In order to provide the Internal Revenue Service (“IRS”) with the necessary information to ensure compliance with the Net CFC Tested Income (“NCTI”) and Subpart F tax regimes, each year a U.S. shareholder who owns at least 10 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation or 10 percent or more of the total value of shares of all classes of stock of such foreign corporation must file a Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.
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” or (“CFC”). Section 958(a)(1) provides the direct ownership rules for determining stock ownership for such purposes. Section 958(a)(2) provides indirect ownership rules to determine beneficial ownership of shares when a foreign entity is interposed between the U.S. person and the foreign person. 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 the indirect ownership rule involving foreign entities. Thus, if a foreign partnership with four equal partners owns four percent of the stock of a foreign corporation, each partner is treated under Section 958(a)(2) as owning one percent of the stock of the foreign corporation. Likewise, if a U.S. person owns 10 percent of the stock of a foreign corporation that owns 25 percent of a second foreign corporation’s stock, the U.S. person is treated as owning 2.5 percent of the stock of the second foreign corporation under Section 958(a)(2).
Section 958(b) applies (with several modifications) the constructive ownership rules of Section 318(a) of the Internal Revenue Code. 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. In the CFC context, Section 958(b) provides that the constructive ownership rules of Section 318(a), with certain modifications, apply for purposes of determining whether: (1) a U.S. person is a U.S. shareholder (within the meaning of Section 951(b)); (2) a foreign corporation of a CFC under Section 957; (3) the stock of a domestic corporation is owned by a U.S. shareholder of a CFC for purposes of Section 956(c)(2); and (4) a corporation or other person is related to the CFC for purposes of Section 954(d)(3).
Section 958(b) provides several modifications to the Section 318 constructive ownership rules, including a taxpayer friendly rule that disallows attribution from a foreign individual to a U.S. tax individual. Section 958(b)(1), (2) and (3) provides exceptions to the general constructive owner rule. Under Section 958(b)(1), a U.S. citizen or resident cannot be treated as owning stock that is actually, indirectly, or constructively owned by a nonresident alien individual. This modification is considered taxpayer friendly because it reduces situations where a U.S. taxpayer can be determined to own stock in a foreign corporation or control a foreign corporation.
Prior to the Tax Cuts and Jobs Act of 2017, Section 958(b) provided an additional taxpayer friendly rule, in Section 958(b)(4), which disallowed so-called downward attribution. Specifically, Section 958(b)(4) provided “[s]ubparagraph (A), (B), (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” Section 318(a)(3)(A) provided that stock is owned by a person who is not a United States person.” Section 318(a)(3)(A) provided that stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as owned by the partnership or estate. In general, Section 318(a)(3)(B) provided that (i) stock owned, directly or indirectly, by or for a beneficiary of certain trusts shall be considered as owned by the trust, unless such beneficiary’s interest in the trust is a remote contingent interest; (ii) stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under the grantor trust rules shall be considered as owned by the trust. Section 318(a)(3)(C) provides if 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock, directly or indirectly, by or for such person.
To illustrate, if foreign person (“FP”) wholly owned all of the stock in a domestic corporation (“Domestic Sub”) and a foreign corporation (“Foreign Sub”)(Base Case), Section 318(a)(3)(C) would cause FP to attribute its shares of Foreign Sub to Domestic Sub, thereby making Foreign Sub a CFC of Domestic Sub. Section 958(b)(4) used to prevent this result. However, with the enactment of the 2017 Tax Cuts and Jobs Act, Section 958(b)(4) was repealed. With the repeal of Section 958(b)(4), Section 318(a)(3)(C) attributes FP shares of Foreign Sub to Domestic Sub in the above example.
The repeal of Section 958(b)(4) resulted in many U.S. persons having unexpected Form 5471 filing requirements.
Rev. Proc. 2019-40 – Clarification of Section 958(b)(4)
In 2019, the IRS issued Rev. Proc. 2019-40 (the “Rev. Proc.”). The Rev. Proc. attempts to alleviate challenges faced by a taxpayer in obtaining information that may not be possible for the taxpayer to obtain. The Rev. Proc. provides a number of safe harbors with respect to determining CFC status and items of income.
In many cases, the repeal of Section 958(b)(4) created an impossible information problem. For example, consider the Base Case above. If a U.S. person were to acquire a 10 percent interest in the Foreign Sub, the U.S. person would have an unexpected Subpart F or Global Intangible Low-Taxed Income GILTI tax liability as a result of owning a U.S. entity in which a foreign corporation was attributed. Often U.S. persons having an ownership in such organizations had no way of knowing if they had a Form 5471 filing requirement or if the entity a U.S. person holds an interest in is even a CFC.
Rev. Proc. 2019-40 states that the IRS will respect the non-CFC determination of a foreign corporation made by a U.S. person if: (i) the U.S. person does not have actual knowledge, statements received, or reliable publicly available information sufficient to determine that the foreign corporation is a CFC; and (ii) if the U.S. person inquires of the foreign top-tier entity in which it holds an interest as to whether that entity is a CFC, whether that entity owns, directly or indirectly, an interest in any domestic entity.
Further, Rev. Proc. 2019-40 provides relief in the context of determining a U.S. shareholder’s Subpart F or GILTI inclusion. The relief comes in the form of a safe harbor to U.S. shareholders of a CFC for which there exists no Section 958(a) U.S. shareholder which is related to the CFC within the meaning of Section 954(d)(3). In that case, a U.S. shareholder may use alternative information in determining its Subpart F and GILTI inclusions to the extent that the true information is not readily available. In this sense, readily available means, as of the date of the U.S. shareholder’s return, information of the CFC that is (a) publicly available; (b) with respect to an interest acquired prior to October 2, 2019, available to the U.S. shareholder by using reasonable efforts and subject to a legal or contractual right to obtain by the U.S. shareholder; or (c) with respect to an interest acquired after October 1, 2019, information which the CFC is not prohibited from prohibited from providing to the U.S. shareholder under the laws of the subject jurisdiction.
Rev. Proc. 2019-40 did not provide any changes to the statutory framework. Rev. Proc. 2019-40 clarified a taxpayer’s ability to make determinations and determine income of a CFC in situations where the taxpayer does not have information, the party that has the relevant to the taxpayer and the information unavailable to the taxpayer. In all other cases, the repeal of Section 958(b)(4) continued to apply during the 2025 tax year.
Rev. Proc. 2019-40 was Incorporated into Category 1 and Category 5 for Purposes of Form 5471
The relief and filing exceptions of Rev. Proc. 2019-40 were incorporated into the instructions for Form 5471 for both Category 1 and Category 5 filers on Form 5471. Categories 1b, 1c, 5b, and 5c were enacted as a result of Rev. Proc. 2019-40. With this in mind, we will now discuss these categories of filers for purposes of the Form 5471.
Category 1 Filer Instructions and Analysis
Category 1 is subdivided into Categories 1a, 1b, and 1c. Category 1a is a catchall category and applies to Category 1 filers who do not otherwise fall under either Category 1b or 1c. Categories 1b and 1c were added to Form 5471 as the result of Revenue Procedure 2019-40, which the IRS issued in response to the repeal of provisions in Section 958(b) that previously disapplied the constructive downward attribution rules of Section 318(a)(3) to the extent that they attributed stock owned by a foreign person to a U.S. person. Categories 1b and 1c specifically apply to those SFCs that are considered to be foreign-controlled for purposes of Form 5471. Such an SFC, referred to herein as a “Foreign-Controlled SFC,” is a foreign corporation that, although classified as an SFC, would not be so classified if the determination were made without applying Section 318(a)(3)’s downward attribution rules so as to consider a U.S. person as owning the stock owned by a foreign person.
As per the instructions to Form 5471, a Category 1 filer is a person who was a U.S. shareholder of a foreign corporation that was a Section 965 specified foreign corporation (“SFC”) at any time during the foreign corporation’s tax year ending with or within the U.S. shareholder’s tax year, and who owned that stock on the last day in that year in which the foreign corporation was a Section 965 SFC.
An SFC is a foreign corporation that either is a CFC or has at least one U.S. shareholder that is a domestic corporation. See IRC Section 965(e)(1). The term SFC includes not only CFCs, but also entities commonly referred to as “10/50 corporations.” These foreign corporations have at least one U.S. shareholder, but are not CFCs because U.S. shareholders do not collectively own more than 50 percent of the corporation’s stock either by vote or value.
For purposes of Category 1, Internal Revenue Code Section 951(b) defines a “U.S. shareholder” as a U.S. citizen, resident alien, corporation, partnership, trust, or estate that owns 10 percent or more of the total combined voting power of all classes of voting stock of a foreign corporation, or 10 percent or more of the total value of all the outstanding stock of a foreign corporation. All forms of stock ownership, — i.e., direct, indirect (ownership through intervening entities), and constructive (attribution of ownership from one related party to another) — are considered in applying the 10 percent test. A Category 1 Filer, a foreign corporation is a CFC if, on any day during its taxable year, all of its U.S. shareholders, taken together as a group, own more than 50 percent of the combined voting power of all classes of the foreign corporation’s voting stock, or more than 50 percent of the total value of all of the foreign corporation’s outstanding stock. See IRC Section 957(a). Only U.S. persons who constitute U.S. shareholders are considered in applying the 50 percent test. Just as in the case of the 10 percent test for determining whether a U.S. person is a U.S. shareholder, direct, indirect, and constructive ownership of stock are all considered in applying the 50 percent test for CFCs. The term “foreign,” when applied to a corporation, means a corporation that is not domestic — i.e., a corporation that is not incorporated in a U.S. state or the District of Columbia. See IRC Section 7701(a)(5).
A Category 1b filer is a U.S. shareholder who owns, directly or indirectly under Section 958(a) (but not constructively under Section 958(b)), the stock of a Foreign-Controlled SFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC. Section 954(d)(3) defines two persons as being “related” to each other in terms of “control,” where one person controls or is controlled by the other, or is controlled by the same person or persons who control the other. Here, control over a corporation means directly or indirectly owning more than 50 percent of the corporation’s stock by either vote or value. A Category 1b filer is typically a shareholder who owns, directly or indirectly, stock in a foreign corporation but is not related to the foreign corporation because the common parent of both the shareholder and the foreign corporation does not control the foreign corporation.
Category 1c filer. A Category 1c filer is a person who is a related constructive U.S. shareholder of a foreign SFC. Category 1c extends relief discussed in Rev. Proc 2019-40. A Category 1c filer is a U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled SFC but is related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC. A Category 1c filer is typically a shareholder that owns the stock of a foreign corporation only because of constructive stock ownership under Section 318(a)(3) and the shareholder is related to the foreign corporation because each of them is under the control of a common parent.
Category 5 Filer Instructions and Analysis
A Category 5 filer is a U.S. shareholder of a foreign corporation that is a CFC at any time during the corporation’s taxable year. However, to be classified as a Category 5 filer, the U.S. shareholder of the CFC must also own the CFC’s stock on the last day of the CFC’s taxable year. The stock ownership rules applicable to Category 5 (including Categories 5a, 5b, and 5c) are the same as the ones applicable to Category 1 (including Categories 1a, 1b, and 1c), as described above under “Filer Categories–Category 1 Filer.” These rules are contained in Internal Revenue Code Section 958, which incorporates and modifies the constructive stock ownership rules of Section 318(a).
Category 5 is subdivided into Categories 5a, 5b, and 5c. Category 5a is a catchall category and applies to Category 5 filers who do not otherwise fall under either Category 5b or 5c. Categories 5b and 5c were added to Form 5471 as the result of Revenue Procedure 2019-40, which the IRS issued in response to the repeal of provisions in Section 958(b) that previously disapplied the constructive downward attribution rules of Section 318(a)(3) to the extent that they attributed stock owned by a foreign person to a U.S. person. Categories 5b and 5c specifically apply to those CFCs that are considered to be foreign-controlled for purposes of Form 5471. Such a CFC, referred to herein as a “Foreign-Controlled CFC,” is a foreign corporation that, although classified as a CFC, would not be so classified if the determination were made without applying Section 318(a)(3)’s downward attribution rules so as to consider a U.S. person as owning the stock owned by a foreign person.
A Category 5b filer is a U.S. shareholder who owns, directly or indirectly under Section 958(a) (but not constructively under Section 958(b)), the stock of a Foreign-Controlled CFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC. Section 954(d)(3) defines two persons as being “related” to each other in terms of “control,” where one person controls or is controlled by the other, or is controlled by the same person or persons who control the other. Here, control over a corporation means directly or indirectly owning more than 50 percent of the corporation’s stock by either vote or value. A Category 5b filer is typically a shareholder who owns, directly or indirectly, stock in a foreign corporation but is not related to the foreign corporation because the common parent of both the shareholder and the foreign corporation does not control the foreign corporation.
A U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled CFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC, is neither a Category 5b nor 5c filer. Such U.S. shareholder is deemed not to fall under the Category 5a catchall and is exempt from the obligation to file Form 5471.
Conclusion
In order to properly determine the proper Category 1 and 5 filer, preparers of the Form 5471 should have a solid understanding of Rev. Proc. 2019-40. Preparers of the Form 5471 should understand that the One Big Beautiful Bill Act (“OBBBA”) partially reinstated Section 958(b)(4). In some cases, this will effectively block downward attribution of stock from a foreign person to a U.S. person. As a result, in the OBBBA, there is a strong probability that the IRS will change a category of filers again for the 2026 filing year.
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.
Written By Anthony Diosdi
Anthony Diosdi focuses his practice on international inbound and outbound tax planning for high net worth individuals, multinational companies, and a number of Fortune 500 companies.
