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How Controlled Foreign Corporation Rules Look Around the World: United States of America

10 min readBy: Sebastian Dueñas, Daniel Bunn

This post is the first in a series about Controlled Foreign Corporation (CFC) rules, which were created to provide countries a tool to taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. part of the income that foreign subsidiaries earn abroad.

Multinational corporations do business in different countries around the world. Taxing businesses across multiple jurisdictions raises several key issues, including what income should be taxed by any given country. Countries have various approaches to taxing the income of foreign subsidiaries of multinationals, and territorial taxation is most common these days. This means a corporation pays taxes in a country only on the income that is earned from the operations within that country’s boundaries.

One of the problems that territorial systems face is that multinational companies can structure their businesses to reduce the amount of taxes paid. In some cases, those structures can lead to base erosion and profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. , leaving a country with little or no tax collected from the parent company. To protect their tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s, countries often have rules to determine when the income of a company doing business abroad should be taxed and when foreign income is exempt from taxation.

This is where CFC rules come in. Most CFC rules have a similar structure, but countries have various approaches on how to address any resulting base erosion and profit shifting. Generally, CFC rules help determine when a domestic corporation has enough control of a foreign subsidiary to tax its earnings under domestic law and which earnings and how much of those earnings are taxed. Not all countries have CFC rules, however, and there have been significant changes to CFC legislation in various countries in recent years.

CFC Rules in the U.S.

CFC rules in the U.S. were created in 1960 and have been modified significantly over the years. The following timeline shows how CFC rules have emerged and developed since 1960.

Year Event


Following the end of World War II, U.S. policy was supportive to foreign private investment overseas by way of tax deferral, to allow multinational companies to invest abroad.


CFC rules were created to gather information on U.S. entities investing overseas.


President John F. Kennedy proposed a reform to eliminate deferral of U.S. tax on foreign source income.


CFC rules were modified to include Subpart F income; the new rules incorporated the 50 percent control standard. The U.S. shareholder concept was created for any U.S. person who owned 10 percent of a foreign corporation.


Germany is the second country to adopt CFC rules.


The Tax Reduction Act in the U.S. expanded the Subpart F regime to include types of shipping income.


Canada incorporates CFC rules to its tax regime.


Japan enacts CFC rules.


France incorporates the CFC regime into its legislation to address the abusive use of the participation exemption.


The United Kingdom incorporates CFC rules, to address paper regimes that lead to capital exports with no consequences.


The 1986 Tax Reform Act in the U.S. adjusted the control standard to 50 percent of the stock entitled to vote or the total value, of shares owned by U.S. persons.


Spain incorporates CFC rules.


The American Jobs Creation Act allowed a one-time 85 percent dividend deduction for cash dividends received from CFCs.


The People’s Republic of China enacts CFC legislation.


The United Kingdom reforms its CFC rules.


The OECD releases the final report of BEPS Action 3 on CFC rules.


The Republic of Colombia enacts CFC rules. The EU Council releases the Anti-Tax Avoidance Directive (ATAD).


TCJA is enacted, the 50 percent control and 10 percent shareholding thresholds are expanded to vote or value. The U.S. creates the Global Intangible Low-Taxed Income (GILTI).


The Netherlands incorporates CFC rules. ATAD is mandatory on January 1, 2019.

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What is the basic structure of CFC rules?

CFC rules generally follow a basic outline. First, the rules contain an ownership threshold to determine if a foreign entity is sufficiently controlled by domestic shareholders to be considered a CFC. Second, there is a taxation condition that can include a rule to determine whether the income of the CFC has already been taxed at a minimum level by the foreign country, and sometimes this is combined with a list of territories that determine whether the foreign entity should be exempt from domestic taxation. Third, CFC rules identify the type of income to which the rules are applicable, whether only passive income (that is, interest or capital gains) or all income that is received by the CFC. Each of those three requirements will be addressed when analyzing the rules of each of the presented countries.

Shareholding requirement for the control determination in the U.S.

The U.S. standard for control lays out the ownership requirement to determine if a foreign entity is a CFC. The Internal Revenue Code defines a U.S. shareholder as any person who holds 10 percent or more of vote or value of a foreign corporation. A foreign corporation is a CFC if more than 50 percent of the vote or value of the entity is controlled by U.S. shareholders. This control threshold can be met using assessments of direct, indirect, and constructive ownership.

Direct ownership is when U.S. shareholders own more than 50 percent of the vote or value of the foreign entity.

To illustrate how the indirect ownership rules work, imagine that Pete and Anne are both U.S. persons and each directly owns 50 percent of a foreign entity called ForCo A. Additionally, ForCo A directly owns 60 percent of another foreign entity ForCo B.

Indirectly, then, Pete and Anne each owns 30 percent of the shares of ForCo B, calculated as follows (50% x 60% = 30%). Because both Pete and Anne are considered U.S. persons, and each holds more than 10 percent of the foreign corporation shares (30 percent), both will be considered U.S. shareholders of ForCo B. Also, more than 50 percent of ForCo B is owned by U.S. persons (both hold a total of 60 percent) and therefore ForCo B is considered a CFC.

The calculation using constructive ownership rules consists of:

  • Adding up the effective ownership of stock that is owned by related persons including entities, individuals, spouses, children, grandchildren, or parents.
  • Combining stock that is owned directly by a foreign entity, if it is indirectly owned by U.S. shareholders in proportion to their ownership of that foreign entity. This applies to foreign corporations, estates, or partnerships.

Applicability of the rules

Once an entity is categorized as a CFC, it is necessary to determine what foreign income should be taxed in the U.S. Generally, the income that falls into one of the categories defined in Subpart F of the Internal Revenue Code income is taxed in the U.S.

Income from a CFC that is categorized as Subpart F income has to be included in the gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” of the parent company and will be taxed at the U.S. income tax rate in the hands of the shareholders. CFC income is determined for each individual foreign entity level and then attributed to U.S. shareholders to be taxed.

Subpart F income has different subcategories that include insurance income and foreign base company income (foreign personal holding company income, foreign base company sales income, foreign base company services income, foreign base company shipping income). Subpart F income also includes income that is subject to international boycott rules, illegal bribes, kickbacks, or other unlawful payments, and income derived from any foreign country.

The U.S. has not adopted a list of countries considered as tax havens, and its approach has been more focused on transactions and the abusive use of tax shelters. Treasury regulations require that certain tax shelters and transactions be registered, or that a list of investors is maintained by the parties that are part of any of these transactions (parties can include banks, corporations, or other persons). The IRS requires that some of this information be disclosed on tax returns of the participants for control purposes.

What is the type of income that is taxable: all income or just passive income?

The income that is assessable under CFC rules is generally passive income. Before tax reform, U.S. legislation primarily targeted foreign passive income, and income derived from low-tax jurisdictions to be taxed as Subpart F income. Certain foreign investment companies that do not qualify as a CFC but still have one or more U.S. persons as owners on their structure face rules similar to CFC rules, and the income derived from their operations is taxed in the U.S.

For passive foreign investment companies (PFICs) that are taxed when 75 percent of a foreign investment company’s total income is derived from passive sources (that is, capital gains or interest income), or 50 percent of the assets produce passive income, such investment funds are subject to current domestic taxation. When a company that is considered a PFIC also qualifies as a CFC then that company is taxed under Subpart F income rules and the passive foreign investment rules are not applicable. The main idea on both cases is to allow the U.S. to tax some of the income that is derived from other countries and may not face U.S. taxation if there were no rules in place.

As part of the Tax Jobs and Cuts Act enacted in 2017, the Global Intangible Low-Taxed Income (GILTI) expanded the breadth of the U.S. CFC regime. GILTI broadened the tax base for U.S. multinational companies, not only making the U.S. system more complex but also more aggressive against base erosion and profit shifting.

As with CFC rules, GILTI rules only apply to foreign entities that are 50 percent owned by U.S. shareholders; the definition of U.S. shareholder is also shared in the application of the rules. Unlike Subpart F rules, GILTI is calculated by adding up all the income and losses of CFCs to determine how much income will be subject to GILTI for domestic taxation. A 10 percent exclusion for qualified business asset investment (QBAI) is allowed for each foreign entity before aggregating the amount of foreign income subject to GILTI. Interest expenses for foreign entities reduce the amount of the QBAI exclusion at the entity level. The GILTI also limits the tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. for foreign taxes paid to 80 percent.

This results in GILTI income being taxed within a range of 10.5 percent to 13.125 percent. However, some businesses are finding that their GILTI is being taxed at much higher effective rates.

The positive tested income (the excess of gross income, not considering dividends and Subpart F income among others) is aggregated at the shareholder level, and the total amount is netted against tested losses (for the CFC that had a negative result at the end of a period). In the GILTI calculation there is a 50 percent deduction of GILTI income at the shareholder level that reduces the amount of tax to be paid.


The United States was the first country to enact CFC rules, and it is probably the country with the most complex set of rules that will be presented in this blog series. The rules determine control using a combined ownership test: one for the corporation and the other at the shareholder level. The assessable income under the rules is generally passive income but the amount of foreign income subject to U.S. tax has expanded with the adoption of GILTI.

Note: This is the first of nine posts which describe how CFC rules work in the United States, China, Spain, Germany, Colombia, France, Netherlands, Japan, and the United Kingdom. A longer discussion of the history of CFC rules and more details on these countries can be found here.

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