Controlled Foreign Corporation - Motivations

Motivations

The tax law of many countries, including the United States, does not tax a shareholder of a corporation on the corporation's income until the income is distributed as a dividend. Prior to U.S. CFC rules, it was common for U.S. publicly traded companies to form foreign subsidiaries in tax havens and shift "portable" income to those subsidiaries. Income shifted included investment income (interest and dividends) and passive income (rents and royalties), as well as sales and services income involving related parties (see transfer pricing). U.S. tax on this income was avoided until the tax haven country paid a dividend to the shareholding company. This dividend could be avoided indefinitely by loaning the earnings to the shareholder without actually declaring a dividend. The CFC rules of Subpart F were intended to cause current taxation to the shareholder where income was of a sort that could be artificially shifted or was made available to the shareholder. At the same time, such rules were intended not to interfere with active business income or transactions with unrelated parties.