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Cross Border Ownership Structures Under Heightened IRS Scrutiny

Mastering the Compliance Challenges of Forms 1120-F, 5471, 5472 and 926

presents

Today's panel features: William P. Elliott, Partner, Cherry Bekaert & Holland, Vienna, Va. Kirk Sinclair, Senior Tax Accountant, Holtz Rubenstein Reminick, Melville, N.Y. Russell Mansky, Partner, Spott Lucey & Wall, San Francisco

Wednesday, April 29, 2009 The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific

The audio portion of this conference will be accessible by telephone only. Please refer to the dial in instructions emailed to registrants to access the audio portion of the conference.

A Live 100-Minute Audio Conference with Interactive Q&A

1

Cross-Border Ownership Structures Under Heightened IRS Scrutiny Teleconference

April 29, 2009 William P. Elliott Kirk Sinclair Cherry Bekaert & Holland Holtz Rubenstein Reminick belliott@cbh.com ksinclair@hrrllp.com Russell Mansky Spott Lucey & Wall CPAs russell.mansky@SpottLuceyWall-CPAs.com

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Today’s Agenda

Form TD F 90-22.1 Slides 3-24 . . . . . . . . . . . . . . . . . . William B. Elliott Form 1120-F Slides 25-59 . . . . . . . . . . . . . . . . . . . . . . .William B. Elliott Form 5471 And Related Forms Slides 60-74 . . . . . . . . Russell Mansky Form 926 Slides 75-85 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Kirk Sinclair

3

Form TD F 90-22.1

Report Of Foreign Bank And Financial Accounts

4

Form TD F 90-22.1

Report Of Foreign Bank And Financial Accounts

FBAR Origin → Congress created the BSA because of concern that financial institutions in tax haven jurisdictions were being used by U.S. persons to hide the proceeds of their illegal activities, evade tax, and for other criminal purposes. The FBAR is a by-product of the Bank Secrecy Act (BSA), which was first enacted in 1970 FBAR Scope → The FBAR requirements apply to any "U.S. person," which includes all U.S. citizens and resident aliens The JCT Report proposals would put the responsibility for determining whether a taxpayer has an FBAR filing requirement on tax preparers, by extending to the FBAR the Section 6695(g) due diligence requirement

5

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Typology of accounts subject to FBAR → Generally, any type of account that holds liquid assets or marketable securities will be a "financial account" for purposes

• f

the FBAR requirements. Thus, everything from a cash account to a foreign mutual fund, such as an exchange traded fund, is classified as a financial account → Only financial accounts actually located in a foreign jurisdiction are subject to FBAR reporting. For example, an investment account with a U.S. branch of a foreign financial institution or brokerage house would not require an FBAR but an account with such a financial entity’s foreign offices would

6

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Power of signature or other authority → If an individual can order the distribution or disbursement of funds

• r other property from the institution where the funds or property are

maintained, by signing a document providing such direction (or in conjunction with one other person signing the document), that individual has signature authority over the financial account

7

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Power of signature or other authority → Similarly, if an individual can exercise the same control verbally

• r via other means of communication, the individual has other

authority over a financial account → These powers should not be confused with the power of investment

8

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Financial interest → The definition of what constitutes a financial interest for purposes of the FBAR is based on who owns the interest. Essentially, an individual has a financial interest in every account for which the individual is the

• wner of record or has legal title, whether the account is for the
• wner's benefit or for the benefit of another

9

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Financial interest → Individuals serving as shareholders, partners, and trustees also may be deemed to hold a financial interest in an account if the account is

• wned by or the individual with legal title is any of the following:

(1) A person acting as an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person (2) A corporation in which the U.S. person owns more than 50% of the total stock either directly or indirectly (3) A partnership in which the U.S. person owns an interest in more than 50% of the profits

10

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Due date for FBAR filings → If a U.S. person has a foreign account that satisfies the FBAR requirements, the FBAR is due on June 30 of the following year (with no extensions.) The form is filed with the Detroit Service Center → The duty to file the FBAR is independent of the obligation to file an income tax return even though the FBAR is cross referenced on Form 1040, Schedule B, Part III

11

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Due date for FBAR filings → A foreign account that satisfies the FBAR requirements must be reported even if the account does not generate taxable income. Thus, a taxpayer who fails to file an FBAR because the account generates no taxable income will be subject to penalty → The IRS has six years within which to assess a civil penalty related to an FBAR violation. It is unclear, however, whether the statute will toll if the FBAR is not filed

12

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Penalties for FBAR non-compliance

• I. Civil penalties

→ AJCA expanded civil penalties for FBAR violations in that after the AJCA, there is now a penalty of up to $10,000 for a non-willful failure to file the FBAR → To satisfy the reporting necessitated for the reasonable cause exception, the taxpayer must be certain to include on the Form 1040 any income generated by the foreign account and to the extent possible a detailed explanation of the transaction

13

Form TD F 90-22.1

Report Of Foreign Bank And Financial Accounts

Penalties for FBAR non-compliance

• I. Civil penalties

→ For a willful violation of the FBAR reporting requirement, the penalty is now a fine equal to the greater of $100,000 or 50% of the amount of the transaction or of the balance of the account at the time of the offense. Violations that are deemed to be willful are not subject to the reasonable cause exception

14

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Penalties for FBAR non-compliance

• II. Criminal penalties

→ While the AJCA did not change any aspect of the criminal penalties, such penalties are premised on the violation's being

• willful. Thus, if the failure to file the FBAR is deemed to be a

criminal violation, the penalty can include a fine of up to $250,000, imprisonment for up to five years, or both

15

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Penalties for FBAR non-compliance

• II. Criminal penalties

→ If the failure to file is deemed to be part of a criminal activity (i.e., it occurs during the violation of another law or is part of an illegal activity involving more than $100,000 in a 12-month period), the maximum fine increases to $500,000 and the possibility of imprisonment increases to up to 10 years

16

Form TD F 90-22.1 (Cont.)

Report Of Foreign Bank And Financial Accounts

Penalties for FBAR non-compliance

• II. Criminal penalties

→ There is, of course, a possibility that both the $500,000 penalty and ten-year jail term will be applicable AJCA expanded civil penalties for FBAR violations in that after the AJCA, there is now a penalty of up to $10,000 for a non-willful failure to file the FBAR

17

What is an FBAR? An FBAR is a Report of Foreign Bank and Financial

• Account. The form number is TD F 90-22.1

(PDF) Who must file an FBAR? Any U.S. person who has a financial interest in or signature authority, or other authority over any financial account in a foreign country, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year What is a U.S. person? A U.S. person is: A citizen or resident of the U.S.; a domestic partnership; a domestic corporation; a domestic estate or trust What is a foreign country? A “foreign country” includes all geographical areas

• utside the U.S., the Commonwealth of Puerto Rico, the

Commonwealth of the Northern Mariana Islands, and the territories and possessions of the U.S. (including Guam, American Samoa, and the U.S. Virgin Islands)

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR)

18

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

What is a financial account? A “financial account” includes any bank, securities, securities derivatives

• r other financial instruments accounts. The term includes any savings,

demand, checking, deposit, or any other account maintained with a financial institution What constitutes signature or other authority over an account? A person has signature authority over an account if such person can control the disposition of money or other property in it by delivery of a document containing his or her signature (or his or her signature and that

• f one or more other persons) to the bank or other person with whom the

account is maintained Other authority exists in a person who can exercise comparable power

• ver an account by direct communication to the bank or other person

with whom the account is maintained, either orally or by some other means What does “maximum value of account” mean (for Box 22 on the FBAR)? The maximum value of account is the largest amount of currency and non-monetary assets that appear on any quarterly or more frequent account statements issued for the applicable year. If periodic account statements are not issued, the maximum account value is the largest amount of currency or non-monetary assets in the account at any time during the year. Convert foreign currency by using the official exchange rate at the end of the year. The value of stock, other securities or other non-monetary assets in an account reported on TD F 90-22.1 (PDF) is the fair market value at the end of the calendar year. If the asset is withdrawn from the account, the value is the fair market value at the time

• f the

withdrawal

19

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

Is an FBAR required if the account generates neither interest nor dividend income? Yes, an FBAR must be filed whether or not the foreign account generates any income How do foreign account holders report their accounts to the IRS? The holders report their foreign accounts by completing boxes 7a and 7b

• n Form 1040 Schedule B and completing Form TD F 90-22.1

(PDF) When is the FBAR due? The FBAR is due by June 30 of the year following the year that the account holder meets the $10,000 threshold. The granting, by IRS, of an extension to file Federal income tax returns does not extend the due date for filing an FBAR. There is no extension available for filing the FBAR If an account holder does not have all the available information to file the return by June 30th, they should file as complete a return as they can and amend the document when the additional or new information becomes available Where are FBAR forms available? FBAR forms are available: On the IRS.gov (PDF) Web site; On the Department of the Treasury’s Financial Crimes Enforcement Network Web site for Money Services Businesses.By calling IRS at (800) 829- 3676 Is there a help line for questions about completing the form? You can get answers to questions concerning the FBAR form by calling (800) 800-2877, option 2

20 Where do account holders file the FBAR? Send completed forms to: U.S. Department of the Treasury P.O. Box 32621 Detroit, MI 48232-0621 The FBAR is not to be filed with the filer’s federal tax return. How does an FBAR filer amend a previously filed FBAR? FBAR filers can amend a previously filed FBAR by:Writing the word “Amended” at the top of a new FBAR form;Adding or correcting the account information; and,Stapling it to a copy of the original FBAR. If the amendment is for a delinquent FBAR, the filer should also attach an explanation giving the reasons why the form was not filed timely What is the statute of limitations for assessing civil penalties for violations

• f the FBAR requirements?

Civil penalties can be assessed anytime up to six years after the date of the violation How long should account holders retain records of the foreign accounts? Records of accounts required to be reported on an FBAR must be retained for a period of five years. Failure to maintain required records may result in civil penalties, criminal penalties, or both

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

21 What happens if an account holder is required to file an FBAR and fails to do so? Failure to file an FBAR when required to do so may potentially result in civil penalties, criminal penalties, or both An American citizen, X, gives a person who is a citizen or resident of the U.S. power of attorney to X’s Canadian bank accounts. X files an FBAR form annually. Does the power of attorney also need to file an FBAR? Yes, because the power of attorney has a financial interest in the accounts and because he is a U.S. person A fiduciary who is a U.S. person has control as a trustee for an IRA with a foreign account. Should an FBAR be filed? Yes, because the fiduciary is a U.S. person Does the term “other authority over a financial account” mean that a person, who has the power to direct how an account is invested, but who cannot make disbursements to the accounts, has to file an FBAR? No, an FBAR is not required because the person has no power of disposition of money or other property in the account Does more than one form need to be filed for a husband and wife owning a joint account? No, if the names and social security numbers of the joint owners are fully disclosed on the filed FBAR. This is not stated in the instructions for the FBAR but it is the practice of the IRS to accept one filing for both when the names of the joint owners are fully disclosed. This practice only applies to joint owners who are husband and wife and who reside at the same address. Other joint owners must file separate FBARs

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

22 Must a U.S. person file an FBAR on a Eurodollar account in the Cayman Islands? Yes, the Cayman Islands account is a foreign account A New York corporation owns a foreign company that has foreign

• accounts. The corporation will file an FBAR for the foreign

company’s accounts. Do the primary owners of the U.S. company also have to file? Yes, if any owner directly or indirectly owns more than 50 percent of the total value

• f the shares of stock, that owner will have to file an FBAR

A company has over 25 foreign accounts. What should they enter in Part ll

• f the FBAR?

If the filer holds a financial interest in more than 25 accounts, indicate the number of accounts in box 20. Do not complete any further items in Part II. Sign the form in box 36 and enter the date signed in box 37. Any person who lists more than 25 accounts in item 20 must provide all the information called for in Part II when requested by the Treasury Department A person is a non-resident alien living in the U.S. and owns several foreign

• accounts. Does that person have to file an FBAR?

Not at this time. The current instructions for the FBAR form do not include non-resident aliens in its definition of U.S. persons. The contemplated revision of the FBAR instructions related to the definition

• f a U.S. person may include the use of the “Tax Code Test.”

(You may be considered a U.S. person if you live in the U.S. for 180 days

• r 30

days with no strong tax home)

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

23

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

What are the exceptions to the FBAR filing requirement? Accounts in U.S. military banking facilities, operated by a United States financial institution to serve U.S. Government installations abroad, are not considered as accounts in a foreign country. For this reason, these accounts do not have to be reported on an FBAR An officer or employee of a bank which is subject to the Supervision of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, or the Federal Deposit Insurance Corporation need not report that he has signature or other authority over a foreign bank, securities or other financial account maintained by the bank, if the officer or employee has NO personal financial interest in the account An officer or employee of a domestic corporation whose equity securities are listed on a national securities exchange or which has assets exceeding $10 million and 500 or more shareholders

• f record, need not file a report concerning the other signature

authority over a foreign financial account of the corporation, if he has NO personal financial interest in the account and he has been advised, in writing, by the chief financial officer of the corporation that the corporation has filed a current report, which includes that account

24

FAQs Regarding Report Of Foreign Bank And Financial Accounts (FBAR) (Cont.)

What are the exceptions to the FBAR filing requirement? Accounts in U.S. military banking facilities, operated by a U.S. financial institution to serve U.S. government installations abroad, are not considered as accounts in a foreign country. For this reason, these accounts do not have to be reported on an FBAR An officer or employee of a bank which is subject to the Supervision of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, or the Federal Deposit Insurance Corporation need not report that he has signature or other authority over a foreign bank, securities or other financial account maintained by the bank, if the officer or employee has NO personal financial interest in the account An officer or employee of a domestic corporation whose equity securities are listed on a national securities exchange or which has assets exceeding $10 million and 500 or more shareholders of record, need not file a report concerning the other signature authority over a foreign financial account

• f the corporation, if he has NO

personal financial interest in the account and he has been advised, in writing, by the chief financial officer of the corporation that the corporation has filed a current report, which includes that account

25

Form 1120-F

U.S. Return Of A Foreign Corporation

26

Form 1120-F

U.S. Return Of A Foreign Corporation

Taxation of foreign corporation on the basis of source of income Since organized outside the United States, a foreign corporation cannot be taxed on the basis of domestic status but can be taxed only on the basis of its U.S.-source income The various common categories of income of a foreign corporation subject to tax in the United States include: (1) investment income; (2) income that is effectively connected with the conduct of a trade or business in the United States; and (3) real property disposition gains However, jurisdiction to tax these various income items might be moderated by the terms of an applicable U.S. income tax treaty Foreign persons doing business in the United States are taxed at regular graduated rates on income effectively connected with that business. Deductible expenses that are allocable or apportionable to such effectively connected income are reported on the appropriate lines on the income tax returns for foreign persons (for corporations, Form 1120-F)

27

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Taxation of foreign corporation on the basis of source of income These returns follow the same general pattern as their domestic counterparts, except that they segregate two general types of income: effectively connected income and non-effectively connected FDAPI income In addition, there is one other major difference in the case of foreign corporations—computation of the branch tax U.S.-source investment income of a foreign corporation will be taxed at 30 percent of the gross

• amount. However, this rate may be significantly reduced under an

applicable U.S. income tax

• treaty. A foreign corporation's taxable income that is effectively connected with the U.S. trade
• r business is taxed at the regular graduated rates. An applicable U.S. income tax treaty might

moderate whether taxing jurisdiction attaches (under the permanent establishment clause of the treaty) and the amount of income associated with that permanent establishment However, a bilateral treaty will not reduce the income tax rate that is applicable to business income

28

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Requirement of foreign corporations to file Form 1120-F annually Every foreign corporation engaged in a U.S. trade or business at any time during the taxable year must file an income tax return on Form 1120-F, if a return would be required had the corporation been a U.S. corporation This is so even if (1) the corporation has no income effectively connected with the U.S. trade or business, (2) it has no income from U.S. sources, or (3) its income is exempt from tax under a treaty or Code provision If there is no gross income, the schedules of the return need not be completed. Instead, a statement should be attached to the return showing the amount and nature of any exclusions claimed

29

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation IRS Form 1120-F for 2008, includes the following components: ... 2008 Form 1120-F, U.S. Income Tax Return of a Foreign Corporation ... 2008 Schedule H (Form 1120-F), Deductions Allocated to Effectively Connected Income Under Regulations Section 1.861-8 ... 2008 Instructions for Schedule H (Form 1120-F) ... 2008 Schedule I (Form 1120-F), Interest Expense Allocation Under Regulations Section 1.882-5 ... 2008 Instructions for Schedule I (Form 1120-F) ... 2008 Schedule P (Form 1120-F), List of Foreign Partner Interests in Partnerships ... 2008 Instructions for Schedule P (Form 1120-F) ... 2008 Schedules M-1 and M-2 (Form 1120-F), Reconciliation of Income (Loss) and Analysis of Unappropriated Retained Earnings per Books ... 2008 Schedule M-3 (Form 1120-F), Net Income (Loss) Reconciliation for Foreign Corporations With Reportable Assets of $10 Million or More

30

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Branch profits tax—Form 1120F A foreign corp. engaged in a U.S. trade or business through a branch

• ffice is liable for a branch profits tax (in addition to the regular income tax,

equal to 30% of the dividend equivalent amount (below) for the year A corp.'s dividend equivalent amount is its effectively connected earnings and profits (ECEP), reduced (not below zero) by the increase for the year in the corp.'s U.S. net equity (i.e., amounts reinvested in the U.S. business), and increased by the decrease for the year in its U.S. net accumulated ECEP. Form 1120-F is used to compute and pay the branch profits tax

31

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Branch-level interest tax—Form 1120-F For U.S. income tax purposes, if a foreign corporation is engaged in a U.S. trade or business (or has gross income that is treated as effectively connected income, interest--including original issue discount, OID) paid by the corporation's U.S. trade or business (“branch interest”) is treated as if it were paid by a U.S. corporation (other than a U.S. corporation that meets the 80% foreign business requirement) This means that a U.S. branch of a foreign corporation is, in effect, treated like a U.S. subsidiary. To the extent provided in regs, this treatment doesn't apply to interest in excess of the amounts reasonably expected to be allocable to effectively connected income (or to income treated as effectively connected) To the extent that allocable interest exceeds the interest payment that's treated as paid by a U.S. corporation, the foreign corporation is liable for the 30% tax

• n the excess, as if the excess were paid to the foreign corporation by its

wholly-owned U.S. sub on the last day of its tax year

32

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Foreign corporations with treaty income If the gross income of a foreign corporation includes treaty income, a statement must be attached to the Form 1120-F, that shows, with respect to that income: (a) The amounts of tax withheld, (b) The names and post office addresses of withholding agents, and (c) Other information required by the return form or by the form's instructions, as to the taxpayer's entitlement to the reduced rate of tax under the tax treaty Although the regs speak in terms of an attached statement, (Form 8833, Treaty-Based Return Position Disclosure Under the IRC) it must be used for each treaty-based return position taken. If this form is used, Item V at the bottom of page 5 of Form 1120-F must also be completed For the reporting required if a foreign corporation takes a treaty-based return position (i.e., that a tax treaty overrules or modifies the Code.) The treaty-based return position rules do not change or otherwise modify the regular rules for who must file income tax returns

33

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation U.S. obligations held by banks in U.S. possessions Interest on obligations of the U.S., which is not portfolio interest and is received by a bank organized in, or under the law of, a U.S. possession is treated as income effectively connected with a U.S. business whether or not it has such a business Thus, banks which hold the obligations are taxed on this income on a net basis, with interest income offset by allocable expenses. Portfolio interest received by the banks on obligation of the U.S. is exempt from net basis U.S. tax (unless the bank is engaged in a U.S. trade or business and the interest is actually effectively connected therewith) Possessions of the U.S. include Guam, Midway, the Panama Canal Zone, Puerto Rico, American Samoa, the Virgin Islands and Wake Island

34

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Income effectively connected with the conduct of a U.S. trade or business Nonresident aliens and foreign corporations are subject to tax at regular U.S. rates on their income, gain, or loss which is effectively connected with the conduct of a U.S. trade or business. Although all U.S. source income may be treated as effectively connected with a U.S. trade or business, only certain foreign source income is so treated, and tax treaties may reduce the U.S. tax on that foreign source income. Deductions attributable to effectively connected income are allowed in computing the net amount subject to tax A foreign corporation's interest expense attributable to income effectively connected with a U.S. trade or business is determined under a three-step process. A foreign corporation which is not engaged in business in the U.S. at any time during the taxable year is not required to make a return if its tax liability is fully satisfied by the withholding of tax at source

35

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Income effectively connected with the conduct of a U.S. trade or business However, the following corporations must file a return regardless of whether the withholding requirement is met: ... a foreign corporation which has income for the taxable year which is treated as income which is effectively connected with the conduct of a trade or business in the U.S. by that corporation (real property income or interest received from banks

• rganized in U.S. possessions)

... a foreign corporation making a claim for the refund of an overpayment of tax for the taxable year, or ... a foreign corporation subject to the accumulated earnings tax If a foreign corporation so elects, it need only show on the balance sheet portion

• f the return its assets located in the U.S. and its assets used

in the U.S. trade

• r business. In the reconciliation of income section of the return, a foreign

corporation is only required to show its effectively connected income and other income from U.S. sources

36

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation U.S. investment income of foreign corporation (30 percent tax rate on gross investment income) The U.S. investment income of a foreign corporation will be subject to a flat 30 percent tax realized by a foreign corporation if the income is not effectively connected with the conduct of a U.S. trade or business This income fits within the category known as “fixed or determinable annual or periodical gains, profits, and income” In some situations (e.g., portfolio interest investments), this 30 percent tax is eliminated under an applicable Code provision In other instances, this tax is reduced or eliminated by reason of a provision in an applicable bilateral U.S. income tax treaty

37

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Capital gains to foreign corporation A foreign corporation realizing capital gains on the disposition

• f stock or

securities will not be subject to U.S. income tax on those gains assuming: (1) those gains are not effectively connected with a U.S. trade or business, or (2) are not real property gains (as described below) However, the gain derived from the sale of stock back to the issuing corporation (i.e., a redemption) may not be treated as a capital gains event and will be subject to 30 percent withholding at source

38

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Allocation and apportionment of deductions--Form 1120-F Schedule H Deductions of foreign corporations: A foreign corporation is normally allowed deductions only against income effectively connected with the conduct of a U.S. trade or business and

• nly for expenses connected with, or allocated and apportioned to, that

income However, the charitable contribution deduction is allowed even if not allocable to effectively connected income This deduction is allowed only if a true and accurate return is filed The allocation and apportionment of deductions is based on “the factual relationship of deductions to gross income”

39

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Allocation and apportionment of deductions--Form 1120-F Schedule H For most items, their application is a two-step process: Deductions are first allocated to income from the activities and investments in which the deductible costs were incurred. If the income class to which a deduction is allocated consists solely of income within or without the relevant taxable income category (e.g., foreign source taxable income or effectively connected taxable income), which is called the “statutory grouping,” the allocation is the final step in the process A deduction allocated to a class of income including both income in the statutory grouping and other income (the residual grouping) is apportioned between these groupings. The apportionment must be done on a basis that reasonably reflects the factual relationships between deductions and income

40

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Allocation and apportionment of deductions--Form 1120-F Schedule H Income is grouped into classes on the basis of factual relationships between gross income and deductions, not on the basis of predetermined categories. A deduction is definitely related to a class of gross income if “it is incurred as a result of, or incident to, an activity or in connection with property from which such class of gross income is derived.” A deduction may be definitely related to all of the taxpayer's gross income For example, if a taxpayer manufactures goods in a foreign country and sells them through several sales branches, including one in the United States, expenses of the U.S. branch are definitely related to gross income from sales by this branch because they are incurred in an activity contributing to the production of this gross income. In contrast, expenses of sales through branches in other countries are definitely related to foreign source gross income from those sales. Because expenses of general management are definitely related to all of the taxpayer's income, they are allocated to a class consisting

• f all gross income

41

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Allocation and apportionment of deductions- Form 1120-F Schedule H Gross income is also divided between “statutory groupings” and “residual groupings.” A statutory grouping consists of gross income that, reduced by deductions, is relevant under particular operative provisions An apportionment must be done in a way that “reflects to a reasonably close extent the factual relationship between the deduction and the grouping of gross income” A deduction for state, local, or foreign income taxes is allocated to the income on which the tax is imposed. If the tax base includes income in two or more groupings, the tax is apportioned ratably An NOL deduction is allocated in the same way as the deductions constituting the NOL Deductions unrelated to a taxpayer's business activities and investments are apportioned ratably among all gross income. This rule applies to deductions for real estate taxes on a personal residence, medical expenses, and alimony The deduction for charitable gifts is allocated solely to gross income from sources within the United States

42

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F If a foreign corporation carries on a trade or business in the United States, it is allowed a deduction for interest expense apportioned to gross income effectively connected with the trade or business Interest is generally apportioned for this purpose by a three-step process based on the value of the corporation's U.S. assets, its worldwide debt-to-assets ratio, and the liabilities recorded on the books of the U.S. business A corporation resident in a country with which the United States has an income tax treaty is usually allowed deductions under the treaty for expenses “incurred for the purposes of” a permanent establishment of the corporation in the United States 1. Adjusted U.S. booked liabilities (AUSBL) method. Interest deductible in determining effectively connected taxable income is usually calculated by the following steps:

43

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F a. The corporation's U.S. assets (generally, the assets of the U.S. business) are identified and valued

• b. U.S.-connected liabilities are computed as the product of the U.S. assets and

a fraction whose numerator is the corporation's worldwide liabilities and whose denominator is worldwide assets

• c. The liabilities shown on the books of the U.S. business are identified and

compared with U.S. connected liabilities. If these two amounts are equal, the U.S. branch's interest expense is the interest on U.S. booked liabilities If U.S. booked liabilities exceed U.S. connected liabilities, a ratable portion of the interest on U.S. booked liabilities is disallowed. If U.S. booked liabilities are less than U.S. connected liabilities, U.S. interest expense is the sum of the interest on U.S. booked liabilities and interest on the excess U.S. connected liabilities at the average interest rate on the corporation's U.S. dollar liabilities not booked in the United States

44

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F Step one. The first of the three steps is to determine the aggregate value

• f the

corporation's U.S. assets, which consist of the following: a. Cash balances needed in the present conduct of a U.S. trade or business

• b. Inventory taken into account in determining the cost of goods sold by a U.S. business
• c. Depreciable property if depreciation on the property is allocable to effectively

connected income

• d. An account receivable if (1) income on the sale, services, or leasing transaction

generating the receivable is effectively connected income and (2) the receivable does not bear interest and matures within six months

• e. An installment obligation if both gain on the installment sale and interest on the
• bligation are effectively connected income
• f. An interest in a partnership engaged in business in the United States
• g. Any other asset if income from its use and gain on its disposition would be effectively

connected income

45

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F Step two A foreign corporation must determine its “U.S. connected liabilities,” which equal aggregate U.S. assets for the year, multiplied by either an “actual ratio”

• r, if the taxpayer so elects and uses the adjusted basis of its

assets in step

• ne, a “fixed ratio.”

The actual ratio is the sum of the taxpayer's worldwide liabilities, divided by the aggregate value of its worldwide assets The actual ratio may be determined in either U.S. dollars or the functional currency of the taxpayer's home office. The IRS may adjust the actual ratio to prevent the taxpayer “from intentionally and artificially increasing its actual ratio” For example, liabilities arising from loans between related persons may be disregarded if a principal purpose for making the loans was to increase the actual ratio artificially

46

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F Step three U.S. connected liabilities computed in Step two are compared with “U.S. booked liabilities,” which are usually the liabilities on the books

• f the corporation's U.S. trade or business that satisfy at least one of the

following requirements:

• a. “The liability is secured predominantly by a U.S. asset”
• b. The corporation “enters the liability on a set of books reasonably

contemporaneous with the time at which the liability is incurred and the liability relates to an activity that produces” effectively connected income (ECI)

• c. The corporation maintains books for activities producing ECI,

and the IRS's “Director of Field Operations determines that there is a direct connection or relationship between the liability and that activity”

47

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F Alternative separate currency pools method A foreign corporation whose U.S. assets are denominated in more that one currency may elect to determine deductible interest expense by a separate currency pools method. Under this method, the three steps are applied separately for each currency, as follows: a. U.S. assets in each currency are identified and valued by procedures described above

• b. U.S. connected liabilities in each currency pool are computed

as the value of U.S. assets in that currency, multiplied by the actual ratio (ratio of worldwide liabilities to worldwide assets) or, at the taxpayer's election, by the fixed ratio (95 percent for banks, 50 percent for others)

• c. The interest deduction for a particular currency pool consists of

interest on U.S. connected liabilities in that currency divided by its average worldwide liabilities in the currency)

48

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Interest Expense of Foreign Corporations Engaged in Business in the United States Schedule I-Form 1120-F Direct allocations In two situations, a foreign corporation must allocate interest solely to income from investments financed by the indebtedness. First, interest on nonrecourse indebtedness is allocated solely to income from the property securing the indebtedness if all of the following requirements are met: a. The debt was incurred to finance the purchase, construction, or improvement of the property, and the loan proceeds were applied for this purpose

• b. The property is depreciable tangible property, real property, or an amortizable intangible,

and its useful life exceeds one year

• c. The creditor can look only to the property for payment of the debt and interest thereon.
• d. Cash flow from the property is “reasonably expected”

to be sufficient to cover debt service

• e. Restrictions in the loan agreement ensure that none of the foregoing requirements can be

defeated by a transfer of the property

49

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F Direct allocations In two situations, a foreign corporation must allocate interest solely to income from investments financed by the indebtedness Second, a foreign corporation must allocate interest on debt incurred as part

• f an “integrated financial transaction”

solely to income from the investment funded by the borrowing. An integrated financial transaction consists of “an identified term investment” and a borrowing to finance the investment An example of such an investment is a purchase of a portfolio of stocks approximating the composition of a stock index coupled with a forward contract to sell a specified quantity of the stocks in the index at a designated future date for a specified price

50

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Interest expense of foreign corporations engaged in business in the United States--Schedule I-Form 1120-F

• Elections. A foreign corporation must make all elections under the interest

allocation rules on its original return for its first taxable year to which the rules

• apply. A corporation makes an election by calculating its interest deduction for

that year in accordance with the election Treaty modifications. The Treasury's position has long been that the regulations prescribe the “exclusive” means of determining interest expense of a U.S. permanent establishment. However, in National Westminster Bank v. United States, the Court of Appeals for the Federal Circuit held that the regulations were not consistent with the 1975 treaty between the United States and the United Kingdom, which was quite similar in the relevant provisions to the current U.S. Model

51

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Partnership allocations (Schedule P--Form 1120-F) There are three separate sets of withholding provisions that can apply to foreign persons that are partners in U.S. partnerships.

• 1. The first is the non–effectively connected FDAP provisions previously discussed. The U.S. tax
• n investment income earned by nonresident aliens and foreign corporations is imposed by

withholding-at-source rules. A U.S. partnership is required to withhold tax to the extent taxable investment income is included in a nonresident alien's or foreign corporation’s distributive share of partnership income (whether or not such income is actually distributed)

• 2. A second set of withholding provisions applies to U.S. partnerships with U.S. real property

assets, which is viewed in the disposition of real property context

• 3. The Tax Reform Act of 1986 created the third U.S. withholding

scheme by adding Section 1446 , requiring withholding on distributions by a partnership of effectively connected taxable income to foreign partners in certain circumstances. The amount of tax required to be withheld is determined by multiplying the highest applicable rate of U.S. tax (35 percent in the case of an individual or noncorporate partner and 35 percent in the case of a corporate partner) by the amount of the partnership’s effectively connected taxable income that is allocable to the foreign partner

52

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Partnership allocations (Schedule P-Form 1120-F) Definition of “foreign partner” A “foreign partner” for Section 1446 purposes is any partner that is not a “United States person” —a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, or foreign estate A partnership may rely on a partner's certification of non-foreign status until the end

• f the third year after the partnership’s taxable year during which the certificate is
• btained, unless during that time the partnership receives notice from the partner that

the partner has become a foreign person or obtains actual knowledge that the partner is or has become a foreign person The partnership must retain a certificate of nonforeign status until the end of the fifth taxable year after the last taxable year in which the partnership relies on the certificate

53

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation Partnership allocations (Schedule P-Form 1120-F) Effectively connected taxable income of partnership A partnership’s “effectively connected taxable income” equals the partnership’s taxable income that is effectively connected with the conduct

• f a U.S. trade or business, with certain adjustments

In order to determine the amount of its withholding obligation under Section 1446 a partnership must ascertain: (1) whether it was engaged in a U.S. trade or business during the taxable year; (2) the amount of gross income that was effectively connected (or treated as effectively connected) with its U.S. trade or business; and (3) the allowable deductions that are connected to the effectively connected income

54

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Form 1120-F, Schedule M-3 for large and midsize corporations Schedule M-3 provides a complete reconciliation from financial accounting net income to taxable income in a standardized and detailed format. The Form 1120 Schedule M-3 has three parts Part I reconciles from the worldwide financial statement net income amount reported to shareholders to the financial statement net income amount of the consolidated tax return group (includible corporations). As will be discussed, if a corporation has certified financial statements, it must begin with those statements. In other words, Schedule M-3 provides a consistent and clearly defined financial net income starting point. Parts II and III reconcile financial statement net income

• f includible corporations to taxable income reported on Form 1120, page 1, line 28

Part II reconciles income and gain/loss items Part III reconciles expense and deduction items. Unlike Schedule M-1 Schedule M-3 clearly differentiates temporary and permanent differences

55

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Form 1120-F, Schedule M-3 for large and midsize corporations Part I: Financial information and net income (loss) reconciliation While Schedule M-3, in its entirety, provides significant improvements to transparency as

• pposed to Schedule M-1, Part I of Schedule M-3 is particularly noteworthy because of its

correction of what was arguably Schedule M-1’s most serious deficiency—the lack of an identifiable starting point Schedule M-3 remedies this problem by providing a detailed and standardized method of

• reconciliation. This improvement provides greatly improved transparency

For example, in the case of the Schedule M-3 for corporations, Part I, line 11, “Net income (loss) per income statement of includible corporations” is equivalent to Schedule M-1 line 1, “Net income (loss) per books”. The difference is that Schedule M-3, line 11 is preceded by detailed lines of reconciliation to the worldwide income reported to shareholders

56

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Form 1120-F, Schedule M-3 for large and midsize corporations Part I: Financial information and net income (loss) reconciliation The starting point with Schedule M-3 is the creation of a preference or “pecking order” for financial statements to be used as a starting point commencing with “Worldwide consolidated net income (loss)” as the starting point. The idea is that only the most reliable financial information should be used The IRS considers SEC filed financial statements to be the most reliable of the three categories presented on Part I. Therefore, if SEC financial statements are filed, they must be used as the starting point for Schedule M-3 A certified audited income statement is considered a “second choice” financial statement and may be used only if the corporation did not file a Form 10-K with the SEC for the particular tax year Regardless of the type of income statement prepared, if a taxpayer is selected for audit, an IRS examiner will use Schedule M-3 to as a pre-audit analysis tool. This will typically involve reviewing the financial statements, including footnote disclosures, and taking note of any material book-tax differences and large, unusual, or questionable items

57

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Form 1120-F, Schedule M-3 for large and midsize corporations Part I: Financial information and net income (loss) reconciliation In addition to entering the amounts, a supporting schedule must be attached which provides the name, tax identification number, and net income (loss) per the financial statement or books and records for

• each. These are entities that are included in the tax return but

not included in financial statement income, and therefore, were not reviewed as part of a certified audit Generally, for those corporations removed above, dividends will be added back which are received by the U.S. consolidated tax group and adjustment made for minority interests What is important and noteworthy about the foregoing is that unlikeSchedule M-1, which starts with financial statement income and leaves it up to the IRS to accept

• r audit the result, the Schedule M-3

requires multiple but separate lines of information be provided to illustrate how that number is computed If the taxpayer's tax period differs from the financial statement, this line will highlight those reconciling items

58

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Form 1120-F, Schedule M-3 for large and midsize corporations Schedule M-3, Parts II and III Parts II and III reconcile financial net income of includible corporations to taxable income reported

• n Form 1120

Part II generally reconciles items of income, gain, and loss. Part III deals with expense and deduction items Parts II and III contain four columns to identify and differentiate the book and tax aspects of each line item. Column (a) represents financial statement income or expense amounts maintained in the corporation’s books and records, using the income statement source determined in Part I. Column (d) represents amounts as reflected in the tax return. For each line item, the difference between the amount shown in column (a) and the amount shown in column (d) is shown either as a temporary difference in column (b) or as a permanent difference in column (c). The clear statement of both the book and tax amounts as well as the reconciling differences aids the IRS in setting materiality thresholds for the reconciling differences shown

59

Form 1120-F (Cont.)

U.S. Return Of A Foreign Corporation

Form 1120-F, Schedule M-3 for Large and Midsize Corporations Schedule M-3, Parts II and III The detail required by Parts II and III is particularly enhanced by the differentiation of temporary and permanent differences Temporary (timing) differences occur because tax laws require the recognition of some items of income and expense in different periods than are required for book purposes. Temporary differences

• riginate in one period and reverse or terminate in one or more subsequent periods

Temporary differences between book and tax are questions of “when” not “if” There are four basic categories of temporary differences:

• 1. Income recognized in financial statements before it is taxable;
• 2. Income reported as taxable before it is recognized in financial statements;
• 3. Expenses recognized in financial statements before they are deducted on

the tax return; and,

• 4. Expenses deductible on the tax return before they are recognized on

financial statements

60

Accurately Completing Form 5471 And Related Forms

61

Form 5471: Taxation of U.S. shareholders in controlled foreign corporations, related-party transactions, ownership changes Form 8858: Information-reporting for foreign disregarded entities Form 5472: Proper disclosure of related-party transactions for 25% or greater foreign-owned businesses Form 8865: Information-reporting for controlled foreign partnerships Form 8832: Entity classification election

Common Issues In Completing Form 5471 And Other Foreign Disclosure Forms

62

Purpose of form: Disclosure of investment in foreign corporations Who must file? U.S. shareholders and certain U.S. citizens or residents who are officers or directors of the foreign corporation Penalties for failure to file: $10,000 per form Additional $50,000 maximum penalty for failure to file within 90 days after receipt of IRS notification, and 10% reduction in foreign tax credits Effective 1/1/09: Automatic assessment of penalties for late/incomplete/missing filed forms for corporate shareholders Warning – IRS has been issuing penalty letters incorrectly for non-calendar year filers

Completing Form 5471

63

Completing Form 5471 (Cont.)

Form 5471 Schedule H (CFCs only): Used to calculate annual earnings and profits in the functional currency for U.S. tax purposes TAX TIP:

• The net income starting figure comes from

Schedule C, which is calculated using US GAAP rules

• There is an exception to straight-line

depreciation rules if less than 20% of gross income is U.S.-sourced E&P is tracked cumulatively on Schedule J and is used to determine exposure to Subpart F income and for foreign tax credit purposes

64

Completing Form 5471 (Cont.)

Form 5471 Schedule I (CFCs Only): Subpart F inclusion Section 956 inclusions TAX TIP: Use the worksheets to ensure all types

• f income are properly treated and to accurately

calculate the appropriate inclusion items Do not forget to verify if any income of the CFC was blocked, as blocked income is not included in E&P of a CFC (IRC Sect. 964(b))

65

Completing Form 5471 (Cont.)

Form 5471 Schedule J (CFCs Only): Used to report accumulated annual earnings and profit adjustments Report in functional currency TAX TIP: It is very important to keep track of previously taxed income (IRC 959) in column C to avoid double-taxation on items previously included, but not yet distributed Double-check amounts on Schedule J against the income statement, balance sheet, Schedules H and I and Form 1118 (if relevant)

66

Completing Form 5471 (Cont.)

Form 5471 Schedule M (CFCs Only): Reports related-party transactions Highlights potential transfer pricing issues to taxing authorities Identification of potential Subpart F transactions and Section 956 income TAX TRAP: Schedule M is not designed to highlight Subpart F income categories and should not be relied upon to do so TAX TIP: If a Form 5472 is filed to disclose transactions with this entity, confirm that reports reconcile

67

Completing Form 5471 (Cont.)

Form 5471 Schedule O: Used to report details of corporate reorganizations and changes in ownership Remember to include organizational chart when required (where CFC is a member of a chain of corporations) TAX TRAP: Don’t forget that if someone becomes a U.S. person and owns at least 10% of a foreign corporation, they have a Form 5471 filing requirement in that tax year TAX TIP: Do not forget to attach any relevant statements or elections (IRC 332, 351, 367, 338, etc.)

68

Completing Form 5471 (Cont.)

Documentation and support: The IRS has stated that it will be assessing penalties on any filings that it deems

• incomplete. Thus, to protect yourself and

your clients, you need to obtain all information necessary to properly complete the Form 5471 and its various schedules

69

Purpose of form: Foreign disregarded entity information reporting Who must file: U.S. tax owner, and indirect U.S. tax owner Penalties for failure to file: $10,000 per form Additional $50,000 maximum penalty for failure to file within 90 days after receipt of IRS notification, and 10% reduction in foreign tax credit

Completing Form 8858

70

Completing Form 8858 (Cont.)

Form 8858: Schedules C requires reporting of income under GAAP rules, not the rules of the foreign country Schedule C-1 requires reporting of any gain or loss under the branch transaction rules (IRC Sect. 897) Schedule H must be computed using U.S. tax rules just like with Form 5471 TAX TRAP: Identifying what qualifies as Section 987 remittances is vitally important Question 4 in Schedule G requires an understanding of the disregarded entity’s status under the dual consolidated loss rules. Otherwise, it could result in additional reporting requirements or the non-deductibility

• f the disregarded entity’s flow-through losses

71

Purpose of form: Disclose nature and amount of foreign and domestic related-party transactions for foreign-owned businesses Who must file: Certain 25% foreign-owned U.S. corporations U.S. branches of foreign corporations Penalties for failure to file: $10,000 penalty, and Additional $10,000 penalty for failure to file within 90 days of receipt of IRS notification TAX TIP: Transactions are not required to be disclosed on page 2 if the party in Part III is a U.S. person TAX TRAP: If a U.S. consolidated Form 5472 is filed, each reporting member is jointly and severally liable for a $10,000 penalty

Completing Form 5472

72

Purpose of form: Controlled foreign partnership information- reporting Who must file: U.S. person that controls a foreign partnership U.S. person that has a 10% interest in a CFP U.S. person that contributed property worth over $100,000 to a foreign partnership in exchange for an ownership interest U.S. person that acquired, disposed or had a change in proportional interests in the foreign partnership that affected the 10% threshold TAX TIP: If there is a Category 1 filer, no person is considered to be a Category 2 filer

Completing Form 8865

73

Penalties for failure to file: $10,000 per form Additional $50,000 maximum penalty for failure to file within 90 days after receipt

• f IRS notification, and

Possible reduction in foreign tax credit Criminal penalties for filing false or fraudulent information 10% of FMV of unreported property that was contributed to foreign partnership TAX TIP: Do not forget to attach any relevant partnership elections, i.e. Section 754, etc.

Completing Form 8865 (Cont.)

74

Purpose of form: Declare entity classification Who may file: Certain domestic and foreign LLCs, partnerships and trusts Timeliness of filing: Must be filed no more than 75 days after or

• ne year before the date the election is to

take effect, or accept default classification Failure to timely file may result in costly Section 9100 relief procedure Revenue Procedure may provide relief for certain late filings

Completing Form 8832

TAX TIP:

• An EIN (Form SS-4) is necessary to file
• Improperly signed forms are invalid and ineffective

75

Completing Form 926

76

Completing Form 926

Purpose of the form: Use Form 926 to report certain transfers of tangible and intangible property to a foreign corporation required by section 6038B Who must file: Generally, a U.S. citizen or resident, a domestic corporation, or a domestic estate or trust must file Form 926 to report transfers of property described in section 6038B(a)(1)(A)* to a foreign corporation

* Section 6038B (a)(1)(A) transactions include: non recognition transactions covered under IRC sections 332, 351, 354, 355, 356, 361(a) and (b), and 336

77

Completing Form 926 (Cont.)

Special rules: Transfers by a partnership: If the transferor is a partnership (domestic or foreign), the partners of the partnership, not the partnership itself, are required to comply with section 6038B and file the Form 926. Each domestic partner is treated as a transferor

• f its proportionate share of the transferred property

Transfers by a husband and wife: A husband and wife may file Form 926 jointly, but only if they file a joint return

78

Completing Form 926 (Cont.)

Special rules (Cont.): Transfers of cash: A U.S. person that transfers cash to a foreign corporation must report that transfer on Form 926 if (a) immediately after the transfer the person holds directly or indirectly at least 10% of the total voting power or total value of the foreign corporation or (b) the amount of cash transferred by the person to the foreign corporation during the 12-month period ending on the date of the transfer exceeds $100,000

79

Completing Form 926 (Cont.)

Penalties for failure to file: The penalty equals 10% of the fair market value of the property at the time of transfer The penalty is limited to $100,000 unless the failure to comply was due to intentional disregard Reasonable cause claim (not due to “will neglect”) will be sustained

80

Completing Form 926 (Cont.)

Other effects of failure to file: The period of limitations for assessment of tax upon the transfer of that property is extended to the date that is 3 years after the date on which the information required to be reported is provided Gain (not loss) must be recognized, as if the property had been sold at it fair market value at the time of the contribution Adjustments to transferor’s basis in the contributed property as result

• f the recognition of the gain are made as if the gain was

recognized in the year the failure to report was finally determined

81

Completing Form 926 (Cont.)

Other forms that may be required: Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts A U.S. transferor required to enter into a gain recognition agreement (GRA) under section 367(a) in order to qualify for non recognition treatment must file Form 8838, Consent To Extend Time To Assess Tax Under Section 367 – Gain Recognition Agreement, or similar statement, to extend the statute of limitations with respect to the gain realized but not recognized on the transfer

82

Completing Form 926 (Cont.)

Reporting requirements: Any U.S. person required to report a transfer to a foreign corporation must provide the required information on the Form 926, Return by a U.S. Transferor or Property to a Foreign Corporation. Form 926 and any attachments must be filed with the income tax return for the tax year in which the transfer occurred For tax years beginning before Jan. 1, 2003, the Form must be signed under penalties of perjury declaring that the information is true correct and complete to the best of the transferor’s knowledge and belief For tax years beginning after Dec. 31, 2002, the verification of the Form 926 (including attachments) and occurs by signing the income tax return with which it is filed. This is to facilitate the filing of the Form with the taxpayer’s income tax return

83

Completing Form 926 (Cont.)

Information required: Disclosures required for Code Section 332, 351, 354, 355, 356, or 361 exchanges, Code Section 336 liquidating distributions, and certain cash transfers to foreign corporations include: The name, address and TIN of the U.S. person making the transfer; The date of the initial transfer, a general description of the transfer and any wider transaction, and the name, address, TIN (if any) and country of incorporation of the transferee foreign corporation; and A general description of the subsequent transfer and any wider transaction, a a calculation of any gain required to be recognized by the U.S. person, and the name, address and TIN

• f each person who will be considered to receive contingent

annual payments for the use of the intangible property

84

Completing Form 926 (Cont.)

Special preparation note: Part III – Information regarding the transfer of property Line 9 – Date of transfer. The date of transfer is the first on which title to, possession of, or rights to use of stock, securities, or other property pass pursuant to the plan of reorganization Line 11 – Description of transaction. A brief description must be provided regarding the property transferred. In addition, taxpayers must attach to Form 926 the information required under Regulation section 1.6038B-1(c) Temporary Regulations sections 1.6038B-1T(c)(1) through 1.6038B- 1T(c)(5) and 1.6038B-1T(d)

85

Completing Form 926 (Cont.)

Special preparation notes:

• Partnership transferor –

Aggregate vs. entity theory considerations

• Form TD F 90-22.1 –

important considerations

• Trusts compliance –

grantor trust vs. entity theory

• Late-filed returns

Click here for a PDF version of Form TDF 90-22.1, Report Of Foreign Bank And Financial Accounts: http://www.irs.gov/pub/irs-pdf/f90221.pdf Click here for a PDF version of Form 1120-F, U.S. Income Tax Return Of A Foreign Corporation: http://www.irs.gov/pub/irs-pdf/f1120f.pdf Click here for the instructions to Form 1120-F: http://www.irs.gov/pub/irs-pdf/i1120f.pdf Click here for a PDF version of Form 5471, Information Return Of U.S. Persons With Respect To Certain Foreign Corporations: http://www.irs.gov/pub/irs-pdf/f5471.pdf Click here for the instructions to Form 5471: http://www.irs.gov/pub/irs-pdf/i5471.pdf Click here for a PDF version of Form 5472, Information Return Of A 25% Foreign-Owned U.S. Corporation Or A Foreign Corporation Engaged In A U.S. Trade Or Business: http://www.irs.gov/pub/irs-pdf/f5472.pdf Click here for a PDF version of Form 8858, Information Return Of U.S. Persons With Respect To Foreign Disrefarded Entities: http://www.irs.gov/pub/irs-pdf/f8858.pdf Click here for the instructions to Form 8858: http://www.irs.gov/pub/irs-pdf/i8858.pdf Click here for a PDF version of Form 8865, Return Of U.S. Persons With Respect To Certain Foreign Partnerships: http://www.irs.gov/pub/irs-pdf/f8865.pdf Click here for the instructions to Form 8865: http://www.irs.gov/pub/irs-pdf/i8865.pdf Click here for a PDF version of Form 8832, Entity Classification Election: http://www.irs.gov/pub/irs-pdf/f8832.pdf Click here for a PDF version of Form 926, Return By A U.S. Transferor Of Property To A Foreign Corporation: http://www.irs.gov/pub/irs-pdf/f926.pdf