Downward attribution: How a non-US controlled corporation magically becomes US-controlled
by: Anthony Parent
As kids, my siblings and I would play a game called Opposite Day. When you said something, the meaning was intended to be the exact opposite of the words you used. Maybe you enjoyed had a similar game. And generally, it was harmless fun, but the game would grow weary. Likewise, Tax Reform created its own opposite day. Now a foreign-controlled corporation may now considered to be the opposite, as US-controlled foreign corporation, creating a weary game. A very weary game indeed.
Understanding the rationale behind IRS Form 5471
How we got here takes a little bit a research. In 1960, Congress passed the first law that required corporations and individuals to self-report extensively on their US-controlled foreign corporations. The purpose was to reduce the ability of US taxpayers from “playing games.” The law made it so that the IRS can look at mostly everything a US-controlled corporation is doing overseas, to make sure their overall worldwide income was properly assessed and taxed. Self-reporting is completed on an IRS Form 5471.
IRS Form 5471 is quite intense. And unfortunately the same burdens apply if you are a large multinational corporation or if your foreign corporations are not quite as large and closely held.
With complicated instructions, the Form 5471 requires you to know which category of filer you are to determine which schedules you need to file. The IRS requires you to convert the accounting method you use overseas over to GAAP. The US is the only country in the world that uses GAAP and all Form 5471 filed with the IRS must comport to GAAP or else penalties can be imposed.
IRS Form 5471 penalities
IRS Form 5471 penalties can be assessed for not filing or filing a substantially incomplete Form 5471 start at $10,000 per year and can reach $50,000. Additionally, if a Form 5471 is not filed, the statute of limitations on the Form 5471 (along with the accompanying income tax return, i.e., 1040, 1065, 1120-S, 1120, 1120-F) is indefinite.
So who has to file a Form 5471?
Generally if you or your corporation is a "US shareholder" (this has a technical definition) in US-controlled foreign corporation then you probably have a Form 5471 requirement and must attach it to your return.
Opposite Day! But also, tax reform made it so non-US means US!
Tax Reform changed what it means to be a US-controlled foreign corporation. For every other similar subsidiary around the world, s US-based foreign owned subsidiary probably has a Form 5471 requirement.
So how did this happen?
Downward attribution is what the term is used to justify turning a non-US controlled corporation into a US-controlled corporation. If you are confused great, it means you are paying attention. Because downward attribution makes about as much sense as “wet roads causing rain.”
Downward attribution is a way get something to mean exactly what it doesn’t mean.
So why is Congress playing these word games?
First, I don’t think anyone who voted for this knew what they were voting on. This rule came into place because a section of tax code was removed by tax reform, not added.
The justification for this rule is the same argument from my first example. A US subsidiary could be “playing games” with transfer pricing, allocating income and expenses to lower US subsidiaries tax bill. Therefore, the argument goes, a Form 5471 is required so that IRS could track both or all sides of every transaction with every related party to the subsidiary.
Does this onerous compliance regime actually help the US?
Here’s the thing, international tax compliance is so difficult the IRS does not have the staff to actually administer it effectively. Two main reasons. One it takes a long time --- a very long time. Second, it actually take a pretty special people to be able to understand the complexities. Whether you are talking about a tax firm representing you or IRS international team tasked to examine you, on both sides, it takes elite talent to properly work an international Form 5471 case.
The fact is Tax Reform made international tax compliance far more complicated. If you or your company needs help in navigating not just the old minefields, but these fresh new minefields, don’t hesitate to contact us to see how we can help you get your compliance worries behind you.