Because of this rule and the application of attribution rules, a U.S. shareholder of shareholders are unable to avoid U.S. shareholder status by distributing stock of a foreign corporation to related parties.  For example, if Corporation 1 spread ownership equally amongst 20 other U.S. affiliates within an affiliated group, and thus each corporation would own 5% of the stock of Corporation 1, U.S. shareholder status could not be avoided for each shareholder because of the attribution rules, and each corporation would be treated as constructively owning the shares.  It can also be important to remember that the attribution rules, attribute the stock on the value of the shares owned and the not the voting power.  For example, assume stock was held by John in a corporation and the stock held was 10% of the votes but 25% of the value.  The value would be considered as owning 25% of the stock held.

What about ownership in a foreign partnership, foreign trust or even a foreign estate?  Do the controlled foreign corporation rules in Subpart F apply to these foreign “entities?”  The answer would be no because a foreign entity must be a corporation to fall within the definition of a controlled foreign corporation, and therefore, Subpart F would not apply as a result of ownership by a United State person.  Thus, we must ask the question, for purposes of a controlled foreign corporation, how is a corporation defined?  One should reference Internal Revenue Code Section 7701(a)(3) per the regulations when determining whether or not a foreign business or entity is in fact a corporation within the definition of the code.  Prior to 1997 a facts and circumstances test applied reviewing continuity of life, centralized management, limited liability and free transferability of assets whereby now, under 7701(a)(3) regulations, there are elective rules for classifying most foreign entities.  These classification matters could be akin to certain options, often referred to as “check the box” regulations.  For more information regarding check the box regulations, see 910 T.M.

You can contact a tax attorney and business attorney at The McGuire Law Firm to discuss your tax & business related matters.  The McGuire Law Firm has offices in Denver, Colorado and Golden, Colorado for your convenience and offers a free consultation to all potential clients.

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.