Avoiding the 35% penalty on failure to report outbound transfers to foreign entities under sec. 1494(c).

• Author: Seitz, Timothy

The IRS has issued guidance on the application of the penalty provision of Sec. 1494(c) in Notice 97-18. As noted in the March Tax Clinic item (page 151), "Penalty for Failing to File Information Returns on Certain Outbound Transfers of Property Substantially Expanded," this provision subjects a U.S. person making certain transfers of property to a foreign entity after Aug. 20, 1996 to a penalty equal to 35% of the gross value of the property transferred if it does not properly report the transfer on Form 926,5471 or 5472.

Scope of Transfers Subject to Sec. 1494(c)

Sec. 1494(c) potentially applies to capital contributions to foreign corporations and all transactions with foreign partnerships and trusts (collectively, "Sec. 1491 transfers"). In response to taxpayer alarm and confusion over the scope of this provision, the Service suspended the application of Sec. 1494(c) until it could provide additional guidance; see Notice 96-60. Application of the penalty to Sec. 1491 transfers occurring in the context of Secs. 301, 302, 305 and 731 remains suspended under the notice.

Notice 97-18 clarifies that the Sec. 1494(c) penalty generally applies to all Sec. 1491 transfers,including:

[] Transfers of cash and nonappreciated property.

[] Sales made to 10%-owned foreign partnerships, even if made at fair market value.

[] Capital contributions to foreign corporations in which the transferor owns at least 10%, but not more than 50%, of the transferee.

[] Deemed contributions to capital, including:

1. deemed capital contributions in Sec. 304 transactions;

2. deemed capital contributions resulting from certain Sec. 482 adjustments (e.g., when a sale is made to a subsidiary at below market price); and

3. deemed capital contributions occurring when "checking the box" to treat a first-tier foreign corporation as a partnership.

[] Transfers made through a tax-free exchange, gift or sale in which gain recognition is deferred (e.g:, installment sales), corporate distribution, partnership distribution, or a deemed transfer (e.g., resulting from a Sec. 304 transaction or Sec. 482 adjustments).

Application of Sec. 1494(c) Penalty

The notice clarifies the application of the Sec. 1494(c) penalty in two ways. First, the Sec. 1494(c) penalty is imposed only to the extent the Sec. 1491 transfer is not properly reported, i.e., the penalty will apply only to the portion of the property's gross value not properly reported. Second, the penalty will not apply if the U.S...