U.S. persons who are direct or indirect shareholders of a “controlled foreign corporation” (CFC) are subject to unique taxation rules that differ from those applicable to traditional corporations.
Typically, shareholders of traditional corporations are generally taxed when dividends are distributed or when they sell their shares. In contrast, shareholders of CFCs may be required to include the foreign corporation’s profits on their personal U.S. tax return in the year the income is earned, regardless of whether they have received any distributions. This regulation is designed to prevent shareholders from deferring taxes by keeping profits offshore.
Next, let’s understand the key aspects of a CFC and how the income of a CFC is taxed in the United States.
Let’s delve into the details of CFCs.:
A Controlled Foreign Corporation is a type of foreign corporation in which U.S. shareholders—those owning at least 10% of the corporation’s voting power or value—together hold more than 50% of the total voting power or value of the corporation’s stock.
For more details about CFC, please refer to the following article.
Now, let us understand the different ways a U.S. shareholder can own a CFC through various methods in the next section.
Understanding the CFC ownership method is crucial as it determines how U.S. tax rules apply and how income is ultimately taxed. Next, let’s discuss the CFC ownership methods.
U.S. shareholders can own a CFC in various ways. Let’s discuss these methods as follows:
Direct Ownership
Direct ownership occurs when U.S. shareholders hold more than 50 percent of the voting power or value of a foreign corporation. Under this method, the U.S. shareholder maintains immediate control and ownership interest in the foreign entity without any intermediary structures.
Indirect Ownership
Indirect ownership arises when a U.S. shareholder owns an interest in one foreign entity, which in turn holds an interest in another foreign entity. The U.S. shareholder’s indirect ownership percentage is calculated based on their proportional interest through the ownership chain.
Constructive Ownership
Constructive ownership attributes stock ownership based on specific relationships and legal structures, even when direct ownership does not exist. The following are possible attributions to constructive ownership:
A U.S. shareholder is defined as any U.S. person who owns and holds a voting power of 10% or more of all classes of stock in a foreign corporation. In that case, such a U.S person or company generally qualifies as a U.S. Shareholder for CFC purposes.
Conversely, U.S. persons or companies holding less than a 10% voting interest will unlikely qualify as U.S. shareholders for CFC purposes. Instead, they will likely be considered shareholders for a Passive Foreign Investment Company (PFIC). For more information about PFIC, please see the following article.
Next, it is important to understand the Section 965 transition tax on deferred foreign earnings. It explains how the accumulated profits of Controlled Foreign Corporations (CFCs) were historically taxed and brought within the U.S. tax system.
Prior to the Tax Cuts and Jobs Act (TCJA), U.S. shareholders of Controlled Foreign Corporations (CFCs) were generally not taxed on the CFC’s undistributed earnings until dividends were repatriated to the United States. To address this, the TCJA introduced a one-time transition tax under Section 965 that deemed these previously untaxed earnings as repatriated.
Section 965 imposed a one-time transition tax on accumulated post-1986 foreign earnings, triggered in the 2017 tax year, with optional installment payments spanning 2018–2025.
Although the tax is now largely settled, the rules remain relevant. This is because positions taken during the 2017–2025 period, such as E&P calculations and elections, may still impact prior-year compliance, audits, and amended filings.
Next, let’s understand the concept of the transition tax under Section 965 and how it played a key role in taxing the previously untaxed profits of CFCs in the United States.
Before 2018, U.S. companies with overseas subsidiaries could delay paying U.S. taxes on foreign profits. This was allowed as long as the profits remained offshore and were not repatriated as dividends.
Over time, this created a significant loophole. Enormous amounts of foreign earnings accumulated overseas without ever being taxed in the United States.
Section 965 ended this deferral practice by introducing a one-time transition tax on the accumulated foreign earnings of Controlled Foreign Corporations (CFCs). The law deemed all post-1986 undistributed foreign earnings as if they had been repatriated to the United States in 2017. This applied regardless of whether any actual cash was distributed, creating a deemed dividend for U.S. tax purposes.
U.S. shareholders had to include these earnings in their taxable income for that year. To reduce the burden, the law provided lower tax rates of 15.5% on cash and 8% on non-cash assets.
It also allowed taxpayers to pay the tax in installments over several years. This helped companies manage the impact of taxing large accumulated profits.
In simple terms, Section 965 ensured that old foreign earnings were taxed once and could no longer be avoided by U.S. taxation.
Please note that Section 965 imposed a one-time transition tax on accumulated foreign earnings of CFCs earned after December 31, 1986, up to December 31, 2017.
This tax is now fully settled. The income inclusion was required in the 2017 tax year for most calendar-year taxpayers (or 2018 for fiscal-year taxpayers). Taxpayers who elected to pay in installments under Section 965(h) had eight years to pay, with the final installment generally due in 2025.
Next, let’s understand who is subject to the transition tax.
The transition tax generally applies to U.S. persons who owned at least 10% of a Specified Foreign Corporation (SFC). The shares are generally required to be owned on the last day of the SFC’s tax year beginning before January 1, 2018.
This ownership is measured by voting power or the value of shares.
Ownership can be held directly, indirectly, or constructively. Such owners are referred to as U.S. shareholders under the tax law.
A Specified Foreign Corporation (SFC) is any foreign corporation classified as a Controlled Foreign Corporation (CFC). It also includes any foreign corporation with at least one U.S. corporate shareholder. However, a corporation classified as a Passive Foreign Investment Company (PFIC) is excluded, unless it is also a CFC.
U.S. shareholders can utilize several strategies to minimize the impact of the transition tax. Let’s understand some of these strategies as follows:
U.S. taxpayers may generally claim a foreign tax credit (FTC) for taxes they already paid or accrued to a foreign country. In particular, they may claim credit for earnings subject to the Section 965 transition tax.
However, this credit is subject to limitations. Under special rules, taxpayer may not be able to claim the full credit as a large portion of the foreign taxes is disallowed.
A special rule under Section 965(g) significantly reduces the allowable foreign tax credit. This works by applying an “applicable percentage” to the taxes associated with the Section 965(c) deduction amount.
Next, let’s understand the Section 962 election. It allows individual U.S. shareholders to significantly reduce their transition tax liability by electing to be taxed as a domestic corporation.
Under Internal Revenue Code §962, individual shareholders can elect to be taxed at corporate rates on foreign earnings. This allows them to apply the corporate tax rate under Internal Revenue Code § 11 rather than higher individual rates.
The election also enables access to indirect foreign tax credits under Internal Revenue Code §960. Without this election, individuals may claim credits for taxes paid by the foreign corporation. As a result, foreign earnings may be taxed both abroad and again in the United States at individual rates.
The Section 962 election helps reduce this double taxation.
Next, let’s understand Global Intangible Low-Taxed Income (GILTI), a key rule requiring U.S. shareholders to pay tax on Controlled Foreign Corporation (CFC) earnings even if no dividends are received.
Global Intangible Low-Taxed Income (GILTI) refers to a tax on the U.S. shareholders’ intangible foreign earnings from Controlled Foreign Corporations (CFCs). It is a U.S. tax provision brought under the Tax Cuts and Jobs Act (TCJA) in 2017.
GILTI was introduced to ensure that U.S. corporations and individuals pay tax on income derived from intangible assets held by their controlled foreign corporations (CFCs). Here, intangible assets include Patents, copyrights, trademarks, and similar assets.
The primary objective of GILTI is to discourage U.S. corporations from shifting profits to low-tax jurisdictions by exploiting intangible assets. Let’s understand some of the key features of GILTI:
GILTI is calculated through a multi-step process that first determines the net CFC-tested income and then compares it to a deemed return on tangible assets.
Let’s understand the steps for GILTI calculation, which are as follows:
GILTI = Net CFC Tested Income – Net DTIR
Next, let’s break down the above calculation formula in simple terms.
The first step is to determine Net Controlled Foreign Corporation (CFC) Tested Income. This is the U.S. shareholder’s total share of profits and losses across all their Controlled Foreign Corporations (CFCs), calculated as follows:
As we can see, a net CFC Tested Income calculation is done by taking into account something called “tested Income” and “tested loss” of the CFC. Generally, Tested Income and Loss is the portion of a CFC’s income that qualifies for inclusion in the GILTI computation.
Not all CFC income qualifies because certain categories are excluded by law.
Next, let’s understand how to arrive at the Tested Income and Loss of CFC. This will help in calculating the Net CFC Tested Income of the U.S. Shareholder of that CFC.
Tested Income is calculated for every Controlled Foreign Corporation (CFC) separately, as follows:
Result: The amount left after these steps is the CFC’s Tested Income. Such tested income can be positive or negative.
For example, let’s say a tested income comes out negative. A negative tested income, also known as a tested loss, happens when a CFC’s allocable deductions exceed its gross tested income. This results in a negative amount or net loss.
Next, let’s understand how to arrive at the U.S. Shareholder’s Net CFC Tested Income, after calculating the tested income and the tested loss. This matters because it determines the amount included under GILTI.
Let’s understand the above calculation in a simple example, which is as follows.
Simple Example:
Suppose you are a U.S. Shareholder of two CFCs. You own 100% of two CFCs:
Net CFC Tested Income = Tested Income-Tested Loss
= $400,000 – $150,000 = $250,000
Let’s suppose CFC B had a tested loss of $500,000.
CFC A had a tested income of $400,000.
Then the Net CFC Tested Income may appear to be -100,000. Although it is negative, it will be counted as zero. Therefore, Net CFC Tested Income would be $0, but not negative.
We’ve now learned how to determine Net CFC-Tested Income, the first major component of the GILTI calculation.
Next, let’s understand Net Deemed Tangible Income Return (Net DTIR), the second important component used in the GILTI formula.
Net Deemed Tangible Income Return (DTIR) represents the deemed normal return (10%) that the U.S. tax rules allow on the tangible business assets owned by your CFCs. In simple terms, the law assumes a 10% return is reasonable on physical assets.
Here, “return” means the profit expected from using those assets, and “deemed” means this profit is assumed by law, even if actual earnings differ.
Any profit earned above this 10% is treated as intangible income and may be subject to GILTI.
Next, let’s understand how to calculate Net DTIR.
Net DTIR = (10% × QBAI) – Net Interest Expense
Let’s understand the above formula in a simple manner, which is as follows
We have now understood the two main building blocks of GILTI, which are as follows:
Next, let’s combine them using the official GILTI formula and calculate the final result.
GILTI is calculated as follows:
GILTI = Net CFC Tested Income – Net DTIR
The formula subtracts this 10% deemed normal return (Net DTIR) from the Net CFC tested income. This way, only the excess profit, assumed to arise from intangible assets, is included in GILTI.
In the above calculation,
Therefore, GILTI likely arises when the step 1 calculation exceeds the step 2 calculation. This means that GILTI arises when the U.S. shareholder’s share of CFC profits exceeds a 10% deemed return on the shareholder’s share of QBAI (net of specified interest expense).
Let’s understand the GILTI Calculation through a simple example, which is as follows:
Example
A U.S. shareholder owns 100% of a CFC in a low-tax jurisdiction. For the year:
Step 1: Net CFC Tested Income
Net Tested Income = Gross Income − Excluded Income − Operating Expenses − Net Interest Expense
= $1,200,000 − $200,000 − $150,000 − $50,000
Net Tested Income = $800,000
Step 2: DTIR Calculation
DTIR = (10% × QBAI) − Net Interest Expense
= $300,000 − $50,000 = $250,000
DTIR = $250,000
Step 3: GILTI
GILTI = Net Tested Income − DTIR
= $800,000 − $250,000 = $550,000
GILTI = $550,000
Final Result
The U.S. shareholder will generally include $550,000 as GILTI in U.S. taxable income.
Next, let’s understand the recent changes to the GILTI provision, made under the One Big Beautiful Bill Act.
Next, let’s examine the tax impact of GILTI on U.S. shareholders. This is important to discuss because GILTI determines how a U.S. shareholder’s share of CFC earnings is included in and taxed under the U.S. tax system.
Let’s dive into the GILTI Tax implications on U.S. Shareholders in the next section.
GILTI income is taxed at ordinary corporate tax rates for U.S. Corporate shareholders. For U.S. individuals, it is taxed at their ordinary income tax rates. This income is included in the U.S. shareholder’s gross income.
However, corporate shareholders are potentially eligible for a 50% deduction on GILTI.
Conversely, individuals can opt for a Section 962 election to be taxed similarly to corporations and benefit from comparable deductions.
Net CFC Tested Income (NCTI) is the starting point for determining a U.S. shareholder’s GILTI inclusion and therefore directly drives the overall tax impact. It represents the combined net income of all Controlled Foreign Corporations (CFCs) after excluding items such as income effectively connected with a U.S. trade or business and Subpart F income, and after deducting related expenses, including interest. The higher the NCTI, the greater the potential GILTI exposure, making it a key determinant in how much income is ultimately taxed under the GILTI regime.
Recent Update on GILTI
Starting in 2026, GILTI has been renamed Net CFC Tested Income (NCTI) under the One Big Beautiful Bill Act. However, this is not merely a name change as it reflects a substantive shift in how the inclusion is computed.
The 10% return on tangible assets (Net DTIR / QBAI) is now completely removed. This means U.S. shareholders are required to include the full Net CFC Tested Income as NCTI, with no carve-out for routine returns on physical assets. The effective U.S. tax rate on it has also increased to about 12.6%.
The changes apply prospectively for taxable years beginning after December 31, 2025, and do not affect prior years.
This means earlier filings remain governed by the existing GILTI framework, which includes the QBAI-based 10% deemed return. Accordingly, taxpayers may not be required to amend previously filed returns solely due to this update. Audits for pre-2026 years may continue to apply the old rules required to compute GILTI.
Next, let’s understand the new Net CFC Tested Income (NCTI) and how it replaced the GILTI Provision. As a result, we will analyze the impact of the NCTI on the taxable income exposure of U.S. shareholders.
Net CFC Tested Income (NCTI), formerly known as Global Intangible Low-Taxed Income (GILTI), refers to a tax on the U.S. shareholders’ foreign earnings from Controlled Foreign Corporations (CFCs). It is a U.S. tax provision originally introduced under the Tax Cuts and Jobs Act (TCJA) in 2017 and significantly modified under the One Big Beautiful Bill Act (OBBBA).
NCTI ensures that U.S. corporations and individuals are taxed on income earned through their controlled foreign corporations, even if such income is not distributed.
Beginning in 2026, NCTI replaced the GILTI regime under OBBBA. The earlier GILTI regime primarily targeted income associated with intangible assets such as patents, copyrights, and trademarks. However, the revised framework under OBBBA expands the scope by taxing a broader base of foreign earnings.
Let’s now examine the key changes under the NCTI regime and how they replace the earlier GILTI framework.
Beginning in 2026, the GILTI regime is replaced by Net CFC Tested Income (NCTI) under OBBBA. This is not just a name change. It changes how the taxable amount is calculated.
To understand this, let’s first look at how the earlier GILTI rules worked.
Under the earlier rules, the calculation had two main steps.
First, the total Net CFC Tested Income was calculated. This represented the U.S. shareholder’s share of income from all CFCs.
Second, the law allowed a 10% assumed return on tangible assets. These assets are referred to as QBAI. This return was called Net DTIR.
After this, the taxable amount was determined.
Only the income above this 10% return was taxed. In other words, the difference between Net CFC Tested Income and Net DTIR was included in taxable income.
Now, under the revised NCTI framework, this entire approach has changed.
The concept of a 10% return on tangible assets no longer exists. As a result, the following changes were made under NCTI:
This means there is no longer any reduction for routine returns on physical assets.
As a result, the entire tested income of the CFCs is now subject to U.S. tax.
Next, let’s examine the effective date from which the NCTI rules will apply.
Effective Date and Transition from GILTI to NCTI
These changes apply prospectively to taxable years beginning after December 31, 2025. Prior years continue to be governed by the existing GILTI framework, including the QBAI-based deemed return.
Accordingly, taxpayers are generally not required to amend previously filed returns solely due to this change. Audits relating to pre-2026 years will also continue to apply the earlier GILTI rules.
Let’s understand how the NCTI is calculated in the next section.
Under OBBBA, the GILTI calculation has been simplified. The earlier approach of comparing income to a deemed return on tangible assets has been eliminated.
NCTI is now calculated thruugh a streamlined process that focuses only on the net tested income of all CFCs.
Formula:
NCTI = Net CFC Tested Income
Next, let’s break down the above calculation in simple terms.
The first step is to determine Net Controlled Foreign Corporation (CFC) Tested Income. This represents the U.S. shareholders’ total share of profits and losses across all their Controlled Foreign Corporations (CFCs), calculated as follows:
As we can see, the Net CFC Tested Income calculation is based on “tested income” and “tested loss” of each CFC.
Generally, tested income and tested loss represent the portion of a CFC’s income that qualifies for inclusion in the NCTI computation. Not all CFC income qualifies because certain categories are excluded by law.
Next, let’s understand how to arrive at the Tested Income and Loss of CFC. This will help in calculating the Net CFC Tested Income of the U.S. Shareholder of that CFC.
Result: The amount left is the CFC’s tested income. This amount can be positive or negative.
If deductions exceed gross tested income, the result is a tested loss.
Next, let’s understand how to arrive at the U.S. Shareholder’s Net CFC Tested Income, after calculating the tested income and the tested loss.
Formula:
Net CFC Tested Income =Tested Income -Tested Loss
Let’s understand the Net CFC Tested Income Calculation through a simple example, which is as follows:
Simple Example
Suppose you are a U.S. shareholder of two CFCs and own 100% of both:
Net CFC Tested Income = 400,000 − 150,000 = $250,000
If the tested loss were $500,000 instead, the result would be negative. However, it is limited to zero, not negative.
We have now learned how to determine Net CFC Tested Income, which is the only component required under the revised regime.
Next, let’s understand how to compute NCTI.
Under the earlier GILTI regime, a second step required the subtraction of a deemed return on tangible assets (DTIR).
However, under OBBBA, this step has been completely removed. There is:
Therefore:
NCTI Inclusion = Net CFC Tested Income
This means that the entire Net CFC Tested Income is included in the U.S. shareholder’s taxable income.
Let’s understand the NCTI Calculation through a simple example, which is as follows:
Example
A U.S. shareholder owns 100% of a CFC. For the year:
Step 1: Net Tested Income
Net CFC Tested Income = 1,200,000 − 200,000 − 150,000 − 50,000
= $800,000
Step 2: NCTI Inclusion
NCTI = Net CFC Tested Income
=$800,000
Final Result
The U.S. shareholder will include $800,000 as NCTI in U.S. taxable income.
Unlike the earlier GILTI regime, there is no reduction for a deemed return on tangible assets. This may effectively result in a higher taxable base for the U.S. Shareholders.
Next, let’s examine the tax impact of NCTI on U.S. shareholders. This is important to discuss because NCTI determines how a U.S. shareholder’s share of CFC earnings is included in and taxed under the U.S. tax system.
Let’s dive into the NCTI Tax implications on U.S. Shareholders in the next section.
NCTI income is taxed at ordinary corporate tax rates for U.S. corporate shareholders. For U.S. individuals, it is taxed at their applicable ordinary income tax rates and included in gross income.
Corporate shareholders remain eligible for a reduced Section 250 deduction (approximately 40%), subject to limitations. In addition, foreign tax credits remain available, with a reduced haircut compared to prior law.
Individuals may consider making a Section 962 election to be taxed in a manner similar to corporations and potentially benefit from deductions and foreign tax credits.
Net CFC Tested Income is the starting point for determining a U.S. shareholder’s inclusion and directly drives the overall tax impact. Since there is no longer a reduction for tangible assets, the full amount of NCTI becomes critical in determining the U.S. tax liability. The higher the NCTI, the greater the exposure, making it the central component of the revised regime.
Next, let’s understand the Subpart F income provisions and how they directly impact US shareholders. Generally, these provisions require U.S. shareholders to currently include certain types of income earned by their CFCs, regardless of whether that income is distributed.
Let’s understand in more detail in the next section.
Subpart F income is a specific type of foreign income that is immediately taxable in the U.S., even if it hasn’t been distributed to shareholders. This rule, part of the IRC’s Subpart F provisions, aims to prevent U.S. taxpayers from deferring taxes by keeping specific income within Controlled Foreign Corporations (CFCs).
The Subpart F income rules apply to U.S. shareholders of a Controlled Foreign Corporation (CFC). Generally, CFC is a foreign company with a U.S. shareholder. Here, each U.S. shareholder owns at least 10% of the voting stock in a controlled foreign corporation and, collectively, more than 50% of the voting stock in that corporation. The ownership and control can be either direct or indirect.
To learn more about CFC, please refer to the following article.
Under these rules, it is assumed that CFC’s shareholders receive a proportionate share of specific categories of current earnings and profits from the controlled foreign corporation (CFC). Although no income was distributed to CFC’s shareholders.
Thus, U.S. shareholders generally must report Subpart F income in the United States, even if the CFC does not distribute it.
U.S. shareholders of Controlled Foreign Corporation (CFCs) encounter important tax implications related to Subpart F income. This income is subject to U.S. taxation at ordinary income tax rates, for both corporations and individuals, even if it has not been distributed as a dividend.
These ordinary income tax rates are generally higher than the qualified dividend tax rate. For context, ordinary income tax rates for individuals can reach 37%. On the other hand, qualified dividends qualify for preferential long-term capital gains rates, typically 0%, 15%, or 20%, depending on tax bracket.
U.S. shareholders generally cannot defer taxes on passive income from CFCs due to Subpart F provisions.
Consequently, shareholders likely pay taxes on this income in the year it is earned, regardless of whether they receive any distributions.
The income types defined under Subpart F are referred to as “Subpart F income,” in accordance with IRC section 952.
The primary categories of Subpart F income include:
Foreign Base Company Income (FBCI) – §954
This is the largest category of Subpart F income earned by a Controlled Foreign Corporation (CFC), which consists of several subcategories, as follows:
This includes passive income, such as:
This includes income from buying or selling generally personal goods, which is derived via the following:
This includes income from services, which is derived via the following:
This includes income related to oil exploration, drilling, or mineral extraction, with specific definitions and exceptions.
This refers to the earnings generated by foreign insurance companies that fulfil specific criteria.
This includes Income derived from operations in countries that participate in international boycotts.
This includes Income obtained through illegal means, such as bribes and kickbacks.
Exceptions to Subpart F rules permit the exclusion of certain types of income from being classified as Subpart F income. This allows U.S. shareholders to avoid being taxed on that income.
Understanding these exceptions is essential for U.S. shareholders with interests in foreign corporations to manage their tax liabilities effectively.
Let’s discuss some of these exceptions, which are as follows:
If a CFC’s Subpart F income is below the lower of $1 million or 5% of the CFC’s gross income, that income is not considered Subpart F income.
Income that is taxed at a rate greater than 90% of the U.S. corporate tax rate is not considered Subpart F income. For instance, if the highest U.S. corporate tax rate is 21%, then income taxed at a rate exceeding 18.9% qualifies for this exception.
A Controlled Foreign Corporation (CFC) may invest in “U.S. property.” In that case, the U.S. shareholder is likely required to include a portion of that investment in their taxable income under Section 956. This applies even if the CFC does not actually distribute any cash or dividends.
What does “Investment in U.S. Property” mean?
It generally includes situations where the CFC’s earnings are used in ways that bring economic value back to the U.S., such as:
In simple terms, Section 956 treats these investments as if the CFC had distributed the money back to the U.S. shareholder as a deemed dividend, even if no actual cash is received.
What is the meaning of “United States Property” for Section 956 purposes?
For Section 956 purposes, the term “United States property” refers to any property (if obtained after December 31, 1962) that includes the following:
The following does not constitute a “United States Property”:
An amount equivalent to certain earnings and profits from before 1963.
The following are some of the income types subject to Section 956 inclusions:
When CFC lends money to its U.S. shareholders or related parties, this is likely treated as an investment in U.S. property and can trigger a deemed distribution.
When a CFC guarantees a loan made to a U.S. person (particularly related parties), this guarantee is considered an indirect investment in U.S. property.
When CFC stock is pledged as collateral for debts or obligations of U.S. persons, this can constitute an investment in U.S. property under Section 956.