• Monte Silver, Tax lawyer

Can a foreign corporation with a single U.S. shareholder who owns only 31% of the company be a CFC?

Can a foreign corporation with a single U.S. shareholder who owns only 31% of the company be a CFC? Yes!

It is common knowledge among U.S. tax practitioners that a controlled foreign corporation (“CFC”) is a foreign corporation where “U.S. Shareholders” own more than 50% of either: (i) the total combined voting power of stock of a corporation entitled to vote, or (ii) the total value of the corporation’s stock.

We also know that a U.S. Shareholder is a U.S. Person (citizen, greencard holder or U.S. resident) who owns 10 percent or more of the foreign corporation’s stock.*

Is the above definition of a CFC exclusive? No. In fact, the Treasury’s CFC regulations clearly state that a foreign company may be a CFC even if the above tests are not met.

When? Where a foreign corporation has two classes of stock, and one or more U.S. Persons own a majority of the class of shares that has the power to appoint a majority of the board of directors, that company is a CFC.

A numerical example may be helpful. Let us assume that a foreign corporation has two classes of stock – Common Stock A and Preferred Stock B. The majority of Stock A holders can elect 7 board members and a majority of Stock B holders can elect 3 board members, totaling 10 board members.

Now let us assume that there are 60 A stock and 40 B stock outstanding. Finally, let us assume that Person X is a U.S. citizen who holds 31 shares of Stock A, and that the company has no other shareholders who are U.S. Persons.

If this company a CFC? Under standard rules, no. Why? Only 31% (less than the requisite 50% of the voting stock) is owned by U.S. Shareholders.

But under the regulations, this corporation is a CFC. Why? Because Person X can elect a majority of the Board! Very bad surprise! Note that the same result would be true if three different U.S. Persons - X, Y, Z – together owned the 31 shares (say 10, 10 and 11 shares).

In the age of GILTI and Transition tax, being a CFC can be quite painful. Thus foreign companies that have U.S. Person shareholders and have or are considering to have more than one class of shares should beware.

* Of course, there are also attribution rules. For example, stock owned by my American children or wife are attributable to me, the father. See Code section 958.

Nothing herein is considered legal advice

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