Tips for preparing the Form 5471 for controlled foreign corporations.

• Author: Jacobs, Vernon K.

EXECUTIVE SUMMARY

* Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, is designed to report the activities of the foreign corporation and to function as a roadmap for the IRS on transfer pricing.

* Form 5471 requires information and details about the corporation's ownership, stock transactions, shareholder and company transactions, foreign taxes, foreign bank and financial accounts, accumulated earnings and profits, and currency conversions.

* Preparation of Form 5471 requires consideration of a number of issues and concepts that do not apply to domestic corporations, including subpart F income, foreign tax credits, and transfer pricing.

* Foreign corporations that are required to file Form 5471 may be required to file a number of other forms specific to foreign corporations.

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It may be a cliche that the world is getting smaller, but it is true that interaction among people around the globe has become much easier, faster, and far less expensive than even a dozen years ago. Thanks to these changes, and with the help of a variety of international trade agreements, an increasing number of U.S. businesses are expanding into other countries.

However, the U.S. income tax system is generally based on assumptions about a relatively closed society that were made as far back as the introduction of the modern income tax nearly a century ago. (1) The United States is the only major industrial country that imposes income and estate tax on its citizens without regard to where they reside. (2) All other industrial nations that have an income tax system use a territorial approach in which only residents are subject to the income tax.

Because of the unique approach to the taxation of citizens and entities based in the United States, any U.S. person (3) that ventures offshore potentially can be taxed by two countries on the same income. This has resulted in the introduction of numerous tax code provisions designed to avoid the potential for double taxation. Over the past 95 years, Congress has also seen fit to introduce an assortment of rules to prohibit tax avoidance through the use of foreign entities.

For those who do not work extensively in the niche of international taxation, these rules are novel and involve unfamiliar code sections, regulations, tax forms, instructions, and challenges. Some of the obstacles that a preparer may encounter include:

* Constructive ownership is a pervasive problem in international tax law.

* Tax returns for U.S. and foreign entities may involve the application of treaty benefits.

* Clients may be subject to a combination of pass through and tax-deferred earnings.

* U.S. and foreign tax withholding regimes can be complex.

* Sec. 482 controlled group allocations and transfer pricing may require the engagement of a specialist.

* Multiple reporting of foreign bank accounts is possible.

* The inadvertent creation of a permanent establishment in a nonresident country can cause extremely undesirable tax results.

* Foreign accounting methods often substantially differ from U.S. methods.

* There are complex foreign tax credit limitations.

* There are special rules for oil, insurance, securities, and exporting.

* There may be traps for the uninformed or the unwary, including complex tax election requirements (e.g., foreign tax credit, check-the-box elections, and Sec. 362(e)(2)(C) basis elections in certain Sec. 351 transactions).

* Accounting records may require conversions of multiple currencies.

* Extensive details are required for any intercompany transactions and for ownership and ownership changes.

* Larger U.S. companies may have complex transfer pricing problems.

* Larger U.S. companies must report the impact for foreign taxes on earnings per share as well as FIN 48 accounting application standards.

Form 5471

Who Must File Form 5471

Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, is designed to report the activities of the foreign corporation and to function as a roadmap for the IRS on transfer pricing. The first problem the practitioner encounters with Form 5471 is determining whether a client is required to file the form. The IRS instructions identify the categories (4) of filers based on various ownership percentages or changes in ownership of the corporation. Practitioners are also often confused because the form is not actually limited to the U.S. owners of a controlled foreign corporation. (5) In some instances, an officer or director who is not an owner is required to file Form 5471.

Another common source of confusion can arise from the treatment of a foreign limited liability company as a foreign corporation in the absence of an entity classification election to be treated as either a foreign partnership (multiple owners) or a foreign disregarded entity (one owner). In addition, some practitioners are not familiar with the nature of an international business...