Controlled Foreign Corporation (CFC): US Citizens with Canadian Corporations

A controlled foreign corporation (CFC) is any foreign corporation where US shareholders (each owning 10% or more) collectively own more than 50% of the total combined voting power or total value. For a US citizen in Canada who owns a Canadian corporation (CCPC, professional corporation, or holding company), the corporation is almost always a CFC because the US citizen typically owns more than 50%. The CFC classification triggers three consequences: annual Form 5471 reporting (a multi-schedule information return), potential current taxation of certain income under Subpart F and GILTI even when no dividends are paid, and a set of anti-deferral rules that interact with Canada’s small-business tax rate in ways that are not intuitive.

What makes a corporation a CFC?

A foreign corporation is a CFC under IRC 957(a) if US shareholders own (directly, indirectly, or constructively) more than 50% of either:

• The total combined voting power of all classes of stock entitled to vote, or
• The total value of shares of all classes of stock

A “US shareholder” for CFC purposes is a US person who owns 10% or more of the total combined voting power or value of the corporation, under IRC 951(b).

For a US citizen in Canada:

• Sole owner. If you own 100% of a Canadian corporation, it is a CFC. You are a US shareholder (you own more than 10%), and US shareholders own more than 50%. This is the most common scenario.
• Majority owner. If you and your US-citizen spouse each own 50%, both of you are US shareholders and collectively own 100%. CFC.
• Minority owner. If you own 30% and a non-US Canadian partner owns 70%, you are a US shareholder (over 10%), but US shareholders do not own more than 50%. Not a CFC. However, you may still have Form 5471 filing obligations as a Category 4 or Category 5 filer depending on the ownership changes and transaction thresholds.

The constructive ownership rules under IRC 958 attribute ownership between family members (spouse, children, grandchildren, parents) and through entities (partnerships, trusts, corporations). A US citizen who does not directly own a majority may constructively own one through a spouse or child.

What is Form 5471?

Form 5471 (Information Return of US Persons With Respect to Certain Foreign Corporations) is the annual information return that US shareholders of CFCs must file. It is attached to the US citizen’s Form 1040 and reports:

• Schedule C. Income statement of the CFC (revenue, cost of goods sold, deductions, net income)
• Schedule F. Balance sheet (assets, liabilities, equity)
• Schedule H. Current earnings and profits (E&P), which determines the taxable amount of dividends
• Schedule I-1. GILTI computation (the inclusion of tested income above the deemed return on tangible assets)
• Schedule J. Accumulated E&P and distributions
• Schedule M. Transactions between the CFC and its US shareholders (management fees, loans, payments)
• Schedule O. Organization and reorganization, including stock acquisitions and dispositions
• Schedule P. Previously taxed earnings and profits (PTEP), tracking income already included under Subpart F or GILTI

The penalty for failing to file Form 5471 is $10,000 per form per year, with additional penalties of $10,000 per month (up to $60,000) if the failure continues after IRS notice. See the penalty abatement guide for relief options.

What is Subpart F income?

Subpart F (IRC 951-964) requires US shareholders of a CFC to include certain types of passive and mobile income in their US taxable income currently, even if the CFC has not distributed any dividends. The idea is to prevent US persons from parking passive income in a low-tax foreign corporation.

The main categories of Subpart F income:

• Foreign personal holding company income (FPHCI). Dividends, interest, rents, royalties, and capital gains earned by the CFC. If your Canadian corporation earns investment income (interest on corporate bank accounts, dividends from a stock portfolio, rental income from property held in the corporation), that income is Subpart F and included in your US income currently.
• Foreign base company sales income. Income from buying and selling property where the CFC is an intermediary (manufactured goods produced outside the CFC’s country of incorporation and sold for use outside that country). This rarely applies to a Canadian corporation serving Canadian clients.
• Foreign base company services income. Income from services performed outside the CFC’s country of incorporation for or on behalf of a related party. This can apply when a Canadian corporation performs services in the US for a related US entity.

For a typical Canadian professional corporation or operating company, Subpart F exposure comes from investment income held inside the corporation. The active business income (fees, sales, service revenue) is generally not Subpart F income because it is earned in the CFC’s country of incorporation (Canada).

What is GILTI?

Global Intangible Low-Taxed Income (GILTI) under IRC 951A is a broader inclusion than Subpart F. Enacted in 2017 (Tax Cuts and Jobs Act), GILTI captures most active business income of a CFC that exceeds a deemed 10% return on the CFC’s qualified business asset investment (QBAI, essentially the depreciated basis of tangible assets).

For a Canadian corporation:

• Tested income. The CFC’s gross income minus deductions, excluding Subpart F income, income effectively connected with a US trade or business, and certain other excluded categories. For most Canadian operating companies, tested income is the corporation’s net active business income.
• QBAI. The average adjusted basis of the CFC’s tangible depreciable property. A service-based Canadian corporation with minimal physical assets has low QBAI, which means almost all its income is GILTI.
• Net CFC tested income. Tested income minus 10% of QBAI. If the corporation earns $200,000 and has $50,000 in QBAI, the GILTI inclusion is $200,000 minus $5,000 (10% of $50,000) = $195,000.
• Individual limitation. Individual US shareholders (as opposed to corporate US shareholders) cannot claim the IRC 250 deduction that reduces the effective GILTI rate for C corporation shareholders. This means the full GILTI amount is included in the individual’s taxable income at ordinary rates, offset by the deemed-paid FTC.

The deemed-paid FTC under IRC 960 allows the US shareholder to credit 80% of the foreign taxes attributable to the GILTI income. For a Canadian corporation paying the combined small-business rate (approximately 12.2% in Ontario), 80% of the Canadian tax may not fully offset the US tax on the GILTI inclusion at ordinary rates, creating residual US tax.

How does the Canadian corporate tax interact with CFC rules?

Canada’s corporate tax system has two key features that interact with the CFC rules:

Small-business deduction (SBD). Canadian-controlled private corporations (CCPCs) pay a reduced rate (approximately 12.2% combined federal-provincial in Ontario) on the first $500,000 of active business income. This rate is low enough that the deemed-paid FTC (80% of 12.2% = approximately 9.8%) does not fully offset the US tax on a GILTI inclusion at ordinary rates (up to 37% federal). The shortfall creates incremental US tax that would not exist if the income were earned personally.

Integration. Canada’s tax system is designed so that income earned through a corporation and distributed as dividends produces approximately the same total tax as income earned personally (the “integration” principle). The corporate tax plus the personal tax on the dividend equals roughly the personal marginal rate. But the US does not participate in integration. A US citizen who earns income through a Canadian corporation pays: (1) Canadian corporate tax, (2) potential US tax on the GILTI or Subpart F inclusion, and (3) Canadian personal tax on the dividend. The integration math breaks down because the US layer is additive, not integrated.

This does not mean a US citizen should never incorporate in Canada. The SBD benefit, the ability to retain earnings at a low rate, and the flexibility of corporate structures still have value. But the CFC rules mean the US cost must be modeled before deciding.

What are previously taxed earnings (PTEP)?

When a US shareholder includes Subpart F or GILTI income, that income is recorded as previously taxed earnings and profits (PTEP) under IRC 959. When the CFC later distributes dividends, the PTEP portion is not taxed again. This prevents double taxation: you pay US tax on the inclusion (offset by the FTC), and when the dividend is eventually paid, the portion attributable to PTEP is excluded from income.

• Tracking PTEP. Schedule P of Form 5471 tracks the PTEP balance by year and category (Subpart F, GILTI, Section 956). Accurate tracking is essential because PTEP distributions are tax-free and non-PTEP distributions are taxable dividends.
• Canadian side. Canada taxes dividends from a corporation to the shareholder, regardless of whether the income was already included in the US shareholder’s US income under Subpart F or GILTI. The FTC on the US return credits the Canadian dividend withholding tax (if any) and the personal tax differential.

What should I do next?

If you are a US citizen in Canada who owns a Canadian corporation, the CFC rules apply from the date of incorporation (or the date you become a US person, if later). Form 5471 must be filed annually, and the Subpart F and GILTI calculations must be run each year to determine whether you owe current US tax on the corporation’s undistributed income.

• Do I file Form 5471 for my Canadian corporation?, the filing requirements and categories
• Form 5471/5472 penalty abatement, what to do if you missed filing
• Subpart F income from a Canadian corporation, the passive-income inclusion
• GILTI and net CFC tested income, the active-income inclusion
• Form 1116 and the foreign tax credit, the credit mechanism that offsets US tax on CFC inclusions
• Cross-border self-employment tax, the payroll side if you pay yourself from the corporation

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.