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 R of Form 5471 is used to report basic information pertaining to distributions from foreign corporations by Sections 245A, 959, and 986(c).
This article will review each column of the new 2020 Schedule R of the Form 5471. The year the Internal Revenue Service (“IRS”) added new categories of filers for the Form 5471. This article will also discuss the new category of filers.
Who Must Complete the Form 5471 Schedule F
Form 5471 and appropriate accompanying schedules must be completed and filed by certain persons. In order to properly complete a Form 5471, the individual preparing the return must understand certain key terms. Below is a list of these 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.
Form 5471 and appropriate accompanying schedules must be completed and filed by certain categories of persons. Below, each category of filer will be discussed.
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.
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.
Category 4 and 5a filers must complete Schedule R.
We will now walk through the columns of Schedule R.
Column (a) is entitled “Description of Distribution.” For Column (a), each CFC shareholder should list each distribution whether the distribution was cash or non-cash and taxable or nontaxable to the shareholders. Each distribution will need to be identified under the applicable code Section. For example, “taxable cash dividend eligible for a dividends received deduction under Section 245A.” If the CFC shareholder received a non-cash distribution from the corporation, the CFC shareholder is required to attach a statement to the Schedule R and show both the tax bases and the fair market value of the distribution.
Column (b) is entitled “Date of Distribution.” For Column (b), each CFC shareholder that is required to complete Schedule R must enter the month, day, and year of the distributions received from the CFC. According to the instructions, the month, day, and year must be entered using the following format: MM-DD-YYYY. For example, June 30, 2020, would be entered as “06-30-2020.”
Column (c) is entitled “Amount of Distribution in Foreign Corporation’s Functional Currency.” For Column (c), Section 985(b)(1)(A) states the general rule for functional currency. Section 985(b)(1)(A) provides that the functional currency will be the “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 the CFC in keeping its books and records.” See IRC 985(b)(1)(B). The amount of distribution is generally the amount of any money paid to the shareholder plus the fair market value of any property transferred to the shareholder. However, this amount is reduced by any liability the shareholder assumes in connection with the distribution and any liability to which the property is subject immediately before and immediately after the distribution. The fair market value of any property distributed to a shareholder becomes his or her basis in the property.
Column (d) is entitled “Amount of E&P Distribution in Foreign Corporation’s Functional Currency.” For Column (d), a corporate distribution to a shareholder is generally treated as a distribution of earnings and profits. The CFC shareholder must report distributions from either current or accumulated earnings and profits. These amounts are taxed as dividends to the shareholder. Distributions that are not from the CFC’s earnings and profits should not be reported under Column (d). If a PTEP or previously taxed earnings and profits are distributed, any foreign currency gain or loss on the distribution should be included under Column (d) computed under Section 986(c) of the Internal Revenue Code. In general, the Section 986 gain or loss represents the change in U.S. dollar value of functional currency E&P between the time it was included in income and the time it is distributed.
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. Anthony Diosdi is a frequent speaker at international tax seminars. 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: firstname.lastname@example.org.
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.