- 1 Foreign Passive Holding Company Income (FPHCI)
- 2 First, What is Subpart F Income?
- 3 The Purpose Behind Subpart F Income
- 4 Foreign Passive Holding Company Income FPHCI
- 5 The Concept of FPHCI Explained
- 6 Can CFC Dividends be Qualified?
- 7 Late Filing Penalties May be Reduced or Avoided
- 8 Current Year vs Prior Year Non-Compliance
- 9 Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
- 10 Need Help Finding an Experienced Offshore Tax Attorney?
- 11 Golding & Golding: About Our International Tax Law Firm
Foreign Passive Holding Company Income (FPHCI)
One of the most complicated aspects of international tax law involves Subpart F income. Generally, Subpart F income is a type of income that is primarily derived from foreign passive income generated within a Controlled Foreign Corporation (CFC). A CFC is a foreign corporation that is owned more than 50% by US persons who are considered U.S. shareholders. As a result of being a Controlled Foreign Corporation, certain passive income generated by the foreign corporation in years that the company generates positive Earnings and Profit (E&P) may be attributed to the shareholders even though that income has not been distributed. There are different types of subpart F income and one of the more common types is referred to as Passive Foreign Holding Company Income (FPHCI). Let’s walk through the basics of what passive foreign holding company income is.
First, What is Subpart F Income?
The idea behind subpart F income dates back 50-plus years ago when the U.S. income tax rates were much higher than they are now. As a result of these high tax rates, U.S. shareholders would shift income overseas via foreign sources and try to generate income overseas in countries with lower tax rates. Then, instead of repatriating the money back to the United States — where they would then pay a hefty tax — taxpayers would get crafty with distributing money other ways, such as loans to shareholders that were ultimately forgiven so that no one ended up paying any U.S. tax on the income — which should have otherwise been taxed at a very high tax rate. This led to a further increase in the tax gap and the development of Subpart F income.
The Purpose Behind Subpart F Income
In general, the purpose behind subpart F income is to make sure that money overseas is still being taxed at the same rate that it would be taxed in the United States. As a result, taxpayers may have to pay tax on income that has not even been distributed in the foreign country yet if it has been attributed to the Taxpayer — and there was positive earnings and profit (E&P) in that year. It is also important to note that there are exceptions to having to pay tax on Subpart F income — with one common exception being the high-tax exception. In other words, if the taxpayer is in a country that has a tax on income similar to that of the United States, then this is typically going to be an exception to Subpart F Income so that the taxpayer does not get dinged extra when they are paying tax in a country that the IRS determined has a legitimate tax scheme.
Stated another way, the goal of subpart F income is to prevent taxpayers from high-tailing it overseas and avoiding paying tax in the foreign country and then avoiding paying tax in the United States on that same income — it is not designed to penalize taxpayers who are already paying tax in a high tax jurisdiction like the United States.
Foreign Passive Holding Company Income FPHCI
Income generated from an FPHC is passive in nature and is one of the categories of subpart F income.
As provided by the IRS:
“There are many categories of Subpart F income . In general, it consists of movable income. For example, a major category of Subpart F income is Foreign Base Company Income (FBCI), as defined under I.R.C. § 954(a), which includes foreign personal holding company income, or FPHCI, which consists of investment income such as dividends, interest, rents and royalties.
Other forms of FBCI includes income received by a CFC from the purchase or sale of personal property involving a related person (i.e. foreign base company sales income, or FBCSI) and from the performance of services by or on behalf of a related person (i.e. foreign base company services income, or FBC Services Income). Note the rules for investments of earnings in U.S. property, FBC Oil Related Income, and FBC Insurance Income are not discussed in this Concept Building Block.”
What does this mean?
It means that there are various types of Subpart F income and that one of the main categories of this income is foreign passive holding company income. In general, foreign passive holding company income falls under the more general category of foreign-based company income and includes your typical type of investment income such as dividends, interest, rents, and royalties.
The Concept of FPHCI Explained
As further provided by the IRS:
“When Congress enacted Subpart F, it recognized the need for U.S. businesses with active business operations abroad to be on equal competitive footing from a tax standpoint with other operating businesses in the same countries. However, where a CFC has portfolio types of investments, or where the CFC is merely passively receiving investment income, there is no competitive justification to defer the tax until the income is repatriated. As such, the provisions of Subpart F require a U.S. shareholder to include its pro-rata share of the CFC’s FPHCI in income currently.
FPHCI generally includes a CFC’s income from dividends, interest, annuities, rents, royalties, and net gains on dispositions of property producing any of the foregoing types of income (as well as several other types of income not covered in this Concept Unit – see separate Practice Unit on FPHCI). § 954(c)”
What does this mean?
It means that when certain Subpart F income from CFCs is considered foreign passive holding company income it will become subject to the subpart of tax rules unless it is otherwise exempt or excluded by one of the exceptions.
Can CFC Dividends be Qualified?
Yes, in certain situations even dividends from a controlled foreign corporation can be considered qualified, but it is to be distinguished from so part of income that is not technically categorized as dividends per se under the tax code. We have a separate article detailing how qualified dividends may operate with a CFC.
Late Filing Penalties May be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.
Current Year vs Prior Year Non-Compliance
Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
Need Help Finding an Experienced Offshore Tax Attorney?
When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.
Contact our firm today for assistance.