The “deemed dividend” rule, the source of much wrangling between multi-national borrowers and lenders over the years, may be on its way out.

To refresh your possibly painful memories: under existing federal tax law, the ability of a borrower’s foreign subsidiary to provide credit support—a guaranty or collateral—for a loan to its parent is limited by federal tax law. Section 956 of the Internal Revenue Code treats a “controlled foreign corporation” (the sub) as “holding an obligation” of its U.S. parent if it guaranties the debt or gives collateral to secure it.

The effect of this rule is to tax the U.S. parent on overseas earnings of a subsidiary that would otherwise go untaxed until they were repatriated through the payment of dividends—a “deemed dividend.” As a result, multi-national borrowers have resisted, for legitimate business reasons, lenders’ requests to secure loans to parent companies with assets or guaranties of foreign subsidiaries, even when it was clear that foreign subs would be using the proceeds of the credit, refuting the time-honored notion that you can’t have it both ways.

A slight regulatory fix was made, allowing U.S. parent companies to pledge less than two-thirds of the stock of a foreign subsidiary without triggering a deemed dividend, so long as the lender didn’t restrict subsidiaries’ ability to dispose of assets and incur additional debt. Nonetheless, transactional costs in multi-national credits were driven higher—with no benefit to anybody involved—by the prospect that a company’s best-laid tax plans would be upset by a lender’s legitimate underwriting concerns.

Proposed regulations by the IRS and the Treasury Department would treat deemed dividends as subject to a “participation exemption” created by the Tax Cuts and Jobs Act of 2017, part of the trend toward a worldwide system of taxation. A holding period and certain other requirements will apply, but if met, a U.S. parent can qualify for a 100%-dividends-received deduction to offset the deemed dividend for tax years after 2017. The regulations are not yet effective, but since they reflect a statutory change, it is likely that they will be adopted.

So what was never a dividend in the first place may soon be “deemed” to be what it always was—legitimate credit support for a multi-national credit.

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