How the OBBBA Modified the CFC Pro Rata Share Rules

On July 4, 2025, the “One Big Beautiful Bill Act” (“OBBBA”) became law. The OBBBA made significant changes to a number of international tax laws. One international tax provision that was changed by the OBBBA was the controlled foreign corporation (“CFC”) “pro rata share” rule. The OBBBA significantly modified the “pro rata share” method used to determine a US shareholder’s Subpart F and/or CFC Tested Income (“NCTI”) with respect to a CFC. This article discusses the changes the OBBBA made to the “pro rata share” rules.

Introduction

The Revenue Act of 1962 adopted the mechanism of taxing U.S. shareholders on their pro rata shares of CFC’s undistributed income as if those shares of income had been distributed as dividends.

Definition of U.S. Shareholders and CFC

Section 957(a) of the Internal Revenue Code defines a “controlled foreign corporation” (“CFC”) as a foreign corporation of which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned, directly, indirectly or constructively under the Section 958 ownership rules, by “U.S. shareholders” on any day during the foreign corporation’s tax year. Internal Revenue Code Section 951(b) defines a “U.S. shareholder” as a U.S. citizen, resident alien, corporation, partnership, trust or estate, owning directly, indirectly or constructively under the ownership rules of Section 958, ten percent or more of the total combined voting power of all classes of stock of a foreign corporation. Only those U.S. shareholders owning ten percent or more of the voting power are taken into account in determining whether a foreign corporation is a CFC.

U.S. Shareholder of CFCs Inclusion of E&P Before OBBBA

Prior to the enactment of the OBBBA, if a a foreign corporation was a CFC at any time during any taxable year, every person who was a U.S. shareholder (as defined in Section 951(b)) of such corporation and who owned (within the meaning of Section 958) stock in such corporation on the last day , in such year, on which such corporation was a CFC was required to its gross income, for its taxable year in which or with which such taxable year of the corporation ends: 1) its pro rata share of the corporation’s Subpart F income; and 2) the amount determined under Section 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under Section 959(a)(2)).

Each U.S. shareholder of the corporation (as defined in Section 951(b)) was required to include in gross income a pro rata share of the corporation’s Subpart F income. The U.S. shareholder’s pro rata share was determined with reference to the percentage of the corporation’s stock owned by the shareholder. In addition, if the U.S. shareholder acquired CFC stock during the year, the pro rata share was reduced by a portion of the dividends paid to the shareholder’s predecessor in interest during the year. IRC Sections 951(a)(1) and (a)(2). Similar pro rata share rule calculations of U.S. shareholders applied to Global Intangible Low-Taxed Income (“GILTI”) inclusions.

U.S. Shareholder Inclusion of E&P After OBBBA

Under the new OBBBA rules, the so-called “Last Day Rule” is replaced by a hypothetical distribution approach. Under the hypothetical distribution approach, a U.S. shareholder’s pro rata share of a CFC’s Subpart F income for such taxable years is the amount that is “attributable to” (1) the stock of such corporation owned, directly or indirectly, by the U.S. shareholder based on an “ownership-based test;” and (2) any period of the CFC’s taxable year during which any stock is so owned by the U.S. shareholder, such U.S. shareholder was a U.S. shareholder of such CFC, and U.S. shareholder was a U.S. shareholder of such CFC, and such corporation was a CFC. This is known as the “time-based test.” Thus, a U.S. shareholder’s pro rata share of a CFC’s Subpart F income for a CFC year is the portion of the income attributable to:

(A) the stock of such corporation owned (within the meaning of Section 958(a)) by such shareholder, and

(B) Any period of the CFC year during which (i) such shareholder owned (within the meaning of Section 958(a))) such stock; (ii) such shareholder was a U.S. shareholder of such corporation; and (iii) such a foreign corporation was a CFC.

Any amount required to be included in gross income by a U.S. shareholder with respect to a CFC year shall be included in gross income for the shareholder’s taxable year which includes the last day on which the shareholder owns (within the meaning of Section 958(a) stock in the CFC during such CFC year.

The OBBBA enacted a transition rule for the 2025 tax year to bridge the pre-OBBBA rules  to the new time and ownership based rule. Under the transition rule, a dividend paid (or deemed paid) by a CFC shall not be treated as a dividend for purposes of applying Section 951(a)(2)(B) of the Internal Revenue Code if:

(A) such dividend (i) was paid (or deemed paid) on or before June 28, 2025, during the taxable year of such CFC which includes such date and the U.S. shareholder described in Section 951(a)(1) did not own (within the meaning of Section 958(a)) the stock of such CFC during the portion of such taxable year on or before June 28, 2025, or (ii) was paid (or deemed paid) after June 28, 2025, and before such CFC’s first taxable year beginning after December 31, 2025, and

(B) such dividend does not increase the taxable income of a United States person that is subject to federal income tax for the taxable year (including by reason of a dividends received deduction, an exclusion from gross income, or an exclusion from Subpart F income).

The new pro rata share rule was enacted to minimize or prevent the double non-taxation of mid-year CFC shares. The Transition Rule accomplishes this by increasing the amount of Subpart F and GILTI that is included by the U.S. shareholder that owns, directly or indirectly, stock of a CFC on the last day of such CFC’s taxable year when certain mid-year sales have occurred. The post-2025 pro rata share accomplishes this by ensuring that all U.S. shareholders include their pro rata share of Subpart F income and NCTI for a taxable year, even if they do not own, directly or indirectly stock in the CFC on the last day of its taxable year. The OBBBA’s enactment of the “attributable to” and NCTI rules represents a major step towards a system of flow-through for international taxation rather than anti-deferral. The OBBBA’s pro rata share rules align with a flow-through tax regime in that Subpart F and NCTI inclusions are now includable throughout a taxable year rather than just the last-day of a U.S. shareholder.

Conclusion

The OBBBA modifies the “pro rata share” rules that determine the amount of Subpart F or NCTI a US shareholder must include with respect to a CFC. Prior to the enactment of OBBBA, a US shareholder included its pro rata share of Subpart F income and/or tested income to the extent it held stock in the CFC on the last day of the year. Expect the IRS and Treasury Department to issue regulations in the future clarifying the new “pro rata share” rule codified in the OBBBA. Under the OBBBA rules, a U.S. shareholder that owns stock of a CFC at any time during a year may have a Subpart F or NCTI taxable inclusion.

Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony has advised various Fortune 500 companies and large privately held businesses in their cross-border tax planning. Anthony is a frequent author and speaker on international tax topics.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.