Usually, the undistributed earnings of the CFC’s are subject to U.S. taxation. Such earnings are usually referred to as Subpart F Income.
Subpart F Income rules require that certain income earned by a controlled foreign corporation (CFC) be taxed to the U.S. shareholder immediately. This happens even if the income is not actually paid out to the shareholder. Basically, Subpart F acts as if a U.S. shareholder actually received their share of certain types of the CFC’s current earnings and profits (E&P). This means taxpayers may not use foreign companies to defer paying U.S. tax on certain types of Subpart F income.
This means that even if the profits are not repatriated back to the U.S., they will be immediately taxed on the U.S. Shareholders.
To subject a CFC’s undistributed earnings to U.S. taxation, three threshold requirements have to be met, as per I.R.C. § 951(a) :
- The foreign corporation has to be classified as a CFC.
Let’s say TechGlobal Ltd is a holding company based in Singapore. This company has two U.S. Shareholders Sarah and John. Sarah owns 30% and John owns 40% of the company. Here both the U.S. shareholders own 70% of the voting stock collectively, with each of them owning more than 10% of the company. This means that TechGlobal Ltd qualifies as a CFC, as it is owned by U.S. shareholders. Each shareholder owns more than 10% and collectively, they own more than 50% of TechGlobal Ltd.
- The shareholder has to qualify as a U.S. shareholder.
In the above example, John and Sarah, as U.S. citizens, own more than 10% of the voting stock of TechGlobal Ltd. Therefore, both qualify as U.S. shareholders for CFC purposes.
- The CFC should have Subpart F income.
Subpart F rules apply only if the CFC earns specific types of income. There are several categories of Subpart F Income. For more information about Subpart F income, please refer to the following article
Let’s say Tech Global Ltd. earned significant passive income. These types of income will be immediately taxable to U.S. shareholders, even if the profits are not distributed.
International tax rules like Subpart F and GILTI are complex—but you don’t have to navigate them alone. Contact Arora Law P.C. for a comprehensive tax consultation today and ensure you are compliant with the CFC regulations.
Disclaimer: The information provided in this article is for general informational purposes only and does not include legal advice. This article does not comprise an attorney-client relationship between the reader and Arora Law P.C. or its attorneys. If you have specific questions regarding your individual situation, please consult with a licensed attorney.
The information in this article is current as of the publication date. U.S. Tax laws and regulations change frequently, and readers should confirm whether any updates have occurred since.