TCJA and OBBBA Changes to the Downward Attribution Rules

Under U.S. federal tax law, if a foreign corporation is classified as a “controlled foreign corporation” or “CFC,” special rules apply. Internal Revenue Code Section 957(a) defines a 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. Section 951(b) defines a “U.S. shareholder” as a U.S. citizen, resident alien, corporation, partnership, trust or estate, owned 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. Thus, 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, and a foreign corporation will fall within the definition of more than 50 percent of the total combined voting power of all classes of its stock are owned directly, indirectly or constructively by such ten-percent U.S. shareholders.

In determining whether a U.S. person meets the Section 951(b) definition of a U.S. shareholder and whether a foreign corporation meets the Section 957(a) definition of a CFC, Section 958 applies direct, indirect, and constructive ownership rules to determine stock ownership in the foreign corporation. Stock ownership under all three types of rules counts for purposes of determining whether a shareholder is a “U.S. shareholder” and whether a foreign corporation is a “controlled foreign corporation.’

Section 958(a)(1) provides the direct ownership rules to determine beneficial ownership of shares when a foreign entity is interposed between the U.S. person and the foreign corporation. Specifically, stock of a foreign corporation owned, in turn, by another foreign corporation or by a foreign partnership, trust or estate is deemed to be owned proportionately by the latter’s shareholders, partners or beneficiaries. There is no minimum threshold of ownership interest in the foreign corporation necessary to trigger the application of this indirect ownership rule involving foreign entities.

Section 958(b) applies (with several modifications for Subpart F purposes) the constructive ownership rules of Section 318(a). These constructive ownership rules of Section 318(a) require attribution of stock between certain family members and between corporations, partnerships, trusts and estates, on the one hand, and their shareholders, partners or beneficiaries, on the other hand. In the case of corporation-to-shareholder attribution or shareholder-to-corporation attribution, a minimum threshold of stock ownership must be met for the attribution rule to be applied. See IRC Section 318(a)(2)(C), (a)(3)(C).  The Section 958(b) makes the following modifications to Section 318(a) constructive ownership rules:

1. In applying the entity-to-owner constructive ownership rules in Section 318(a)(2), Section 958(b)(2) provides that if a partnership, estate, trust, or corporation owns more than 50 percent of the combined voting power of a corporation, it will be treated as owning all of the voting stock of the corporation.
2. Section 318(a)(2)(C) treats stock owned by a corporation as owned proportionately by its shareholders, but only if the shareholders meet a minimum threshold of stock ownership in the corporation. Section 958(b)(3) reduces that threshold from 50 percent to ten percent.
3. Section 318(a)(3)(C) requires attribution of stock owned by a partner of a partnership, a beneficiary of a trust or estate or 50-percent-or-more shareholder of a corporation to the partnership, trust, estate or corporation. However, Section 958(b)(4) provides that stock owned by a foreign person (i.e., nonresident alien, individual, foreign corporation, foreign partnership or foreign trust or estate) will not be attributed to a U.S. person under Section 318(a)(3)(C).

Prior to its repeal by the 2017 Tax Cuts and Jobs Act, Section 958(b)(4) provided the following:

Subparagraphs (A), (B), and (C) of Section 318(a)(3) provided the following:

Subparagraphs (A), (B), and (C) of Section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person. The 2017 Tax Cuts and Jobs Act repealed Section 958(b)(4) effective for the last tax year of a foreign corporation beginning before January 1, 2018, and for tax years of U.S. shareholders within which the foreign corporation tax year ends. As a result, many foreign corporations who were not CFCs became CFCs

In repealing Section 958(b)(4), the Senate Finance Committee explained:

“The Committee is aware of certain transactions used to avoid subpart F provisions. One such transaction involves effectuating “de-control” of a foreign subsidiary, by taking advantage of Section 958(b)(4) rule that effectively turns off the constructive stock ownership rules of 318(a)(3) when to do otherwise would result in a U.S. person being treated as owning stock owned by a foreign person. Accordingly, such a transaction converts former CFCs to non-CFCs, despite continuous ownership by U.S. shareholders. The Committee believes this provision is necessary to render de-controlling transactions ineffective as a means of avoiding the subpart provisions.”

The repeal of Section 958(b)(4) was overly broad in application and created unintended “faux CFCs.”

Below, please see the below illustration as an example as to how the Section 958 attribution rules operate after the enactment of the 2017 Tax Cuts and Jobs Act.

For purposes of the illustration, Domestic Sub is a U.S. corporation wholly owned by Foreign Parent and Foreign Sub is a foreign corporation wholly owned by the Foreign Parent. Prior to the 2017 Tax Cuts and Jobs Act, Section 958(b)(4) provided that in applying the constructive “attribution to entity” rules of Section 318(a)(3), stock owned by a non-U.S. person would not be attributed to a U.S. person. The 2017 Tax Cuts and Jobs Act repealed Section 958(b)(4). In this structure, because Foreign Parent owns 100% of U.S. Sub, U.S. Sub is deemed to own the stock that Foreign Parent owns because of downward attribution under Section 318(a)(3)(C). This will trigger a Form 5471 filing requirement for Domestic Sub because Foreign Sub could be treated as a CFC for U.S. tax purposes.

If a foreign corporation is a CFC, special rules apply. If a foreign corporation is classified as a CFC, the U.S. shareholders will be subject to the Subpart F or Global Intangible Low Income (“GILTI”)/Net CFC Tested Income (“NCTI”) tax regimes. The computation of the tax associated with Subpart F income, GILTI, and NCTI are slightly different. But, all these tax regimes have one thing in common, these tax regimes are anti-deferral in nature and they are all computed based on a so-called hypothetical dividend distribution of a CFC. The hypothetical dividend tax associated with these anti-deferral provisions of the Internal Revenue Code often triggers federal tax consequences to U.S. shareholders.

In addition, Domestic Sub may have a Form 5471 filing obligation for Foreign Sub.

OBBBA Restores Section 958(b)(4) With Significant Limitations

The One Big Beautiful Bill Act (“OBBBA”), signed on July 4, 2025, includes changes that apply to CFCs and their shareholders. Effective for tax years of foreign corporations beginning after December 31, 2025, the OBBBA restores Section 958(b)(4), generally prohibiting downward attribution from a foreign person for purposes of determining U.S. shareholder and CFC status, except in applying new Internal Revenue Code Section 951B. The OBBBA added new Section 951B, which would retain the downward attribution rule to foreign controlled US shareholders (“FCUSS”) of foreign controlled foreign corporations (“FCFC”). Section 951B is designed to target “de-control” structures more broadly by applying a modified CFC regime to FCUSS. Being classified as an FCUSS does not itself trigger a tax consequence. A FCUSS only becomes taxable if it directly owns FCFC stock. Internal Revenue Code Section 951B defines a FCUSS as any U.S. person who would be considered a U.S. Shareholder of a foreign corporation if:

1. Downward attribution applied regardless of reinstated Section 958(b)(4).
2. The definition of “U.S. Shareholder” under Section 951(b) was modified to require ownership of more than 50% of the foreign corporation, rather than the typical 10% or more threshold.

Section 951B is narrower than the previous 2017 Tax Cuts and Jobs Act regime. However, Section 951B can also create ‘faux CFCs’ through downward attribution, but only taxes U.S. persons to the extent of their direct ownership of such entities.

Potential Disadvantage of the OBBBA Downward Attribution Rule Change

As a result of the restoration of Section 958(b)(4) under the OBBBA in many cases, many foreign subsidiaries that are treated as CFCs for U.S. tax purposes will lose that status and be taxed under the harsh passive foreign investment company (“PFIC”) tax regime. Once CFC status for foreign branches, U.S. shareholders associated with a multinational chain of entities must recess their exposure to the PFIC tax regime and determine if certain timely elections to be to minimize the tax consequences of the PFIC tax regime.

Conclusion

The OBBBA’s reenactment of Section 958(b)(4) and the enactment of Section 951B has significantly changed the CFC rules. These news rules will be welcome for some because of a decrease in compliance burdens. However, the change in the law gives rise to new complexities as an increased exposure to the PFIC tax regime.

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.