By Anthony Diosdi
Form 5471 is used by certain U.S. persons who are officers, directors, or shareholders of foreign entities that are classified as corporations for U.S. tax purposes. The schedules of Form 5471 are used to satisfy the reporting requirements of the Internal Revenue Code. Schedule F of Form 5471 is required to be filed by filers. Schedule F of Form 5471 requires the shareholders of a foreign entity classified as a controlled foreign corporation (“CFC”) to prepare a balance sheet for the entity. The balance sheet of the foreign corporation should be prepared and translated in accordance with the U.S. GAAP.
This article will take review into each column and line of 2020 Schedule F of the Form 5471.
Who Must Complete the Form 5471 Schedule F
There are five categories of U.S.persons that are required to complete a Form 5471 for each tax year. Whether or not a filer is required to complete Schedule F depends on what category of filer he or she can be classified. For purposes of Form 5471, CFC shareholders are broken down by the following categories:
Category 1- includes a US shareholder of a Section 965 “specified foreign corporation” at any time during any tax year of the foreign corporation, and who owned that stock on the last day in that year. A specified foreign corporation includes: 1) a controlled foreign corporation, or 2) any foreign corporation with respect to which one or more domestic corporations are a US shareholder.
Category 2- US persons who are officers or directors of a foreign corporation in which since the last time Form 5471 was filed, a US person has acquired a ten percent or greater ownership or acquired ten percent or greater ownership.
Category 3- A US person who (a) has acquired a cumulative ten percent or greater ownership in the outstanding stock of the foreign corporation, (b) since the last filing of Form 5471 has acquired an additional ten percent or greater ownership in such stock, (c) owns ten percent or greater of the value of the outstanding stock of the foreign corporation when it is reorganized, or (d) disposes of sufficient stock in the foreign corporation to reduce the value of his ownership of stock in that corporation to less than ten percent, or who becomes a US person while owning ten percent, or who becomes a US person while owning ten percent or greater in value of the outstanding stock of the foreign corporation.
Category 4- a US person who had “control” of a foreign corporation for an uninterrupted period of at least 30 days during the foreign corporation’s annual accounting period. Control means more than 50 percent of the voting power or value of the CFC applying the Section 958 attribution rules.
Category 5- A US person who is a ten percent or greater shareholder in a corporation that was a CFC for an uninterrupted period of thirty days during its annual accounting period and who owned stock in the CFC on its last day of its annual accounting period.
Filers that are classified as Category 3 and Category 4, and Category 5 filers must complete and attach Schedule F to their Form 5471.
Schedule F Balance Sheet
The Schedule F “Balance Sheet” is broken down into column (a) entitled “beginning of annual accounting period” and column (b) entitled “end of annual accounting period.”. The filer must report all information in the foreign corporation’s functional currency in accordance with U.S. GAAP and translate using U.S. GAAP transaction rules. Section 985(b)(1)A) states the general rule that the functional currency will be “the dollar.” However, the functional currency will be “the currency of the economic environment in which a significant part of the CFC’s activities is “conducted and which is used by such CFC in keeping its books and records. See IRC Section 985(b)(1)(B). If the foreign corporation uses DASTM, the balance sheet on Schedule F should be prepared and translated into U.S. dollars according to Treasury Regulation Section 1.985-3(d), rather than U.S. GAAP. A CFC that would otherwise have to use a foreign functional currency may be permitted under the regulations to elect to treat the dollar as its functional currency if it keeps books and records in dollars or uses a method of accounting that “approximates a separate transaction method.” See IRC Section 985(b)(3). This method (sometimes called the “dollar approximate separate transaction method of “DASTAM”), which is explained at Treasury Regulation Section 1.985-3, basically requires conversion into dollar equivalents when discrete transactions in other currencies occur. This election to use the dollar as the functional currency has been authorized for a CFC that would otherwise have used a “hyperinflationary currency.” See Treas. Reg. Section 1.985-2(b).
Schedule F is broken down into two sections. The first section of Schedule F requires filers to disclose the assets of the CFC at the beginning and ending of the reporting period. The second section of Schedule F requires filers to disclose the liabilities and shareholders’ equity in the CFC at the beginning and ending of the reporting period. We will now discuss each line of Schedule F.
Assets of the CFC
Line 1: Cash- Line 1 asks the filer to state the cash held by the CFC. The filer must disclose the CFC’s cash at the beginning and the end of the reporting period. If the CFC’s cash is held in foreign bank accounts, the filer should make sure the CFC’s cash is properly disclosed on FinCEN 114s and Form 8938s to the Internal Revenue Service (“IRS”).
Line 2a: Trade Notes and Account Receivables- Line 2a asks the filer to list any trade notes or account receivables at the beginning and the end of the reporting period. A trade note is typically a payment such as a check or bank note. An account receivable is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers.
Line 2b: Less Allowance for Bad Debt- Line 2b asks the filer to list any bad debt associated with trade notes or account receivables at the beginning and ending of the reporting period.
Line 3: Derivatives- Line 3 asks the filer to list any derivatives at the beginning and the end of the reporting period. A derivative is a financial security with a value that is reliant upon or derived from, an underlying asset or group of assets. The derivative itself is a contract between two or more parties, and the derivative derives its price from fluctuations in the underlying asset. ASC 815 requires a derivative to be recorded on Schedule F as an asset or liability and to be measured at it’s fair value.
Line 4: Inventories- Line 4 asks the filer to disclose inventories at the beginning and ending of the reporting period. Inventory should be disclosed on Schedule F using the cost of goods sold COGS Reconciliation Process.
Line 5: Other Current Assets- Line 5 asks the filer to disclose “other current assets” at the beginning and the end of the reporting period. The filer should attach a detailed statement to Schedule F detailing the current assets of the CFC.
Line 6: Loans to Shareholders and Other Related Persons- Line 6 asks the filer to disclose any loans to the shareholders or other related parties (as per Sections 958 and 318 of the Internal Revenue Code) at the beginning and the end of the reporting period. CFC shareholders should beware that loans from a CFC to U.S. shareholders could trigger a U.S. income tax consequence under Section 956 of the Internal Revenue Code.
Line 7: Investment in Subsidiaries- Line 7 asks the filer to disclose any investments in subsidiaries at the beginning and the end of the reporting period. If the CFC invested in a subsidiary, the investment should be stated in a detailed attached statement. Any investment in a subsidiary may also trigger a reporting requirement on Schedule M of the Form 5471.Schedule M is designed to measure a CFC’s intercompany payments. Schedule M requires the majority CFC owners to provide information on transactions between the CFC and its shareholders or other related parties.
Line 8: Other investments- Line 8 asks the filer to disclose any other investments on Line 8 at the beginning and the end of the reporting period. These other investments should be reported on a detailed attached statement. If the “other investments” are in other CFCs, the preparer should consider the reporting implications of Schedule O for Form 5471. Schedule O is used to report the organization or reorganization of a foreign corporation and the acquisition or disposition of stock.
Line 9a. Building and other depreciable assets- Line 9a asks the filer to disclose any investments in buildings and depreciable assets at the beginning and end of the reporting period. The preparer should disclose any investments in buildings and depreciable assets on line 9a.
Line 9b. Less accumulated depreciation- Line 9b asks the filer to disclose any accumulated depreciation at the beginning and end of the reporting period. The preparer should disclose any accumulated depreciation. Accumulated depreciation is the cumulative depreciation of an asset up to a single point in its life.
Line 10a. Depletable assets- Line 10a asks the filer to disclose any depletable assets of the CFC at the depreciation at the beginning and the end of the reporting period. Examples of depletable assets are timber, coal, oil, precious metals such as gold and silver, and gemstones such as diamonds, rubies, and emeralds.
Line 10b. Less accumulated depletion- Line 10b asks the filer to disclose any accumulated depletion at the beginning and the end of the reporting period. Accumulated depletion is the amount of depletion expense that has built up over time in relation to the use of a natural resource.
Line 11. Land (net of any amortization)- Line 11 asks the filer to disclose any net amortization taken on land held by the CFC. Line 11 asks the preparer to disclose the Net Plant and Equipment (“PP&E”) at the beginning and end of the reporting period. PP&E is the value of all buildings, land, furniture, and other physical capital that a business has purchased to run its business. The term “Net” means that it is “Net” of accumulated depreciation expenses. For example, assume that a CFC buys a building worth $1,000,000, along with $50,000 of furniture. The CFC’s Net PP&E at the moment of purpose is $1,050,000. Each year, however, the CFC must depreciate the value of the PP&E to account for the fact that it will wear out and need to fix or repurchase equipment. For example, assume that in the first year, the CFC depreciates the building and furniture by $105,000. As a result, at the end of its tax year, the CFC’s net PP&E will be:
$1,050,000 – $105,000 = $945,000
If the CFC acquires additional PP&E, the CFC’s net PP&E will increase. As time passes, the value of its PP&E will decrease.
Line 12. Intangible Assets- Lines 12a through 12d asks the filer to disclose all intangible assets of the CFC at the beginning and end of the reporting period. Intangible assets must be separated into specific categories stated on the form. When reporting intangible items of Schedule F, U.S. GAAP accounting principles must be utilized.
Line 12a. Goodwill- CFCs’ can elect to amortize goodwill on a straight-line basis over 10 years.
Line 12b. Organization costs- CFC organizational costs should be expensed as incurred. This includes an analysis or survey of potential markets, products, labor supply, transportation facilities, advertisements for opening of the business, salaries and wages for employees who are being trained and their instructors, travel and other necessary costs for securing prospective distributors, suppliers, or customers, salaries and fees for executives and consultants, or for similar professional services.
Line 12c. Patents, trademarks, and other intangible assets- patents, trademarks, and other intangible assets held by CFCs need to be amortized over the course of their life.
Line 12d. Less accumulated amortization for lines 12a, 12b, and 12c- line 12b requires the filer to disclose any accumulated amortization from lines 12a, 12b, and 12c. Accumulated amortization is the total amortization expense recorded for an intangible asset.
Line 13. Other Assets – Line 13 asks the filer to attach a detailed statement listing the assets of the CFC at the beginning and end of the reporting period. Line 13 may seem identical to Line 5 of Schedule F. Line 13 should only be utilized to disclose long term assets.
Line 14. Total Assets- Line 14 asks the filer to list the CFC’s total assets.
Liabilities and Shareholder Equity
For questions 15 through 24, the filer must disclose the liabilities and shareholders’ equity in the CFC.
Line 15. Accounts payable- Line 15 asks the filer to disclose the accounts payable at the beginning and end of the reporting period.
Line 16. Other current liabilities- Line 16 to list all current liabilities at the beginning and end of the reporting period. The filer should consider the impact of current liabilities on Schedule M of Form 5471.
Line 17. Derivatives- Line 17 asks the filer to list any derivatives which are liabilities at the beginning and end of the reporting period. The reporting must comply with Financial Accounting Series (“FASB”) accounting standards of Topic 815. The gross and not net position must be reported.
Line 18. Loans from shareholders and other related persons- Line 18 asks the filer to state any loans from shareholders and other related parties as defined under Sections 958 and 318 of the Internal Revenue Code at the beginning and end of the reporting period. The filer should consider the reporting of shareholder loans on Schedule M of the Form 5471 and whether an appropriate interest rate is being charged on the loans.
Line 19. Other Liabilities- Line 19 asks the filer to list any other liabilities at the beginning and end of the reporting period.
Line 20. Capital stock- Line 20 asks the filer to list any capital stock of the CFC at the beginning and end of the reporting period. Capital stock is the amount of common and preferred shares that a CFC is authorized to issue.
Line 21. Paid-in or capital surplus- Line 21 asks the filer to list pid-in or capital stock. The filer must attach a reconciliation.
Line. 22 Retained earnings- Line 22 asks the filer to state the retained earnings of the CFC at the beginning and end of the reporting period. Retained earnings refers to profits earned by the CFC, minus any dividends it paid in the past. The filer should obtain audited financial statements if possible.
Line 23. Less cost of treasury stock- Line 22 asks the filer to reduce the cost of the treasury stock at the beginning and end of the reporting period. Treasury stock refers to previously outstanding stock that is bought back from shareholders by the CFC. These shares are issued but no longer outstanding and are not included in the distribution of dividends or the calculation of earnings per share.
Line 24. Total liabilities and shareholders’ equity- Line 24 asks the filer to list the total liabilities and shareholder equity at the beginning and end of the reporting period.
Anthony Diosdi is one of several international tax attorneys at Diosdi Ching & Liu, LLP. As an international tax attorney, Anthony Diosdi provides international tax advice to closely held and publicly traded entities. Anthony Diosdi regularly advises CFCs, CFC shareholders, and other tax professionals regarding Form 5471 compliance requirements. Diosdi Ching & Liu, LLP has offices in San Francisco California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: 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.