IRS provides guidance on new pro rata share transition rule under OBBBA

Prior to the enactment of the One Big Beautiful Bill Act (OBBBA), U.S. shareholders who owned stock of a controlled foreign corporation (CFC) on the last day of the taxable year picked up any inclusions of subpart F and/or global intangible low-taxed income (GILTI) as calculated on a per share basis. OBBBA changes these pro rata share rules post-2025 to ensure all U.S. shareholders holding stock of a CFC at any point during the foreign corporation’s taxable year picks up their pro rata share of net CFC tested income (NCTI) (formerly GILTI) and/or subpart F based on (i) the period of the taxable year the shareholder held the CFC, (ii) the period the U.S. person was a U.S. shareholder and (iii) the period the foreign corporation was a CFC. Any deemed inclusions of income resulting from CFC investments in U.S. property under section 956 will continue to be based on the U.S. shareholder(s) who hold(s) such stock on the last day of the taxable year (retaining the “hot potato” rule for this particular purpose). For more on the OBBBA change to the pro rata share rules, see:

• 2025 Year-end tax considerations for international tax planning
• Revamp and rebrand of the GILTI regime in the One Big Beautiful Bill Act 

Historically, when a U.S. shareholder acquired shares of a CFC during a taxable year, such acquiring shareholder reduces any subpart F and/or GILTI tested income or loss attributable to the acquired shares for dividends paid to the former U.S. shareholder (or any other person) holding those shares during such taxable year. This includes any gains to the former U.S. shareholder on the disposition of shares that is recharacterized as dividend income in its hands to the extent of any previously untaxed earnings and profits (E&P) attributable those shares under section 1248. Any reduction allowed to the acquiring U.S. shareholder for dividends paid during the taxable year to a former shareholder of the acquired shares is subject to a limitation so as to not reduce any inclusion below what would be attributable to the acquiring shareholder based upon the ratable portion of the CFC’s taxable year during which the acquiring U.S. shareholder holds the acquired shares.

Transition rule

Taxpayers that have more recently undergone (or looking to complete before a CFC’s (or CFCs’) first taxable year beginning after Dec. 31, 2025) acquisitions of CFC shares will need to consider whether a transition rule introduced under the OBBBA applies whereby any dividends paid (or deemed paid) to a former shareholder might not be treated as dividends paid (or deemed paid) for purposes of the reduction otherwise allowed the acquiring U.S. shareholder if such dividend does not increase taxable income of a U.S. person that is subject to U.S. taxation. This could result, for example, by reason of a dividends received deduction or other dividend-related income exclusion from U.S. taxable income and/or subpart F. A dividend is subject to the transition rule if the dividend is either:

• Paid (or deemed paid) on or before June 28, 2025, and during the taxable year of a CFC that includes such date, provided the acquiring U.S. shareholder for whom a determination of pro rata share of deemed inclusion of income is being made did not own the acquired shares of the CFC during the portion of such taxable year on or before June 28, 2025, or
• Paid (or deemed paid) after June 28, 2025, and prior to a foreign corporation’s first taxable year beginning after Dec. 31, 2025.

The IRS and Treasury released Notice 2025-75 (the Notice), the second in a series of four notices addressing various OBBBA international provisions, which announces forthcoming regulations and provides guidance on the following with regard to the aforementioned transition rule:

• Definition of dividend paid (or deemed paid)
• What it means to increase taxable income of a U.S. person subject to U.S. federal income tax
• Application (or nonapplication) of the transition rule for CFC stock owned on or before June 28, 2025

Definition of dividends paid (deemed paid)

The Notice clarifies that for purposes of the transition rule any distribution paid to any other person that would be treated as a dividend for the purposes of being excluded from subpart F and/or GILTI prior to OBBBA’s enactment will be treated as a dividend. This primarily ensures that deemed dividends under section 1248 are captured in the transition rule.

What it means to increase “taxable income” of a “U.S. person” subject to U.S. federal income tax

In applying the transition rule, a “U.S. person” would exclude domestic partnerships, S corporations, domestic grantor trusts or bona fide residents of Guam, the Commonwealth of the Northern Marina Islands or the U.S. Virgin Islands, and includes nonresident aliens that elect to be treated as U.S. residents. A look-through rule would apply to domestic partnerships and S corporations with the determination of a dividend being paid and included in income occurring at the partner or shareholder level. In the case of a tiered structure where a partnership is owned by another partnership or S corporation, the look-through rule is applied through the tiers until such rule is no longer relevant. Any dividends paid (or deemed paid) shall be deemed to have increased U.S. taxable income of a U.S. person subject to Federal income tax if the dividend is allocated to de minimis partners (generally, holding 5% or less on any day of the domestic partnership’s taxable year) of publicly held domestic partnerships, unless the partnership has actual knowledge contrary to this general assumption.

Per the Notice, “taxable income” generally refers to income subject to U.S. tax including investment company taxable income, real estate investment trust (REIT) taxable income and unrelated business taxable income (UBTI) as taxable income being subject to U.S. Federal income tax as it relates to regulated investment companies (RICs), REITs and tax exempt organizations, respectively, and for purposes of the transition rule. The determination of whether a dividend paid (or deemed paid) increases taxable income of a U.S. person subject to income tax occurs after considering any relevant exclusions that would exclude part or all of the dividend from taxable income (e.g., a dividends received deduction) and is determined on a per-share basis. For this purpose, relevant exclusions can include distributions of previously taxed E&P (PTEP), the application of the CFC look-through rule or high-tax exception when such distribution is received by an upper-tier CFC from a lower-tier CFC.

Furthermore, for purposes of the transition rule, the determination of the amount by which a dividend paid by a CFC increases the taxable income of a U.S. person subject to Federal income tax is made without regard to decreases to taxable income resulting from generally applicable deductions of the U.S. person that are not particular to the receipt of a dividend (e.g., deductions for net operating losses, depreciation, distributions under section 651 or 661, for dividends paid under section 852(b)(2)(D) or 857(b)(2)(B)). The Notice clarifies if a dividend paid (or deemed paid) does not increase taxable income by the full amount (e.g., through the application of the aforementioned CFC look-through rule or where the dividend is not fully includible in an upper tier CFC’s subpart F or GILTI as is not wholly owned by an inclusion shareholder), the portion of the dividend that was excluded would not be treated as a dividend for purposes of the acquiring U.S. shareholder reducing any subpart F and/or GILTI. The determination that any dividend paid (or deemed paid) increased a U.S. person’s taxable income for Federal income tax purposes must be properly documented as prescribed under the Notice and disclosed via a statement attached to the acquiring US shareholder’s Form 5471 filing(s) for which there is a respective claimed reduction in pro rata share.

The transition rule, as described in the Notice, is applied after considering all other applicable provisions of the code, including the rules under section 245A and Treas. Reg. section 1.245A-5. Any extraordinary reduction amount in determining any dividends received deduction under section 245A would be calculated first before applying the transition rule and, therefore, the closing-of-the-books election under Treas. Reg. section 1.245A-5 remains viable.

Application (or nonapplication) of the transition rule for CFC stock owned on or before June 28, 2025

The Notice reiterates that a dividend paid (or deemed paid) is not subject to the transition rule if it is paid on or before June 28, 2025, and during the CFC’s taxable year which includes such date and the inclusion shareholder owned the CFC stock during the period of that taxable year on or before June 28, 2025, as determined on a per share basis. By way of example, the Notice provides that a U.S. shareholder acquiring CFC stock after June 28, 2025, any dividends paid on or before June 28, 2025, with respect to such shares, and during the CFC’s taxable year that includes such date, are subject to the transition rule. This is true even if the U.S. shareholder owned other tranche(s) of shares in the CFC on or before June 28, 2025.

Applicability and reliance

The Notice can be relied upon until such time the forthcoming regulations are published with those regulations expected to apply to CFC taxable years that include or begin after June 28, 2025, but before a CFC’s first taxable year beginning after Dec. 31, 2025. Comments on the rules set forth in the Notice are requested and must be submitted by Feb. 2, 2026.

If you have questions on how the above information may impact your tax situation, please reach out to your Baker Tilly tax advisor.