Anti-Deferral and Controlled Foreign Corporations

December 13, 2013

Based on the general rule of deferral, a U.S. shareholder of a foreign corporation defers U.S. federal taxation on earnings of the foreign corporation until a dividend distribution is actually repatriated to the U.S. shareholder. There are some important exceptions to this general rule under the anti-deferral tax regime that applies to controlled foreign corporations. A controlled foreign corporation (CFC) is a foreign corporation of which more than 50% of the vote or value is owned by U.S. shareholders who each own at least 10% of the voting stock of the foreign corporation. A U.S. shareholder of a CFC is required to pay U.S. federal tax on deemed distributions of undistributed income from the foreign corporation, even though an actual cash dividend is not received. The U.S. shareholder is considered to have a deemed dividend inclusion subject to U.S. federal tax if the foreign corporation has Subpart F income or if the foreign corporation has earnings invested in U.S. property.

There are several categories of Subpart F income. One main category of Subpart F income is foreign base company income, which includes several subcategories of income: foreign personal holding company income, foreign base company sales income, foreign base company services income and foreign base company oil related income.

  • Foreign personal holding income includes passive types of income such as interest, dividends, rents, royalties, annuity income, gains from the sale of property which produces such income, income from commodities, currency and swap transactions and income from certain personal service contracts.
  • Foreign base company sales income includes income from transactions where the CFC purchases from or sells goods to a related party, the property is manufactured or produced outside the CFC’s country of incorporation and the property is sold for use, consumption or disposition outside the CFC’s country of incorporation.
  • Foreign base company services income is income from services that the CFC provides outside the country of incorporation to or for the benefit of a related party.

There are de minimis and full inclusion rules for Subpart F income. Based on the de minimis rule, the CFC is not considered to have Subpart F income for the year if the total of its gross Subpart F income is less than the lesser of 5% of all gross income or $1 million. Based on the full inclusion rule, the CFC is required to treat 100% of its gross income for the year as Subpart F income if the Subpart F income is greater than 70% of the total gross income.

A CFC is considered to have earnings invested in U.S. property if it has trade or service receivables owed to the CFC by a U.S. person or if the CFC guarantees the obligation of a U.S. person or stock of the CFC is pledged as collateral for the obligation of a U.S. person. A CFC also is considered to have earnings invested in U.S. property based on investments in stock of U.S. corporations, obligations of U.S. persons or rights to utilize intangible property in the United States.

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