The reporting requirements for IRS Form 5471 are complex, including 'category of filer' and required…
Substantially Completed Form 5471 is Required to be Filed
IRS has recently released a new International Practice Unit (IPU) providing guidance to its examiners on the monetary penalties applicable if certain categories of U.S. shareholders fail to comply with the reporting requirements on Form 5471 (Information Return of U.S. Persons With Respect To Certain Foreign Corporations). Referencing prior rulings and other guidance, the IPU addresses the meaning of “substantial” Form 5471 compliance for purposes of assessing and collecting the Code Sec. 6038 penalties.
Background on IPUs.
In general, IPUs identify strategic areas of importance to IRS and can provide insight as to how IRS examiners may audit a particular issue or transaction. However, they are not official pronouncements of law or directives and cannot be used, cited, or relied upon as such. Since Dec. 15, 2014, IRS has released over 75 IPUs. Some of the IPUs cover major international tax areas, while others focus on highly specific technical areas.
Background on Form 5471.
Certain U.S. persons, who are officers, directors, or shareholders in certain foreign corporations are required to file Form 5471. The form and schedules are used to satisfy the information reporting requirements of Code Sec. 6038, Code Sec. 6046 , and the regs thereunder, as they apply to certain foreign corporations.
In general, all U.S. persons described in the five “Categories of Filers” must complete the schedules, statements, and/or other information requested in the chart, “Filing Requirements for Categories of Filers” in the instructions to Form 5471.
Form 5471 is attached to and filed with the applicable income tax return, a partnership return, or an exempt organization return. The period during which the required information is provided is the annual accounting period of the foreign corporation that falls within the U.S. person’s tax year. (Code Sec. 6038(a)(1))
Penalties for failure to file Form 5471 discusses the monetary penalties that may apply when certain categories of U.S. shareholders fail to comply with the reporting requirements on Form 5471.
Even though the instructions to Form 5471 list five categories of filers, the IPU focuses on only the following two categories of filers:
- A U.S. person who owns (directly or indirectly) more than 50% of the combined voting power or value of all classes of stock in a foreign corporation for an uninterrupted period of at least 30 days during the annual accounting period of the foreign corporation (a Category 4 filer), and
- A U.S. shareholder who owns (directly, indirectly, or constructively) stock in a CFC for an uninterrupted period of 30 days or more during the corporation’s tax year and owned such stock on the last day of that year (a Category 5 filer).
For this purpose, the IPU notes that when multiple persons are required to file the same Form 5471, it may be jointly filed by attaching it to only one person’s return. In that case, the other persons must attach a statement to their respective returns. Item D on a jointly filed Form 5471 must list the name, address and identifying number of each person on whose behalf Form 5471 is filed. Also, each person’s status as officer, director and/or other must be noted. Schedule I (Summary of Shareholder’s Income From Foreign Corporation) is required to be filed for each shareholder listed in Item D.
The IPU notes that the penalties under Code Sec. 6038 may apply when Form 5471 is filed late, substantially incomplete, or not at all. For any of these three types of failures, an initial penalty of $10,000 per Form 5471 per year may be assessed. (Code Sec. 6038(b)(1)) In addition, a continuation penalty of $10,000 per Form 5471 per year may be assessed for every 30-day period (or fraction thereof) beginning 90 days after the U.S. person was notified that a failure exists. (Code Sec. 6038(b)(2)) However, the maximum continuation penalty per Form 5471 per year is $50,000. (Code Sec. 6038(b)(2)) These penalties may apply per Form 5471 required on an annual basis. Finally, a reduction in foreign tax credits may be applicable. (Code Sec. 6038(c))
The statute of limitations for assessing and collecting Code Sec. 6038 penalties ends three years after a “substantially complete” Form 5471 is filed.
“Substantially complete” requirement detailed. The IPU states that the “substantially complete” requirement has not been met for purposes of Code Sec. 6038 if a Form 5471 is filed with the following errors on page 1 of the form:
- Item B: “Category of the filer” is omitted or incorrect, so the schedules to Form 5471 that are required to be completed cannot be determined;
- Item C: “the total percentage of the foreign corporation’s voting stock … owned at the end of its accounting period” is omitted (when no Item B category was indicated) or incorrect (when compared to the Item B category indicated), so the schedules to Form 5471 that are required to be completed cannot be determined;
- Item 1a: “Name or address of foreign corporation” is omitted, so other information provided on Form 5471 cannot be associated with a specific foreign corporation;
- Items 1b(1) and 1b(2): “Reference ID number” under 1b(2) (only required for foreign corporation tax years beginning in 2012 and later) is omitted when the “Employer identification number” under 1b(2) is not provided, so other information provided on Form 5471 cannot be associated with a specific foreign corporation; and
- Schedules required to be attached to Form 5471 are not included.
According to IRS, even though substantial compliance of a Form 5471 is not defined in the Code or regs, Reg. § 1.6038-2(k) discusses the failure to furnish required information.
The IPU sets out the following common reasons for Form 5471 non-compliance:
- Stating that required information will be furnished upon request or audit;
- Providing computer-generated Form 5471s that were not IRS-approved and did not conform to requirements;
- Failing to provide financial statements for controlled foreign corporations; and
- Providing consolidated financial statements of two or more foreign corporations.
Furthermore, the IPU references a 1997 Field Service Advice (FSA) that addressed whether a U.S. person “substantially complied” with Code Sec. 6038 when significant understatements of related party purchases and/or sales (see Schedule M (Transactions Between Controlled Foreign Corporation and Shareholders or Other Related Persons and significant inconsistencies were reported for earnings and profits (see Schedule H (Current Earnings and Profits) of Form 5471). The FSA states that Congress did not intend that providing more of the required information than not (an aggregate approach) qualify as substantial compliance. Rather, it was more important to determine substantial compliance on a significant item by significant item basis.
Furthermore, the IPU refers to Chief Counsel Advice 200429007(CCA), which provides a facts and circumstances analysis for “substantially complete” in contrast to a strict interpretation of the regs that any over-reported or underreported transaction amount meant the form was “substantially incomplete.” Although the CCA applies to Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business), the IPU states that “the analysis should also apply to Form 5471.”
Finally, referencing Chief Counsel Advice 200645023, the IPU provides that a Form 5471 is not “substantially complete” if it includes required balance sheet and income statement amounts that are “not in accord with U.S. Generally Accepted Accounting Principles (GAAP)” or income statement and income tax amounts that “were not in both functional and U.S. currencies.” See Schedules C (Income Statement), F (Balance Sheet), and E (Income, War Profits, and Excess Profits Taxes Paid or Accrued) of Form 5471
According to the IPU, the examiner should use the analysis in the aforementioned guidance to determine whether an error was significant and whether the IRS’s ability to gather information necessary to conduct an effective examination was impacted. Depending on the complexity and magnitude of the error and the explanations provided by USP, an analysis using the seven factors in Chief Counsel Advice 200429007 might be useful in determining whether the U.S. person substantially complied with Code Sec. 6038.
The seven factors stated in CCA 200429007 are: The magnitude of the underreporting, or of the over-reporting, of the erroneous reported transaction in relation to the actual total amount of that reported type of transaction(s); Whether the reporting corporation has reportable transactions other than the erroneous reported transaction(s) with the same related party and correctly reported those other transactions; The magnitude of the erroneous reported transactions in relation to all of the other reportable transactions as correctly reported; The magnitude of the erroneous reported transactions in relation to the reporting corporation’s volume of business and overall financial situation; The significance of the erroneous reported transactions to the reporting corporation’s business in a broad functional sense; Whether the erroneous reported transactions occur in the context of a significant ongoing transactional relationship with the related party; and Whether the erroneous reported transactions are reflected in the determination and computation of the reporting corporation’s taxable income.
Form 5471 Category 4 and 5 filers should use the above examples and references to determine whether an error or omission was significant enough to consider their Form 5471 filing(s) as substantially incomplete for purposes of applying penalties that may apply under Section 6038.
In addition, the IRS has requested its auditors review the U.S. person’s Form 5471 for any schedules required (based on their filing category) but not prepared. If the Form 5471 does not contain any of the required schedules, Section 6038 is not substantially complied with. Section 1.6038-2(k) discusses the failure to furnish required information. In determining whether a Form 5471 is substantially complete, it may be necessary to review this regulation in addition to the guidance set forth in the IPU.
Taxpayers and practitioners should pay close attention to how Form 5471 and the related schedules are completed, including reviewing Forms 5471 from prior years. Failure to properly complete the forms and schedules can have significant penalty and perhaps other income tax ramifications for taxpayers in years ahead, not the least of which is the statute of limitation not running until the forms are filed, all of which could be difficult to resolve. If you feel you may have a Form 5471 filing requirement or would like additional information, contact our office to speak with an experienced tax attorney.