Foreign acquisitions may bring hidden taxable income. US companies that buy shares in foreign corporations may be at risk of having to pay tax currently in the United States on income that the foreign target corporation earned before the acquisition.

The risk arises when a US company buys enough shares to become a “United States shareholder” in a “controlled foreign corporation.” This means that the US entity acquires 10% or more of the stock in the foreign target, and the target is more than 50% owned by US persons. Certain types of income — generally passive income like rents, dividends and interest — earned by the target pass directly up to US tax returns of its US owners. This is known as “subpart F income.” US tax rules require that anyone who owns shares in a foreign corporation on the last day of the year must report his share of the company’s income for the entire year. Thus, someone who buys into the company in December is at risk of having to report income for the entire year.

Some US buyers can protect themselves by making a “section 338 election.” This will end the target’s tax year as of the date of the sale, which prevents any pre-sale subpart F income from reaching the buyer’s tax return. However, this election is only available if the US shareholder acquires at least 80% of the foreign target within a 12-month period.