Section 956 Income Inclusion for US Shareholder of Controlled Foreign Corporations

Overview

It is quite well known that US persons who own a Controlled Foreign Corporation (CFC) are typically subject to additional reporting requirements and potentially punitive income taxation. The most talked about regimes include the Net CFC Tested Income (formerly Global Intangible Low Taxed Income, GILTI) rules required under Section 951A, and the Subpart F income inclusion as defined under Section 952.

However, there is another regime – the Section 956 inclusion, that is less talked about, but which could be easily missed and could cost you a huge amount of money. Section 956 could be triggered if a CFC invests its earnings in United States property. This includes the situation where the US shareholder takes out a loan from the company, which could come with US tax implications that the shareholder may not be aware of.

The rules are intended to discourage taxpayers from investing the CFC earnings back into the US without withdrawing the profits first, which could otherwise be a taxable event.

Take a CFC as an example with $100 of non-previously taxed income. If the shareholder takes a dividend of $100 and invests it into the US stock market, the $100 would be treated as a taxable distribution. Absent the 956 rules, the taxpayer could leave the $100 in the CFC to make the same investment, thus deferring the US individual income tax on the CFC earnings until an eventual withdrawal.

General Rule

Pursuant to Section 951(a)(1)(B) and Section 956, a US shareholder of a CFC shall include in gross income his or her pro-rata share of the “Section 956 amount”.

The Section 956 amount is calculated to be the quarterly average of the adjusted cost basis of “United States property” held by the CFC, excluding any previously taxed Section 956 amounts, limited to the “applicable earnings” of the CFC.

“Applicable earnings” is defined to be the accumulated earnings and profits (not including a deficit) plus the current year earnings and profits, reduced by the distributions made during the year and the amount of previously taxed Section 956 amounts. This means that, even if the company had been in a loss position since inception and did not pay it off, Section 956 could still be triggered if the CFC earned net income in any given year.

What is considered to be “United States Property”

United States property usually includes the following by definition:

• Tangible property located in the US
  • Such as real estate, personal property
• Stock of a domestic corporation
  • Such as US listed stocks and US subsidiaries
• An obligation of a United States person
  • Such as a US corporate bond
• Any right to use in the US of:
  • a patent or copyright,
  • an invention, model or design,
  • a secret formula or process, or
  • any other similar right

which is acquired or developed by the CFC for use in the US.

Several exceptions apply to exclude certain assets from falling into the definition of “United States Property,” such as:

• US bank deposits
• Properties purchased in the US for export purposes
• Ordinary and necessary amounts due from US persons arising in connection with the sale of property
• An obligation of an unrelated non-corporate person

Shareholder / US Related-Party Loan

As briefly mentioned in the overview section, a shareholder loan could also fall within the definition of “United States Property” as an obligation of a United States person, because the shareholder is a US tax resident him or herself. A US shareholder should consider the Section 956 tax implications before taking out a shareholder loan. This is a commonly seen mistake that could unexpectedly cost shareholders who are not aware of the rules a significant amount of tax.

In the case of multiple US shareholders of a CFC, if one of the US shareholders took out a loan, the other US shareholders might also be impacted because there could be a Section 956 income inclusion to the other US shareholders who did not take out a loan.

Any amount due to the CFC from a US corporation or US subsidiary could also fall within the definition. This includes accounts receivable from a related US corporation, even if they are accounts receivable that are ordinary and necessary for business operations not intended to be a formal loan.

Illustration

Mike, a US citizen living in Canada, owns 100% of a Canadian corporation, which is treated as a CFC for US tax purposes. Mike earned enough income outside of the CFC to be in the highest US tax bracket of 37%. The CFC had previously been in a loss position but earned $200,000 of income this year. Mike, while unaware of the rules, took out a shareholder loan of $100,000 on Apr 1, 2025.

The shareholder loan would be treated as “United States Property” because this is an obligation of Mike, who is a US person. The Section 956 amount is determined by the quarterly average of the US property, which is $0 for Q1 and $100,000 for Q2-Q4. The quarterly average would be $75,000.

Since the CFC earned $200,000 during the year, even though it had been in a loss position in the past, the $200,000 would be treated as the “applicable earnings.” As the quarterly average of US property for $75,000 does not exceed the applicable earnings, the entire $75,000 would be treated as Mike’s Section 956 amount.

At his marginal tax rate of 37%, this would mean an additional $27,750 US tax liability. Foreign tax credits likely would not apply here.

To discuss the implications of holding your Canadian corporation as a US resident, we strongly recommend reaching out to schedule a cross-border tax and financial planning consultation.