The Code employs various definitions of what constitutes “ownership” in various circumstances, and with regards to the classification of foreign companies as CFCs, the definition is overwhelmingly inclusive. As outlined in our previous blog post, The “Controlled Foreign Corporation” Regime: What is a CFC Anyway?, a foreign company will be a CFC its U.S. Shareholder(s) “owns” at least 50% of the company’s total voting stock or value. Under this rule, however, ownership may be through direct, indirect, or constructive means.
Under this direct ownership, a U.S. Shareholder will own the shares they personally hold. Thus, if U.S. Corporation X owns 80% of the voting shares in foreign Corporation Y, then Corporation X is treated as directly owning the shares in Corporation Y.
Under indirect ownership, a U.S. Shareholder will own shares that are being held by another entity for their benefit. For example,using the same example as above, if a U.S. partnership owns 80% of the voting shares in Corporation Y, then the U.S. partners of the partnership will be treated as indirectly owning the shares in Corporation Y. Indirect ownership generally arises in scenarios where a flow-through entity holds shares in foreign company.
Under constructive ownership, a U.S. Shareholder will own shares that are assigned to them under the Code’s attribution rules applicable to CFCs. Specifically, for purposes of determining a company’s CFC status, a U.S. Shareholder will be treated as owning shares that can be imputed to them by the family, upward, and downward attribution rules.
While direct ownership is straightforward, the indirect and constructive ownership rules have proven to be quite tricky to navigate. Thus, if you have a foreign company that is either entering the U.S. market or has shareholders relocating to the U.S., then you will need to be very careful about how you make the CFC determination. Remember, the company need only meet the requirements of a CFC for one day for it to be classified as a CFC for the entire tax year. Any failure to oblige with the CFC tax obligations comes with high punishment, both civil and criminal, so be sure to seek proper advice.
For an in-depth discussion on CFCs and the corresponding ownership rules, please refer to our whitepaper, The Expansion of “United States” Taxpayers: How the TCJA Drags Unassuming Foreign Companies and Individuals under its Scope. Please also visit our website, AsrenaAdvisors.com to learn more about how we can help navigate you through these rules to preserve your wealth.