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Video of Subpart F Income of Controlled Foreign Corporations U.S. Taxation in Tax Accounting course by Edspira channel, video No. 52 free certified online
U.S. companies have an incentive to shift profits to subsidiaries in low-tax countries. Congress has passed laws to prevent this; one way is by taxing Subpart F income of controlled foreign corporations as a constructive dividend.
A controlled foreign corporation (CFC) is a non-U.S. corporation in which at least 50% of (a) the combined voting power of all voting stock or (b) the total value of all stock is owned by U.S. shareholders (a U.S. shareholder is a U.S. person or company that owns at least 10% of the foreign corporation's voting stock).
When the CFC has Subpart F income, a U.S. shareholder will be taxed on their pro rata share of the Subpart F income, regardless of whether they receive a distribution. Subpart F income includes:
(1) foreign personal holding company income (royalties, interest, dividends, rent, annuities)
(2) foreign base company sales income (sales made to customers outside the CFC's country when a related party is involved and the CFC has little connection to the income)
(3) foreign base company services income (income from services performed for a related party outside the CFC's country)
For example, assume that a U.S. company owns 60% of the voting stock of an Irish subsidiary (the Irish subsidiary is thus a controlled foreign corporation). If the Irish subsidiary has $200,000 of interest income, this interest income would be considered Subpart F income. The U.S. company would be taxed on its pro rata share, which is $120,000 (60% $200,000). The $120,000 would be taxable to the U.S. corporation as ordinary income (whether or not it receives a distribution) and the U.S. corporation would not receive a dividends received deduction.—
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