December 9, 2018

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Benefits of a Section 338 Election to a US Buyer of CFC Stock

The 2017 Tax Act significantly increased the benefits of a section 338(g) election for a domestic corporate purchaser of stock in a controlled foreign corporation (CFC). If an election is made, the Buyer is treated as organizing a “new” CFC that purchases the assets of the “old” target CFC for the amount paid for the CFC stock. The primary benefit for the Buyer is a stepped-up basis in the CFC’s assets, which can facilitate tax efficient post-acquisition integration and which results in a reduction of future global intangible low-taxed income (GILTI).

When the Buyer makes a section 338(g) election, the tax year of the target CFC closes on the date of the sale of the stock and all of the CFC’s prior tax attributes are eliminated. The Seller reports the tax consequences of the CFC’s gain on the deemed sale of its assets under section 338, including any Subpart F income and GILTI [see Insight]. The Seller also includes in its income any other Subpart F income or GILTI arising during the year of sale prior to the transaction date. Without a section 338(g) election, a US Buyer generally would be taxable on the target CFC’s Subpart F income and GILTI for the entire year of sale (albeit reduced by the amount of current year earnings included in the Seller’s income as a deemed dividend under section 1248).

The step up in basis in the target CFC’s assets provides additional amortization and depreciation deductions for the target CFC, which are generally available to reduce future Subpart F income and tested income for purposes of GILTI. In addition, the step up in basis of tangible property can increase the Buyer’s “qualified business asset investment” and thus further reduce the amount of the Buyer’s GILTI inclusion. The fair market value basis in the target CFC’s assets also generally eliminates gain on post-acquisition integration transactions involving further transfers of the CFC’s assets that otherwise might give rise to Subpart F income or GILTI. The closing of the target CFC’s tax year prevents the Buyer from having a Subpart F income or GILTI inclusion by reason of actions taken by the Seller during the year of the sale. Finally, the elimination of the CFC’s historical earnings and profits avoids complications that may arise regarding the application of section 245A and the Subpart F and GILTI rules for the Buyer going forward.

While favorable tax attributes of the “old” target CFC (such as foreign tax credits and previously taxed income) do not carry over to the “new” CFC following a section 338(g) election, such attributes generally are less important following the 2017 Tax Act. For example, pre-acquisition foreign taxes of the target CFC are more difficult to access following the 2017 Tax Act (given the repeal of section 902 and modifications of section 960), and distributions of future non-GILTI/non-Subpart F earnings of the target CFC will frequently be eligible for a 100 percent dividends received deduction under section 245A.

For foreign tax credit purposes, the section 338(g) election is treated as a covered asset acquisition under section 901(m). As a result, a credit is not permitted for foreign taxes paid on amortization and depreciation deductions that are not taken into account for purposes of calculating foreign income taxes. The disallowed foreign tax credits are still deductible by the CFC, however, to determine tested income and earnings and profits.

Subject to a notice requirement to the Seller, a corporate purchaser of CFC stock may unilaterally make a section 338(g) election. Nevertheless, the Seller will likely ask that the sales agreement set forth whether the Buyer is permitted contractually to make a section 338(g) election, and may require that the Buyer make the Seller whole if the Seller incurs additional tax costs as a result of such election (or, alternatively, the Seller may request an increase in the purchase price at the time of the sale so that the Seller can effectively share a portion of the Buyer’s tax benefits). As discussed in a prior Insight, a Seller under certain situations can actually benefit from a Buyer’s section 338 election.

In summary, a section 338(g) election generally is beneficial for a domestic corporate purchaser of CFC stock because the stepped-up basis results in a reduction of the amounts of future Subpart F income and GILTI inclusions. The election also facilitates tax-efficient integration into the Buyer’s foreign operations. Although a Seller may require that it be made whole for any additional tax costs resulting from a section 338(g) election, under certain circumstances the Seller’s tax result will be more favorable.

© 2018 McDermott Will & Emery

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About this Author

Lowell D. Yoder, International Tax Planning, Attorney, McDermott Will, Law Firm
Partner

Lowell D. Yoder is a partner in the law firm of McDermott Will & Emery LLP and is based in the Chicago office.  He is head of the U.S. & International Tax Practice Group. Lowell’s practice focuses on international tax planning for multinational companies.   He handles cross-border acquisitions, dispositions, mergers, reorganizations, joint ventures and financings.  He advises concerning multi-jurisdictional business structures and the use of special purpose foreign entities.  He also works with an extensive network of foreign lawyers on developing structures that minimize...

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Timothy S Shuman, Corporate Tax Attorney, McDermott Law Firm
Partner

Timothy S. Shuman is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm's Washington, D.C., office.  Tim focuses his practice on corporate and international tax matters for U.S. and foreign multinationals, with particular emphasis on acquisitions, dispositions, restructurings and liquidations.  He has extensive experience in structuring and providing advice on tax-free reorganizations and spin-offs involving both privately held and publicly traded companies and regularly represents clients in obtaining private letter rulings and other guidance from the IRS.  His work has included a number of corporations with special tax status, such as regulated investment companies.

Tim also has experience with international tax issues including supply chain planning and principal structures, foreign tax credit planning, tax-efficient repatriation strategies, tax basis planning and cross-border mergers and acquisitions.

Tim also has represented a number of clients before the IRS in connection with audits and the IRS Appeals process, including with respect to worthless stock losses and foreign tax credit issues. 

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Michael Wilder, Washington DC Corporate international tax lawyer, McDermott Will
Partner

Michael J. Wilder is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C. office.  He focuses his practice on corporate and international tax issues.  He has extensive experience in structuring corporate mergers and dispositions, spin-offs, liquidations, cross-border transfers, and financing instruments, as well as in the areas of consolidated returns, bankruptcy, and insolvency tax matters.   He is a frequent speaker on these issues.  Michael represents a number of clients in seeking private letter rulings from the...

202-756-8159
Jonathan Lockhart, McDermott Will Emery, International Tax Attorney
Associate

Jonathan Lockhart is as an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm's Chicago office. He focuses his practice on U.S.& International tax matters. Jonathan received his LL.M. in Taxation from the New York University School of Law and his J.D., magna cum laude, from the William Mitchell College of Law. While in law school, Jonathan served as an assistant editor for the William Mitchell Law Review and was a National Tax Moot Court participant. Jonathan also served...

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