Question

1. Five unrelated U.S. individuals own all of the shares of Popping, a corporation organized in the United States but operating fully in the country Vivace. Mariam, one of the shareholders, asks you whether the income from Popping will be taxed to her immediately as earned, as she believes the entity is classified as "a controlled foreign corporation (CFC)." Explain how the Federal income tax law applies to the profits earned by Popping. Use the correct Federal income tax terminology in your comments.

Answer 1

Controlled foreign corporation (CFC) rules are features of an income tax system designed to limit artificial deferral of tax by using offshore low taxed entities. The rules are needed only with respect to income of an entity that is not currently taxed to the owners of the entity. Generally, certain classes of taxpayers must include in their income currently certain amounts earned by foreign entities they or related persons control.

A set of rules generally defines the types of owners and entities affected, the types of income or investments subject to current inclusion, exceptions to inclusion, and means of preventing double inclusion of the same income. Countries with CFC rules include the United States (since 1962), the United Kingdom, Germany, Japan, Australia, New Zealand, Brazil, Russia (since 2015),^[1] Sweden, and many others. Rules in different countries may vary significantly

As a general rule, the earnings of a foreign corporation are not subject to U.S. taxation until such earnings are distributed as dividends. The Subpart F rules have long been in place to subject the earnings of a controlled foreign corporation (CFC) to U.S. taxation whether or not such earnings are actually distributed. The tax reform legislation passed in Dec. 2017 imposed an additional anti-deferral rule referred to as GILTI (Global Intangible Low-Taxed Income). The new GILTI inclusion rules function in a manner similar to the existing Subpart F regime.

The facts and circumstances of each situation will dictate the appropriate alternative. U.S. Shareholders of CFCs should discuss their facts with their KSM advisor. The following information will help determine the size and scope of the potential GILTI inclusion:

• Detailed organizational charts to clarify direct and indirect ownership percentages of foreign entities
• Projected 2018 earnings for all foreign corporations owned directly or indirectly, including interest income and interest expense
• Projected 2018 fixed assets and accumulated depreciation (note that accumulated depreciation must be determined using ADS methods)
• Any foreign income taxes paid or accrued in 2018 with respect to the 2018 earnings