On a fully distributed basis, profits of a corporation are taxed twice. First, profits are taxed at the corporate level.1 They are taxed again as after-tax earnings & profits are paid out in the form of dividends. Double taxation applies whether the corporation distributing the dividend is a domestic corporation or a foreign corporation. To alleviate the problem, Code §1(h)(11) taxes "qualified dividend income" at the beneficial long-term capital gains rates of 20%. For a dividend from a domestic corporation, this results in overall Federal taxation of 36.8% on a fully distributed basis.2 For earnings generated by a foreign corporation in a low-tax jurisdiction, this can be even more attractive if Code §1(h)(11) is applicable. If not applicable, the tax on dividends received from a foreign corporation can be quite high, as the top rate of tax on ordinary income is 37%. That rate also applies to income that is taxed under the all U.S. anti-deferral rules such as Subpart F, the Global Intangible Low-Taxed Income ("G.I.L.T.I."), and the Passive Foreign Investment Company ("P.F.I.C.") rules, all of which are beyond the scope of this article.

QUALIFIED FOREIGN CORPORATION

Code §1(h)(11)(C) provides qualified dividend income treatment to dividends received from a foreign corporation that is treated as a "qualified foreign corporation." A qualified foreign corporation ("Q.F.C.") is a foreign corporation that meets one of two tests:3

  • The corporation is organized in a U.S. possession.
  • The corporation is eligible for benefits of a comprehensive tax treaty with the U.S. that contains an exchange of information provision, and which the I.R.S. determines is satisfactory for these purposes.

A foreign corporation cannot be a Q.F.C. if it is, or was during the preceding taxable year, a P.F.I.C., unless the P.F.I.C. status is ignored because the corporation is also a controlled foreign corporation ("C.F.C.").

Footnotes

1 Current U.S. Federal corporate tax rate is 21%.

2 Does not take into account 3.8% Net Investment Income Tax. Compare with the current maximum individual Federal income tax rate of 37%

3 A separate rule provides that dividend from a foreign corporation which is not treated as a Q.F.C. will equally benefit from the reduced rate of taxation if the shares of stock are regularly tradable on an established securities market in the U.S

Originally published June 2, 2020.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.