A Close Look at IRS Form 5471 Schedule F Used to Disclose a CFC’s Balance Sheet

Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) is used by certain U.S. persons who are officers, directors, or shareholders in respect of certain foreign entities that are classified as corporations for U.S. tax purposes. Form 5471 and its schedules are used to satisfy the reporting requirements of Internal Revenue Code Sections 6038 and 6046.

Substantively, Form 5471 backstops various international sections of the Internal Revenue Code, including Sections 901 and 904 (foreign tax credits), Section 951(a) (subpart F income), Section 951A (global intangible low-taxed income or “GILTI”), Section 965 (one-time transition tax on a U.S. shareholder’s deferred foreign income), and Section 482 (transfer pricing). Other forms associated with Form 5471 include Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation), Form 5713 (International Boycott Report), Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), and Forms 1116 and 1118 (Foreign Tax Credit).

Form 5471 includes 12 schedules. This article discusses Schedule F of the Form 5471.
Schedule F of Form 5471 requires the shareholders of a foreign entity classified as a controlled foreign corporation 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.

Key Terms for Form 5471

Form 5471 provides for five general categories of filers, numbered 1 through 5. Two of these general categories are subdivided into three subtypes each, with each subtype being a separate filer category as well. The filer category that a taxpayer falls under dictates the schedule or schedules that the taxpayer must include with the form. In order to understand how these filer categories work, it is helpful to review some basic terms.

U.S. Person

Only U.S. persons who own stock in a foreign corporation can have a Form 5471 filing obligation. 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, each as defined in Internal Revenue Code Section 7701(a)(30)(A) through (E). A tax-exempt U.S. entity may have a Form 5471 filing obligation. In addition, an individual who relies on the residency provision of an income tax treaty to reduce his or her U.S. income tax liability (and files Form 8833) remains a U.S. person for purposes of Form 5471. See Treas. Reg. Section 301.7701(b)-7(a)(3). There are some slight modifications to the definition of a U.S. person which will be discussed in more detail below. All of the Form 5471 filer categories apply to U.S. persons.

U.S. Shareholder

Internal Revenue Code Section 951(b) defines a “U.S. shareholder” as a U.S. citizen, resident alien, corporation, partnership, trust, or estate that owns 10 percent or more of the total combined voting power of all classes of voting stock of a foreign corporation, or 10 percent or more of the total value of all the outstanding stock of a foreign corporation. All forms of stock ownership, — i.e., direct, indirect (ownership through intervening entities), and constructive (attribution of ownership from one related party to another) — are considered in applying the 10 percent test.

Controlled Foreign Corporation (“CFC”)

A foreign corporation is a CFC if, on any day during its taxable year, all of its U.S. shareholders, taken together as a group, own more than 50 percent of the combined voting power of all classes of the foreign corporation’s voting stock, or more than 50 percent of the total value of all of the foreign corporation’s outstanding stock. See IRC Section 957(a). Only U.S. persons who constitute U.S. shareholders are considered in applying the 50 percent test. Just as in the case of the 10 percent test for determining whether a U.S. person is a U.S. shareholder, direct, indirect, and constructive ownership of stock are all considered in applying the 50 percent test for CFCs. The term “foreign,” when applied to a corporation, means a corporation that is not domestic — i.e., a corporation that is not incorporated in a U.S. state or the District of Columbia. See IRC Section 7701(a)(5).

Treasury Regulations 301.7701-2(b)(8) provides a list of foreign entities that are conclusively treated as “per se” corporations for U.S. tax purposes. An individual preparing a Form 5471 should be aware that abbreviations in an entity name such as “Ltd.” and “S.A.” do not always stand for “Limited” or “Sociedad Anonima” (or “Societe Anonyme”). The preparer should confirm what the unabbreviated terms are, preferably from a charter or other official document from the relevant jurisdiction. If a foreign entity is not in the list of per se corporations, Treasury Regulations Section 301.7701-3(b)(2) provides that, unless a contrary election is made, the foreign entity will be treated as (1) an association taxable as a corporation if all its members have limited liability, (2) a partnership it it has two or more members (at least one of which does not have limited liability), or (3) a disregarded entity if it has a single owner who does not have limited liability.

Section 965 Specified Foreign Corporation (“SFC”)

An SFC is a foreign corporation that either is a CFC or has at least one U.S. shareholder that is a domestic corporation. See IRC Section 965(e)(1). The term SFC includes not only CFCs, but also entities commonly referred to as “10/50 corporations.” These foreign corporations have at least one U.S. shareholder, but are not CFCs because U.S. shareholders do not collectively own more than 50 percent of the corporation’s stock either by vote or value.

Stock Ownership

For purposes of Form 5471, a U.S. person can own stock in a corporation in three possible ways. First, the person can own the stock “directly.” For example, owning stock in a brokerage account constitutes direct ownership of the stock. Second, the U.S. person can own the stock “indirectly” through an intervening entity, such as a corporation, partnership, estate, or trust, in which the U.S. person owns an interest. In these cases, the stock owned by the intervening entity is typically considered to be owned proportionately by its shareholders, partners, or beneficiaries, as the case may be. For example, if a U.S. person directly owns 40 percent of the stock of a corporation and that corporation, in turn, directly owns 50 percent of the stock of a second corporation, then the U.S. person is considered to own indirectly 20 percent (i.e., 40% × 50%) of the stock of the second corporation. Indirect stock ownership can extend through several layers of intervening entities, where each intervening entity directly owns an interest in the one immediately below it. The third way that a U.S. person can own stock is by “constructively” owning the stock due to a relationship with another person. This relationship most commonly involves family members. For example, if a U.S. citizen mother directly owns 6 percent of a corporation’s stock and her U.S. citizen daughter directly owns 5 percent of the same corporation’s stock, then each of them is considered to own constructively the shares of the other. As a result, the mother and daughter are each considered to own 11 percent of the corporation’s stock. Another less common relationship involves sister entities. This form of constructive ownership (referred to as downward attribution) arises when an individual or entity parent directly or indirectly owns stock in a corporation and, at the same time, owns an interest in another entity. Under downward attribution, the corporation’s stock that the parent owns is attributed downward from the parent to the second entity. As a result, the second entity is considered to own constructively the same stock owned by the parent. Generally, the stock that is owned constructively by one person due to family or downward attribution cannot be further owned constructively by another.

All three kinds of stock ownership apply when determining which Form 5471 filer category or categories a taxpayer falls under, but there are variations among the categories. For example, in Categories 2 and 3, constructive family ownership includes attribution of stock from siblings, grandparents, and nonresident aliens, whereas the other three categories do not allow for these attributions. Categories 1, 4, and 5 define indirect ownership to mean only indirect ownership through foreign intervening entities, and include indirect ownership through intervening U.S. entities as constructive upward attribution. Categories 2 and 3 specifically provide for indirect ownership, but only through entities that are foreign corporations or partnerships, and refer to this type of non-direct ownership as both indirect and constructive ownership. Constructive ownership in the form of downward attribution does not exist in Categories 2 and 3, but exists in Categories 1, 4, and 5. Category 4’s version of downward attribution prohibits attribution of stock from a foreign entity to a U.S. person. Category 1 and 5’s version, however, contains no such prohibition due to the Tax Cuts and Jobs Act of 2017 (the “TCJA”). All these variations, as well as others not described above, will need to be taken into account when preparing a Form 5471.

Filer Categories

Form 5471, together with its applicable schedules, must be completed (to the extent required on the form) and filed by the taxpayer according to the taxpayer’s filer category. What follows is a description of each filer category.

Category 1 Filer

A Category 1 filer is a U.S. shareholder of a foreign corporation that is an SFC at any time during the corporation’s taxable year. However, to be classified as a Category 1 filer, the U.S. shareholder of the SFC must also own the SFC’s stock on the last day of the SFC’s taxable year.

The stock ownership rules applicable to Category 1 (including Categories 1a, 1b, and 1c) are contained in Internal Revenue Code Section 958, which incorporates and modifies the constructive stock ownership rules of Section 318(a). For Category 1 purposes, if a person does not directly own stock, the person can own stock as follows:

• Indirect stock ownership through an intervening entity. The intervening entity (i.e., a corporation, partnership, estate, or trust) can only be a foreign entity. The person, who is to become the indirect owner of stock through the intervening entity, is not required to hold a minimum ownership interest (i.e., stock, partnership interest, or beneficial interest) in the intervening foreign entity.
• Constructive stock ownership from another person.
  • Attribution from family members. A person can only be attributed stock owned by his or her parent, spouse, child, or grandchild. However, no attribution is permitted from a nonresident alien to a U.S. citizen or resident.
  • Upward attribution from entities. The attributing entity can be either a U.S. or foreign entity. However, if the attributing entity is a corporation, the person to whom the stock is to be attributed must own at least 10 percent (by value) of the attributing entity’s stock. Furthermore, if the stock to be attributed upward constitutes more than 50 percent of a corporation’s voting stock, then the stock is deemed to constitute 100% of the corporation’s voting stock when it gets proportionately allocated among the attributing entity’s owners.
  • Downward attribution from persons. The attributing person can be either an individual or entity. However, if the stock is to be attributed downward to a corporation, the attributing person must own at least 50 percent (by value) of that corporation’s stock.

Category 1a, 1b, and 1c Filers

Category 1 is subdivided into Categories 1a, 1b, and 1c. Category 1a is a catchall category and applies to Category 1 filers who do not otherwise fall under either Category 1b or 1c. Categories 1b and 1c were added to Form 5471 as the result of Revenue Procedure 2019-40, which the IRS issued in response to the repeal of provisions in Section 958(b) that previously disapplied the constructive downward attribution rules of Section 318(a)(3) to the extent that they attributed stock owned by a foreign person to a U.S. person.

Categories 1b and 1c specifically apply to those SFCs that are considered to be foreign-controlled for purposes of Form 5471. Such an SFC, referred to herein as a “Foreign-Controlled SFC,” is a foreign corporation that, although classified as an SFC, would not be so classified if the determination were made without applying Section 318(a)(3)’s downward attribution rules so as to consider a U.S. person as owning the stock owned by a foreign person.

A Category 1b filer is a U.S. shareholder who owns, directly or indirectly under Section 958(a) (but not constructively under Section 958(b)), the stock of a Foreign-Controlled SFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC. Section 954(d)(3) defines two persons as being “related” to each other in terms of “control,” where one person controls or is controlled by the other, or is controlled by the same person or persons who control the other. Here, control over a corporation means directly or indirectly owning more than 50 percent of the corporation’s stock by either vote or value. A Category 1b filer is typically a shareholder who owns, directly or indirectly, stock in a foreign corporation but is not related to the foreign corporation because the common parent of both the shareholder and the foreign corporation does not control the foreign corporation.

A Category 1c filer is a U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled SFC but is related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC. A Category 1c filer is typically a shareholder that owns the stock of a foreign corporation only because of constructive stock ownership under Section 318(a)(3) and the shareholder is related to the foreign corporation because each of them is under the control of a common parent.

A U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled SFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC, is neither a Category 1b nor 1c filer. Such U.S. shareholder is deemed not to fall under the Category 1a catchall and is exempt from the obligation to file Form 5471.

Category 2 Filer

A Category 2 filer is a U.S. person who is an officer or director of a foreign corporation in which there has been a substantial change in its U.S. ownership. A U.S. person can be a Category 2 filer even if the change relates to stock owned by another U.S. person and regardless of whether or not that other U.S. person is an officer or director of the foreign corporation. For Category 2 purposes, a U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, estate, or trust. However, Category 2 also expands the definition of a U.S. person to include a bona fide Puerto Rico resident, a bona fide possessions resident, and a nonresident alien as to whom a Section 6013(g) or (h) election is in effect (i.e., where a nonresident alien spouse has made an election to be taxed as a U.S. person). In regard to the definition of an officer or director, there is no clear answer as to what constitutes an officer or director for purposes of a Category 2 filer. Treasury Regulations Section 1.6046-1(d) provides that “persons who would qualify by the nature of their functions and ownership in such associations, etc., as officers, directors, or shareholders thereof will be treated as such for purposes of this section without regard to their designations under local law.”

For purposes of Category 2, a substantial change in U.S. ownership in a foreign corporation occurs when any U.S. person (not necessarily the U.S. citizen or resident who is the officer or director) either (1) acquires stock that causes that U.S. person to own a 10 percent block of stock in that foreign corporation (by vote or value) or (2) acquires an additional 10 percent block of stock in that corporation (by vote or value). More precisely, if any U.S. person acquires stock that, when added to any stock previously owned by that U.S. person, causes the U.S. person to own stock meeting the 10 percent 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, however, does not create filing obligations under Category 2 for U.S. officers and directors of that foreign corporation.

The stock ownership rules applicable to Category 2 are contained in Internal Revenue Code Section 6046(c) and Treasury Regulations Section 1.6046-1(i). For Category 2 purposes, if a person does not directly own stock, the person can own stock as follows:

• Constructive stock ownership from another person.
  • Attribution from family members. A person can only be attributed stock owned by his or her brother, sister, spouse, ancestors, and lineal descendants. Attribution from nonresident aliens is permitted.
  • Upward attribution from entities. The attributing entity can be either a foreign corporation or a foreign partnership. The person, who is to become the constructive/indirect owner of stock through the attributing foreign corporation or partnership, is not required to hold a minimum ownership interest (i.e., stock or partnership interest) in the attributing foreign corporation or partnership. By negative implication, there is no attribution of stock from U.S. entities, or from foreign estates or trusts. Nevertheless, stock owned by U.S. entities that are not treated as entities separate from their owners for U.S. income tax purposes (i.e., grantor trusts and disregarded entities) should be attributable to their owners.

Category 3 Filer

A U.S. person who owns stock in a foreign corporation is a Category 3 filer if any one of the following events occurs during the taxable year:

1. The U.S. person acquires stock in the corporation that, when added to any stock already owned by the person, causes the person to own at least 10 percent (by vote or value) of the corporation’s stock.
2. The U.S. person acquires stock that, without regard to any stock already owned by the person, constitutes at least 10 percent (by vote or value) of the corporation’s stock.
3. The U.S. person becomes a U.S. person while owning at least 10 percent (by vote or value) of the corporation’s stock.
4. The U.S. person disposes of sufficient stock in the corporation to reduce the person’s interest to less than 10 percent (by vote or value) of the corporation’s stock.
5. The U.S. person owns at least 10 percent (by vote or value) of the corporation’s stock when the corporation is reorganized.

For Category 3 purposes, a U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, estate, or trust. However, Category 3 also expands the definition of a U.S. person to include a bona fide Puerto Rico resident, a bona fide possessions resident, and a nonresident alien as to whom a Section 6013(g) or (h) election is in effect (i.e., where a nonresident alien spouse has made an election to be taxed as a U.S. person).

The stock ownership rules applicable to Category 3 are the same as the ones applicable to Category 2, as described above under “Filer Categories–Category 2 Filer.” These rules are contained in Internal Revenue Code Section 6046(c) and Treasury Regulations Section 1.6046-1(i).

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. For Category 4 purposes, a U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, estate, or trust. However, Category 4 also expands the definition of a U.S. person to include a bona fide Puerto Rico resident, a bona fide possessions resident, and a nonresident alien as to whom a Section 6013(g) or (h) election is in effect (i.e., where a nonresident alien spouse has made an election to be taxed as a U.S. person). See Treas. Reg. Section 1.6038-2(d).

A U.S. person is considered to “control” a foreign corporation for purposes of Category 4 if at any time during the person’s taxable year, such person owns more than 50 percent of the combined voting power of all classes of the foreign corporation’s voting stock, or more than 50 percent of the total value of all of the foreign corporation’s outstanding stock. See IRC Section 6038(e)(2). It is important to note that the concept of control here for Category 4 filers is distinct from the one in the definition of CFC, a term used for Category 1 and Category 5 filers. There, control over a foreign corporation exists when more than 50 percent (by vote or value) of the corporation’s stock is owned by one or more U.S. shareholders, each of whom individually owns at least 10 percent of the corporation’s stock. By contrast, a Category 4 filer is a single U.S. person who individually owns more than 50 percent (by vote or value) of the foreign corporation’s stock.

The stock ownership rules applicable to Category 4 are contained in Internal Revenue Code Section 6038(e)(2), which incorporates and modifies the constructive stock ownership rules of Section 318(a). For Category 4 purposes, if a person does not directly own stock, the person can own stock as follows:

• Constructive stock ownership from another person.
  • Attribution from family members. A person can only be attributed stock owned by his or her parent, spouse, child, or grandchild. Attribution from nonresident aliens is permitted.
  • Upward attribution from entities. The attributing entity can be either a U.S. or foreign entity. However, if the attributing entity is a corporation, the person to whom the stock is to be attributed must own at least 10 percent (by value) of the attributing entity’s stock. Furthermore, because Section 6038(e)(2) defines control for purposes of Category 5 as owning more than 50% (by vote or value) of a corporation’s stock, if a person controls a corporation that, in turn, owns more than 50% (by vote or value) of the stock of a second corporation, then such person will be treated as in control of the second corporation as well.
  • Downward attribution from persons. The attributing person can be either an individual or entity. However, if the stock is to be attributed downward to a corporation, the attributing person must own at least 50 percent (by value) of that corporation’s stock. Furthermore, no downward attribution is allowed if it results in a U.S. person constructively owning stock that is owned by a foreign person (as the attributing person).

Category 5 Filer

A Category 5 filer is a U.S. shareholder of a foreign corporation that is a CFC at any time during the corporation’s taxable year. However, to be classified as a Category 5 filer, the U.S. shareholder of the CFC must also own the CFC’s stock on the last day of the CFC’s taxable year.

The stock ownership rules applicable to Category 5 (including Categories 5a, 5b, and 5c) are the same as the ones applicable to Category 1 (including Categories 1a, 1b, and 1c), as described above under “Filer Categories–Category 1 Filer.” These rules are contained in Internal Revenue Code Section 958, which incorporates and modifies the constructive stock ownership rules of Section 318(a).

Category 5a, 5b, and 5c Filers

Category 5 is subdivided into Categories 5a, 5b, and 5c. Category 5a is a catchall category and applies to Category 5 filers who do not otherwise fall under either Category 5b or 5c. Categories 5b and 5c were added to Form 5471 as the result of Revenue Procedure 2019-40, which the IRS issued in response to the repeal of provisions in Section 958(b) that previously disapplied the constructive downward attribution rules of Section 318(a)(3) to the extent that they attributed stock owned by a foreign person to a U.S. person.

Categories 5b and 5c specifically apply to those CFCs that are considered to be foreign-controlled for purposes of Form 5471. Such a CFC, referred to herein as a “Foreign-Controlled CFC,” is a foreign corporation that, although classified as a CFC, would not be so classified if the determination were made without applying Section 318(a)(3)’s downward attribution rules so as to consider a U.S. person as owning the stock owned by a foreign person.

A Category 5b filer is a U.S. shareholder who owns, directly or indirectly under Section 958(a) (but not constructively under Section 958(b)), the stock of a Foreign-Controlled CFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC. Section 954(d)(3) defines two persons as being “related” to each other in terms of “control,” where one person controls or is controlled by the other, or is controlled by the same person or persons who control the other. Here, control over a corporation means directly or indirectly owning more than 50 percent of the corporation’s stock by either vote or value. A Category 5b filer is typically a shareholder who owns, directly or indirectly, stock in a foreign corporation but is not related to the foreign corporation because the common parent of both the shareholder and the foreign corporation does not control the foreign corporation.

A Category 5c filer is a U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled CFC but is related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC. A Category 5c filer is typically a shareholder that owns the stock of a foreign corporation only because of constructive stock ownership under Section 318(a)(3) and the shareholder is related to the foreign corporation because each of them is under the control of a common parent.

A U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled CFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC, is neither a Category 5b nor 5c filer. Such U.S. shareholder is deemed not to fall under the Category 5a catchall and is exempt from the obligation to file Form 5471.

Schedule F

Schedule F is required to be filed by Category 3 and Category 4 filers.

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. A bad debt allowance represents the CFC’s estimate of the amount of accounts that will not be paid. The allowance for bad debt is calculated by multiplying the balance of accounts receivable by a reserve rate.

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 its 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. Reporting inventory using the COGS Reconciliation Process involves comparing the calculated cost of goods sold based on inventory usage records with the actual inventory count, ensuring that the total cost of goods sold accurately reflects the inventory that was used during the CFC’s tax year.

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. Other current assets is a category of things of value that a CFC owns, benefits from, or uses to generate income that can be converted into cash within one business cycle. These assets are typically referred to as “other” because they are uncommon or insignificant.

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) (A detailed discussion regarding Section 958 and 318 can be found under Line 18)  at the beginning and the end of the reporting period. A shareholder loan is an agreement of a shareholder to borrow funds from the foreign corporation for any purpose.

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. Section 951(a) generally requires that every person who is a U.S. shareholder of a CFC and owns (within the meaning of Section 958(a)) stock of such CFC to include in gross income the amount determined under Section 956 for the relevant tax year (but only to the extent not excluded from gross income under Section 959(a)(2)). The amount determined under Section 956 with respect to a U.S. shareholder for any taxable year is generally the lesser of (1) the excess of the shareholder’s pro rata share of the average of the amounts of United States property held (directly or indirectly) by the CFC as of the close of each quarter of the taxable year over the amount of the E&P described in Section 959(c)(1)(A) with respect to the shareholder or 2) the shareholder’s pro rata share of the applicable earnings of the CFC. The amount of the Section 956 inclusion is computed after giving affect to subpart F income inclusions and distributions during the year.

U.S. property includes an obligation of a U.S. person. For these purposes, an obligation generally includes a note, account receivable, note receivable, or other indebtedness. The amount taken into account with respect to an obligation of a U.S. shareholder or other related party is determined by reference to the CFC’s adjusted basis in the obligation.

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. An intangible asset is a non-physical asset that has value for business. Examples of intangible assets include trademarks, copyrights, and patents and goodwill. 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. Under GAAP, development costs of an intangible are expensed and the ordinary business and development costs are not capitalized. Research costs to develop an intangible are also expensed under GAAP.

Line 12a. Goodwill- Line 12a is used to report the goodwill of a CFC. Goodwill is an intangible asset that represents the extra value of a business beyond its physical assets. Goodwill can include a CFC’s reputation, customer base, brand, and other intangibles. Goodwill is a long-term asset that can generate value for the CFC and can be depreciated. CFCs’ can elect to amortize goodwill on a straight-line basis over 10 years for depreciation purposes. The depreciation amounts for goodwill should be listed on Line 12a.

Line 12b. Organization Costs- Line 12b is used to depreciate “Organizational Costs.”
Organizational costs for depreciation purposes 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. The depreciation for “Organizational Costs” should be disclosed on Line 12.

Line 12c. Patents, trademarks, and other intangible assets- Line 12c is used to report amortization of patents, trademarks, and other intangible assets. Patents, trademarks, and other intangible assets held by CFCs need to be amortized over the course of their useful life. However, costs related to creating, applying for, and registering trademarks should be capitalized. These costs include design and legal costs. Amortization for patents, trademarks, and other intangible assets should be disclosed on Line 12c.

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 Shareholders’ 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. Accounts payable is money a CFC owns to its suppliers for goods or serves purchased on credit.

Line 16. Other Current Liabilities- Line 16 to list all current liabilities at the beginning and end of the reporting period. Current liabilities are typically a CFC’s short-term financial obligations, or debt that must be paid within a year.

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 to the CFC as defined under Sections 958 and 318 of the Internal Revenue Code at the beginning and end of the reporting period. In order to determine if there are any loans “related parties,” the Section 958 and Section 318 attribution rules must be explained.

In the CFC context, Section 958(b) provides that the constructive ownership rules of Section 318(a), with modifications, apply for purposes of determining whether: (1) a U.S. person is a U.S. shareholder (within the meaning of Section 951(b)); (2) a foreign corporation is a CFC under Section 957; (3) the stock of a domestic corporation is owned by a U.S. shareholder of a CFC for purposes of Section 956(c)(2); and (4) a corporation or other person is related to the CFC for purposes of Section 954(d)93)

Section 958(b) provides several modifications to the Section 318 constructive ownership rules, including a taxpayer friendly rule that disallows attribution from a foreign individual to a U.S. tax resident. Under Section 958(b)(1), a U.S. citizen or resident cannot be treated as owning stock that is actually, indirectly, or constructively owned by a nonresident individual. This modification is taxpayer friendly as it minimizes situations when a taxpayer satisfies one of the four situations discussed above. Section 958(b)(2) and 958(b)(3) further modify the constructive ownership rules. A partnership, estate, trust, or corporation that owns, directly or indirectly, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of a corporation, shall be considered as owning all the stock entitled to vote. See IRC Section 958(b)(2). Additionally, if 10 percent or more in value of the stock in a corporation is owned, directly, or indirectly, by or for any person, such person shall be considered as owning the stock directly or indirectly of such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all stock of such corporation. See IRC Section 958(b)(3).

Before the enactment of the Tax Cuts and Jobs Act of 2017, Section 958(b) provided an additional taxpayer friendly rule, in Section 958(b)(4), which did not permit downward attribution. Under this rule, Section 958(b)94) provided that “[s]ubpargraphs (A), (B), and (C), of Section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person.” Section 318(a)(3)(A) provides that stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as owned by the partnership or estate. Section 318(a)(3)(B) states that (1) stock owned, directly or indirectly, by or for a beneficiary of certain trusts shall be considered as owned by the trust, unless such beneficiary’s interest in the trust is a remote contingent interest; (2) stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under the grantor trust rules shall be considered as owned by the trust. Section 318(a)(3)(C) states if 50 percent or more in value of the stock in a foreign corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock directly or indirectly, by or for such person.

The above discussed Section 958 and Section 318 should carefully be considered to determine if an individual loaning money to a CFC can be considered “related” to the CFC for U.S. tax purposes.

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. The amount received by the CFC when its shares of capital stock should be disclosed on Line 20.

Line 21. Paid-In or Capital Surplus- Line 21 asks the filer to list paid-in or capital stock. The filer must attach a reconciliation. Paid-in capital is the money a CFC receives when it sells stock, while paid-in surplus is the amount a CFC receives above the par value of the stock. For Schedule F reporting purposes, paid in capital represents money raised by selling equity, rather than through business operations. Capital surplus refers to the surplus resulting after common stock is sold for more than its par value. Capital surplus should not be classified as retained earnings on Schedule F.

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. For Line 22 purposes, 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 in order to properly disclose retained earnings on Schedule F.

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. To reduce the cost of treasury stock of Schedule F purposes, a CFC can only resell the treasury shares at a price higher than the cost at which they were originally purchased; this will result in a credit to the “Paid-in Capital from Treasury Stock” account, effectively reducing the overall cost of the treasury stock on the Schedule F when the shares are sold at a gain.

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. Shareholder equity is the CFC’s net worth and it is equal to the total dollar amount that would be returned to the shareholders if the CFC were to be liquidated and all its debts were paid off. Thus, shareholder equity is equal to a CFC’s total assets minus its total liabilities should be listed on Line 24.

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.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & 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 tax professionals.

Anthony 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 [email protected].

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.