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Foreign Corporations and Subpart F Income – Part I



TaxConnections Offshore BusinessForeign Corporations Generally. A foreign corporation entity is the vehicle of choice in utilizing the benefits of Financial Centers Offshore. A foreign corporation is one which is not created or organized in the United States and therefore is not a domestic corporation. A domestic corporation is taxable on its worldwide income. By definition, a foreign corporation is not a United States person and income is not taxable as a United States person. It is not subject to taxation of its accumulated earnings and profits until distributed to its United States shareholders. The general taxation of a foreign corporation is subject to the application of Subpart F Income taxation which is specifically designed to re-characterize foreign corporations as controlled foreign corporations.

Subpart F Income Taxation. Subpart F income rules are the core legislation designed to create controlled foreign corporations. By virtue of the codification, United States shareholders’ accumulated earnings of a foreign corporations’ profits are deemed distributed each taxable year. The accumulated earnings that would otherwise be lodged as foreign corporate accumulated earnings and not taxable until distributed, becomes taxable by Subpart F Income treatment. The essence of Subpart F Income tax treatment is to attribute a tax to United States shareholders of a foreign corporation with respect to their pro rata share of a foreign corporation’s deemed distributed earnings and profits for a corporate taxable year.

There are two planning concepts to avert the requirement that a foreign corporation’s accumulated earnings are deemed distributed each taxable year. One is ownership and the other pertaining to the type of company specific activities performed offshore. That is to say, there are two features to plan around, ownership rules and activities rules of what are known as Foreign Base Company Income. The elimination of either enables the foreign corporate taxpayer to remove itself from Subpart F Income treatment. This statement addresses the planning opportunities of ownership principles.

Controlled Foreign Corporations Legislation. The crux of understanding these Subpart F provisions is the distinction between a foreign corporation and a controlled foreign corporation. The distinction relies on the percentages of ownership of a foreign corporation and the definitional designation of who is regarded as United States shareholders. A United States shareholder by definition is a United States person who owns directly, indirectly, or constructively ten percent or more of the total combined voting power of all classes of stock that have been issued by a foreign corporation. A United States person is defined as a United States partnership, a domestic estate or a domestic trust.

The taxation results from the combination of a foreign corporate entity being characterized by statutory definition as a controlled foreign corporation and the shareholder or shareholders being United States shareholders. Those two elements result in a foreign corporation being subject to Subpart F Income treatment. The controlled foreign corporation status is what prevents the entity from the ability to maintain its accumulated earnings offshore without a deemed distribution.

Gaining a command of Subpart F Income rules is necessary to understand the factors that cause an entity to be deemed a controlled foreign corporation. The ability to manage these two components of Subpart F Income affords various structural planning strategies in the organization process to avoid a controlled characterization.

In order for Subpart F Income rules to be applicable to a foreign corporation, the United States shareholders must control the foreign corporation. A foreign corporation is construed by statute to be a controlled foreign corporation if the United States shareholders have ownership of a foreign corporation in two ways. One such way occurs if stock is owned and more than fifty percent of ownership of the total combined voting power of all classes of stock entitled to vote is owned by United States shareholders. It is deemed a controlled foreign corporation in such case. The second method results in it being a deemed controlled foreign corporation if stock is owned by United States shareholders and more than fifty percent ownership of the total value of the stock issued by the foreign corporation is so held.

In accordance with Circular 230 Disclosure

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William Richards is a Sole Practitioner in Orlando, Florida, USA 32626. Attorney at Law, Legal Advisor. 1978 – Present

PUBLICATIONS: International Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2012, 378 pages. The Handbook of Offshore Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2004, 266 pages; Offshore Financial Centers and Tax Havens, Archives of Tulane Law Library, Tulane Law School, Tulane University, New Orleans, Louisiana, Copyright, 1996, 512 Pages.

2 thoughts on “Foreign Corporations and Subpart F Income – Part I

  1. Avatar taxgeek1 says:

    Why is a “US corporation” excluded from your definition of a “United States person” or a citizen or resident of the US?

    • Avatar taxgeek1 says:

      To: DannyGroves@yahoo.com
      Question: Comment:
      Why is a “US corporation” excluded from your definition of a “United States person” or a citizen or resident of the US

      Answer: Mr. Groves:

      This is in response to your question above regarding whether a US corporation, citizen or resident of the US should be excluded from the definition of a United States person.

      I assume you are referring to the statement in Section Four that “… a United States person is defined as a United States partnership,a domestic estate or a domestic trust…”

      Mr. Groves you are quite correct. An all inclusive definition in accordance with Section 7701(a)(30)states specifically that, “… A United States person means – (A) a citizen or resident of the United States, (B) a domestic corporation, and (C)any estate or trust other than a foreign estate or trust within the meaning of IRC Section 7701 (a) (31.

      Thank you for the question and the opportunity to clarify it for you.

      Cordially,

      William L. Richards Jr

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