Welcome back. In this video, we're going to learn about controlled foreign corporations or CFCs. A foreign corporation is a CFC if more than 50 percent of the total value or combined voting power of all classes of stock is owned directly, indirectly, or constructively by US shareholders. Now, what's the big deal about being a CFC? Well, let's look at the following diagram. Here we have a domestic US Corporation, USA, Inc, that has a foreign branch and a foreign subsidiary. As you'll recall, a branch is not a separate legal entity, so all of the branches income will be currently taxable on the USA, Inc's US tax return. Of course, USA, Inc will be able to compute a foreign tax credit based on taxes paid in the foreign country on that branch's foreign source income. Now, how will the foreign subsidiary be taxed? Well, it differs pretty substantially from the branch. First, the United States' tax system respects foreign legal entities. As a general rule, the shareholder of a foreign entity, whether an individual or a corporation, will not be taxable on any income generated by the foreign corporation until it is paid back to the shareholder or repatriated as a dividend. But if a foreign corporation is classified as a controlled foreign corporation or a CFC, then the treatment will vary quite significantly. Instead of earnings only being taxable when repatriated to the shareholder as a dividend, some or all of the CFCs income will be currently taxable to the US shareholder under Subpart F and the global and tangible low tax income or GILTI regimes, regardless of whether any amount is actually repatriated as a dividend. Now we'll learn more about Subpart F and GILTI in later videos. But for now, let's continue to focus on recognizing if a foreign corporation is a CFC. When we look back at the definition of a CFC, we see that we are looking for a foreign corporation that is more than 50 percent owned either by value or vote, and either directly, indirectly or constructively by US shareholders. Importantly here, the definition of who is a US shareholder might be a little bit surprising, and that's because not all US persons are US shareholders. Instead, a US shareholder is a US person that owns at least 10 percent of the combined value or vote of the foreign corporation. A US person that owns less than 10 percent of a foreign corporation is not a US shareholder. Let's do an example. Here we have a foreign corporation that is equally owned by 11 unrelated US persons. Being equally owed, each shareholder owns about nine percent of the foreign corporation. Here we have a foreign corporation that is entirely owned by US persons. But is this foreign corporation a controlled foreign corporation? The answer to that is no. That is because here we have no US shareholders in the structure. There are no US shareholders because there are no US persons that own at least 10 percent of the foreign corporation. A US person who owns nine percent of the foreign corporation is not a US shareholder. Therefore, this foreign corporation is zero percent owned by US shareholders and thus is not a controlled foreign corporation. But if we were to change our example, so a foreign corporation that is owned equally by 10 US persons, then how does the result change? Well, now each US person owns 10 percent of the foreign corporation, meaning that each shareholder is a US shareholder because they are each a US person who owns 10 percent of a foreign corporation. That means that this foreign corporation is 100 percent owned by US shareholders. Meaning that this foreign corporation, by virtue of being greater than 50 percent owned by shareholders, is a controlled foreign corporation. Let's do another one. Here we have a foreign corporation that is 50 percent owned by a US corporation and 50 percent owned by a foreign corporation. Since the US Corporation owns at least 10 percent of the foreign corporation, that US corporation is a US shareholder. However, the foreign corporation is not a CFC because it is owned 50 percent by US shareholders. CFC status requires ownership of greater than 50 percent by US shareholders. However, if we tweak the example and increase the US shareholders ownership to 51 percent, we've now converted the foreign corporation into a CFC because it is now greater than 50 percent owned by US shareholders. What about this situation? Here we have a foreign corporation that is owned by four shareholders. A US person owning 25 percent of the foreign corporation, a US person owning 20 percent, a US person owning seven percent, and a foreign person owning 48 percent. Here, this corporation is 52 percent owned by US persons. However, you'll recall that the test for CFC status is whether the foreign corporation is greater than 50 percent owned by US shareholders and not all US persons here are US shareholders. The seven percent US persons shareholder is not a US shareholder because they do not own at least 10 percent of the foreign corporation. Thus, this foreign corporation is only 45 percent owned by US shareholders under the threshold needed to be classified as a CFC. But if we tweak the example and make every US person a US shareholder by virtue of owning at least 10 percent of the foreign corporation, we now have a CFC, a foreign corporation that is greater than 50 percent owned by US shareholders. Whenever we see a foreign corporation with US owners, we must determine whether that foreign corporation is a controlled foreign corporation. If so, then that foreign corporation, even though it is a separate foreign legal entity, it could be currently taxable in the United States through either the Subpart F or the GILTI, global intangible low tax income regime.
