Investing in a foreign corporation can have significant tax consequences for U.S. taxpayers. In this blog post, we will discuss the tax implications of investing in a foreign corporation, including controlled foreign corporation (CFC) rules, subpart F income, Global Intangible Low Taxed Income (GILTI) and the requirement to file Form 5471.
First, let’s define a foreign corporation. A foreign corporation is a corporation that is incorporated in a country other than the United States. U.S. taxpayers who own stock in a foreign corporation may be subject to U.S. tax on their share of the foreign corporation’s income, regardless of whether the income is distributed to the shareholders.
It’s important to understand the definition of U.S. Shareholders for CFC purposes, which is any U.S. person who owns directly, indirectly, or constructively, 10% or more of the voting power or value of the foreign corporation.
One important concept to understand when investing in a foreign corporation is the controlled foreign corporation (CFC) rules. A CFC is a foreign corporation in which U.S. shareholders, in the aggregate, own more than 50% of the voting power or value of the stock. U.S. shareholders of a CFC are subject to certain rules that may result in the inclusion of the CFC’s income in the U.S. shareholders’ taxable income, even if the income is not distributed to the shareholders.
The CFC rules apply to the foreign corporation’s “subpart F income.” Subpart F income includes certain types of income, such as passive income (e.g. dividends, interest, rents, and royalties) and certain types of foreign base company income (e.g. sales or services performed in the U.S.). U.S. shareholders of a CFC are required to include their pro rata share of the CFC’s subpart F income in their taxable income, regardless of whether the income is distributed to the shareholders.
Additionally, The Tax Cuts and Jobs Act (TCJA) introduced a new concept called Global Intangible Low Taxed Income (GILTI). GILTI is income generated by a foreign corporation that is considered to be a low-taxed foreign corporation. U.S. shareholders of a CFC are subject to GILTI tax on their pro rata share of the CFC’s GILTI income, whether or not distributed.
In addition to the CFC rules, U.S. taxpayers who are officers, directors, or shareholders in a foreign corporation may be required to file Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” Form 5471 is used to report information about the foreign corporation, such as its income, assets, and ownership. The form must be filed with the taxpayer’s income tax return and failure to file may result in penalties.
In summary, investing in a foreign corporation can have significant tax consequences for U.S. taxpayers. U.S. shareholders of a controlled foreign corporation may be subject to inclusion of the CFC’s subpart F income and GILTI in their taxable income, even if the income is not distributed to the shareholders. U.S. taxpayers who are officers, directors, or shareholders in a foreign corporation may also be required to file Form 5471. It’s important to consult with a tax advisor before making any foreign corporation investments to understand and minimize the potential tax liability. Understanding the definition of U.S. shareholders, and being aware of the CFC rules, subpart F income, GILTI, and Form 5471 requirements, is crucial for making informed decisions about investing in a foreign corporation.
It’s worth noting that there are also ways to mitigate the impact of these rules such as electing for a Check-the-box entity, Qualified Business Asset Investment (QBAI) and Foreign Derived Intangible Income (FDII) deductions.
Investing in a foreign corporation can be a great opportunity for growth and diversification, but it’s important to be aware of the potential tax implications. The tax rules and regulations surrounding foreign corporations are complex, and it’s essential to have a thorough understanding of them before making any investments.
Don’t hesitate to reach out to us if you have any questions or concerns about the tax implications of investing in a foreign corporation. Our team of experts is here to help you make informed decisions and achieve your financial goals.
We recommend the following resources for learning more about your U.S. tax obligations when investing in a foreign corporation: