Special CFC Provisions to Puerto Rico Residents

Where a foreign corporation is characterized are a “Controlled Foreign Corporation” (“CFC”), its “United States Shareholders” are taxed annually on the “Subpart F income” and “Global Intangible Low-Taxed Income” (“GILTI”) of the CFC, whether or not such earnings are distributed at the time, and on the CFC’s increased investment in certain U.S. property. A CFC is classified as a foreign corporation in which more than 50 percent of its stocks are owned (by vote or value), directly or indirectly by “United States shareholders.” Under U.S. tax law, a U.S. shareholder is a U.S. person that owns directly, indirectly, or constructively, at least ten percent of the foreign corporation by voting power or by value. However, a U.S. person that is a bona fide resident of Puerto Rico will not be treated as a “U.S. shareholder” for purposes of determining whether a Puerto Rican corporation is a CFC, if a dividend received by such individual from the Puerto Rican corporation would be treated, for purposes of Section 933(1), as Puerto Rican-source income. See IRC Section 957(c)(1).

For this purpose, dividends paid by a Puerto Rico corporation typically are treated as Puerto Rican source income as long as less than 25 percent of the Puerto Rican corporation’s gross income is composed of income effectively connected to a U.S. trade or business. See IRC Section 861(a)(2)(B). In other words, as long as a Puerto Rican corporation does not derive at least 25 percent of its income from income effectively connected to a U.S. trade or business, that corporation will not be treated as a CFC for U.S. tax purposes. If a foreign corporation is not treated as a CFC, U.S. shareholders of such CFC who are bona fide residents of Puerto Rico will not be required to file a Form 5471 with the IRS or be subject to the Subpart F and GILTI tax regimes. See Treas. Reg. Section 1.6038-2(d)(2).

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.