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OBRA and CFCs: still more complexity.


The Omnibus Budget Reconciliation Act of 1993 adds an additional layer of complexity to the current tax on controlled foreign corporation (CFC) earnings. Newly created tax code section 956A applies to CFCs that have "excess passive assets" and is effective for taxable years of foreign corporations beginning after September 30, 1993.

Normally, shareholders of foreign corporations are not subject to U.S. tax on foreign corporate earnings until the earnings are distributed. However, provisions limiting such deferral apply to foreign corporations that are CFCs (generally, foreign corporations more than 50% owned by U.S. shareholders, including only U.S. shareholders that each own at least 10% of the CFC's stock).

One provision limiting deferral applies when CFCs earn subpart F income (which includes passive income and certain income earned outside the CFC's country of formation). A second deferral-limiting provision applies when a CFC invests earnings in certain types of U.S. property, such as a related U.S. corporation's stock.

Yet another provision applies to passive foreign investment companies (PFICs). Foreign corporations are PFICs if either 75% of their income or 50% of their assets are passive. U.S. persons holding shares in a PFIC must pay interest charges on deferred earnings when they either receive an excess distribution from the PFIC or sell PFIC shares. Alternatively, an election may be made for U.S. shareholders to include their pro rata share of a PFIC's earnings in their current taxable income.

Section 956A was enacted to create, for a CFC that does not meet the threshold of the PFIC provisions, a greater incentive to repatriate earnings not reinvested in the CFC's active business. It requires a U.S. shareholder of a CFC to include the lesser of two amounts in income. The first amount is the excess of the shareholder's pro rata share of the CFC's excess passive assets (if any) over the earnings of the CFC that already have been included in income for the U.S. shareholder under these rules.

A CFC has excess passive assets to the extent passive assets exceed 25% of total assets, based on a quarterly average. For this purpose, all members of a "CFC group" (one or more chains of CFCs linked by common ownership with a top-tier CFC) are treated as though they are one corporation.

The second amount is the U.S. shareholder's pro rata share of the CFC's post-September 30, 1993, current and accumulated earnings and profits, reduced by distributions during the year as well as by the portion of these earnings previously subject to tax under section 956A and the investment in U.S. property provisions.

Observation: One technique taxpayers are considering to avoid section 956A is to form CFC groups to take advantage of the aggregation rule.

In addition to forming CFC groups, other planning techniques should be investigated to avoid the application of these complex rules. --Marianne Burge, CPA, director of international tax services, Kenneth Kral, CPA, international tax partner, and Jack Serota, Esq., international tax manager, at Price Waterhouse, New York City.
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Title Annotation:Omnibus Budget Reconciliation Act of 1993, controlled foreign corporations
Author:Serota, Jack
Publication:Journal of Accountancy
Date:Dec 1, 1993
Previous Article:IRS clarifies taxation of "boot." (Brief Article)
Next Article:Qualifying for section 1244.

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