Three variations of foreign corporations can produce tax consequences for U.S. persons: Controlled Foreign Corporations (CFC), Foreign Personal Holding Companies (FPHC), and Passive Foreign Investment Companies (PFIC). U.S. shareholders of CFCs are taxed on specific types of corporate earnings as dividends even if not distributed in the year earned. Such CFC income includes dividends, interest, rent, royalties, capital gains (passive income), sales income on property purchased from or sold to related parties, and service income generated on behalf of a related party.
A U.S. shareholder (U.S. person only) can own shares in a foreign corporation that is not controlled without being required to report and pay taxes on the corporation's income until distributed. So a foreign corporation is not subject to the taxing jurisdiction of the Internal Revenue Service (IRS). But U.S. shareholders are subject.
A foreign corporation earning effectively connected income through a U.S. trade or business becomes subject to IRS taxing jurisdiction. Such income is then taxable according to domestic corporate income tax rates. U.S. source income of the foreign corporation not effectively connected is subject to 30% withholding unless a tax treaty has set a lower rate. A foreign shareholder of a foreign corporation deriving effectively connected U.S. income is subject to 30% withholding on that income.
Understanding the tax implications of a foreign corporation is a major undertaking. So the rules according to IRS for filing Form 5471 are extremely complicated and tedious. Perhaps for this reason, IRS estimates some 32 hours work on average to prepare and file the form as along as the recordkeeping is done rightly.
The penalty for failing to file the return is $10,000 per incident. If the taxpayer is notified by IRS to file this form, the penalty can accumulate for each month of delay up to $50,000. In certain cases, IRS may pursue criminal penalties for its neglect. Although a U.S. person required to file does not normally pay income taxes on the corporation's income until distributed either as a dividend or salary, the requirement to file remains an important priority, even when the corporation has a loss. The ability of the Service to exchange information with foreign taxing authorities makes it increasingly difficult and risky to ignore this filing requirement.
According to Marti Sartipi, International Policy Program Manager with Internal Revenue Service, the IRS has armed itself with 300 auditors trained in international compliance matters and are in process of hiring and training another 100. Sartipi announced that these auditors will 1) automate processes to assist in identifying non-filers, 2) audit 10,000 tax returns with international issues, 3) impose penalties for failure to submit required disclosure documents. Disclosure documents include Form 5471.
U.S. persons, domestic corporations or domestic estates or trusts must file Form 926 - Return by a U.S. Transferor of Property to a Foreign Corporation, to report exchanges or transfers of property. Persons filing Form 926 may also be required to file Form TD F 90-22.1 - Report of Foreign Bank and Financial Accounts.
Form 5472 is required to be filed by a reporting corporation that has reportable transactions with foreign or domestic related parted. A reporting corporation is either a U.S. corporation that is a 25% foreign-owned or a foreign corporation engaged in a trade or business within the United States. A corporation is 25% foreign-owned if it has at least one direct or indirect 25% foreign shareholder at any time during the tax year.
Form 8865 - Return of U.S. Persons With Respect to Certain Foreign Partnerships - is used with respect to controlled foreign partnerships, transfers to foreign partnerships, and changes in foreign partnership interests. Within the filing instructions are four categories of filers. A foreign corporation can elect to be classified as a domestic partnership. But Form 8865 must still be filed.
Form 926 - Transfers to Controlled Foreign Corporation
Form 1040-NR - Non-resident alien tax return
Form 1116 - Foreign Tax Credit for Individuals
Form 1118 - Foreign Tax Credit for Corporations
Form 1120-F - Tax Return for Foreign Corporations Doing Business in United States
Form 2555 - Foreign Earned Income Exclusion
Form 3520 - Transfers to Foreign Trust
Form 3520-A - Annual Return of Foreign Trust
Form 5471 - Information Return of Foreign Corporation
Form 5472 - Information Return of Foreign Owned Corporation
Form 8621 - Information Return for Passive Foreign Investment Company
Form 8804 & 8805 - Foreign Partner's Information Statement
Form 8832 - Entity Classification Election
Form 8833 - Treaty Based Return Position
Form 8865 - Information Return for Foreign Partnership
Form TD F 90-22.1 - Information Return for Foreign Financial Accounts
Tax forms and instructions are available at the IRS website: http://www.irs.gov/forms_pubs/formpub.html
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