The Tax Cuts and Jobs Act enacted in December 2017 changed a constructive ownership rule that determines whether a foreign corporation is a controlled foreign corporation (CFC) for U.S. federal tax purposes. A controlled foreign corporation is any foreign corporation of which more than 50% of the vote or value is owned by U.S. shareholders that own at least 10%. U.S. shareholders of CFCs are subject to certain anti-deferral rules under the U.S. federal tax laws. The anti-deferral rules may require a U.S. shareholder of a CFC to report and pay U.S. tax on undistributed earnings of the foreign corporation.
Prior to the new law, the former rules in effect provided that there was not downward attribution and constructive ownership of foreign corporation stock from a foreign person to a U.S. corporation, U.S. partnership, or U.S. trust. The stock of a foreign corporation owned directly by a foreign person was not considered as being owned by a U.S. corporation, a U.S. partnership, or U.S. trust of which the foreign person was a shareholder, partner, or beneficiary.
The new law repealed this prior rule, which was under Section 958(b)(4) and incorporated Section 318(a)(3) of the U.S. Internal Revenue Code. With the new law, a U.S. corporation, U.S. partnership, or U.S. trust in which a foreign person is a shareholder, partner, or beneficiary is now considered to own the stock in a foreign corporation that the foreign person owns directly. The foreign person must own more than 50% of the U.S. corporation before the U.S. corporation is considered to own the foreign corporation’s stock.
For example, if a foreign corporation is owned 49% by a U.S. shareholder and 51% by a foreign shareholder, the foreign corporation would not be a CFC under the prior rule. However, under the new rule, if the foreign person also owns more than 50% of a U.S. corporation then the U.S. corporation is considered to own the 51% of the foreign corporation stock that the foreign person owns. Under the new rule, the foreign corporation is considered to be owned 49% directly by the U.S. shareholder and also 51% constructively by the U.S. corporation. Under the new rule, the foreign corporation is a controlled foreign corporation (CFC) when taking into account the U.S. corporation’s constructive ownership of the foreign corporation’s stock from the foreign person.
The new CFC constructive ownership rule in the recent U.S. tax legislation will have a significant impact on U.S. shareholders of foreign corporations. As a result, U.S. shareholders may need to comply with additional U.S. international tax reporting requirements. Other possible U.S. federal tax consequences may include additional taxable income and corresponding U.S. federal tax liability for U.S. shareholders of CFCs.
For more information, please contact our international tax specialists at 301.231.6200.