Controlled Foreign Corporation - Basic Mechanisms

Basic Mechanisms

The rules vary, so this paragraph may not exactly describe a particular tax system. However, the features listed are prevalent in most CFC systems. A domestic person who is a member of a foreign corporation (a CFC) that is controlled by domestic members must include in such person's income the person's share of the CFC's subject income. The includible income (often determined net of expenses) generally includes income received by the CFC:

• from investment or passive sources, including
  • interest and dividends from unrelated parties,
  • rents from unrelated parties, and
  • royalties from unrelated parties;
• from purchasing goods from related parties or selling goods to related parties where the goods are both produced and for use outside the CFC's country;
• from performing services outside the CFC's country for related parties;
• from non-operating, insubstantial, or passive businesses, or
• of a similar nature through lower-tier partnerships and/or corporations.

In addition, many CFC rules treat as a deemed dividend earnings of the CFC loaned by the CFC to domestic related parties. Further, most CFC rules permit exclusion from taxable income of dividends paid by a CFC from earnings previously taxed to members under the CFC rules.

CFC rules may have a threshold for domestic ownership, below which a foreign entity is not considered a CFC. Alternatively or in addition, domestic members of a foreign entity owning less than a certain portion or class of shares may be excluded from the deemed income regime.