By Anthony Diosdi
The Internal Revenue Code provides that a United States shareholder of a Controlled Foreign Corporation or (“CFC”) is subject to tax on the CFC’s Subpart F or “global intangible low-taxed income” or (“GILTI”). The Subpart F and GILTI are anti-deferral tax regimes. Subpart F and GILTI results in most income earned by foreign corporations being subject to current U.S. taxation. All U.S. shareholders other than U.S. C corporations are disadvantaged under the Subpart F and GILTI regimes, because foreign tax credits and certain deductions (i.e., Section 250 permits a deduction of 50 percent of the GILTI amount calculated under Section 951A) apply only to domestic corporations. Unless an affected U.S. shareholder undertakes planning to minimize their tax exposure on Subpart F income and GILTI, such as the reshoring or domestication of a CFC, they will be required to include the full amount of their Subpart F or GILTI as gross income subject to the progressive federal tax rates.
To demonstrate how the domestication of a CFC can potentially take place, let’s assume that F was incorporated in Country Y. (Country Y is a hypothetical foreign country). Let’s also assume that for valid business reasons, the shareholders of F decided that it would be advantageous for F to become a State A corporation. Under State A corporate law, a foreign corporation may become a State A corporation by filing a certificate of domestication and a certification of incorporation with the appropriate official. Pursuant to a plan of reorganization, F filed a certificate of domestication and a certificate of incorporation in State A.
Upon filing the certificate of domestication and certificate of incorporation, F was considered by State A to be incorporated in State A and became subject to State law, whether or not F continued to be considered a Country Y corporation for Country Y purposes. Thus F was not required to incorporate anew in State A, but merely “converted” itself into a State A corporation by filing the appropriate documents. For State A law purposes, the existence of F was deemed to have commenced on the date F commenced its existence in Country Y. Following the domestication, F possessed the same assets and liabilities as before the domestication and continued its previous business without interruption.
For federal income tax purposes, the conversion of F from Country Y to State A corporation under the State A domestication statute could be treated as: (1) a transfer by a foreign corporation (F) of all of its assets and liabilities to a new domestic corporation in exchange for stock; and 2) a liquidating distribution by F to its shareholders of the stock received in exchange for F’s assets and liabilities. This type of transaction could potentially qualify as a Type F tax-free reorganization under Section 368(a)(1)(F) of the Internal Revenue Code. A Type F reorganization involves “a mere change in identity, form, or place of organization of one corporation, however effected.” A transaction does not qualify as a reorganization under Section 368(a)(1)(F) unless there is no change in existing shareholders or in the assets of the corporation. However, a transaction will not fail to qualify as a reorganization under Section 368(a)(1)(F) if dissenters owning fewer than 1 percent of the outstanding shares of the corporation fail to participate in the transaction. See Rev. Rul. 66-284, 1966-2 C.B. 115.
In the example discussed above which involved the conversion of F from Country Y to State A, there was no change in the shareholders of F or in the shareholders’ proprietary interests. Furthermore, F possessed the same assets and liabilities and continued the same business activities after the conversion as F did before the conversion. Because there was no alteration in shareholder continuity, asset continuity, or business enterprise, the effect of the conversion was a mere change in the place of organization of F. Therefore, the conversion may qualify as a reorganization under Section 368(a)(1)(F) of the Internal Revenue Code, which provides that the term “reorganization” includes a mere change in identity, form or place of organization of one corporation, however effected. See Rev. Rul. 87-27, 1987-15 I.R.B. 5, concluding that the reincorporation in a foreign country of a dual resident U.S. corporation was a reorganization under Section 368(a)(1)(F).
The benefit of domesticating a CFC is that the shareholders of the corporation will no longer be subject to the Subpart F and GILTI tax regimes. Subpart F and GILTI only applies to U.S. shareholders of a CFC. Once the CFC is reshored, it will no longer be classified as a CFC for U.S. tax purposes and as a result, the U.S. shareholders of the corporation will no longer be subject to Subpart F or GILTI inclusions. It is however worth noting that the shareholders of a domesticated CFC could recognize taxable gain under Section 1248. Section 1248 converts previously untaxed offshore earnings and profits to dividends. If a domesticated corporation sells or leases tangible or intangible property to non-U.S. customers, the corporation may be subject to a U.S. federal tax rate of only 13.125% under the foreign-derived intangible income or (“FDII”) provisions of the Internal Revenue Code. FDII is a type of income that when earned by a U.S. domestic C corporation is entitled to a deduction equal to 37.5%. Because the current U.S. federal corporate income tax rate is 21%, FDII income is taxed at an effective rate of 13.125%.
Despite the U.S. tax advantages of reshoring a foreign corporation, anytime, a reorganization of a foreign corporation takes place, it is important to determine if a foreign tax liability is not triggered. For example, the contribution of a CFC to a domestic holding corporation may give rise to foreign tax and other issues, including corporate transfer and income tax considerations. The reshoring of a foreign corporation can be viewed differently. A corporation organized in the United States is treated as a U.S. resident. Many countries use criteria other than place of incorporation to determine whether a corporation is a domestic resident for their tax purposes. For example, countries, such as the United Kingdom and Australia, treat corporations as a domestic resident if it is managed or controlled there, regardless of where the corporation is incorporated. Because of the application of differing criteria for determining corporate residence it is possible for a U.S. corporation to be treated as a dual resident corporation. For U.S. tax purposes, this means a domesticated CFC will not be treated as a foreign corporation and as a result, its U.S. shareholders will not be subject to Subpart F or GILTI inclusions. For foreign tax purposes, the reshored CFC could remain a domestic resident corporation. Since the domesticated CFC will not change its form or ownership, such a reorganization may avoid foreign transfer taxes. Foreign counsel should always be consulted in any domestication of a foreign corporation to determine any potential foreign tax liabilities associated with such a reorganization.
Conclusion
Despite its complicated framework, with proper planning, a CFC may be domesticated or reshored to reduce U.S. tax consequences associated with offshore income.
Anthony Diosdi is an international tax attorney 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.