Business Structures And Their Tax Treatment
entities doing business overseas can use a variety
of structures. Some of the most important are
listed below with notes about their taxation characteristics:
foreign subsidiary of a US corporation or a foreign
company owned by US shareholders is typically
a Controlled Foreign Corporation (CFC).
A CFC means any foreign corporation if on any
day during the foreign corporation's taxable year
US shareholders own more than 50% of:
The total combined voting power of all voting
The total value of all the stock.
A foreign corporation is any corporation not created
or organized in the United States. A US shareholder
is a US person that owns 10% or more of the voting
power of all classes of stock entitled to vote
of the foreign corporation. A US person is a citizen
or resident of the United States, a domestic partnership
or corporation, or any estate or trust unless
its income from sources outside the US (other
than income that is effectively connected with
a US trade or business) is not includable in gross
income under US tax law.
determining whether a US person is a US shareholder,
the US person will be considered to own stock
that it owns:
through foreign entities; or
Constructively under certain rules that attribute
stock ownership from one entity to another.
A US shareholder includes actual distributions
from a CFC in taxable income, plus under Subpart
F of the Tax Code certain types of undistributed
income of a CFC, including:
Passive investment income;
Income from the purchase of goods from, or sale
to, certain related entities;
Income from the performance of services for
or on behalf of certain related entities;
Certain types of shipping and oil-related income;
Insurance income from insuring risk located
outside the CFC's country of incorporation;
Income from bad conduct activities, such as
participation in an international boycott, payment
of illegal bribes and kickbacks, and income
from a foreign country during any period that
country is "tainted" under IRC 901(j);
In addition, the US shareholders of a CFC are
required to include in income their share of
the CFC's increase in earnings invested in US
Subpart F rules are extremely complex, and professional
advice is absolutely necessary in interpreting
legislation dating from 1984, which was eventually
declared unacceptable by the World Trade Organization
after a complaint from the European Union, the
US Internal Revenue Code authorized the establishment
of foreign sales corporations (FSCs), being corporate
entities in foreign jurisdictions through which
US manufacturing companies could channel exports.
15% of the revenue concerned was exempted from
corporation tax, meaning (at 35% tax) that companies
kept 5.25% more of their revenue.
The FSC rules generally replaced the domestic
international sales corporation (DISC) rules.
IC-DISCs exist, however, for small domestic taxpayers.
See here for details.
The FSC tax regime and its replacement ETI legislation
are described in detail here.
FSC and ETI regimes were replaced with general
other tax concessions under the American
Jobs Creation Act 2004.
Possessions corporations may operate to obtain
the benefits of section 936 in all US possessions
including the US Virgin Islands. However, the
overwhelming majority of possessions corporations
are operating in Puerto Rico.
Possessions corporations must have:
Filed a valid Form 5712, Election To Be Treated
as a Possessions Corporation Under Section 936
(an election cannot normally be revoked for
the first ten years);
Derived 80% or more of their gross income from
sources in a US possession during the applicable
period immediately before the tax year ended,
Derived 75% or more of their gross income from
the active conduct of a trade or business in
a US possession during the applicable period
immediately before the tax year ended. In 1976
the amount was 50%. This amount increased over
the years to 75%.
is generally the shorter of 36 months or the period
when the corporation actively conducted a trade
or business in the US possession.
domestic international sales corporation (DISC)
or a former DISC, or a corporation that owns stock
in a DISC, former DISC, foreign sales corporation
(FSC), or a former FSC is ineligible for Section
A possessions corporation is allowed a credit
against its US tax liability equal to the portion
of its tax that is attributable to:
The taxable income from non-US sources from
the active conduct of a US trade or business
within a US possession, and
The qualified possession source investment income.
The credit is not allowed against environmental
tax, tax on accumulated earnings, personal holding
company tax, additional tax for recovery of foreign
expropriation losses, tax increase on early disposition
of investment credit property, tax on certain
capital gains of S corporations or recapture of
low income housing credit.
A possessions corporation may elect either the
cost sharing or profit split method of computing
taxable income with respect to a certain possession