome. For example, a Section 245A DRD is not allowed with respect to a "hybrid dividend". Per Section 245A(e), a hybrid dividend in an amount received by a USCorp from a controlled foreign corporation (CFC) for which: (i) a Section 245A deduction would otherwise be allowed; and (ii) the CFC received a deduction or other tax benefit with respect to any income tax imposed by a foreign country or possession of the U.S. Section 245A(e)(4). This situation arises with respect to a debt obligation of the SFCorp (CFC) which it deducts in computing its taxable income in the foreign country in which it resides or maintains a PE. The interest portion of the "dividend" is a hybrid dividend for purposes of Section 245A. See Section 245A(e) ("hybrid deduction account").

Where a domestic (USCorp) corporation which establishes the requisite holding period of stock ownership in a foreign corporation its is permitted to claim a 100% DRD with respect to the “foreign-source portion” of “any dividend received from a specified 10-percent owned foreign corporation.” Section 245A was made effective for distributions made after December 31, 2017. Generally, a specified 10% owned foreign corporation (SFC) under Section 245A is a foreign corporation of which the dividend recipient is a “United States shareholder.” A domestic corporation is a U.S. shareholder if it owns at least 10% of the distributing foreign corporation’s voting stock, directly, indirectly, or constructively. See Section 961(b). Congress intended the phrase “dividend received” to be “interpreted broadly. As discussed below however, a recent Chief Counsel's Memorandum seems to have taken a narrower view of Congress's intent. For example, domestic corporation USC indirectly owns stock of a foreign corporation (FC) through a partnership (USP) and the domestic corporation would qualify for the participation DRD under Section 245A for dividends directly received from FC. Congress intended that the USCorp be allowed a 100% DRD for its distributive share of the dividend from the FC. As to the integration of the dividend rule in Section 78 and Section 245A see Varian Medical Systems, Inc. v. Commissioner, 163 TC No. 4 (2024). No foreign tax credit under Section 901 or deduction for foreign taxes paid is allowed. Moreover, Section 245A does not apply to any hybrid dividend received by a US shareholder.

The foreign-source portion of a dividend that may qualify for the DRD is the amount of the dividend, multiplied by the corporation’s “undistributed foreign earnings” and divided by the corporation’s “total undistributed earnings.” Section 245A(c)(1). A corporation’s “undistributed earnings” are its earnings and profits as of the close of the taxable year during which the dividend is distributed, “without diminution by reason of dividends distributed during such taxable year.” Section 245A(c)(2). See also Section 964(a) (computation of earnings and profits of a foreign corporation). All undistributed earnings are “undistributed foreign earnings,” except (1) amounts subject to U.S. tax as income effectively connected with the conduct of a trade or business in the U.S. subject to U.S. income tax; and (2) dividends from a U.S. corporation at least 80% of the stock of which is owned by the foreign corporation. The dividend from U.S. source income may still be eligible for the 50% or 65% DRD under Section 245 for the U.S. source portion of dividends paid by an SFC. Other applicable rules may affect the outcome in this area with respect to the eligible portion of a foreign dividend under Section 245A. The entire amount of a dividend is considered foreign source where the foreign corporation is not engaged in carrying on a US trade or business and is not a shareholder of a domestic corporation.

Holding Period Requirement. The Section 245A deduction is allowed only if the taxpayer holds the shares for more than 365 days during the 731-day period beginning 365 days before the dividend becomes ex-dividend with respect to the dividend. Section 246(c)(1)(A), 246(c)(5)(A). A day is included in a taxpayer’s holding period for purposes of this rule only if, on that day, the foreign corporation is an SFC, and the taxpayer is a U.S. shareholder of the subject foreign corporation. Section 246(c)(1)(B). Also, the DRD is denied where the taxpayer is under an obligation … to make related payments with respect to positions in substantially similar property when it receives the dividend. Another example is with respect to a U.S. domestic corporation making a qualified electing fund election under Section 1291(d)(2)(B) under the PFIC rules. Section 245A(f) denies a Section 245A deduction for any deemed dividends created by operation of Section 1291(d)(2)(B).

Extraordinary Dispositions and Extraordinary Reductions.

Another limitation that blocks a U.S. domestic corporation owning stock in a SFCorp from "opening the door" to the 100% DRD under Section 245A are the rules contained in the final regulations issued in 2020 with respect to extraordinary dispositions and reductions. An extraordinary disposition occurs where the SFC generates net gains from certain dispositions during the period commencing 1/1/2018 through the close of the SFCorp's last taxable year to which the GILTI provisions do not apply, i.e., during the SFCorp's status as a CFC as well. An extraordinary reduction can occur in any year of a CFC during which, as a result of certain transactions, the ownership interest of a "controlling Section 245A shareholder" (more than 50% ownership of the CFC stock) is reduced by at least 5 percentage points. Where the controlling Section 245A shareholder receives a dividend from the CFC in that year and certain other requirements are met, the extraordinary reduction amount will be no less than the sum of such shareholder's pro rata share of the CFC's subpart F income and net CFC tested income for that taxable year without regard to the relevant transactions. See Reg. Section 1.245A-5.

The "ineligible amount" of any dividend from a SFCorp which would otherwise qualify under Section 245A is: (i) 50% of the dividend's "extraordinary disposition amount"; and (ii) 100% of the dividend's "extraordinary reduction amount". The rationale for these rules is to deny access to Section 245A with respect to certain transactions that result in a step-up in basis or reduction of the controlling Section 245A shareholder's ownership interest in a CFC.

Controlled Foreign Corporations That Are Also Specified Foreign Corporations

There may be overlap for dividends received from a foreign corporation by a CFC and whether Section 245A can still apply to a US shareholder of a SFC or , alternatively, whether the CFC rules override since the dividend would constitute foreign personal holding company income. Where the dividend from a foreign corporation is included in Subpart F income of a CFC it would seem fair that U.S. domestic corporation's pro rata share of such SFCorp dividend should still qualify under Section 245A. While "should" is a good thought, one should also expect having to possibly make some form of disclosure based on "substantial authority" given the government’s recently issued CCA on this subject as is referred to below.

It is most important to recognize that the previously taxed earnings and profits (PTEP) rules of Sections 959 and 961 override application of Section 245A per Section 959(d). Under Section 959(d), PTEP distributions under Section 959(a) or Section 959(b) are not treated as “dividends” for purposes of Chapter 1 of the Internal Revenue Code. Under the passive foreign investment company (“PFIC”) purging distribution rule, any amount that a shareholder of a PFIC has made a qualifying electing fund (“QEF”) election to be treated as a deemed dividend in accordance with Section 1291(d)(2)(B) is not eligible to be treated as a dividend for purposes of Section 245A. See Section 245A(f).

Section 956 income inclusions for investments made by CFCs in the United States, are also not treated as dividends for purposes of the Internal Revenue Code and therefore are not eligible for a Section 245A deduction. The U.S. Treasury has issued regulations under Section 960 (a) providing that no foreign taxes are deemed paid with respect to Section 956 inclusions. See T.D. 9882 (12/17/2019).

Under Section 1248 A U.S. shareholder’s gain on a sale of stock of a CFC is a treated as a dividend for U.S. tax purposes to the extent of the earnings and profits of the CFC (and any lower-tier CFC) attributable to the stock sold for periods while the shareholder sold the stock. Accordingly, the Section 245A deduction may be allowed for such a dividend (a "deemed" Section 1248 dividend). A dividend received deduction may also be allowed to a U.S. shareholder if a CFC sells or exchanges stock of a foreign corporation that it has held for at least a year. Section 1248 is applied to such a sale or exchange as though the CFC were a domestic corporation, any gain on the transaction characterized under Section 1248 as a dividend is considered subpart F income to the extent of the foreign-source portion, and a U.S. shareholder of the CFC must include its ratable share of the subpart F income in gross income and is allowed the Section245A deduction with respect to this income. See Section 964(e). But, as noted above, one must consider the "extraordinary disposition" and extraordinary reduction" limitations imposed on Section 245A.

In December 2024, the IRS released proposed regulations for previously taxed earnings and profits (PTEP). The first set of proposed PTEP regulations (more are expected in the future) address longstanding issues under §959 and §961, as well as new provisions and amendments resulting from the 2017 enactment of the TCJA. The proposed PTEP regulations were highly anticipated because the TCJA effectively expanded the amount of PTEP for most corporate taxpayers with international activity. See August, "Tracking the PTEP Account Footprints of the Controlled Foreign Corporation Monster: the Service Issues PTEP Proposed Regulations", Journal of Corporate Taxation (WG&L) March/April 2025 and Journal of International Taxation (WG&L) Mar/Apr 2025.

While the much await PTEP regulations are still being evaluated in Washington, D.C., the Office of Chief Counsel in CCA Memorandum 202436010 (July 31/2024) recently announced that a CFC is ineligible for a Section 245A DRD. Seems unfair right? Shouldn't a U.S. domestic corporation that is a U.S. shareholder under Section 951(b) of a CFC be allowed to characterize dividends received by the CFC from another foreign corporation that is an SFCorp (but is not a CFC) as being eligible for Section 245A treatment with respect to such U.S. shareholder's pro rata share of the dividend? CCA 202436010 concludes that because the CFC (FC1) owning the stock of the dividend remitting FC2 is neither a domestic corporation nor a U.S. shareholder with respect to FC2, the "analysis of the issued ends there and FC1 is not permitted to benefit from the Section 245A DRD for the dividend from FC2. The CCA continues to address and reject arguments made from the professional community to allow indirect pass through of SFCorp dividends to qualify under Section 245A. Another issue is whether Section 964(e)(4), which applies where one CFC sells the stock of another CFC may recharacterize some or all of the gain as a deemed dividend and therefore may qualify for the Section 245A DRD if the selling U.S. shareholder is a U.S. domestic corporation. This is essentially the same result where a U.S. shareholder selling stock in a CFC includes in gross income its pro rata share of such subpart F income and may be allowed a Section 245A DRD as if such subpart F income were a dividend received by the U.S. shareholder. For excellent discussion on the intersection of Section 245A with Sections 965(e)(4) See Calianno and Dokko, "IRS Slams the Door on Section 245A DRDs for CFCs--But is the Door Truly Shut", Corporate Taxation (WG&L) (May/June 2025).

Comment: Tax professionals looking at the statutory language of Section 245A may, at first blush, consider it easy to "open the door" in claiming the 100% DRD for dividends from SFCorps in advising their clients. While in straight forward situations the "door is open", the width of the provision is far narrower than a literal read of the statute may otherwise suggest. One must go through a gauntlet of limitations and exceptions to determine if the particular dividend qualifies for the 100% DRD under Section 245A. Additional guidance from the U.S. Treasury and Internal Revenue Service in this area is anticipated.

This post is issued by August Tax Law, P.C. solely for informational and educational purposes and may not be used or otherwise relied upon as legal or tax advice by the reader.