[Title 26 CFR 1.957-1]
[Code of Federal Regulations (annual edition) - April 1, 2002 Edition]
[Title 26 - INTERNAL REVENUE]
[Chapter I - INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY]
[Subchapter A - INCOME TAX (CONTINUED)]
[Part 1 - INCOME TAXES]
[Sec. 1.957-1 - Definition of controlled foreign corporation.]
[From the U.S. Government Printing Office]


26INTERNAL REVENUE102002-04-012002-04-01false1.957-1Sec. 1.957-1INTERNAL REVENUEINTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURYINCOME TAX (CONTINUED)INCOME TAXES
Sec. 1.957-1  Definition of controlled foreign corporation.

    (a) In general. The term controlled foreign corporation means any 
foreign corporation of which more than 50 percent (or such lesser amount 
as is provided in section 957(b) or section 953(c)) of either--
    (1) The total combined voting power of all classes of stock of the 
corporation entitled to vote; or
    (2) The total value of the stock of the corporation, is owned within 
the meaning of section 958(a), or (except for purposes of section 
953(c)) is considered as owned by applying the rules of section 958(b) 
and Sec. 1.958-2, by United States shareholders on any day during the 
taxable year of such foreign corporation. For the definition of the term 
United States shareholder, see sections 951(b) and 953(c)(1)(A). For the 
definition of the term foreign corporation, see Sec. 301.7701-5 of this 
chapter (Procedure and Administration Regulations). For the treatment of 
associations as corporations, see section 7701(a)(3) and Secs. 301.7701-
1 and 301.7701-2 of this chapter. For the definition of the term stock, 
see sections 958(a)(3) and 7701(a)(7). For the classification of a 
member in an association, joint stock company or insurance company as a 
shareholder, see section 7701(a)(8).
    (b) Percentage of total combined voting power owned by United States 
shareholders--(1) Meaning of combined voting

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power. In determining for purposes of paragraph (a) of this section 
whether United States shareholders own the requisite percentage of total 
combined voting power of all classes of stock entitled to vote, 
consideration will be given to all the facts and circumstances of each 
case. In all cases, however, United States shareholders of a foreign 
corporation will be deemed to own the requisite percentage of total 
combined voting power with respect to such corporation--
    (i) If they have the power to elect, appoint, or replace a majority 
of that body of persons exercising, with respect to such corporation, 
the powers ordinarily exercised by the board of directors of a domestic 
corporation;
    (ii) If any person or persons elected or designated by such 
shareholders have the power, where such shareholders have the power to 
elect exactly one-half of the members of such governing body of such 
foreign corporation, either to cast a vote deciding an evenly divided 
vote of such body or, for the duration of any deadlock which may arise, 
to exercise the powers ordinarily exercised by such governing body; or
    (iii) If the powers which would ordinarily be exercised by the board 
of directors of a domestic corporation are exercised with respect to 
such foreign corporation by a person whom such shareholders have the 
power to elect, appoint, or replace.
    (2) Shifting of formal voting power. Any arrangement to shift formal 
voting power away from United States shareholders of a foreign 
corporation will not be given effect if in reality voting power is 
retained. The mere ownership of stock entitled to vote does not by 
itself mean that the shareholder owning such stock has the voting power 
of such stock for purposes of section 957. For example, if there is any 
agreement, whether express or implied, that any shareholder will not 
vote his stock or will vote it only in a specified manner, or that 
shareholders owning stock having not more than 50 percent of the total 
combined voting power will exercise voting power normally possessed by a 
majority of stockholders, then the nominal ownership of the voting power 
will be disregarded in determining which shareholders actually hold such 
voting power, and this determination will be made on the basis of such 
agreement. Moreover, where United States shareholders own shares of one 
or more classes of stock of a foreign corporation which has another 
class of stock outstanding, the voting power ostensibly provided such 
other class of stock will be deemed owned by any person or persons on 
whose behalf it is exercised or, if not exercised, will be disregarded 
if the percentage of voting power of such other class of stock is 
substantially greater than its proportionate share of the corporate 
earnings, if the facts indicate that the shareholders of such other 
class of stock do not exercise their voting rights independently or fail 
to exercise such voting rights, and if a principal purpose of the 
arrangement is to avoid the classification of such foreign corporation 
as a controlled foreign corporation under section 957.
    (c) Illustrations. The application of this section may be 
illustrated by the following examples:

    Example 1. Foreign corporation R has two classes of capital stock 
outstanding, 60 shares of class A stock, and 40 shares of class B stock. 
Each share of each class of stock has one vote for all purposes. E, a 
United States person, owns 51 shares of class A stock. Corporation R is 
a controlled foreign corporation.
    Example 2. Foreign corporation S has three classes of capital stock 
outstanding, consisting of 60 shares of class A stock, 40 shares of 
class B stock, and 200 shares of class C stock. The owners of a majority 
of class A stock are entitled to elect 6 of the 10 corporate directors, 
and the owners of a majority of the class B stock are entitled to elect 
the other 4 of the 10 directors. Class C stock has no voting rights. D, 
a United States person, owns all of the shares of the class C stock. He 
also owns 31 shares of class A stock and as such an owner can elect 6 
members of the board of directors. None of the remaining shares of class 
A stock, or the 40 shares of class B stock, is owned, or considered as 
owned, within the meaning of section 958, by a United States person. 
Since, as owner of 31 shares of the class A stock, D has sufficient 
voting power to elect 6 directors, D has more than 50 percent of the 
total combined voting power of all classes of stock entitled to vote, 
and S Corporation is a controlled foreign corporation.
    Example 3. M, a United States person, owns a 51-percent interest in 
R Company, a foreign

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company of which he is a member. The company, if it were domestic, would 
be taxable as a corporation. The remaining interest of 49 percent in the 
company is owned by seven other members none of whom is a United States 
person. The memorandum of association of R Company provides for only one 
manager, who with respect to the company exercises the powers ordinarily 
exercised by a board of directors of a domestic corporation. The manager 
is to be elected by unanimous agreement of all the members. Since M owns 
51 percent of the company, he will be deemed to own more than 50 percent 
of the total combined voting power of all classes of stock of R Company 
entitled to vote, notwithstanding that he has power to elect a manager 
only with the agreement of the other members. Company R is a controlled 
foreign corporation.
    Example 4. Domestic corporation M owns a 49-percent interest in S 
Company, a foreign company of which it is a member. The company, if it 
were domestic, would be taxable as a corporation. Company S is formed 
under the laws of foreign country Y. The remaining interest of 51 
percent in S Company is owned by persons who are not United States 
persons. The organization contract of S Company provides for one 
manager, B, a citizen and resident of country Y who is an officer of M 
Corporation in charge of its foreign operations in such country, or any 
person M Corporation may at any time appoint to succeed B in such 
capacity. The manager has the sole authority with respect to S Company 
to exercise powers ordinarily exercised by a board of directors of a 
domestic corporation. Since M Corporation has the discretionary power to 
replace B and to appoint his successor as manager of S Company, the 
company is a controlled foreign corporation.
    Example 5. N, a United States person, owns 50 percent of the 
outstanding shares of the only class of capital stock of foreign 
corporation R. An additional 48 percent of the outstanding shares is 
owned by foreign corporation S. The remaining 2 percent of shares is 
owned by P, a citizen and resident of foreign country T, who regularly 
acts as attorney for N in the conduct of N's business affairs in country 
T. All of the shares of the outstanding capital stock of R Corporation 
are bearer shares. At the time of the issuance of the shares to him, P 
places the certificates for such shares in a depository to which N has 
access. On several occasions N, with P's acquiescence, has taken such 
shares from the depository and, on one such occasion, used the shares as 
collateral in borrowing funds on a loan. Although dividends, when paid, 
are paid to P on his shares, his charges to N for legal fees are reduced 
by the amount of the dividends paid on such shares. Although P votes his 
shares at meetings of shareholders, the facts set forth above indicate 
an implied agreement between P and N that N is really to retain dominion 
over the stock. N is deemed to own the voting rights ostensibly attached 
to the stock owned by P, and R Corporation is a controlled foreign 
corporation.
    Example 6. M, a domestic corporation which manufactures in the 
United States and distributes all of its production for foreign 
consumption through N, a person other than a related person or a United 
States person, forms foreign corporation S to purchase products from M 
Corporation and sell them to N. Corporations S and M have common 
directors. The outstanding capital stock of S Corporation consists of 
10,000 shares of $100 par value class A stock, which has no voting 
rights except to vote for dissolution of the corporation on a share-for-
share basis, and 500 shares of no par class B stock which has full 
voting rights. Each class of the outstanding stock is to participate on 
a share for share basis in any dividend. The class A stock has a 
preference as to assets on dissolution of the corporation to the extent 
of its par value as well as the right to participate with the class B 
stock in all other assets on a share for share basis. All of the shares 
of class A stock are issued to M Corporation in return for property 
having a value of $1 million. Of the class B stock, 300 of the shares 
are issued to N in return for $3,000 in cash and 200 shares are issued 
to M Corporation for $2,000 in cash. At stockholder meetings N never 
votes in opposition to M Corporation on important issues. Corporation S 
has average annual earnings of $200,000, all of which will be subpart F 
income if S Corporation is held to be a controlled foreign corporation. 
All such earnings are accumulated. Although N ostensibly has 60 percent 
of the voting power of S Corporation by virtue of his ownership of 300 
shares of class B stock, he has the right to only approximately 3 
percent of any dividends which may be paid by S Corporation; in 
addition, upon liquidation of S Corporation, N is entitled to share in 
the assets only after M Corporation has received the par value of its 
10,000 shares of class A stock, or $1 million. Thus, the voting power 
owned by N is substantially greater than its proportionate share of the 
earnings of S Corporation. In addition, the facts set forth above 
indicate that N is not exercising his voting rights independently and 
that a principal purpose of the capitalization arrangement is to avoid 
classification of S Corporation as a controlled foreign corporation. For 
these reasons, the voting power ostensibly provided the class B stock 
will be deemed owned by M Corporation, and S Corporation is a controlled 
foreign corporation.
    Example 7. Foreign corporation A, authorized to issue 100 shares of 
one class of capital stock, issues, for $1,000 per share, 45 shares to 
domestic corporation M, 45 shares to foreign

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corporation B, and 10 shares to foreign corporation C. Corporation C, a 
bank, lends $3 million to finance the operations of A Corporation. In 
the course of negotiating these financial arrangements, D, an officer of 
C Corporation, and E, an officer of M Corporation, orally agree that C 
Corporation will vote its stock as M Corporation directs. By virtue of 
such oral agreement M Corporation possesses the voting power ostensibly 
owned by C Corporation, and A Corporation is a controlled foreign 
corporation.
    Example 8. For its prior taxable year, JV, a foreign corporation, 
had outstanding 1000 shares of class A stock, which is voting common, 
and 1000 shares of class B stock, which is nonvoting preferred. DP, a 
domestic corporation, and FP, a foreign corporation, each owned 
precisely 500 shares of both class A and class B stock, and each elected 
5 of the 10 members of JV's board of directors. The other facts and 
circumstances were such that JV was not a controlled foreign corporation 
on any day of the prior taxable year. On the first day of the current 
taxable year, DP purchased one share of class B stock from FP. JV was a 
controlled foreign corporation on the following day because over 50 
percent of the total value in the corporation was held by a person that 
was a United States shareholder under section 951(b). See Sec. 1.951-
1(f).
    Example 9. The facts are the same as in Example 8 except that the 
stock of FP was publicly traded, FP had one class of stock, and on the 
first day of the current taxable year DP purchased one share of FP stock 
on the foreign stock exchange instead of purchasing one share of JV 
stock from FP. JV became a controlled foreign corporation on the 
following day because over 50 percent of the total value in the 
corporation was held by a person that was a United States shareholder 
under section 951(b).
    Example 10. X, a foreign corporation, is incorporated under the laws 
of country Y. Under the laws of country Y, X is considered a mutual 
insurance company. X issues insurance policies that provide the 
policyholder with the right to vote for directors of the corporation, 
the right to a share of the assets upon liquidation in proportion to 
premiums paid, and the right to receive policyholder dividends in 
proportion to premiums paid. Only policyholders are provided with the 
right to vote for directors, share in assets upon liquidation, and 
receive distributions. United States policyholders contribute 25 percent 
of the premiums and have 25 percent of the outstanding rights to vote 
for the board of directors. Based on these facts, the United States 
policyholders are United States shareholders owning the requisite 
combined voting power and value. Thus, X is a controlled foreign 
corporation for purposes of taking into account related person insurance 
income under section 953(c).

    (d) Effective date. Paragraphs (a) and (c) Examples 8 through 10 of 
this section are effective for taxable years of a controlled foreign 
corporation beginning after November 6, 1995.

[T.D. 6688, 28 FR 11631, Oct. 31, 1963, as amended by T.D. 8216, 53 FR 
27510, July 21, 1988; T.D. 8618, 60 FR 46529, Sept. 7, 1995; 60 FR 
62026, Dec. 4, 1995; T.D. 8704, 62 FR 21, Jan. 2, 1997]