~ Immigration Tax Planning ~
Controlled Foreign Corporation "CFC"
Definition of a CFC
In general, a foreign corporation is a CFC if at least 50% of either the total voting power or total value of the stock of the foreign corporation is owned by U.S. persons, each of whom owns at least 10% of voting power of the corporation (each such U.S. person a "Ten Percent Shareholder"). Note that, unlike a passive foreign investment company "PFIC" or a foreign personal holding company "FPHC", the type of income or assets of the corporation does not affect whether a foreign corporation qualifies as a CFC, but those attributes will affect how much income is taxable to the Ten Percent Shareholders under the CFC rules.
Consequences to U.S. Shareholders of a CFC
The Ten Percent Shareholders of a CFC are taxed on their share of the corporation's "Subpart F Income" whether or not this income was distributed. Subpart F Income generally includes interest, dividends, rents, royalties, and business income derived from transactions with related parties unless the business in conducted entirely within the country in which the CFC is organized. The Ten Percent Shareholders of a CFC must also include their share of certain amounts of previously untaxed income which is invested in U.S. property and certain amounts of previously untaxed income which is invested in so-called "excess passive assets".
As with the other anti-deferral regimes, the CFC rules can cause a cash-flow problem for Ten Percent Shareholders who are taxed on income which is not distributed to them by the corporation.
Coordination with Other Anti-Deferral Rules
There are coordination rules which determine how to tax income which is subject to both the PFIC and CFC rules. Generally, so long as the U.S. persons are deemed to be Ten Percent Shareholders with respect to that foreign corporation, income subject to both regimes it is treated as Subpart F income taxable under the CFC rules and is not taxed again as QEF income or as an excess distribution from a PFIC. Since Subpart F income generally retains its character in the hands of a U.S. Shareholder, being taxed on a pro rata share of Subpart F income should not differ substantially from being taxed on the income from the corporation's assets as if the Ten Percent Shareholders owned their share of the corporation's assets directly, unless the foreign corporation generates substantial earnings and profits which are not taxable income but which generate a current inclusion under Section 956 (earnings and profits invested in U.S. situs assets) or Section 956A (earnings and profits invested in passive assets). This ability to retain the character of capital gains is one of several reasons why it is advisable to make a QEF or mark-to-market election for any PFIC owned by a U.S. citizen or resident which is not a CFC or where the person is not a Ten Percent Shareholder.
Reporting Rules
In addition to the substantive rules, there are significant record-keeping and reporting burdens placed on U.S. shareholders of a foreign corporation that is a PFIC or CFC. Transfers to foreign corporations must be reported on Form 926, and the information required under Section 6038B must be attached to the form. U.S. shareholders of CFCs must annually file Form 5471 regarding U.S. ownership and control of foreign corporations and the corporation must file Form 5472 regarding transactions with related parties. In addition, each U.S. shareholder of a PFIC (which in the case of an S corporation includes both the corporation and its shareholders and in the case of a partnership includes both the partnership and its partners) must annually file Form 8621.