Indian entities and U.S. taxation: Controlled foreign corporations – defining key terms

In 1960s the concept of controlled foreign corporation (CFC) was introduced in the U.S. tax code to tax the U.S. taxpayer’s share of certain income in foreign entities irrespective of its actual distribution.  We have often observed that U.S. citizens or green card holders who are Indian tax residents owning Indian entities may have U.S. tax exposure applying the CFC rules even if such entities do not operate in the U.S.  Even if there are no profits or earnings in such Indian businesses, there are reporting obligations and failure to file timely information returns can have penalty exposures. It is, therefore, important for owners of Indian entities to understand if CFC provisions may apply.

Before we see the implications of CFCs vis-à-vis Indian entities and U.S. taxation, lets first understand the key terms that are generally used while discussing the CFC provisions.

Controlled foreign corporations 

CFCs are generally foreign corporations that are owned by U.S. shareholders with total combined 50% or more of their stake either in value or vote, on any day during the tax year.  The ownership may be directly or indirectly.

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U.S. shareholders

U.S. shareholders are U.S. persons who directly, indirectly or constructively own 10% or more of the total voting power or value of all classes of stocks in the foreign corporation. 

U.S. Persons

A U.S. Person means any U.S. citizen or an individual alien admitted for permanent residence in the U.S. under the immigration laws of the U.S., any corporation, partnership or other entity organized or incorporated under the U.S. laws.

Constructive ownership

Where the U.S. shareholders do not directly own stock in foreign corporations, such foreign corporations may still be considered as CFC by applying construction ownership, that is, stock owned by related persons (including entities).   A corporation, partnership, trust or estate that owns more than 50% of stock of a foreign corporation is considered to own 100% of the stock of such corporation.