What Is Foreign Base Company Income Under IRC 954?
IRC Section 954 provides a framework for analyzing a CFC's income, distinguishing between deferred earnings and amounts currently taxable to U.S. shareholders.
Internal Revenue Code Section 954 is an anti-deferral component of the United States international tax system. Generally, the U.S. allows domestic parent companies to defer paying U.S. tax on their foreign subsidiaries’ profits until they are repatriated as dividends. Section 954 creates an exception to prevent taxpayers from using foreign corporations to accumulate mobile income in low-tax jurisdictions to delay U.S. taxation.
The rules identify specific income categories earned by certain foreign corporations with significant U.S. ownership. When a foreign corporation earns this income, its U.S. owners must pay tax on their share immediately, regardless of whether they receive cash distributions. This framework, known as the Subpart F regime, treats the income as if it were distributed in the year it was earned.
The Foundation of Foreign Base Company Income
Foreign Base Company Income (FBCI) is the term for earnings considered susceptible to being artificially shifted to low-tax countries. The FBCI framework applies only to a foreign corporation that qualifies as a Controlled Foreign Corporation (CFC). A foreign corporation is a CFC if U.S. Shareholders own more than 50 percent of its stock, based on either voting power or value.
A U.S. Shareholder is a U.S. person, such as a citizen, resident, or domestic corporation, who owns 10 percent or more of the foreign corporation’s stock by vote or value. When these U.S. Shareholders collectively own more than 50 percent of the foreign company, it becomes a CFC.
Once a company is a CFC, its FBCI is a component of a broader category called “Subpart F income.” U.S. Shareholders must include their share of this Subpart F income in their gross income for the current year. This process eliminates the tax deferral benefit for the specific income streams defined as FBCI.
Passive and Financial Income Categories
The most detailed category of FBCI is Foreign Personal Holding Company Income (FPHCI), which targets passive and financial earnings that are easily movable between jurisdictions. This includes:
- Dividends, interest, royalties, rents, and annuities.
- Net gains from the sale or exchange of property that generates these income streams, such as stocks or debt instruments.
- Net gains from commodities transactions, unless they arise from the active business of the CFC.
- Foreign currency gains, unless they are directly related to the business needs of the CFC.
- Income that is “equivalent to interest,” such as commitment fees or certain factoring income.
The Active Business Exception
An exception applies to rents and royalties derived from the active conduct of a trade or business. If a CFC performs significant activities, such as developing, marketing, or servicing the property it licenses or rents out, the resulting income is not FPHCI. This distinguishes active business earnings from passive investment income.
Related Party Exceptions
Another exception, often called the “same country” exception, applies to payments from related persons. Dividends and interest received from a related corporation are not FPHCI if the payor is organized and has substantial business assets in the same foreign country as the recipient CFC. A similar rule applies to rents and royalties for property used within that same country, allowing groups to move active earnings within a single foreign jurisdiction without triggering U.S. tax.
The CFC “look-through” rule provides similar relief, excluding dividends, interest, rents, and royalties received from a related CFC from FPHCI, provided the income was not Subpart F income for the payor. This provision allows for more flexible movement of active foreign earnings between related CFCs in different countries. It is scheduled to expire for taxable years of foreign corporations beginning after December 31, 2025.
Sales and Services Income Categories
The FBCI rules also target certain active business income when commercial activities are artificially split between related entities to isolate profits in a low-tax jurisdiction. The two categories addressing these structures are Foreign Base Company Sales Income and Foreign Base Company Services Income.
Foreign Base Company Sales Income (FBCSI) arises from profit on the sale of personal property under specific circumstances. The income is FBCSI if a CFC buys property from a related person and sells it to anyone, or buys from anyone and sells to a related person. For this rule to apply, the property must be manufactured outside the CFC’s country of incorporation and sold for use outside that same country. A “related person” is an entity like a parent, subsidiary, or commonly controlled company.
For example, if a U.S. parent manufactures goods in Germany and sells them to its Swiss CFC, which then sells them to a customer in Italy, the Swiss CFC’s profit is FBCSI. The income is taxed currently to neutralize the benefit of routing the sale through the lower-tax Swiss entity. However, if the CFC substantially transforms the property it purchases, its sales income is not FBCSI under the “manufacturing exception.”
Foreign Base Company Services Income (FBCSVI) applies a similar logic to services. This income arises when a CFC performs services for, or on behalf of, a related person, and those services are performed outside the country where the CFC is organized. For instance, if a U.S. corporation contracts with a client and has its Bermuda CFC perform the services in Spain, the Bermuda CFC’s income is FBCSVI. The rule can also be triggered if the related person provides substantial assistance to the CFC, such as marketing or engineering support.
Overarching Exceptions and Special Rules
After an amount is identified as potential FBCI, a set of overarching rules can modify or eliminate this classification. These rules are applied to the CFC’s aggregate FBCI and function as final tests before determining the U.S. Shareholder’s income inclusion.
The de minimis rule provides a safe harbor for CFCs with a small amount of FBCI. If a CFC’s gross FBCI for a year is less than the lesser of 5% of its gross income or $1,000,000, then none of its gross income is treated as FBCI for that year. This rule avoids complex calculations for insignificant amounts of base company income.
Conversely, the full inclusion rule applies if a CFC’s gross FBCI for a year exceeds 70% of its total gross income. In this case, the CFC’s entire gross income for that year is treated as FBCI. This presumes that if the vast majority of a CFC’s income is the type targeted by the anti-deferral rules, the entire entity is likely serving a tax avoidance purpose.
The high-tax exception allows a U.S. Shareholder to elect to exclude an item of income from FBCI if it was subject to a high rate of foreign income tax. To qualify, the foreign tax paid on the income must be greater than 90% of the maximum U.S. corporate tax rate. With the current U.S. rate at 21%, the foreign tax rate must exceed 18.9%. If income is already taxed at a rate comparable to the U.S. rate, the incentive to shift profits is diminished, and the anti-deferral rules are not needed.