Controlled Foreign Corporation - Understanding the Basics

Controlled Foreign Corporation – Understanding the Basics

Controlled Foreign Corporation – Understanding the Basics

What is a controlled foreign corporation?

Controlled Foreign Corporation 

Controlled Foreign CorporationIRS tax law defines a Controlled Foreign Corporation (CFC) is a foreign corporation owned by more than 50% by U.S  persons, who each own at least 10% (Attribution Rules apply). If you have a Controlled Foreign Corporation, the IRS tax and reporting rules becomes infinitely more complicated.

 The two primary elements of determining if you have a Controlled Foreign Corporation is when the foreign corporation is:

  • Owned more than 50% by U.S. Persons; and
  • Each U.S. Person owns at least 10% (attribution riles apply).

Once a foreign corporation is deemed a controlled foreign corporation, the tax rules changes, as well as certain reporting requirements in accordance with Form 5471.

As defined by the IRS:

” A controlled foreign corporation is any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of the corporation.

Definition of a Controlled Foreign Corporation (Additional Terms)

It a foreign corporation is majority owned by U.S. Persons (who each own more than 10%), then the foreign corporation becomes a Controlled Foreign Corporation.  As a result, some of the tax deferrals are lost, and the IRS reporting rules are intensified.

When it comes to controlled foreign corporations, it can get complicated. So, beyond the definition of a Controlled Foreign Corporation, we wanted to provide some additional summary.

Non-Controlled Foreign Corporation

A Non-controlled foreign corporation refers to a foreign corporation that is not owned by at least 50% by U.S. Person. Most foreign corporations are non-controlled, and the IRS has less control over it.

How is a Controlled Foreign Corporation Taxed?

Controlled Foreign Corporation Taxation can get intense. That is because there are many complex issues, including:

  • Subpart F
  • Income Tax

Examples of Controlled Foreign Corporations

While Controlled Foreign Corporations  come in many shapes and sizes, there a few common we work with at Golding & Golding. They include:

– A Sociedad Anonima, in which the U.S. Person usually owns 90% of the Foreign Corporation, with a local resident owning 10%

– A Wholly Owned Foreign Corporation such as Hong Kong Ltd., BVI, or Australia PTY Ltd.

– A Foreign Corporation (Even if established just as a Foreign Trust), but is considered a Per Se Corporation under IRC§ 301.7701-2

Controlled Foreign Corporation Reporting

Controlled Foreign Corporation Reporting involves the reporting of information and disclosure to the IRS. If a person’s ownership interest meets the Form 5471 reporting requirements.

Form 5471 and Controlled Foreign Corporation Reporting

Reporting a controlled foreign corporation on Form 5471 can be complex, and is not limited to controlled foreign corporations.. We have prepared two separate summaries to assist you:

What is a Controlled Foreign Corporation?

What is a Controlled Foreign Corporation?

Additional Controlled Foreign Corporation FAQ

Common questions we receive about controlled foreign corporations, include:

What is IRC Section 957?

IRC section 957 is the code section in the Internal Revenue Code which details Controlled Foreign Corporations (CFC).

What is CFC IRS?

CFC IRS is just a

Foreign Corporation Tax Reform

In 2018 the tax rules have changed. With the introduction of TCJA, GILTI, and updated Form 5471 reporting requirements, the landscape for reporting Controlled Foreign Corporations has intensified.

Controlled Foreign Corporation Dividends

Dividends are generally taxed in the year they are received. In addition, there may be some Subpart F income for the controlled foreign corporation — even in years when no income was distributed.

Examples of a Controlled Foreign Corporation

Examples of a Controlled Foreign Corporation

What is Subpart F?

Generally, subpart F income is income that is earned within a Controlled Foreign Corporation that is going to be taxed to the U.S. person — whether or not any money was distributed to the U.S. persons.

More Than 50% U.S. Ownership

In order for a Foreign Corporation to be considered a Controlled Foreign Corporation, it must be owned more than 50% by U.S. Persons. It is important to note that if the Foreign Corporation is owned 50% by U.S. Person (one U.S. Person and One Non-U.S. Person each owning 50% of the corporation), it is not considered a Controlled Foreign Corporation, because it is not being ‘controlled’ in the legal sense of the word.

10% Ownership

Beyond the Foreign Corporation being owned more than 50% by U.S. Persons, it must be also be that each of the shareholders within that +50% each own at least a 10% share. In other words, if 6 unrelated U.S. Persons own at least 9% share each, they would technically own 54% of the corporation, but because none of them each own at least 10%, it is not considered to be a Controlled Foreign Corporation (unless attribution rules applied)

What is Attribution IRC (958)?

Attribution is the idea that one person considered to constructively own stock that another person owns only due to the relationship between the two individuals. The main purpose of attribution is to avoid artificially low tax reductions strategies by making sales or transfers between “related” parties. More information can be found in Internal Revenue Code section 958. As provided by the IRS :

Constructive ownership rules apply for determining whether the U.S. person is a U.S. Shareholder and whether a foreign corporation is a CFC, but are not considered in determining the amount of a U.S. Shareholder’s Subpart F inclusion.

– A corporation, partnership, trust or estate that owns more than 50% of the voting stock of a corporation is considered to own 100% of the voting stock of that corporation.

– Stock owned by a non-resident alien individual is not treated as owned by a U.S. person.

– More than one family member can be attributed the same stock. For example, stock owned by a child can be attributed to both a parent and a grandparent.

What is Subpart F Income (IRC 951)

Subpart F income is income that is earned within a Controlled Foreign Corporation that is going to be taxed to the U.S. person — whether or not any money was distributed to the U.S. persons. One of the main purposes behind this law is that in days past,Controlled Foreign Corporations would stockpile money and neither distribute nor issue it as income, dividends, interest, capital gains, etc.. Thereafter, the Controlled Foreign Corporation would issue loans to shareholders (which is not income) and then when it’s time to repay the loan, the company would simply forgive loan (no major detriment to the corporation).

Therefore, the IRS developed subpart F income, which can be very detailed.

The main information is found in code section IRC 951:

Amounts included

In general: If a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days or more during any taxable year, every person who is a United States shareholder (as defined in subsection (b)) of such corporation and who owns (within the meaning of section 958(a)) stock in such corporation on the last day, in such year, on which such corporation is a controlled foreign corporation shall include in his gross income, for his taxable year in which or with which such taxable year of the corporation ends—

(A)the sum of—

(i) his pro rata share (determined under paragraph (2)) of the corporation’s subpart F income for such year,

(ii) his pro rata share (determined under section 955(a)(3) as in effect before the enactment of the Tax Reduction Act of 1975) of the corporation’s previously excluded subpart F income withdrawn from investment in less developed countries for such year, and

(iii) his pro rata share (determined under section 955(a)(3)) of the corporation’s previously excluded subpart F income withdrawn from foreign base company shipping operations for such year; and

(B) the amount determined under section 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under section 959(a)(2)).

But I Did Not Receive any Subpart F Income Distribution

It is immaterial whether the US shareholder of controlled foreign corporation actually received any of the money. That is why the phraseology used by the Internal Revenue Service code is “pro rata share” and “amount determined” vs. “received.” There are certain other factors that are important regarding subpart F income such as whether there is any current earnings and profits (E&P), whether taxes have been paid, and whether dividends have also been issued (these will all impact the complex ordering rules of Subpart F Income)

What is Form 8938

Under current U.S. Tax law, the IRS and U.S. Government have made Foreign Financial Reporting a key enforcement priority.

Form 8938 (Statement of Specified Foreign Financial Assets) is an IRS Form associated with FATCA (Foreign Account Tax Compliance Act). It is similar to the FBAR, but more detailed in scope as to what has to be filed (Stock Ownership and Actual Income Earned for example). The failure to file this FATCA Form can lead to extensive Fines and Penalties.

CFC Penalties Will Flow Through 8938

There are many penalties a person may be subject to if they have a controlled foreign corporation but did not file properly. These include penalties for not filing of an FBAR or 8938. They also include started properly report Subpart F Income, or filing a form 5471 form 8621 (depending on the nature of a controlled foreign entity/partnership).

What if I Never Reported Income or Asset?

Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

What Should You Do?

Everyone makes mistakes. If at some point you discover that you should have been reporting your foreign income, accounts, assets or investments, the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure programs.

Controlled Foreign Corporation Lawyers – Golding & Golding, Board-Certified Tax Specialist 

Golding & Golding represents clients worldwide in over 70-countries exclusively in Streamlined, Offshore and IRS Voluntary Disclosure matters. We have successfully completed more than 1,000 streamlined and voluntary disclosure submissions.

International Tax Lawyers - Golding & Golding, A PLC

International Tax Lawyers - Golding & Golding, A PLC

Golding & Golding: Our international tax lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70+ different countries. Managing Partner Sean M. Golding is a Board-Certified Tax Law Specialist Attorney (a designation earned by < 1% of attorneys nationwide.). He leads a full-service offshore disclosure & tax law firm. Sean and his team have represented thousands of clients nationwide & worldwide in all aspects of IRS offshore & voluntary disclosure and compliance during his 20-year career as an Attorney.

Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
International Tax Lawyers - Golding & Golding, A PLC

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