The Deemed Dividend Problem Revisited

Abstract

Since 1962, the United States has taxed some of the foreign source income earned overseas by foreign subsidiaries of US-based multinationals. However, as a technical matter, the US does not tax these subsidiaries (controlled foreign corporations, or CFCs) directly. 2 Instead, under IRC section 951(a), the "United States shareholder" of a CFC is taxed on the CFC's "Subpart F income" as if it were a dividend distributed to it on the last day of the CFC's taxable year. Such a deemed dividend carries with it indirect foreign tax credits (IRC sec. 960) and the related earnings and profits of the CFC are not taxed again upon actual distribution (IRC sec. 959). This approach was retained for the global intangible low-taxed income (GILTI) tax adopted in 2017, which taxes currently income of CFCs above a 10% return on tangible assets. This deemed dividend approach was adopted in 1962 because it was successfully used previously for foreign personal holding companies (IRC sec. 551, enacted in 1937 and repealed in 2004) and because of doubts about the ability of the United States as a jurisdictional matter to tax directly non-residents on foreign source income. However, these doubts have since been resolved, and the IRS now believes it has the authority to tax foreign corporations controlled by US residents directly on foreign source income. Moreover, the deemed dividend approach has led to significant complexity and given rise to tax planning opportunities. Thus, this column argues that the deemed dividend approach in Subpart F and GILTI is obsolete and should be abandoned in favor of direct taxation of CFCs on whatever Congress determines is the appropriate scope of Subpart F income.