Controlled Foreign Corporation

Definition

A Controlled Foreign Corporation (CFC) is a foreign corporation where U.S. shareholders, who own more than 50% of the total combined voting power or value of the stock, have significant control over its operations. This status is crucial for understanding tax implications, as it determines how income from foreign subsidiaries is reported and taxed in the United States.

5 Must Know Facts For Your Next Test

1. To qualify as a CFC, more than 50% of the stock must be owned by U.S. shareholders, either directly or indirectly, on any day during the year.
2. CFC rules were significantly impacted by the Tax Cuts and Jobs Act (TCJA) in 2017, which introduced new tax provisions for U.S. shareholders.
3. U.S. shareholders of a CFC are required to report their ownership and certain income details on Form 5471.
4. CFCs can help U.S. companies defer U.S. taxation on foreign income until it is repatriated back to the United States.
5. Tax benefits associated with CFCs can be negated by high foreign taxes, making careful planning essential for multinational corporations.

Review Questions

• What criteria determine whether a foreign corporation qualifies as a Controlled Foreign Corporation?
  • A foreign corporation qualifies as a Controlled Foreign Corporation if U.S. shareholders collectively own more than 50% of its total combined voting power or value of stock during any day in the taxable year. This ownership can be direct or indirect through other entities. This definition is vital because it influences how the income of these corporations is treated under U.S. tax law.
• How do Subpart F income rules apply to Controlled Foreign Corporations and their shareholders?
  • Subpart F income consists of specific types of income earned by a Controlled Foreign Corporation that are subject to immediate taxation for U.S. shareholders, regardless of whether that income is distributed. This includes passive income like dividends, interest, and royalties, which can lead to significant tax liabilities for shareholders. Understanding these rules is essential for managing potential tax exposure and compliance obligations.
• Evaluate the implications of GILTI on U.S. shareholders of Controlled Foreign Corporations and discuss potential strategies to mitigate its impact.
  • GILTI imposes a tax on U.S. shareholders for income earned by their Controlled Foreign Corporations that exceeds a specified return on tangible assets. This provision aims to discourage profit shifting to low-tax jurisdictions. To mitigate its impact, shareholders can engage in careful tax planning, such as utilizing foreign tax credits or restructuring operations to align with GILTI thresholds, ensuring they maximize tax efficiency while remaining compliant with regulations.

Related terms

Subpart F Income: Income earned by a CFC that is subject to immediate taxation in the U.S., even if it has not been distributed to shareholders.

Foreign Tax Credit: A tax credit that U.S. taxpayers can claim for taxes paid to foreign governments, which helps to reduce double taxation on foreign income.

GILTI (Global Intangible Low-Taxed Income): A provision that taxes U.S. shareholders of CFCs on certain types of income generated by their controlled foreign corporations that exceed a specified return.