The General Accounting Office Has A New Report “Information on Foreign-Owned but Essentially U.S.-Based Corporate Groups Is Limited” - GAO -12-743

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Tax Attorney Alvin S. Brown Highlights The Complexities Identified by the GAO Where There Are Foreign-Owned U.S. Corporations.

The anti-deferral rules generally do not apply to foreign controlled domestic corporations.

The GAO Report addressed to Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT), can be found at

The  new report by the Government Accountability Office (GAO) has analyzed the prevalence of, and potential tax advantages or abuse stemming from, Foreign Controlled Domestic Corporations (FCDC) that conduct the majority of their worldwide operations in the U.S. 

The GAO report, states that a multinational corporate group, whether U.S.-owned or foreign-owned, can generally shift income to subsidiaries in low-tax countries to avoid or evade U.S. taxes, even if the majority of their economic activity is in the U.S. However, use of a FCDC structure can provide a tax avoidance or evasion advantage over structures where U.S. parents own foreign subsidiaries.

The GAO states that FCDC ownership structure could provide a tax avoidance or evasion advantage relative to a structure where U.S. parents own foreign subsidiaries. According to IRS officials contacted by the GAO, the FCDC structure could confer a tax advantage because certain rules that can limit potential abuse by U.S. parent companies and their foreign subsidiaries may not apply to FCDCs and their foreign parent companies. These rules (called anti-deferral rules) make immediately taxable to U.S. corporations certain types of income such as interest, rents, and royalties of their foreign subsidiaries. These types of income tend to be easily moveable from one taxing jurisdiction to another and hence more amenable to transfer pricing abuse. The GAO report also concluded that this structure doesn't provide a greater opportunity to avoid the transfer pricing rules.

According to tax attorney Alvin Brown, U.S. corporations are generally taxed on income from outside the U.S. just as they are on income from inside the U.S under IRS Code Section 862. This rule is intended to ensure an even playing field and eliminate any tax advantage that would otherwise be derived by a U.S. corporation doing business in a low-tax country. However, subject to certain limitations, the U.S. corporation's foreign-source income is insulated from U.S. tax until it is actually brought back to the U.S. and distributed to the U.S. owners. Thus, U.S. corporations can defer income by simply forming a wholly-owned subsidiary in a low-tax country. The Code's subpart F “anti-deferral” regime addresses this issue by taxing U.S. shareholders of a controlled foreign corporation (CFC) on their pro rata share of the CFC's subpart F income under IRS Code Section 952(a) and investments in U.S. property, regardless of whether these amounts were actually distributed to the shareholders. Under IRS Code Section 482 the IRS is authorized to distribute, apportion, or allocate gross income, deductions, credits or allowances among organizations, trades, or businesses owned or controlled by the same interests in order to prevent tax evasion or to reflect the true taxable income of any such entity. This prevents the shifting of income and deductions among certain related taxpayers for the sole purpose of minimizing taxes. The standard to be applied is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer. The arm's length result of a controlled transaction must be determined under the method that provides the most reliable measure of an arm's length result.

The GAO report concludes that the primary advantage of the FCDC structure is that, unlike U.S. parent companies and their foreign subsidiaries, the anti-deferral rules generally don't apply to an FCDC structure. Rather, the anti-deferral rules only apply to an FCDC if it is also the owner of a CFC, or to the foreign parent of an FCDC if the foreign parent is itself a CFC.

However, with respect to tax evasion through transfer pricing abuse, FCDC structures don't provide any particular advantage since they are subject to the same rules as U.S. corporations with foreign subsidiaries. Any questions on this discussion can be addressed to Tax Attorney Alvin S. Brown ab (at) irstaxattorney (dot) com.

The Tax Law Firm of Alvin Brown & Associates
575 Madison Ave., 8th Floor
New York, NY 10022-8511

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