Subpart F

Question 1

Generally, US taxpayers do business in a foreign country through: (3 answers)

Answer 1

Business activities in a foreign country through a
1) branch office
2) corporation
3) partnership

Question 2

A domestic corporation is subject to US taxation on its worldwide income, including income derived

Answer 2

A domestic corporation is subject to US taxation on its worldwide income, including income derived through a foreign branch and the distributive share of foreign income of a partnership.

Question 3

Income earned by a foreign corporation is generally not taxed at the level of its corporate US shareholder(s) at the full US corporate income tax rate, unless…

Answer 3

…the income is subpart F income of a CFC (or the corporation is a PFIC and a QEF election is made).

Question 4

Instead of incorporating the President’s proposal, subpart F as added to the Code by the Revenue Act of 1962 provided…

Answer 4

…for a US shareholder to currently include in gross income only its pro rata share of “ tainted ” streams of current income earned by CFC, called the CFC’s “subpart F income.”

Question 5

Subpart F income ” originally included…

Answer 5

1) Investment type income such as interest, dividends, rents, and royalties (“foreign personal holding company income” (FPHCI)); and

2) Business profits that were especially susceptible to be shifted to low taxed foreign “base companies” (“foreign base company income”)

Question 6

Subpart F inclusions of a US shareholder are a type of what’s sometimes called “ phantom income,” because…

Answer 6

…no cash or property is remitted to the US shareholder, yet the US shareholder is required to include the amount in gross income on a current basis.

Question 7

Income inclusions under subpart F apply only to US shareholders of foreign corporations which…

Answer 7

are CFCs at some point during the corporation’s tax year that ends with or within the shareholder’s tax year.

Question 8

A person that is treated as US shareholder of a foreign corporation on the last day of the corporation’s tax year on which it was a CFC, and who owns stock in the corporation directly, or indirectly through foreign entities, must include in gross income, for the shareholder year in which such last day falls, the…

Answer 8

shareholder’s “ pro rata share ” of the corporation’s subpart F income for the tax year of the corporation referred to above

Question 9

If the CFC’s income is measured in a currency other than the US dollar, the dollar amount of the inclusion is the currency amount translated into dollars at the ___________ exchange rate for the CFC’s tax year

Answer 9

average

Question 10

Direct Stock Ownership

Answer 10

§958(a)(1)(A)

Question 11

Indirect Stock Ownership

Answer 11

§958(a)(1)(B) & (2)
Stock owned, directly or indirectly, by or for a foreign corporation, foreign partnership, or foreign trust or foreign estate shall be considered as owned proportionately by its shareholders, partners, or beneficiaries.

Question 12

Proportionate interest

Answer 12

Reg §1.958-1(c)(2)
Generally, in determining a person’s proportionate interest in a foreign corporation, the purpose for which the rules of §958(a) are being applied will be taken into account.

Question 13

Subpart F income inclusions

Answer 13

• Subpart F income is a NET income concept.
• Subpart F income includes foreign base company income (FBCI), among other things, which is the sum of the following types of GROSS income, in each case reduced (but not below zero) by allocable deductions (including taxes)
  ◦ Foreign Personal Holding Company Income (FPHCI)
  ◦ Foreign Base Company Sales Income (FBCSI)
  ◦ Foreign Base Company Services Income (FBCSvI)

Question 14

Types of FBCI

Answer 14

• Foreign Personal Holding Company Income (FPHCI)–§954(c)
• Foreign Base Company Sales Income (FBCSI)– §954(d)
• Foreign Base Company Services Income (FBCSvI)– §954(e)

Question 15

FBCSI generally includes:

Answer 15

• income derived in connection with the purchase of personal property from a related person and its sale to any person,
• income derived from the sale of personal property to any person on behalf of a related person,
• income derived from the purchase of personal property from any person and its sale to a related person, and
• income derived from the purchase of personal property from any person on behalf of a related person
  IF
  (A) the property is produced outside the country under the laws of which the CFC is created or organized, and
  (B) the property is sold (or purchased on behalf of a related person) for use, consumption, or disposition outside such country.

Question 16

If the CFC has a branch outside its country of incorporation, and the CFC’s income is not FBCSI under the rules stated above, the branch rule (§954(d)(2) and Reg §1.954-3(b)) may

Answer 16

• treat the branch as if it were a wholly owned subsidiary of the CFC,
• require the separate incomes of the branch and the remainder of the CFC to be tested again under the rules stated above, and
• may result in some of the branch’s or remainder’s income being treated as FBCSI

Question 17

Foreign Base Company Services Income (FBCSvI) under §954(e):

Answer 17

• Generally, income derived in connection with the performance of technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial, or like services which—
  (A) are performed for or on behalf of any related person, and
  (B) are performed outside the country under the laws of which the CFC is created or organized
• But: FBCSvI excludes certain income from services related to the CFC’s sale, or effort to sell, property produced by the CFC, where the services are performed before the sale (if any)

Question 18

FBCSvl performed for or on behalf of a related person:

Answer 18

− CFC is paid or reimbursed by a related person for performing services,
− CFC performs services that a related person is obligated to perform,
− CFC performs services in relation to property that a related person has sold (and performance of the services constitutes a condition or a material term of the sale), or
− Substantial assistance contributing to the performance of the services has been furnished by related person(s) (through direction, supervision, services, know-how, financial assistance (other than contributions to capital), equipment, material, supplies, etc.)
* Generally, test is met if 80% or more of CFC’s total cost of providing the services is provided by US related person(s).

Question 19

One exception for dividends, interest, rents and royalties—the “CFC Look-thru rule” (§954(c)(6))

Answer 19

• Dividends, interest, rents, and royalties from a CFC which is a related person shall not be treated as FPHCI to the extent attributable to income of the related person which is not subpart F income or ECI, and does not create or increase a “qualified deficit” that could reduce the subpart F income of the payor or another CFC.
• §954(c)(6) was enacted in 2006 with the intention of facilitating the intragroup flow of funds between foreign subsidiaries.
• §954(c)(6) has always been a temporary provision, and has always been renewed in the past when it would otherwise have expired. Currently, it is effective for taxable years of foreign corporations beginning before January 1, 2026.

Question 20

Related Party defined – §954(d)(3)

Answer 20

• A person is a “related person” with respect to a CFC if the person is—
  − an individual, corporation, partnership, trust, or estate that controls or is controlled by the CFC; or
  − a corporation, partnership, trust, or estate that is controlled by the same person or persons who control the CFC
• “Control”
  − Corporation: Direct or indirect ownership of stock possessing more than 50% of the total combined voting power or value of the corporation’s stock
  − Partnership, trust, or estate: Director or indirect ownership of more than 50% (by value) of the beneficial interest in the partnership, trust, or estate
  − A modified version of §958 applies for this purpose. See Reg §1.954-1(f)(2)(iv)

Question 21

5 Step FBCI Computation

Answer 21

Step 1—Is there gross FBC, or do exceptions apply?
Step 2—What is the adjusted gross FBCI?
Step 3—Determine net FBCI (Allocate and apportion CFC deductions to adjusted gross FBCI)
Step 4—Determine adjusted net FBCI (what the Code calls “FBCI”)
Step 5—§952(c)(2) Recapture

Question 22

Adjusted gross FBCI

Answer 22

The gross FBCI of a CFC adjusted by the de minimis and full inclusion rules

Question 23

De Minimis Exception:

Answer 23

• If, in a particular year, a CFC’s Gross FBCI is:
  – Less than $1 million, and
  – Less than 5% of the CFC’s gross income,

Question 24

Full Inclusion Rule:

Answer 24

If, in a particular year, a CFC’s gross FBCI exceeds 70% of gross income, the CFC’s entire gross income is treated as adjusted FBCI

Question 25

Special rule for related party interest expenses:

Answer 25

Allocate first to passive FPHCI

Question 26

Net FBCI (Allocation/Apportionment of CFC Deductions) Five Step Process:

Answer 26

Step 3.1 — Determine the gross amount of each “item of income” described in Reg §1.954-1(c)(1)(iii)
Step 3.2 — Any expenses definitely related to less than all gross income as a class are allocated and apportioned under the principles of §§ 861, 864, and 904(d) to the items determined in Step 3.1
Step 3.3—Passive FPHCI is reduced (but not below zero) by related person interest expense allocable to passive income under Reg §1.904-5(c)(2)
Step 3.4—The related person interest expense allocated in Step 3.3 is further allocated among the separate groupings and categories of passive FPHCI specified in Reg §1.954-
1(c)(1)(iii)(B)
Step 3.5—The amount of each item determined in Step 3.1 is reduced by other expenses allocable and apportionable to such income under the principles of §§ 861, 864, and 904(d)

Question 27

Determine adjusted net FBCI (what the Code calls “FBCI”)

Answer 27

• E&P Limitation—Reduce net FBCI by amounts excluded from subpart F pursuant to §952(c)
  − Subpart F income cannot exceed the CFC’s current E&P
• High Tax Exception—Reduce net FBCI by items excluded from subpart F income by the high tax exception
  − High tax exception can be elected if the CFC’s “current year taxes” (see Reg §1.960-1(b)(4)) allocated and apportioned under Reg § 1.960-1(d)(3)(ii) to the “subpart F income group” (see Reg § 1.960-1(d)(2)(ii)(B)) that corresponds with the net item of FBCI, divided by the sum of the net item plus the taxes, > 90% of the US corporate income tax rate (i.e., > 18.9% (90% x 21%))

Question 28

§952(c)(2) Recapture

Answer 28

If the CFC’s subpart F income was reduced in a prior year due to the E&P limitation, any excess of current-year E&P over current-year subpart F income that is recharacterized as subpart F income and FBCI in the current year by §952(c)(2) increases adjusted net FBCI

Question 29

E&P Limitation

Answer 29

• Subpart F income is limited to current E&P
• If subpart F income is reduced by reason of the E&P limitation, recapture account is created under §952(c)(2)

Question 30

High Tax Exception

Answer 30

• Net item of net FBCI that is taxed at > 90%of the US corp income tax rate can be excluded from FBCI
• Must make election on tax return

Question 31

CFC Look-Thru Rule

Answer 31

• Certain dividends, interest, rents, and royalties, if not attributable or allocable to subpart F income or ECI, excluded from FPHCI
• Currently effective for CFC tax years beginning before 2026

Question 32

Same-Country Exception

Answer 32

Certain dividends and interest received from a related CFC organized, and having > 50% of its assets used in a trade or business, in the same country as payee, excluded from FPHCI

Question 33

FBCSI Exceptions

Answer 33

• FBCSI may exclude income derived from property either:
  o Produced by the CFC,
  o Produced in the CFC’s country of organization, or
  o Sold for use in the CFC’s country of organization

Question 34

FBCI exceptions

Answer 34

• Exceptions from FBCI
  o De Minimis §954(b)(3)
  o High Tax §954(b)(4)
• Exceptions from FPHCI
  o CFC Look-Through §954(c)(6)
  o Same Country §954(c)(3)(A)(i)
  o Active Rents and Royalties §954(c)(2)(A)
  o Qualified Finance Income §954(h)
  o Destination Test §954(d)(1)(B)
• Exception from FBCSI
  o Manufacturing by the CFC Reg §1.954-3(a)(4)

Question 35

Types of subpart F income other than FBCI

Answer 35

• Subpart F insurance income
• Income from operations participating or cooperating in an international boycott
• Illegal bribes, kickbacks, or other payments to government officials, employees, or agents
• Income from any foreign country to which §901(j) applies (a country whose government the US does not recognize, or with which the US has severed or does not conduct diplomatic relations, or designated as supporting acts of terrorism)

Question 36

Subpart F inclusions are also referred to as
“deemed distributions”, as opposed to “actual distributions”, because…

Answer 36

No cash or property is remitted to the US shareholder, yet the US shareholder is required to include the deemed distribution amount in taxable income on a current basis.

Question 37

Section 951(b) to defines United States shareholder as…

Answer 37

A United States person who owns, or is considered to own (within the meaning of either section 958(a) or 958(b)):
‒ 10% or more of the total combined voting power of all classes of voting stock of the foreign corporation, or
‒ 10% or more of the total value of shares of all
classes of stock in such foreign corporation

Question 38

6 Types of FPHCI

Answer 38

1. Dividend (§ 954(c)(1))
2. Interest (§ 954(c)(1))
3. Rents (§ 954(c)(1))
4. Royalties (§ 954(c)(1))
5. Excess of gain over loss from sale of stock, debt instruments, less-than-25% partnership interests, property that does not give rise to income (e.g., options) (§ 954(c)(1)(B))
6. Various other categories of income (e.g., certain commodities and currency gains, certain notional principal contract income, certain payments in lieu of dividends, etc.)

Question 39

Allocation and Apportionment

Answer 39

• Pursuant to Reg. § 1.861-8 and -8T
• Generally, the same rules for allocating and apportioning deductions to foreign source income for the FTC limitation (section 904)
• Special rule for related party interest expense: Allocated first to passive FPHCI (as you will learn in applying look-through for basketing)