Indian entities and U.S. taxation: Controlled foreign corporations and its ownership by a U.S. shareholder
Our whitepaper, The Interaction of Indian and U.S. Tax Laws addresses how the foreign corporations are treated as controlled foreign corporations (CFCs), and their passive income, commonly known as Subpart F income, is attributed to the U.S. shareholders. There are circumstances in which an Indian corporation with Indian and U.S. subsidiaries will be classified as a CFCs pursuant to stock attribution rules.
Our last blog, lists key terms that you would generally see in connection with CFC provisions. Subpart F income applies to foreign corporation that are considered as CFCs pursuant to the ownership of stock by a U.S. shareholder. Stocks may be owned or attributed directly, indirectly or constructively. This blog discusses application of stock attribution rules vis-à-vis CFCs.
Under direct ownership, a U.S. shareholder (whether an individual or an entity) directly owning a foreign corporation should be identified first.
For example, an Indian corporate entity, ABC Private Limited, is 80% owned by Miss A, a U.S. green card holder, and 20% by Miss I, an Indian resident. Miss A is a U.S. shareholders as she is a U.S. resident and holds more than 10% of the stock in ABC Private Limited. ABC Private Limited is a CFC as more than 50% of the stock is owned by a U.S. shareholder, i.e. Miss A.
The indirect ownership flows from an individual to a foreign entity that further owns stake in a foreign entity. The indirect ownership is based on the proportional interest or stake a U.S. shareholder has in a foreign entity.
For example, an Indian corporate entity, ABC Private Limited wholly owns another Indian corporate entity XYZ Private Limited. The ownership of ABC Private Limited is same as under direct ownership example. Thus, XYZ Private Limited is indirectly held by a U.S. shareholder, Miss A.
Unlike the constructive ownership rules that require a U.S. shareholder to own atleast 10% share, the indirect shareholders are not required to hold a minimum percentage in a foreign entity to be classified as a CFC.
For example, Miss A, a U.S. resident owns 50% in ABC Private Limited, an Indian corporation. The balance ownership is held by XYZ Private Limited, an Indian corporation. Miss A also holds 1% in XYZ Private Limited. Thus, ABC Private Limited will be a CFC as Miss A, a U.S. shareholder indirectly holds more than 50% of its stock. Please note that XYZ Private Limited is not a CFC and Miss A is not required to hold at least 10% in order for indirect ownership rules to apply.
The constructive ownership is attributed by reason of:
- family attribution, i.e. stock ownership is attributed by reason of specified family members including direct or indirect ownership held by an individual’s spouse, parent, grandparents or children;
- attribution of corporations, partnerships, estates, trusts to its shareholders, partners or beneficiaries; or
- attribution from corporations, partnerships, estates, trusts from its shareholders, partners or beneficiaries.
Unlike the indirect attribution, construction attribution requires a shareholder to be U.S. shareholder i.e. at least s U.S. person holds atleast 10% of stock in a corporation. Further, the downward attribution of stock ownership from a foreign person to U.S. person may consequently treat the subsidiary of the subsidiary of the foreign corporation as a CFC. Pursuant to the downward attribution rules if a U.S. tax resident holds as little as 10.01%, it requires a U.S. shareholder to report the foreign corporation as a CFC even though there is no attributable subpart F or global intangible low-taxed income (GILTI). This is a game changer and means that it will be very easy to see a situation in which GILTI and Subpart F income derived by Indian-owned CFCs will be attributed to and taxable to U.S. shareholders or who own a minority stake in foreign corporate groups.
Albeit the stock attribution rules are mechanical to construe a foreign entity as a CFC or not, but post application of these rules the tax implication (including subpart F income and GILTI) should be carefully analyzed and addressed.