Subpart F and Controlled Foreign Corporations

Subpart F of the Internal Revenue Code deals with controlled foreign corporations (sometimes referred to as a CFC), and does not necessarily apply to every United States person or business entity that owns stock in a foreign corporation.  Subpart F applies to United States shareholders of controlled foreign corporations.  See Internal Revenue Code Section 951(a).  Thus, as a shareholder of a controlled foreign corporation, Subpart F may apply to you or a business you are affiliated with.  It is also important to note that the code covering controlled foreign corporations is different than the sections dealing with Passive Foreign Investment Companies (sometimes referred to as a PFIC).  The PFIC rules apply to all U.S. owners not just U.S. owners of controlled foreign corporations.

An initial issue to consider when looking at Subpart F and controlled foreign corporations is how is a United States shareholder defined?  Generally, under Internal Revenue Code Section 951(b) a U.S. shareholder could be defined as a U.S. person who owns, or is considered to own 10% or more of the total combined voting power of all classes of stock of which are entitled to vote in a foreign corporation.  Thus, you look at voting  power regarding a U.S. shareholder, and a U.S. person is generally defined as a U.S. citizen or resident, or a domestic entity.  See IRC Sections 957(c) and 7701(a)(30) regarding the definition of a U.S. person.

When determining whether a foreign corporation is a controlled foreign corporation, it is important to remember that only the stock of U.S. shareholders is considered.  Generally, a controlled foreign corporation would be a foreign corporation whereby U.S. shareholders own or are considered to own more than 50% of the total combined voting power of all classes of stock that are entitled to a corporate vote or the total value of the stock of the corporation.  For “look back” purposes the ownership percentage can be any day during the applicable taxable year of the corporation. 

To be subject to Subpart F, the shareholder of a foreign corporation must be a United States person, or to be used when determining whether or not the foreign corporation is in fact a foreign corporation.  Internal Revenue Code Section 7701(a)(30) defines a U.S. Person as a citizen or resident of the United States, a domestic partnership, a domestic corporation and any estate or trust (apart from a foreign trust or estate).  Thus, a U.S. Person as defined by the code does not include nonresident aliens, foreign corporations and foreign partnerships.  Thus, Subpart F is really limited to shareholders who are persons and business entities already likely to be subject to taxation by the United States.

The above article was drafted by John McGuire, a tax attorney in Denver, Colorado and the founding partner of The McGuire Law Firm.  You are welcome to contact The McGuire Law Firm to discuss your tax questions and issues with a tax attorney.

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