By Anthony Diosdi
A foreign corporation is a controlled foreign corporation (“CFC”) if more than 50% of the total combined voting power of all classes of such corporation entitled to vote, or of the total value of the stock of such corporation, is owned within the meaning of Internal Revenue Code Section 958(a) or Internal Revenue Code Section 958(b). Prior to the enactment of the 2017 Tax Cuts and Jobs Act, for purposes of subpart F income, a “U.S. Shareholder” only included a U.S. person who owns or is considered as owning 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation, with attribution rules applying. The Tax Cuts and Jobs Act expanded the definition of a U.S. Shareholder” to include U.S. persons who own 10% or more of the total value of shares of all classes of stock of the foreign corporation.
To prevent avoidance of the stock ownership rules by dividing ownership among related persons, Internal Revenue Code Section 958 provides detailed ownership and attribution rules. Under Internal Revenue Code Section 958(a), stock owned directly or indirectly by or for a foreign corporation, foreign partnership, foreign trust, or foreign estate is considered as being owned proportionately by its shareholders, partners or beneficiaries. Internal Revenue Code Section 958(b) provides for Section 318(a) of the Internal Revenue Code to apply for the purposes of treating a U.S. person as a U.S. Shareholder for purposes of the ten percent test for classifying a foreign corporation as a CFC. Thus, under Section 318(a)(2), stock owned directly or indirectly by a foreign trust is treated as owned by its beneficiaries in proportion to the actuarial interests of such beneficiaries.
The Tax Cuts and Jobs Act repealed Internal Revenue Code Section 958(b)(4). As a result of the repeal of Section 958(b)(4), stock of a foreign corporation owned by a foreign person can be attributed to a U.S. person under Section 318(a)(3) of the Internal Revenue Code for purposes of determining whether such U.S. person is a U.S. shareholder of the foreign corporation and whether a foreign corporation should be characterized as a CFC. Internal Revenue Code Section 958(b) now provides for “downward attribution” from a foreign person to a U.S. person in circumstances in which pre-Tax Cuts Jobs Act rules did not previously do so.
The new constructive attribution rules may also cause a foreign corporation to be a “deferred foreign income corporation” or Specified Foreign Corporation (“SFC”) under Section 965 of the Internal Revenue Code based on other assets of its shareholders and related parties. An SFC is a foreign corporation that is either a CFC or has at least one U.S. shareholder that is a corporation. In other words, the term SFC includes not only CFCs, but also entities which have at least one U.S. shareholder, but are not CFCs because U.S. shareholders do not own more than 50% by vote or value. For example, an individual shareholder foreign or a U.S. citizen, may own 50 percent of a U.S. Subchapter C corporation stock and 10 percent of a foreign corporation’s stock. Section 318(a)(3)(C) will treat the C corporation as constructively owning any stock owned by a 50 percent or greater shareholder. Consequently, under Section 318, the domestic C corporation constructively owns 10 percent of the foreign corporation’s stock. Since the foreign corporation has a constructive 10 percent corporate U.S. shareholder, it will be characterized as a SFC. This will result in Section 965 of the Internal Revenue Code to apply to its individual U.S. shareholders. The result is the same if the U.S. C corporation stock is 50 percent owned by the U.S. person’s foreign grandparent. This will result in the individual shareholder’s 10 percent of the foreign corporation being constructively owned by the grandparent under Section 318(a)(1)(A) of the Internal Revenue Code and the foreign stock will also be constructively owned by the U.S. C corporation.
Conclusion
This article was designed to provide the reader with an introduction to new attribution rules. These rules can become extremely complicated. If you owe or plan to owe shares of a foreign corporation, you should consult with a tax attorney who has a deep understanding of the new CFC rules.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. As a domestic tax attorney and international tax attorney, Anthony Diosdi provides international tax advice to individuals, closely held entities, and publicly traded corporations. Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: 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.