Issues for a US Citizen who owns a
Foreign Corporation
The general rule is that shareholders do not pay tax on corporate income until the income is distributed as a dividend.
1. FOREIGN PERSONAL HOLDING COMPANY Is your foreign corporation a “personal holding company”
The foreign corporation can be both a domestic personal holding corporation and a foreign holding corporation. Test for both basically the same.
A. Test for if the corp. is a FPHC.
1. More than 50% of the stock is owned by fewer than 5 people. (FPHC does not apply if 11 s/h own equal shares =9.99% each)
AND
2. 60% of its adjusted GROSS ordinary income is from
Personal Holding Company Income
(1) Dividends, etc. Dividends, interest, royalties (other than
mineral, oil, or gas royalties or copyright royalties), and annuities.
(2) Rents The adjusted income from rents; except that such adjusted income shall not be included if—
(A) such adjusted income constitutes 50 percent or more of the adjusted ordinary gross income,
and
(B) the sum of dividends paid and deemed and consented paid > than X. X = PHCI – (10% X OGI)
For example,
PHCI is 40,000 and OGI is 30,000
Dividends have to be paid > 7,000 (40,000-33,000)
(3) Mineral, oil, and gas royalties
(4) Copyright royalties
(5) Produced film rents
(6) Use of corporate property by shareholder
(7) Personal service contracts
(A) Amounts received under a contract under which the corporation is to furnish personal services; if some person other than the corporation has the right to designate (by name or by description) the individual who is to perform the services, or if the individual who is to perform the services is designated (by name or by description) in the contract; and
(B) amounts received from the sale or other disposition of such a contract.
(8) Estates and trusts
2. PASSIVE FOREIGN INVESTMENT COMPANIES
The foreign corporation is PFIC if either:
A. 75% or more of its gross income is from passive income
(Dividends, Interest, Rents)
OR
B. 50% or more of the average value of the corporate’s ASSETS during the year: 1. produce passive income
2. or held for the production-of passive income. (for example holding raw land)
The asset test is met if 50% or more of the foreign corporation’s average assets (as defined in the IR Code) produce, or could produce passive income, or are assets (such as cash and bare land) that produce no income. The test is applied based on the foreign corporation’s adjusted basis, for U.S. tax purposes, of the assets, or at the election of the particular shareholder, fair market values of the assets.
Look-thru of 25% subsidiaries: Interests in 25% or more owned foreign corporations are treated similarly to partnership interests (i.e., looked through) for the income test and the asset test.
NOT PFIC income
1. Rents from an active business
2. Banking income
3. Dividends or interest received from a related person
Incorporated in the same country as PFIC
Can be subject to these rules even if you own just one share.
Indirect shareholder of a PFIC must report. Generally, a U.S. person is an indirect shareholder of a PFIC if it is:
A 50%-or-more shareholder of a foreign corporation that is not a PFIC and that directly or indirectly owns stock of a PFIC,
A shareholder of a PFIC where the PFIC itself is a shareholder of another PFIC,
A 50%-or-more shareholder of a domestic corporation where the domestic corporation owns a section 1291 fund, or
A direct or indirect owner of a pass-through entity where the pass-through entity itself is a direct or indirect shareholder of a PFIC. For more information on determining whether a U.S. person is an indirect shareholder, see Temporary Regulations section 1.1291-1T(b)(8) and Notice 2014-28.
For purposes of these rules, a pass-through entity is a partnership, S Corporation, trust, or estate.
NO DEEMED DISTRIBUTION
But when distributions are made taxed at highest rate + interest.
Can avoid by making election to include % of income even though not distributed.
A taxpayer may avoid the regime by purging the PFIC taint by a deemed sale election, a deemed dividend election, or by means of two alternative elections: (1) the qualified electing fund (QEF) or (2) the mark-to-market election. If a QEF election is made, a taxpayer usually includes in income each year its pro rata share of the PFIC’s ordinary earnings and its pro rata share of the PFIC’s net capital gain. Taxpayers holding marketable PFIC stock may make the mark-to-market election to include annually in gross income the excess of the fair market value over the PFIC stock’s adjusted basis
3. CONTROLLED FOREIGN CORPORATION DEEMED DISTRIBUTION
I Ownership Test.
A. 10% rule Must have one US shareholder who owns 10% of voting power
(CFC does not apply if 11 US shareholders own equal shares =9.99% each)
Is John Smith a shareholder in any corporation where a US shareholder has 10% interest.
And voting means can the 10% or more s/h elect in 10% or more of the Board of Directors.
10% count includes shares owned by family members, TRUST, stock thru intermediate corporations
John Smith owns 50% of F1 and F1 owns 30% of F2, John Smith is deemed to own 15% of F2.
AND
B. More than 50% of corp owned by US Shareholders.
II. Type of Income Test,
If CFC does the CFC have Income that is a problem
1. Foreign Personal Holding Company Income
2. Foreign Base Company Sales Income
US corp sets up overseas corp F that buys and sells to customers around world to take advantage of low tax rates for corp F.
3. Foreign Base Service Income
F Corp provides services for a related person (US parent for example) And services not perform in the country where F is located.
4. Foreign Base Shipping Income
5. Foreign Base Oil Income
We will ignore 2,3, 4, and 5.
Remember No “Deemed Distribution if CFC has no earning and profits.”
Additional RULE
If the CFC has passive assets = 25% of total assets, then
DEEMED DIVIDEND for excess passive assets.
GOOD NEWS only “US Shareholder” – 10% voting has “Deemed Distribution”
See your tax advisor before using this Memorandum.