Section 958: Rules for Determining Stock Ownership

Determining who owns a foreign corporation is a fundamental question in the United States international tax system. The rules in Section 958 establish the framework for identifying ownership interests, a necessary step for applying many other international tax provisions. The application of these ownership rules carries significant financial implications for U.S. individuals and companies with connections to foreign entities. Understanding how the tax code defines and measures ownership is a requirement for anyone navigating cross-border business and investment.

Foundations of Stock Ownership Rules

The most straightforward method of ownership under Section 958 is direct ownership. This occurs when a U.S. person, which can be an individual or a domestic company, holds shares of a foreign corporation in their own name.

A more complex layer of ownership is defined as indirect ownership. This concept addresses situations where a U.S. person owns stock in a foreign corporation through one or more foreign entities. The rules create a chain of ownership, treating a person as owning a proportionate share of stock held by a foreign corporation, foreign partnership, or foreign trust in which they have an interest. This prevents taxpayers from using foreign holding structures to circumvent U.S. tax laws.

For example, consider a U.S. citizen who owns 100% of a foreign holding company. If that foreign holding company, in turn, owns 50% of the stock of a foreign operating company, the U.S. citizen is treated as indirectly owning 50% of the foreign operating company. The ownership flows through the foreign holding company to the U.S. owner.

The calculation of this proportionate interest is important. If a U.S. company owns 40% of a foreign partnership, and that partnership owns 30% of a foreign corporation, the U.S. company is considered to indirectly own 12% of the foreign corporation (40% of 30%). These rules are designed to reflect the economic reality of a U.S. person’s interest in lower-tier foreign entities.

Understanding Constructive Ownership

Beyond owning stock directly or through foreign entities, U.S. tax law employs a broader concept known as constructive ownership. These attribution rules treat a person as owning stock that is legally owned by another related person or entity. The purpose is to prevent taxpayers from nominally dividing ownership among family members or controlled entities to avoid meeting certain ownership thresholds.

One form of attribution is family attribution. Under the rules of Section 318, an individual is considered to own the stock owned by their:

• Spouse
• Children
• Grandchildren
• Parents

A modification to this family rule exists: stock owned by a nonresident alien individual is not attributed to a U.S. citizen or resident family member. For example, if a U.S. resident’s nonresident alien spouse owns 100% of a foreign corporation, that stock ownership is not attributed to the U.S. resident spouse.

Attribution also occurs from entities to their owners. Stock owned by partnerships, estates, and trusts is treated as being owned proportionately by the partners or beneficiaries. Stock owned by a corporation is attributed to its shareholders, but this attribution only occurs if the shareholder owns a certain percentage of the corporation, such as 10% or more, depending on the specific tax provision being applied.

Consequences of Ownership Determination

Applying the direct, indirect, and constructive ownership rules of Section 958 determines whether a U.S. person meets certain ownership thresholds. The first is becoming a “U.S. Shareholder,” which is defined as a U.S. person who owns 10% or more of the total voting power or value of a foreign corporation’s stock.

Once a person is classified as a U.S. Shareholder, their ownership is tested at a collective level. When U.S. Shareholders as a group own more than 50% of the vote or value of a foreign corporation, that entity becomes a Controlled Foreign Corporation (CFC). This CFC status is a designation that changes how the United States taxes the income of that foreign entity with respect to its U.S. Shareholders.

The primary consequence of a foreign corporation being classified as a CFC is that its U.S. Shareholders can be subject to current U.S. taxation on their pro-rata share of certain types of the corporation’s income, even if no cash is distributed. This includes “Subpart F income,” which consists of passive income like dividends and interest, or income from certain related-party transactions.

In addition to Subpart F, a category of income subject to current taxation is Global Intangible Low-Taxed Income (GILTI). The GILTI rules act as a broad backstop to Subpart F, subjecting most of a CFC’s active business income to a minimum level of U.S. tax. The determination of CFC status is the gateway to the application of both the Subpart F and GILTI tax regimes.

Impact of Tax Reform on Attribution

The Tax Cuts and Jobs Act of 2017 (TCJA) introduced a significant change to the stock ownership rules by repealing Section 958(b)(4). Before this change, a limitation existed that prevented “downward attribution” from a foreign person to a U.S. person. This meant that a U.S. subsidiary of a foreign parent company was not considered to own the stock of other foreign subsidiaries owned by the same foreign parent.

The repeal of this rule had an immediate effect. With the limitation gone, stock owned by a foreign corporation can now be attributed downward to its U.S. subsidiary. This change created many new Controlled Foreign Corporations (CFCs) without any change in the underlying ownership structure of multinational groups.

To illustrate, consider a foreign parent corporation (FP) that wholly owns both a U.S. subsidiary (USS) and a foreign subsidiary (FS). Before the TCJA, FP’s ownership of FS was not attributed downward to USS. As a result, FS would not have been a CFC, assuming it had no other U.S. Shareholders.

After the TCJA repealed the rule, the landscape shifted. FP’s 100% ownership of FS is now attributed downward to USS. Consequently, USS is treated as owning 100% of FS, making USS a U.S. Shareholder and FS a CFC. This change pulled many foreign-parented multinational groups into U.S. anti-deferral tax regimes, such as GILTI and Subpart F, and the IRS has since issued guidance to provide some relief from the associated reporting burdens.

Required Informational Filings

Once the ownership rules are applied and a U.S. person is determined to be a U.S. Shareholder of a Controlled Foreign Corporation (CFC), a reporting obligation is often triggered. The primary document for this reporting is Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” This form is a comprehensive return that provides the Internal Revenue Service (IRS) with detailed information about the foreign corporation.

The requirement to file Form 5471 is directly linked to the status determinations made under the ownership rules. The form serves to report the U.S. Shareholder’s pro-rata share of the CFC’s income, such as Subpart F income and GILTI, which may be currently taxable. It also discloses financial information about the CFC, including its balance sheet and income statement.

Failing to file Form 5471 can lead to substantial penalties. The penalty for each failure to file a complete and accurate form is $10,000 per foreign corporation per year. Additional penalties can be assessed if the failure continues after the IRS provides notice.