Every now and then, I encounter foreign business structures built on the incorrect belief that only direct ownership matters for U.S. tax reporting purposes in general and Form 5471 purposes in particular. In this essay, I broadly address the question of Form 5471 reporting with respect to indirect ownership of a foreign company (I am not discussing the major issue of “constructive ownership” in this essay).
Form 5471 Reporting Requirements
In an earlier article I already discussed the purpose of Form 5471 and the general reporting requirements this form entails, but I will briefly address these issues here.
Form 5471 is used by certain categories of U.S. taxpayers to report their ownership of foreign corporations. Generally, the form is designed to address the reporting requirements of IRC (Internal Revenue Code) Sections 6038 and 6046.
Under these IRC provisions, four general categories of U.S. taxpayers must file Form 5471 together with their U.S. tax returns: (1) U.S. taxpayers considered as U.S. shareholders (generally, U.S. taxpayers who own 10% or more of a foreign corporation) (these are category 3 filers), (2) U.S. persons who are directors and/or officers of a foreign corporation in which there are U.S. shareholders which meet the requirements of Form 5471 (these are category 2 filers), (3) U.S. persons who had control of a foreign corporation for an uninterrupted period of 30 days (these are category 4 filers); and (4) U.S. shareholders who owned a stock in a foreign corporation that is considered to be a Controlled Foreign Corporation for an uninterrupted period of 30 days and who owned that stock on the last day of the year (these are category 5 filers). Note, that Category 1 was repealed by Congress in section 413(c)(26) of the American Jobs Creation Act of 2004.
What truly adds to the complexity of the application of these four categories are the specific definitions of virtually every word in the description of these four categories which may differ from category to category. For example, “US taxpayer”, “US person”, “control”, “owned” – these are some of the words that are separately defined in the IRS regulations with respect to each category above.
Therefore, for a non-attorney, it is extremely dangerous to rely on these general definitions. Rather, the determination of whether Form 5471 requirement applies to you should be made by an international tax attorney.
Ownership Has Broad Definition for Form 5471 Purposes
As mentioned above, word “owned” has a number of diverse and special meanings for Form 5471 purposes. Generally, it includes not only the direct ownership of a stock, but also indirect ownership and constructive ownership. The concepts of “indirect ownership” and “constructive ownership” are described in separate complex IRS regulations.
The upshot of this discussion is that “ownership” is defined very broadly under the IRS regulations related to Form 5471, and one should not rely on direct ownership in determining whether Form 5471 needs to be filed.
Indirect Ownership for Form 5471 Purposes: IRC Section 958
We now came to the main purpose of this article – discussion of “indirect ownership” for Form 5471 purposes. Form 5471 Instructions as well as IRS regulations generally refer to IRC Section 958 for the definition of indirect ownership.
This provision sets forth the rules for determining stock ownership, including direct, indirect and constructive ownership of a stock. For the purposes of our discussion, we concentrate on Section 958(a)(2) which describes the rules for stock ownership through foreign entities. It states as follows:
“(2) Stock ownership through foreign entities: For purposes of subparagraph (B) of paragraph (1), stock owned, directly or indirectly, by or for a foreign corporation, foreign partnership, or foreign trust or foreign estate (within the meaning of section 7701(a)(31)) shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. Stock considered to be owned by a person by reason of the application of the preceding sentence shall, for purposes of applying such sentence, be treated as actually owned by such person.”
Thus, it becomes clear that, generally, a U.S. shareholder of a foreign company is likely to be considered a shareholder of other foreign companies owned by this foreign company. For example, where foreign corporation A owns 25% of foreign corporation B, a 45% shareholder of Company A is likely to be deemed as a 11.25% owner of company B. Obviously, this is a very general example and there are various facts and circumstances that may change this simplified calculation. Again, you should retain an international tax attorney to determine your ownership of foreign companies under IRC Section 958.
Implications for Form 5471 Reporting and Tax Planning Strategies
The most obvious result of IRC Section 958 are additional Forms 5471 that need to be timely filed with the U.S. shareholder’s US tax return. It is now easy to see why I would encounter in my practice a situation where a client would comply with Form 5471 requirements for the purposes of some of his companies and fail to do so with respect to the others because either he or his accountant simply did not understand the implications of Section 958 indirect ownership rules.
Section 958 also has a major influence on a U.S. person’s tax plan. Where such person and his tax advisor ignore the relevant implications of IRC Section 958, they are engaging in a potentially disastrous course of action. Beyond the penalties associated with the failure to file Form 5471 timely (as well as other potential penalties stemming from other U.S. international tax forms that may need to be filed), the effect of the entire tax structure could be nullified and potentially expose U.S. taxpayer to additional US taxes.
Contact Sherayzen Law Office for Help With Form 5471 and Tax Planning
If you or your business own companies overseas, contact Sherayzen Law Office for help with U.S. tax compliance, including Form 5471, as well as creating a comprehensible tax plan that would allow you to avoid over-payment of U.S. taxes while remaining in compliance with the Internal Revenue Code.