New IRS practice unit: “Substantial compliance” doctrine, international information return penalties

The IRS Large Business and International (LB&I) division last week publicly released a “practice unit” that addresses what the term “substantially complete” means with reference to international information return penalties, particularly Form 5471.

The IRS recently released a new International Practice Unit (“IPU”) on failures to file form 5471.  IPUs are meant to act as a guide for IRS examiners and give insight to taxpayers as to how the IRS will evaluate certain tax situations.  The unit specifically deals with penalties associated with Internal Revenue Code § 6038, which assess a $10,000 penalty when certain forms are filed late, substantially incomplete, or not filed at all.  Though the IPU specifically relates to Form 5471, Form 5472 is subject to the same penalties under the same code provision.

Form 5471 is filed by U.S. taxpayers with respect to certain interests and transactions related to their ownership in foreign corporations.  Conversely, Form 5472 is filed by either U.S. corporations with some foreign owners or a foreign corporation which engages in a U.S. trade or business.  The Form 5472 filing obligation is triggered by certain transactions.

The IPU focuses specifically on what information qualifies Form 5471 as being “substantially complete.”  It is important to note that neither the Internal Revenue Code nor the Treasury Regulations define “substantially complete” for the purposes of Form 5471, but the IPU does provide situations and examples to illustrate the concept.

The IPU is available on the IRS practice unit webpage (release date of June 19, 2017).

Substantial compliance doctrine

International information returns must be substantially complete in order for the filer to have met its filing requirement. However, the terms “substantially complete” and “substantially incomplete” are not defined in the Code or regulations.

As noted in the practice unit, if the filer of an information return did not submit a substantially complete return, then penalties under sections 6038, 6038A, and 6046 may apply. The practice unit provides informal guidance for IRS agents examining a U.S. entity with foreign ownership or foreign-owned U.S. businesses, for purposes of determining whether the required international information return is substantially complete so that the filing requirement is met.

The practice unit begins by explaining the substantial compliance doctrine—a judicial concept that applies to certain tax returns, elections, and the substantiation of certain deductions. In some cases, courts require strict compliance with the statutory or regulatory requirements, but in other situations, the courts will accept substantial compliance. While the concept of substantially complete has not been the subject of judicial review, the body of case law concerning the substantial compliance doctrine provides guidance as to how a court may interpret whether an international information return is substantially complete. This background can be applied to supplement existing informal guidance on substantial completeness or, when the IRS has not provided specific informal guidance, this background can suggest a general approach for the IRS agent to follow.

Tax professionals have observed that the practice unit released today provides valuable insight into the IRS viewpoint on application of the substantial compliance doctrine, and the meaning of “substantially complete” for purposes of imposing penalties related to international information return obligations and associated filing requirements. In this practice unit, the IRS discusses these terms and instructs agents how to interpret and apply them—specifically with regard to Form 5471 and Form 5472 filing obligations—and notes how these principles might apply to other international information return penalties. The practice unit also provides guidance regarding when a strict compliance requirement is to apply. Taxpayers with international information return obligations might find it helpful to review this practice unit.

When completing Forms 5471 and 5472 it is imperative to provide all necessary information so that the form will be considered “substantially complete.”  If the form is filed but it is deemed not “substantially complete,” the taxpayer may be subject to a $10,000 penalty for each form filed which is not “substantially complete.”

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