Indirect Stock Ownership Rules for Foreign Corporations (CFC)

Indirect Stock Ownership Rules for Foreign Corporations (CFC)

Indirect Stock Ownership Rules

One of the most complicated aspects of international tax law and tax law, in general, is the constructive ownership/attribution rules. From a baseline perspective, constructive ownership is the idea that a person is deemed an owner of certain assets, etc. even though technically they are not the actual or ‘direct’ owner of the assets. In the world of offshore tax compliance, this is a significant complication when US Taxpayers have to file Form 5471 which is used to report foreign corporations. While the US person may not have actual ownership of the foreign stock — based on the constructive ownership attribution rules — they may be deemed to have ownership for reporting purposes — and required to file certain IRS Tax forms. Failure to file these forms may result in significant fines and penalties – which is why it is important to have a basic understanding of whether these rules impact you.

*This summary is focused on individual attribution and constructive ownership rules.

Common Attribution Factual Scenario

David is originally from a foreign country but relocated to the United States several years ago as a lawful permanent resident. Together with his family members who still live abroad, he owns a minority share of a Sociedad Anónima that has ownership of various properties and assets. His wife is also a minority shareholder in the company — and is considered a US person as well. Let’s take a walk through some of the important code sections involving constructive ownership:

Section 318

U.S. Code § 318 – Constructive ownership of stock

General rule

      • For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable—

        • (1) Members of family

          • (A)In general

            • An individual shall be considered as owning the stock owned, directly or indirectly, by or fo r—

              • his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and (ii)his children, grandchildren, and parents.

What does this Mean?

It means that a US person will be considered as owning the stock of a company as a result of either their spouse child, grandchild, or parent owning the stock. The concept behind this rule is to make sure that there is no funny business behind the scenes in which some family members own the stock — but they are actually owning it on behalf of another person, although not technically serving as an agent and not having direct ownership of the stock.

Subsection 318 5(b)

Subsection 5(b) of Internal Revenue Code section 318 cross-references other sections of the Internal Revenue Code, including section 958(b) which are specifically for CFCs (Controlled Foreign Corporations).

26 USC 958 (b) – Constructive ownership

      • For purposes of sections 951(b), 954(d)(3), 956(c)(2), and 957, section 318(a) (relating to constructive ownership of stock) shall apply to the extent that the effect is to treat any United States person as a United States shareholder within the meaning of section 951(b), to treat a person as a related person within the meaning of section 954(d)(3), to treat the stock of a domestic corporation as owned by a United States shareholder of the controlled foreign corporation for purposes of section 956(c)(2), or to treat a foreign corporation as a controlled foreign corporation under section 957, except that—

        • (1) In applying paragraph (1)(A) of section 318(a), stock owned by a nonresident alien individual (other than a foreign trust or foreign estate) shall not be considered as owned by a citizen or by a resident alien individual.

        • (2) In applying subparagraphs (A), (B), and (C) of section 318(a)(2), if a partnership, estate, trust, or corporation owns, directly or indirectly, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of a corporation, it shall be considered as owning all the stock entitled to vote.

        • (3) In applying subparagraph (C) of section 318(a)(2), the phrase “10 percent” shall be substituted for the phrase “50 percent” used in subparagraph (C). Paragraph (1) shall not apply for purposes of section 956(c)(2) to treat stock of a domestic corporation as not owned by a United States shareholder.

What does this Mean?

This means that section 318 (referring to construction ownership of stock) applies to Controlled Foreign Corporations in accordance with section 958. One very important aspect of this code section is subsection (1) which provides that if one of the related parties is a non-resident alien, then their ownership is not applied to determine constructive ownership by a resident alien or US citizen.

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