Controlled Foreign Corporations (CFCs) are a hot topic for U.S. expats who own or are considering owning a foreign company abroad. Understanding the U.S. tax implications of a CFC is crucial for compliance and optimal tax planning. This article aims to provide a comprehensive overview of what a CFC is, the benefits, and the tax obligations under U.S. law, focusing on the Internal Revenue Code (IRC) sections relevant to CFCs in the United States.
WHAT IS A CONTROLLED FOREIGN CORPORATION?
A Controlled Foreign Corporation is a corporate entity registered and operated in a foreign jurisdiction, where more than 50% of the total combined voting power or value is owned by U.S. shareholders. According to IRC Section 957, U.S. shareholders are defined as U.S. persons who own at least 10% of the foreign entity’s voting shares. This direct ownership is crucial for determining whether a corporation is a CFC under U.S. tax rules.
COMBINED VOTING POWER AND STOCK OWNERSHIP
The term “combined voting power” refers to the total voting rights held by U.S. shareholders in a foreign company. Stock ownership is not just direct but can also be indirect ownership through another entity. Understanding both direct and indirect ownership is crucial for determining CFC status.
FUNCTIONAL CURRENCY AND FINANCIAL STATEMENTS
The functional currency is the primary currency used in the day-to-day operations of the CFC. Financial statements, including balance sheets and income statements, must often be translated into U.S. dollars for reporting purposes.
PLR 202304008: Taxpayer Does Not Have Section 961(b)(2) Gain for Mid-Year Distributions
Introduction to Section 961 and Mid-Year Distributions
For years, there has been a longstanding question under the subpart F rules on whether a controlled foreign corporation’s (“CFC”) mid-year earnings could be taken into account in determining section 961 basis adjustments with respect to a mid-year distribution of current year earnings to a U.S. shareholder. If a CFC distributed earnings in excess of its U.S. shareholder’s section 961(a) basis in the CFC, the distribution would trigger gain under section 961(b)(2). As a result, U.S. parented groups with CFCs were limited in the amount of current year earnings that could be distributed to avoid triggering non-economic section 961(b)(2) gain as a result of basis adjustments. In PLR 202304008, the IRS confirmed that, at least in the case of the taxpayer that submitted the PLR, mid-year earnings could be taken into account when determining a section 961(b) basis reduction. The ruling is consistent with how many international tax practitioners viewed these rules. Below, we discuss the basics of section 961 as well as the facts and ruling of PLR 202304008.
Section 961 Basis Adjustments
In a U.S. parented group with CFCs, the rules under sections 951-965 (i.e., subpart F), require each U.S. shareholder of a CFC to currently include in income its pro rata share of the CFC’s subpart F income for the tax year. Thus, when a CFC generates earnings, the U.S. shareholder of that CFC must include its pro rata share of such amounts in income. A related and important component of these rules is that under section 961(a), a U.S. shareholder is required to increase its basis in the stock of the CFC by the amount that the U.S. shareholder is required to include in income under section 951(a) with respect to such CFC stock. Similarly, under section 961(b), if a U.S. shareholder receives an amount which is excluded from gross income under section 959(a) (i.e., previously taxed earnings and profits (“PTEP”)), the U.S. shareholder is required to reduce its adjusted basis in the stock of the CFC. Typically, this involves a distribution of PTEP.
Whirlpool Petition For Cert
In a brief filed on October 19, 2022, the IRS asked the U.S. Supreme Court to refuse to review the decision of the Sixth Circuit affirming, in a 2-1 split decision, that $45 million earned by appliance maker Whirlpool’s controlled foreign corporation (“CFC”) in Luxembourg was foreign base company sales income taxable under Subpart F of the Internal Revenue Code.
Whirlpool’s parent company maintains that income from its Luxembourg affiliate’s sales of appliances to its Mexican subsidiary cannot be taxed under Subpart F because it was generated by two foreign affiliates manufacturing different products. However, the IRS contends that the transactions fall within the I.R.C. §954(d) definition of foreign base company sales income (“FBCSI”) earned by a U.S. parent’s CFC and are therefore taxable under Subpart F.
Through its domestic and foreign subsidiaries, Whirlpool engages in the manufacture and distribution of major household appliances, including refrigerators and washing machines, in the United States and abroad. Whirlpool International Holdings, S.a.r.l. (“WIH”), is a wholly owned subsidiary of Whirlpool organized under the laws of Luxembourg. When it filed its petition, WIH had its principal place of business in Luxembourg. Before December 31, 2010, WIH was known as Maytag Corp. (Maytag) and was likewise engaged in the manufacture and distribution of household appliances.
International operations often give rise to unique (and sometime unanticipated) compliance obligations and complex reporting requirements. Recent tax reform rules and regulations have imposed a number of new requirements. This post focuses on, and provides a short introduction to, the Controlled Foreign Corporation (“CFC”) rules under Subpart F of the Code.
Historically, U.S. taxpayers were not subject to tax on the income derived by a foreign subsidiary from operations outside the United States. This concept—deferring the income of the foreign subsidiary until it is repatriated in the form of a dividend or otherwise—is known as deferral. The Subpart F provisions were a congressional attempt to eliminate deferral for certain types of categories of foreign income.
Private equity funds pool capital for investment in privately-held businesses. Increasingly, PE funds are looking to global investment markets and foreign opportunities.
Investors and fund managers generally share a number of common tax goals, including minimizing “phantom” income—that is, profit allocations that do not have a corresponding cash distribution.
In keeping with this goal, funds investing outside of the United States typically attempt to mitigate, if not avoid, U.S. anti-deferral regimes. Historically, the two most notable regimes in this respect are the Subpart F rules applicable to U.S. shareholders of “controlled foreign corporations” (CFCs) and the “passive foreign investment company” (PFIC) regime. In addition, the Tax Cuts & Jobs Act introduced another commonly encountered anti-deferral regime: global intangible low-taxed income (“GILTI”).
Controlled Foreign Corporations (“CFCs”)
Quick Summary. Located “down under” in the Southern Hemisphere and covering the Indian and Pacific Oceans, Australia consists of a mainland continent, the island of Tasmania, and several smaller islands. Australia comprises six states and 10 territories, with its capital at Canberra. Australia boasts the world’s 14th-largest economy and one of the highest per-capita incomes in the world.
Australia is a parliamentary, federal constitutional monarchy. Its system of government combines elements of the systems of the United Kingdom and the United States. Its constitution provides for a bicameral Parliament, with a Senate and House of Representatives, as well as a monarch. Its executive branch, the Federal Executive Council, is comprised of a prime minister and other ministers. In addition, its judicial branch is headed by the High Court of Australia.
Australia is a member of the United Nations, G20, OECD, and World Trade Organization.