US persons with ownership interests in foreign corporations or who are directors or officers of foreign corporations are subject to special reporting rules. The first article of this series provided the general reporting requirements under Form 5471. This article will focus on the reporting requirements of “Category 2 Filers”, which are the reporting requirements of a US citizen or resident who is an officer or director of a foreign corporation.
A Category 2 Filer is a US citizen or resident who is an officer or director of a foreign corporation in which a US person has acquired 10% or more ownership interest by value or vote, or acquired an additional 10% or more ownership interest by vote or value, of the outstanding stock of a foreign corporation (“10% Stock Ownership Requirement”). The US citizen or resident who is an officer or director of a foreign corporation will have a reporting requirement whether or not they actually own directly or indirectly any of the stock of the foreign corporation.
For purposes of a Category 2 Filer, the term “US Person” means a citizen or resident of the US, a domestic partnership, corporation, estate or trust. In determining whether there is a reporting requirement as a Category 2 Filer, it will be important to understand the requirements of stock acquisition and ownership.
The regulations and instructions to Form 5471 separate the acquisition requirement from the ownership requirement. This is important because if the acquisition requirement is separate from the ownership requirement, then for a US citizen or resident who is an officer or director of a foreign corporation to have a reporting obligation as a Category 2 Filer, there must be direct ownership in the foreign corporation by a US Person. However, the instructions to Form 5471 also contradict the direct ownership requirement by providing:
A Category 2 filer does not have to file Form 5471 if the US person(s) for which the Category 2 filer is required to file Form 5471 does not directly own an interest in the foreign corporation but is required to furnish the information solely because of constructive stock ownership from a US person and the person from whom the stock ownership is attributed furnishes all of the required information.
The importance of the acquisition requirement being separate from the ownership is that there is not deemed acquisition through a relationship with another individual that would trigger a filing requirement for a Category 2 Filer. However, in light of the language of the instructions to Form 5471 quoted above and the penalties that can be imposed by the IRS for noncompliance, a protective filing by the Category 2 Filer may be the best approach under these circumstances.
In determining whether a US Person meets the 10% Stock Ownership Requirement, certain constructive ownership rules apply. A US Person is considered to own the shares of stock owned by their spouse, siblings (whether by the whole or half blood) ancestors, and lineal descendants. Also, stock owned directly or indirectly by or for a foreign corporation or a foreign partnership is considered as being proportionately owned by its shareholders or partners. A US citizen or resident, who is an officer or director of a foreign corporation, would be required to report as a Category 2 Filer the acquisition by a US Person of a 0.1% ownership interest of a foreign corporation if that US Person’s sibling, who is not a US Person, owns 9.9% or more of the stock of the foreign corporation.
As alluded to above, the penalties imposed on a Category 2 Filer who fails to report a reportable transaction are significant; especially considering the Category 2 Filer may not directly or indirectly own stock in the foreign corporation. A Category 2 Filer who fails to file or report all of the information requested is subject to a $10,000 penalty for each failure to report a reportable transaction. If the failure continues after a notice is received from the IRS, the penalty could reach a maximum of $50,000 for each failure to report a reportable transaction.