Controlled Foreign Corporation

Definition

A controlled foreign corporation (CFC) is a foreign corporation in which U.S. shareholders own more than 50% of the total combined voting power or value of the stock. This term is particularly important in understanding how U.S. tax laws apply to foreign income and the differences between worldwide and territorial tax systems, as CFCs are subject to specific tax rules that can impact how income is reported and taxed for U.S. shareholders.

5 Must Know Facts For Your Next Test

1. CFC rules are designed to prevent U.S. shareholders from deferring tax on foreign earnings by keeping them in foreign corporations.
2. The ownership requirement for a CFC is based on U.S. shareholders, defined as those owning at least 10% of the voting power of the foreign corporation.
3. Income from a CFC may be taxed under Subpart F provisions, which can include categories such as foreign base company income and insurance income.
4. U.S. shareholders of CFCs may also face additional compliance requirements, including the need to file Form 5471 with their tax returns.
5. The recent tax reforms introduced concepts like GILTI that further complicate the taxation landscape for CFCs, making it crucial for U.S. shareholders to understand their implications.

Review Questions

• How does the definition of a controlled foreign corporation impact the taxation of U.S. shareholders?
  • The classification of a foreign corporation as a controlled foreign corporation significantly affects how U.S. shareholders are taxed on its earnings. When U.S. shareholders own more than 50% of a foreign corporation, they must report certain types of income immediately under Subpart F provisions, which can lead to taxes on income that is not actually distributed back to the shareholders. This mechanism prevents deferral of tax and requires careful reporting and compliance by shareholders.
• Discuss the implications of Subpart F Income for U.S. taxpayers with interests in controlled foreign corporations.
  • Subpart F Income plays a crucial role in the taxation framework for controlled foreign corporations, as it requires U.S. shareholders to recognize certain types of income immediately, regardless of actual distribution. This means that even if profits are retained in the foreign corporation, U.S. taxpayers must still account for and pay taxes on those earnings. The implications include increased compliance obligations and potential higher tax liabilities, leading many businesses to strategize their global operations carefully.
• Evaluate how recent changes in tax law regarding GILTI affect the management strategies of companies with controlled foreign corporations.
  • The introduction of Global Intangible Low-Taxed Income (GILTI) has transformed how companies manage their controlled foreign corporations by imposing a minimum tax on low-taxed foreign income. This change compels companies to reassess their global structures and profit allocation strategies, as they must balance the benefits of maintaining operations in low-tax jurisdictions against the potential for increased tax liabilities in the U.S. As a result, firms may seek to optimize their capital structures and rethink their international investment strategies to minimize exposure to GILTI while remaining compliant with evolving tax regulations.

Related terms

Subpart F Income: Certain types of income earned by a controlled foreign corporation that are subject to immediate taxation for U.S. shareholders, regardless of whether the income is distributed.

Foreign Tax Credit: A credit that allows U.S. taxpayers to reduce their U.S. tax liability based on taxes paid to foreign governments, often used to mitigate double taxation of foreign income.

Global Intangible Low-Taxed Income (GILTI): A provision that taxes U.S. shareholders of controlled foreign corporations on certain types of low-taxed foreign income, aimed at discouraging profit shifting to low-tax jurisdictions.