Moving the "management and control" of a foreign corporation to achieve favorable U.S. tax results.

• Author: Rubinger, Jeffrey L.
• Position: Part 1

There is a multitude of international tax provisions in the Internal Revenue Code (Code) where the U.S. federal income tax consequences of a particular transaction turn on where a foreign corporation is "created or organized." For example, in the subpart F provisions of the Code, (1) dividends or interest received by a controlled foreign corporation (CFC) (2) from a related corporation that is created or organized under the laws of the same foreign country in which the CFC is created or organized will not be treated as "foreign personal holding company income" so long as the related corporation has a substantial part of its assets used in its trade or business located in such same foreign country (otherwise known as the "same country" exception). (3) This rule applies even if the CFC is "managed and controlled," and therefore resident in a different jurisdiction from the related foreign corporation. Similarly, a CFC will generate "foreign base company services income" only if, among other things, the income is derived from the performance of services outside of the jurisdiction in which the CFC is created or organized. (4)

The two parts of this article will examine these and other provisions that essentially allow a taxpayer to form a foreign corporation in a particular jurisdiction and move the management and control of such entity to a more favorable taxing jurisdiction, while at the same time avoiding certain adverse U.S. federal income tax provisions of the Code.

Determination of Corporate Residence

The U.S. federal income tax treatment of a corporation depends on whether the corporation is domestic or foreign. For U.S. federal income tax purposes, a corporation is treated as domestic if it is incorporated under the law of the United States or of any state. (5) All other corporations (for example, those incorporated under the laws of foreign countries) are treated as foreign. (6)

U.S. Taxation of Domestic Corporations

The United States employs a "worldwide" tax system, under which domestic corporations are generally taxed on all income, whether derived in the United States or abroad. To mitigate the potential double taxation that may result from such a system, a foreign tax credit is allowed for income taxes paid to foreign countries, and this reduces or eliminates the U.S. tax liability imposed on foreign-source income, subject to certain limitations. (7)

In addition to the direct taxation of a domestic corporation, income earned by a domestic parent corporation through foreign corporate subsidiaries is generally not subject to U.S. federal income tax until such time as the profits are repatriated to the United States in the form of a dividend. Certain antideferral regimes, however, may cause the domestic parent corporation to be taxed currently with respect to certain categories of passive or highly mobile income earned by its foreign subsidiaries, regardless of whether any distributions are made. The main antideferral regimes in this context are the CFC rules of subpart F and the passive foreign investment company rules (PFIC). (8) For purposes of this article, the primary category of subpart F income is foreign base company income (FBCI), (9) which includes foreign personal holding company income (FPHCI), foreign base company sales income (FBC sales income), and foreign base company services income (FBC services income). (10)

Taxation of Foreign Corporations

Unlike domestic corporations, foreign corporations are generally subject to U.S. federal income taxation on two categories of income: 1) certain passive types of U.S. source income (e.g., interest, dividends, rents, annuities, and other types of "fixed or determinable annual or periodical income," collectively known as FDAP); (11) income that is effectively connected to a U.S. trade or business (ECI). (12) FDAP income is subject to a 30 percent withholding tax that is imposed on a foreign person's gross income (subject to reduction or elimination by an applicable income tax treaty), and ECI is subject to tax on a net basis at the graduated tax rates generally applicable to U.S. persons. (13)

"Management and Control" in the Non-U.S. Context

Unlike the Code, where the place of incorporation is the sole factor in determining whether a corporation is domestic or foreign, in many foreign jurisdictions, a foreign corporation is considered a "resident" of a particular jurisdiction if that corporation is either incorporated or managed and controlled in that jurisdiction. For example, in both the U.K. and Ireland, a company will be treated as a corporate resident if it is either incorporated in such jurisdiction or its central management and control is situated in that jurisdiction. Similarly, in Spain, a company is considered a Spanish resident if the company is incorporated in Spain, the company's legal seat is in Spain, or the company's effective management is in Spain. For this purpose, management and control generally exist in a particular jurisdiction if regular board of directors meetings are held in that jurisdiction. (14)

A foreign corporation that is created or organized in one jurisdiction but managed and controlled in a second jurisdiction is considered a "dual-resident" corporation. When a dual-resident corporation exists, the place where such corporation is subject to tax generally depends on whether an income tax treaty is in effect between those two foreign jurisdictions. If an income tax treaty does exist between those two jurisdictions, the treaty's so-called "tie-breaker" provision typically provides that the corporation will be treated as a resident (and therefore taxed) in the jurisdiction where the corporation's "effective management is situated." (15) If, on the other hand, no such treaty exists, then such a dual-resident corporation may be subject to tax in both jurisdictions (that is, the jurisdiction where it is created or organized and the jurisdiction where the effective management is situated). A similar result would occur if a corporation was formed in the United States but managed and controlled in a foreign jurisdiction (that is, it would become a dual-resident corporation and potentially subject to double taxation). (16)

Tax Planning Strategies with Moving Management and Control

As noted above, there are a number of provisions in the Code where the U.S. federal income tax consequences of a transaction turns on where a foreign corporation is created or organized. These provisions include [section] 864(d)(7) (the exception to related party factoring income), [section] 954(c)(3) (the...