Form 5471 Compliance
Mission Society of Enrolled Agents
International Tax Seminar
August 23, 2013
Campbell, CA
William R. Skinner, Esq.
wrskinner@fenwick.com
(650) 335-7669
____________________
Fenwick & West LLP
Silicon Valley Center
801 California Street
Mountain View, CA 94041
Phone: 650.988.8500
www.fenwick.com
Types of Foreign Entities
John
U.S.
Foreign
Trust
Foreign
LLC
Foreign
Partnership
Passive
Foreign
Investment
Company
(PFIC)
Controlled
Foreign
Corporation
(CFC)
Foreign
Corporation
Other
Foreign
Corporation
2
Taxation of Foreign Corporations - Overview
Controlled
Passive For.
Foreign Corps Inv. Cos
(CFCs)
(PFICs)
Other Foreign
Corps
Taxation of
Corporation:
Only on U.S. income
Only on U.S. income
Only on U.S. income
Taxation of
Shareholder on
Undistributed /
Retained Earnings:
Shareholder taxed at
ordinary rates on
“subpart F income” or
investments in U.S.
property
Shareholder may
elect current taxation
to avoid significant
penalty taxes.
N/A. No tax.
Taxation of
Dividends:
Potential cap gain if
corporation qualifies
under IRC 1(h)(11)
Ordinary income,
plus possible penalty
tax.
Potential cap gain if
corporation qualifies
under IRC 1(h)(11)
Taxation of Sales:
Dividend to the extent
of retained earnings,
then capital gain.
Ordinary income,
plus possible penalty
tax.
Capital gain.
3
Purpose of Form 5471

Provides a way for the IRS to obtain information
about foreign corporations from their significant
U.S. owners.

Puts the burden on the U.S. shareholders to present
information in a U.S. tax format.

Monitors compliance with international tax rules,
including:

Subpart F

Dividends

Foreign tax credits
4
Heightened Focus on Form 5471

IRS offshore voluntary disclosure program focuses
on curing Form 5471 and other international noncompliance.

Significant penalties encourage compliance:
•
•
•
•
Monetary penalties of $10,000 for each year’s failure ($50K
if intentional)
10% reduction in any foreign tax credits claimed from the
relevant foreign corporation under IRC Sec. 902.
Tolling of statute of limitations under until Form 5471 is
filed
40% penalty for any income attributable to an unreported
foreign asset (including on Form 5471).
5
Form 5471 – Identifying Different
Categories of Filers
6
Example of Form 5471 Filers
Brothers
Simon
Tony
China/U.S.
Ralph
U.S.
China
45 Shares
45 Shares
10 Shares
Hong Kong
Co LTD
CEO - Tony

On Jan. 1, 2014, Tony becomes a U.S. tax resident.

On Sept. 1, 2014, Ralph joins the company and receives 10
shares of stock. What are the required Form 5471 filings?
7
Form 5471 – Filing Requirements
•
Generally, Form 5471 is only required to be filed if there is at least one
10% U.S. shareholder in the foreign corporation.
•
The following categories of persons are required to file Form 5471:
– Category 1 – obsolete.
– Category 2 – U.S. citizen or resident who is an officer or director, and
a U.S. person has acquired stock that meets a 10% ownership
requirement or a U.S. person has acquired an additional 10% of
stock.
– Category 3 – U.S. citizen or resident who acquires a 10% ownership
interest, sells stock and drops below 10%, or becomes a U.S. person
while owning 10%.
– Category 4 – a U.S. person that had “control” of the corporation for at
least 30 uninterrupted days during its taxable year.
– Category 5 – a U.S. person who was a “United States shareholder” of
a “Controlled Foreign Corporation” for at least 30 uninterrupted days,
and who owned stock on the last day of the foreign corporation’s
taxable year.
8
Key Definitions

Controlled foreign corporation (“CFC”)


Any foreign corporation if, on any day during its
taxable year, U.S. shareholders own more than 50
percent of the total combined voting power or value of
all of the corporation’s stock. (§ 957(a))
United States shareholder

Any U.S. person who owns (within the meaning of §
958(a)) or is considered as owning by applying the
constructive ownership rules of § 958(b), 10% or more
of the total combined voting power of all classes of
stock entitled to vote of the foreign corporation.
(§ 951(b))
9
Example – Analyzing Categories of Filings

Let’s consider each category of Filer separately.
Category 2
Filers
Category 3
Filers
Category 4
Filers
Category 5
Filers
Which of
Tony, Simon
and Ralph are
within the
Category?
10
Lower-tier Companies – Example 1
Brothers
Simon
Tony
China
U.S.
Ralph
U.S.
45 Shares
45 Shares
10 Shares
Hong Kong
Co
100%
China Co

Question: Does Tony and/or Ralph have to File Form 5471 for China
Co? Answer: Yes, both do. “Constructive ownership rules” generally
treat U.S. shareholders as owning a proportionate amount of stock
owned by the foreign corporation.
11
Lower-tier Companies – Example 2
Tony
U.S.
Simon
51%
Hong Kong
Co
49%
51%
China Co

Question: Does Tony have “control” of China Co? Answer: Yes.
Even though Tony’s economic interest is only 26% (.51 * .51), he is
treated as controlling China Co because each link in the chain is greater
than 50% ownership.
12
Form 5471 – Review of Filing
Requirements
13
Filing Requirements by
Category of Filer
Schedule A
Schedule B
Schedules C, E and F
Schedule G
Schedule H
Schedule I
Schedule J
Schedule M
Schedule O - Pt 1
Schedule O - Pt 2
Category of Filer
1
2
3
4
X X X
X X
X X
X X X
X
X
X
X
X
X
5
X
X
X
X
X
14
Form 5471 – Ownership Information
 Purpose of Schedule A and Schedule B –
track ownership of U.S. shareholders and
inclusions of subpart F income.

Schedule O—



Triggered by U.S. persons going above or
below 10% ownership.
Note broad scope of information – any
organizations, acquisitions, dispositions.
Acquisitions / transfers may also trigger Form
926 filing requirement.
15
Form 5471 – Schedule G Items

Schedule G incorporates reporting for
interests held in other foreign entities (e.g.,
a foreign trust) through a Foreign
Corporation.

Schedule G also tracks significant “hot
button” items for the IRS:



Cost-sharing agreements for offshoring IP
Listed and “reportable” transactions
Certain arrangements that hype foreign tax credits
16
Form 5471 – Schedules C, E and F

Schedules C, E and F present the foreign
corporation’s financials in US GAAP.

Corporation’s “functional currency” may
be a non-Dollar currency in which it
conducts significant activities and
maintains its books and records.

Generally cannot change functional
currency without IRS consent (Form 3115).
17
Schedule H – Why is it Important?
Tony
Simon
Ralph
$45K
Declares
Dividend
$10K USD
Hong Kong
Co
$45K
Earnings & Profits — ?

The distribution to Ralph and Tony will be taxable
as a dividend to the extent of HK Co’s current or
accumulated “earnings and profits”
18
Schedule H - Adjustments

“Earnings and profits” are generally the taxable
income, minus taxes, of the foreign corporation
computed under U.S. tax principles.

Schedule H reconciles U.S. tax E&P with
GAAP P&L and categorizes major adjustments.

Translation into US Dollars – generally done
using the spot rate on the date of the dividend.
See Schedule I, line 7.
19
Schedule I – Computing Effects on U.S.
Shareholders
20
Schedule I – Impact on U.S. Shareholders

A U.S. shareholder can include income
from a CFC in one of four ways:
1.
Receive an actual dividend out of CFC’s
earnings and profits
2.
Sell shares and recognize a gain
3.
Include pro rata share of the foreign
corporation’s subpart F income, or
4.
Include pro rata share of foreign corporation’s
investment of earnings in U.S. property under
Section 956.
21
Subpart F – Background

Absent subpart F, a foreign subsidiary’s earnings are not
subject to U.S. tax until distributed to the U.S.
shareholder. Subpart F ends deferral of certain “subpart F
income” or investments in U.S. assets.
Joseph
U.S.
French
CFC
Department Store
28% French Tax
Donald
U.S.
Cayman
CFC
Securities Portfolio
0% Cayman Tax
22
Statutory Overview - Subpart F Income

Section 952 – Subpart F income means, in the case of any
CFC, the sum of

insurance income (§ 953)

foreign base company income (§ 954)

international boycott income

an amount equal to payments which would be unlawful
under the Foreign Corrupt Practices Act of 1977, and

the income derived from any foreign countries with
which the U.S. has severed diplomatic relations
23
Foreign base company income


Section 954 – “Foreign base company income” is comprised of the
sum of:

foreign personal holding company income – § 954(c)

foreign base company sales income – § 954(d)

foreign base company services income – § 954(e)

foreign base company oil related income – § 954(g)
Subpart F income generally includes income of a CFC that is passive
or otherwise easily mobile, but not income earned in an active
business.
24
Foreign Personal Holding Company Income

Joseph
Section 954(c) – Foreign personal holding company income
(“FPHCI”) includes the following types of gross income:

Dividends, interest, royalties, rents, and annuities

Certain property transactions (generally, gains from the
sale of property which (i) gives rise to passive income, (ii)
is a partnership interest, or (iii) which does not give rise to
income)
CFC
Passive income
Examples:
*Bank deposit interest
*Royalties or rents not
in an active business
*Captial gains from sale
Of shares
• Generally excludes property that is used in a trade or
business.

Commodities transactions

Foreign currency gains
• Exceptions for hedging transactions

Income equivalent to interest

Income from notional principal contracts

Payments in lieu of dividends
25
Exceptions to Subpart F Treatment
1. The Same Country Exception: For certain dividends, interest, rents
and royalties which are from related persons (§ 954(c)(3)) organized
in the same country as the CFC.
2. Active Rents and Royalties Exception: Rents and royalties derived
in an active business (§ 954(c)(2)(A)).
A. Active development of the property (e.g., R&D or building the
personal property)
B. Active sales and marketing through an office outside of the U.S.
(25% safe harbor test).
C. Occasional rental of property used in an active business.
3. Section 954(c)(6) CFC look-through rule: Look through dividends,
interest, rents and royalties received or accrued from a CFC which is
a related person are generally not subpart F income.
26
REVIEW - Subpart F Income


Section 954 – Foreign base company income is comprised
of the sum of:

foreign personal holding company income – § 954(c)

foreign base company sales income – § 954(d)

foreign base company services income – § 954(e)

foreign base company oil related income – § 954(g)
Subpart F income generally includes income of a CFC
that is passive or otherwise easily mobile, but not
income earned in an active business.
27
Foreign Base Company Sales Income

Section 954(d)(1) – Foreign base company sales income means

Income derived in connection with any of the following:
1. The purchase of personal property from a related person and its sale to any
person,
2. The sale of personal property to any person on behalf of a related person,
3. The purchase of personal property from any person and its sale to a related
person, or
4. The purchase of personal property from any person on behalf of a related
person

Where the following conditions exist:
(i) The property is manufactured outside the CFC’s country of organization, and
(ii) The property is sold for use outside the CFC’s country of organization
28
Foreign Base Company Sales Income
Joseph
>50%
Unrelated
Party
purchases
sales
S Corp
>50%
CFC
HK Co.
Resales
Makes electronics
in U.S.

This is an example where HK Co very likely has subpart F
sales income because:

Goods are purchased from a related party (S Corp)

Goods are made outside of the Hong Kong (US)

Goods are probably shipped to customers outside Hong Kong.

HK Co. does not appear to further manufacture the goods before
resale.
29
REVIEW - Subpart F Income


Section 954 – Foreign base company income is comprised
of the sum of:

foreign personal holding company income – § 954(c)

foreign base company sales income – § 954(d)

foreign base company services income – § 954(e)

foreign base company oil related income – § 954(g)
Subpart F income generally includes income of a CFC
that is passive or otherwise easily mobile, but not income
earned in an active business.
30
Foreign Base Company Services Income

Section 954(e) – Foreign base company services income
(“services income”) means income (whether in the form
of compensation, commissions, fees, or otherwise)
derived in connection with the performance of technical,
managerial, engineering, architectural, scientific, skilled,
industrial, commercial, or like services which:

are performed for or on behalf of any related person,
and

are performed outside the country under the laws of
which the CFC is created or organized.
31
Foreign Base Company Services Income

Services which are performed for, or on behalf of, a related person”
include (but are not limited to) services performed by a CFC where—

The CFC is paid or reimbursed by a related person for performing
such services;

The CFC performs services which a related person is, or has been,
obligated to perform;

The CFC performs services with respect to property sold by a
related person and the performance of such services constitutes a
condition or a material term of such sale; or

Substantial assistance contributing to the performance of such
services has been furnished by a related person.
32
Foreign Base Company Income –
Limitations and Special Rules

De minimis amount - § 954(b)(3)(A)


If FBCI is less than the lesser of 5% or $1 million, then no FBCI.
Full inclusion rule - § 954(b)(3)(B)

If FBCI exceeds 70% of gross income, then all of the CFC’s gross income will be
FBCI.

High taxed income - § 954(b)(4)

FBCI does not include any item of income received by a CFC if the taxpayer
establishes that such income was subject to an effective rate of income tax imposed
by a foreign country greater than 90 percent of the maximum rate of tax imposed on
corporations.

For example, with a U.S. maximum corporate tax rate of 35%, an item of FBCI
subject to a foreign tax rate in excess of 31.5% would qualify for this exception

Deductions taken into account - § 954(b)(5)

Reduce FBCI by expenses (including taxes) properly allocable and apportionable to
the income.
33
Schedule I – Part II – the Sec. 956 Amount

The U.S. shareholder shall include its pro
rata share of the CFC’s Sec. 956 amount.

The Sec. 956 amount is the lesser of
untaxed “applicable earnings” and average
of amounts of U.S. property held by CFC
on each of its quarter ends.
34
Schedule I – Part II – the Sec. 956 Amount


Definition of “U.S. Property”:

Real or tangible property located in the U.S.

Debt obligations issued by related U.S. persons

Stock in related U.S. persons.

Intellectual property developed or acquired for use in
the United States.
Certain exceptions include inventory for
export, short-term loans and ordinary
course A/R, etc.
35
Schedule I – Another Example

Raj is an Indian citizen who, together with other
members of his family, owns all of a Mauritius
investment company.

Among the company’s assets are U.S. stocks and
bonds, U.S. real estate, Indian real estate, and a
75% stake in an Indian family business.

Raj and his wife obtain greencards and become
U.S. tax residents in 2014. What items may be
relevant to Raj’s Form 5471 disclosure?
36
Example – Steps to Analyze
1.
Is Raj (or his wife) a Form 5471 filer? In what
categories?
2.
Is Mauritius HoldCo and/or Indian family company a
Controlled Foreign Corporation (CFCs)?
3.
If so, does either company have any subpart F income?
4.
A.
Foreign personal holding company income
B.
Foreign Base company Sales Income or Services
Income
Also, if either company is a CFC, does it own any U.S.
property within the meaning of Sec. 956?
37
Form 5471 Schedule J – Earnings
Accounts
38
Example of Previously Taxed Income
Tony
2013 − $200
Sub F Income
U.S.
2014 − $150
Cash Distribution
Hong Kong
Co
2014 E&P − $400 Total
$200 Subpart F from 2013
$200 Other E&P

Review. Distributions from a foreign corporation are
taxable to the extent of current and accumulated earnings
and profits (“E&P”). But here $200 of HK Co’s E&P
was already taxed to Tony under Subpart F.
39
Schedule J – E&P Accounts

Schedule J tracks the foreign corporation’s
accumulated Earnings and Profits in different
categories:


Undistributed / non-previously taxed E&P (col. (a))
Previously taxed income due to subpart F inclusions
and Sec. 956 investments (col. (c))

These accounts are adjusted year-over-year as
different categories of earnings are generated.

Distributions always come from Previously
Taxed Income (PTI) first.
40
Schedule M – Related Party Transactions

Only required to be filed by Category 4 filers
(U.S. shareholder with “control” of the CFC).

Schedule M lists all related party transactions
with the controlling U.S. shareholder and any
foreign affiliates.

Finish completing model Form 5471 for sample
problem (Schedules J, M and O)
41
The IRC Section 962 Election
42
Taxation of Dividends from Foreign Corps


Dividends received from a foreign corporation
are taxed at ordinary income rates, unless the
corporation is a “qualified” foreign corporation:

Publicly traded on a U.S. stock market, OR

Located in a Treaty country and eligible for the Treaty,
AND

NOT a PFIC at any time.
Subpart F inclusions and Sec. 956 investments
are taxable at ordinary rates, even if received
from a qualified foreign corporation.
43
Example
Joseph
Donald
U.S.
U.S.
$70 Distribution
Hong Kong
Co
$70 Distribution
Delaware
Corp
$100 Subpart F Income
($30) French Tax
$70 Distribution
French
Office
$100 Subpart F Income
($30) French Tax
44
Tax Rates on Donald and Joseph
Item
Taxable Income
French Corp Tax
Net Income
US Corp Taxable Inc.
Tent. US Corp. Tax
Comparative All-In Tax Rates
Joseph
$100
($30)
$70
Foreign Tax Credit for French Corp Tax
Net U.S. Corp Tax
Total Corp Tax (%)
Donald
$100
($30)
$70
$100
($35)
30%
$30
($5)
35%
Sub F Inclusion Taxable at OI Rates (35%)
($24.50)
$0
Shareholder Dividend Tax at LTCG (15%)
Rate
Total Shareholder Tax (%)
$0
24.50%
($9.75)
9.75%
All-In Tax Rate
54.50%
44.75%
45
Section 962 Election

Election allows shareholder to be treated as
if it were a Domestic C corporation earning
the subpart F income, and paying tax at
corporate rates.

Shareholder can claim foreign tax credit for
CFC’s foreign taxes under Sec. 960.

Actual distributions by CFC become taxable
to the extent they exceed income tax paid
under Sec. 962.
46
IRS CIRCULAR 230 DISCLOSURE
To ensure compliance with requirements imposed by the IRS, we
inform you that any U.S. federal tax advice in this communication
(including attachments) is not intended or written by Fenwick & West
LLP to be used, and cannot be used, for the purpose of (i) avoiding
penalties under the Internal Revenue Code or (ii) promoting,
marketing, or recommending to another party any transaction or
matter addressed herein.
47