Is Subpart F income and section 956 inclusions from a controlled foreign corporation treated as income from subsidiary capital excluded from entire net income?

Plain-English summary

Peter L. Faber (McDermott, Will & Emery) described a U.S. group in which U.S. Subsidiary (a wholly owned holding company) owns U.K. Parent, which owns U.K. Subsidiary -- both U.K. companies being controlled foreign corporations (CFCs) under IRC section 957. From time to time U.K. Subsidiary has Subpart F income taxed to U.S. Subsidiary under section 951(a)(1)(A) and makes investments in U.S. property (section 956) taxed under section 951(a)(1)(B). The question: are those inclusions income from subsidiary capital excluded from entire net income under section 208.9(a)(1)?

The Department held yes:

• Both the Subpart F income (section 951(a)(1)(A)) and the section 956 investment-in-U.S.-property amounts (section 951(a)(1)(B)) are treated as deemed dividends for federal income tax purposes.
• For Article 9-A, those deemed dividends from a wholly owned CFC are dividends from subsidiary capital, excluded from entire net income under section 208.9(a)(1) (following American International Group).
• Where the inclusion is attributable to a lower-tier CFC (U.K. Subsidiary), it is treated as a dividend up the chain -- from U.K. Subsidiary to U.K. Parent to U.S. Subsidiary -- and, because each link is wholly owned, remains a subsidiary-capital dividend excluded from entire net income.

What this means for you

CFC inclusions get dividend treatment in New York

For Article 9-A, a corporate parent's Subpart F income and section 956 inclusions from a wholly owned CFC are treated like deemed dividends from subsidiary capital -- and dividends from subsidiary capital are excluded from entire net income under section 208.9(a)(1).

The exclusion tiers up the ownership chain

If the income arises at a lower-tier CFC, it is treated as a dividend passing up each wholly owned link to the New York taxpayer, staying a subsidiary-capital dividend the whole way -- so the exclusion is preserved.

Subsidiary-capital status is key

The result depends on the foreign companies being subsidiaries (here, wholly owned). The exclusion follows the subsidiary-capital characterization, so verify the ownership chain qualifies.

Common questions

Q: Is Subpart F income from a CFC excluded from New York entire net income?
A: Yes. It is treated as a deemed dividend from subsidiary capital and excluded under section 208.9(a)(1).

Q: What about section 956 investment-in-U.S.-property inclusions?
A: Same treatment -- a deemed dividend from subsidiary capital, excluded from entire net income.

Q: How are inclusions from a lower-tier CFC handled?
A: They tier up through each wholly owned subsidiary as dividends and remain excluded subsidiary-capital dividends.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 208.9(a)(1) (entire net income excludes income from subsidiary capital)
- Internal Revenue Code section 951(a)(1)(A) (Subpart F income inclusion)
- Internal Revenue Code section 951(a)(1)(B) (section 956 investment in U.S. property)
- Internal Revenue Code section 957 (controlled foreign corporation)
- Peter L. Faber, TSB-A-02(5)C (May 31, 2002)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_2002.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a02_5c.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-02(5)C
Corporation Tax
May 31, 2002

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C010612C

On June 12, 2001, a Petition for Advisory Opinion was received from Peter L. Faber,
McDermott, Will & Emery, 50 Rockefeller Plaza, New York, New York 10020-1605.
The issue raised by Petitioner, Peter L. Faber, is whether income that is taxable to a United
States corporation under Subpart F of the Internal Revenue Code (“IRC”) is income from subsidiary
capital within the meaning of section 208.9(a)(1) of the Tax Law.
Petitioner submits the following facts as the basis for this Advisory Opinion.
U.S. Parent, a corporation organized under the laws of Delaware, owns 100 percent of the
stock of U.S. Subsidiary, a corporation also organized under the laws of Delaware. U.S. Parent is
engaged in an active business. U.S. Subsidiary is a holding company. U.S. Subsidiary owns 100
percent of the stock of U.K. Parent, a corporation organized and headquartered in the United
Kingdom. U.K. Parent is a holding company. It owns 100 percent of the stock of U.K. Subsidiary,
a corporation organized under the laws of the United Kingdom. For federal income tax purposes,
U.K. Parent and U.K. Subsidiary are considered to be “controlled foreign corporations” (“CFCs”)
under section 957 of the IRC.
From time-to-time U.K. Subsidiary may have Subpart F income that is taxed currently to
U.S. Subsidiary under section 951(a)(1)(A) of the IRC and it may make investments in United States
property within the meaning of section 956 of the IRC (including loans to U.S. Parent) that result
in the current taxation of all or a portion of its earnings and profits under section 951(a)(1)(B) of the
IRC.
Discussion
Federal Treatment
Subpart F (sections 951 through 964) of the IRC contains the provisions for the treatment
of CFCs, and provides that every person who is a U.S. shareholder of a CFC shall include in that
person’s gross income certain types of income generated by a CFC, regardless of whether such
income is actually repatriated.
Section 957 of the IRC provides that a CFC is any foreign corporation if more than 50
percent of –
(1) the total combined voting power of all classes of stock of such corporation
entitled to vote, or

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Corporation Tax
May 31, 2002

(2) the total value of the stock of such corporation,
is owned (within the meaning of section 958(a) of the IRC), or is considered as owned by applying
the rules of ownership of section 958(b) of the IRC, by U.S. shareholders on any day during the
taxable year of such foreign corporation.
Section 951(b) of the IRC provides that the term “U.S. shareholder” means with respect to
any foreign corporation, a U.S. person (as defined in section 957(c) of the IRC) who owns (within
the meaning of section 958(a) of the IRC), or is considered as owning by applying the rules of
ownership of section 958(b) of the IRC, 10 percent or more of the total combined voting power of
all classes of stock entitled to vote of such foreign corporation. A U.S. person for purposes of
section 957(c) of the IRC, has the same meaning as assigned to it by section 7701(a)(30) of the IRC,
with certain exceptions applicable to persons in Puerto Rico, Guam, American Samoa or the
Northern Mariana Islands.
Section 951(a) of the IRC provides that if a foreign corporation is a controlled foreign
corporation for an uninterrupted period of 30 days or more during any taxable year, every person
who is a U.S. shareholder of the CFC, and who owns stock in the CFC on the last day, in such year,
on which it is a CFC shall include in the U.S. shareholder’s gross income –
(A) the sum of –
(i) the shareholder’s pro rata share (determined under section 951(a)(2) of the
IRC) of the CFC’s subpart F income for such year,
(ii) the shareholder’s pro rata share (determined under section 955(a)(3) of
the IRC as in effect before the enactment of the Tax Reduction Act of 1975) of the
CFC’s previously excluded subpart F income withdrawn from investment in less
developed countries for such year, and
(iii) the shareholder’s pro rata share (determined under section 955(a)(3) of
the IRC) of the CFC’s previously excluded subpart F income withdrawn from foreign
base company shipping operations for such year; and
(B) the amount determined under section 956 of the IRC with respect to such
shareholder for the year (but only to the extent not excluded from gross income
under section 959(a)(2) of the IRC).
Section 956(a) of the IRC provides that in the case of any CFC, the amount determined under
such section with respect to any U.S. shareholder for any taxable year is the lesser of –
(1) the excess (if any) of –

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Corporation Tax
May 31, 2002

(A) such shareholder’s pro rata share of the average of the amounts of U.S.
property held (directly or indirectly) by the CFC as of the close of each quarter of
such taxable year, over
(B) the amount of earnings and profits described in section 959(c)(1)(A) with
respect to such shareholder, or
(2) such shareholder’s pro rata share of the applicable earnings of such CFC.
The amount taken into account under section 956(a)(1) above with respect to any property
shall be its adjusted basis as determined for purposes of computing earnings and profits, reduced by
any liability to which the property is subject.
Section 1.956-1(a) of the Treasury Regulations provides that the amount of a CFC’s earnings
invested in U.S. property at the close of any taxable year is the aggregate amount invested in U.S.
property to the extent such amount would have constituted a dividend if it had been distributed on
such date.
Section 1.956-1(b) of the Treasury Regulations provides that the amount of a CFC’s earnings
invested at the close of its taxable year in U.S. property is the aggregate amount of such property
held, directly or indirectly, by such corporation at the close of its taxable year to the extent such
amount would have constituted a dividend under section 316 of the IRC and sections 1.316-1 and
1.316-2 of the Treasury Regulations if it had been distributed on such closing day. For purposes of
such section 1.956-1(b), the determination of whether an amount would have constituted a dividend
if distributed shall be made without regard to the provisions of section 959(d) of the IRC.
Article 9-A Treatment
Section 209.1 of Article 9-A of the Tax Law imposes an annual franchise tax on domestic
or foreign corporations for the privilege of exercising a corporate franchise, doing business,
employing capital, owning or leasing property in a corporate or organized capacity, or maintaining
an office in New York State for all or any part of each of its fiscal or calendar years. The tax is
imposed on the basis of the corporation's entire net income base, or upon such other basis (capital
base, minimum taxable income bases or the fixed dollar minimum), as may be applicable, as
determined under section 210 of the Tax Law.
The starting point for computing a corporation’s entire net income base is the corporation’s
federal taxable income with certain modifications. The modification set forth in section 208.9(a)(1)
of the Tax Law provides that entire net income shall not include income, gains and losses from
subsidiary capital except for such amounts from a former DISC which are treated as business income
under section 208.8-A of the Tax Law. Section 208.9(a)(2) of the Tax Law provides that entire net
income shall not include 50 percent of dividends, other than from subsidiaries or amounts treated
as business income under section 208.8-A of the Tax Law.

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TSB-A-02(5)C
Corporation Tax
May 31, 2002

The provisions of Article 9-A of the Tax Law do not specifically provide that Subpart F
income is to be treated as a dividend eligible for the exclusions provided in section 208.9(a)(1) and
(2) of the Tax Law. However, in American International Group, Inc., Adv Opns Comm T&F,
TSB-A-87(23) and (23.1)C and TSB-A-88(7)and (7.1)C, it was determined that, for purposes of
Article 9-A of the Tax Law, Subpart F income is deemed to be a dividend that is directly related to
ownership of stock. If a taxpayer is the owner of more than 50 percent of the voting stock of a CFC,
the taxpayer’s pro rata share of such CFC’s Subpart F income is deemed to be a dividend from such
CFC and is considered as being in the nature of a dividend from subsidiary capital. When
computing entire net income, 100 percent of the dividend may be deducted from the taxpayer’s
federal taxable income pursuant to section 208.9(a)(1) of the Tax Law. In addition, if the taxpayer
is the owner of 50 percent or less of the voting stock of a CFC, the taxpayer’s pro rata share of such
CFC’s Subpart F income is deemed to be a dividend that is attributable to the stock of such CFC and
such dividend is investment income, 50 percent of which may be deducted from the taxpayer’s
federal taxable income pursuant to section 208.9(a)(2) of the Tax Law.
American International Group, id, provides further that where such CFC is a shareholder of
another CFC (second-tier CFC), the taxpayer’s pro rata share of the second-tier CFC’s Subpart F
income is deemed to be a dividend that has been paid to the first-tier CFC. This dividend, in turn,
is deemed to have been paid by the first-tier CFC to the taxpayer. Since the taxpayer’s pro rata share
of the second-tier CFC’s Subpart F income is deemed paid by the first-tier CFC to the taxpayer, such
deemed dividend is attributable to the taxpayer’s ownership in the first-tier CFC. Where the
taxpayer owns more than 50 percent of the voting stock of the first-tier CFC, the deemed dividends
from the second-tier and any lower tier CFC are attributable to subsidiary capital. Where the
taxpayer owns 50 percent or less of the voting stock of the first-tier CFC, the deemed dividends from
the second-tier and any lower tier CFC are attributable to investment capital.
American International Group, id, makes clear that the amount of Subpart F income, as
defined in section 952 of the IRC, and included in the taxpayer’s federal gross income pursuant to
section 951(a)(1)(A) of the IRC, is treated as a dividend for purposes of Article 9-A of the Tax Law.
The same treatment under Article 9-A should be given to the amount of the increase in earnings that
is invested in U.S. property, as determined under section 956 of the IRC, and included in the
taxpayer’s federal gross income pursuant to section 951(a)(1)(B) of the IRC. A U.S. shareholder’s
pro rata share of the amount of the CFC’s earnings invested in U.S. property that the U.S.
shareholder includes in the shareholder’s gross income pursuant to section 951(a)(1)(B) of the IRC,
as determined under section 956 of the IRC and section 1.956-1 of the Treasury Regulations, is
treated like a dividend for federal income tax purposes. See Bittker & Eustice, Federal Income
Taxation of Corporations and Shareholders, 7th Edition, ¶15.62(4)(a) at 15-162, which states, with
respect to section 956 of the IRC, that “[t]he increase in U.S. investments is instead imputed to the
shareholder on a very different theory that the CFC’s earnings have been repatriated pro tanto, even
though not distributed by a formal dividend.” See also, Albert L. Dougherty, 60 TC 917, 930, where
the United States Tax Court referred to the provisions of section 951(a)(1)(B) of the IRC as
“statutory constructive dividend doctrine.”

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TSB-A-02(5)C
Corporation Tax
May 31, 2002

Accordingly, both the Subpart F income that is included in the taxpayer’s computation of
federal taxable income pursuant to section 952(a)(1)(A) of the IRC, as well as the income that is
included pursuant to section 951(a)(1)(B) of the IRC, is treated as a dividend for federal income tax
purposes. Therefore, for purposes of computing entire net income under Article 9-A of the Tax
Law, it is appropriate to treat as a dividend, the taxpayer’s pro rata share of both (1) the amount of
Subpart F income defined in section 952 of the IRC that is included in the taxpayer’s federal gross
income pursuant to section 951(a)(1)(A) of the IRC, and (2) the increase in earnings that is invested
in U.S. property as determined under section 956 of the IRC and included in the taxpayer’s federal
gross income pursuant to section 951(a)(1)(B) of the IRC.
Therefore, in this case, U.K. Subsidiary is a wholly owned subsidiary of U.K. Parent and
both are CFC’s under section 957 of the IRC. U.K. Parent is a wholly owned subsidiary of U.S.
Subsidiary. Following American International Group, id, when U.S. Subsidiary computes its entire
net income under section 208.9 of the Tax Law, the amounts that are treated as a dividend from U.K.
Parent for federal income tax purposes, and included in U.S. Subsidiary’s federal gross income
pursuant to both section 951(a)(1)(A) of the IRC (defined subpart F income) and section
951(a)(1)(B) of the IRC (the increase in earnings that is invested in U.S. property), are treated as a
dividend from U.K. Parent to U.S. Subsidiary for purposes of Article 9-A of the Tax Law. Since
U.K. Parent is a wholly owned subsidiary of U.S. Subsidiary, such deemed dividend is treated as a
dividend from subsidiary capital that is excluded from U.S. Subsidiary’s entire net income under
section 208.9(a)(1) of the Tax Law.
Further, the amounts that are treated as a dividend from U.K. Subsidiary for federal income
tax purposes, and included in U.S. Subsidiary’s federal gross income pursuant to both section
951(a)(1)(A) of the IRC (defined subpart F income) and section 951(a)(1)(B) of the IRC (the
increase in earnings that is invested in U.S. property), are treated as a dividend from U.K. Subsidiary
to U.K. Parent, and then as a dividend from U.K. Parent to U.S. Subsidiary for purposes of Article
9-A of the Tax Law. See, American International Group, id. Since U.K. Parent is a wholly owned
subsidiary of U.S. Subsidiary, such deemed dividend that is passed through from U.K. Subsidiary
to U.K. Parent to U.S. Subsidiary, is treated as a dividend from subsidiary capital that is excluded
from U.S. Subsidiary’s entire net income under section 208.9(a)(1) of the Tax Law.

DATED: May 31, 2002

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.