International Tax Series: Are You a U.S. Shareholder in a Controlled Foreign Corporation? The Basics to Know about Subpart F

A controlled foreign corporation (CFC) is a foreign corporation of which more than 50% of the vote or value of the stock is owned by U.S. shareholders who each own at least 10% of the voting stock.  CFCs are subject to Subpart F of the U.S. Internal Revenue Code which includes Sections 951 et seq.  If a CFC has Subpart F income or if there is an increase in the earnings invested by the CFC in U.S. property for the tax year, the undistributed earnings of the CFC are taxable to the U.S. shareholder on its U.S. federal income tax return before any actual dividend distribution of the CFC’s earnings is made.  Otherwise, if a foreign corporation is not a CFC, the U.S. shareholder is subject to U.S. taxation only when actual dividend distributions are repatriated to the U.S. shareholder.

Subpart F income includes certain categories of income such as foreign base company services income and foreign base company sales income.  A CFC will have foreign base company services income if the CFC provides certain types of services to a foreign parent company or related party and the services are provided in a country other than the CFC’s country of incorporation.  A CFC will have foreign base company sales income if:

(1) the CFC purchases goods or property from or sells them to a U.S. parent company or related party;

(2) the purchased property is manufactured, produced, grown or extracted by a party other than the CFC outside of the CFC’s country of incorporation; and

(3) the CFC sells the property for use, consumption or disposition outside of the CFC’s country of incorporation.

For example, an Italian subsidiary corporation of a U.S. parent corporation has foreign base company sales income if the U.S. parent corporation manufactures consumer products in the United States, the U.S. parent corporation sells the products to the Italian subsidiary, and the Italian subsidiary sells the products to customers in France.

Subpart F income is subject to U.S. taxation on the U.S. shareholder’s U.S. federal income tax return and it must be reported on the Form 5471.

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