8 September 2022
CFC: Controlled foreign corporations
The co-operative adoption and implementation of current CFC rules around the world is the consequence of large scale corporate tax avoidance. Up until recently, profit shifting through subsidiary companies set up in tax havens allowed huge corporations to get out of paying billions in tax in the US, UK and other high tax countries. When the scale of the tax avoidance and the urgent need to do something resulted in the global implementation of the Common Reporting Standards (CRS) and updated regulations on CFCs – Controlled Foreign Corporations.
What are Controlled Foreign Corporations (CFCs)?
Controlled Foreign Corporations (CFCs) are corporate entities domiciled in a different country to the country in which the controlling owners are tax resident. CFCs must be both registered and conduct business in foreign jurisdictions to be considered CFCs by the country (or countries) in which the owners reside (and from where the company is controlled through controlling ownership and shareholder voting power).Almost all high tax countries (including the US, UK, most EU countries, Australia and South Africa – among many others) around the world have CFC rules and regulations to define and identify taxable income from foreign corporations and subsidiaries domiciled in low or no tax jurisdictions.
However, different countries have different CFC regulations, including those relating to what defines a CFC as opposed to an ‘independent foreign corporation’. The following is a brief overview of how the United States defines and taxes what the US determines as a CFC.
US CFC Laws and Reporting Regulations:
The US CFC related tax regulations and reporting protocols are both complex and extensive. However, they are all predicated on the following basic CFC rules and regulations (in place as of December 2017) for how CFCs and shareholders in CFCs are treated by IRS, the US tax Authorities.
(For detailed CFC Tax info for US owners / controlling shareholders see https://www.irs.gov/irm/part4/irm_04-061-007)
US CFC Criteria:
A Foreign Corporation is considered a Controlled Foreign Corporation for US tax purposes if more than 50% of the voting power is owned by US shareholders.
In this case, a qualifying shareholder must own a minimum of a 10% share of voting power.
The qualifying shareholder can be a person or a legal entity – such as a controlling corporation domiciled in the US, or controlled by US tax payers.
Subpart F of the US IRC (Internal Revenue Code):
Subpart F of the IRS CFC regulations plays an important role in determining taxable amounts. Two of the most important to know are:
Subpart F of the US IRC allows for the application of ‘anti-deferral’ rules for taxation of undistributed income from foreign corporations. This includes a variety of reporting rules and regulations to include undistributed income in ‘gross income” calculations.
Regulations consider provisions for an array of CFC rules, definitions, adjustments, exceptions, and exclusions. and limitations. These are applied when determining a CFC, as well as the taxable amounts and tax rates to be applied. Determinations and calculations are influenced by a variety of factors. Aside from shareholders, factors include the type and scope of the CFC corporation’s production or services and how foreign subsidiaries relate operationally and financially to the US domiciled or owned parent company or entity.
Indirect ownership rules – Subsidiaries of CFCs
Subsidiaries of CFCs may also be considered CFCs for tax purposes if US taxpayer owner shareholders hold sufficient stock in the subsidiary. Discovery processes to identify possible US shareholders in subsidiaries may be initiated by a single US taxpayer owning 10% or more of the parent CFC.
US CFC Reporting Rules – Special Reporting Requirements for CFC shareholders
The following rules are applied as of December 2017. They pertain to the reporting of all income involved in the downward attribution and constructive ownership of a foreign corporation.
All US shareholders with a minimum of a 10% controlling interest in a CFC must report their share of earnings and income.
- According to the special reporting requirements related to CFCs, this ‘controlling interest’ can involve both direct and indirect ownership, and the controlling interest either active or passive.
- The minimum 10% controlling interest is 10% or more of the total voting power combined or the total value of shares – from all classes of voting stock.
To look for examples of Closed Foreign Corporations subject to taxation by the US, you need look no further than subsidiaries of ‘Meta’ – the US-based parent company of Facebook (among other subsidiaries). Subsidiaries set up in tax havens and subject to low or no tax in that jurisdiction would absorb profits from profitable subs – to allow taxable income declared in low tax jurisdictions (in this case – Ireland) to be at a minimum. However, as of 2018, US CFC regulations now allow the IRS to access all subsidiary profits – with reporting and taxation in line with CRS, local tax and CFC reporting regulations.