A great many people seem to believe it’s possible to accumulate profits tax free by owning income producing assets with a foreign corporation located in a tax haven country. What these people don’t know is that the laws have changed. It used to be possible (many years ago) to shelter investment profits by putting your investments into a foreign corporation. But the laws have been changed over the years so that some U.S. shareholders of a controlled foreign corporation (CFC) are taxed currently on any investment income and certain types of business income as if the corporation were a partnership or S corporation. The “tainted income” (called Sub-part F income) is subject to current tax by these shareholders as if the income had been distributed to them.

However, there are some exceptions to the rules if you are willing to have unrelated foreign partners or a lot of smaller shareholders. 

First, a “U.S. shareholder” is defined for this purpose as one who owns at least ten percent of the stock of the CFC. Second, the foreign corporation is a “controlled” foreign corporation if five or fewer U.S. shareholders (as defined) own more than 50% of the stock. These mechanical tests leave some room for those who are willing to have effective control rather than absolute control. Here are some examples of the exceptions.   

•  an unrelated foreign person owns 50% of the foreign corporation
•  eleven U.S. persons each own 9.09% of the corporation
•  one U.S. person owns  40% of the corporation and ten others each own 6%

These rules only apply to certain types of income, which is primarily investment income and an assortment of income items derived from transactions with related persons or organizations in the U.S. Income earned from a genuine foreign trade or business is not generally subject to current taxation by U.S. shareholders, even if they control the CFC.

Even if the foreign corporation is not a CFC because of the U.S. ownership of the corporation, any income from investments may still be subject to U.S. tax because of the foreign personal holding company rules or the passive foreign investment company rules. Thus, the benefits of having a non-controlled foreign corporation is essentially limited to income from a bone fide foreign trade or business, in a low tax country. That makes it more difficult to benefit from using a foreign corporation.

Very extensive information on this and related topics is included in the 3rd Edition of the Controlled Foreign Corporation Tax Guide which is co-authored by Richard Duke and myself.