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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Hi, I have a question relating to CFC rules. If an offshore

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Hi,

I have a question relating to CFC rules.

If an offshore corporation A is wholly owned by an EU corporation B and this corporation B is controlled and wholly owned by a US resident alien, the profits from the offshore corporation A won't be subject to the US tax income? Am I right in thinking that the double taxation treaty will 'stop' the profits from being taxed in the US?

I hope the question makes sense.

Thanks for your reply!

Regards

Vlasta

Lev :

Hi and welcome to our site!
the double taxation treaty does NOT 'stop' the profits from being taxed in the US - but allows to avoid situations when the same income is taxed twice. Thus treaties prevent double taxation but do not prevent taxation in the US.
The US resident alien is taxed similar to US citizens - means - all worldwide income is taxed.
Specific issued might be addressed by tax treaties between countries - in situations when the same income is taxed in both contracting countries. However - generally - the tax liability is based on residency and on the permanent establishment within specific jurisdictions.
If there is NO tax treaty - US tax laws allows a credit for foreign taxes.

Lev :

If the same income is taxable abroad and in the US - you may claim a credit for taxes paid abroad - so the same income would not be taxed twice. Use the form 1116 -http://www.irs.gov/pub/irs-pdf/f1116.pdf please find instructions here - http://www.irs.gov/pub/irs-pdf/f1116.pdf
The credit is limited by the US tax liability on the same income - the form 1116 is used to calculate the amount of credit. That means - if tax liability abroad is higher - there will not be US taxes on that income, but if tax liability abroad is lower - in the US you will pay the difference after the credit will be applied.

Lev :

A controlled foreign corporation (CFC) is any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or 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.
The taxation of foreign income earned by U.S. controlled foreign corporation changed with the introduction of Subpart F in 1962. Subpart F provides that certain types of income of CFCs, though undistributed, must be included in the gross income of the US shareholder in the year the income is earned by the CFC.
So while generally - US persons are taxed on income distributed from corporation - in case of CFC - undistributed income which is sitting in the corporate account still may be taxed for US shareholders.

Customer:

Hi Lev, thanks for your quick response. I have probably worded my question in the wrong way. What I was trying to find out is if a US resident alien owns wholly an offshore company, he would be subject to income tax on all profits of that company assuming he owns more than 50% of that foreign company. However, if this offshore company will be sold to an EU corporation, and the US resident alien will own this EU corporation, the profits of the offshore company will not be subject to US income tax ?

Customer:

so basically what CF also means is that if I am a US resident alien and wholly own an Irish company, I will have to pay income tax on all the profits of this Irish company? regardless if I take out some dividend or not?

Customer:

CFC

Lev :

To address this issue - we need to look again into the definition of the CFC which we already referenced above - A controlled foreign corporation (CFC) is any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders.
So far - despite of the change of the ownership - an offshore company will still be CFC - and as such will be subject of Subpart F taxation.
That scheme would be too simple solution.. unfortunately that would not allow to avoid tax liability.

Customer:

Thanks a lot. This explanation is really helpful.

Lev :

Sorry if you expected differently...

Customer:

Yes I did:( So are there any special rules under which I would not have to tax all the profits of the EU company?

Customer:

I mean if I don't withdraw any dividends, just leave the profits sitting in the bank account..

Customer:

I pay the corporation tax in Ireland, for instance and then the rest of profits will be subject to US taxation again?

Customer:

that is insane!

Lev :

I might suggest following examining process that would be used in case you are audited.
http://www.irs.gov/irm/part4/irm_04-061-007.html
If you want to avoid Subpart F taxation - your ownership must be reduced to below 50%.
Otherwise - there is no legal way to avoid Subpart F taxation...
Again - there will NOT be double taxation. If any tax are due in Ireland - your US tax liability will be reduced.

Customer:

ok, thanks a lot!

Lev :

However - as you choose a corporate as your business structure - there is a so-called "built-in" double taxation - corporate pays its own income tax, and then - shareholders pay income taxes on dividends. That is regardless if that a foreign corporation or US corporation.
You may think about expanding your business and invest in additional assets - that will reduce your current taxable income - and will create the basis for future growth.

Customer:

Hmm, that sounds interesting. Would you know someone who has experience in these type of structures/vehicles? I am still EU resident but looking to move to the US in foreseeable future, so we have to come up with some structure before we become US tax residents...

Lev :

Again - the only way to avoid Subpart F taxation - not to own CFC.
That is a very powerful law targeting all offshore business and investment activities.
Practically speaking - assets and funds accumulated in a foreign corporation are constructively owned by you - you may use them, sell, etc without much limitations.
If the CFC receives income - that is practically your income even you legally separate yourself from that corporation.
If funds are not used for business operations - it would be logical to distribute to shareholders - and pay tax on those dividends - by doing that - you will avoid Subpart F tax issues.

Customer:

Ok, thanks a lot!

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