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Demystifying the Form 5471 Part 10. Schedule I

Demystifying the Form 5471 Part 10. Schedule I

By Anthony Diosdi


Schedule I is designed to disclose a U.S. shareholder’s pro rata share of income subpart F income from a controlled foreign corporation (“CFC”). This is the tenth of a series of articles designed to provide a basic overview of the Internal Revenue Service (“IRS”) Form 5471. This article is designed to supplement the IRS’ instructions to Schedule I of IRS Form 5471. This article will go line by line through Schedule I of Form 5471.

Who Must Complete Schedule I

Form 5471 and appropriate accompanying schedules must be completed and filed by the following categories of persons:

Category 1 Filer

U.S. persons who are officers, directors or ten percent or greater shareholders in a CFC. Category 1 includes U.S. shareholders of a Section 965 “specified foreign corporation” at any tax year of the foreign corporation, and who owned that stock on the last day in that year. A SFC includes 1) a CFC, or 2) any foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder (these entities are commonly referred to as 10/50 companies – those which have at least one U.S. shareholder, but which are not CFCs because U.S. shareholders do not own more than 50 percent by vote or value).

Category 2 Filer

U.S. persons who are officers or directors of a foreign corporation in which, since the last time Form 5471 was filed, a U.S. person has acquired a ten percent or greater ownership or acquired an additional ten percent or greater ownership.

Category 3 Filer

A category 3 filer is a U.S. person who (a) has acquired a cumulative ten percent or greater ownership in the outstanding stock of the foreign corporation, (b) since the last filing of form 5471 has acquired an additional ten percent or greater ownership in such strock, (c)  owns ten percent or greater of the value of the outstanding stock of the foreign corporation when it is reorganized, or (d) disposes of sufficient stock in the foreign corporation to reduce the value of his ownership of stock in that corporation to less than ten percent, or who becomes a U.S. person while owning ten percent or greater in value of the outstanding stock of the foreign corporation.

Category 4 Filer

Category 4 filers are U.S. persons who had “control” of a foreign corporation for an uninterrupted period of at least 30 days during the foreign corporation’s annual accounting period. Control is defined as more than 50 percent of voting power or value, with Section 958 of the Internal Revenue Code attribution rules applying.

Category 5 Filer

Before the enactment of the 2017 Tax Cuts and Jobs Act, Category 5 filers were U.S. persons who are ten percent or greater shareholders in a corporation that was a controlled foreign corporation for an uninterrupted period of thirty days during its annual accounting period and who owned stock in the controlled foreign corporation on the last day of its annual accounting period.

What Category of Filers Must File Schedule I

If a CFC has subpart F income (most do) Schedule I must be filed by all category filers. In addition, a separate Schedule I must be filed by or for each Category 4 or 5 U.S. shareholder of a CFC.

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 stock in another foreign corporation described in Internal Revenue Code Section 964(e)(4).

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 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 hybrid dividends received from any other CFC that is treated as subpart F income under Internal Revenue Code Section 245A(e)(2). A hybrid dividend generally is any dividend from a CFC for which the CFC received a deduction for foreign tax purposes. In the way of background, prior to the 2017 Tax Cuts and Jobs Act, dividends from foreign corporations out of foreign earnings that had not previously been taxed by the United States were usually taxable to the shareholder. The 2017 Tax Cuts and Jobs Act provides for new Internal Revenue Code Section 245A, which allows an exemption for certain foreign income of a domestic corporation that is a U.S. Shareholder by means of a 100 percent dividends received deduction (“DRD”) for the foreign source portion of dividends received from “specified 10-percent owned foreign corporations” by certain domestic corporations that are U.S. shareholders of the foreign corporation within the meaning of Internal Revenue Code Section 951(b). Effective for distributions made after December 31 2017, Section 245A(a) allows C corporations that are U.S. shareholders a deduction equal to the foreign source portion of a dividend received from a specified 10 percent owned foreign corporation. The 100 percent DRD is only available to domestic C corporations that are neither real estate investment trusts nor regulated investment companies.

However, a DRD deduction is not available to so-called hybrid dividends of a tiered corporation. In general, a dividend is a “hybrid dividend” if it would otherwise qualify for the Section 245A DRD, and the CFC paying the dividend is or was allowed a hybrid deduction under foreign law. The income tax regulations provide guidance that define hybrid deductions, and provide operating rules that require a connection between the hybrid deduction under the applicable foreign law and the instrument is stock for U.S federal tax purposes.

The income tax regulations provide rules relating to hybrid dividends of tired corporations and require an inclusion under Internal Revenue Code Section 951(a) with respect to a hybrid dividend received by a CFC from another CFC of a tiered corporate structure to the extent that the amount would be a hybrid dividend if the receiving CFC were a domestic corporation. If a CFC receives a tiered hybrid dividend from another CFC, then the tiered hybrid is treated as subpart F income by the CFC that received it and the foreign corporation’s U.S. shareholders must include it in income on a pro rata allocation. Foreign tax credits and other deductions are also disallowed with respect to the subpart F inclusion. If a CFC received hybrid dividends from a tiered corporation, the CFC shareholder’s subpart F inclusion under Section 245(e)(2) is reported on Line 1b.

Line 1c.

Line 1c. requires the CFC shareholder to disclose “Subpart F Personal Holding Company Income.” Internal Revenue Code Section 954(c) defines Personal Holding Company Income. Items of income which can constitute Personal Holding Company Income for subpart F purposes under Section 954(c) include dividends, interest, rents, royalties, annuities, except rents and royalties derived in the active conduct of a trade or business and received from a person other than a related person. See IRC Section 954(c)(2)(A). Under Internal Revenue Code Section 954(d)(3), a related person with respect to a CFC is an individual, corporation, partnership, trust or estate which is controlled by the same person or persons which control the CFC. Control means direct or indirect ownership of more than 50 percent of total voting power or the value of stock in a corporation, and more than 50 percent by value of the beneficial interest in a partnership, trust or estate, applying rules “similar to the rules of Internal Revenue Code Section 958.” Excluded are dividends and interest received from a related person created or organized under the laws of the same foreign country as the CFC and which it has a substantial part of its assets used in its trade or business located for the use of or the privilege of using property within the country under the laws of which the CFC is created or organized, except in either case, for interest, rents or royalties which reduce the payor’s subpart F income or creates a deficit which may reduce the subpart F income of the payor or another CFC.

In order to complete Line 1c. It is necessary to complete the questions on Worksheet A relating to Foreign Personal Holding Company Income. Below, we will review the relevant questions of Worksheet A.

Worksheet A

Below are the questions on Worksheet A which should be answered in order to complete Line 1c. 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 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 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 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 1f.

Line 1f. asks the CFC shareholder to disclose any other subpart F income.

Line 2.

Line 2 asks the CFC shareholder to disclose “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, US. 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 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.

Line 3 asks the CFC shareholder to disclose “Section 245A eligible dividends.” 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 a specified 10 percent foreign corporation (“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. Any eligible dividends under Section 245A must be disclosed on 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 5.

Line 5 asks the CFC shareholder to disclose “dividends received (translated at spot rate on payment under Section 989(b)(1)).” The instructions state the dividends a CFC shareholder receives from the foreign corporation that were not previously taxed under subpart F in the current year or in any prior year.

Line 6.

Line 6 asks the CFC shareholder to state the exchange gain or loss on a distribution of previously taxed earnings and profits. If previously taxed E&P (“PTEP”) described in Section 959(a) or (b) was distributed, enter the amount of foreign currency gain or (loss) on the distribution, computed under Section 986(c). See Demystifying the IRS Form 5471 Part 7. Schedule P and Demystifying the IRS Form 5471 Part 4. Schedule J for a further discussion of PTEPs described in Section 559(a) and (b).

The final two questions 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). Under Internal Revenue Code Section 964(b), no earnings and profits of a CFC will be subjected to constructive dividend treatment under subpart F if they cannot be distributed because of currency or other restrictions imposed by the laws of the foreign country. If the CFC had “blocked” or “unb;ocked” income, the CFC must answer either “Yes” or “No” to the last two questions.

Conclusion

Schedule I of Form 5471 is an incredibly complicated financial statement. The professionals at Diosdi Ching & Liu, LLP have substantial experience preparing all schedules associated with Form 5471. We also assist other tax professionals throughout the world with the preparation of all Form 5471 schedules.

Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com


This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.

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