For tax professionals navigating the complex intersection of the Transition Tax under I.R.C. § 965 and the dividends received deduction (DRD) under I.R.C. § 245A, the United States Tax Court’s recent decision in Varian Medical Systems, Inc. & Subs. v. Commissioner, 166 T.C. No. 8 (April 8, 2026), provides critical guidance. This opinion addresses the mechanical computation of Varian’s DRD under § 245A and the corresponding foreign tax credit (FTC) disallowance under § 245A(d)(1). The analysis clarifies the strict application of holding periods under § 246(c) to indirectly owned controlled foreign corporations (CFCs) and settles the denominator computation for the § 245A(d) FTC disallowance fraction in the context of a § 965(c) deduction.

Factual Background

Varian Medical Systems, Inc. operates globally through corporations in multiple countries, acting as the parent company of a U.S. consolidated group. The taxpayer and its CFCs operated on a fiscal year beginning September 30, 2017, and ending September 28, 2018 (the 2018 Year).

During the 2018 Year, twenty-two of Varian’s CFCs had Accumulated Post-1986 Deferred Foreign Income subject to the I.R.C. § 965 Mandatory Repatriation Tax (MRT). 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 consolidated return, Varian elected to claim FTCs for foreign taxes deemed paid under § 960. Accordingly, Varian grossed up its taxable income under § 78 by approximately $159 million. Varian concurrently claimed a DRD of approximately $60 million under § 245A for the § 78 dividend treated as received from its first-tier CFCs.

The IRS issued a Notice of Deficiency disallowing the § 245A deduction and increasing the § 78 dividend by nearly $1.9 million. In the alternative, the IRS determined that if the § 245A deduction were permissible, "I.R.C. § 245A(d) would disallow any foreign tax credits attributable to that amount". In an initial reviewed opinion, Varian Med. Sys., Inc. & Subs. v. Commissioner, 163 T.C. 76 (2024), the Tax Court held that Varian was statutorily entitled to a § 245A deduction for the amounts treated as dividends under § 78, but concurrently held that § 245A(d)(1) limited the FTCs attributable to those deducted amounts.

Taxpayer Requests for Relief

Following the 2024 decision, the parties disagreed on the mechanical computations of both the DRD and the disallowed FTCs, filing cross-motions for summary judgment. Varian requested relief on three specific grounds:

First, Varian argued procedurally that the Commissioner forfeited the argument that I.R.C. § 246 disallows a portion of Varian’s § 245A deduction because the IRS failed to raise it during the previous litigation.
Second, Varian argued substantively that I.R.C. § 246(c) allows the DRD in full. Varian sought to expand its § 245A deduction by approximately $100 million to include the § 78 dividends arising from its lower-tier CFCs, asserting that indirect ownership satisfied the statutory holding period.
Third, regarding the FTC disallowance under I.R.C. § 245A(d)(1), Varian argued that the formula established by the court must use a pre-§ 965(c) deduction amount in its denominator.

Court's Analysis of the Law

Procedural Determinations on Forfeiture

The court quickly dispatched the forfeiture arguments. Acknowledging that Varian's previous motion was for partial summary judgment focused narrowly on an effective date issue, the court exercised its discretion to hear the Commissioner's § 246 arguments. The court emphasized that the qualifications under § 246 present a "pure legal issue with no disputed facts," meaning that reaching the merits did not improperly prejudice Varian.

Holding Period Requirements

Under Section 246 I.R.C. § 246(c)(1) explicitly states that "[n]o deduction shall be allowed under section 243, 245, or 245A, in respect of any dividend on any share of stock . . . which is held by the taxpayer" for fewer than a specified number of days.

The court engaged in a statutory interpretation of the phrase "held by the taxpayer," which the Code leaves undefined. Applying principles from Dole Food Co. v. Patrickson, 538 U.S. 468 (2003) and Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943), the Tax Court underscored the foundational corporate law doctrine that parent corporations and subsidiaries are distinct legal entities. The court highlighted the Supreme Court's mandate in Dole Food: "A corporate parent which owns the shares of a subsidiary does not, for that reason alone, own or have legal title to the assets of the subsidiary; and, it follows with even greater force, the parent does not own or have legal title to the subsidiaries of the subsidiary".

The court rejected Varian’s argument that "hold" broadly encompasses indirect ownership, emphasizing that "shares held by Varian’s foreign subsidiaries during the relevant period are not treated as Varian’s assets and were not held by Varian or members of its U.S. group within the meaning of section 246(c)(1)". The court noted that when Congress intends to include indirect ownership, it does so explicitly, as it did in § 246(c)(5)(B). The court analyzed § 246(c)(5)(B), which uses the phrase "only if" to establish a maintained ownership status, ruling that this provision "establishes an additional condition that taxpayers must satisfy" but "does not supplant the holding period set out in section 246(c)(1)".

Section 245A(d)(1) Foreign Tax Credit Disallowance

Under I.R.C. § 245A(d)(1), "[n]o credit shall be allowed under section 901 for any taxes paid or accrued (or treated as paid or accrued) with respect to any dividend for which a deduction is allowed under this section". To calculate the disallowance, the Tax Court had previously adopted a proportional formula: Disallowed FTC = Deemed Paid FTC x [Section 78 gross-up / (Net section 965 inclusion + section 78 gross-up)].

The dispute centered on the "Net section 965 inclusion" variable. The MRT mechanics require a taxpayer to compute an inclusion amount under § 965(a), offset by deficits under § 965(b), and then apply a deduction under § 965(c) to achieve targeted reduced effective tax rates (15.5% for cash, 8% otherwise). Varian argued the "Net section 965 inclusion" denominator should be the full inclusion unreduced by the § 965(c) deduction. Conversely, the Commissioner argued the denominator must reflect the post-§ 965(c) deduction amount.

Application of the Law to the Facts

Regarding the DRD holding period, the facts stipulated that the shares of the lower-tier CFCs were "at all times held by intermediate foreign corporations". Therefore, applying the strict direct-ownership reading of § 246(c)(1), Varian failed to hold the shares of the lower-tier CFCs directly. The court concluded that indirect ownership does not satisfy § 246(c)(1) and denied Varian the $100 million DRD associated with the lower-tier CFCs' § 78 dividends.

Regarding the FTC disallowance computation, the court found Varian’s argument structurally flawed. The court noted that because I.R.C. § 965(g)(1) and (4) already heavily reduce (or "haircut") the allowable FTCs and § 78 gross-up amounts proportionately to the § 965(c) deduction, failing to also reduce the denominator by the § 965(c) deduction destroys the mathematical ratio.

The court thoroughly rejected Varian’s formulation, noting that applying pre-§ 965(c) amounts to the denominator while utilizing post-haircut numbers elsewhere artificially deflated the disallowance percentage from 12.52% to 6.5%. The judge forcefully stated, "Using the post-section 965(c) amount for the net section 965 inclusion compares apples to apples and preserves a meaningful ratio; namely, that approach identifies the percentage of the already-reduced foreign taxes attributable to the already-reduced section 78 dividend". Conversely, "Using the pre-section 965(c) amount for the net section 965 inclusion creates an inflated denominator and a meaningless ratio".

Conclusions of the Tax Court

The Tax Court ruled firmly in favor of the Commissioner on all substantive grounds:

First, the court held that "shares are 'held by the taxpayer' for purposes of section 246(c)(1) only if the taxpayer holds the shares directly". Consequently, Varian successfully satisfied the holding period for its first-tier CFCs but failed to do so for its lower-tier CFCs, entirely precluding a § 245A DRD for the § 78 dividends originating from the lower-tier entities.
Second, the court held that the formula determining the FTC disallowance under § 245A(d)(1) must universally incorporate the MRT rate-reduction mechanics. Specifically, the court held that "the 'net section 965 inclusion' in our formula is the section 965(a) inclusion amount with respect to Varian’s first-tier CFCs reduced by the associated section 965(c) deduction".

The court denied Varian's Motion for Summary Judgment and granted the Commissioner’s Cross-Motion for Summary Judgment, effectively cementing the IRS's more restrictive calculation of available credits and deductions.

Prepared with assistance from NotebookLM.