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CFCs—General Overview (Portfolio 926)

Product Code: TPOR43
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Subpart F—General describes the general rules for the U.S. federal income taxation of United States shareholders of controlled foreign corporations (CFCs) under Subpart F of the Internal Revenue Code. Written by Lowell D. Yoder, Esq., McDermott, Will & Emery, this Portfolio begins with a discussion of the background and legislative history of Subpart F. A detailed analysis is provided of the ownership tests that must be satisfied for Subpart F to apply, including such key terms as “controlled foreign corporation,” “United States person,” and “United States shareholder.”

This Portfolio also describes the categories of items included in U.S. shareholders’ income under Subpart F, and the rules for determining the amounts includible in income and the U.S. tax treatment. It further provides an overview of the tax results to U.S. shareholders of various transactions involving CFCs, including the organization and reorganization of a CFC, CFC distributions, and liquidations and dispositions of CFCs. Finally, it describes the rules coordinating Subpart F with various other special rules that apply to foreign entities, and summarizes the reporting and compliance rules that apply to CFCs.

Because the Subpart F Portfolios are meant to be used as a group in analyzing the Subpart F rules, the Worksheets of this Portfolio are intended not only for use with this Portfolio but also may be used in connection with the other Subpart F Portfolios included in the BNA Tax & Accounting Library.

Subpart F—General allows you to benefit from:

  • Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
  • Invaluable practice documents including tables, charts and lists
  • Plain-English guidance from world-class experts
  • Real-world and in-depth analysis that lets you explore various options
  • Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more.
  • Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the Foreign Income Portfolios Library, a comprehensive series containing more than 90 Portfolios, which covers critical transactions and issues in international taxation. This highly-regarded resource service offers commentary on a wide range of foreign income topics including: Foreign Tax Credit, Business Operations in more than 40 foreign countries, Branch ProfitsTax, Source of Income Rules, Subpart F (Controlled Foreign Corporations), Foreign Partnerships and Partners, Transfer Pricing, and more.

 

Detailed Analysis

I. Introduction

II. Background and Legislative History

Introductory Material

A. Pre-Subpart F Rules

1. General Rules

2. Special Rules

a. Personal Holding Companies

b. Foreign Personal Holding Companies

B. 1962 Subpart F Legislation

1. Kennedy Administration Proposal

a. Background

b. Proposal

2. Congress's Response - Revenue Act of 1962

3. Overview of Legislation

a. Subpart F

b. Related Legislation

C. Significant Subsequent Legislative Changes

1. Tax Reform Act of 1969

2. Tax Reduction Act of 1975

a. Repeal of Minimum Distribution Exception

b. Repeal of Less-Developed Country Exception

c. Repeal of Shipping Income Exception

d. Reduction of De Minimis Exception Threshold

3. Tax Reform Act of 1976

a. Section 956 Exceptions

b. Repeal of Section 1248 Exception for Less-Developed Country Earnings

c. Exception for Certain Earnings of Insurance Companies

d. Shipping Income Exception

e. Additional Categories of Subpart F Income

4. Tax Equity and Fiscal Responsibility Act of 1982

5. Tax Reform Act of 1984

a. Factoring Income

b. Insurance Income

c. Coordination of Subpart F with Foreign Personal Holding Company Provisions

d. Coordination of Subpart F and Section 1248

6. Tax Reform Act of 1986

a. Expansion of Types of Subpart F Income

(1) Gains from Certain Property

(2) Income from Commodities Transactions

(3) Currency Gains

(4) Banking and Insurance Passive Income

(5) Income Equivalent to Interest

b. Contraction of Exceptions and Limitations to Subpart F Income

(1) High-Tax Exception

(2) De Minimis Exception

(3) Full Inclusion Rule

(4) Deficit Limitation

c. Expansion of Scope of Application of Subpart F

(1) Control Test

(2) Related Person

(3) Possession Corporations

(4) Captive Insurance Companies

7. Technical and Miscellaneous Revenue Act of 1988

a. Foreign Insurance Companies

b. Earnings and Profits

(1) Measurement of Earnings and Profits

(2) Accumulated Deficits

(3) Chain Deficits

c. Definition of Related Person

d. Subpart F Income

(1) Related Person Exclusion from FPHCI

(2) Gains as FPHCI

8. Omnibus Budget Reconciliation Act of 1989

9. Omnibus Budget Reconciliation Act of 1993

a. Section 956A - Investment in Excess Passive Assets

b. Section 956

c. Foreign Base Company Income

(1) Same-Country Dividend Exception

(2) Foreign Base Company Sales Income

d. Section 959 - Previously Taxed Income

e. Section 960 - Foreign Tax Credits

f. Passive Foreign Investment Company (PFIC) Rules

10. Small Business Act of 1996

11. Taxpayer Relief Act of 1997

a. Subpart F Income

(1) Exclusion For U.S. Source Income

(2) Personal Holding Income

(3) Reduction for Section 1248 Inclusion

b. Exceptions to Definition of U.S. Property

c. Dispositions of Lower-Tier CFCs

(1) Application of Section 1248 to Gain From Stock Sales By CFCs

(2) Basis Increase for Lower-Tier CFC

d. Elimination of CFC-PFIC Overlap

e. Foreign Tax Credit Rules

(1) Expansion of Indirect Foreign Tax Credit to 6th Tier CFCs

(2) Translation and Redetermination of Foreign Taxes Simplified

(3) Simplify Foreign Tax Credit Limitation for Dividends from 10/50 Companies

f. Information Reporting Changes

(1) Transfers to Foreign Corporations and Partnerships

(2) Information Reporting Required for Controlled Foreign Partnerships

(3) Information Return Penalty Increased

(4) Threshold for Reporting Changes in Stock Ownership in Foreign Corporations Increased

(5) Section 6501(c)(8) Amendment

12. Tax and Trade Relief Extension Act of 1998 and Subsequent Extenders

13. American Jobs Creation Act of 2004

14. Tax Increase Prevention and Reconciliation Act of 2005

D. Other Significant Subsequent Legislation of Relevance to CFCs

1. Stapled Stock Entities

2. Accumulated Earnings Tax

3. Passive Foreign Investment Companies

III. Overview of Subpart F and Related Provisions

A. Subpart F Provisions

B. Related Provisions

IV. Definition of U.S. Shareholder

A. General

B. U.S. Person

1. General

2. Individuals Who Are U.S. Citizens or Residents

a. U.S. Citizens

b. U.S. Residents

3. Domestic Partnerships

4. Domestic Corporations

5. Domestic Trusts and Estates

C. Voting Stock Ownership Requirement

1. General

2. Combined Voting Power

3. Constructive Ownership

4. Captive Insurance Companies

V. Definition of Controlled Foreign Corporation

Introductory Material

A. Corporate Classification

1. General Rules

2. Four Characteristics Test (Prior Law)

3. Elective Classification

B. Foreign Status

1. General Rules

2. Foreign Corporations Treated as Domestic Corporations

3. Possession Corporations

C. Control Tests

1. General Rules

a. The Tests

b. U.S. Shareholder Ownership

c. Constructive Ownership

d. Daily Test

e. Concept of Control

2. Majority of Voting Power

a. General Rule

b. Deemed Control

c. Reality of Control Test

d. Cases

3. Majority of Value

4. Debt vs. Equity

a. General

b. Tests

c. Shareholder Guaranteed Debt

d. Preferred Stock

5. Foreign Insurance Companies

D. U.S. Tax Considerations of CFC Status

1. Decontrolling a Foreign Corporation

a. Detriments of CFC Status

b. Ways to Avoid CFC Status

2. Obtaining Control in Foreign Joint Ventures

a. Benefits of CFC Status

b. Ways to Achieve CFC Status

VI. Stock Attribution Rules

A. General

B. Direct Ownership

C. Indirect Ownership

1. General Rules

2. Proportionate Interest

3. Purpose of Rule

D. Constructive Ownership

1. General

2. Family Attribution

3. Partnerships and Estates

4. Trusts

5. Corporations

a. Attribution From Corporation to Shareholders

(1) General Rules

(2) Fifty Percent Voting Stock

b. Attribution From Shareholders to Corporation

c. Reattribution

6. Options

a. General Definition

b. Option to Acquire Option

c. Restrictions and Contingencies

d. Reattribution

e. Rules of Application

7. No Attribution of Foreign Owned Stock to Entities

E. Coordination of Different Attribution Rules

VII. Items Subject to Current Inclusion Under § 951(a)

A. Introduction

1. General Rules

2. Partnership Income

B. Subpart F Income

1. General Rules

2. Insurance Income

a. General Rules

b. Exempt Insurance Income

c. Captive Insurance Companies

d. Election to be Taxed as Domestic Corporation

e. Election to Treat Branch as Foreign Corporation

f. Special Rules and Exceptions

3. Foreign Base Company Income

a. Categories of Income

b. FBCI Special Rules and Exceptions

4. Subpart F International Boycott Income

a. General Rules

b. Legislative History

c. Operative Rules of Section 999 - Overview

(1) Overview

(2) Scope of Section 999

d. Calculation of Subpart F Income

(1) International Boycott Factor Method

(i) International Boycott Factor

(ii) Application of the International Boycott Factor Under Subpart F

(2) Application of the Specifically Attributable Income Method

e. Reporting Requirements

5. Illegal Bribes, Kickbacks, or Other Corrupt Payments

a. General Rules

b. Legislative History

c. Types of Payments Covered Under Section 952(a)(4)

d. Tax Treatment of Section 952(a)(4) Payments

6. Income Derived From Section 901(j) Countries

a. General Rules

b. Legislative History

c. Section 901(j) Countries

d. "Derived From"

e. Calculation of Income

(1) Partial Year Status

(2) Reduced By Expenses

(3) Exceptions and Limitations

7. Exclusions From Subpart F Income

a. Effectively Connected Income

b. Foreign Trade Income of a FSC

C. Investments of Earnings in U.S. Property

1. General Rules

2. Section 956 Amount

3. U.S. Property

a. Specific Investments

b. Exceptions

4. Amount of Investment in U.S. Property

5. Change in CFC Status

a. Investments Made Prior to CFC Status

b. Calculation When CFC Status Ceases

6. Tax Results To U.S. Shareholders

7. Obligations of Related U.S. Persons

a. General Rules

b. Exceptions

(1) Sales or Processing Receivables

(2) Service Receivables

c. Temporary Loans

(1) Period-End Determination

(2) Exception for Short-Term Loans

d. Successive Loans

e. Alternatives to Direct Loans

(1) Other Financing Structures

(2) Conduit Arrangements

(3) Pledges and Guarantees

(4) Receivables Factoring

(5) Finance Foreign Affiliates

f. Planning Guidelines

(1) Direct Loans

(2) Indirect Financing

8. Using § 956 Affirmatively

a. Beneficial Uses of § 956

(1) Accelerate Foreign Tax Credits and Earnings

(2) Direct Distribution of Lower-Tier Earnings

(3) Sale of CFC

b. How to Use § 956

(1) U.S. Property Investment

(2) Calculating the § 956 Amount

c. Support for Affirmative Use of § 956

D. Earnings Invested in Excess Passive Assets (Prior Law)

1. Background

2. General Rules

3. Definition of Excess Passive Assets

a. General Rules

b. Passive Assets Defined

(1) Specific Investments

(2) Exceptions

(3) Subsidiary Look-Through Rules

c. Amount of Assets

(1) General Rules

(2) Research and Experimental Expenditures and Intangible Property

(3) Leased Property

4. Reduction for Earnings Previously Taxed Under § 956A

5. Applicable Earnings Limitation

6. Exclusion for Previously Taxed Subpart F Income

7. PTI Coordination and Ordering Rules

a. Actual Distributions

b. Sections 956 and 956A Deemed Distributions

8. Special Rules for CFC Groups

a. Definition of CFC Group

b. Aggregation Rule

c. Apportionment Rule

9. Corporation Ceases to be a CFC

E. Previously Excluded Subpart F Income Withdrawn From Investment In Less Developed Countries

1. General Rules

2. Legislative Background

3. Taxable Amount Withdrawn From Investment in Less Developed Countries

F. Previously Excluded Subpart F Income Withdrawn from Foreign Base Company Shipping Operations

1. General Rules

2. Legislative Background

3. Taxable Amount Withdrawn from Investment in Shipping Operations

G. Temporary Dividends Received Deduction

VIII. Determination of the Amounts of § 951(a) Items

Introductory Material

A. Thirty-Day Rule

B. CFC Taxable Year

1. General

2. Legislative Background

3. Conformity Rules

a. Scope of Application

(1) Specified Foreign Corporation

(2) Other CFCs

(3) Other Foreign Corporations

b. Required Taxable Year

c. Majority U.S. Shareholder Year

d. Testing Days

e. Inconsistent Majority U.S. Shareholder Years

4. Exceptions

a. No Amounts Includible in Income

b. Treated as Domestic Corporation

5. Change of Taxable Year

a. General Rules

b. Specified CFCs

c. Required Change

d. Conforming Changes in Majority U.S. Shareholder Year

e. Nonconforming Foreign and U.S. Taxable Years

6. Transition Rules

a. Conforming Tax Year

b. Changing Back to Pre-Change Year

C. Calculation of the Amount of Subpart F Income

1. General

2. Gross Income

3. Taxable Foreign Base Company Income

a. FBCI Categories

b. Full Inclusion Rule

c. FBCI Exceptions

d. Net FBCI

D. Calculation of Section 956 Amount

E. Calculation of Section 956A Amount (Prior Law)

F. Amount of Withdrawals From Less Developed Countries

G. Amount of Withdrawals From Shipping Operations

IX. Earnings and Profits Limitations

A. General

B. Calculation of Earnings and Profits

C. Current Earnings and Profits Limitation on Subpart F Income

1. General Rule

2. Regulatory Background

3. Rules for Applying the Current Earnings and Profits Limitation

a. General Allocation Rules

b. Allocation to Separate Categories of Subpart F Income

c. Coordination with § 954

4. Scope of Application

5. Rules of Recapture

a. General

b. Recapture Account

c. Recharacterization

d. Reduction of Recapture Account

6. Distribution Ordering Rules

a. Coordination of Recapture and Distribution Rules

b. Distributions Reduce Recapture Accounts First

7. Examples

D. Use of Accumulated and Chain Deficits to Reduce Subpart F Income

1. Prior Law

2. Accumulated Deficit Rule

3. Chain Deficit Rule

E. Limitation on Investment in U.S. Property

F. Limitation on Investment in Excess Passive Assets (Prior Law)

G. Limitation on Withdrawals of Previously Excluded Subpart F Income

X. Pro Rata Share Taxable to U.S. Shareholders

A. U.S. Shareholders Subject to Taxation

1. General

2. U.S. Shareholder Status

a. Ten Percent Voting Stock Threshold

b. Anytime During Year

c. Resident Aliens

3. Direct and Indirect Ownership

a. General Rule

b. Lower-Tier CFCs

4. Last Day During Year when Foreign Corporation Was a CFC

B. Pro Rata Share

1. General Rules

2. Multiple Classes of Stock

3. Part-Year Ownership

a. Shareholder on Last Day of CFC Status

b. Reduction for Dividends Paid to Other Owners

4. Mid-Year Change of CFC Status

a. General

b. Amounts Attributable to Period of CFC Status

(1) Subpart F Income

(2) Investments in U.S. Property

c. U.S. Shareholder's Pro Rata Share

5. Lower-Tier CFCs

a. General Rules

b. Hopscotch Rule

C. Time Includible in Income

1. General Rule

2. Estimated Tax Payments

D. Character of Inclusion

1. Ordinary Income

2. A Dividend?

XI. Exclusion for Previously Taxed Income

A. General Taxation of CFC Distributions

B. Exclusionary Rules

XII. Deemed-Paid Foreign Tax Credits

XIII. Adjustments to Basis In CFC Stock and Other Property

A. Increases

B. Reductions

XIV. Election by Individuals to be Subject to Tax at Corporate Rates

XV. Organizations, Reorganizations and Dispositions of CFCs

A. Tax-Free Transactions Involving a CFC

1. General

2. Outbound Transfers to a CFC

a. General Rule

b. Exception for Stock or Securities

c. Active Trade or Business Exception

d. Transfers of Intangible Property

3. Foreign-to-Foreign Transactions

a. General Rules

b. Reorganizations

c. Section 351 Transfers

d. Section 332 Liquidations

4. Inbound Reorganizations and Liquidations Involving CFCs

B. Taxable Dispositions of Stock in a CFC

1. Sales or Exchanges

2. Redemptions

3. Liquidations

XVI. Coordination of Subpart F With Other Provisions That Apply to Foreign Corporations

Introductory Material

A. Foreign Personal Holding Company Provisions

1. General Rules

2. Coordination Rules

a. Legislative Background

b. Rules Eliminating Double Taxation

B. Passive Foreign Investment Company Provisions

1. General

2. PFIC Rules

a. Definition of PFIC

b. Tax Regimes

(1) Excess Distribution Rules

(2) Qualified Electing Fund

(3) Mark-to-Market Rules

3. Coordination Rules

a. U.S. Shareholders

b. Non-U.S. Shareholders

c. CFC/PFIC Overlap

(1) QEFs

(2) Non-QEFs

C. Foreign Sales Corporation Provisions

1. General Rules

2. Coordination Rules

D. Foreign Investment Company Provisions

1. General Rules

2. Coordination Rules

XVII. Returns and Reporting Requirements

Introductory Material

A. Reporting of Subpart F Inclusions

B. Estimated Tax Liability for Subpart F Inclusions

1. General Rules

2. Uruguay Round Agreements Act Changes

a. Subpart F Income Included in Computing Annualized Installments

b. Safe Harbors

C. Information Reporting

1. General Rules

2. Penalties

Working Papers

Table of Worksheets

Worksheet 1 Revenue Act of 1962, H.R. 10650, Excerpts from H.R. Rep. No. 1447, 87th Cong., 2d Sess., March 16, 1962

Worksheet 2 Revenue Act of 1962, H.R. 10650, Excerpts from S. Rep. No. 1881, 87th Cong., 2d Sess., August 16, 1962

Worksheet 3 Revenue Act of 1962, H.R. 10650, Excerpts from H.R. Rep. No. 2508 (Conf.), 87th Cong., 2d Sess., October 1, 1962

Worksheet 4 Deficit Reduction Act of 1984, H.R. 4170, Excerpts from the Staff of the Joint Committee on Taxation's General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2d Sess., December 31, 1984

Worksheet 5 Tax Reform Act of 1986, H.R. 3838, P.L. 99-514, Excerpts from the Staff of the Joint Committee on Taxation's General Explanation of the Tax Reform Act of 1986, 99th Cong., May 4, 1987

Worksheet 6 Technical Corrections Act of 1988, H.R. 4333, Excerpts from the Staff of the Joint Committee on Taxation, Description of the Technical Corrections Act of 1988, 100th Cong., 2d Sess. 267-286 (1988) (Excerpts from U.S. Taxation of Income Earned Through Foreign Corporations)

Worksheet 7 Omnibus Budget Reconciliation Act of 1989, H.R. 3299, Excerpts from the Conference Report H.R. Rep. 101-386, 101st Cong. 1st Sess., November 21, 1989

Worksheet 8 Code Section 955 as in Effect Before The Tax Reduction Act of 1975

Worksheet 9 Foreign Corrupt Practices Act of 1977, P.L. 95-213, December 19, 1977

Worksheet 10 Internal Revenue Manual: International Audit Guidelines, 4.61.7, Controlled Foreign Corporations

Worksheet 11 Sample Section 953(d) Election to Treat Foreign Insurance Company as Domestic Corporation

Worksheet 12 Election to Treat Related Person Insurance Income as Effectively Connected with a U.S. Trade or Business

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Committee Reports:

General Explanations to Tax Acts:

Hearings:

Guidelines: International Boycotts

Executive Orders

Treasury Rulings and Procedures:

General Counsel Memoranda

Cases:

UNOFFICIAL

Periodicals:

Pre-1976

1976 - 1981

1982

1983

1984

1985

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Laraine S. Rothenberg
Laraine S. Rothenberg, B.A., University of Pennsylvania; J.D., Columbia Law School; Association of the Bar of the City of New York; New York State Bar Association (Tax Section). Attorney with Fried, Frank, Harris, Shriver & Jacobson LLP.
Lowell D. Yoder
Lowell D. Yoder, B.A. (1979, with highest distinction) and J.D. (1982, magna cum laude), University of Illinois; Order of the Coif; Law Review Editor; Law Clerk, The Honorable James M. Sprouse, Federal Court of Appeals for the Fourth Circuit; frequent lecturer on international tax topics; author of numerous articles on international taxation; member of the Tax Management International Journal Advisory Board, member of the Editorial Board of the Journal of International Taxation, and member of the University of Chicago Law School's Federal Tax Conference Planning Committee; Adjunct Professor of Law at Chicago-Kent College of Law, teaching International Taxation.