The Deferred Foreign Income Corporation Earnings Tax (DFIC)

Deferred Foreign Income Corporation Earnings Taxation Rule

Deferred Foreign Income Corporation Earnings Taxation Rule

A few years ago, the US Government introduced the Tax Cuts and Jobs Act (TCJA). One key component of that Act involved the repatriation tax for certain Post-1986 Deferred Foreign Income (DFI) generated by certain Deferred Foreign Income Corporations (DFIC) — in accordance with Internal Revenue Code Section 965. Unfortunately, many US Taxpayers did not properly comply with this code section (oftentimes because it was too confusing for Taxpayers). In response to the noncompliance, the Internal Revenue Service developed an international tax “Compliance Campaign” designed to promote enforcement. The compliance campaign was introduced last year in 2020 — but only now is working its way to the forefront of offshore tax compliance — including the Internal Revenue Service creating a grandfathered clause within the Streamlined Filing Compliance Procedures involving IRC Section 965 and the one-time repatriation act. Here is a brief introduction to which foreign corporations may be subject to this Deferred Foreign Income taxation rule by our Board-Certified Tax Law Specialist team.

What is a Deferred Foreign Income Corporation?

Until recently, unless a foreign corporation either repatriated foreign earnings back to the United States or had certain Subpart F income tax requirements, Foreign income generated by the corporation would usually not be taxable until one of these catalyst events occur. With the introduction of the Tax Cuts and Jobs Act came both (GILTI – Global Intangible Low-Taxed Income) and the one-time repatriation tax under section 965 for certain deferred foreign income corporations.

Essentially, if certain foreign corporations have aggregated foreign income abroad that was not previously taxed income (PTI) by the US — then all of that income would be taxed at a reduced tax rate (Subject to certain exclusions and limitations) — even before the foreign income is repatriated to the US. As you can imagine, this came as a very unwelcome surprise for US owners of foreign corporations. Take for example a Controlled Foreign Corporation owned by A US person who operates a services company such as an accounting or law firm abroad — and may have many years of non-repatriated foreign income still abroad.

How is a DFIC Defined?

 A deferred foreign income corporation is defined under 26 USC 965 (d)(1) as follows :

• • • (1) Deferred foreign income corporation

      • The term “deferred foreign income corporation” means, with respect to any United States shareholder, any specified foreign corporation of such United States shareholder which has accumulated post-1986 deferred foreign income (as of the date referred to in paragraph (1) or (2) of subsection (a)) greater than zero.

How is Deferred Income Defined?

Not all deferred income is taxable. Rather, the Internal Revenue Service defines deferred income under internal revenue section 965 at follows:

• • • (2) Accumulated post-1986 deferred foreign income The term “accumulated post-1986 deferred foreign income” means the post-1986 earnings and profits except to the extent such earnings—

      • (A) are attributable to income of the specified foreign corporation which is effectively connected with the conduct of a trade or business within the United States and subject to tax under this chapter, or

      • (B) in the case of a controlled foreign corporation, if distributed, would be excluded from the gross income of a United States shareholder under section 959.

    • To the extent provided in regulations or other guidance prescribed by the Secretary, in the case of any controlled foreign corporation which has shareholders which are not United States shareholders, accumulated post-1986 deferred foreign income shall be appropriately reduced by amounts which would be described in subparagraph (B) if such shareholders were United States shareholders.

The IRS further clarifies Deferred Income as follows:

• • • Deferred Foreign Income: Defined in IRC 965(d)(2) and in general means the post-1986 earnings and profits except to the extent such earnings are attributable to income of the specified foreign corporation which is effectively connected with the conduct of a trade or business within the United States and subject to tax under this chapter (ECI), or in the case of a controlled foreign corporation, if distributed, would be excluded from the gross income of a United States shareholder under section 959 (PTI).

IRC 965 Compliance Campaign

• • Practice Area: Withholding and International Individual Compliance

  • Lead Executive: Deborah Palacheck, Director, Withholding and International Individual Compliance

  • Campaign Point of Contact: Ursula Gee, Withholding and International Individual Compliance

  • Pursuant to the changes to IRC §965 under the Tax Cuts and Jobs Act, U.S. shareholders, including individuals, that directly or indirectly own at least 10% of the stock of a specified foreign corporation (SFC) are required to include in gross income their share of the SFC’s accumulated post-1986 deferred foreign income for the last taxable year of the SFC beginning before January 1, 2018, and report this amount on their returns for the taxable year in which or with which their SFC’s taxable year ends (generally, 2017 and/or 2018). The Internal Revenue Service will address noncompliance through soft letters and examinations.

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