Form 5471 Foreign corporation information return

Form 5471 - Information Return of U.S. Persons With Respect to Certain Foreign Corporations

Form 5471 is very complex and comprehensive, and became even more so since enactment of TCJA (Tax Cat and Jobs Act) at the end of 2017.

Many tax code sections and regulations cover various concepts, definitions and rules used to determine who must file the form, what to report on the form, and whether and what income is taxable to a U.S. person. Form 5471 is an information report and not a tax return, although certain owners may have to report income of the foreign corporation on their U.S. tax returns.

Only a very general and broad description of the subject is given in the following text.

Who must file form 5471

Certain U.S. persons who are officers, directors, or shareholders in certain foreign corporations must file form 5471 to comply with reporting obligations in relation to the corporations.

U.S. person is a U.S. citizen or resident, green card holder, U.S. corporation, partnership, trust or estate. Certain non-U.S. citizens or non-resident individuals may also be considered U.S. persons in limited circumstances.

Depending on the relationship to a foreign corporation, a U.S. person may fall into one or more of “category of filers”. There are currently five different categories of filers.

Depending on which category of filer a U.S. person is, the following U.S. persons may be required to file form 5471 in respect to a foreign corporation, with some exceptions (the list represents most but not all situation when filing may be required):

Direct owners of at least 10% of the corporate stock – direct ownership is quite self-explanatory, meaning that a person owns a part of a company directly
Indirect owners of at least 10% of the corporate stock – indirect ownership is an ownership through other foreign entities
Constructive owners of at least 10% of the corporate stock – constructive ownership is a “deemed” ownership of stock, that is an ownership by attribution from another person or entity. Rules for determining constructive ownership are complex and vary depending on a category of filer
Persons who changed their ownership during a year so as to reach at least 10% ownership of the corporation (directly, indirectly or constructively), or acquired an additional 10%, or whose ownership fell below 10%
A person who becomes a U.S. person while having at least 10% ownership in a foreign corporation
U.S. individual who does not own any stock in the foreign corporation, either directly, indirectly or constructively, but who is a U.S. officer or director of the foreign corporation in which another U.S. person acquired stock so to bring their ownership to at least 10% or acquired an additional 10% or more of the outstanding stock of the foreign corporation.

Ownership attribution – constructive ownership

When deciding whether a U.S. person has to file form 5471, a person’s relationship to a corporation, or to other individuals and entities that are related to the corporation, must be carefully analyzed.

The extent of the information that must be reported on Form 5471, and possible inclusion of corporation’s income in the U.S. person’s taxable income depend on the filing category a person falls into. Filing category, in turn, depends to a great extent on the level of ownership of the corporation, either real or constructive.

While real, direct ownership is quite straightforward, constructive ownership rules may be complex and intricate.

In general, under ownership attribution rules, a person is considered to own stock that is owned directly or indirectly by a person’s family members, by a corporation in which a U.S. person owns 50% or more of interest, by a partnership in which a U.S. person is a partner, or by a trust in which a U.S. person is a beneficiary. There are also ownership attributions rules from individuals to entities.

Ownership attribution rules, and persons from whom/to whom ownership of stock may be attributed, vary for the purpose of determining in which filing category a U.S. person falls.

U.S. persons may be required to file form 5471 even if they don’t own any interest in any foreign corporation whatsoever but are related to certain owners of the corporation. One example of such a situation is when a U.S. person is deemed to own stock of the foreign corporation that is wholly owned by a nonresident spouse. If a nonresident spouse sells their company, the U.S. spouse is deemed to dispose of the stock in a foreign corporation and has to file form 5471.

What is a foreign corporation

A foreign corporation is an entity that is created or organized outside of United States and that is classified as a corporation under the U.S. tax laws.

The following types of entities are considered corporations for U.S. Federal tax purposes:

So-called Per Se corporation. A list of entity types by country that are classified by the U.S. tax code as Per Ce corporation can be found in the tax code regulations. For example, in Switzerland a Per Ce corporation is Aktiengesellschaft (AG). Per Ce corporations can’t change their classification and must remain corporations for U.S. tax purposes
An entity that has a default classification as an association taxable as a corporation: entity with one or more owners if all the owners have limited liability
An entity with default classification other than corporation that elected to be classified as an association taxable as a corporation: entity with one owner who does not have limited liability, or entity with more than one owner if at least one owner does not have limited liability

Entity Classification Election

Foreign entities other than Per Ce corporations can elect a different entity classification for U.S. tax purposes by filing Form 8832 Entity Classification Election.

An eligible entity can make an election to choose a desired classification other than the default classification for a newly formed entity, or to change the entity’s current classification.

Eligible entity that can make an election to be classified as a partnership:
A foreign entity with more than one owner if all owners have limited liability (default classification is corporation)
Eligible entity that can make an election to be classified as an entity disregarded from its owner:
A foreign entity with a single owner having limited liability (default classification is corporation)
Eligible entity that can make an election to be classified as an association, taxable as a corporation:
- A foreign entity with more than one owner and at least one owner does not have limited liability (default classification is partnership)
- A foreign entity with a single owner that does not have limited liability (default classification is entity disregarded from its owner)

Important notes

Change in entity classification may be beneficial in saving both tax and compliant costs, but it may have U.S. tax consequences that should be considered before making an election
A change in entity classification only affects the way an entity is classified for U.S. tax purposes. It does not change the entity’s legal form or taxation regime in the country of organization

What is reported on Form 5471

Form 5471 requires to disclose a whole lot of different information on Form 5471 and it is one of the most difficult international U.S. tax forms to prepare.

Starting from 2018, the form was changed a few times and was considerably expanded, including introduction of more detailed and comprehensive schedules. The extent of information that has to be disclosed is determined by a category of filer, with categories 4 (control of a corporation) and 5 (U.S. shareholder of a Controlled Foreign Corporation) being subject to the most rigorous reporting requirements.

In addition to general information about the corporation, personal information and ownership level of all the U.S. owners and all the direct owners, both U.S. and foreign, has to be disclosed.

In additional to personal information, various schedules must be completed to report income, assets and liabilities, accumulated earnings allocated into different categories, income taxes paid by the corporation, also allocated into different categories, transactions of the corporation with certain related parties, and much more. To make things more complicated, some of the schedules must present amounts in U.S. dollars using U.S. GAAP (generally accepted accounting principles), and different currency exchange rates must be used for different schedules.

What income is taxable to corporation’s owner

Despite the requirement to report a lot of information for almost all filing categories, only the U.S. shareholders of the Controlled Foreign Corporation (CFC) may be required to include the foreign corporation’s income in their taxable income.

U.S. shareholder for the purpose of categorizing a foreign corporation as a CFC is generally a U.S. person owning directly, indirectly or constructively at least 10% of the total combined voting power or value of shares of all classes of stock of a CFC.

CFC is a foreign corporation in which the U.S. shareholders own more than 50% (directly, indirectly or constructively) of either the total combined voting power or value of shares of all classes of stock of a CFC.

The important note here is that while a U.S. person may be considered a U.S. shareholder by reason of attribution of a foreign corporation’s stock from a related party, that U.S. person is taxed only on their share of CFC’s income in proportion to their direct or indirect ownership in the foreign corporation. Income attributable to the part of the CFC that is constructively owned by the U.S. person, is not taxed to them.

There are three major types of income that is taxable to U.S. shareholders of the CFC: Subpart F income, Investment of Earnings in U.S. property and GILTI (Global Intangible Low-Taxed Income). GILTI is the new type of taxable income introduced by the TCJA in 2017.

Subpart F income

There are many categories of Subpart F income. The most common category is the Foreign Base Company Income that is further subdivided into 3 categories:

Foreign personal holding company income that generally consists of passive income such as interest, dividends, rents etc.
Foreign base company sales income that generally includes income received by a CFC from the purchase or sale of personal property from, to or on behalf of a related person when the property is both produced and purchased or sold for use, consumption or disposition outside the CFC’s country of incorporation
Foreign base company services income that consists of income from the performance of services by the CFC outside the CFC’s country of incorporation for or on behalf of any related person

There are numerous exceptions and exclusions from the Subpart F income that involve a variety of complex requirements. One of the most common exceptions is that subpart F income inclusion is limited to the CFC’s current E&P (earnings and profits). That means that even if the corporation had Subpart F income during the year but total E&P for that year are negative, the U.S. shareholders would not be required to include any Subpart F income on their U.S. tax returns for that year.

Investment of Earnings in U.S. property

In general, U.S. shareholders are taxed on their pro rata share of the CFC’s increase in earnings invested in U.S. property. U.S. property means any tangible property located in the United States, stock of a U.S. corporation, any obligation of a U.S. person and any right to the use in the United States of a patent, copyright, invention, model, design, secret formula or process, or any other similar right, which is acquired or developed by the CFC.

Loan from the CFC to its U.S. shareholders is an obligation of a U.S. person and may create an Investment of Earnings in U.S. property income that may be required to be included in U.S. taxable income of the U.S. shareholders.

GILTI

Global Intangible Low-Taxed Income, or GILTI was introduced at the end of 2017 by TCJA and basically brought to an end the deferral of U.S. tax liability on income earned by the foreign controlled corporations that the U.S. shareholders enjoyed before. Prior to the TCJA enactment, CFC’s income was generally taxed to shareholders only upon distribution, or in a form of Subpart F or Investment in U.S. property income inclusions. Under GILTI regime, income earned by a CFC is taxed to U.S. shareholders annually, even if not distributed.

Calculation of GILTI may be quite complex, but in a very general sense it is determined as the CFC’s net income reduced by a few other types of taxable income, such as for example Subpart F income, with the result further reduced by 10% of certain qualified tangible assets held by the CFC and by certain interest expense.

GILTI is included on the shareholder’s tax return and is taxed at ordinary income rates.

CFC’s shareholder that is a U.S. C-corporation can further decrease includable income by 50% of GILTI to arrive at taxable GILTI inclusion, and can claim foreign tax credit for foreign taxes paid by the CFC.

Individual shareholders cannot claim a foreign tax credit for the foreign taxes paid by the CFC to reduce their personal U.S. income tax. As a result, total tax costs on both corporate and personal levels for individual shareholders of the CFC can be quite substantial.

When and how to file

Form 5471 is filed as part of the U.S. person’s tax return by the due date of the return, including extensions.

Penalties

Penalties for failure to file form 5471 timely, or for filing an incomplete or incorrect form, or for not filing at all start at $10,000 per form per year.

In addition, up to $50,000 additional penalties may be assessed in case of continuing failure to file if the IRS sent a notice of the failure to the U.S. person.

Because of its highly complicated and technical nature, it is highly recommended that form 5471 is prepared by an experienced tax professional.

U.S. Owners of Foreign Corporations (Form 5471)

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