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.
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”)
Do you know that owning a Controlled Foreign Corporation got affected by New Tax Bill? In a nutshell, Trump’s tax reform now means that all income is Subpart F income. In addition, all currently untaxed retained earnings will be subject to a one-time tax. Read further if you want to find out what it means exactly and how U.S. expats with CFCs are affected.
Let’s take a quick look at a few changes that were introduced in recent tax legislation. Generally, Trump’s tax reform benefits individuals who are struggling with their finances by doubling standard deductions, i.e. from $6,000 to $12,000 for singles, and reducing the rates for five tax brackets of the existing seven. Read More
Pursuant to the Tax Cuts and Jobs Act (“TCJA”) passed on Dec. 22, 2017, the U.S. will tax U.S. corporations with the following tax rates:
– 21 percent general corporate income tax rate,
– 13.125 effective tax rate on U.S. corporation’s foreign derived intangible income (“FDII”), for taxable years from 2018 through 2025;
– 10.5 percent effective tax rate on the U.S. corporation’s pro rata share of global intangible low taxed income (“GILTI”) of a controlled foreign corporation (“CFC”). Read More
A CFC is a foreign corporation where a U.S. shareholder owns “more than” 50% of the offshore company. Practitioners quickly noted the 50% ownership requirement and correctly deduced that, if a non-U.S. shareholder owned the remaining 50%, the foreign corporation could escape being a CFC.
As will be recalled from the previous blog posting that discussed so-called “Controlled Foreign Corporations” (CFC), a United States shareholder of a CFC can possibly be treated as having received “dividend” income at various times. These are when the US shareholder (i) has current income inclusions from the CFC under the anti-deferral regime (Subpart F income); (ii) has amounts actually distributed to him that had not been previously taxed as Subpart F income (these are ‘actual’ dividends); (iii) has amounts actually distributed to him that had been previously taxed as Subpart F income and (iv) recognizes gain on the sale of his CFC stock and the CFC has undistributed earnings and profits.
The question arises whether any of these amounts (i)-(iv), can be treated as “qualified dividend income”? Full details about the tax beneficial treatment of “qualified dividend Read More
The CFC (Controlled Foreign Corporation) rules regarding income inclusion have to thread a very small needle. On one hand, they need to prevent United States taxpayers from moving offshore, thereby taking advantage of a technical reading of the United States tax code that prevents taxation of non-US (foreign) corporations (see Part I and Part II). On the other hand, they can’t be so restrictive they prevent United States corporations from expanding internationally, thereby hindering legitimate business development. In effect, the rules need to exclude income derived from “legitimate” business expansion but include evasion.
Before moving forward, be advised: below is a general summation of the CFC income inclusion rules: there are many nuanced ins and outs to these rules that are far beyond the Read More
Like most subparts in the United States tax code (the CFC rules are a sub-part to sub-chapter N in the code), the CFC rules have specific concepts and definitions that apply only to this particular sub-part. The most important definition is that of a “US shareholder.” In addition, like most sections in the code, the CFC rules require us to reference multiple sections to get a complete definition.
Let’s start with section 957, which states:
For purposes of this subpart, the term “controlled foreign corporation” means any foreign corporation if more than 50 percent of— Read More