Subpart F Income and US CFC Rules: A Practical Guide

What Is Subpart F?

Subpart F of the Internal Revenue Code (Sections 951-965) was enacted in 1962 and is one of the oldest anti-deferral regimes in the world. It requires US shareholders who own 10% or more of a Controlled Foreign Corporation (CFC) to include certain categories of the CFC's income in their US taxable income in the year the income is earned, regardless of whether the CFC distributes that income.

Before Subpart F, a US shareholder could defer US tax on foreign corporation income indefinitely by simply not distributing the profits. Subpart F ended this deferral for categories of income that Congress determined were most susceptible to artificial shifting offshore — primarily passive income and certain sales and service income between related parties.

A CFC is a foreign corporation in which US shareholders (each owning 10% or more) collectively own more than 50% of the vote or value. Post-TCJA (from 2018), the constructive ownership rules were expanded, making it easier for a foreign corporation to become a CFC.

The Seven Categories of Subpart F Income

Category 1: Foreign Personal Holding Company Income (FPHCI)

FPHCI is the broadest and most commonly applicable Subpart F category. It includes:

• Dividends, interest, royalties, and rents received by the CFC
• Gains from sales of property that produces dividends, interest, royalties, or rents
• Gains from commodities transactions
• Currency gains
• Income from personal service contracts

FPHCI is the default category for most passive investment income. A CFC holding a portfolio of stocks and bonds will typically have significant FPHCI.

Exception — look-through rule: Dividends, interest, rents, and royalties received by a CFC from a related CFC that are attributable to active business income of the payor CFC are excluded from FPHCI (the Subpart F look-through rule under Section 954(c)(6)).

Category 2: Foreign Base Company Sales Income (FBCSI)

FBCSI arises when a CFC buys property from (or sells to) a related person, where the property is manufactured and sold outside the CFC's country of incorporation. The classic structure: a Cayman Islands CFC buys goods manufactured in Germany from a German related party, sells them to customers in France, earning a margin — without any connection to the Cayman Islands.

Exception — manufacturing exception: If the CFC itself substantially transforms the property (manufactures it), FBCSI does not arise. If the CFC merely repackages or distributes, it does arise.

Category 3: Foreign Base Company Services Income (FBCSVI)

FBCSVI arises where a CFC performs services for a related person outside the CFC's country of incorporation. A CFC in a low-tax jurisdiction that provides technical support services to related parties' customers worldwide has FBCSVI.

Categories 4-7: Less Common Categories

• Category 4: Foreign base company shipping income
• Category 5: Foreign base company oil-related income (now largely subsumed by other rules)
• Category 6: Certain insurance income
• Category 7: International boycott income

The De Minimis and Full Inclusion Rules

De Minimis Exception

If the total Subpart F income of a CFC is less than the lesser of 5% of the CFC's gross income or $1 million, no amount is treated as Subpart F income for that year. This exception applies on a per-CFC basis.

Full Inclusion Rule

If Subpart F income exceeds 70% of the CFC's gross income, 100% of the CFC's gross income is treated as Subpart F income — even the non-Subpart F portion.

Subpart F as % of Gross Income	Treatment
Less than 5% (or < $1M)	De minimis — no Subpart F inclusion
5% to 70%	Only Subpart F income included
More than 70%	Full gross income treated as Subpart F

The High-Tax Exception

Section 954(b)(4) provides a high-tax exception: income that would otherwise be Subpart F income is excluded if the foreign effective tax rate on that income is greater than 90% of the highest US corporate rate (18.9% at the current 21% rate).

This exception is parallel to the GILTI High-Tax Exclusion discussed separately. It means that income earned in a high-tax jurisdiction — France (25%), Germany (30%), UK (25%) — will not generate a Subpart F inclusion even if it otherwise meets a Subpart F category definition, because the foreign ETR exceeds 18.9%.

The high-tax exception for Subpart F is elective (coordinated with the GILTI HTE election) and is applied on an item-by-item basis.

Subpart F vs GILTI: The Interaction

Since TCJA (from 2018), GILTI and Subpart F both apply to US shareholders of CFCs. Their interaction:

1. Subpart F income is included under Section 951 as a Subpart F inclusion
2. GILTI income (the excess of aggregate tested income over 10% of QBAI) is included under Section 951A
3. The same income cannot be both Subpart F income and GILTI income — Subpart F income is excluded from the tested income calculation for GILTI

In general, income subject to Subpart F is treated more punitively (no 50% Section 250 deduction for corporate shareholders), so the categorisation matters.

Planning Strategies

Check-the-Box to Eliminate CFCs

As discussed in the GILTI article, electing disregarded entity status for a foreign subsidiary eliminates the CFC characterisation — and therefore eliminates both Subpart F and GILTI. This is a useful technique for wholly-owned structures where the foreign entity is in a jurisdiction that does not tax the check-the-box election as a deemed liquidation.

Establishing Genuine Manufacturing or Service Operations

The manufacturing and services exceptions to FBCSI and FBCSVI are powerful where genuine operational substance exists. A CFC that genuinely manufactures its products in the country of incorporation, using local employees and facilities, does not have FBCSI on its sales. Building the substance that triggers these exceptions is a legitimate and robust planning approach.

Using the Look-Through Rule Across CFC Chains

For groups with multiple CFCs, the Section 954(c)(6) look-through rule can prevent passive income from cascading up the ownership chain as Subpart F income. Intercompany dividends and interest that derive from an active business at the bottom of the chain can be shielded from Subpart F characterisation at each intermediate CFC level.

Deferring FPHCI with Active Income Combinations

A CFC that has both active (non-Subpart F) income and passive (FPHCI) income can use the de minimis exception to avoid Subpart F inclusion if the passive income is kept below 5% of total gross income. Managing the mix of income within each CFC can materially reduce Subpart F exposure.

HPT Group advises US individuals and corporations with overseas business structures on Subpart F compliance, GILTI planning, and the restructuring of CFC networks to minimise unnecessary US current inclusions. The interaction of Subpart F, GILTI, Section 245A, and Section 959 PTEP rules is among the most technically complex areas of US international tax — and one where proactive planning yields measurable results. Contact our international tax team or apply for an initial structure review.