Controlled foreign corporation

Controlled foreign corporation (CFC) rules are features of an income tax system designed to limit artificial deferral of tax by using offshore low taxed entities. The rules are needed only with respect to income of an entity that is not currently taxed to the owners of the entity. Generally, certain classes of taxpayers must include in their income currently certain amounts earned by foreign entities they or related persons control.

A set of rules generally defines the types of owners and entities affected, the types of income or investments subject to current inclusion, exceptions to inclusion, and means of preventing double inclusion of the same income. Countries with CFC rules include the United States (since 1962), the United Kingdom, Germany, Japan, Australia, New Zealand, Brazil, Russia (since 2015), Sweden, and many others. Rules in different countries may vary significantly.

The tax law of many countries, including the United States, does not tax a shareholder of a corporation on the corporation's income until the income is distributed as a dividend. Prior to U.S. CFC rules, it was common for publicly traded companies in the United States to form foreign subsidiaries in tax havens and shift "portable" income to those subsidiaries. Income shifted included investment income (interest and dividends) and passive income (rents and royalties), as well as sales and services income involving related parties (see transfer pricing). U.S. tax on this income was avoided until the tax haven country paid a dividend to the shareholding company. This dividend could be avoided indefinitely by loaning the earnings to the shareholder without actually declaring a dividend. The CFC rules of Subpart F were intended to cause current taxation to the shareholder where income was of a sort that could be artificially shifted or was made available to the shareholder. At the same time, such rules were intended not to interfere with active business income or transactions with unrelated parties.

The rules vary, so this paragraph may not exactly describe a particular tax system. However, the features listed are prevalent in most CFC systems. A domestic person who is a member of a foreign corporation (a CFC) that is controlled by domestic members must include in such person's income the person's share of the CFC's subject income. The includible income (often determined net of expenses) generally includes income received by the CFC:

In addition, many CFC rules treat as a deemed dividend earnings of the CFC loaned by the CFC to domestic related parties. Further, most CFC rules permit exclusion from taxable income of dividends paid by a CFC from earnings previously taxed to members under the CFC rules.

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