as income derived from sources within the United States. However, in order to pre-
vent international double taxation, the United States grants primary taxing jurisdic-
tion to the country from where the income is derived. The tax can then either be de-
ducted or claimed as a tax credit, as described in section 30.4.
(b) Foreign Subsidiaries of U.S. Corporations. In general, the United States does not
tax income earned by foreign subsidiaries of U.S. corporations until such income is
repatriated to the United States. There are several exceptions to this general rule in
addition to income earned by certain Canadian and Mexican subsidiaries that are in-
cluded in a consolidated federal income tax return. (Note that such Canadian and
Mexican corporations must meet certain requirements in order to be so included.)
The most important exception applies to those foreign corporations that are con-
trolled by U.S. shareholders and derive certain types of “tainted” income. These cor-
porations are called “controlled foreign corporations,” and the provisions that are ap-
plied to them are known as “Subpart F.” Prior to the Revenue Act of 1962,
corporations formed subsidiaries in tax havens, such as Panama and the Bahamas.
These corporations purchased goods manufactured by the U.S. patent and resold the
products to customers throughout the world. Since Internal Revenue Code Section
482 (discussed in the prior chapter) was not as rigidly enforced in those days as it is
now, these tax haven corporations were able to claim, free from any tax, a significant
portion of the overall profit. These profits were then used to earn investment type in-
come or perhaps were even loaned to the parent company. If the corporation was no
longer needed, it was sold or liquidated and capital gains treatment was claimed. The
Revenue Act of 1962 introduced Subpart F into the Internal Revenue Code, and, in
the ensuing years, these Subpart F provisions were modified and generally tightened
so as to snare more and more types of income within its net. These provisions tax the
U.S. shareholder on tainted types of income derived by controlled foreign corpora-
tions even before the income is repatriated. A correlative provision of the Internal
Revenue Code treats the untaxed income derived after 1962 as a dividend when the
foreign corporation is liquidated or sold.
The term taintedincome is not a term of art but one that is used to describe cate-
gories of income that must be included in the U.S. shareholder’s income. The major
component of this tainted income is “Subpart F income.” However, it also includes
the controlled foreign corporation’s increase in earnings invested in U.S. property as
well as certain other types of income that in earlier years was excluded from imme-
diate taxation as long as the income was reinvested in prescribed activities. Thus, in
earlier years, certain income earned in less developed countries was excluded from
the Subpart F provisions if that income was reinvested in less developed countries,
and shipping income was excluded from the definition of Subpart F income if the in-
come was reinvested in qualified shipping assets. When those amounts are disin-
vested, they are included in “tainted” income.
Subpart F income has five components, and its major component, foreign base
company income, also has five subdivisions. They are:
1.Foreign base company income:
a.Foreign base company sales income
b.Foreign base company services income
c.Foreign base company shipping income30 • 4 INTERNATIONAL TAXATION