In brief
On April 8, 2026, the US Tax Court resolved cross-motions for partial summary judgment in Varian Med. Sys. Inc. & Subs. v. Commissioner, 166 T.C. No. 8 (Apr. 8, 2026). The Court held that for purposes of the section 245A dividends received deduction (DRD) for section 78 dividends arising under the section 965 transition tax, Varian satisfied the section 246(c) holding period rule with respect to its first-tier controlled foreign corporations (CFCs), but not its indirectly-held lower-tier CFCs. The Court also held that the “net section 965 inclusion” in the denominator in the below section 245A(d) foreign tax credit (FTC) disallowance formula must be reduced by the taxpayer’s section 965(c) deduction.
Background
Varian Medical Systems and its CFCs were fiscal-year taxpayers. For the taxable year at issue, Varian’s taxable year started on September 30, 2017, and ended on September 28, 2018 (“FY18”). During FY18, twenty-two of Varian’s CFCs had accumulated post-1986 deferred foreign income subject to section 965. Varian directly owned nine of these CFCs (first-tier CFCs), while the remaining thirteen were held indirectly through intermediary foreign corporations (lower-tier CFCs). On its 2018 tax return, Varian claimed a section 245A DRD with respect to its section 78 dividends arising under the section 965 transition tax from its first-tier CFCs. Varian later amended its petition to claim a section 245A DRD with respect to its section 78 dividends from its lower-tier CFCs.
The IRS audited Varian’s tax return and issued a Notice of Deficiency disallowing Varian’s section 245A DRD. In the alternative, the IRS determined that if Varian was allowed a section 245A DRD on its section 78 dividends, then section 245A(d) would disallow FTCs by the amount that its deemed paid foreign taxes are attributable to the foreign earnings reflected in the section 78 dividend for which the taxpayer claimed a section 245A DRD.
In August 2024, the Tax Court issued its first opinion in Varian Med. Sys., Inc. & Subs. v. Commissioner, 163 T.C. 76 (2024). The Court determined that the best reading of the operative statutes was that Varian could claim a section 245A DRD for the section 78 dividend that arose in connection with Varian’s section 965 transition tax, and that Treas. Reg. § 1.78-1(a) (2018) was invalid because it contravened the clear statutory text. The Court also concluded that section 245A(d) applies to disallow FTCs by the amount that the taxpayer’s deemed paid foreign taxes are attributable to the foreign earnings reflected in the section 78 dividend for which the taxpayer claims a deduction.
Discussion
Following the Court’s 2024 decision, the parties moved for cross-motions for partial summary judgment on the application of section 246(c) and how to compute the section 245A(d) FTC formula. Varian argued that both its first-tier CFCs and lower-tier CFCs satisfied the section 246(c) holding period. The Court rejected Varian’s argument and interpreted “held by the taxpayer” in section 246(c)(1)(A) to require the U.S. shareholder to directly own the CFC from which the section 78 dividend arises. As a result, Varian was only entitled to claim a section 245A DRD for section 78 dividends attributable to foreign taxes paid by first-tier CFCs.
Varian also argued that the “net section 965 inclusion” in the denominator of the Court’s section 245A(d) FTC formula must use the section 965(a) inclusion amount (i.e., the earnings determined under section 965(a) less the earnings and profits (E&P) deficits determined under section 965(b)). The Commissioner, on the other hand, argued that the “net section 965 inclusion” in the denominator should be reduced by the taxpayer’s section 965(c) deduction. The Court held that the “net section 965 inclusion” in the denominator in its formula should be the section 965(a) inclusion reduced by the taxpayer’s section 965(c) deduction.
Implications
The holding in this Tax Court opinion reduces the amount of the section 245A DRD that a taxpayer can claim for its section 78 dividends arising from the section 965 transition tax and determines the amount of FTCs that are disallowed under section 245A(d) to the extent the taxpayer claims a section 245A DRD. On June 15, 2026, the Tax Court issued its final decision in Varian which starts the 90-day period for the parties to file a notice of appeal, which ends on September 14, 2026. If either party files a notice of appeal, the other party can file a cross-appeal by October 13, 2026.