What Is a Controlled Foreign Corporation (CFC)?
A controlled foreign corporation (CFC) is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners.
In the United States, a CFC is a foreign corporation in which U.S. shareholders own more than 50% of the total combined voting power of all voting stock or the total value of the company's stock.
Controlled foreign corporation (CFC) laws work alongside tax treaties to dictate how taxpayers declare their foreign earnings. A CFC is advantageous for companies when the cost of setting up a business, foreign branches, or partnerships in a foreign country is lower even after the tax implications—or when the global exposure could help the business grow.
Key Takeaways
- A controlled foreign corporation (CFC) is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners.
- In the U.S., a CFC is a foreign corporation in which U.S. shareholders own more than 50% of the total combined voting power of all voting stock or the total value of the company's stock.
- A CFC is advantageous for companies when the cost of setting up a business in a foreign country is lower than their home jurisdiction.
Understanding Controlled Foreign Corporations (CFC)
The CFC structure was created to help prevent tax evasion, which was done by setting up offshore companies in jurisdictions with little or no tax, such as Bermuda and the Cayman Islands, historically. Each country has its own CFC laws, but most are similar in that they tend to target individuals over multinational corporations when it comes to how they are taxed.
For this reason, having a company qualify as independent will exempt it from CFC regulations. Major countries, which comply with CFC rules, include the United States, the United Kingdom, Germany, Japan, Australia, New Zealand, Brazil, Sweden, and Russia (since 2015).
A company that is considered independent is exempt from CFC regulations.
Countries differ in how they define the independence of a company. The determination can be based on how many individuals have a controlling interest in the company, as well as the percentage they control. For example, minimums can range from fewer than 10 to over 100 people, or 50% of voting shares, or 10% of the total outstanding shares.
Special Considerations
To be considered a controlled foreign corporation in the U.S., more than 50% of the vote or value must be owned by U.S. shareholders, who must also own at least 10% of the company. U.S. shareholders of CFCs are subject to specific anti-deferral rules under the U.S. tax code, which may require a U.S. shareholder of a CFC to report and pay U.S. tax on undistributed earnings of the foreign corporation.
According to the Internal Revenue Service (IRS), a person may have special reporting requirements if they own shares of a CFC (directly, indirectly, or constructively) as follows:
- "10% or more of the total combined voting power of all classes of the voting stock of a CFC
- Or, in the case of a tax year of a foreign corporation beginning after Dec. 31, 2017, 10% or more of the total combined voting power or value of shares of all classes of stock of a CFC"
These rules have been in effect since December 2017. Prior to this date, there was no downward attribution and constructive ownership of foreign corporation stock from a foreign person to a U.S. corporation, U.S. partnership, or U.S. trust.
U.S. shareholders with controlling interests in foreign corporations must report their share of income from a CFC and their share of earnings and profits of that CFC, which are invested in United States property.
The above information is not an exhaustive list or description of all of the requirements stipulated by the IRS. Please consult a tax professional because tax laws and reporting requirements are quite complex regarding CFCs and income from foreign sources.
