A Deep Dive into IRS Form 5471 Schedule I Used to Report a U.S. Shareholder’s Share of Subpart F Income

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 the Schedule I of Form 5471. This schedule is used to report in U.S. dollars a U.S. shareholder’s pro rata share of income from a foreign corporation reportable under subpart F and other income realized from a corporate distribution.

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 I

Category 4, 5a, and 5b filers are required to complete Schedule I. A separate Schedule I must be filed by or for each Category 4, 5a, or 5b U.S. shareholder of the foreign corporation with respect to which reporting is furnished on the Form 5471.

Questions Asked on Schedule I

Line 1a.

Line 1a. asks the CFC shareholder to enter the foreign-source portion of any subpart F inclusions attributable to the sale or exchange by a CFC of a lower-tier foreign corporation.

In answering this question, it is important to understand that whenever a CFC sells the stock of another company (whether or not a CFC), any gain realized is foreign personal holding company income. However, under Internal Revenue Code Section 964(e), a portion of this gain is re-characterized as a dividend under Internal Revenue Code Section 1248 principles to the extent of the CFC’s share of the E&P of the company sold (Internal Revenue Code Section 1248 recharacterizes otherwise capital gain on the sale or disposition of stock in a CFC into ordinary income to the extent of the earnings and profits of the CFC, with such amount being taxed to the U.S. shareholder as a dividend). The 2017 Tax Cuts and Jobs Act added new Internal Revenue Code Section 964(e)(4), which provides that the “foreign source portion” of such deemed dividend is treated as subpart F income of the selling CFC, includable in the gross income in the hands of the U.S. shareholder. If a CFC shareholder received dividend income from the sale of a lower-tier foreign corporation, its pro-rata distribution under Section 964(e)(4) is reported on Line 1a.

Line 1b.

Line 1b. asks the CFC shareholder to enter the amount of the U.S. shareholder’s subpart F income inclusion attributable to tiered hybrid dividends received by the CFC.
A hybrid dividend generally is any dividend from a CFC for which the CFC received a deduction for foreign tax purposes. Under Section 245A(a), a U.S. corporation is permitted a deduction equal to the foreign source portion of any dividend received from a specified 10-percent owned foreign corporation if the U.S. corporation is a U.S. shareholder with respect to such foreign corporation. This is often referred to as participation exemption. However, Section 245(d) disallows foreign tax credits for and deductions of any taxes paid or accrued with respect to any dividend for which participation exemption is allowed. Section 245A(a) participation exemption does not apply to any dividend from a CFC if the dividend is a hybrid dividend. A hybrid dividend is the amount received from a CFC for which (1) a deduction would be allowed under Section 245A(a) but for this subsection, and (2) the CFC received a deduction (or other tax benefit) with respect to any income, war profits, or excess profits taxes imposed by any foreign country or possession of the United States.

Under Treasury Regulation Section 1.245A(e)-1(c)(1), if a CFC with respect to which a U.S. corporation is a 10% U.S. shareholder receives a tiered hybrid dividend from any other CFC with respect to which such U.S. corporation is also a 10% U.S. shareholder, then, notwithstanding any other provisions of the Internal Revenue Code: 1) the tiered hybrid dividend is treated as subpart F income of the receiving CFC for the taxable year of the receiving CFC in which the dividend was received; 2) the 10% U.S. shareholder includes in gross income an amount equal to the shareholder’s pro rata share of the subpart F income and foreign tax credits are disallowed.

Thus, for purposes of Line 1b, the tiered hybrid dividend amount received by a CFC from another CFC to the extent that the amount would be a hybrid dividend if the receiving CFC were a domestic corporation. See Treas. Reg. Section 1.245A(e)-1(c)(2).

Line 1c.

Line 1c asks the CFC shareholder to enter its subpart F income inclusion attributable to tiered extraordinary disposition amounts resulting from distributions from an extraordinary disposition account of the shareholder filing the Form 5471. The term tiered extraordinary disposition amount means, with respect to a dividend received by an upper-tier CFC from a lower-tier CFC and a Section 245A shareholder, the portion of the dividend that would be an extraordinary disposition amount if the Section 245A shareholder received as a dividend its pro rata share.

Lines 1e Through 1h.

For Lines 1e through 1h, the CFC shareholder enters the amounts stated on Worksheet A.

Worksheet A

Below are the questions on Worksheet A which should be answered in order to complete of Schedule I.

Line 1a of Worksheet A asks the CFC shareholder to disclose “dividends, interest, royalties, and annuities” as per Section 954(c)(1)(A). Internal Revenue Code Section 954(c)(1)(A) states that most types of passive foreign income such as “dividends, interest, royalties, and annuities is subpart F foreign personal holding company income. However, not all foreign dividends, interest, royalties, annuities are foreign personal holding company income. Certain passive income received from a related person incorporated in the same country as the CFC is excluded from foreign personal holding company income (an exception sometimes called the “same-country-related person exception”). Specifically, foreign personal holding company income does not include dividends and interest received from a related person (as defined in Section 954(d)(3)) that is organized under the laws of the same foreign country as the CFC and that has a substantial part of its assets used in its trade or business located in that country. See IRC Section 954(c)(3)(A)(i). In addition, rents and royalties received from a related person (whether or not incorporated in the same jurisdiction) are excluded from foreign personal holding company income if these amounts are received for the use of property within the country in which the CFC is incorporated. See IRC Section 954(c)(3)(A)(ii). A CFC shareholder’s pro rata share of dividends, interest, royalties, and annuities received by a CFC should be stated on Line 1a. of Schedule A.

Line 1b of Worksheet A asks the CFC shareholder to disclose the excess of gains over losses from the sale or exchange of: 1) property that produces gross foreign personal holding company income; 2) an interest in a trust, partnership, or real estate mortgage investment conduit; or 3) property that does not produce any income under Internal Revenue Code Section 954(c)(1)(B).  Under this provision, gain from the sale of dividend-producing stock or interest-producing debt instruments will normally be foreign personal holding company income. A CFC shareholder’s pro rata share of gains or losses from certain property transactions under Section 954(c)(1)(B) should be disclosed on Line 1b of Worksheet A.

Line 1c. of Worksheet A asks the CFC shareholder to enter the excess of gains over losses from transactions (including futures, forwards, and similar transactions) in any commodities. Foreign personal holding company income includes the excess of gains over losses from transactions in any commodities. An exception is provided for certain commodities gains or losses arising out of commodity hedging transactions or transactions that occur in the active business of a foreign corporation. See IRC Section 954(c)(5)(A) and IRC Section 1221. A CFC shareholder’s pro rata share of gains over losses from commodity transactions defined in Section 954(c)(1)(C) should be disclosed on Line 1c. of Worksheet A.

Line 1d. of Worksheet A asks the CFC shareholder to enter the excess of foreign currency gains over foreign currency losses from Section 988 transactions. An exception applies to transactions directly related to the business needs of a CFC. Another component of foreign personal holding company income for subpart F purposes is the excess of foreign currency gains over foreign currency losses (as defined in Section 988(b)) attributable to any Section 988 transaction. See IRC Section 954(c)(1)(D). This provision incorporates concepts contained in Section 988 dealing with foreign currency gains. “Foreign currency gain” is defined for purposes of Section 988 as “gain from a Section 988 transaction to the extent such gain does not exceed gain realized by reason of changes in exchange rates on or after the booking date and before the repayment date. “Foreign currency loss” is defined in Section 988(b)(2). If a CFC has a loss on the overall Section 988 transaction, there is no foreign currency gain. A CFC shareholder’s pro rata share of gains over foreign currency losses defined in Section 954(c)(1)(D) should be disclosed on Line 1d. of Worksheet A.

Line 1e. of Worksheet A asks the CFC shareholder to enter any income equivalent to interest, including income from commitment fees (or similar amounts) for loans actually made. Under Internal Revenue Code Section 864(d)(1), any income arising from a trade or service receivable acquired directly or indirectly by a foreign corporation from a related person is treated as if there were interest on a loan to the obligor-buyer under the receivable. A CFC shareholder’s pro rata share of income equivalent to interest defined in Section 954(c)(1)(E) should be disclosed on Line 1e. of Worksheet A.

Line 1f. of Worksheet A asks the CFC shareholder to include net income from notional principal contracts (except a contract entered into to hedge inventory property). Treasury Regulation Sections 1.446-3(c)(1)(i) and 1.863-7(a)(1) define a “notional principal contract” as a financial instrument providing “for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal contract in exchange for specified consideration or a promise to pay similar amounts.” Interest rate swaps, current swaps, interest rate caps, interest rate floors and other similar agreements are notional principal contracts under this definition. See Treas. Reg. Section 1.446-3(c)(1)(i). For example, suppose that DC, a U.S. corporation, enters into an interest rate swap contract with FC, an unrelated foreign corporation. Under the contract, DC must pay FC fixed rate dollar amounts, and FC must pay DC floating rate dollar amounts, each of which is determined solely by reference to a notional dollar denominated principal amount that is specified in the contract. See Treas. Reg. Section 1.863-7(d), Ex. A CFC shareholder’s pro rata share of notional principal contract income defined in Section 954(c)(1)(F) should be disclosed on Line 1f. of Worksheet A.

Line 1g. of Worksheet A asks the CFC shareholder to include payments in lieu of dividends. The definition of foreign personal holding company income to include payments in lieu of dividends that are made under an agreement to which Internal Revenue Code Section 1058 applies. See IRC Section 954(c)(1)(G). Section 1058 applies to an agreement relating to a transfer of securities if 1) the agreement provides for the return to the transferor of securities identical to the securities transferred; 2) the agreement requires that payment be made to the transferor of securities equivalent to all interest, dividends and other distributions that the owner of the securities is entitled to receive during the period starting with the transfer of the securities by the transferor and ending with the transfer of identical securities back to the transferor; 3) the agreement does not reduce the risk of loss or opportunity for gain of the transferor of the securities in the transferred securities; and 4) meets any other requirements provided  by the Treasury in the regulations. Congress believed such payments to be economically equivalent to dividends. A CFC shareholder’s pro rata share of payments in lieu of dividends defined in Section 954(c)(1)(G) should be disclosed on Line 1g. of Worksheet A.

Line 1h. of Worksheet A asks the CFC shareholder to enter amounts received: a) under a contract under which the corporation is to furnish personal services if 1) some person other than the corporation has a right to designate (by name or by description) the individual who is to perform the services, or 2) the individual who is to perform the services is designated (by name or by description) in the contract; and 3) from the sale of other disposition of such a contract. Line 1h applies with respect to amounts the CFC received for services under a particular contract only if at some time during the tax year 25 percent or more in value of the outstanding stock of the corporation is owned, directly or indirectly, by or for the individual who has performed, is to perform, or may be designated (by name or by description) as the one to perform such services. A CFC shareholder’s pro rata share of personal services defined in Section 954(c)(1)(H) should be disclosed on Line 1h. of Worksheet A.

Line 1i. of Worksheet A asks the CFC shareholder to disclose “certain amounts from sales of partnership interests to which the look-through rule of Section 954(c)(4) applies.” Under the “look-through rule,” in the case of any sale by a CFC of an interest in a partnership with respect to which the CFC is a 25 percent owner, such CFC is treated for purposes of computing its foreign personal holding company income as selling the proportionate share of the assets of the partnership attributable to such interest by a CFC that meets the ownership threshold constitutes subpart F income only to the extent that a proportionate sale of the underlying partnership assets attributable to the partnership interest would constitute subpart F income. A CFC shareholder’s pro rata share of the payments of partnership interests in Section 954(c)(4) should be disclosed on Line 1i. of Worksheet A.

Line 2. of Worksheet A asks the CFC shareholder to disclose all personal holding company income. This is done by adding up lines 1a through 1i.

Line 1d.

Line 1d of Schedule I asks the CFC shareholder to disclose “Subpart F Foreign Base Company Sales Income.” Under Internal Revenue Code Section 954(d) Foreign Base Company Sales Income is that arising from the purchase of personal property where:

1) The property is both produced outside the CFC’s country of incorporation and sold for use, consumption or disposition outside such country; and

2) The property is either bought from a related person or sold to any person, bought from any person and sold to a related person, or bought or sold on behalf of a related person. See IRC Section 954(d)(1). Such income is included, whether in the form of profits, commissions, fees or other similar income. Agricultural commodities not grown in the United States in commercially marketable quantities are excluded. A related person is an individual, corporation, partnership, trust, or estate which controls, is is controlled by, the controlled foreign corporation, or controlled by the same person or persons which control the controlled foreign corporation; control means the ownership, directly or indirectly, of stock possessing more than 50 percent of the total voting power of all classes of stock entitled to vote or of the total value of stock of such corporation, or more than 50 percent (by value) of beneficial interests in a partnership trust or estate See IRC Section 954(d)(3).

To prevent manipulation of the same country exception, a branch of a CFC may be treated as a separate corporation (and thus a related party) for determination of Foreign Base Company Sales Income where the carrying on of activities by the CFC through a branch or similar establishment outside of the country of incorporation has substantially the same effect as if such branch or similar establishment were a wholly-owned subsidiary corporation deriving such income. See IRC Section 954(d)(2). A branch is considered to have substantially the same effect as a subsidiary if income derived by the branch is taxed at an effective rate that is less than 90 percent of, and at least five percentage points lower than, the rate applying in the CFC’s country of incorporation. See Treas. Reg Section 1.954-3(b)(1)(i) and (ii).
In order to complete the question raised in Line 1d, it is necessary to complete a number of relevant questions raised in Worksheet A. Below we will review the questions raised in Worksheet A which should be answered in order to complete Line 1d. of Schedule I.

Line 3. of Worksheet A asks the CFC shareholder to disclose gross foreign base company sales income. When answering this question, it is important to understand the primary target of the foreign base company sales income components of subpart F. These provisions are designed to reach U.S. shareholders of a CFC who divert sales income to a foreign base company located in a low-tax or no-tax foreign country that is neither the origin or destination of the products sold. Accordingly, income earned in a low-tax or no-tax foreign country that is neither the origin or destination of the products sold is reported on Line 3 of Worksheet A.

Line 5. of Worksheet A asks the CFC shareholder to disclose foreign base company income by adding up lines 2 through 4.

Line 6. of Worksheet A asks the CFC shareholder to disclose all gross insurance income. The term “insurance income” means any income which: 1) is attributable to the issuing (or reinsuring) of an insurance or annuity contract, and 2) would be taxed under subpart L of the Internal Revenue Code if such income were the income of a domestic insurance company. See IRC Section 953(a).

Line 7. of Worksheet A asks the CFC shareholder to disclose all gross foreign base company income and gross insurance income by adding up lines 5 and 6.

Line 8. of Worksheet A asks the CFC shareholder to enter 5 percent of total gross income (as computed for income tax purposes).

Line 9. of Worksheet A asks the CFC shareholder to enter 70 percent of the total gross income (as computed for income tax purposes).

Line 10. of Worksheet A asks “if line 7 is less than line 8 and less than $1 million, enter -0- on this line and skip lines 11 through 19. If the sum of foreign base company income (determined without regard to Section 954(b)(5)) and gross insurance income (as defined in Section 954(b)(3)(C)) for the tax year is less than the smaller of 5 percent of gross income for income tax purposes, or $1 million, then no portion of the gross income for the tax year is treated as foreign base company income or insurance income. In this case, enter zero on line 10 and skip lines 11 through 19. Otherwise, go to line 11.

Line 11. of Worksheet A states “if line 7 is more than line 9, enter total gross income (as computed for income tax purposes).” Line 11 is known for disclosing the “Full inclusion rule.” This is because if the sum of foreign base company income (determined without regard to Section 954(b)(5)) and gross insurance income for the tax year exceeds 70 percent of gross income for income tax purposes, the entire gross income for the tax year must (subject to the high tax exception described below, the Section 952(b) exclusion, and the deductions to be taken into account under Section 954(b)(5)) to be treated as foreign base company income or insurance income, whichever is appropriate. In this case, the CFC shareholder must enter total gross income (for income tax purposes) on line 1. Otherwise, the CFC shareholder will enter zero.

Line 12. of Worksheet A asks the CFC shareholder to “total adjusted gross foreign base company income and insurance income” (the CFC shareholder must enter the greater of line 7 or line 11).

Lines 13g, 14d, 15d, 16d, 18d, and 19d of Worksheet A relate to reporting for purposes of claiming the high-taxed income exception. Lines 13g, 14d, 15d, 18d, 19d ask the CFC shareholder to disclose the total annual amount of subpart F income for purposes of the high-taxed income exception. Under the high-taxed income exception, an item of subpart F income normally subject to an immediate subpart F taxable inclusion. This is the case if the subpart F income was subject to an effective foreign tax rate greater than 90 percent of the maximum U.S. federal corporate tax rate. Under current federal tax law, if an item of subpart F income of a CFC is subject to a foreign tax of more than 18.90  (i.e., 90 percent of 21 percent), it will not be foreign base company income. See IRC Section 954(b)(4). This exception applies after reducing the income by deductions (including taxes).

Line 20. of Worksheet A asks the CFC shareholder to disclose any “International boycott income.”  For purposes of answering this question, if a CFC or a member of a controlled group (within the meaning of Section 993(a)(3))) that includes the CFC has operations in, or related to, a country (or with the government, a country (or with the government, a company, or a national of a country) that requires participation in or cooperation with an international boycott as a condition of doing business within such country or with the government, company, or national of that country, a portion of the CFC’s income is included in subpart F income. The amount included is determined by multiplying the CFC’s income (other than income included under Section 951 and U.S. source effectively connected business income described in Section 952(b)) by the international boycott factor.

Line 21. of Worksheet A asks the CFC shareholder to enter the total of any illegal bribes, kickbacks, or other payments (within the meaning of Section 162(c)) paid by or on behalf of the corporation, directly or indirectly, to an official, employee, or agent of a government.

Line 22. of Worksheet A asks that the CFC shareholder enter the income described in Internal Revenue Code Section 952(a)(5). The income of a CFC derived from any foreign country during any period during which Section 901(i) applies to such foreign country will be deemed to be income to the U.S. shareholders of such CFC. This is applied to Iran, North Korea, Sudan, and Syria.

Lines 24, 27, 30, and 33 of Worksheet A entitled “Exclusion of U.S. Income” asks the CFC shareholder to exclude Subpart F income that does not include any U.S. source income (which, for these purposes, includes all carrying charges and all interest, dividends, royalties, and other investment income received or accrued by a FSC) that is effectively connected with a CFC’s conduct of a trade or business in the United States unless that term is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation.

Line 34. of Worksheet A asks the CFC shareholder to state the exclusions under Section 959(b) that apply to line 16e, 18e, 19e, 20, 21, and 22. For more discussion on Section 959(b), please see our blog entitled Demystifying the Form 5471 Part 4. Schedule J for a discussion regarding the exclusions of Section 959(b).

Line 35. This question asks the CFC shareholder to subtract the sum of lines 33 and 34 from the sum of lines 16e, 18e, 19e, 20, 21, and 22.

Line 36. Enter the total subpart F income. Add lines 26, 29, 32, and 35.

Line 37. A CFC’s subpart F income is limited to the sum of the following:

Line 37a. Its current E&P, computed under the special rule of Section 952(c)(1). Enter this amount on line 37a.

Line 37b. Any tested loss under Section 951A(c)(2)(B)(ii). If the total of all lines 6 of all separate Schedule 1-f for the CFC is a negative number, enter the amount as a positive number on line 37b. If the total of all lines 6 is a positive number or zero, enter -0- on line 37b. The amount included in the gross income of a U.S. shareholder of a CFC under Section 951(a)(1)(A)(i) for any tax year attributable to a qualified activity must be reduced by the shareholder’s pro rata share of any qualified deficit.

Lines 39 through 43. If line 37c is less than the amount on line 36, allocate the subpart F income remaining to the four categories of subpart F income listed on lines 40 through 43 using the rules of regulations in Sections 1.952-1(e).

1e.

Line 1e asks the CFC shareholder to disclose “Subpart F Foreign Base Company Services Income.” This includes income arising out of the performance by a CFC of technical, managerial or similar services performed for or on behalf of a related person in a country other than the CFC’s country of incorporation. Treasury Regulation Section 1.954-4(b) provides that a CFC will be deemed to perform services for or on behalf of a related person where:

1) The CFC is paid by or otherwise receives substantial benefit from a related person for performing the services;

2) The CFC performs services which a related person is, or has been, obligated to perform; or

3) The CFC performs services with respect to which the property sold by a related person in the performance of such services constitute a condition or material term of such sale: and

4) Where related persons furnish substantial assistance contributing to the performance of the services by a CFC.

Subpart F base company income includes foreign base company shipping income.
This includes income derived from the use (or leasing) of an aircraft or vessel in foreign commerce, from the performance of services directly related to such use of an aircraft or vessel or from the sale or exchange of the aircraft or vessel. Shipping income derived from transportation between two points within the CFC’s country of incorporation and of registration of the aircraft or vessel, is excluded from foreign base company shipping income.

In order to answer the question raised on Line 1e., it is necessary to complete the relevant questions stated on Worksheet A. Below, we will review these questions.

Line 1e. of Schedule A asks the CFC shareholder to determine foreign base company services income.

Line 4. of Worksheet A asks the CFC shareholder to disclose all foreign base company services income. The primary target of foreign base company services income components of subpart F income is business income from transactions in which the CFC is being used by its U.S. shareholders largely as a conduit for diverting income from the U.S. to low-tax or no-tax foreign countries in which a CFC is organized. Foreign base company services income is disclosed on Line 4 of Worksheet A.

Line 15a. of Worksheet A asks the CFC shareholder to enter the amount from line 4.

Line 1f.

Line 1f asks the CFC shareholder to enter the results of Worksheet A for expenses allocated for foreign base company sales income. Foreign base company sales income is defined as income derived from the purchase and sale of personal property (1) if the property is either purchased from (or on behalf of) a related person or sold to (or on behalf of) a related person and 2) if the property purchased is manufactured, produced, grown or extracted outside of the country where the CFC is organized and the property also is sold for use, consumption or disposition outside that country. See IRC Section 954(d)(1)(A) and (B).

Line 15b. of Worksheet A asks the CFC shareholder to allocate expenses from the foreign base company sales income allocated to the shareholder. Line 15d of Worksheet A asks the CFC shareholder to exclude base company services income as the result of the high-tax exception.

Line 1g.

Line 1g. asks the CFC shareholder to disclose any other Subpart F Foreign Base Company Services Income. Foreign base company income is “foreign base company service income” which is defined as income derived from the performance of technical, managerial, engineering, architectural, scientific skilled, industrial, commercial or similar services, if such services are performed outside the country in which the CFC is organized. See IRC Section 954(e)(1).

Line 1h.

The CFC shareholder enters other Subpart F income on Line 1h.

Line 2.

Line 2 asks the CFC shareholder to disclose Section 956 or “Earnings Invested in U.S. Property.” Generally, a U.S. shareholder must include in his or her income pro rata share of the CFC’s increase in its E&P invested in U.S. property for the taxable year. For purposes of Internal Revenue Code Section 956, U.S. property includes most tangible and intangible property owned by a CFC that has a U.S. situs and that was acquired after December 31, 1962, such as tangible property located in the United States; stock of a domestic corporation; an obligation of a U.S. person; and a right to use a patent, copyright, or other forms of intellectual property in the United States if acquired or developed by the CFC for that use. A CFC is also treated as owning a proportionate interest in U.S. property owned by a partnership in which the CFC is a partner. If a CFC receives earnings invested in U.S. property, its pro-rata distribution under Section 956 is reported on Line 2.

In order to properly complete Line 2, Worksheet B must be completed to determine  a U.S. shareholder’s pro rata share of earnings of a CFC invested in U.S. property that is subject to tax. Only earnings of a CFC not distributed or otherwise previously taxed are subject to these rules. Thus, the amount of previously untaxed earnings limits the Section 956 inclusion. A CFC’s investment in U.S. property in excess of this limit will not be included in the taxable income of the CFC’s U.S. shareholders. The balances in the previously taxed accounts of prior Section 956 taxed accounts of prior Section 956 inclusions and current or prior subpart F inclusions reduce what would otherwise be the current Section 956 inclusion.

U.S. property is measured on a quarterly average basis. For purposes of Worksheet B, the amount taken into account with respect to U.S. property is its adjusted basis for E&P purposes, reduced by any liability to which the property is subject.

Line 1. of Worksheet B asks the CFC shareholder to state the amount of U.S. property held (directly or indirectly) by the CFC as of the close of:

1a. The first quarter of the tax year.

1b. The second quarter of the tax year.

1c. The third quarter of the tax year.

1d. The fourth quarter of the tax year.

Line 2. of Worksheet B asks the CFC shareholder to state the number of quarter-ends the foreign corporation was a CFC during the tax year.

Line 3. of Worksheet B asks the CFC shareholder the average amount of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of the tax year (add lines 1a through 1d. Divide this amount by the number on line 2.)

Line 4. of Worksheet B asks the CFC shareholder to state the U.S. shareholder’s pro rata share of the amount on line 3.

Line 5. of Worksheet B asks the CFC shareholder state the earnings and profits described in Section 959(c)(1)(A) with respect to the U.S. shareholder after reductions (if any) for current year distributions that affect the U.S. shareholder’s Section 959(c)(1) E&P account.

Line 6. of Worksheet B asks the CFC shareholder to subtract line 5 from line 4.

Line 7. of Worksheet B asks the CFC shareholder to state the foreign corporation’s applicable earnings.

Line 7a. of Worksheet B asks the CFC shareholder to state the foreign corporation’s current year earnings and profits.

Line 7b. of Worksheet B asks the CFC shareholder to state the foreign corporation’s current year earnings and profits plus the foreign corporation’s accumulated earnings and profits.

Line 8. of Worksheet B asks the CFC shareholder to enter the greater of line 7a or line b.

Line 9. of Worksheet B asks the CFC shareholder to state the distributions made by the CFC during the tax year.

Line 10. of Worksheet B asks the CFC to subtract line 9 from line 8.

Line 11. of Worksheet B asks the CFC shareholder to state the foreign corporation’s earnings and profits described in Section 959(c)(1).

Line 12. of Worksheet B asks the CFC shareholder to subtract line 11 from line 10.

Line 13. of Worksheet B asks the CFC shareholder to state its Section 959(a)(2) amount.

Line 14. of Worksheet B asks the CFC shareholder to enter the smaller of line 6 or line 13.

Line 15. of Worksheet B asks the CFC shareholder to state the amount of E&P described in Section 959(a)(2) with respect to the U.S. shareholder.

Line 16. of Worksheet B asks the CFC shareholder to subtract line 15 from line 14.

Line 17. of Worksheet B asks the CFC shareholder to translate the amount on line 16 from functional currency to U.S. dollars at the end of the year spot rate (as provided in Section 989(b)).

Line 3.

Filers are currently not required to complete Line 3.

Line 4.

Line 4 asks the CFC shareholder to disclose “factoring income.” The instructions state enter factoring income (as defined in Section 864(d)(1)) if no subpart F income is reported on Line 1a. When a seller of goods or services takes back from the buyer a receivable (a promise to pay in the future) in exchange therefor and then sells the receivable to a third party (a “factor”) at a discount, the seller’s income on the sale of the goods or services is reduced by the amount of that discount. Upon collection or sale of the receivable, the factor realizes income equal to the difference between the amount for the receivable and the amount received by the factor on collection or sale of the receivable. Under Internal Revenue Code Section 864(d)(1), any income (whether as discount, stated interest or in some other form) arising from a trade or service receivable acquired directly or indirectly by a foreign corporation from a related person is treated as if it were interest on a loan to the obligor-buyer under the receivable. Any factoring income must be disclosed on Line 4.

Line 5a.

Line 5a asks the CFC shareholder to enter the amount of dividends received by the shareholder from the foreign corporation that is eligible for a deduction under Section 245A. Under Internal Revenue Code Section 245A(a), a U.S. corporation is permitted a deduction equal to the foreign source portion of any dividend received from a specified 10-percent owned foreign corporation if the U.S. corporation is a U.S. shareholder with respect to such foreign corporation. This is often referred to as a participation exemption. This amount does not include the amounts of dividends that are not eligible for a deduction under Section 245A and are instead entered on Lines 5b, 5c, and 5d.

Line 5b.

Line 5b asks the CFC shareholder to enter the amounts of the dividends received by the shareholder of the foreign corporation that is an extraordinary disposition amount. Below, please find an explanation as to how an extraordinary disposition amount is calculated. Internal Revenue Code Section 245A allows a 100 percent dividends received deduction for the foreign source portion of certain dividends received by a domestic corporation from an SFC. The Temporary Regulations limit the amount of Section 245A deduction with respect to a distribution received from an SFC to 50 percent of the “extraordinary disposition amount.”  The extraordinary disposition amount generally reflects dispositions attributable to earnings and profits generated from certain related-party dispositions made during the SFC’s disqualified period, but is tracked shareholder-by-shareholder rather than by actual earnings. In general, under the Temporary Regulations, the extraordinary disposition amount is defined as the portion of a dividend received by a Section 245A shareholder from an SFC that is paid out of the Section 245A shareholder’s “extraordinary disposition account.” A shareholder’s extraordinary disposition account represents the shareholder’s pro rata portion (determined by the value of the shareholder’s shares in the CFC) of the SFS’s “extraordinary disposition of the earnings and profits” which is reduced from this account.

Line 5c.

Line 5c asks the CFC shareholder to enter the amount of the dividend by the shareholder from the foreign corporation that is an extraordinary reduction amount.

Line 5d.

Line 5d asks the CFC shareholder to enter the amount of hybrid dividends received by the U.S. shareholder from the foreign corporation. A hybrid dividend equals the amount received from a CFC for which (1) a deduction would be allowed under Section 245A(a) but from this subsection, and (2) the CFC profits, or excess profits taxes imposed by any foreign country or possession of the United States. If a CFC with respect to which a U.S. corporation is a 10% U.S. shareholder receives a tiered hybrid dividend from any other CFC with respect to which such U.S. corporation is also a 10% U.S. shareholder, then, notwithstanding any other provisions of the Internal Revenue Code: 1) the tiered hybrid dividend is treated as subpart F income of the receiving CFC for the taxable year of the receiving CFC in which the dividend was received; 2) the 10% U.S. shareholder includes in gross income an amount equal to the shareholder’s pro rata share of the subpart F income; and 3) foreign tax credits are disallowed. Consequently, a tiered hybrid dividend is the amount received by a CFC from another CFC to the extent that the amount would be a hybrid dividend if the receiving CFC were a domestic corporation. See Treas. Reg. Section 1.245A(e)-1(c)(2).

Line 5e.

For Line 5e, the CFC shareholder enters the dividends not reported on Lines 5a, 5b, 5c, and 5d.

Line 6.

Line 6 states if previously taxed E&P (PTEP) was previously distributed, the CFC shareholder should enter the amount of foreign currency gain or loss recognized on the distribution, computed under Section 986(c). Section 986 prescribes the methods applicable to translating earnings and taxes of foreign affiliates of U.S. corporations that have a foreign functional currency.

Lines 7a and 7b.

Lines 7a and 7b of Schedule I asks if any income of the foreign corporation was blocked and if such income became unblocked during the year as per Internal Revenue Code Section 964(b). Sections 951 through 972 of the Internal Revenue Code taxes certain income of CFCs to U.S. shareholders. An exception in Section 964(b) of the Internal Revenue Code provides that no part of such income would be taxed if it is established that such income “could not have been distributed by the CFC to U.S. shareholders because of currency or other restrictions or limitations imposed under the laws of any foreign country. The purpose of Subpart F was to eliminate certain tax haven abuses by taxing the income of the CFC directly to its controlling shareholders when earned. The advantage accruing to the shareholder of retaining practical economic control over the earnings without subjecting them to United States tax until they are actually distributed (tax deferred) are thereby eliminated. This is justified on the premise that the shareholders, by controlling the corporation, have the full power of disposition over its earnings. Because blocked foreign income, by definition, may not be distributed to shareholders in the United States, the controlling shareholders do not have the power to pay themselves dividends and an exception to the tax was made. If the CFC had “blocked” or “unbocked” income, the CFC must answer either “Yes” or “No” for the questions stated on Lines 7a and 7b.

Lines 8a.

For Line 8a, the CFC shareholder must check the “yes” box had an extraordinary disposition account with respect to the foreign corporation having a balance greater than zero at any time during the tax year of the foreign corporation. The term “extraordinary disposition amount” means the portion of a dividend received by a Section 245A shareholder from an SFC that is paid out of the extraordinary disposition account with respect to the Section 245A shareholder.

In order to understand if a CFC shareholder had an extraordinary disposition account with a balance greater than zero, we will provide an overview of the extraordinary disposition rules. In certain cases, the extraordinary disposition rule and the disqualified basis rule, when applied together may give rise to excess taxation as to a Section 245A shareholder (Section 245A allows an exemption for certain foreign income of a domestic corporation that is a U.S. shareholder). For example, consider a case in which a CFC that is wholly owned by a Section 245A sells an item of specified property during the disqualified period to another CFC that is wholly owned by the Section 245A shareholder. In this case, there is a single amount of gain (the gain that the transferor CFC recognizes upon the sale), which gives rise to both extraordinary disposition of E&P of the transferor CFC (the E&P generated upon the sale) and disqualified basis in the item of specified property held by the transferred CFC (the basis step-up in the item of specified property resulting from the sale). The gain will in effect be subject to U.S. tax as to the Section 245A shareholder when the extraordinary disposition E&P are distributed as a dividend by the transferor CFC. In addition, an amount (such as an amount of future gross tested income of the transferred CFC) equal to the gain might be indirectly taxed as to the Section 245A shareholder as a result of not being offset or reduced by deductions or losses would have offset or reduced the amount sheltered it from U.S. tax). Moreover, the disqualified basis rule may in certain cases have the effect of reducing, in an amount equal to the gain, E&P of the transferred CFC that would otherwise have been eligible for the Section 245A deduction when distributed as a dividend to the Section 245A shareholder. This could occur because deductions or losses that are subject to the disqualified basis rule reduce E&P.

Section 245A provides for so-called extraordinary disposition accounts. An extraordinary disposition account takes into account adjustments of the earnings of the CFC that could give rise to an extraordinary disposition. In certain cases, an item of property may have a disqualified basis that may impact an extraordinary disposition account.

Line 8b.

If “yes” is checked on Line 8a, the shareholder should enter on Line 8b the U.S. shareholder’s extraordinary disposition account balance at the beginning and end of the foreign corporation’s tax year. The CFC shareholder should also attach a statement detailing any differences between the starting and ending balance of the extraordinary disposition account reported on Line 8b.

Line 8c.

For Line 8c, the CFC shareholder should enter the total extraordinary disposition account balance with respect to all U.S. shareholders of the CFC at the beginning of the CFC year and at the end of the CFC tax year. The CFC shareholder should attach a statement detailing any difference between the starting and ending balances supported on Line 8c.

Line 9.

For Line 9, if the foreign corporation is a CFC and the filer is a domestic corporation, the CFC shareholder should enter on Line 9 the sum of the hybrid deduction accounts with respect to each share of stock of the CFC that the domestic corporation owns directly or indirectly (within the meaning of Section 958(a)(2), and determined by treating a domestic partnership as foreign). The reported amount should reflect the balance of the hybrid deduction accounts as of the close of the tax year of the CFC, and after all adjustments to the hybrid deduction accounts for the tax year.

A dividend can be a hybrid dividend only to the extent of the sum of the U.S. shareholder’s (or, in the case of tiered hybrid dividends, the CFC’s) hybrid deduction accounts, which must be maintained on a share-by-share basis with respect to each CFC by 10% U.S. corporate shareholders. It is generally increased by hybrid deductions of the CFC and decreased by hybrid deductions that gave rise to hybrid dividends or tiered hybrid dividends. This tracking requirement allows the rules to capture D/NI (an outcome whereby deductions are allowed in one jurisdiction but no corresponding income is included in the tax base in another jurisdiction) outcomes in cases where the dividend and the hybrid deduction do not arise pursuant to the same payment or in the same taxable year for U.S. and for foreign tax purposes, and it does so by matching hybrid deductions to dividends paid in subsequent taxable years.

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.