By Anthony Diosdi
Schedule I-1 for Form 5471 is used to report information determined at the CFC level with respect to amounts used in “global intangible low-taxed income” or GILTI inclusions by U.S. shareholders. The information from Schedule I-1 is used by U.S. shareholder(s) of a CFC to file IRS Form 8892, U.S. Shareholder Calculation of GILTI, and may assist in the completion of Form 1118 and 1116.
Who Must Complete the Form 5471 Schedule R
Anyone preparing a Form 5471 knows that the return consists of many schedules. Schedule R is just one schedule of the Form 5471. Whether or not a CFC shareholder is required to complete Schedule R depends on what category of filer he or she can be classified as. For purposes of Form 5471, CFC shareholders are broken down by the following categories:
Key Terms
U.S. person: A U.S. person is generally a citizen or resident of the United States, a domestic partnership, a domestic corporation, or a domestic trust or estate. A tax-exempt U.S. entity may have a Form 5471 filing obligation.
U.S. Shareholder: A U.S. shareholder is a U.S. person who owns (directly, indirectly, or constructively, within the meaning of of Section 958(a) and Section 958(b)), 10% or more of either the total combined voting power of all classes of voting stock of a foreign corporation or the value of all the outstanding shares of a foreign corporation.
Controlled foreign corporation (“CFC”): A CFC is a foreign corporation with U.S. shareholders that own (directly, indirectly, or constructively, within the meaning of Section 958(a) and 958(b)) on any day of its taxable year, more than 50% of either 1) the total combined voting power of all classes of its voting stock, or 2) the total value of its stock.
Section 965 Specified Foreign Corporation (SFC): A CFC, or any foreign corporation with one or more 10% domestic corporation shareholders. Passive foreign investment companies or (“PFICs”) are not included in this definition.
Category 1 Filer
A Category 1 filer is a U.S. shareholder of a SFC at any time during any taxable year of the SFC who owned that stock on the last day in that year on which it was an SFC. A foreign corporation is an SFC if it is either a CFC or a foreign corporation with at least one corporate U.S. shareholder.
Category 2 Filer
A Category 2 filer is a U.S. citizen or resident who is an officer or director of a foreign corporation in which there has been a change in substantial U.S. ownership – even if the change relates to stock owned by a U.S. person who is not an officer or director. A substantial change in U.S. ownership is when any U.S. person (not necessarily the U.S. citizen or resident who is the officer or director) acquires stock that causes him or her to own a 10% block, or acquires an additional 10% block, of stock in that corporation. More precisely, if any U.S. person acquires stock, which, when added to any stock previously owned, causes him or her to own stock meeting the 10% stock ownership requirement, the U.S. officers and directors of that foreign corporation must report. A disposition of shares in a foreign corporation by a U.S. person does not create filing obligations under Category 2 for U.S. officers and directors. Stock ownership is a vote or value test.
Category 3 Filer
A U.S. person is a Category 3 filer with respect to a foreign corporation for a year if the U.S. person does any of the following during the U.S. person’s year:
1. Acquires stock in the corporation, which, when added to any stock owned on the acquisition date, meets the Category 2 filer 10% stock ownership requirement.
2. Acquires additional stock that meets the 10% stock ownership requirement.
3. Becomes a U.S. person while meeting the 10% stock ownership requirement.
4. Disposes of sufficient stock in the corporation to reduce his or her interest to less than 10% stock ownership requirement.
5. Meets the 10% stock ownership requirement with respect to the corporation at a time when the corporation is reorganized.
Stock ownership is a vote or value test. Constructive ownership includes certain family members, such as brothers or sisters, spouse, ancestors, and lineal descendants.
Category 4 Filer
A U.S. person is a Category 4 filer with respect to a foreign corporation for a taxable year if the U.S. person controls the foreign corporation. A U.S. person is considered to control a foreign corporation if at any time during the person’s taxable year, such person owns: 1) stock possessing more than 50% of the total combined voting power of all classes of stock entitled to vote; or 2) more than 50% of the total value of shares of all stock of the foreign corporation.
For Category 4 purposes, U.S. persons include those individuals who make a Section 6013(g) or (h) election to be treated as resident aliens of the United States for income tax purposes.
The constructive ownership rules of Section 318 are applied, with few modifications, to determine if the U.S. person “controls” the foreign corporation.
Category 5 Filer
A Person is a Category 5 filer if the person: 1) is a U.S. shareholder of a CFC at any time during the CFC’s taxable year; and 2) owns stock of the foreign corporation on the last day in the year in which that corporation is a CFC. For category 5 purposes, constructive ownership is determined under Section 318 as modified by Section 958(b). Pursuant to Section 958(b), there is no attribution from a nonresident alien relative.
New Categories
Categories 1 and 5 have been expanded to 1a, 1b, 1c, 5a, 5b, and 5c in order to separate those filers who are under some relief and may not need to file the same schedules.
1a- Category 1 filer who is not defined in 1b or 1c. This means a greater than 50% owner of the SFC.
1b- Unrelated Section 958(a) U.S. shareholder. This means an unrelated person would not control (more than 50% vote or value) the SFC or be controlled by the same person which controls the SFC.
1c- Related constructive U.S. shareholder- This means an entity controlled by (more than 50% vote or value) the same person which controls the SFC and files only due to this downward attribution.
5a- Category 5 filer who is not defined in 5b or 5c – This means a greater than 50% owner of the CFC.
5b- Unrelated Section 958(a) U.S. shareholder- This means an unrelated person would not control (more than 50% vote or value) the CFC or be controlled by the same person which controls the CFC.
5c- Related constructive U.S. shareholder- This Means an entity controlled by (more than 50% vote or value) the same person which controls the CFC and files only due to this downward attribution.
These new categories will distinguish those 5471 filers who only need to file a Form 5471 due to downward attribution caused by the repeal of Section 958(b)(4) and will therefore not be required to attach certain schedules to their Form 5471s.
CFC shareholders that are classified as Category 3, Category 4, Category 5a, Category 5b, and Category 5c filers must complete and attach Schedule I-1 to their Form 5471.
Separate Category
Schedule I-1 asks the CFC shareholder to enter a category of income. Schedule I-1 is completed once (for general income, passive income, or both). A Schedule I-1 that includes passive category income must enter (“PAS”) in the entry space at the top of Schedule I-1. This is the case even if the Schedule I-1 also includes general income. With respect to CFC shareholders with only general income (and no passive income), the CFC shareholder should only enter the code “GEN” in the entry on the top of the schedule.
Line 1. Gross Income
On Line 1, CFC shareholders must enter the CFC’s gross income in its functional currency. The functional currency is “the currency of the economic environment in which a significant part of such activities” is “conducted and which is used by the [corporation] in keeping its books and records.” See IRC Section 985(b)(1)(B). If the CFC’s cost of goods sold exceeds its gross income, a negative amount is permitted on Line 1.
Line 2(a). Effectively Connected Income Exclusion
On Line 2a, CFC shareholders are asked to enter the amount of the CFC’s income described in Section 952(b), which is generally income from sources within the United States that is effectively connected to the conduct of a trade or business by the CFC in the United States and not reduced or exempted from U.S. tax pursuant to an income tax treaty.
Line 2b. Subpart F Income
For Line 2b, the CFC shareholder must enter the amount, if any, of the CFC’s gross income or loss taken into account in determining subpart F income. Amounts determined to be 956(a) income is not classified as subpart F income for purposes of Line 2b. Subpart F income is defined in Internal Revenue Code Section 952 as the sum of the corporation’s:
1. Insurance income;
2. Foreign base company income. Foreign base company income includes foreign personal holding company income, foreign base company sales income, foreign base company services income, and foreign base company shipping income.
3. International boycott income or income equal to illegal bribe/kickbacks paid on behalf of the CFC.
Line 2c. High-Tax Exception
On Line 2c, CFC shareholders must disclose the amount, if any, of the CFC’s gross income excluded from foreign base company income (as defined in Section 953) by reason of Section 954(b)(4), the high-tax exception. An item of income of a CFC that would otherwise be foreign base company will not be tainted if it was subject to an effective foreign tax rate greater than 90 percent of the maximum U.S. corporate tax rate specified in Section 11 of the Internal Revenue Code. The amount excluded under the high-tax exception is entered on Line 2c.
Line 2d. Related Party Dividends
On Line 2d, CFC shareholders must enter the amount of any dividend income received by the CFC of a related person as defined in Section 954(d)(3). A related party is an individual, corporation, partnership, trust, or estate that controls or is controlled by a CFC is a “related party” with respect to that CFC. See IRC Section 954(d)(3)(A). In addition, a corporation, partnership, trust or estate that is controlled by the same person or persons that control a CFC is a “related party” with respect to the CFC.
Line 2e. Foreign Oil and Gas Extraction Income
One Line 2e, CFC shareholders must enter the amount of the CFC’s taxable income or loss from sources outside the United States from the following:
1) The extraction (by the corporation or any other person) of minerals from oil or gas wells located outside the United States.
2) The sale or exchange of assets used in the trade or business of extracting minerals from oil or gas wells located outside the United States and its possessions.
Line 3. Total Exclusions
On Line 3, the CFC shareholders should enter the sum of Lines 2a through 2e.
Line 4. Gross Income Less Exclusions
One Line 4, the CFC shareholders should subtract line 3 from line 1 and enter the result on Line 4.
Line 5. Deductions Properly Allocable to Amount on Line 4
On Line 5, CFC shareholders should enter the deductions (including taxes) properly allocable to the amount on Line 4 (or to which such deductions would be allocable if there were such gross income).
Line 6. Tested Income (Line 4 minus Line 5)
On Line 6, CFC shareholders should subtract line 5 from line 4 and enter the result on Line 6. The CFC shareholders should report the exchange rate using the “divide-by convention.”
If the amount entered on Line 6 is positive (tested income), the CFC shareholder will enter that amount in U.S. dollars on Form 8892, Schedule A Column (c), for the CFC’s row. If, however, the amount entered on Line 6 is negative (tested loss), the CFC will enter that loss amount in U.S. dollars on Form 8992, Schedule A, Column (d), for the CFC’s row.
In order to understand the numbers that must be entered on Line 6 (i.e., the “tested income” and “tested loss”), the individual preparing Schedule I-1 should understand how GILTI is computed. A U.S. shareholder’s GILTI for a taxable year is the excess, if any, of the U.S. shareholders’ “net CFC tested income” for the taxable year over that shareholder’s “net deemed tangible income return” for the taxable year. Net CFC tested income with respect to any U.S. shareholder is the excess (if any) of the aggregate of the shareholder’s pro rata share of the “tested income” of each CFC with respect to which the shareholder is a U.S. shareholder of the taxable year over the aggregate of the shareholder’s pro rata share of the “tested loss” of each CFC with respect to which the shareholder is a U.S. shareholder for the taxable year of the U.S. shareholder. See IRC Section 951A(c). These amounts are determined for each taxable year of the CFC which ends in or with the taxable year of the U.S. shareholder.
The formula for determining GILTI can be expressed as follows:
GILTI = Net CFC Tested Income – Net Deemed Tangible Income Return = [Tested Income – Tested Loss] – [10% of QBAI – Certain Interest Expense]
The tested income income of a CFC is the excess (if any) of the gross income of the CFC determined without regard to certain items (stated below) over deductions properly allocable to that gross income. The items excluded from gross income are as follows:
1. Any item of income described in Internal Revenue Code Section 952(b). This includes any U.S. source income effectively connected with the conduct by such corporation of a trade or business within the U.S.
2. Any gross income taken into account in determining subpart F income of the CFC.
3. Any gross income excluded from the foreign base company income and the insurance income of the CFC by reason of Internal Revenue Code Section 954(b)(4), the high tax exception.
4. Any dividend received from a related person as defined in Section 954(d)(3).
5. Any foreign oil and gas extraction income of the CFC.
The tested loss of a CFC is the excess (if any) of associated deductions that exceed tested income.
Line 7. Tested Foreign Income Taxes
The CFC shareholders must disclose the CFC’s tested foreign taxes on Line 7. According to the IRS’s instructions, if the CFC has a tested loss on Line 6, the CFC shareholder should enter zero. If the CFC has tested income on Line 6, enter only those foreign income taxes that are properly attributable to the CFC’s tested income.
Line 8. Qualified Foreign Asset Investment (“QBAI”)
If the CFC has a tested loss on Line 6, the CFC shareholder must enter zero. If the CFC has tested income on line 6, the CFC shareholder should enter the QBAI. This amount must be converted from functional currency to U.S. dollars using the average exchange rate for the year of the CFC. QBAI is the average of the CFC’s aggregate adjusted basis, as of the close of each quarter or its taxable year, specified tangible used in its trade or business in the production of tested income, and for which a deduction is allowed under Section 167 of the Internal Revenue Code. Adjusted basis in any property must be determined by using the alternative depreciation system under Section 168(g) and allocating depreciation deductions with respect to such property ratably to each day during the period in the taxable year to which such depreciation relates.
Specified tangible property means any tangible property used in the production of tested income. If such property was used in the production of tested income (for example- dual-use property), the property is treated as specified tangible property in the same proportion that the amount of tested income determined before allocable deductions (line 4) produced with respect to the property bears to the total amount of gross income produced with respect to the property.
A CFC with tested income that a partner of a partnership that has depreciable tangible property determines its share of the partnership’s average adjusted basis in the depreciable tangible property of the partnership based on the amount of the distributive share of the gross income produced by the property that is included in the CFC’s gross tested income relative to the total amount of gross income produced by the property. The partnership’s average adjusted basis in the depreciable tangible property of the partnership is generally determined based on the average of the adjusted basis in the property as the close of each quarter of the partnership’s tax year that ends with or within the CFC’s tax year.
Lines 9a through 9d. Interest Expense
For Lines 9a through 9d, the CFC shareholder must disclose their “interest expense.” A CFC shareholder’s tested interest expense is the amount by which the tested interest expense reduces (as an allowable deduction) the CFC shareholder’s pro rata share of tested income (or increases the U.S. shareholder’s pro rata share of tested loss, or both). A CFC shareholder’s pro rata share of tested interest income is the amount by which the CFC’s tested interest income increases (as an item included in gross tested income) the CFC shareholder’s pro rata share of tested income (or reduces the U.S. shareholder’s pro rata share of tested income (or reduces the U.S. shareholder’s pro rata share of tested loss, or both). See Prop. Regs. Sections 1.951A-1(d)(5) and (6).
Prop. Regs Section 1.951A-4 defines a CFC’s tested interest expense. Tested interest expense means interest expense paid or accrued by a CFC that is taken into account to determine the tested income or tested loss of that CFC, reduced by the CFC’s qualified interest expense. Interest expense means any expense or loss treated as interest expense under the Internal Revenue Code or its regulations, and any other expenses or loss incurred to secure the use of funds when the time value of money is the predominant consideration.
Line 9a.
For Line 9a, the CFC shareholder should enter the amount of interest expense included on Line 5.
Line 9b.
For Line 9b, the CFC shareholder should enter the CFC’s qualified interest expense.
Line 9c.
For Line 9c, the CFC shareholder should enter the CFC’s tested loss QBAI amount as defined in Treasury Regulation Section 1.951A-4(b)(1)(iv).
Line 9b.
For Line 9b, the CFC shareholder should subtract the sum of Line 9b and Line 9c from Line 9a and enter the result on Line 9b.
Line 10a through 10c. Interest Income
For Lines 10a through 10c, the CFC shareholders must disclose tested interest income. Tested interest income means interest income included in the CFC’s gross tested income, reduced by the CFC’s qualified interest income. Interest income means any income or gain treated as interest income under the Income or gain recognized to secure the forbearance of funds when the time value of money is the predominant consideration.
Line 10a.
For Line 10a, the CFC shareholder should enter the amount of interest income included on Line 4.
Line 10b.
For Line 10b, the CFC shareholder should enter the CFC’s qualified interest income as defined in Treasury REgulation Section 1.951A-4(b)(2)(iii).
Line 10c.
For Line 10c, the CFC shareholder should subtract Line 10b from Line 10a and enter the result on LIne 10c.
Conclusion
The IRS Form 5471 is an incredibly complicated return. Each year an international tax attorney should review direct, indirect, and constructive ownership of the reporting CFC to determine the impact of any changes in percentages, filer categories, and CFC status. Workpapers should also be prepared and maintained for each U.S. GAAP adjustment and foreign exchange. In addition, an accounting should be made for adjustments to prior and current year previously taxed E&P that become PTEPs on Schedule J, E-1, and P.
It is extremely important to work with an international tax specialist to ensure accurate preparation of your Form 5471. Having the wrong professional complete your Form 5471 can result in significant penalties. The Internal Revenue Code authorizes the IRS to impose a $10,000 penalty for failure to file substantially complete and accurate Form 5471 returns on time. An additional $10,000 continuation penalty may be assessed for each 30 day period that noncompliance continues up to $60,000 per return, per tax year. In addition, the IRS can assess a 40 percent accuracy penalty on incorrectly reported income and reduction of foreign tax credits by 10 percent.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.