Chapter 6 – Options for
Anti-Deferral Tax Regimes
Alternative approaches to U.S. taxation of U.S.
owners & foreign corporate income:
1) Complete deferral (or a territorial approach?).
2) Partial deferral – “Subpart F” approach.
3) Deferral, but imposition of an interest charge
when income distribution later occurs.
4) Deferral, but a tax characterization change to
ordinary income when gain is received.
5) No deferral - all current income recognition is
required (or “acceleration”?).
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Present/Former U.S. AntiDeferral Tax Structures
1) FPHC - current attribution of investment
income (repealed in 2004) (but rules are used for
Subpart F definitions).
2) Controlled foreign corporation or “CFC” Subpart F provisions - partial current
recognition of undistributed income.
3) Foreign investment companies - (repealed in
2004) - characterization of a distribution.
4) Passive foreign investment company rules PFIC - interest charge on an excess distribution
or on stock sales proceeds
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Purposes for Use of “Base
Country” Corp.
p.487
1) Holding stock in foreign subsidiaries.
2) Licensing arrangements.
3) Export sales or import purchases concluded
through a “base company.”
4) Services provided from a base company.
5) Financing operations provided at foreign base.
What is a “base country”? Tax haven country,
including no tax imposed on income realized
outside the base country.
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Picking a Base Country
p.488
Choices of foreign country jurisdiction:
- Tax haven (no tax on transactions through the
jurisdiction).
- Legal system – probably based on English
common law.
- Types of countries: (1) Developed countries –
Switzerland or Luxembourg; or (2) Islands, etc. –
Cayman Islands, BVI, Bermuda, Bahamas,
Channel Islands, Gibralter, Isle of Man (often
engaged in a “race to the bottom”).
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The “Subpart F” Provisions
Summarized
p.489-490
Code §§ 951-964.
Current income taxation to U.S. shareholders (even
though income not actually received):
1) Must be a “controlled foreign corporation” (or
CFC), i.e. more than 50% “U.S. shareholders.”
2) Must be a 10% or greater shareholder.
3) Limited to certain types of movable income - not
including “active” income, e.g., manufacturing
income.
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PFIC Provisions
Summarized
p.490
Code §§1291-1298 (TRA-1986)
“Passive Foreign Investment Company” (or PFIC)
status – passive investment income.
Deferral is permitted since no CFC status for the
corporation in the U.S. (e.g., for an offshore
investment fund with a large shareholder base).
But, the benefit of the income tax deferral is
recaptured (through an interest charge) when
either (1) an “excess distribution,” or (2) a stock
sale occurs.
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PFIC Provisions, cont.
p.491
No stock ownership percentage test; PFIC rules
applicable only to U.S. taxpayer owners.
Income of PFCI must be 75% passive (or 50% of
the entity’s assets must be those producing
passive income).
Options for U.S. shareholder avoiding a subsequent
interest charge on the deferral benefit:
1) Qualified electing fund
2) “Mark to market” for PFIC stock – assuming
marketable stock.
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“Temporary” Dividends
Received Deduction p.492
Code §965 – temporary (2004) provision enabling
an 85% DRD. Expired, but to be renewed?
Therefore, tax of 35% times 15% income inclusion
in U.S. tax base = 5.25% effective U.S. income
tax rate.
Only cash dividends. Must be extraordinary
dividends (i.e., exceeding average repatriations)
Reinvestment in U.S. required – (1) must be a
dividend reinvestment plan, and (2) funds are
to be used for prescribed purposes.
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Definition of a “Controlled
Foreign Corporation” p.494
Code §957(a) defines a “controlled foreign
corporation” (CFC) as a foreign corporation where
more than 50 percent of:
(i) the vote, or (ii) the value
of all the outstanding stock is owned (or is
considered as owned) by one or more “United
States shareholders” on any day during the taxable
year (determined on a year-by-year basis).
“United States shareholder” defined – next slide.
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“United States
Shareholder” Defined p.494
Who are “United States shareholders”? See the
Code §951(b) definition.
U.S. citizens, resident aliens, corporations,
partnerships, trusts or estates owning directly or
indirectly or constructively (under the ownership
rules of §958) 10% or more of the total combined
voting power of all classes of stock of a foreign
corporation for at least 30 days during the year.
Less than 10% ownership: a “portfolio interest”
and not a “direct interest”.
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Subpart F Constructive
Dividends Concept
p.496
1. Include a pro rata share of “Subpart F income”
(§951(a)(1)(A)(i)), as determined on the last day
of the year. Objective: Constructive receipt economic power exists to control the income
and an immediate accretion to wealth thereby
causes gross income inclusion. Reduced by
amounts paid earlier in year to prior owner.
2. Include pro rata share of investment in “U.S.
Property” (§956) - a deemed repatriation of
profits into U.S. (income type is not relevant).
continued
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Subpart F Constructive
Dividends Concept, cont.
3. Income attributed to the shareholder is treated
as ordinary income (i.e., capital gain may be
transformed into ordinary income). Important
to an individual situation. Cf., branch status.
4. No loss pass-through from CFC to the
shareholder; cf., branch treatment.
5. Subsequent stock disposition gain – ordinary
income to the extent of profits allocable to the
stock sold (if not previously included). §1248 (i.e., not capital gain). Important to individual.
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Subpart F - Foreign Tax
Credit Availability
p.498
An indirect foreign tax credit is available for U.S.
corporate shareholders when current Subpart F
inclusion is required - similar to §902. See §960.
The §78 gross-up to the deemed dividend is
required for the taxes deemed paid which are
attributable to the deemed distribution.
§962 – election is available to an individual
shareholder for the same treatment (i.e., to
enable availability of the deemed paid foreign tax
credit & income tax at corporate rates).
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Subpart F - Adjustment
Mechanisms
p.498
§959(a) - actual distributions from the CFC are
sourced first from amounts already taxed under
§951(a). Similar treatment for previously taxed
§956 U.S. investment amounts (& §951(a)(1)(B).
§961(a) – an increase in tax basis is made for shares
held by the U.S. shareholder by the amount
included in gross income under §951(a).
§961(b). A reduction of tax basis for shares is made
for untaxed distributions. Cf., S corporation
treatment for distributions to shareholders.
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Subpart F Income
Elements - §952(a)
p.499
1) “Foreign base company income” – derived from
a diversion of passive (& similar) income to a lowtax jurisdiction.
2) Income from insurance activities. §953.
3 International boycott-related income.
4) Illegal bribes and kickbacks.
5) Bad country income. Cf., §901(j) re FTC.
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Foreign Base Company
Income - §954(a)
p.500-1
Categories of FBC income:
1) Foreign personal holding company income
(FPHCI). Identified in §954(c).
2) Foreign base company sales income.
3) Foreign base company services income.
4) Foreign base company oil related income.
Not active business income; formerly, also,
foreign base company shipping income; income in
less-developed country corps.
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Limits on Subpart F
Income Inclusion
p.502
1) §954(b)(3)(A)&(B) - de minimis (exclusion) rule
(5%); but, also, a 70% “full inclusion” rule.
2) §952(c)(1) provides a limit on CFC's Subpart F
income to the CFC’s “earnings and profits” for
that year.
3) §952(b) excludes from Subpart F income certain
U.S. source income - ECI with a U.S. trade or
business (since this income is currently subject to
U.S. income tax on basis of geographic source).
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Definition of a “Controlled
Foreign Corporation”
p.502
§957 - more than 50% of the vote or value of the
corp. stock is owned by “U.S. shareholders.”
§958 specifies (1) direct, (2) indirect and (3)
constructive ownership rules to determine 50% test.
§958(a)(2) - indirect ownership rules (e.g., subs).
§958(b) - constructive ownership rules concerning
attribution between family members and between
(i) entities and (ii) their shareholders, partners or
(iii) beneficiaries. Cf., §318 (Subchapter C)
constructive ownership
rules.
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Problem 1
CFC Status?
p.504
Zeus as a Swiss corp has 1,000 shares of a single
class of stock outstanding. Jupiter, a widely held
U.S. corporation, owns 460 shares and the
remaining 540 shares are owned equally by six
unrelated U.S. individuals.
Result: None of the individuals is a “U.S.
shareholder” because none owns 10%; therefore,
Zeus is not a CFC (since not over 50% “U.S.
shareholders.”). §957(a) and §951(b).
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Problem 2
p.504
More than 10% Individuals
The number of corporate shareholders is reduced
from six to five.
Each individual shareholder then owns more than
10 percent (10.8%, or 108/1000).
Result: Each individual would be a “United States
shareholder.”
Therefore, Zeus would be a CFC (since more than
50% of its stock is owned by “United States
shareholders”).
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Problem 3
p.504
Attribution to Partnership
1) A partnership (one of the six shareholders each
owning 9%) owns 90 shares, and 2) a partner owns
90 shares. The partner's shares are attributed to
the partnership and the partnership is deemed to
hold 180 shares. §958(b) and §318(a)(3)(A).
Zeus is a CFC (when including Jupiter’s shares).
§958(b) and §318(a)(3)(A). 180 plus 460 Jupiter
shares (= 640) & is more than 50 percent.
2) Is the partner a U.S. shareholder? No, 318(a)(2)
(5% of 90 shares = 4.5 shares).
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Problem 4
p.504
Husband & Wife Attribution
Two of the individuals are husband and wife. Each
spouse's shares are attributed to the other under
§958(b) and §318(a)(1)(A)(i). Query: Who is a
“spouse” for this purpose?
Each spouse is deemed to own 180 shares (90
actually and 90 by ownership attribution) and
each spouse is a U.S. shareholder.
Therefore, Zeus is a CFC - when the 180 shares of a
spouse are combined with the 460 Jupiter shares
(= 640).
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Problem 5
p.504
Nonresident Alien Status
Two of the individual shareholders are husband
and wife. One spouse is a nonresident alien.
No ownership attribution occurs under
§318(a)(1)(A)) to/from a nonresident alien
spouse. See §958(b)(1) limiting § 318(a)(1)(A)
attribution in this context.
Therefore, Zeus S.A. is not a CFC.
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Problem 6
p.505
Attribution Among Siblings?
Two of the individuals are brother and sister.
No attribution occurs between siblings under
§318(a)(1)(A).
But, attribution from each child to parent & parent
then owns 180 shares & then add Jupiter’s 460 =
640 shares (more than 50%)? Therefore, Zeus
S.A. is a CFC.
But, only Jupiter has actual §951(a) gross income
inclusion. §951(a)(2)(A).
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Problem 7
p.505
Corp/Shareholder Attribution
One of individuals (owning 90 shares) owns 50% of
stock of Jupiter corp. (a U.S. corp, which owns
46% of Zeus).
All of the individual’s 90 shares are attributed from
the individual to Jupiter Corp. and, then, Jupiter
owns 550 shares (460 + 90). §318(a)(3)(C).
Zeus is therefore a CFC.
Cf., attribution to individual (yes, ½ of 460 shares).
§318(a)(2)(C). U.S. shareholder (230 plus 90 =
320).
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Problem 8
10% Share Ownership
p.505
One of the individuals (owning 90 shares) owns 10%
(not 50%) of the stock of Jupiter corporation (the
U.S. corp. which owns 46% of Zeus), and that
individual is a U.S. shareholder.
The individual’s 90 shares are combined with 10%
of Jupiter Corp. 460 shares for 136 shares &
individual is a “U.S. shareholder.”
§318(a)(2)(C) & §958(b)(3) (i.e. 10%, not 50%).
Therefore, Zeus is a CFC. 90 plus 460 = 550 shares.
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Problem 9
5% Share Ownership
p.505
One of the individuals (owning 90 shares) owns five
percent of the stock of Jupiter corporation (U.S.
corp. which owns 46% of Zeus).
The individual’s 90 shares are not attributed from
individual to Jupiter Corp. See §318(a)(2)(C) &
§958(b)(3).
Zeus is not a CFC since Jupiter is the only “U.S.
shareholder” (holding 46%), within the meaning
of §951(b).
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Problem 10
p.505
Ownership Thru Foreign Corp.
410 shares of Zeus are owned by Jupiter Corp, and
90 shares are owned by a U.S. citizen who (1) also
owns 3% of the shares of Juno B.V. (a Dutch
corporation) & (2) Juno B.V. owns 500 Zeus
shares (i.e., U.S. citizen indirectly owns 15
additional shares of Zeus or a total 105).
See §958(a)(2) for indirect ownership rule.
105 shares plus 410 shares (total 515 shares) means
Zeus is a CFC.
Juno (foreign corp.) is not a U.S. shareholder.
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Stock Voting Power (or
Value?) Test - 50% plus
CCA, Inc. p. 505 Old CCA owned all of the
issued and outstanding stock of AG (Swiss).
AG was exporter of CCA products from the United
States. AG had exclusive right to use CCA
trademarks. AG had manufacturing plants in
other European jurisdictions.
After 1962, an objective existed to “decontrol” AG
for Subpart F purposes (after distribution of
shares of active subsidiaries).
Accomplished here. Yes. Why/how?
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Koehring case
p.515
Nominal control irrelevant
KOS, a Panamanian sub, operating as a wholly
owned sub of the U.S. parent corporation.
Voting control transferred to Newton
Chambers, an English company, by its
purchase of cumulative voting preferred
stock having 55% of the vote (but stock
subject to cash-out?).
See Reg. §1.957-1(b)(2) re shifting only of
formal voting power & a cross-investment
arrangement. KOS was treated as a CFC.
What impact of the(c)“clearly
erroneous” rule?
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Problem 4, p.526
Avoiding CFC Status
Still possible to decontrol foreign corp.? yes, but
preferred stock must also have a value equal
to at least 50% of total corporate value, and:
1) restrictions re no transfer to a U.S. person;
2) 50 percent of the Board of Directors as
preferred share representatives;
3) no common share right to redeem preferred;
4) no means to resolve the deadlocks, etc.
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Stapled Stock
Corporations
p.527
Structure: Holdings in (1) the U.S. corp. and (2)
the foreign corp. can only trade as a unit.
“Stapling” occurs to avoid the applicability of the
Subpart F rules for the foreign corp. - & the
sufficiently wide distribution of shares of the
foreign corporation to not be a CFC.
§269B specifies that the foreign corporation
when stapled is treated as a U.S. corporation
(subject to worldwide U.S. income taxation).
Cf., a nonstapled corp.
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Corporate Inversions
p.529
Transformation of a U.S. publicly traded
corporation into a subsidiary of a foreign
corporation. U.S. tax treatment of this change?
After the transaction the U.S. shareholder
ownership of the foreign corporation is widely
dispersed & foreign corporation is not a CFC.
Stripping profits outbound from the U.S. sub to
the foreign parent would then be enabled.
But, foreign corp. may be treated as a U.S. corp.
See §7874.
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Possible Rules for
Corporate Residency p.530
Should the corporate residency status be
determined by where the primary corporate
officers reside and regularly work (rather than
being based on the place of organization)?
Cf., other foreign country tests of the place of
“management and control” for determining
the situs of a corporation. Is this different
from the place where the corporate business is
regularly conducted?
Problem under this approach is in determining
with clarity the residence status of corporation.
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Mechanics of Subpart F
Income Inclusion
p.530
§951(a)(1) - gross income inclusion is possibly
required for a shareholder if the corporation is
a CFC for a 30 day period during the tax year.
Every person who is a “United States
shareholder” must include his/her/its pro rata
share of the Subpart F income at year-end.
Pro rata share of a person’s includible Subpart F
income is determined by reference only to
direct and indirect CFC ownership (but not to
constructive ownership rules).
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Subpart F Mechanics, cont.
p.531
If CFC for only part of the year - then pro rata
allocation for a portion of year. §951(a)(2)(A).
Reduction of Subpart F income amount if dividends
were actually received earlier in the same year by
a prior owner (plus §1248 gain). §951(a)(2)(B).
Note: How negotiate a corporate acquisition
transaction with this Subpart F income
consideration? Wanting dividend or no dividend
treatment? Consider the FTC situation to the
potential acquirer (after a dividend was paid).
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Subpart F Income Inclusion,
cont.
p.532
If multiple classes of stock are outstanding, how
allocate the Subpart F income among the several
classes? Allocation is to be based on the E&P
amounts allocable to each class. P. 532.
How allocate income if directors have discretionary
power to allocate income among the several
classes of stock? Allocation is based on the
relative values of the shares.
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Subpart F Income Inclusion,
Multiple Tiers
p.533
If multiple tiers of corporations, how determine the
shareholder’s Subpart F income amount? Use
the “hop-scotch” method for Subpart F income
from lower corps to the U.S. shareholder(s).
Eligibility for an (indirect) foreign tax credit? Yes.
Gross-up the Subpart F income amount by the
allocable deemed paid credit amount under §960.
Shareholder increases tax basis for above tier corps.
What happens when 1st tier corporation sells shares
of 2nd tier corporation? Tax basis increase for the
holding in the 2nd tier sub. §961.
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The Partnership “Blocker”
Transaction
p.534
Possible to interpose a domestic partnership in the
middle of a chain of foreign corporations to avoid
CFC status for the foreign corporation(s) held
below the domestic partnership?
Identified as a “Subpart F income partnership
blocker.”
See Notice 2010-41 that indicates that (for §951
purposes) the U.S. partnership is to be classified
as a foreign partnership to determine CFC status
of the lower tier corp.
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Foreign tax credit availability
p.535
§960 – similar to §902 concerning availability of the
indirect FTC to upstream corp. shareholders.
Indirect credit is available down to the 6th tier
foreign corporation if a controlled foreign
corporation. Cf., §902(b)(2).
At least 10% corporate ownership of voting stock
must exist at each level.
No indirect FTC below the 6th tier (but then use a
“disregarded entity”?).
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Problem 1
p.537
FBC Income Allocation
Two NRAs and a U.S. corporation organize Irish
Foreign Base Company, Inc. (FBC). Two NRAs get
30% each & Widgets (U.S.) gets 40%.
On August 8 NRA Molly gets a “green card.”
FBC has net income of $400,000 for year one – 1/2 of
this amount being Subpart F income.
FBC paid $80,000 in foreign income tax on pre-tax
foreign net income of $480,000 (16+% rate).
continued
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Problem 1, continued
CFC status during mid-year
FBC becomes a CFC on August 8 when FBC has a
40% & a 30% U.S. shareholder (Molly).
For the year $200,000 is Subpart F income (after
foreign taxes) (§954(b)(5)).
Proportionate allocation of the Subpart F income is
to be made to that period during which the
corporation is a CFC - 40% (145/365) of that
year, times $200,000 ($80,000), CFC income.
Equals (1) $32,000 inclusion for Widgets (40%) and
(2) $24,000 inclusion for Molly (30%).
continued
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Problem 1, continued
Basis & FTC Treatment?
Molly tax basis adjustment for her FBC stock:
$30,000 cost plus $24,000 Subpart F income –
$54,000. No indirect FTC (since an individual),
assuming no §962 election made by Molly.
Widgets’ basis increase for its FBC stock: $40,000
cost, plus $32,000 Subpart F income = $72,000
basis. Widgets gets a §960 deemed paid credit:
32,000/400,000 x 80,000 (total tax) = 6,400.
No tax basis increase for Widgets’ stock for this
6,400 FTC amount (since used as a FTC).
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Problem 2
p.537
Actual dividend distribution
Year two distribution of dividends is made from
FBC: $20,000 to Widgets, and $15,000 to Molly
and Sam. FBC breaks even for 2nd year.
Sam (foreigner) is not subject to U.S. income tax.
Under §959 no tax to Widgets & Molly since
amounts received are paid from earnings
previously taxed (under §951). See §959(c)
ordering rules.
Under §961(b) share basis is reduced (prior tax
basis increase when earlier income inclusion).
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Exclusion of U.S. Trade or
Business Income
p.537
§952(b) provides an exclusion from Subpart F for
U.S. trade or business income. Assumption of net
basis income taxation in the United States to
enable this exclusion from Subpart F income.
No exclusion from Subpart F income, however,
where the trade or business income in the U.S.:
(1) is entitled to an exclusion from gross income
(e.g., no P.E.) under a tax treaty, or
(2) has a reduced rate of tax under an income tax
treaty.
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Subpart F Income Is Based
on Current E&P
p.538
§952(c)(1)(A) - Subpart F income is limited to
CFC’s current “earnings and profits.”
Some CFC current losses may reduce the CFC’s
Subpart F income (even though losses are not
attributable to Subpart F type activities).
However, possible subsequent Subpart F income
recapture is required when an excess of current
earnings and profits is realized over the Subpart
F income. §952(c)(2). This is a timing rule.
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Accumulated Deficits As
Reducing Subpart F Income
Accumulated deficits do not reduce Subpart F
income for the current year, except as permitted
in §952(c)(1)(B) (i.e., "qualified activity"). P. 539.
Deficits in related companies cannot be used to
reduce Subpart F income except where the same
“qualified activity” is conducted by a "qualified
chain member” and deficits are incurred.
Qualified activities produce: (1) FBC oil-related
income, (2) FBC sales income, (3) FBC services
income, (4) certain insurance co. income, or (5)
certain financial co. income.
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Defining Foreign Base
Company Income
p.540
Definition of FBCI is specified in §954(a):
1) Foreign personal holding company income.
Certain “same country” exceptions.
2) Foreign base company sales income.
3) Foreign base company services income.
4) Foreign base company oil related income.
FBCI formerly included foreign base company
shipping income.
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Defining “Foreign Personal
Holding Company Income”
P. 540. Definition is provided in §954(c) Interest, dividends, rents, royalties, annuities
and gains from the sale of stock or securities.
Exception for rents and royalties received from
unrelated persons when derived in the active
conduct of a business - §954(c)(2)(A).
Exception for “same country” dividends and
same country interest from a related person.
§954(c)(3)(A)(i) & (ii). Same for “same
country” rents and royalties. continued
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Defining FPHCI, continued
p. 542-3
The exception for related party payments is not
applicable where payments reduce Subpart F
income of payor. §954(c)(3)(B). P.542.
“Look-through rule” applies for payments
received or accrued from a related controlled
foreign corporation. §954(c)(6). This
transforms Subpart F income (e.g., dividends)
into non-Subpart F income. Extended in the
2014 tax legislation through the year 2014.
Enables remarshalling of foreign assets without
FPHCI results.
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Defining FPHCI, continued
p. 544
Gain on the sale by a CFC of another foreign
corp stock is treated as a dividend as if §1248
would be applicable. §964(e). P.544. But, an
anti-taxpayer rule if the FTC is also available?
Similar treatment if a §311(b) gain recognition
transaction upon distribution of CFC stock by
foreign parent to U.S. shareholder.
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Related Person Factoring
Income
p.546
Sale of receivables to a “factor” at a discount.
What is a “receivable” for this purpose? §864(d)(3).
§864(d)(1) - discount income to foreign corporation
from factoring with a related person is treated as
“interest” income from a loan.
Also, a loan to a purchaser from a related party is
treated as a receivable purchase for purposes of
this rule. §864(d)(6).
A same country exception is available in some
situations. §864(d)(7). See p. 548.
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Other Foreign Personal
Holding Company Income
P. 548. Foreign currency gains. §954(c)(1)(D). A
hedging exception is applicable.
Income from commodity transactions.
§954(c)(1)(C). A hedging exception is available.
§954(c)(5)(A).
P. 549-550. Income derived from the sale of
property producing either (1) passive income or
(2) no income is FPHCI. §954(c)(1)(B).
Exceptions exist for certain property sales
(particularly sale of trade or business assets).
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The “Check & Sell” Plan
The Dover case
p.551
A CFC’s sale of stock (including the stock of a 2nd
tier foreign subsidiary) produces a capital gain
which is FPHC income.
Assume the sale of sub’s assets produces no FPHCI
- but may cause a foreign country gains tax.
Option: Use the “check the box” entity
characterization rules (assuming an “eligible
entity”) to (1) cause a deemed liquidation of the
foreign corp. (under §332), and (2) then sell the
stock (which is a sale of assets for U.S. income
tax purposes).
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Active Financing
Exception
p. 555
Exception from FPHCI definition for certain
active financing income realized by a CFC.
§954(h).
Note:
1) Line item veto history – p. 555.
2) This exception also extended through the year
2014 in year-end “extenders” legislation.
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Foreign Base Company
Sales Income
p.556
§954(d). Defined as income derived from the
purchase and the sale of personal property:
(1) if purchased from or sold to a related party, &
(2) the property was manufactured outside the
country where (a) the CFC is organized and (b) the
property is sold for ultimate use.
Includes income from “commission” sales.
A “tax avoidance” purpose is not relevant.
Requires three countries & two related parties.
Cont.
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Foreign Base Company
Sales Income, continued
Exception from FBC sales income treatment where
CFC conducts significant manufacturing of the
product sold: But, what is “manufacturing”?
Three alternative tests:
(1) Must be “substantial transformation.”
(2) A 20%+ “safe-harbor” is possible for the CFC.
Minor assembling is not sufficient.
(3) “Substantial contribution” test (re outsourcing,
i.e., “contract manufacturing”).
See Dave Fischbein case (later, Ch. 11, p. 911).
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57
Foreign Base Company
Sales Income, cont. p.558
Possible application of a “branch rule,” i.e.,
treating the branch as a separate corporation.
§954(d)(2). Why?
Example: Swiss CFC is engaged in manufacturing
and uses a Cayman Islands branch for its sales
operation. Tax arises only in Switzerland on the
manufacturing income (i.e., a Swiss territorial
taxation approach). No tax imposed in Cayman
Islands on the sales activity (and the income).
CI branch is treated as a separate sub for FBC
sales income purposes.
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Foreign Base Company
Services Income –
p.558
§954(e)(1). Services are performed (1) for a related
person and (2) outside the country where the
CFC is organized. Both a "related person" test
and a "geographic" test need to be satisfied.
Consider foreign construction or drilling companies
engaged in offshore activities.
"Substantial assistance" provided to the foreign
subsidiary may cause this rule to apply. P.559.
See the exception for financing activities. P.561 &
§954(h).
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Foreign Base Company Oil
Related Income –
p.561
§954(g)(1). “Oil related” income realized by big
producers outside the country of the oil & gas
production. E.g., refining, transportation &
distribution income from oil and gas products.
See §907(c)(2)&(3) for definitions.
Applicable only to large oil producers (1,000 +
barrels per day).
Exception applies for “in country” consumption.
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Subpart F Definition of a
“Related Person”
p.562
§954(d)(3) specifies that a “related person” is one
of the following:
1) More than 50% of the vote or value of a
corporation owned by that person.
2) More than 50% of value of the beneficial
interests in a partnership, trust or estate owned
by that person.
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Special Rules for
Inclusion/Exclusion
p.563
1) De minimis rule (lesser of 5% of GI or $1 mil. is
FBCI; e.g., for interest received on cash balances at
a bank). §954(b)(3)(A). An anti-abuse rule applies
for aggregation among related entities.
2) Full inclusion (70%+) of GI rule. §954(b)(3)(B).
3) Exception for a high-taxed income item. P.565.
§954(b)(4). At least a 31.5% (effective, a nominal)
tax rate. No PLR issuance is available.
Note: Blocked earnings exclusion. §964(b). P.567.
But, see re swap and similar
arrangements.
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Income Earned by CFC
Through Partnership p.568
Consider Subpart F income when realized by a
partnership - attribution to the partners,
including a CFC (sub of a US parent)?
§702 - provides for separate characterization.
See Brown Group cases & §954(d)(3).
§701 anti-abuse regulations - partnership to be
treated as an “aggregate” (and not an “entity”).
Notice 96-39 (IRS disagreement with Brown Group
8th Cir. decision). See p. 571.
Subsequent aggregation regulations & then
§954(c)(4) look-through rules (2004).
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Subpart F and the New
Economy
p.573
U.S. Treasury Department Study, 12-2000,
examining the impact of the Subpart F rules on
transactions conducted through websites and the
Internet.
Sourcing issues: Where is the place of performance
or the place of use?
Sales of goods? Royalties? Services?
Manufacturing within the CFC, e.g., for software?
Relevance of “branch rules”? Or, “U.S. trade or
business status”?
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Problem 1a Matterhorn, S.A.
Swiss sub of USM(US) p.581
Matterhorn (a CFC) acquires from its parent corp.
and sublicenses patents for royalties to be
received from independent licensees outside
Matterhorn’s place of organization.
Royalties are included in the definition of FPHCI.
Unless: (i) same country-related person exception
under §954(c)(3)(A)(ii), or (ii) the active business
- unrelated person exception of §954(c)(2)(A).
But, not here – not an active business.
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Problem 1b
p. 581
Matterhorn
Matterhorn patents are acquired from inventions
developed by Matterhorn’s own technicians.
Not FPHC income since for Matterhorn the
royalties are “derived in the active conduct of a
trade or business,” i.e., its own business.
§954(c)(2)(A); see Reg. §1.954-2(d).
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Problem 1c
p.581
Matterhorn
Matterhorn (Swiss Co.) receives 200x of dividends
and 100x of interest from each of two wholly
owned subs - (i) Belgium & (ii) Switzerland.
Dividend and interest income normally constitutes
FPHCI under §954(c)(1). Consider the same
country related person exception for the Swiss
sub. §954(c)(3)(A)(i). But, consider the rule that
a payment is not permitted to reduce Subpart F
income. The interest from the Swiss sub is
deductible & would reduce Subpart F income.
§954(c)(3)(B).
continued
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Problem 1c
continued
Matterhorn
p.581
Dividends and interest from Belgium sub.
Not same-country, but related companies.
Under Code §954(c)(6) 80 percent of dividends and
interest received by Matterhorn is not FPHCI
(since attributable to non-Subpart F type income.
This look-thru rule extended through 2014 in the
2014 extenders tax legislation (P.L. 113-295).
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Problem 1d
p.581
Matterhorn
Sales of gold coins having numismatic value.
Coins were purchased for investment. Sale is made
to an independent dealer in Switzerland.
This is an investment in property which “does not
give rise to any income”.
Gain on this sale is FPHCI. See §954(c)(1)(B)(iii).
Not FPHCI if purchased by a dealer (i.e.,
inventory) (&, also, not foreign currency gain).
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Problem 1e
Matterhorn
p.581
Sales Gain re Patents
Sale of all the rights to a group of patents to a
related Swiss corporation.
The gain will be FPHCI under §954(c)(1)(B)(i).
No exclusion exists where not an active trade or
business income concerning these royalties
(where same country related party exception of
§954(c)(3)(A)(ii) would otherwise be available).
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Problem 1f
p. 581
Matterhorn
Sale of golf balls outside Switzerland.
§954(d) - FBC sales income.
Purchase of golf balls and their resale would
constitute FBC sales income here:
(1) Purchase from a related person and (2) sales (to
independent distributors) outside Switzerland.
The packaging is not “manufacturing” in
Switzerland - which would eliminate FBC sales
income treatment.
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Problem 1g
p. 581
Matterhorn
Sale of golf balls to independent distributors in
Switzerland (assuming the property is for actual
use in Switzerland).
No FBC sales income exists here since the goods
are sold within Switzerland, i.e., no third
country is involved (assuming no subterfuge on
the destination of the purchases!).
Remember the rule: For FBC sales income – three
countries and two related parties.
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Problem 1h
p. 581
Matterhorn
Purchase of golf balls (i) from an unrelated person
and also sales (ii) to an unrelated person.
No FBC sales income here since no related person
is involved in these purchase or sale transactions.
§954(d)(3) – the related party rule is not invoked in
this situation.
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Problem 1i
p. 582
Matterhorn
Manufacture by Matterhorn of golf balls in
Switzerland occurs with component material
purchased from the U.S. parent corporation.
What constitutes “manufacturing” for this
purpose? (Fischbein case in later chapter).
§954(d)(1), but minor assembly or repackaging is
not sufficient to be manufacturing for this
purpose.
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Problem 1j
p. 582
Matterhorn
Manufacture for Matterhorn under a “contract
manufacturing” arrangement with an unrelated
corporation.
The manufacturing is occurring outside
Switzerland.
No significant Matterhorn employee oversight of
the manufacturing process is occurring and,
therefore, income is FBC Sales income.
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Problem 1k
p. 582
Matterhorn
Manufacture for Matterhorn under a “contract
manufacturing” arrangements with an unrelated
corporation. The manufacturing is outside
Switzerland.
But, Matterhorn’s employees do engage in product
design and quality control in this situation.
Result: The “substantial contribution” test is
applicable (assuming supported by the acutal
facts and circumstances).
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Problem 1l
Matterhorn
Foreign taxes reduced p.582
Matterhorn (1) purchases from (a) USM 49%
owned German corp. & (b) USM 51% owned
Dutch corp. and (2) resells outside Switzerland.
Issue concerns what is a “related party” for Subpart
F purposes - see §954(d)(3) concerning the
definition of a related party. More than 50% of
the vote or value is required.
Germ. Co. is not related & no FBC sales income.
Dutch is related and FBC sales income.
Note: Foreign tax reduction (& U.S. tax increase).
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Problem 1m
Matterhorn
Definition of “related”? P.582
Matterhorn (Swiss Corp) purchases from a
50 percent owned (vote & value) German
corporation.
The German corporation would be related (to
Matterhorn) and the sales income would be
foreign base company sales income.
See §958(b) & §318(a)(3)(C) re “related party”
attribution of all Matterhorn stock from USM to
German corp.
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Problem 1n
p. 582
Matterhorn
Matterhorn acts as a sales agent, receiving a
commission for services, rather than buying and
reselling.
Tax results are the same as above: inclusion since
(in addition to purchase/resale arrangements) the
FBC sales income definition also contemplates
sales commission income.
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Problem 1o
page 582
Matterhorn
Services are rendered by Matterhorn to
independent customers outside Switzerland:
- not for or on behalf of a related party
- although performed outside the country where
Matterhorn was organized.
Not FBC services income – not performed for a
related party. See §954(e).
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Problem 1p
page 582
Matterhorn
Services are rendered for a brother-sister corp.
The parties are “related.” See §954(d)(3).
But, the services are performed in the country
(Switzerland) where Matterhorn is organized.
Consequently, not FBC services income (the
geographic element of the FBC services income
test is not met).
See §954(e).
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Problem 1q
p.582
Matterhorn
Only 4% of the income is FBC Services income
and, therefore, all this income is within the
protection of the “de minimis” rule (i.e., no FBC
income taint arises).
This is a gross income test. See §954(b)(3)(A).
Planning: generate a large amount of active
operation gross income (20 mil.) to protect a
limited (no more than 5%) passive income
amount (up to 1 mil.).
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Problem 1r
Matterhorn
Full Inclusion Rule
p.583
75 percent of the Matterhorn income is foreign base
company sales income.
Therefore, all the Matterhorn income (including
the 25% non-tainted income) is treated as foreign
base company sales income under the
§954(b)(3)(B) “full inclusion” (more than 70%
FBC income) rule.
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Problem 1s
Matterhorn
High Foreign Tax Rule p.583
Services income is subject to an “effective rate” of
Swiss and other foreign income taxes of 32
percent.
Problem 1q facts: No FBC income.
Problem 1r facts: Services income is excluded
from FBC services income if the proper hightaxed income election is made. Effective tax rate
is to be greater than 31.5% (90% of 35%).
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Problem 1t
Partnership &
Matterhorn
p.583
Matterhorn as a 60% partner in a Belgium
partnership. This partnership receives interest
income that would be FPHCI if received directly
by Matterhorn.
Make an income classification decision concerning
the income as if the income is being received
directly by the partner? Is an entity or aggregate
analysis applicable? See Reg. §1.954-1(g)(1) &
Brown case (Tax Court, not 8th Circuit), to apply
an “aggregate” approach.
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Problem 2
Factoring Income?
p.583
Sale by a US seller to a Swiss sub of installment
notes received by the US seller.
Price paid is less than the unpaid balance on the
obligations. Swiss sub either (1) collects on the
debt or (2) sells it at profit to an unrelated party.
Income (when) realized is (1) related party
factoring income & treated as interest income
(§864(d)(1)) and, therefore, (2) FPHCI (assuming
not active banking income to Matterhorn &
§954(h) applies).
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Problem 3
p. 583
Loan to Parent’s Customers
Matterhorn loans funds directly to unrelated
foreign customers who use these borrowed funds
to buy USM goods.
The income (i) would be interest income, and (ii)
therefore, would be FPHC income. §864(d)(6).
Also, a §956 problem (investment in U.S. property,
discussed later).
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Problem 4
p.583
Sale of good or service?
Eastlaw (US) on-line legal research database.
Foreign Base Co. (sub) purchases access to database
& sells access to unrelated customers in other
foreign countries.
Foreign base company income to sub?
1) Is this sales income (sale of goods)? - then FBC
sales income under §954(d).
2) Is this services income? Not FBC services income
(not performed for a related person?) – unless the
“substantial assistance” rule applies.
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Problem 5
p.583
In-Country Services (Sales)?
US Corp sells computers on Internet.
Tax haven sub processes customer orders and
arranges delivery into third countries.
Tax haven sub receives a fee for its services.
Foreign base company services income? Not if
services are rendered in tax haven; if performed
outside the tax haven, FBC services income.
§954(e).
But, what if §954(d) FBC sales income (sale of
personal property on behalf of a related person)?
Doubtful analysis.
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Earnings Invested in U.S.
Property - §956
p.584
Concept of deemed repatriation of foreign earnings
(any income type - not limited to “tax-haven”
type income realized by CFC).
For determining this amount “invested in U.S.
property” – i.e., the lesser of:
1) the current year investment, or
2) the shareholder’s pro rata share of
"applicable earnings".
Limit of the required inclusion is the adjusted tax
basis of the property acquired (less debt).
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§956
Ancillary Effects
p.585
2nd inclusion is avoided if prior Subpart F inclusion
has occurred - §959.
§960 provides for foreign tax credit availability if
income inclusion is required under §951(a)(1)(B).
Exploiting §956 applicability: Cause a constructive
dividend under §956 –
1) FTC is available for U.S. income tax purposes.
2) No foreign withholding tax at source on the
deemed dividend (occurring for U.S. tax
purposes).
Result: possibly reducing the foreign tax rate.
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Defining Investment in
“U.S. Property”
p.587
1) Tangible property located in the United States §956(c)(1)(A).
2) Stock of a U.S. corporation, if related (25%
ownership connection). §956(c)(1)(B).
3) Debt obligations of related U.S. persons.
§956(c)(1)(C) (as of end of each quarter)
Special exception in 2009-2010 – why? Next slide.
4) Rights to use U.S. patents, know-how, copyrights
or similar U.S. use property.
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Short-term Loans to Related
Party
p.588
Certain short-term loans disregarded.
A series of short-term loans might be integrated for
§956 purposes.
Notice 2008-91: “60-180” obligation.
repay loan with 59 days & total loan days cannot
exceed 180 days. Two year rule.
Notice 2009-10: extend to 3 years availability
Notice 2010-12: rule applies through 2010.
Anti-abuse rule: e.g., dropping cash into CFC sub
to make loan & sub has no E&P.
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Exclusions from “United
States Property” §956(c)(2)
Examples (not U.S. Property):
1) U.S. Treasury obligations and bank deposits.
But, consider The Limited 6th Cir. case (p. 588)
situation of purchase of CDs from related (credit
card) bank by CFC. Held: bank deposits. But, see
§956(c)(2)(A) (2004), as revised, re a “real bank.”
2) Stock issued by an unrelated corporation.
3) Transportation equipment outside U.S.
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Pledges & Guarantees
Indirect Repatriations
p.590
See §956(d) concerning deemed repatriation
treatment for pledges & guarantees.
Possible alternative situations triggering §956(d):
1) CFC guarantees the financial obligation of the
U.S. corp.
2) U.S. corporation pledges the stock of the CFC
to secure financing to U.S. corporation.
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Ludwig case
Pledging Stock of CFC
p.590
Stock of CFC (Oceanic, a Panamanian corporation)
was pledged by Ludwig as collateral for a loan to
enable Union Oil stock acquisition by Ludwig.
Holding: CFC (Oceanic) was not a guarantor of
Ludwig’s obligation. No undertakings by CFC to
pay Ludwig’s debt to bank. Remedy is a sale of
the pledged stock (not Oceanic’s liquidation).
Note Rev. Rul. 76-125 (p. 594) issued by IRS during
this litigation.
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Sequels to the Ludwig case
p. 600
Reg. §1.956-2(c)(2) concerning indirect pledges.
Why a 66 2/3% requirement (and
accompanying “negative covenants”)?
What authority for the IRS to promulgate this
§956 regulation?
What result if back-to-back (or parallel)
arrangements for (1) foreign sub deposit and
(2) loan to U.S. parent arranged with an
independent bank?
What if two loans made with pledges of 35% and
65% of the stock of the CFC to two separate
(unrelated) lenders?
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Indirect Ownership of U.S.
Property (thru Partnership)
Rev. Rul. 90-112
p.601
CFC is a minority partner in a foreign partnership
which owns real property in U.S.
The partnership is foreign country based.
Code §956(c)(1) includes indirectly owned property
as being a U.S. real property interest within the
concept of U.S. property.
Use of an “aggregate” partnership approach
deemed appropriate. Should this be a
permissable U.S. tax planning device?
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What about a Pledge of a U.S.
LLC Interest?
Assume (1) U.S. parent corp. pledges its interest in
a U.S. LLC, and
(2) the U.S. LLC itself owns stock in a CFC (and an
interest in a U.S. business).
Should the LLC be treated as disregarded for
applicability of §956? Probably.
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Further §956 Questions
re Pledges
1) What if a pledge of an asset worth less than the
amount of the loan? Inclusion to the amount of
the loan or the lesser value of asset?
2) Guarantee by the CFC, but the value of CFC is
less than the loan?
3) Pledge of partnership interest when the
partnership holds CFC stock?
4) Loan by CFC to foreign partnership owner where
US partner holds majority/minority interest in
the partnership?
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Problem 1
Delft, N.V., a CFC
p.602
Dutch corporation owned by U.S. corp; Dutch
corp. is engaged in manufacturing.
Assume no FBC income. Dutch corp's surplus
earnings are loaned to U.S. parent corporation.
Loan to a related person is treated as an investment
in U.S. property under §951(a)(1)(B) and §956.
Similar treatment for purchase of U.S. patent.
Not such treatment for an investment in stock of an
unrelated NYSE listed company.
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Problem 2
Sale or Loan to CFC
p.603
1) Amount paid by Matterhorn from its earnings to
USM is an investment in U.S. property to the
extent of the U.S. obligations. §956(c)(3) and
§864(d).
2) Loan to unrelated foreign customers of USM is
not an investment in U.S. property since not
acquiring a trade or business receivable from a
related U.S. person. §956(c)(3)(A).
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Previously Taxed Income
and Ordering Rules p.603
Three levels of possible income recognition:
1) Subpart F
2) §956 - investment in U.S. property
3) Actual dividend distribution.
See §959(c) re order of distributions
(§956 income first, then Subpart F income).
If previously taxed, nontaxable distributions not
carrying out foreign tax credits.
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Previously Taxed Income
and Ordering Rules, cont.
Consider an upstream dividend from a 2nd tier
subsidiary (CFC) to a first tier subsidiary
(CFC). Subpart F (FPHC) income to the first
tier subsidiary?
Yes, unless previously included in shareholder
income under §951(a). See §959(b). P.604
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Treatment of Stock Sale
Gain as Ordinary Income
Gain realized on the disposition of the CFC stock
investment is (partly) treated as dividend income.
§1248 transforms cap gain into a dividend
distribution to the extent of a 10% shareholder's
allocable E&P, limited to amount of stock gain.
Is §1248 treatment preferred? Yes, for a corporate
shareholder, since the deemed paid FTC is
available. See Reg. §1.1248-1(d).
And, no foreign withholding tax if a stock sale
(rather than if an actual dividend distribution)?
Avoiding §1248 by an individual – hold until death.
continued
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Treatment of Stock Sale
Gain as Ordinary Income
§1248(b) limits the tax attributable to the deemed
dividend.
Deemed dividend under §1248 does not reduce the
CFC’s E&P.
But, §959(e) treats §1248 deemed dividend as
previously taxed E&P and, therefore, not subject
to tax on a later distribution.
E&P reduced when a subsequent nontaxable
distribution is actually made. §959(e).
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Previously Taxed Income
and Ordering Rules
Consider (1) a sale of CFC stock and (2) CFC
income previously included as Subpart F income
in seller’s income (or includible under §956.
Inclusion in gross income again? No, §959(a).
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Problem - §1248
p.608
Corp. Partial Stock Sale
Corp. shareholder sells 20% interest in FC for 300x;
basis is 50x. 250x LT cap gain? No.
Prior 36x (20% of 180k, after tax net earnings, i.e.,
200x less 20x tax) previously Subpart F income.
No prior actual dividends assumed made.
Stock sale gain is 300k less 50x basis = 250x.
§1248 amount: 1.2 mil less 120x tax = 1.08 mil.
earnings times 20% = 216x less 36x prior deemed
distribution = (i) 180x ordinary income (§1248)
and (ii) 70x cap gain & FTC available.
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Problem - §1248
p.608
Individual Stock Sale
Individual sells 100% interest in FC for 300k; basis
is 50x. 250x cap gain? No.
§1248 gain is 180x. Calculation: 1.2 mil earnings
less 120x taxes = 1.08 mil. earnings times 20% (her
interest sold) = 216x less 36x prior deemed
distribution = (i) 180x ordinary income (§1248)
and (ii) 70x LT cap gain (& §1(h) capital gain).
No indirect credit (to individual) under §§ 960 &
902, assuming no § 962 election for taxation as a
corporation.
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Sale or Exchange of a
Patent to a CFC
p.610
§1249 transforms capital gain into ordinary income
when a patent is sold to a foreign corporation by a
U.S. transferor which owns more than 50% of the
voting power of the purchaser foreign
corporation.
To preclude capital gains sales to CFC which then
sublicenses (receiving ordinary, deferred income;
but FPHC income?)
Cf., §367(d) re contribution of intangibles to foreign
corporation.
Note §174 re prior R&D deduction.
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PFIC - Passive Foreign
Investment Co.
p.611
PFIC provisions - §§1291-1298
Applicable to all (no minimum) U.S. shareholders.
Choices of taxation for U.S. shareholders:
1) Election for current inclusion (QEF), possible
deferral of tax payment, subject to a later
interest charge.
2) Mark to market election (current income)
3) Not QEF - tax on (i) distribution from the QEF
or (ii) sale of shares (plus interest charge).
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Definition of a PFIC
p.612
(i) 75% of Corp’s gross income is passive income
(an income test, i.e., income that would be
foreign personal holding company income) or
(ii) 50% of its assets are held for the production of
passive income (the asset test, based on value,
subject to election - except for public company to use tax basis; plus mandatory requirement for
non-public CFCs to use tax basis). §1297(a).
Year-by-year test.
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Special PFIC Status Rules
p.613-614
Active banking business exception.
§1297(b)(2)(A).
Interest, dividend, rent and royalty from a related
person exception (sourced from business income
received by the related party). §1297(b)(2)(C).
Leased properties treated as assets held by PFIC - as
part of the active business assets. §1298(d).
R&D expenses – see p.614.
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Look-Through Rule
p. 615
Look thru rule for categorizing income from 25
percent or more owned subsidiaries - §1297(c).
Purpose: To enable foreign corps having active
subs from being treated as PFICs.
Dividends and interest received from this
subsidiary are eliminated from income for
purposes of the income test.
Stock of this subsidiary is eliminated for purposes
of the asset test. §1297(c).
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The Starting or Changing
Business Rules
p.616
Special rules apply for:
1) the start-up year for an active business
operation, §1298(b)(2), and
2) corporations changing from one active
businesses to another active business.
Corporation is not treated as a PFIC. §1298(b)(3).
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Subpart F – PFIC Overlap
P. 617
If both rules would apply, the Subpart F rules take
priority over PFIC rules. §1297(e).
This enables deferral without an interest charge
accruing (for the non-Subpart F income) and
PFIC rules do not apply.
Non “U.S. shareholders” (e.g., less than 10%
ownership) are subject to the PFIC rules.
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Excess Distribution from or
Disposition of PFIC p.618
If PFIC not a QEF, an interest charge is imposed
on the value of the tax deferral at the time of:
1) the disposition of the PFIC stock at a gain,
or
2) the receipt of an "excess distribution” from the
PFIC (i.e., above 125% of prior dividend
distribution level). §1291(a)(1) & (2).
PFIC distribution to a U.S. corp. does enable
deemed paid FTC. See §1291(g). But, has any
foreign tax actually been paid?
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Qualified Electing Fund
(QEF)
p.620
Election by each shareholder
- not by the PFIC.
Information to come from the corporation.
Current inclusion in gross income of the
shareholder’s prorata share of the PFIC's
earnings and profits. §1293.
Can divide into the prorata shares of fund's:
(i) net capital gains, and
(ii) ordinary income. §1293(a)(1).
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QEF & Tax Deferral
When No Distribution
p.620
§1294 does permit the PFIC – QEF election
shareholder to elect to defer the tax amount if no
actual distribution has occurred.
No deferral permitted if §951 applies.
Deferral is subject to an interest charge.
Loan to a shareholder is treated as a distribution.
§1294(f).
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Mark-to-Market Election
p. 622
Available for “marketable stock” of PFIC.
§1296 - U.S. shareholder includes in (ordinary)
income the excess of fair market value of the
PFIC stock at close of year over basis (as
previously adjusted).
Treated as ordinary income.
What if loss? Permitted to the extent of the
“unreversed inclusions.” Treated as ordinary
loss. §1296(a)(2).
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Problem 1
p.626
PFIC & CFC Comparison
PFIC provisions apply even if no CFC status. Apply
even to less than 10 percent ownership by U.S.
shareholder in PFIC.
CFC applies to more income types. PFIC only
applies to passive income.
PFIC ends benefits of deferral for all income of the
PFIC, not limited to specified types of gross
income. PFIC has a more complete termination
of the possible deferral of income recognition.
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Problem 2a
CFC Status?
p.26
Tax Avoidance is a CFC under §957(a):
Two “United States shareholders” hold more than
50%:
1) US Parent owns 40 shares &
2) Sam (US citizen) owns 12 shares; no attribution
to Sam from NRA sister - §958(b)(1).
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Problem 2b
PFIC Status?
p.627
Tax Avoidance is a PFIC under §1297(a):
Meets the 50% passive assets test (based on tax
basis ratios).
§1297(a)(2) & §1297(f)(2)(A).
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Problem 2c
CFC Income?
p.627
U.S. shareholders are U.S. Parent (40%) and Sam
(12%).
They have constructive dividends for their pro
rata shares of Tax Avoidance’s $6.5 million
Subpart F income:
1) $5.5 million dividends & capital gains
(§954(c)(1)(A) & (B)), and
2) $1 million FBC sales income (§954(d)).
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Problem 2d
PFIC Applicability?
p.627
PFIC provisions apply without regard to the amount
of ownership.
But, not treated as a PFIC for those persons treated
as U.S. shareholders of a CFC. §1297(e). This is
applicable to U.S. Parent & Sam.
1) Alexandra (indirect ownership), (2) USA, Inc.,
and (3) John are subject to the PFIC rules. Options
for them: interest charge or QEF. No “mark-tomarket” option.
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Problem 2e
p.627
Regularly Traded Stock
Stock would constitute “marketable stock” within
the meaning of §1296(e).
Those shareholders who are subject to the PFIC
rules (Alexandra, USA, Inc. and John) could
make the “mark to market” election under
§1296.
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Reporting Requirements
p.627-628
Information returns (IRS Form 5471):
§6046 – information on formation of the foreign
corporation.
§6038 – annual information by every person who
is in control of a foreign corporation.
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Summary
Policy Options
p.632
Options for Foreign Income Taxation:
1. Current full inclusion in U.S. gross income.
2. Subpart F Structure
3. Foreign corporation dividend exemption.
See:
JCT 2005 Options Paper, p. 650.
Bush 2005 Tax Panel Recommendations
2000 U.S. Treasury Study, p.633.
2015 JCT Report on Cross-Border Taxation.
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