Part One of The TCJA Attribution Rules: Family Matters

Our previous post, “Owning” Shares that aren’t Yours: The Code’s Confusing Definition of “Ownership”, we discussed the broad terminology behind what the U.S. considers “ownership” for purposes of determining whether a foreign company will be classified as CFC. In that post, we provided an overarching discussion of constructive ownership and how it arises out of the Code’s attribution rules. Over the course of the next few blog posts (including this one), we will dive deeper into the different rules of attribution, and end with a discussion on why an understanding of the rules are critical for the tax planning of foreign companies and their shareholders.

So, let’s begin with the rule on family attribution outlined in Section 318(a)(1) of the Code. Under this section, “an individual shall be considered as owning the stock owned, directly or indirectly, by or for–(i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and (ii) his children, grandchildren, and parents.” For purposes of this section, if a child has been legally adopted then they are treated as blood descendants of the individual, which means that, where applicable, they will be treated as the individual’s grandchild.

Family attribution then requires three steps:

  1. Identify the relevant family members;
  2. Determine the amount of stock directly owned;
  3. Determine the amount of stock indirectly owned; and
  4. Calculate the total amount of stock constructively owned through family attribution.

Step One: Identifying Relevant Family Members

This rule is only relevant to the individual’s spouse, children, grandchildren and parents. Accordingly, siblings, cousins, and other family members not specifically included in the aforementioned sentence will not be relevant for purposes of determining constructive ownership on the basis of family attribution.

Please note, that a relevant family member will become irrelevant if they are a nonresident alien individual. In this case, any shares owned by the nonresident alien will not be attributable to family members who are U.S. citizens or residents for purposes of determining whether the stock of a foreign corporation is considered owned by a U.S. Shareholder.

Step Two: Determining the Amount of Directly Owned Stock

This step is quite simple. Say A has three family members, parent B, child C1, and child C2. If B directly owns 6% of foreign company, X, and C1 directly owns 4% of X, then A’s relevant family members own a direct 10% interest in X.

Step Three: Determining the Amount of Indirectly Owned Stock

This step can get quite complex, determining on the number of family members and the type of interests they hold. Using the example from above, let’s say C1 is the sole beneficiary of trust, T, and that T owns 5% of X. Under indirect ownership, C1 is treated as owning 5% of X because the shares are being held the beneficial use of C1, even though they are not being held by C1 directly.

Step Four: Calculating the Total Amount of Stock Constructively Owned through Family Ownership.

Now, to determine the total amount of stock to be attributed to the individual through the relevant family members, the number of shares in steps two and three need to be added together. Under our example, B and C1 directly own 10% of X and C1 indirectly owns 5% of X; thus, the relevant family members own a combined 15% of X. As such, A will be considered as constructively owning 15% of X through family attribution.

If A already holds a 5% direct ownership and 5% indirect ownership in X (and all other shareholders were nonresident aliens), then after completing this analysis on A’s constructive ownership in X through family attribution, it would appear as though foreign corporation X, would not be a CFC. This is because only 25% of X would be deemed as being owned by a U.S. Person. However, this could not be the case, as we only applied one of the three attribution rules for determining constructive ownership in a CFC. Thus, further analysis would need to be conducted with regards to the other two attribution rules to determine the total amount of constructively owned stock.

In the next post we will discuss how constructive ownership can be increased through upward attribution. Thereafter, we will discuss downward attribution, which is the last constructive ownership rule.

For an in-depth analysis of these constructive ownership rules, along with a discussion on why a CFC classification matters for U.S. tax purposes, please reference to our whitepaper, The Expansion of “United States” Taxpayers: How the TCJA Drags Unassuming Foreign Companies and Individuals under its Scope. Please also visit our website, AsrenaAdvisors.com to learn more about how we can help navigate you through these rules to preserve your wealth.