If you are a U.S. citizen and 10% stockholder of a foreign company, the foreign company is classified as a Controlled Foreign Corporation (CFC). If the CFC is paying you for services or distributing dividends, such payments received will be classified as Subpart F income.  

Subpart F is very complicated and needs to be analyzed in great detail to prevent unintended consequences.  In this article, we endeavor only to provide you with a brief synopsis of the issues you have to take note of and discuss with your tax professional. 

From the outset it is important to take note: Subpart F income DOES include passive income.  Any foreign investment you might have that is making a passive income for you in the current financial year, will in all probability be deemed to be Subpart F income and be taxable even if it is not distributed.

So What Are A Controlled Foreign Corporations?

Not all foreign investments nor all foreign corporations are automatically defined as “controlled foreign corporations.”  A Controlled Foreign Corporation is defined by law as a corporation with more than 50% U.S. ownership in which individual U.S. persons each own at least 10% of the corporation.

The 10% rule falls under the rules of attribution. This means that family members fall under closer scrutiny and in some situations, the individual shares of family members can be attributed to one member of the family for Subpart F.

For example, a family owned corporation with say twelve members who all own a proportionate share, around 8% each, structurally avoid the 10% rule.  No one owns the statutory 10% for the rule to come into play? 

You would be wrong to make this assumption: this is exactly where attribution will come into play and derail your plans.  Meticulous care should be taken – allow a professional to assess the situation.

Can These CFC Rules Be Circumvented?

It is possible to set up a business to navigate around these CFC rules, but this might be a bit more difficult than it sounds, i.e. it will be risky.  It can be done if you register a foreign corporation with assets under $10,000,000 in locations like the British Virgin Islands, Hong Kong or the like.  However, it is imperative that you are the majority shareholder of the business. 

Obviously it will not be precautions at all to start up a foreign corporation and to invest substantial money in doing so with the objective to allow some third party with no real stake in the outcome to control it.  It is common cause that corporation such as these remain in U.S. ownership up to a scale of between 75 and 90% and to allow foreign ownership for the balance as might be prescribed by local law.