According to the IRS, a foreign corporation is defined as a corporation that is not a U.S. domestic corporation. This means that a foreign corporation is a business entity established under the laws of a country outside the United States. Under U.S. tax law, a foreign corporation is considered an independent legal entity for tax purposes. This means it has its own legal identity, financial statements, and tax obligations that are distinct from those of its U.S. owners.
A U.S. person who owns shares in a foreign corporation may have different tax obligations depending on whether that foreign corporation is classified as a controlled foreign corporation. Let’s explore this in detail.
If Controlled Foreign Corporation (CFC):
A Controlled Foreign Corporation is a type of foreign corporation in which U.S. shareholders—those owning at least 10% of the corporation’s stock and together holding more than 50% of the corporation’s stock.
U.S. shareholders of a CFC are subject to taxation on the income earned by the foreign corporation, even if that income is not distributed to them. For more detailed information about CFCs, please refer to the following article.
If Non-Controlled Foreign Corporation (CFC):
All foreign corporations that do not meet the criteria for controlled foreign corporations (CFCs) are classified as non-CFCs. A foreign corporation does not qualify as a CFC if U.S. persons own 50% or less of the total voting power or value of the corporation’s stock.
In this case, U.S. shareholders are only taxed on the dividends they receive. If these dividends originate from a treaty country, U.S. shareholders may be eligible for a reduced or exempt tax rate on the dividend.