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Comments on IRS Form 5471.

Comments on IRS Form 5471

INTRODUCTION

Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) is used by U.S. shareholders of controlled foreign corporations (CFCs) to disclose the information required by sections 6035, 6038, and 6046 of the Internal Revenue Code. Tax Executives Institute appreciates this opportunity to review and comment on the proposed revision of Form 5471. As a professional organization whose 4,300 members representing over 2,000 corporations in the United States and Canada annually prepare and file thousands of such forms, the Institute believes it is uniquely qualified to comment on the form.

GENERAL COMMENTS

Although the drafters of IRS forms and schedules should be commended for their efforts to implement the changes enacted by the Tax Reform Act of 1986 and subsequent legislation, the Institute continues to believe that extraneous information is being sought by the IRS. We believe forms should seek only that information actually necessary to determine the taxpayer's liability for tax. Indeed, where particular information will not be used to select returns for audit (or where the taxpayer's return will be audited in any event), we believe the information required to be filed with the return should be limited, especially with respect to continually audited taxpayers. In this regard, much of the information required to be submitted (for example, on Schedules C, D, and I) could be made available at the commencement of an audit of a taxpayer's return.

In addition, the IRS should accord taxpayers ample flexibility to submit required information in alternative formats. Although the instructions to the Form 5471 authorize such alternatives, taxpayers are required to obtain the IRS's prior approval. As we pointed out in our July 20, 1990, submission on various IRS forms, instructions, and schedules, taxpayers have experienced difficulty in obtaining IRS approval of computer-generated forms. Moreover, we question whether prior approval should be necessary as long as the information is set forth in the materials submitted with the taxpayer's return.

More fundamentally, we question the breadth and quantity of information requested on Form 5471 and related schedules. The proposed changes generally require technical, quantitative calculations rather than qualitative information. In essence, Schedule J constitutes the equivalent of filing a Form 1120 (U.S. Corporation Income Tax Return) for each controlled foreign corporation (CFC) - a tremendous burden for U.S. multinationals that have hundreds of affiliates. In addition, much of the data required is duplicative, e.g., the data relating to the CFC's earnings and profits and foreign tax credits are already reported on Form 1118. Requiring unnecessary and duplicative information needlessly increases the administrative costs and burden on U.S. multinationals.

We are also concerned about the type and form of information requested. It is often unclear whether the information being requested should be based on book or tax accounting principles, such as those underlying the calculation of earnings and profits. In many cases, the information is requested in a form other than that required by the underlying substantive Code provision or that conflicts with sound accounting principles. For example, the requirements for translation of foreign currency statements are inconsistent with U.S. generally accepted accounting principles and the tax accounting requirements imposed under section 902 or 964 of the Code. We strongly recommend that the IRS permit the required financial statements to be prepared in accordance with GAAP and submitted in the foreign corporation's functional currency.

In sum, TEI believes that the information required on Form 5471 could be submitted in a simpler, easier to read, and less detailed form without jeopardizing the IRS's information-gathering responsibilities. Recognizing that many of our suggestions relate not to proposed changes in Form 5471 but to provisions that are in the current version of the form, we submit that the adoption of the following suggestions will reduce the cost and burden of tax administration and compliance to the benefit of taxpayers and the government alike.

SPECIFIC COMMENTS

Form 5471, General Information

1. In Box B (Category of Filer) (on page 1 of the Form 5471), the taxpayer is instructed to "check the appropriate box." In many cases, however, the taxpayer may fall into more than one category. For example, a taxpayer may be a U.S. shareholder of a CFC (Category 5), as well as a U.S. person who acquired, increased holdings in, or disposed of stock of a foreign corporation greater than five percent (Category 3). The form and instructions should clarify how a taxpayer in this situation should complete the box. Perhaps the use of a question-and-answer format would make it easier for taxpayers to fill out the information. For example, the taxpayer could answer "yes," "no," or "not applicable" to questions concerning its filing category. The questions could also request supplemental statements, depending upon the taxpayer's response. A question-and-answer format would also make it easier for an IRS examining agent to review the information.

2. Box C requires the taxpayer to "[e]nter the total percentage of voting stock of the foreign corporation you owned at the end of its annual accounting period." It is unclear whether the box refers to (i) the taxpayer's total direct interest in the controlled foreign corporation (CFC), (ii) its direct and indirect interests, or (iii) its direct, indirect, and constructive interests. The instructions should clarify what information is being requested.

Schedule A, Part II

3. Schedule A, Part II (Additional Information With Respect to Classes of the Foreign Corporation's Preferred Stock) is a new section that must be completed by foreign personal holding companies. Because most CFCs do not issue preferred stock, the new section seems unnecessary. If preferred shares have been issued, the taxpayer could list them in Part I (Information With Respect to All Classes of the Foreign Corporation's Stock) and supply the additional information on audit, if necessary. Alternatively, the information could be included in Schedule N.

Schedule B

4. Schedule B (U.S. Shareholders of Foreign Corporation) requires the taxpayer to submit a statement explaining any changes in stock ownership. Because any material changes in ownership are already required to be filed on Schedule O, the requirement is redundant and should be eliminated. In addition, the comment made in paragraph 2 above applies equally in respect of Schedule B.

5. Data concerning the taxpayer's pro-rata share of Subpart F income (column 9g) of the schedule) must also be filed on Schedule I. Thus, this column should be deleted from Schedule B. In addition, data concerning the percentages of value of the class of stock (columns (d) and (f) may be obtained from Schedule A, Part I; these columns should be eliminated.

Schedules C, D, E, F, and G

6. Treas. Reg. [Section] 1.6038-2(g) requires a foreign corporation to submit certain information concerning its income, balance sheet, and surplus "prepared in conformity with generally accepted accounting principles and in such form and detail as is customary for the corporation's accounting records." The information required in Schedules C, D, E, F, and G, however, often deviates from GAAP principles.

We submit that, in lieu of the information requested on Schedules C (Income Statement) and F (Balance Sheet), the taxpayer should be permitted to file a copy of the CFC's Income Statement and Balance Sheet prepared for financial or other reporting purposes. In the draft form, it is unclear whether Schedules C, D, E, F, and G may be prepared on the basis of the CFC's functional currency. If taxpayers are required to submit financial statements translated into U.S. dollars according to Financial Accounting Standard (FAS) No. 52, they face a horrendous task of unraveling their Income Statements and Balance Sheets. Moreover, requiring statements based on FAS 52 ignores the foreign currency translation provisions enacted by the Tax Reform Act of 1986. See I.R.C. [Sub-Section] 985(b) and 989(b). Such statements are not required for any other tax purpose.

The instructions should clarify that taxpayers may present the data on Schedules C and F, as well as Schedules D (Cost of Goods Sold), E (Income, War Profits, and Excess Profit Taxes Paid or Accrued), and G (Analysis of Unappropriated Retain Earnings per Books), in the CFC's functional currency as long as the adjustments required by Treas. Reg. [Section] 1.964-1(b) are included.

7. If the CFC's functional currency is the U.S. dollar, the instructions to Schedule C should clarify whether the numbers are to be submitted according to GAAP or tax accounting principles.

Schedule C

8. If a CFC pays a dividend to its U.S. shareholders, those shareholders must report the CFC's earnings and foreign taxes paid on Form 1116 or 1118 (Computation of Foreign Tax Credit). Requiring U.S. multinationals (that may have hundreds of foreign subsidiaries) to calculate these items on Schedule C (as well as Schedule H) for every CFC, creates a difficult, if not impossible, administrative burden. We suggest that this information be limited to those CFCs paying a dividend (or deemed dividend) during the year.

9. The instructions to Schedule C should clarify whether the schedule is prepared on a book or U.S. tax accounting basis. Presumably, the income statement is based on GAAP principles, while the tax adjustments are made on Schedule H.

10. Information concerning related party sales (lines 1a and 1b of Schedule C) should be reported on Schedule M.

11. Line 19 requires the taxpayer to list "[e]xtraordinary items and prior period adjustments." The term "extraordinary," however, is not defined in the instructions. In the absence of such a definition, the line should be deleted.

12. For U.S. tax purposes, foreign income taxes are translated into U.S. dollars at the rate in effect on the date the taxes are actually paid. See I.R.C. [Section] 986(a). How is this information reconciled on line 20? The fact that the earnings and profits are calculated in a CFC's functional currency, then pooled, and translated only when remitted makes the annual translation of foreign taxes paid or accrued into U.S. dollars a distorting and irrelevant activity. If the income statement required on Schedule C is translated at any rate other than a dividend rate, the accumulated E&P calculations (Line 9 of Schedule H) will be incorrect. We submit that the translation of the foreign taxes paid should be required only on the Form 1118.

The instructions should also clarify that only the tax liability, not the reserve for taxes, should be reported on Line 20.

Schedule D

13. The title of Schedule D has been changed from "Cost of Goods Sold and/or Operations" to "Cost of Goods Sold." Line 7 of the schedule, however, retains the old caption. The line should be amended to agree with the title of the schedule.

14. Information concerning purchases (lines 2a and 2b) should be reported on Schedule M.

Schedule E

15. The space provided for Schedule E (Income Taxes Paid or Accrued) is too small for reporting multiple payments of federal and local foreign taxes. More important, information concerning the foreign taxes paid or accrued by a CFC is relevant only when a dividend is paid. As noted above, the translation of foreign taxes into U.S. dollars should be required only with respect to the filing of Form 1118. Schedule E should thus be deleted.

Schedule F

16. Lines 4, 5, and 9 of Schedule F (Balance Sheets) require the taxpayer to submit a specific breakdown of investments in U.S. government and tax-exempt securities and other investments. The majority of CFCs, however, do not invest in U.S., state, or tax-exempt securities. Moreover, because most companies have designed their internal reporting systems to provide the data required on the current schedule, the additional items may require taxpayers to re-program their systems (adding to their costs and administrative burdens) without producing any concomitant benefit to the IRS or the public fisc. We suggest that the additional items on Schedule F be deleted.

17. Lines 7 and 18 request information on related party indebtedness which is duplicative of information requested on Schedule M. Either these lines or line 9 of Schedule M should be eliminated.

Schedules G and H

18. Schedules G (Analysis of Unappropriated Retained Earnings per Books) and H (Current Earnings and Profits) require taxpayers to submit certain information concerning their earnings. Many multinationals, however, retain companies with minimum capital and activity for legal purposes. The prior schedule (Schedule I) had a de minimis rule, i.e., if total assets were less than $25,000, taxpayers were not required to submit the schedule. TEI recommends that a similar de minimis rule be adopted with respect to these schedules.(1)

19. The "current year net income" requested on Line 1 of Schedule H apparently requires data based on tax accounting principles. On the other hand, Schedule G starts with line 21 of Schedule C and refers to the "books" as the starting point. The instructions should clarify the distinction.

Schedule H

20. Line 1 of Schedule H (Current Earnings and Profits) currently requires taxpayers to submit the "[c]urrent year net income or loss before any reduction for any income, war profits, and excess profits taxes." The underlined phrase has been deleted from the draft on the basis that line 3 requires the taxpayer to adjust to U.S. taxable income using the tax accounting standards described in Treas. Reg. [Section] 1.964-1(c). Lines 2 and 3 of the revised schedule also require adjustments to conform to the translation methods of Treas. Reg. [Sub-Section] 1.964-1(d) and (e). The Tax Reform Act of 1986, however, required taxpayers to use the translation methods of sections 985 and 989 of the code. We therefore suggest that the underscored phrase be restored to line 1 and that lines 2 and 3 be deleted. The adjustments required under Treas. Reg. [Section] 1.964-1(c) should be included in line 4.

21. If Schedule H is to be completed in U.S. dollars regardless of the CFC's functional currency, a line should be added to indicate the translation method used.

22. The draft Schedule H eliminates Lines 6 and 7 of the old schedule (relating to unrealized exchange gain (or loss) and earnings and profits for the year). Because of the different translation rates required to be used, adjustments for unrealized gains (or losses) will always be required. Thus, these lines should be retained for reconciling E&P and financial statement data.

Schedule I

23. Schedule I (Summary of Shareholder's Pro-Rata Share of Subpart F Income) replaces Form 3646. The drafters are to be commended for streamlining the format for submitting the data.

Schedule J

24. Earnings and profits are translated at different rates under sections 902, 959, and 964 of the Code, particularly in pre-1987 tax years. Since E&P is a functional currency computation in post-1986 tax years, translating the data required on Schedule J (Accumulated Earnings and Profits) into U.S. dollars will prove meaningless.

25. Lines 3 and 4 (relating to distributions during the year from current or accumulated E&P) duplicate information provided on Form 1118. The distribution information will be required only for those foreign companies that pay dividends. Furthermore, the important distinction in respect of E&P is between pre-1986 and post-1986 earnings. Consequently, because of the interrelationship of the requested data, the quantitative calculations must be reconciled. This reconciliation only adds to the complexity of completing the form. These mechanical calculations are equivalent to a separate U.S. tax return for each U.S.-owned foreign corporation, rather than an information return. We recommend that the lines be deleted.

Schedule K

26. The information in Schedule K (Person on Whose Behalf this Information Return is Filed) could more easily be requested in a question-and-answer format on page 1 of the form. Detailed information could be submitted on a separate statement.

Schedule N

27. Part I, Section B of Schedule N (Report of Officers, Directors, and Ten Percent or More Shareholders of a Foreign Personal Holding Company) should be presented in a question-and-answer format and a description of preferred shares, if any, could be attached.

Schedule O

28. Schedule O (Organization or Reorganization of Foreign Corporation, and Acquisitions and Disposition of its Stock) must be prepared for every disposition or acquisition of five percent or more of the shares in the reporting foreign corporation. The description of many transactions must also be reported for purposes of section 367 of the Code. Thus, we suggest that completion of the schedule be eliminated for taxpayers required to report transactions under section 367.

Worksheet A

29. Inserts 1 and 2 for Worksheet A (U.S. Shareholders Pro Rata Share of Subpart F Income) (on page 38 of 68) do not appear to be correctly cross-referenced to the appropriate lines of the worksheet. For example, Insert 1 shows an amendment to line 12 of the worksheet; the reference should be to line 16.

Worksheets C and D

30. The insert references on Worksheets C (Pro-Rata Share of Increase in Earnings Invested in U.S. Property) and D (Pro-Rata Share of Previously Excluded Subpart F Income Withdrawn from Qualified Investments in Less Developed Countries and from Qualified Investments in Foreign Base Company Shipping Operations) should be to Form 5471-P6 (rather than Form 5471-P7).

CONCLUSION

Tax Executives Institute appreciates this opportunity to present our views on the proposed changes to Form 5471. If you have any questions, please do not hesitate to call Linda B. Burke, chair of TEI's IRS Administrative Affairs Committee, at (412) 553-4153 or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at (202) 638-5601.

(1) Because of differences in tranlating current E&P and dividends, the total unappropriate E&P requested on Schedule G is probably a fictitious number and would not reconcile with the taxpayer's financial statements or accumulated E&P under section 902 or 964. See Schedule G, Lines 1, 2, and 5.
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Publication:Tax Executive
Date:Sep 1, 1990
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