Definition
A Controlled Foreign Corporation (CFC) is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners. The controlling owners are typically majority shareholders who are U.S residents. This concept is important in tax law as U.S. shareholders may be taxable on the income of a CFC even if it isn’t distributed.
Key Takeaways
- A Controlled Foreign Corporation (CFC) is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners.
- The CFC rules were created to limit the deferment of tax through the use of offshore low taxed entities. The rules are used to prevent tax evasion by corporations who set up offshore subsidiaries in low or no-tax jurisdictions and park their earnings there.
- The income of a CFC that is deemed controlled by U.S. shareholders is subject to immediate taxation in the U.S., regardless of whether the profits are distributed to the shareholders or not. This is known as ‘Subpart F income’ under the U.S. tax code.
Importance
The finance term Controlled Foreign Corporation (CFC) is important because it refers to a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners.
The CFC rules are a significant part of the tax laws in many countries and are designed to limit profit shifting to low tax or no-tax jurisdictions, often referred to as tax havens.
They prevent tax evasion by companies that try to hide their profits abroad and ensure that profits made by the CFC could still be taxed by the home country.
This promotes tax fairness and boosts domestic revenue collections, hence its crucial importance in international finance and taxation.
Explanation
Controlled Foreign Corporation (CFC) is a regulatory measure that nations adopt to prevent their citizens from deferring tax by using offshore low tax jurisdictions. The key purpose of CFC rules is to limit the deferral of tax by using foreign corporations to shield income from taxation until it is repatriated.
CFC rules are most commonly found in the tax code of the United States, but are also present in other jurisdictions such as the United Kingdom and Australia. Essentially, these rules dictate that, in certain circumstances, a country has the right to tax its residents on their share of the income of a foreign corporation, whether or not that income has been distributed as a dividend.
CFC rules serve a vital function in the international tax landscape. By setting forth guidelines for what type of foreign corporation income should be included in the taxable income of the country’s residents, CFC rules help to prevent taxpayers from using foreign corporations to defer taxation on passive income.
This implies that it is controlling tax evasion that may occur when high tax residents attempt to shift their tax base to a low tax foreign jurisdiction. The CFC rules act as a deterrent to this scheme by ensuring that certain types of income cannot escape the tax net of the home country.
Examples of Controlled Foreign Corporation (CFC)
Google’s Complex Tax Structure: Google, being a multinational corporation, has numerous Controlled Foreign Corporations (CFCs). For instance, Google Ireland Ltd is a CFC that manages most of the company’s overseas operations. This subsidiary allows Google to take advantage of Ireland’s comparatively lower corporate tax rate.
Apple’s Foreign Operations: Following substantial controversy, Apple Inc. disclosed their CFC in Ireland, Apple Operations International (AOI). This CFC did not formally reside in any country for taxation purposes, allowing them to accumulate significant profits without being taxed. Consequently, the disclosure led to an extensive review of international tax law and spurred governments worldwide to impose stricter regulations on CFCs.
Amazon’s Luxemburg Subsidiary: Luxsar S.A.R.L is a subsidiary of Amazon which is a Controlled Foreign Corporation located in Luxembourg. This subsidiary was subject to scrutiny due to Amazon’s use of it to lower its corporate tax liabilities, channeling its European profits through this low-tax jurisdiction.
FAQs for Controlled Foreign Corporation (CFC)
What is a Controlled Foreign Corporation (CFC)?
A Controlled Foreign Corporation (CFC) is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners. Control is generally determined based on the percentage of voting power, hence a controlling owner is typically seen as such if they own more than 50% of the voting power.
What is the purpose of the CFC rules?
The CFC rules were created to prevent U.S. citizens or residents from setting up offshore companies in low tax jurisdictions to avoid U.S. taxation. The CFC rules ensure that profits generated in these offshore companies are taxed on a current basis in the United States.
How are the profits of a CFC taxed?
Under current U.S. tax law, if a U.S. shareholder owns more than 50% of a CFC, they may be required to report and pay tax on their proportional share of the CFC’s profits, even if those profits have not been distributed.
What is the impact of the CFC rules on U.S. corporation owners?
U.S. corporations that own CFCs may be subject full U.S. taxation on the profits earned by those CFCs if they are deemed to have Subpart F income, which includes most types of passive income such as interest, dividends, rents, and royalties.
What solutions are there for U.S. taxpayers who own a CFC?
There are several strategies that can potentially reduce the amount of U.S. tax that a person might owe on the income of a CFC. Some of these include checking the applicability of foreign tax credits, looking at possible exceptions under the Subpart F rules, and considering structuring changes or reorganizing the CFC.
Related Entrepreneurship Terms
- Subpart F Income
- Foreign Tax Credit (FTC)
- Permanent Establishment (PE)
- 10% U.S. Shareholder
- Global Intangible Low-Taxed Income (GILTI)
Sources for More Information
- Internal Revenue Service (IRS): The IRS is the US government agency responsible for tax collection and tax law enforcement. It provides detailed information about Controlled Foreign Corporations (CFCs).
- Investopedia: Investopedia is a widely respected site for finance-related information, including Controlled Foreign Corporations (CFCs).
- PricewaterhouseCoopers (PwC): PwC is a global network of firms delivering assurance, tax and consulting services for businesses. They can provide in-depth information about CFCs and their role in international business.
- Tax Foundation: Tax Foundation is America’s leading independent tax policy nonprofit. They provide clear, insightful accessible information about tax policies including laws regarding CFCs.
