Details of Public Law 119-21, section 70353 , One Big Beautiful Bill Act

Federal law provides rules to determine stock ownership of a corporation, including requirements for direct ownership, indirect ownership, and constructive ownership, to determine whether a foreign corporation is a foreign owned controlled foreign corporation (CFC) and for purposes of determining the amounts includable in a United States (U.S.) shareholder’s gross income from a foreign owned CFC.

Prior to the Tax Cuts and Jobs Act (TCJA) (Public Law (P.L.) 115-97), for purposes of determining constructive ownership, federal law prohibited downward attribution, meaning that certain stock of a foreign corporation owned by a foreign person was not attributed to a related U.S. person for purposes of determining whether the related U.S. person was a U.S. shareholder of the foreign corporation and whether the foreign corporation was a CFC. In 2017, the TCJA (P.L. 115-97, section 14213) amended the constructive ownership rules of Internal Revenue Code (IRC) section 958(b) to repeal that prohibition on downward attribution.

This provision amends the ownership attribution rules of IRC section 958(b) to restore the prohibition on downward attribution of stock ownership of IRC section 958(b)(4) that was repealed by the TCJA (P.L. 115-97, section 14213). It also adds to subpart F, IRC section 951B, the income inclusion rules that would be applied with respect to such U.S. shareholders of a foreign owned CFC.

In addition, the provision defines a “foreign controlled United States shareholder” with respect to any foreign corporation, if a U.S. shareholder with respect to such foreign corporation (1) owns 50 percent or more of the foreign corporation, and (2) the IRC section 958(b) constructive ownership rules were applied without regard to IRC section 318(a)(3)(A),(B), and (C) that apply to a person who is not a U.S. person.

The provision also defines “foreign controlled foreign corporation” as a foreign corporation, other than a CFC, which would be a CFC if the CFC definition of IRC section 957(a) was satisfied with ownership of “foreign controlled United States shareholders,” rather than “United States shareholders."

California conforms to the changes to IRC section 958, but does not conform to the changes to IRC section 951B.

Worldwide Unitary Method

California corporate taxpayers doing business both within and without California are required to compute their California franchise or income tax using the worldwide unitary method. Under this method, a corporate taxpayer's business income from both domestic and foreign unitary operations is considered in the calculation of the taxpayer's tax base, and a share of that business income is then “apportioned” to California using a formula. Income apportioned to California is subject to California franchise or income tax. The formula measures relative levels of business activity in the state by using the amount of the taxpayer’s sales in California divided by the taxpayer's sales everywhere. This measure of activities is commonly called the “single sales-factor formula.” The amount of sales from both domestic and foreign activities are included in the calculation of the apportionment formula. Generally, dividends paid from one member to another within the unitary group from unitary earnings are eliminated from tax computations under Revenue and Taxation Code (RTC) section 25106.

California Water's-Edge Election

As an alternative to the worldwide unitary method, California law allows corporations to elect to determine the business income of their combined reporting group on a “water's-edge” basis. In general, the water’s-edge method excludes foreign corporations from the calculation of business income. An exception to this general rule is a CFC with subpart F income. The income and factors of the CFC are included in a water's-edge combined report based on the CFC's inclusion ratio. This ratio is equal to the CFC’s current year subpart F income divided by the CFC’s current year earnings and profits.

While California does not conform to the subpart F scheme of the IRC, for purposes of computing the CFC's inclusion ratio under water's-edge, California incorporates the federal definitions of a “controlled foreign corporation,” “subpart F income” and “earnings and profits ” as applicable for federal income tax purposes for the same taxable year. This is limited to provisions of the IRC referred to in the water's-edge election provisions that are not otherwise applicable for California franchise or income tax purposes.

RTC section 25110 specifically refers to ""controlled foreign corporation"" as defined in IRC section 957. IRC section 957 applies the stock ownership rules under IRC section 958 to determine if a foreign corporation meets the U.S. shareholder ownership requirement to be a controlled foreign corporation. As a result, the new ownership attribution rule is applicable with respect to water's-edge elections for taxable years of foreign corporations beginning after December 31, 2025, and for taxable years of U.S. shareholders in which or within which such taxable years of foreign corporations end.

California does not conform to the provisions of Section 951B.

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