How The Trump Tax Reform Is Changing Foreign Corporations U.S. Source Income Reporting
To file Form 1120-F tax return for foreign corporations reported on an annual basis, regulation § 1.6012-2(g)(1) requires foreign corporations to be engaged in ongoing U.S. trade or business activity. Even if there is no Effectively Connected Income (ECI), U.S.-source income, or where income is entirely exempt from tax under IRC or a treaty provision, applicable foreign corporations are required to file. However, regulation § 1.6012-2(g)(1)(i) allows the corporation to claim no taxable income for U.S. purposes if they provide identifying information on the return along with a statement indicating the amount and nature of any exclusions under code or via treaty, and Form 8833, which discloses the treaty-based return position required by regulation § 301.6114-1(a)(1)(ii). Special attention should be given to foreign corporations claiming exemption from filing a return under the rules of regulation § 1.6012-2(g)(1) due to not establishing a permanence in the U.S. under an applicable treaty. This type of a corporation may still need to file a U.S. return according to rule § 6114 to disclose applicable return positions that are treaty-based.
Foreign Corporations Subject to Tax Under Subtitle a of The IRC
If foreign corporations are not deemed to be engaged in any U.S. trade or business, they still need to file a U.S. return to report income under subtitle A of the Code under regulations § § 1.6012-2(g)(1)(i), -2(g)(2)(i)(a) if the associated tax liability is not satisfied by withholding at source. Foreign corporations whose tax liability is satisfied by withholding are still required to file a U.S. return if they are seeking a refund of U.S. tax or if they are subject to accumulated earnings tax under Regs. § 1.612-2(g)(2)(i)(b).
When and Where to File
When foreign corporations are required to file, they must do so on or before the 15th day of the third month following the close of the corporation’s taxable year (see Regs. § 1.6072-2(b)). If the foreign corporation does not have a U.S. office or fixed place of business, they are granted an extension of three months to file their U.S. tax return. To take advantage of this extension, the foreign corporation is required to attach a statement to its return claiming eligibility for the extension due to not having a fixed place of business in the U.S. This three-month extension also applies to the foreign entity’s tax payment schedule. The automatic extension also tolls the imposition of late payments for three months but does not toll interest on payments made after the original due date and during the extension time period. Corporations are still required to file within 6 months of the original due date of the return even if they qualify for the three-month automatic extension. Foreign corporations can receive a six-month extension of time to file through the filing of Form 7004 and paying their estimated unpaid tax liability by the original due date of the return. This filing however, does not extend the time for payment if the foreign corporation does not meet the qualifications for the automatic three-month extension. The foreign corporation is still subject to interest and penalties for payments made after the initial due date of their U.S. tax return. All foreign corporations must file with the IRS Service Center in Ogden, Utah.
Information Returns Required of Foreign Corporations
Foreign corporations should be aware of the variety of information reporting requirements in the U.S. Foreign corporations may need to file Forms 1096 and 1099 just as domestic corporations are required to do. If foreign corporations make payments of U.S. source income to foreign persons, they can be required to file Form 1042. Reporting requirements are also applicable to U.S. shareholders, officers and/or directors of foreign corporations if more than 10% of the stock is owned by U.S. persons. In addition, if foreign corporations are engaged in U.S. trade or business must file Form 5472 to disclose information regarding the corporation and any and all transactions that involved related parties during the tax year
Effectively Connected Income (ECI)
Foreign corporations normally have ECI only if they are engaged in business or trade within the U.S. Net ECI is taxable at normal corporate rates under § 882. Expenses incurred in the process of earning the ECI, may be deducted from the net ECI calculation.
Branch Profits Tax
Foreign corporations could also be liable for a branch profits tax.
Section 881 Taxation of Non ECI But U.S. Source Income
Fixed or determinable annual or periodical (FDAP) income, including dividends, royalties and other comparable compensation derived by a foreign corporation from U.S. sources, but not deemed ECI are taxed under § 881. This tax is 30% on a gross income basis.
Anti-deferral Provisions Applicable to Foreign Corporations
Foreign corporations with U.S.-source income and where at least one of its shareholders would be subject to U.S. income tax if they received a distribution from the company could have the 20% accumulated earnings tax imposed by section 531 if they accumulate earnings beyond their reasonable business needs
Taxation of U.S. Shareholders of Foreign Corporations
Even though there are limitations in the taxing nexus of the U.S. over foreign corporations even if the corporation is owned entirely by U.S. residents, establishing a taxing nexus over its own citizens has no bounds. Thus, the U.S. has established a variety of ways to tax U.S. persons based on ownership interest in a foreign entity. Under the controlled foreign corporation regulations of subpart F, U.S. persons can be taxed on their foreign holdings. In addition, foreign holdings can also be taxed under passive foreign investment company regulations, and many other provisions.
The affect of Tax Treaties on The Taxing of Foreign Corporations
U.S. statutory application manners may be altered when a foreign corporation receives the benefits of a treaty. One example of this involves the right of the U.S. to impose tax under § 882 being limited to situations where the corporation maintains a “permanent establishment” in the U.S. and has profits that are attributable to the permanent establishment. Treaty provisions could reduce or even eliminate the 30% withholding tax imposed on a gross basis under § 881 on all U.S. source dividends, interest and other comparable income.
When a taxpayer takes a treaty-based return position, the regulations under § 6114 come into play. Under regulations § 301.6114-1(a)(2)(i) a taxpayer is considered to have adopted a return position if the taxpayer determines their tax liability even if no tax return is filed. Determination of whether a tax return position is treaty-based, the taxpayer needs to compare the tax liability reportable on a tax return, including the effect of a treaty with the liability that potentially could be required if the treaty provision did not exist. If there is a difference, it is considered a treaty-based return position and § 6114 reporting is required.
Penalties For Failing to Disclose a Treaty Based Return Position
When treaty-based return positions are not reported, Section 6712 hits corporations with a $10,000 penalty. Under § 301.6712-1(a) payors are penalized per transaction and not per annual filing. Therefore, each reportable payment or income item will result in a penalty where the required disclosure is not made. If the omitted disclosure was not due to “willful neglect”, IRS can waive all or a portion of these penalties under § 301.6712-1(b).
Classification of Foreign Entities For US Tax Purposes
Controversy regarding the definition of a foreign entity as a corporation versus a partnership or trust prompted check the box regulations in 1996. The code defines corporations as joint-stock companies, insurance companies, and/or associations. The check-the-box regulations elective clarifies the classifications of foreign entities. Form 8832 allows eligible entities to make an entity classification, but a foreign multiple member entity can only be classified if all members of the entity have limited liability. If this is not the case, the foreign entity will be classified as a partnership or a disregarded entity if there is only one member.
When a member has no personal liability for the debts or claim against the entity because of being a member, limited liability for foreign entity classification exists. If the entity’s creditors can seek satisfaction from the member of any portion of their debts or claims, then the member is personally liable. Determinations are based on the interpretation of the foreign law where the entity is organized. U.S. tax services often provide listings of common foreign entities by country. U.S. tax services also provide a determination of the equivalent entity in the U.S.
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