Tax Reform - Specified Foreign Corporations and Importance for Americans Abroad
Who is Affected:
Under the Law H.R. 1 originally known as the “Tax Cuts and Jobs Act”, U.S. persons (citizens, resident aliens, and domestic corporations) with 10% or higher stock ownership in Specified Foreign Corporations (SFC) are subject to “deemed repatriation” tax.
Which foreign corporations are SFC:
1. All Controlled Foreign Corporations (CFC). A CFC is any foreign corporation in which more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of the corporation. This means that foreign corporation in which one or more US persons hold more than 50% of stock is a CFC, thus it is also a SFC (except for PFIC corporations explained below).
2. Any foreign corporation, which has a U.S. corporate shareholder.This means that non-CFC is not a SFC unless one of the U.S. shareholders is a U.S. business that owns at least 10% of the foreign corporation.
Important Change on Stock Ownership through Attribution From Non-Residents
Under the existing rules, stock owned by a nonresident alien individual (other than a foreign trust or foreign estate) is not considered as owned by a United States shareholder. This was a special limitation to the attribution rules through the family members.
The passed tax reform removes this limitation. Stocks owned constructively through the non-resident spouse or relative are considered owned by US shareholder.
Example A: U.S. shareholder owns 50% stock in a foreign corporation . The NRA spouse owns 10%. Direct and constructive ownership of the US person, under the new law, is 60%. The corporation is now a CFC and therefore a SFC.
Who is not affected:
1. U.S. shareholders who own directly, indirectly or constructively less than 51% of shares in a non-CFC corporation not affected.
Example B: U.S. person owns 50% in a foreign corporation. Other shareholders are non-U.S. persons. This is not a SFC.
2. Shareholders in PFIC corporations are not affected.
Example C: U.S. person is a single owner of PFIC corporation (75% of the corporation's gross income is "passive" derived from investments). This corporation is a CFC but it is not a SFC. All corporate income is subject to Subpart F inclusion under old rules as well. No changes to PFIC regime.
For tax years starting after December 31, 2017 the scope of U.S. persons required to include more income under the subpart F rules will increase.
The new law revises the definition of a U.S. shareholder to include individual U.S. persons who own at least 10% of the value of the shares of the foreign corporation. As a result of this provision, a U.S. person would be treated as a U.S. shareholder of a foreign corporation for subpart F purposes when the person owns at least 10% of either the voting power or the value of the foreign Corporation.
The provision is effective for the tax years of foreign corporations beginning after December 31, 2017, therefore this category of taxpayers is not affected by the mandatory income repatriation of previously deferred income.