Subpart F Income of Controlled Foreign Corporations | U.S. Taxation

U.S. companies have an incentive to shift profits to subsidiaries in low-tax countries. Congress has passed laws to prevent this; one way is by taxing Subpart F income of controlled foreign corporations as a constructive dividend.

A controlled foreign corporation (CFC) is a non-U.S. corporation in which at least 50% of (a) the combined voting power of all voting stock or (b) the total value of all stock is owned by U.S. shareholders (a U.S. shareholder is a U.S. person or company that owns at least 10% of the foreign corporation's voting stock).

When the CFC has Subpart F income, a U.S. shareholder will be taxed on their pro rata share of the Subpart F income, regardless of whether they receive a distribution. Subpart F income includes:
(1) foreign personal holding company income (royalties, interest, dividends, rent, annuities)
(2) foreign base company sales income (sales made to customers outside the CFC's country when a related party is involved and the CFC has little connection to the income)
(3) foreign base company services income (income from services performed for a related party outside the CFC's country)

For example, assume that a U.S. company owns 60% of the voting stock of an Irish subsidiary (the Irish subsidiary is thus a controlled foreign corporation). If the Irish subsidiary has $200,000 of interest income, this interest income would be considered Subpart F income. The U.S. company would be taxed on its pro rata share, which is $120,000 (60% * $200,000). The $120,000 would be taxable to the U.S. corporation as ordinary income (whether or not it receives a distribution) and the U.S. corporation would not receive a dividends received deduction.—
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