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Selected Terms and Concepts
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Controlled Foreign Corporation—Section 957 of the Internal Revenue Code defines a foreign corporation as being “controlled” if more than 50 percent of the total combined voting power of all classes of stock of such corporation entitled to vote, or more than 50 percent of the value of all its outstanding stock, is owned (directly, indirectly, or constructively) by U.S. shareholders on any day during the foreign corporation’s tax year. A U.S. shareholder for purposes of determining control is defined as a “U.S. person” owning 10 percent or more of the foreign corporation’s voting stock. For purposes of these statistics, a foreign corporation was “controlled” only if a single U.S. corporation satisfied the ownership requirements for an uninterrupted period of at least 30 days. These are the only foreign corporations for which complete Form 5471 filings are required. U.S corporations may also control a CFC through a partnership where the U.S. corporation is the controlling partner. To the extent possible, these CFCs have also been included in these statistics.
Country of incorporation—The country of incorporation is the country under whose laws the CFC is legally created. The CFC’s country of incorporation is not necessarily the principal place of business. For Tax Year 2004, 1,728 CFCs (2.3 percent) reported a principal place of business that differed from the reported country of incorporation.
Current earnings and profits—“Current earnings and profits” represent the difference between total earnings and profits of the foreign corporation at the end of the current year (before reduction by dividends paid during the year) and the accumulated earnings and profits of the corporation at the beginning of the year. Although current earnings and profits typically are an after-tax measure of profits, they are shown in these statistics both before and after taxes. “Earnings and profits” is a tax concept referring to the economic capacity of a corporation to make a distribution to shareholders that is not a return on capital. The term “earnings and profits” is not specifically defined in the Internal Revenue Code. In those instances where current earnings and profits were not reported for the foreign corporation, net income per books was used in place of missing earnings and profits.
Distributions out of earnings and profits—Distributions out of earnings and profits represent payments to shareholders from the foreign corporation’s pool of earnings and profits. A distribution comes first from current earnings and profits and then from accumulated earnings and profits. Distributions may be from previously taxed earnings and profits or non-previously taxed earnings and profits.
Income taxes—CFCs reported income, war profits, and excess profits taxes paid or accrued to any foreign country or U.S. Possession as income tax for their annual accounting period.
OPEC countries—The member countries of the Organization of Petroleum Exporting Countries for Tax Year 2004 were: Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela.
Previously taxed earnings and profits—This includes any earnings and profit amounts that were subject to U.S. tax in the current year or in a prior year, but not distributed. Previously taxed earnings and profits include amounts related to Subpart F income (see definition below), earnings related to investments in certain U.S. property, previously excluded Subpart F income withdrawn from qualified investments, previously excluded export trade income withdrawn from investment in export trade assets, factoring income, and earnings invested in excess passive assets.
Total assets—Total assets represent the tangible and intangible economic resources owned by controlled foreign corporations. The statistics presented generally refer to ending assets unless otherwise noted.
Total payments by foreign corporations to related parties—Total payments to related parties equal the sum of business expenditures reported on Form 5471, Schedule M. These payments include purchases of stock in trade, purchases of tangible property, purchases of property rights, compensation for services, commissions, rents, royalties, license fees, dividends, and interest paid to related parties.
Total receipts—Total receipts equal business receipts (gross receipts from sales and operations) plus income from investment activity.
Total receipts by foreign corporations from related parties—Total receipts from related parties equal the sum of business receipts on Form 5471, Schedule M. These receipts include sales of stock in trade, sales of property rights, compensation for services, commissions, rents, royalties, license fees, dividends, interest, and insurance premiums received from related parties.
Total Subpart F income—Internal Revenue Code sections 951 and 952 stipulate specific cases in which earnings and profits are deemed to have been paid by a CFC to a U.S. shareholder. Such income is subject to U.S. tax whether or not it is repatriated to U.S. shareholders in the form of an actual dividend. Internal Revenue Code section 951 requires that U.S. shareholders include in their gross incomes certain undistributed profits of foreign corporations controlled by U.S. shareholders. Subpart F income from a CFC includes certain insurance income of U.S. risks, “foreign base company” income, international boycott participation income, bribes and other illegal payments to foreign government officials, and income from any country which the United States does not recognize or with which it has severed relations, or which repeatedly provides support for acts of international terrorism. For purposes of these statistics, total Subpart F income also includes other types of includible income reported on Form 5471 Schedule I, such as earnings invested in U.S. property, previously excluded Subpart F income withdrawn from qualified investments, previously excluded export trade income withdrawn from investment in export trade assets, and factoring income.
Data Sources and Limitations
The Controlled Foreign Corporation statistics are based on information collected from corporate tax returns (Form(s) 1120) with accounting periods ending July 2004 through June 2005 and their attached Form(s) 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. A U.S. corporation is required by Internal Revenue Service regulations to submit a Form 5471 for any Controlled Foreign Corporation (CFC) with an accounting period ending with or within the U.S. parent’s accounting period. Thus, the accounting periods for Tax Year 2004 CFCs may have ended as early as July 2003 and as late as June 2005. However, most CFC activity occurred in Calendar Year 2004. These statistics report data for active foreign corporations controlled by U.S. corporations.
Coefficient of variation (CV) tables are not provided because these data are not subject to significant sampling error. For example, for Tax Year 2004 CFCs sampled at a 100-percent rate accounted for more than 95.0 percent of the number of CFCs and more than 99.9 percent of the total ending assets for all CFCs. However, these data may be subject to nonsampling error.
Several limitations apply when making comparisons to prior-year statistics. First, the data for Tax Years 2004 and later are based upon a sample of U.S. corporations. For Tax Year 2004, this sample includes all CFCs controlled by U.S. corporations with $10 million or more in total assets or $2.5 million or more in “proceeds” and all CFCs filed by U.S. corporations with less than $10 million in the SOI corporate sample. The sample for the Tax Year 2004 CFC statistics is far more inclusive than recent studies, which included only the 7,500 largest CFCs controlled by U.S. corporations with $500 million or more in total assets.
Second, the composition of the 7,500 largest CFCs (for Tax Years 2002 and earlier) is not consistent across tax years. For example, many of the 7,500 largest CFCs for Tax Year 2000 not included among the 7,500 largest CFCs for Tax Year 2002 were still controlled by U.S. corporations, but the size of their total assets for Tax Year 2002 excluded them from this group. In addition, some of the 7,500 largest CFCs for Tax Year 2000 were not included in Tax Year 2002 because they were no longer “controlled” or the U.S. parent corporation’s total assets had fallen below $500 million.
Finally, fluctuations in exchange rates can have significant effects on the reported statistics. Financial statistics that are translated using current (as opposed to historical) rates of exchange can be distorted by large exchange rate fluctuations. The weakening of the U.S. dollar against many currencies from Tax Year 2002 to Tax Year 2004 certainly contributed to the large increases in some of the statistics presented in this article.
Caution should also be used when comparing data by industrial groupings. For Tax Years 1998, 2000, 2002, and 2004, CFCs were classified under the North American Industry Classification System (NAICS), which differs from the Standard Industrial Classification (SIC) system used before Tax Year 1998. While most industries were not affected by the implementation of NAICS, the groupings of some economic activities were changed. The most significant change was the movement of the management of companies and enterprises sector from finance, insurance, and real estate under the SIC system to the services sector under NAICS. Furthermore, CFCs were classified by industry based on their principal business activity as reported on Form 5471. However, assets, receipts, and profits may have also been related to secondary business activities. It is not possible to measure the extent of these secondary business activities due to these activities not being detailed on Form 5471.
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