US TAX SURPRISES AND REPORTING REQUIREMENTS SERIES
Here we will briefly discuss the ownership attribution rules for purposes of Form 5471, and introduce the different filing categories under Form 5471. The rules and reporting requirements for each category of filer are unique and will be discussed in more detail in subsequent articles.
Before describing the four different filing categories for Form 5471, it is important to understand how ownership interest in a foreign corporation is determined. In determining whether there is a reporting requirement under Form 5471, a US citizen or resident can own stock in a foreign corporation directly, indirectly, or constructively. Constructive ownership of stock means deemed ownership of the stock of a foreign corporation through constructive ownership rules, generally through family or entity attribution.
To make matters more complicated, there are three different attribution rules that apply to the four categories of Form 5471 filers. The attribution rules for each category of filer will be discussed in more detail in subsequent articles that specifically address each category of filer.
It is important to understand that a US citizen or resident who has no actual or indirect ownership in a foreign corporation can have constructive or “attributed” ownership in a foreign corporation requiring them to file Form 5471 or be subject to penalties for noncompliance. There are general exceptions to the filing requirements for these US citizens or residents with no actual or indirect ownership in a foreign corporation however, the exceptions usually require that the individual or entity of whom the ownership is being attributed, not only file Form 5471, but file Form 5471 and include all of the information required of that individual or entity.
In other words, the exception is based on the reliance that another individual or entity correctly files Form 5471.
Category 2
A Category 2 filer includes 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 stock ownership by value or vote (“10% Stock Ownership Requirement”). The rules for a Category 2 filer introduce the term US person, which includes a citizen or resident of the US, a domestic partnership, corporation, estate or trust. A Category 2 filer is required to report the acquisition of ownership interest of another US person, regardless of whether the Category 2 filer has an ownership interest in the foreign corporation or not. To make matters more complicated, a Category 2 filer would be required to report a US person who only constructively owns stock in the foreign corporation, meaning the Category 2 filer must not only know the actual and indirect ownership of the foreign corporation stock, but also the constructive owners of the foreign corporation stock. This filing requirement appears to ignore the fact that the Category 2 filer could be unrelated to the shareholders of the foreign corporation, and therefore would be unlikely to know the constructive owners of the foreign corporation.
Category 3
A Category 3 filer’s requirement to file Form 5471 is generally triggered by acquisition and disposition of stock in a foreign corporation. A Category 3 filer includes a US person who: acquires stock in a foreign corporation which, when added to stock already owned, meets the 10% Stock Ownership Requirement; acquires stock which meets the 10% Stock Ownership Requirement; a person who becomes a US person while meeting the 10% Stock Ownership Requirement; or a US person who disposes of sufficient stock in the foreign corporation to reduce their stock ownership in the foreign corporation below the 10% Stock Ownership Requirement. The same constructive ownership rules that apply to Category 2 filers also apply to Category 3 filers.
Category 4
A Category 4 filer is a US person who for at least an uninterrupted period of 30 days during the annual accounting period of the foreign corporation owned more than 50% of the foreign corporation stock by value or vote. For purposes of a Category 4 filer, a US person is defined as a citizen or resident of the US, a nonresident alien who elects to be treated as a US resident taxpayer, a domestic partnership, corporation, or estate or trust. Category 4 filers are subject to different constructive ownership rules than other category filers.
Category 5
A Category 5 filer includes US shareholders who own stock in a foreign corporation that is a Controlled Foreign Corporation (“CFC”) for an uninterrupted period of 30 days or more during any tax year of the foreign corporation, and who owned stock on the last day of the tax year. A US shareholder is defined as a US person who owns 10% or more of the voting power of the CFC. For purposes of a Category 5 filer, a US person is defined as a citizen or resident of the US, a domestic partnership, corporation, or estate or trust. A CFC is a foreign corporation with US shareholders that own more than 50% of the stock of a foreign corporation by value or vote. Category 5 filers are subject to different constructive ownership rules than other category filers. A foreign corporation’s classification as a CFC generally leads to adverse income tax consequences to the US shareholders of the foreign corporation.
While filing Form 5471 may or may not be a difficult task, determining whether you have a filing obligation is complex. A filing requirement can result even if an individual has no actual or indirect ownership in a foreign corporation. Also, Form 5471 applies different attribution rules and defines the same terms inconsistently for the different categories of filers. Moreover, failure to file Form 5471 can result in substantial civil and criminal penalties.