In prior U.S. Tax Tips we have discussed the increased complexity in the United States’ Controlled Foreign Corporation (“CFC”) rules and the corresponding increase in the complexity of meeting the filing requirements. There are significant penalties for failure to timely and accurately file Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations”.
Though it is clear (in our humble opinion) that the thrust of these changes were to target large U.S. multi-nationals, (i.e., Amazon, Starbucks, Google, etc..) and their use of offshore tax shelters and structures, U.S. citizens who, as individuals, own shares in private foreign entities are also caught. The classification as to whether a foreign entity is a corporation is made pursuant to U.S. tax law.
As a reminder, a U.S. citizen (actually any U.S. person) who owns at least 10% of the votes or value of a foreign corporation will be classified as a “United States shareholder” for these purposes. When “United States shareholders”, either individually or in aggregate, own greater than 50% of the votes or value of the foreign corporation, the foreign corporation is a CFC for U.S. tax purposes.
Once a foreign corporation is a CFC, the United States shareholder may be subject to adverse tax implications including income inclusions under subpart F and Global Intangible Low Taxed Income (“GILTI”) on a flow through basis without any corresponding foreign tax credits (since it is the foreign corporation that is paying the tax, not the United States shareholder). Certain elections may need to be filed to alleviate any potential double taxation.
The question then becomes, how you determine when a U.S. taxpayer is a “United States shareholder”? The answer may seem obvious but it is not. Internal Revenue Code (IRC) sections 318 and 958 provide the legislative guidance.
The taxpayer is considered to own all shares that he owns directly, shares that he owns indirectly (i.e., from a partnership, estate, trust or corporation) and shares that are considered to be constructively owned by him (via, for example, certain family members). As such, it is extremely important to ensure that the corporation’s stock register is up to date and that a thorough analysis of who owns what is performed on a regular basis (we would recommend that a review be done annually when the U.S. taxpayer’s U.S. income tax return is being prepared). Even if the foreign corporation is not a CFC (as United States shareholders do not exceed the 50% threshold), depending on who owns the remaining shares Form 5471 may still be required to be filed.
The Tax Cuts and Jobs Act (P.L. 115-97 (2017)) changed the attribution rules under IRC 958(b). Historically, shares could not have attributed from a foreign person to a United States person. This provision was repealed with the result that “downward attribution” of stock from foreign persons would now be taken into account for purposes of determining whether a U.S. person is a “United States shareholder” of a foreign corporation. For example, stock owned by a foreign corporation is to be treated as constructively owned by its wholly owned (U.S.) domestic subsidiary for purposes of determining the United States shareholder status of the subsidiary and the CFC status of the foreign corporation.
The repeal of section 958(b)(4) was intended “to render ineffective certain transactions that are used to (sic) as a means of avoiding the subpart F provisions”. [H.R. Rep. No. 115-466, at 633 (2017)(Conf. Rep.)]. The repeal, however, brought in additional unintended taxpayers within the CFC regime.
On October 1, 2019, the IRS released Revenue Procedure 2019-40 and proposed regulations (REG-104223-19). The proposed regulations are intended to provide additional relief to taxpayers affected by the repeal of IRC §958(b)(4), and proposes modifications to current regulations that are intended to provide, in certain circumstances, that the operation of certain rules is consistent with their application BEFORE the repeal of IRC §958(b)(4). Congress is trying to correct the “error” that resulted with the repeal.
While the proposed regulations may provide some relief, the overall CFC legislation and reporting requirements remain complex, more so with the changes brought about with the Tax Cuts and Jobs Act. Cadesky U.S. Tax can assist you and your clients with a review of the current ownership structure to determine the impact of these changes and to assist with any filing requirements.
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