AN EARNINGS REPATRIATION strategy has come under fire.

The United States taxes US corporations on worldwide income, but foreign corporations are taxed only on income from US sources. This means that a US corporation can defer US taxes on earnings from its operations outside the United States by putting the operations under a subsidiary corporation in the Cayman Islands, Bermuda, Holland, Luxembourg or another country. The United States will look through the offshore subsidiary and tax any dividends, interest or other forms of passive income received by the subsidiary, but US taxes on income from active business operations can be deferred until the income is repatriated to the United States.

US multinational corporations look for ways to have the use of the money in the United States without formally repatriating it to avoid triggering taxes.

Lending the offshore earnings to the US parent does not work unless the loan is for no more than 30 days. Up to two such short-term loans can be made. If a loan is made for a longer period, then the offshore subsidiary will be treated as having repatriated its undistributed earnings up to the amount of the loan.

A US company tried getting around this by having its offshore subsidiaries with large amounts of undistributed earnings make loans to lower-tier offshore subsidiaries with fewer earnings that then re-lent the money to the US parent.

The IRS said it would treat the subsidiaries that were the original source of the funds as the real lenders — and use their earnings to determine how much was repatriated — rather than focusing on the intermediate entities. It addressed the strategy in an internal legal memorandum that it made public in December. The memo is Chief Counsel Advice 201446020.

The IRS is planning to issue guidance soon on the treatment of loans by offshore subsidiaries to foreign partnerships with a US partner. The issue is when and how much of such a loan will be considered repatriation of earnings to the US partner.

Keith Martin in Washington