By Anthony Diosdi
Each year certain U.S. persons with interests in foreign corporations must file an IRS Form 5471 otherwise known as “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” This is the fifth of a series of articles designed to provide a basic overview of the Form 5471. This article will focus on Schedule I-1, and is designed to supplement the IRS instructions to Schedule I-1.
Who Must Complete the Form 5471 Schedule J
Schedule I-1 is used to report information determined at the CFC level with respect to amounts used in the determination of GILTI inclusions by U.S. shareholders. The information from Schedule I-1 is used by U.S. shareholder(s) of a CFC to file Form 8992, U.S. Shareholder Calculation of GILTI, and may assist in the completion of Form 1118, Foreign Tax Credits – Corporations, or Form 1116, Foreign Tax Credit (Individual, Estate, or Trust).
Line 1. Gross Income
According to the instructions promulgated by the IRS, taxpayers are asked to enter the CFC’s gross income in its functional currency on Line 1 for the taxable year. Under IRC 985, functional currency is “the dollar”, or “the currency of the economic environment in which a significant part of such [CFC’s] activities” is “conducted” and which is used by a CFC in keepings its books and records.
Line 2a. Effectively Connected Income Exclusion
On Line 2a of Schedule l-1, taxpayers are asked to enter the amount of the CFC’s income described in Section 952(b), which is generally income from sources within the United States that is effectively connected to the conduct of a trade or business by the CFC in the United States and not reduced or exempted from U.S. tax pursuant to an income tax treaty with the U.S.
Line 2b. Subpart F Income Exclusion
On Line 2b of Schedule I-1, taxpayers must enter the amount, if any, of the CFC’s gross income taken into account in determining the CFC’s subpart F income (as defined under Section 952). The amount to be entered is computed after application of the high-tax exception in Section 954(b)(4), but before application of the Earnings and Profits (“E&P”) limitation in Section 952(c)(1). (See below for a discussion of the high-tax exception to subpart F income).
Subpart F income that must be disclosed on Line 2b is defined as the sum of the corporation’s:
1. Insurance income.
2. Foreign base company income; and
3. international boycott income and an amount equal to illegal bribe/kickbacks paid on behalf of the CFC and income derived from any foreign country for which Internal Revenue Code Section 901(j) denies a foreign tax credit for taxes paid to such country.
Line 2c. High Tax Exception Exclusion
On Line 2c, taxpayers must disclose the amount, if any, of the CFC’s gross income excluded from foreign base company income (as defined in Section 953) by reason of Section 954(b)(4), the high-tax exception.
In order to complete Line 2c, the taxpayer or preparer of Schedule I-1 must know the meaning of foreign base company income. Foreign base company income includes foreign personal holding company income, foreign base company sales income, foreign base company services income and foreign base company shipping income.
Items of foreign personal holding company income includes items of income includes dividends, interest, rents, royalties, and annuities, except rents and royalties derived in the active conduct of a trade or business. See IRC Section 954(c)(2)(A). Foreign base company sales income under Internal Revenue Revenue Code Section 954(d) is income arising from the purchase or sale 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). Foreign base company services income arises 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 foreign base company shipping income includes income derived from the use of an aircraft or vessel or from the sale or exchange of the aircraft or vessel.
As discussed above, Section 954 defines the categories of income that is treated as “foreign base company income.” Pertinent to answering Line 2C is Section 954(b)(4) which provides that foreign base company income shall not include any “item of income” of a CFC that the taxpayer establishes has been subject to an effective rate of income tax of at least 90 percent of the U.S. corporate tax rate (i.e., 18.9 percent). Any amount of foreign base company income excluded from U.S. taxation under Section 954(b)(4) must be disclosed on Line 2c of Schedule I-1.
Line 2d. Related Party Dividends
On Line 2d, taxpayers must disclose the amount of related party dividends. A related party is an individual, corporation, partnership, trust or estate that controls or is controlled by a CFC is a “related party” with respect to that CFC. See IRC Section 954(d)(3)(A). In addition, a corporation, partnership, trust or estate that is controlled by the same persons or persons that control a CFC is a “related party” with respect to the CFC. Any dividends received from a “related party” must be disclosed on Line 2d of Schedule I-1.
Line 2e. Foreign Oil and Gas Extraction Income
On Line 2e, taxpayers must disclose the amount of foreign oil and gas extraction income for the taxable year. This income consists of the following:
1. The extraction (by the corporation or other person) of minerals from oil or gas wells located outside the U.S. and its possessions.
2. The sale or exchange of assets used (by the corporation) in the trade or business of extracting minerals from oil or gas wells located outside the United States and its possessions.
Line 3. Total Exclusions
On Line 3, taxpayers should enter the sum of lines 2a through 2e.
Line 4. Gross Income Less Exclusions (line 1 minus line 3)
On Line 4, taxpayers should subtract line 3 from line 1 and enter the result on line 4.
Line 5. Deductions Properly Allocable to Amount on Line 4
On Line 5, taxpayers should enter the deductions (including taxes) properly allocable to the amount on line 4 (or to which such deductions would be allocable if there were such gross income).
Line 6. Tested Income (line 4 minus line 5)
On Line 6, taxpayers should subtract line 5 from line 4 and enter the result on line 6. This amount must be converted from functional currency to U.S. dollars.
Report the exchange rate using the “divide-by convention” specified under
If the amount entered on line 6 is positive (tested income), the U.S. shareholder will enter that amount in U.S. dollars on Form 8992, Schedule A column (c), for the CFC’s row. If, however, the amount entered on line 6 is negative (tested loss), the U.S. shareholder will enter that loss amount in U.S. dollars on Form 8992, Schedule A, column (d), for the CFC’s row.
In order to understand the numbers that must be entered on Line 6 (i.e the “tested income” and “tested loss”), any individual preparing Schedule I-1 should understand how GILTI is computed. A U.S. shareholder’s GILTI for a taxable year is the excess, if any, of the U.S. shareholder’s “net CFC tested income” for the taxable year over that shareholder’s “net deemed tangible income return” for the taxable year. Net CFC tested income with respect to any U.S. shareholder is the excess (if any) of the aggregate of the shareholder’s pro rata share of the “tested income” of each CFC with respect to which the shareholder is a U.S. shareholder of the taxable year over the aggregate of the shareholder’s pro rata share of the “tested loss” of each CFC with respect to which the shareholder is a U.S. shareholder for the taxable year of the U.S. shareholder. See IRC Section 951A(c). These amounts are determined for each taxable year of the CFC which ends in or with the taxable year of the U.S. shareholder.
The formula for determining GILTI can be expressed as follows:
GILTI = Net CFC Tested Income – Net Deemed Tangible Income Return = [Tested Income – Tested Loss] – [10% of QBAI – Certain Interest Expense]
The tested income of a CFC is the excess (if any) of the gross income of the CFc determined without regard to certain items (stated below) over deductions properly allocable to that gross income. The items excluded from gross income are as follows:
1. Any item of income described in Internal Revenue Code Section 952(b). This includes any U.S. source income effectively connected with the conduct by such corporation of a trade or business within the U.S.
2. Any gross income taken into account in determining subpart F income of the cFc.
3. Any gross income excluded from the foreign base company income and the insurance income of the CFC by reason of Internal Revenue Code Section 954(b)(4), the high tax exception.
4. Any dividend received from a related person as defined in Section 954(d)(3).
5. Any foreign oil and gas extraction income of the CFC.
The tested loss of a CFC is the excess (if any) of associated deductions that exceed tested income.
Line 7. Tested Foreign Income Taxes
Taxpayer’s disclose the CFC’s tested foreign taxes on Line 7. According to the IRS instructions, if the CFC has a tested loss on line 6, enter zero. If the CFC has tested income on line 6, enter only those foreign income taxes that are properly attributable to the CFC’s tested income.
A CFC’s tested foreign income taxes are determined as follows: a corporation that has a GILTI inclusion is treated as having paid foreign income taxes equal to 80 percent of the product of its “inclusion percentage” and the aggregate “tested foreign income taxes” paid or accrued by its CFC’s. See IRC Section 960(d). A U.S. corporation’s inclusion percentage for a tax year means the ratio (expressed as a percentage) of its GILTI inclusion to the aggregate of its pro rata shares of the tested income of its CFCs. Tested foreign income taxes of a CFC are the foreign income taxes paid or accrued by the CFC that are properly attributable to the tested income of the CFC taken into account by the U.S. corporation under Section 951A. This can be expressed in a formula as follows:
80% x Inclusion Percentage x Aggregate tested foreign income taxes paid or accrued = 80% x [GILTI Inclusion / Aggregate Tested Income] x [Foreign income taxes properly attributable to the tested income of such CFC].
While foreign tax credits deemed paid are only 80 percent of the product determined above, 100 percent of such product are treated as dividends from the CFC for purposes of Internal Revenue Code Section 78.
Line 8. Qualified Foreign Asset Investment
Taxpayers disclose “qualified foreign asset investments (“QBAI”) on Line 8. QBAI equals the CFC’s average aggregate adjusted bases for “Specified Tangible Property” during the taxable year. See IRC Section 951A(d). Specified tangible property means any tangible property used in the production of tested income. If such property was used in the production of tested income and income that is not tested income, the property is treated as tangible property in the same proportion that the amount of tested income determined before allocable deductions (i.e., line 4) produced with respect to the property bears to the total amount of gross income produced with respect to that property.
QBAI is measured at the close of each quarter and adjusted basis is determined by using the alternative depreciation system under Internal Revenue Code Section 168(g). Depreciation is allocable ratably to each day during the period in the taxable year to which such depreciation relates.
If the CFC has a tested loss on line 6, zero should be entered on Line 6. However, if the CFC has tested income on Line 6, the QBAI should be entered on Line 8.
Line 9. Interest Expenses
On Line 9, the taxpayer enters the amount of interest expense taken into account for Line 5.
The rules discussed above are extraordinarily complex. Any U.S. shareholder of a CFC should consult with a qualified international tax professional should they have any questions regarding their U.S. tax compliance requirements.
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 international 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.