How CFCs Impact International Tax Planning
The global economy relies on businesses expanding across borders, which results in more complex tax planning. For instance, controlled foreign corporations (CFCs) significantly impact international tax planning.
Those involved in international ventures must understand how CFCs affect their own tax obligations to avoid penalties or fines.
What Is a CFC?
A CFC is a corporate entity registered in a jurisdiction or country other than that of the owners (controlling owners). It would then conduct business in the country or jurisdiction it is registered in.
In the U.S., a foreign corporation is referred to as a CFC if American shareholders own at least half of it. Ownership can mean half of the voting power or half of the total value of the business. Additionally, all shareholders must have at least a 10% stake in the foreign corporation.
How Do Tax Treaties Apply to CFCs?
Tax treaties and CFC laws work together to instruct taxpayers on declaring foreign earnings. A CFC is beneficial when business setup costs or the cost of foreign partnerships are lower after the tax implications.
But, CFC shareholders cannot neglect their tax obligations. The entire CFC structure was designed to prevent tax evasion. Each country follows its own CFC laws, but the guidelines are mostly the same.
CFC laws aim to prevent companies from setting up offshore entities in jurisdictions with little or no tax obligations.
Moreover, CFC rules exist to establish whether a CFC’s income has already been minimally taxed in a foreign country and to identify the type of income to which CFC rules apply.
Under the U.S. tax code, American shareholders of CFCs must adhere to anti-deferral rules. These may require an American CFC shareholder to report and pay U.S. tax on the foreign business’ earnings (undistributed earnings).
There are exemptions that appear on Form 5471, so if a shareholder meets any of these exemption thresholds, they must file the said form. Other forms that play a role in tax reporting are Form 8992 and 8621. Form 8992 is used to report GILTI (global intangible low-taxed income), while Form 8621 is for U.S. shareholders who own shares in a Passive Foreign Investment Company (PFIC).
Tax Cuts and Jobs Act Impact on CFC Rules
The Tax Cuts and Jobs Act (TCJA) introduced the GILTI, which imposes a minimum tax on CFC earnings. It is calculated as a minimum effective tax rate of 10.5%
Moreover, the Foreign-Derived Intangible Income (FDII) allows U.S. corporations to deduct some of their foreign-derived intangible income.
BEAT (Base Erosion and Anti-Abuse Tax) imposes a minimum tax on U.S. corporations that get a large portion of their income from foreign sources.
CFCs Remain a Complex Area of International Tax Law
U.S. taxpayers with stakes in CFCs must be aware of the various rules and regulations that apply to these entities. By understanding these requirements and implementing the appropriate tax strategies, U.S. taxpayers can work towards minimizing their tax liability on CFC income.
Sources
https://www.ghjadvisors.com/ghj-insights/controlled-foreign-corporations-is-control-a-good-thing
https://www.investopedia.com/terms/c/cfc.asp
https://tax.thomsonreuters.com/en/glossary/global-intangible-low-taxed-income
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