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Foreign Corporations

FILING REQUIREMENTS

U.S. persons who are shareholders or officers in a foreign corporation whether directly or indirectly through a U.S. corporation or partnership may be required to file Form 5471 - Information Return of U.S. Persons With Respect to Certain Foreign Corporations. Internal Revenue Service considers a U.S. person to be 1) a citizen or resident of the United States, 2) a domestic partnership, 3) a domestic corporation, 4) an estate or trust that is not a foreign estate or trust. A foreign corporation is formed outside of the United States according to the laws of the foreign country where formed. A corporation organized in Guam, American Samoa, the Northern Mariana Islands or the Virgin Islands is not considered foreign for U.S. tax purposes.

CATEGORIES OF FILERS

Requirements for filing this information return depend upon the category of filer. Category 1 relating to a foreign personal holding company has been repealed. Category 2 is a U.S. person who is an officer or director of a foreign corporation and who owns a 10% or more interest in the foreign corporation. Category 3 is a U.S. person who acquires or disposes of 10% interest in the foreign corporation. Category 4 is a U.S. person who had more than 50% control of a foreign corporation for 30 or more days during the tax year. Category 5 is a U.S. shareholder who owned stock in a foreign corporation that was a Controlled Foreign Corporation for 30 or more days during the tax year. Control is determined by category 4. Read about the experience of an American Expat who set up several Foreign Corporations.

Family members who independently own 10% or more of the voting stock of a foreign corporation are included in determining percentage ownership. Two or more members of a family could together own more than 50%, resulting in control of the foreign corporation. A 50% owner of a U.S. corporation or partnership that owns shares in a foreign corporation is considered as owning those shares for purposes of control. Shareholders in a CFC are subject to more stringent taxation even if such ownership of shares only occurred for 30 days during the taxable year.

FORM 5471 PREPARATION

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TAX ISSUES TO CONSIDER

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.

TIME REQUIRED TO PREPARE FORM 5471

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.

PENALTY FOR FAILURE TO FILE

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.

BREAKING NEWS

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.

OTHER FILING REQUIREMENTS

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.

FORMS RELATED TO FOREIGN TAX FILINGS

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

FILING INSTRUCTIONS AND FORMS

Tax forms and instructions are available at the IRS website: http://www.irs.gov/forms_pubs/formpub.html

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FOREIGN CORPORATION TAX GUIDES

U.S. International Taxation
Offshore Corporations
Form 5471 reporting for resident aliens complicated by...
Revised Form 5471 creates uncertainties.
Taxation of Controlled Foreign Corporations
CFC buyer's sec. 338 election deprives seller of FTCs....
CFC's treatment of partnership income.
Current issues in taxation of U.S.-controlled foreign ...
Foreign Ownership and the Consequences of Direct Inves...
Tax Reporting for Foreign-Owned U.S. Corporations
Tax Treaties and Controlled Foreign Company Legislation...
Taxation of Domestic Shareholders on Undistributed Inc...
U.S. Foreign Tax Policy
U.S. shareholders of CFCs
Us Tax Guide for Foreigners And Foreign Corporations
IRS targets multinationals.
A guide to foreign corporation.

OUR SERVICE

Contact us for a free consultation. We have 12 years experience preparing and filing Form 5471 and its accompanying schedules and other international tax matters.