What Happened to CFC Tax Amounts From 1991 to 2015?

The tax treatment and reporting of Controlled Foreign Corporation (CFC) amounts in the United States evolved significantly between 1991 and 2015. During these years, U.S. tax laws aimed to prevent the indefinite deferral of U.S. taxation on certain foreign earnings, even if those earnings were not physically brought back to the United States.

Core Concepts of CFC Taxation (1991-2015)

A Controlled Foreign Corporation (CFC) during the 1991-2015 period was defined as any foreign corporation where U.S. shareholders owned more than 50% of the total combined voting power or the total value of its stock. A U.S. shareholder was a U.S. person who owned 10% or more of the foreign corporation’s voting stock.

A primary mechanism for taxing CFCs was through Subpart F income, which mandated current taxation of certain passive or mobile income to U.S. shareholders, regardless of whether the income was actually distributed. Categories of Subpart F income included foreign personal holding company income (FPHCI), such as interest, dividends, rents, royalties, and gains from the sale of property that generates such income.

Subpart F also covered foreign base company sales income (FBCSI), which arose from transactions involving related parties where goods were manufactured and sold outside the CFC’s country of incorporation. It also included foreign base company services income (FBCSvI), derived from services performed for related persons outside the CFC’s country of incorporation.

Another aspect of CFC taxation was the concept of investments in U.S. property, outlined in Internal Revenue Code Section 956. This rule treated certain investments made by a CFC in U.S. property as a deemed distribution to its U.S. shareholders, triggering immediate U.S. taxation. Examples included loans to U.S. shareholders or related U.S. persons, and tangible property located in the United States.

The amount included under Section 956 was limited by the CFC’s earnings and profits (E&P), which served as a ceiling on the amount of income that could be deemed distributed. E&P represented the CFC’s economic income, adjusted for U.S. tax accounting principles, and played a role in determining the taxability of both Subpart F income and Section 956 inclusions.

Impact of Major Legislation on CFC Amounts (1991-2015)

A legislative development impacting CFC amounts during this period was the American Jobs Creation Act of 2004 (AJCA). The AJCA aimed to encourage U.S. companies to repatriate foreign earnings by offering a temporary incentive through Section 965.

Section 965 allowed U.S. corporations to claim an 85% dividends-received deduction for certain repatriated foreign earnings. This provision reduced the U.S. corporate tax rate on these amounts from 35% to 5.25%. The incentive was available for a single tax year.

This temporary repatriation holiday influenced CFC amounts by facilitating the return of offshore profits that might otherwise have remained abroad. To qualify for the reduced rate, repatriated funds were required to be used for specific domestic purposes, such as reinvestment in the U.S. economy.

The AJCA’s Section 965 provided a unique, limited window for companies to bring back accumulated foreign earnings at a preferential tax rate. While the primary effect was on actual repatriated dividends, it indirectly influenced the overall landscape of CFC amounts by offering a temporary relief from the cumulative tax burden on previously untaxed foreign income.

Reporting Requirements for CFC Amounts

U.S. persons with interests in Controlled Foreign Corporations were required to report their ownership and associated CFC amounts to the Internal Revenue Service (IRS) using Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations.

Form 5471 required filers to provide information about the foreign corporation, including its ownership structure, financial statements, and operational data. All financial information reported on the form needed to be presented in U.S. dollars, translated from the CFC’s functional currency.

Form 5471 included several schedules for reporting CFC amounts. Schedule I, “Summary of Shareholder’s Income From Foreign Corporation,” was used to report a U.S. shareholder’s pro rata share of Subpart F income inclusions.

Schedule J, “Accumulated Earnings & Profits (E&P) of Controlled Foreign Corporation,” tracked and reported the CFC’s E&P, which limited Subpart F income and Section 956 inclusions. Schedule P, “Investments in U.S. Property,” was used to report amounts included in income due to a CFC’s investment in U.S. property under Section 956.

Form 5471 was not a standalone tax return; it was attached to the U.S. person’s income tax return, with the same filing deadline. Failure to file Form 5471, or filing it incorrectly, could result in significant penalties.