New Controlled Foreign Corporation Constructive Ownership Rule
April 13, 2018
The Tax Cuts and Jobs Act enacted in December 2017 changed a constructive ownership rule that determines whether a foreign corporation is a controlled foreign corporation (CFC) for US federal tax purposes. A CFC is any foreign corporation of which more than 50% of the vote or value is owned by US shareholders that own at least 10%. US shareholders of CFCs are subject to certain anti-deferral rules under the US federal tax laws. The anti-deferral rules may require a US shareholder of a CFC to report and pay US tax on undistributed earnings of the foreign corporation.
Prior to the new law, the former rules in effect provided that there was not downward attribution and constructive ownership of foreign corporation stock from a foreign person to a US corporation, US partnership or US trust. The stock of a foreign corporation owned directly by a foreign person was not considered as being owned by a US corporation, a US partnership or a US trust of which the foreign person was a shareholder, partner or beneficiary.
The new law repealed this prior rule, which was under Section 958(b)(4) and incorporated Section 318(a)(3) of the US Internal Revenue Code. With the new law, a US corporation, US partnership or US trust in which a foreign person is a shareholder, partner or beneficiary is now considered to own the stock in a foreign corporation that the foreign person owns directly. The foreign person must own more than 50% of the US corporation before the US corporation is considered to own the foreign corporation’s stock.
For example, if a foreign corporation is owned 49% by a US shareholder and 51% by a foreign shareholder, the foreign corporation would not be a CFC under the prior rule. However, under the new rule, if the foreign person also owns more than 50% of a US corporation then the US corporation is considered to own the 51% of the foreign corporation stock that the foreign person owns. Under the new rule, the foreign corporation is considered to be owned 49% directly by the US shareholder and also 51% constructively by the US corporation. Under the new rule, the foreign corporation is a CFC when taking into account the US corporation’s constructive ownership of the foreign corporation’s stock from the foreign person.
The new CFC constructive ownership rule in the recent US tax legislation will have a significant impact on US shareholders of foreign corporations. As a result, US shareholders may need to comply with additional US international tax reporting requirements. Other possible US federal tax consequences may include additional taxable income and corresponding US federal tax liability for US shareholders of CFCs.
To learn more about the new controlled foreign corporation constructive ownership rule and how it impacts your business, contact Aprio’s International Tax team today.