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Many Foreign Corporations Must File Form 5472. Penalty for Non-compliance $10,000
It has come to our attention that, based on advise from their U.S. tax advisors and CPAs, that foreign corporations with income effectively connected with U.S. operations are not required to file Form 5472, Information Return of w 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, pursuant to Internal Revenue Code (“the Code or IRC”) Sections 6038A and 6038C).
Be advised that this is often not true and that pursuant to the Code a “Reporting Corporation” is defined as a foreign corporation doing business in the United States. Further a “Reportable Transaction” is any type of transaction listed in Part IV of Form 5472 for which monetary consideration was the sole consideration paid or received during the reporting corporations tax year. Accordingly, unless one of the exceptions applies (and they are limited) a reporting corporation must file Form 5472 if it had a reportable transaction with a foreign or domestic related party.
One of the exceptions sometimes cited by tax advisors is that if a transaction between a foreign corporation and a foreign owner or related party do not result in the generation of income tax, or if a transaction is exempt pursuant to the provisions of a tax convention (treaty) between the U.S. and the country of residence of the foreign corporation, then there is no requirement to file Form 5472. Although this is true, there are some factors that are often overlooked.
As regards a treaty exemption, the relief from filing Form 5472 only applies if the corporation files Form 8833. Treaty-Based Return Disclosure pursuant to IRC Section 6114 or 7701(b).
As regards transactions listed as reportable transactions, often the most frequently overlooked line item are the ones showing loans to and loans from foreign shareholders of the corporation. Loans between corporations and foreign shareholders usually have significant tax consequences. For example, if the corporation borrows money from the shareholder the interest paid to the shareholder is tax deductible to the corporation and taxable income to the foreign shareholder. The payment of interest in cash or other property is required to be reported to the IRS as a payment to a foreign person and may also be subject to U.S. withholding tax. If the loan is absent a loan agreement then the taxpayers are required to impute the interest and if they don’t the IRS will do it for them. As regards interest paid to a foreign shareholder and reported as a loan that could have more severe US tax consequences. The loan itself may be a disguised distribution of earning and profits (IE dividends) to the foreign shareholder, which would otherwise possibly be subject to US tax withholding at source (along with other reporting requirements or even potentially more significant, it could be a deemed a distribution of accumulated income that is subject to the punitive U.S. branch profits rules. The message is to examine the rules carefully.