Controlled Foreign Corporations

Tx 8300

Learning Objectives

1. Explain the reason for Subpart __,

2. Identify ____ and U.S. shareholders,

3. Compute _______ __ income, and

4. Determine when a CFC’s ________ are invested in U.S. ________.

You should be able to:

U.S. Tax of FCs and Owners

• Foreign corporations– Effectively _________ income– U.S. source _________ income– ______ profits tax

• U.S. shareholders of FCs– ______ dividends– ____________ dividends

Direct Exporting

U.S.Company

Siva

Shifting Profit to Tax Haven

ForeignSubU.S.

Parent

No-TaxCountry

Siva

Time Is Money

Discount Rate

Years U.S. Residual Tax

Deferred

Present Value of $100 U.S. Residual Tax

Percentage of U.S. Residual

Tax Saved

10% 5 $62 38%

10% 10 $39 61%

10% 20 $15 85%

15% 10 $25 75%

15% 20 $ 6 94%

CFC Defined

• Foreign corporation in which

ForeignCorporation

U.S.Shareholders

• More than ___%– ______ power or– Stock _____

• U.S. ____________ own– Directly,– __________, or– Constructively

U.S. Shareholder Defined

ForeignCorporation

U.S.Persons

• At least ___% of voting power

• U.S. ______ owning– Directly,– Indirectly, or– _____________

• In foreign corporation

U.S.Persons

U.S. Person Defined

• U.S. ________ and residents

• Domestic ____________

• Domestic ____________

• Non-foreign _______ and trusts

Example: Identifying CFCs

ForeignCorporation

U.S.Citizen

NRA

DC

FC DC

U.S.Citizen

DC

NRA

Identify the U.S. persons and shareholders.

Is the FC a CFC?

What assumption did we make?

Example: Identifying CFCs

ForeignCorporation

U.S.Citizen

NRA

DC

FC DC

U.S.Citizen

DC

NRA

Identify the U.S. persons and shareholders.

Is the FC a CFC?

When Ownership Rules Apply

• Direct ownership

• Indirect ownership– Proportionate– Through _______ entities

• Constructive ownership– Attribution ____– Attribution __

Example: Indirect Ownership

FC1

FC2

FC3

FC4

FC1

FC2

DC3

FC4

What is John’s indirect ownership in FC4?

What is Mary’s indirect ownership in FC4?

John Mary

Attribution from Family

Individuals constructively own stock that parents, children, and grandchildren directly or indirectly own.

Example: Family Business

Forco

a. Identify Forco’s U.S. shareholders.

Joe(U.S. citizen)

Joe’s sister(RA)

Joe’s granddaughter(U.S. citizen)

Joe’s father(NRA)

b. Is Forco a CFC?

Attribution from Transparent Entity

FC

P/S

Partner

• _____________ attribution• If transparent owns > ___%, it’s treated as ___%• ___attribution

FC

Beneficiary

FC

Shareholder

Estate SCorp

Attribution from Corporation

• _____________ attribution only if SH owns ≥ ___%• If corporation owns > ___%, it’s treated as ___%• ___attribution

FC

Shareholder

C

Examples: Attribution from Rules

FC

P/S

Partner

FC

Shareholder

C

FC

Beneficiary

Estate

Examples: Attribution from Rules

FC

P/S

Partner

FC

Shareholder

C

FC

Shareholder

C

Example: Ownership Rules

Forco

U.S.P/S

U.S.Citizen

Domco

How much of Forco does the individual own?

Who are Forco’s U.S. shareholders?

Is Forco a CFC?

Assuming Forco has Subpart F income, who receives a constructive dividend?

Example: Ownership Rules

DC

FC1

FC2

Identify the U.S. shareholders of FC1.

ResidentAlien

Assuming FC1 has Subpart F income, who receives a constructive dividend?

Identify the U.S. shareholders of FC2.

Assuming FC2 is a CFC with Subpart F income, who receives a constructive dividend?

Example: Ownership RulesHow much of Forco does the U.S. partnership own?

How much of Forco does the U.S. citizen own?

Is Forco a CFC?

If Forco has Subpart F income, who receives a constructive dividend?

Forco

U.S.P/S

U.S.Citizen

ForP/S

Example: Ownership RulesHow much of FC2 does citizen A own?

How much of FC2 does citizen B own?

Is FC2 a CFC?

If FC1 earns Subpart F income, who recognizes the constructive dividend?

FC1

FC2

CitizenA

CitizenB

Example: Ownership RulesWho are the U.S. shareholders of FC?

Is FC a CFC?

If FC earns Subpart F income, who recognizes the constructive dividend?

DC

FC

CitizenA

CitizenB

Attribution to Transparent Entity

FCP/S

Partner

• _____ attribution• No attribution via ________ persons• No ___attribution

Beneficiary Shareholder

Estate SCorpFC FC

Attribution to Corporation

• _____ attribution if SH owns ≥ ___%• No attribution via ________ persons• No ___attribution

Shareholder

Corp FC

Examples: Attribution to Rules

Shareholder

Corp FCFCP/S

Partner

FCP/S

Partner

Shareholder

Corp FCFCP/S

PartnerShareholder

Corp FC

Example: Ownership Rules

FC

U.S.Citizen NRA

U.S.P/S

How much of FC does the U.S. P/S own?

Who are the U.S. shareholders of FC?

Is FC a CFC?

If FC earns Subpart F income, who recognizes the constructive dividend?

Example: Ownership Rules

FC

U.S. CitizenA

U.S. CitizenB

How much of FC does the DC own?

Who are the U.S. shareholders of FC?

Is FC a CFC?

If FC earns Subpart F income, who recognizes the constructive dividend?

DC

Example: Voting Power

Forco has class A and class B shares, both with 100 outstanding shares. Class A stock carries sufficient voting power to elect __ directors. Class B shareholders can elect __. Domco owns __ class A shares and __ class B shares. Is Domco a U.S. shareholder?

Example: Voting Power

Domco owns ___% of Forco. Unrelated foreign persons own the other ___%. Forco’s articles of incorporation vest all powers normally reserved for the board of directors in Dilbert, Domco’s director of foreign operations. Domco can replace Dilbert at any time. Is Forco a CFC?

Example: Voting Power

Domco owns ___%, a foreign trust owns ___%, and a foreign bank owns ___% of Forco. The bank lends $12 million to finance Forco’s operations. During loan negotiations, the bank orally agrees to vote its ___% the same as Domco. Is Forco a CFC?

Constructive Dividend

Subpart FIncome

Earnings Investedin U.S. Property

Subpart F Income Does Not Include

• Aggregate limits– Amounts exceeding ____– FBCI and insurance income if ___ __ smaller of

$__ million or __% of gross income

• Transaction limits– U.S. ___ unless _____ reduces U.S. tax– ____ or insurance income if effective foreign tax

rate > ___% of top U.S. rate

Foreign Base Company Sales Income

• Sale of personalty if CFC– Purchases from _______ person,– Sells to _______ person, or– Acts as purchase or sales _____ of related person,

• Buyer uses or consumes item _______ ___ country, and

• Item manufactured _______ ___ country

Not FBCSI

• Sale of ______,

• Sale not involving _______ person,

• Use or consumption ______ CFC country, or

• Manufacture ______ CFC country

Manufacturing Defined

• ___________ transformation of raw materials,

• Direct _____ + ________ ≥ ___% of CGS, or

• Major ________ of component parts– Substantial processes that– ________ considers manufacturing

Example: ManufacturingHogshead Processors (an Estonian CFC) slaughters hogs and packages the meat. HPP buys hogs from its U.S. parent for $____ each. The cost to slaughter, process, and package a hog is $____. HPP sells the packaged meat from each hog to a Romanian wholesaler for $____. Is the profit Subpart F income?

Branch Rule

• Applicable if– Branch located _______ ___ country,– ___ country doesn’t tax ______ profits, and– ___ in branch country ≤ ___% of ETR in CFC

country and at least __ percentage points less

• Results– Branch treated as ________ CFC and– Branch profit treated as ___ _____ income of

actual CFC

Example: Branch RuleDomco manufactures and sells health products. Ten years ago, Domco set up a manufacturing CFC in Hitaxia. Hitaxia normally imposes a ___% tax, but Domco qualified for a tax holiday. Now, the tax holiday is expiring. To serve its foreign market in the future, Domco will set up a sales branch in Lotaxia where the tax rate is ___%. Assuming all customers reside outside Hitaxia and Lotaxia, does the branch rule apply?

Foreign Base Company Services Income

• Commissions, fees, or other compensation

• Received for technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial, or ______ services

• If services are performed– _______ ___ country and– For _______ person

Example: FBC Services IncomeDomco sells personal digital assistants to the Pakistani government under a long-term repair contract. In which of the following cases does foreign base company services income result?

a. Domco performs repairs in the U.S.

b. Domco’s Belgian sub repairs the PDAs in Belgium.

c. Domco’s Belgian sub repairs the PDAs in Poland.

Foreign Personal Holding Company Income

• Most investment income

• Exceptions– Business rent and royalties from _________

persons– Rent and royalties from _______ corporation

for using assets within ___ country– Interest and dividends from _______

corporation with substantial assets and legal domicile within ___ country

Foreign Base Company Oil-Related Income

• Includes _______ source income from– Processing, transporting, distributing,

or selling oil and gas from wells,– Directly _______ services, and– _______ oil-related property

• When average _____ production < _____ barrels, no FBC oil-related income results.

Foreign Base Company Oil-Related Income

• Excludes income sourced within country where– Oil and gas _____ are located, – CFC sells oil, gas, or primary product for ___

or consumption, and– Aircraft or vessel _____ oil, gas, or primary

product as ____

Insurance Income

• If– U.S. ____________ own > ___% of FC and– Gross premiums from insuring _______ risks >

___% of total gross premiums

• Then– FC is a ___ and– Insurance income from insuring _______ risks

is Subpart F income

Related Person Insurance Income

• If– U.S. _______ own > ___% of FC and– Gross premiums from insuring _______ risks >

___% of total gross premiums

• Then– FC is a ___ and– Insurance income from insuring _______ risks

of _______ _______ is Subpart F income

Boycott-Related Income

• Occurs when CFC, as a _________ for doing business, discriminates

• Participation or ___________ in international boycott– Produces _________ income– Reduces ___

Ain’t Misbehaving

?• Subpart F income results when CFCs earn

income from countries:– To which U.S. law prohibits sale of _______

items,– With which U.S. has severed ____ or has no

_________ relations, or– Supporting international _________.

• Cuba, Iran, ____, Libya, North Korea, Sudan, and Syria

Bribes and Kickbacks

• CFCs include as Subpart F income an amount equal to– ______ bribes and kickbacks– Paid to __________ personnel

• Foreign _______ Practices Act is touchstone

Constructive Dividend

Earnings Invested in U.S. Property

• What does CFC do with _____ (other than Subpart F income) not paid as dividends?

• If invested in U.S. ________, U.S. shareholders recognize ___________ dividends.

U.S. Property Defined

• ________ property in U.S. unless– Destined for ______,– Used for _____________ abroad, or– Used in certain _____ activities

• Stock and securities of DC if– DC is U.S. ___________ or– U.S. shareholders of CFC own ≥ ___% of DC

U.S. Property Defined

• Obligations of non-_________ U.S. persons other than– U.S. __________ securities,– U.S. currency,– Bank ________,– Debt instruments of ________ persons, and– Trade receivables

• Rights to use ____________ intangibles in U.S.

Example: U.S. PropertyDuring its first year, Domco’s wholly-owned CFC had foreign earnings of $_______. Of this amount, $______ was Subpart F income. The CFC loaned $______ to Domco and deposited the rest in its U.S. bank account. How much is Domco’s constructive dividend?