Foreign Corporations
Foreign corporations can face US taxation if they fall under certain categories.
A US citizen or resident who has a 10% or more interest in, or is a director or officer in certain foreign corporations may be required to file Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations.
A form 5471 filing requirement is triggered for:
This ownership threshold is met when a US person owns 10% or more of the total value of the foreign corporation’s stock or the combined voting power of all stock classes with voting rights.
When more than 50% of a foreign corporation is owned directly, indirectly or constructively by US shareholders, the term CFC is applied. Percentage ownership is calculated in regards to both the combined voting power of all classes of stock and the value of the corporate stock.
Form 5471 reports activity and financial assets of the foreign corporation. Examples of information required to be reported includes balance sheet details, income statement information, personal shareholder details, business operations, payments to officers, directors, and shareholders, loans and dividends. All transactions between the filer and the corporation must be reported.
Certain types of income from a CFC, referred to as Subpart F income, flow through onto the income tax returns of the US shareholders and become taxable income, regardless of whether this income was actually distributed to shareholders. Until the Tax Cut and Jobs Act passed at the end of 2017, subpart F income had a narrower definition. It generally consisted of movable, investment income such as dividends, interest, rents and royalties. As well as income attributed to related party purchases not manufactured or distributed in the CFC’s country of incorporation and services performed by the CFC for on behalf of a related party outside the country of incorporation. For countries whose corporate tax rate is at least 90% of the US tax rate, no sub-part F income is includable; known as the high tax exception. With the passing of the Tax Cut and Jobs Act the definition of sub-part F income expanded giving rise to Section 965 transition tax and GILTI, explained below.
Prior to the passing of the Tax Cut and Jobs Act, earnings of a CFC were deferred until repatriation (except for earnings falling into the narrow sub-part F regime). Section 965 of the Internal Revenue Code in effect pierced the foreign corporate veil and made all CFC retained earnings taxable on the shareholder level. The new act imposed a one-time “repatriation tax” on retained earnings of CFCs as of December 31st, 2017. The tax was a flat 8% or 15.5% tax, depending on whether or not the retained earnings were held in liquid or non-liquid assets. For US individual shareholders, general category foreign tax credits from other sources of income could be utilized to offset the 965 tax. Individuals could also make a Section 962 election treating themselves as if they were a US C-Corporation thus being allowed to utilize foreign corporate taxes paid to offset the repatriation tax. Without a 962 election, individuals could not utilize foreign corporate taxes paid to offset the section 965 individual tax. For calendar year CFCs, the section 965 income and related tax was included on a shareholder’s 2017 calendar year tax return. For certain fiscal year CFCs the repatriation income was included on the shareholder’s 2018 tax return filing.
Global Intangible Low Taxed Income was introduced into the US tax code for tax year 2018 and on. GILTI is similar to the repatriation tax that applied to the 2017 tax year. Per IRC section 951(a) all undistributed earnings of a CFC in excess of 10% of the company’s qualified business assets, are defined as sub-part F income and thus includable as taxable income on the shareholder level.
For US individual shareholders of a CFC, this creates the same problem as the section 965 transition tax in the sense that corporate taxes paid by the CFC cannot be used to offset personal income tax liability. However, using a Section 962 election will once again allow the US individual shareholder to be treated for tax purposes as a corporation thus allowing use of foreign corporate taxes paid to offset the US GILTI liability.
New regulations issued in 2019 expand the high tax exception to include GILTI. Therefore, income that is subject to an effective corporate tax rate of at least 90% of the US tax rate, would be deducted for GILTI calculation purposes. The US corporate tax rate is now at a flat 21%. Therefore, corporate earnings from countries that are taxed at 18.9% or higher could elect to exclude this income from GILTI calculations. To do so, one must attach an election statement under Section 954(b)(4). This election must be made for each controlled foreign corporation. Once made, the election remains in effect unless revoked. If one revokes this election, the HTE cannot be made again for this CFC for the next five years unless a private letter ruling is received from the IRS.
The form is filed along with an individual’s income tax return. For US businesses that own 10% or more interest in foreign corporations, Form 5471 is filed along with the related business tax return.
An individual who fails to file Form 5471 is faced with a $10,000 penalty per year for each foreign corporation for which he/she failed to file. There is an additional penalty of $10,000 per thirty-day period for failure to file after receipt of an IRS notification; up to a maximum penalty of $50,000. Furthermore, there is no statute of limitations limiting the IRS’s ability to penalize the taxpayer within a set time frame. This means that if the IRS becomes aware that an individual failed to file for many years – he can be penalized for each of those years, separately for each corporation in which he held 10% or more interest.
With the IRS’s recent FATCA agreements with many foreign countries and related party reporting by foreign financial institutions, the IRS is more likely than ever to obtain information about the shareholders of foreign corporations.
Form 5471 Foreign Corporation Informational Return | $340 |
Section 962 Election | $240 |
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