992 / Are there any exceptions that can prevent Subpart F income from being currently taxable to U.S. shareholders in a CFC?

Various exceptions are included in the Subpart F provisions to provide relief for U.S. taxpayers. In limited situations, the exceptions may be useful in the U.S. tax planning context. These exceptions include a de minimis rule which prevents Subpart F income from being currently includable in gross income when that income is a very small component of the CFC’s income. Further, Subpart F income is not currently taxable if it has already been subjected to a high rate of foreign income tax.

The 5-70 Rule

None of a CFC’s gross income for a taxable year is treated as foreign base company income (or tax haven insurance income) if the sum of the corporation’s gross foreign base company income (and gross tax haven insurance income) for the year is less than the lesser of (i) five percent of its gross income or (ii) $1 million.¹

CFCs with a functional currency other than the U.S. dollar must translate income using the appropriate exchange rate.² If, however, the foreign base company income of the CFC exceeds 70 percent of the CFC’s gross income, the CFC’s entire gross income for the year (not limited to its Subpart F income) is treated as foreign base company income (and, therefore, currently included in the income of the U.S. shareholders).³

If the foreign base company income is between five percent and 70 percent of the CFC’s gross income, the actual portion of gross income which is foreign base company income is to be so treated for current income inclusion purposes.⁴

An anti-abuse rule applies in this context. The income of two or more CFCs must be aggregated and treated as the income of a single corporation if a principal purpose for separately organizing, acquiring, or maintaining the structure is to avoid the application of either (i) the de minimis rule or (ii) the full inclusion rule.⁵

The “High Foreign Tax” Exception

Under the “high foreign tax exception”, foreign base company income and insurance income does not include any item of income received by a CFC if the taxpayer has established that the specific income item was subject to an effective rate of foreign country income tax greater than 90 percent of the maximum corporate income tax rate specified in IRC Section 11.⁶

The taxpayer may make an election to use this exception and exclude the specific income item from the computation of Subpart F income.⁷

In other words, because the current U.S. corporate tax rate is 21 percent, the foreign effective tax rate with respect to the particular income item must exceed 18.9 percent to qualify under this exception.

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Planning Point: Note that what is required to qualify for this exception is an “effective rate” and not a nominal tax rate. The effective rate at which taxes are imposed on a net item of income is (i) the U.S. dollar amount of foreign income taxes paid or accrued (or deemed paid or accrued) with respect to the net item of income divided by (ii) the U.S. dollar amount of the net item of foreign base company income, as increased by the amount of attributable taxes.⁸

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For purposes of determining a CFC’s foreign base company income, the CFC may take into account deductions properly allocable to the income.⁹ These rules essentially incorporate the deduction rules that apply to domestic corporations.