Proposed Regulations Implement OBBBA Changes To Income Inclusions Resulting From Sales Of Controlled Foreign Corporation Stock

On August 26, the Treasury Department published proposed regulations (the “Proposed Regulations”) under Code sections 951 and 951A addressing the determination of a U.S. shareholder’s pro rata share of subpart F income, tested income, and tested loss of a controlled foreign corporation (“CFC”). The Proposed Regulations implement amendments to subpart F made by the One Big Beautiful Bill Act (“OBBBA”). These amendments fundamentally changed the mechanics for determining how much subpart F income and net CFC tested income a U.S. shareholder must include in gross income when ownership interests in a CFC vary over the course of a year.

Like the OBBBA amendments, the Proposed Regulations generally apply to taxable years of foreign corporations beginning after December 31, 2025. The Proposed Regulations provide critical guidance for international tax planning and will impact the structuring and documentation in M&A transactions involving CFCs.

Background: the OBBBA amendments

Prior to the OBBBA, under the so-called “hot potato rule,” the Code generally required a U.S. shareholder to include in gross income its pro rata share of a CFC’s subpart F income and global intangible low-taxed income (“GILTI”) only if the shareholder owned stock on the last day of the CFC’s taxable year on which the corporation was a CFC. A U.S. shareholder’s pro rata share was determined under a hypothetical-distribution methodology, and certain dividends received by former shareholders could reduce the inclusion amount of the last-day owner.

The OBBBA replaced this framework for taxable years beginning after December 31, 2025. Certain key statutory changes include:

• A U.S. shareholder that owns section 958(a) stock in a foreign corporation on any day during a taxable year in which at any time such corporation is a CFC (a “CFC year”) must now include its pro rata share of the CFC’s subpart F income, tested income, and tested loss for that year.
• A U.S. shareholder’s pro rata share is measured as the portion of subpart F income or net CFC tested income (“NCTI”) attributable to (i) the CFC stock owned by the shareholder and (ii) the period during which the shareholder owns that stock, is a U.S. shareholder within the meaning of section 951(b), and the foreign corporation is a CFC. NCTI is the same as GILTI prior to the OBBBA with certain adjustments, including the elimination of the deduction for qualified business asset investments.
• The inclusion generally occurs in the U.S. shareholder’s taxable year that includes the last day on which the shareholder owns stock in the CFC during the CFC year.

The OBBBA provided broad, open-ended authority to the Treasury Department to prescribe regulations or other guidance to implement the foregoing changes, including guidance allowing taxpayers to elect, or requiring taxpayers, to close the taxable year of a CFC upon a direct or indirect disposition of stock of the CFC.

The Proposed Regulations

Pursuant to its authority under the OBBBA, the Treasury Department introduced the following rules in the Proposed Regulations:

• Daily proration is used to determine a shareholder’s pro rata share. 

The Proposed Regulations adopt a daily proration approach to determine the portion of subpart F income, tested income, or tested loss that is “attributable to” stock owned by a shareholder under sections 951 and 951A. For a CFC with a single class of stock and no change in outstanding shares during the taxable year, a U.S. shareholder’s pro rata share equals the CFC’s subpart F income, tested income, or tested loss multiplied by (i) the shareholder’s ownership percentage and (ii) a fraction reflecting the number of days during the CFC year that the U.S. shareholder owned the stock of the foreign corporation while it was a CFC. For CFCs with multiple classes of stock, the regulations retain a hypothetical-distribution concept to allocate subpart F income, tested income, or tested loss among stock classes, followed by daily proration within each class. The Treasury Department selected this methodology rather than either an interim closing of the books approach or per diem approach with exceptions for extraordinary items (each of which is used in other areas of the Code) because it viewed such alternative approaches as complex, administratively burdensome, or inappropriate for this purpose.

• Status change events of foreign corporations result in a mandatory closing of the taxable year. 

Under the Proposed Regulations, a foreign corporation must close its taxable year if there is a “status change event,” which occurs if a foreign corporation becomes or ceases to be a CFC. If there is a status change event, the taxable year of the foreign corporation closes for all purposes of the Code, and this applies to all shareholders of the foreign corporation. Special rules apply for stock in a foreign corporation held by a domestic partnership and with respect to options to acquire stock of a foreign corporation. The Treasury Department noted that the mandatory closing of the foreign corporation’s taxable year may mitigate compliance burdens related to obtaining information regarding the foreign corporation from foreign persons.

• U.S. shareholders may elect to close the taxable year of a CFC for significant ownership variances. 

Under the Proposed Regulations, if a “significant ownership variance” occurs, U.S. shareholders may elect to close a CFC’s taxable year. A “significant ownership variance” of a CFC arises if one or more U.S. shareholders’ aggregate stock ownership of the CFC under section 958(a) (measured by vote or value) decreases by more than 50 percentage points as a result of a specified transfer (including multiple specified transfers if they occur pursuant to the same plan). The election requires a written, binding agreement between all controlling U.S. shareholders (as defined under the Proposed Regulations) and certain other information to be provided to the IRS. A consistency rule requires that if a significant ownership variance occurs with respect to multiple CFCs pursuant to a plan or series of related transactions, the election must be made with respect to each CFC. The Treasury Department viewed the more than 50-percentage point decrease as the appropriate threshold for this permissive election as such a decrease generally indicates the seller or seller group has relinquished control of the CFC. A lower threshold was rejected because of potential administrative burdens and opportunities for manipulation.

Limitations apply with respect to transfers involving related parties to prevent potential abuse of this election.

• Certain foreign income taxes may be allocated in the event of a mandatory or elective closing. 

When a mandatory or elective closing causes a CFC’s U.S. taxable year to close before its foreign taxable year, the Proposed Regulations allocate a portion of foreign income taxes accruing in the following U.S. taxable year back to the short period, based on the portion of foreign taxable income attributable to the pre-closing period.

• Guidance is solidified with respect to the transition period.

The OBBBA included a transition rule (the “Transition Rule”) applicable to taxable years before the OBBBA amendments to sections 951(a) and 951A took effect. Under the Transition Rule, certain dividends are not treated as dividends for purposes of applying former section 951(a)(2)(B), which allowed for a reduction to a last day owner’s subpart F income or tested income inclusion for dividends received by a former shareholder. In Notice 2025-75, the Treasury Department described guidance regarding the Transition Rule to be included in forthcoming regulations. Consistent with Notice 2025-75, the Proposed Regulations provide that certain dividends subject to the Transition Rule are not treated as dividends to the extent the dividend does not increase the taxable income of a U.S. person subject to U.S. federal income tax. Taxpayers that reduce their subpart F income or tested income inclusion by dividends subject to the Transition Rule must substantiate their analysis by attaching a “Pro Rata Share Transition Rule Statement” to Form 5471, describing the relevant dividends, and how the taxpayer determined that the dividends increased the taxable income of a U.S. person subject to federal income tax.

• Additional information reporting is required. 

The Proposed Regulations would require disclosure of information relating to the ownership of outstanding stock, including changes in certain direct and indirect ownership during the annual accounting period on Form 5471.

Implications for U.S. shareholders of foreign corporations and cross-border transactions

The Proposed Regulations increase the importance of tracking ownership changes throughout the taxable year and will affect the structuring, documenting and diligence of M&A transactions involving CFCs.

In particular, buyers and sellers will need to consider the allocation of subpart F and NCTI inclusions for partial-year ownership periods and pay close attention to tax covenant and indemnity provisions. The Proposed Regulations can heighten post-closing compliance burdens, as buyers and sellers may each require access to CFC earnings, tested income, and ownership data from periods before and after closing to accurately compute their respective income inclusions. As a result, transaction documents should include robust information-sharing, cooperation, and tax record-retention covenants, as well as clear procedures for addressing later adjustments arising from IRS examinations or revised CFC calculations. Taxpayers who are eligible for the permissive election to close the CFC year should consider requiring such election to be made in the transaction documents.

More broadly, the Proposed Regulations are likely to increase international tax compliance burdens by requiring taxpayers to maintain detailed ownership and financial records sufficient to support the allocation of subpart F income and NCTI among multiple shareholders and ownership periods. Taxpayers should evaluate whether existing reporting processes, information-sharing arrangements, and documentation practices are adequate to satisfy these requirements and support positions taken on Forms 5471 and related international tax filings.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.