Revised Form 1120-F: practical issues and missed opportunities.

• Author: Conklin, Susan J.

In early 2007, the IRS published a substantially revised Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, to be used for tax years beginning in 2007. The revisions were intended to provide for increased disclosure of information regarding items such as allocable interest expense and home office expense allocations, as well as effectively and noneffectively connected income reported on Form 1120-F.

At that time, the IRS indicated that these changes--along with the new Schedule M-3, Net Income (Loss) Reconciliation for Foreign Corporations with Reportable Assets of $10 Million or More--would enable the IRS to identify high-risk returns requiring compliance action.

To this end, the IRS issued the following new Form 1120-F schedules:

* Schedule H, Deductions Allocated to Effectively Connected Income Under Regulations Section 1.861-8;

* Schedule I, Interest Expense Allocation Under Regulations Section 1.882-5; and

* Schedule P, List of Foreign Partner Interests in Partnerships.

Based on taxpayer queries during the 2008 compliance season, significant confusion in completing the new form and schedules ironically arose among taxpayers with the least complex U.S. tax situations. Some of the issues and concerns expressed by those taxpayers about the revised form and schedules are briefly discussed below.

Foreign Corporations Filing Certain Protective Returns

Prior to the revision of Form 1120-F, some foreign corporations filing protective returns under the procedures prescribed by Regs. Sec. 1.882-4(a)(3)(vi) did not answer the questions on page 1 of the form because they typically did not view these questions as relevant to a protective return. The instructions for the 2007 Form 1120-F now require taxpayers to answer page 1 questions, such as whether they had a U.S. agent or whether they were engaged in the conduct of a U.S. trade or business. In some cases the requirement has resulted in a fairly significant additional compliance burden, particularly when the questions did not seem relevant to many protective return filers.

A frequent complaint came from foreign corporations that felt strongly they had no permanent establishment (PE) in the United States under the provisions of a relevant income tax treaty and that properly disclosed that position on an attached Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b). Eligibility for an exemption under treaty permanent establishment provisions generally...