The earnings of foreign corporations generally are not taxed in the U.S. until the foreign corporation repatriates its earnings through the distribution of dividends. This is known as the concept of “deferral” (i.e., U.S. taxation is deferred until repatriation). Various exceptions to deferral exist today (often referred to as “anti-deferral” regimes). Subpart F income is one of these exceptions to deferral. Subpart F income only applies to Controlled Foreign Corporations (CFC’s).
A CFC, very generally, is defined as a foreign corporation in which U.S. persons own more than 50 percent of the corporation’s stock (measured by vote or value). Stock ownership includes direct ownership as well as stock owned indirectly or constructively.
When a CFC earns subpart F income, the United States generally taxes the corporation’s U.S. shareholders currently on their pro rata share thereof. Those shareholders are effectively treated as having received current income consisting of subpart F income.
Subpart F income typically is income that is relatively movable from one taxing jurisdiction to another and that is subject to low rates of foreign tax. Subpart F income consists of various types of income.
Earnings and profits (“E&P”) of a CFC that have been included in the income of the U.S. shareholders are not taxed again when such earnings are actually distributed to the U.S. shareholders. These earnings are known as “previously taxed income” or “PTI.”
Various special provisions apply in the application of the subpart F rules, including “de minimis” and “full inclusion” rules, and an exception for certain income subject to high foreign taxes. Furthermore, the subpart F income of a CFC is limited by its current E&P.
Foreign Personal Holding Company Income
Foreign Personal Holding Company Income (“FPHC income”) is a major type of subpart F income. Generally, it consists of passive income such as interest, dividends, annuities, net gains from sales of property that do not generate active income, net commodities gains, net foreign currency gains, certain rents and royalties, and income from personal service contracts.
An exclusion exists for certain dividends, interest, rents, and royalties received from related corporations where the payor corporation is organized and operating in the same foreign country as the recipient. This exclusion, often colloquially referred to as the “same country exception,” is subject to various exceptions. Another exclusion exists for rents and royalties received from unrelated persons in the active conduct of a trade or business.
A temporary exception (known as the "CFC look-thru rule"), which has been extended several times, excludes certain dividends, interest, rents, and royalties from FPHC income, even if the paying entity is not incorporated in the same country as the recipient.
Foreign Base Company Sales Income
Foreign Base Company Sales Income is income attributable to related-party purchases and sales of personal property made through a CFC if the country of the CFC’s incorporation is neither the origin nor the destination of the goods and the CFC itself has not “manufactured” these goods.
Special branch rules can deemed certain related party transactions.
Foreign Base Company Services Income
Foreign Base Company Services Income includes income from services performed by a CFC for or on behalf of a related party where the services are performed outside the country of the CFC’s incorporation.
There are also several other types of Subpart F Income not described here.