TCJA and Expanding the definition of and number of "Controlled Foreign Corporations" subject to Subpart F

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As goes the number of “Controlled Foreign Corporations“, so goes the size of the U.S. tax base. The “messaging” was that the United States was moving to a system of “Territorial Taxation” for corporations. The reality is that the TCJA has actually increased the number of “non-U.S. corporations” that the United States claims to be be its “tax subjects”. (This has been accomplished by increasing the ways in which “non-U.S. corporations” can be treated as “controlled foreign corporations”. Furthermore, those “non-U.S. corporations (“controlled foreign corporations”), subject to U.S. tax jurisdiction, will be subject to U.S. tax on more income. I do understand that those “non-U.S. corporations” cannot be taxed directly by the United States. Fair enough. But “non-U.S. corporations” are clearly taxed indirectly by attributing income earned by the “controlled foreign corporation” to “United States Shareholders” under the Subpart F regime. In the same way that the United States is imposing taxation on the “worldwide” income of individuals who are “tax residents” of other nations, the United States is imposing taxation on the “worldwide income” of “non-U.S. corporations”. (This is done indirectly by imposing taxation on the “United States Shareholder” rather than on the “controlled foreign corporation” directly.) Although this has always been true, the “Tax Cuts and Jobs Act” has significantly expanded this taxation. This has been accomplished in at least three ways:
1. Expanding the definition of “United States Shareholder” in the Internal Revenue Code – Internal Revenue Code Sec.. 951
2. Expanding the circumstances under which the income from a “Controlled Foreign Corporation” is attributed to “United States Shareholders – Deleting the 30 day requirement – Internal Revenue Code Sec. 951
3. Increasing the number of “United States Shareholders” through changes in the “attribution rules” – Say “Good Bye” to Internal Revenue Code Sec. 958(b)(4)
This list is not intended to be exhaustive. I will discuss each of these in turn.

1. Expanding the definition of “United States Shareholder” in the Internal Revenue Code – Internal Revenue Code Sec.. 951
Prior to the TCJA, the test for “United States Shareholder” was based on 10% or more of the “voting control” of a “foreign corporation. The TCJA increased amended the test for to 10% of voting control or 10% of ownership of value of a “foreign corporation”.

(b) United States shareholder defined
For purposes of this title, the term “United States shareholder” means, with respect to any foreign corporation, a United States person (as defined in section 957(c)) who owns (within the meaning of section 958(a)), or is considered as owning by applying the rules of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, or 10 percent or more of the total value of shares of all classes of stock of such foreign corporation.

There are now more ways that one can qualify as a “United States Shareholder”.
2. Expanding the circumstances under which the income from a “Controlled Foreign Corporation” is attributed to “United States Shareholders – Deleting the 30 day requirement – Internal Revenue Code Sec. 951

(a) Amounts included
(1) In general If a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days for more at any time during any taxable year, every person who is a United States shareholder (as defined in subsection (b)) of such corporation and who owns (within the meaning of section 958(a)) stock in such corporation on the last day, in such year, on which such corporation is a controlled foreign corporation shall include in his gross income, for his taxable year in which or with which such taxable year of the corporation ends—

Prior to the TCJA, foreign corporations that were “controlled foreign corporations” for fewer than 30 uninterrupted days were NOT subject to the Subpart F rules.
3. Increasing the number of “United States Shareholders” through changes in the “attribution rules” – Say “Good Bye” to Internal Revenue Code Sec. 958(b)(4)
The old Sec. 958(b)(4) included the following:

Subparagraphs (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person.

Sec. 958(b)(4) has now been deleted.
Hmmm…, what could this possibly mean?
It appears that subparagraphs (A), (B), (C) of Internal Revenue Code Sec. 318(a)(3) can now be applied to consider a “United States person” as owning stock which IS owned by somebody who is NOT a “United States person”.
*The full text of Internal Revenue Code Sec. 318 is at the bottom of this post.
Next, let’s have a look at Internal Revenue Code Sec. 318(a)(3)(C) (here is a post by Phil Hodgen discussing this section) which describes how “constructive ownership” is attributed TO corporations.

(C) To corporations
If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person.

Notice that this part of Sec. 318 describes how to attribute ownership of stock “to corporations”.
Here is the sequence of events:
1. A “foreign company” is the 100% owner of a “U.S. company”.
2. Pursuant to Sec. 318(a)(3)(C), the “U.S. company” owns the stock of the “foreign company”.
3. The “foreign company” is the owner of a “foreign subsidiary”.
4. By owning the shares of the “foreign company”, the “U.S. company” steps into the shoes of the “foreign company”, and now owns the shares of the “foreign subsidiary”.
5. If the “foreign company” owns more than 50% of the shares of the “foreign subsidiary” then the “U.S. company” (because it is the owner of the shares of the “foreign company”) now owns more than 50% of the “foreign subsidiary”.
6. The “foreign subsidiary” (which has nothing whatsoever do do with the United States) is now a “Controlled Foreign Corporation” for U.S. tax purposes.
7. This means that the “U.S. company” (as the owner of a CFC) is now subject to: Form 5471, Subpart F income and possibly the new Sec. 965 “transition tax” (and possibly the GILTI regime).
Simply incredible …
To give credit where credit is clearly due, this issue is discussed by Alex Perez in the posts referenced in the following tweets:


and here


More unintended consequences
As Mr. Perez points out in his post:

The really sad thing here is that Congress didn’t intend this result. The legislative history of the statute indicates the change in the law is intended to combat a specific type of abuse—a “de-controlling transaction.” But the law change now affects every non-US company with a US subsidiary, not just those guilty of performing “de-controlling” transfers of shares. Tax professionals are already calling this change the “Permanent Employment for Tax Professionals Act.” Thank you U.S. Congress.

Of course the possible application of the “transition tax” to the individual U.S. shareholders living abroad is also an unintended consequence.
And the question is …
What should be the response of one who in the “cross hairs” of the incredibly unfair application of the unintended consequence of a law?
Conclusion:
It would appear that when the United States moved to a limited form of “territorial taxation” for corporations, it was really expanding it’s “tax territory” into other countries!
_________________________________________________________________________________________________
Appendix – Attribution Legislation
Part A – Introduction – Three kinds of ownership
There are thee ways that one can own shares in a company
1. Direct ownership – you own the shares directly
2. Indirect ownership – you own something that owns the shares
3. Constructive ownership – because of your relationship with somebody you are deemed to own the shares that they own
Each of these kinds of ownership is reflected in the following sections of the Internal Revenue Code
Part B – Internal Revenue Code – Sec. 318 – The General Attribution Rule
*
https://www.law.cornell.edu/uscode/text/26/318
General attribution rules

26 U.S. Code § 318 – Constructive ownership of stock
(a) 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 for—
(i) 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.
(B) Effect of adoption
For purposes of subparagraph (A)(ii), a legally adopted child of an individual shall be treated as a child of such individual by blood.
(2) Attribution from partnerships, estates, trusts, and corporations
(A) From partnerships and estates
Stock owned, directly or indirectly, by or for a partnership or estate shall be considered as owned proportionately by its partners or beneficiaries.
(B) From trusts
(i) Stock owned, directly or indirectly, by or for a trust (other than an employees’ trust described in section 401(a) which is exempt from tax under section 501(a)) shall be considered as owned by its beneficiaries in proportion to the actuarial interest of such beneficiaries in such trust.
(ii) Stock owned, directly or indirectly, by or for any portion of a trust of which a person is considered the owner under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by such person.
(C) From corporations
If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.
(3) Attribution to partnerships, estates, trusts, and corporations
(A) To partnerships and estates
Stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as owned by the partnership or estate.
(B) To trusts
(i) Stock owned, directly or indirectly, by or for a beneficiary of a trust (other than an employees’ trust described in section 401(a) which is exempt from tax under section 501(a)) shall be considered as owned by the trust, unless such beneficiary’s interest in the trust is a remote contingent interest. For purposes of this clause, a contingent interest of a beneficiary in a trust shall be considered remote if, under the maximum exercise of discretion by the trustee in favor of such beneficiary, the value of such interest, computed actuarially, is 5 percent or less of the value of the trust property.
(ii) Stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by the trust.
(C) To corporations
If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person.
(4) Options
If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock.
(5) Operating rules
(A) In general
Except as provided in subparagraphs (B) and (C), stock constructively owned by a person by reason of the application of paragraph (1), (2), (3), or (4), shall, for purposes of applying paragraphs (1), (2), (3), and (4), be considered as actually owned by such person.
(B) Members of family
Stock constructively owned by an individual by reason of the application of paragraph (1) shall not be considered as owned by him for purposes of again applying paragraph (1) in order to make another the constructive owner of such stock.
(C) Partnerships, estates, trusts, and corporations
Stock constructively owned by a partnership, estate, trust, or corporation by reason of the application of paragraph (3) shall not be considered as owned by it for purposes of applying paragraph (2) in order to make another the constructive owner of such stock.
(D) Option rule in lieu of family rule
For purposes of this paragraph, if stock may be considered as owned by an individual under paragraph (1) or (4), it shall be considered as owned by him under paragraph (4).
(E) S corporation treated as partnershipFor purposes of this subsection—
(i) an S corporation shall be treated as a partnership, and
(ii) any shareholder of the S corporation shall be treated as a partner of such partnership.
The preceding sentence shall not apply for purposes of determining whether stock in the S corporation is constructively owned by any person.
(b) Cross references For provisions to which the rules contained in subsection (a) apply, see—
(1) section 302 (relating to redemption of stock);
(2) section 304 (relating to redemption by related corporations);
(3) section 306(b)(1)(A) (relating to disposition of section 306 stock);
(4) section 338(h)(3) (defining purchase);
(5) section 382(l
)(3) (relating to special limitations on net operating loss carryovers);
(6) section 856(d) (relating to definition of rents from real property in the case of real estate investment trusts);
(7) section 958(b) (relating to constructive ownership rules with respect to controlled foreign corporations); and
(8) section 6038(e)(2) (relating to information with respect to certain foreign corporations).

The constructive ownership rules in Sec. 318 are (in some respects) modified by the “Rules for determining stock ownership” found in Internal Revenue Code Sec. 958 and Internal Revenue Code Sec. 6038. Note that Sec. 958 is part of Subpart F. Therefore, these rules are used to attribute share ownership for the purpose of (1) defining who/what is a “United States Shareholder” or (2) determining whether a “foreign corporation” is a “controlled foreign corporation”.
Part C – Internal Revenue Code – Sec. 958 – Modification of Sec. 318 for Subpart F Only

26 U.S. Code § 958 – Rules for determining stock ownership
a) Direct and indirect ownership
(1) General rule For purposes of this subpart (other than section 960), stock owned means—
(A) stock owned directly, and
(B) stock owned with the application of paragraph (2).
(2) Stock ownership through foreign entities
For purposes of subparagraph (B) of paragraph (1), stock owned, directly or indirectly, by or for a foreign corporation, foreign partnership, or foreign trust or foreign estate (within the meaning of section 7701(a)(31)) shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. Stock considered to be owned by a person by reason of the application of the preceding sentence shall, for purposes of applying such sentence, be treated as actually owned by such person.
(3) Special rule for mutual insurance companies
For purposes of applying paragraph (1) in the case of a foreign mutual insurance company, the term “stock” shall include any certificate entitling the holder to voting power in the corporation.
(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.

Part D – Internal Revenue Code – Sec. 6038 – Attribution rules for Sec. 6038 Only
Internal Revenue Code Sec. 6038
https://www.law.cornell.edu/uscode/text/26/6038
The “constructive ownership” rules in Sec. 318 are modified by Internal Revenue Code Sec. 6038. Sec. 6038 defines who is a “United States Shareholder” and whether a “foreign corporation” is a “controlled foreign corporation” for Sec. 6038 reporting purposes.

26 U.S. Code § 6038 – Information reporting with respect to certain foreign corporations and partnerships
(e) Definitions For purposes of this section—
(1) Foreign business entity
The term “foreign business entity” means a foreign corporation and a foreign partnership.
(2) Control of corporation A person is in control of a corporation if such person owns stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or more than 50 percent of the total value of shares of all classes of stock, of a corporation. If a person is in control (within the meaning of the preceding sentence) of a corporation which in turn owns more than 50 percent of the total combined voting power of all classes of stock entitled to vote of another corporation, or owns more than 50 percent of the total value of the shares of all classes of stock of another corporation, then such person shall be treated as in control of such other corporation. For purposes of this paragraph, the rules prescribed by section 318(a) for determining ownership of stock shall apply; except that—
(A) subparagraphs (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person, and
(B) 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)

How the attribution rules in Sec. 6038 differ from the attribution rules in Sec. 958
1. (A) subparagraphs (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person, and
(applies in Sec. 6038 and does NOT apply in Sec. 958)
2. Under Sec. 958 a U.S. person cannot have share ownership attributed to him from an “alien”. Under Sec. 6038 a U.S. person CAN have ownership attributed to him from an alien.
Internal Revenue Code Sec. 6046 – Prescribes information return requirement for change in share ownership
https://www.law.cornell.edu/uscode/text/26/6046
Part E – Internal Revenue Code – Sec. 6046 – Attribution rules for Sec. 6046 Only
Internal Revenue Code Sec. 6046

26 U.S. Code § 6046 – Returns as to organization or reorganization of foreign corporations and as to acquisitions of their stock
(a) Requirement of return
(1) In general A return complying with the requirements of subsection (b) shall be made by—
(A) each United States citizen or resident who becomes an officer or director of a foreign corporation if a United States person (as defined in section 7701(a)(30)) meets the stock ownership requirements of paragraph (2) with respect to such corporation,
(B) each United States person—
(i) who acquires stock which, when added to any stock owned on the date of such acquisition, meets the stock ownership requirements of paragraph (2) with respect to a foreign corporation, or
(ii) who acquires stock which, without regard to stock owned on the date of such acquisition, meets the stock ownership requirements of paragraph (2) with respect to a foreign corporation,
(C) each person (not described in subparagraph (B)) who is treated as a United States shareholder under section 953(c) with respect to a foreign corporation, and
(D) each person who becomes a United States person while meeting the stock ownership requirements of paragraph (2) with respect to stock of a foreign corporation.
In the case of a foreign corporation with respect to which any person is treated as a United States shareholder under section 953(c), subparagraph (A) shall be treated as including a reference to each United States person who is an officer or director of such corporation.
(2) Stock ownership requirements A person meets the stock ownership requirements of this paragraph with respect to any corporation if such person owns 10 percent or more of—
(A) the total combined voting power of all classes of stock of such corporation entitled to vote, or
(B) the total value of the stock of such corporation.
(b) Form and contents of returns
The returns required by subsection (a) shall be in such form and shall set forth, in respect of the foreign corporation, such information as the Secretary prescribes by forms or regulations as necessary for carrying out the provisions of the income tax laws, except that in the case of persons described only in subsection (a)(1)(A) the information required shall be limited to the names and addresses of persons described in subparagraph (B) or (C) of subsection (a)(1).
(c) Ownership of stock
For purposes of subsection (a), stock owned directly or indirectly by a person (including, in the case of an individual, stock owned by members of his family) shall be taken into account. For purposes of the preceding sentence, the family of an individual shall be considered as including only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.
(d) Time for filing
Any return required by subsection (a) shall be filed on or before the 90th day after the day on which, under any provision of subsection (a), the United States citizen, resident, or person becomes liable to file such return (or on or before such later day as the Secretary may by forms or regulations prescribe).
(e) Limitation
No information shall be required to be furnished under this section with respect to any foreigncorporation unless such information was required to be furnished under regulations which have been in effect for at least 90 days before the date on which the United States citizen, resident, or person becomes liable to file a return required under subsection (a).
(f) Cross reference
For provisions relating to penalties for violations of this section, sections 6679 and 7203.

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