Recent changes in filing requirements for foreign partnerships.

The advent of the check-the-box rules has simplified taxpayers' ability to select the form of their foreign business entities. Congress determined that the proliferation of check-the-box entities heightened the need for compliance requirements comparable to those applicable to controlled foreign corporations.

U.S. persons with a controlling interest in a foreign corporation have long been subject to reporting on the foreign corporation's financial position, ownership structure and related-party transactions. Prior to the Taxpayer Relief Act of 1997 (TRA '97) and guidance of the regulations, no comparable reporting was required for foreign partnerships.

On Sept. 8, 1998, the IRS issued proposed regulations requiring U.S. persons owning interests in foreign partnerships to report annually. Specifically, the regulations addressed the following Code sections:

* Sec. 6038: Information reporting in relation to certain foreign partnerships owned by U.S. persons;

* Sec. 6038B: Transfers to foreign partnerships; and

* Sec. 6046A: Acquisitions, dispositions or substantial changes in ownership of foreign partnership interests.

The Service issued final regulations for Sec. 6038B on Feb. 4, 1999, and final regulations for Secs. 6038 and 6046A on Dec. 29, 1999.

Sec. 6038

General rule. Regs. Sec. 1.6038-3 requires U.S. persons owning 10% or more of a controlled foreign partnership (CFP) to file Form 8865, Information Return of U.S. Persons with Respect to Certain Foreign Partnerships, annually. A CFP is defined as a non-U.S, partnership in which U.S. persons control or allocate more than 50% of the capital or profit interests (or deductions or losses).

Generally, if a single U.S. person controls a CFP, that person may file only one Form 8865 on behalf of all U.S. partners required to report. If there is more than one controlling partner, only one controlling partner is required to report on one return. If there is no controlling U.S. person, each 10% owner must file Form 8865.

Sec. 6031 overlap. Special rules apply when U.S. persons must file a foreign partnership return under Secs. 6031(e) and 6038 (Regs. Sec. 1.6038-3(j)). If a foreign partnership files Form 1065, because it had U.S.-source income or was engaged in a U.S. trade or business, the U.S. partner must use a copy of the relevant parts of Form 1065 to fulfill its Sec. 6038 filing obligation.

Effective date. The final regulations apply to partnership annual accounting periods ending on or after Dec. 31, 2000.

Sec. 6038B

General rule. Regs. Sec. 1.6038B-2 requires U.S. persons contributing property to a foreign partnership under Sec. 721 in exchange for a partnership interest to report certain information on Form 8865. Reporting is required even if no gain is recognized on a transfer.

Form 8865 must be filed if, immediately following a transfer, a U.S. person owns, directly or indirectly, a 10%-or-more interest in the partnership. The form must also be filed if the transferred property's value, when added to the value of any other property transferred in a Sec. 721 contribution during the 12-month period ending on the transfer date, exceeds $100,000.

Additionally, if a U.S. person has contributed appreciated property and the partnership disposes of the property while he is still a partner, he must report the disposition on Form 8865. Further, the U.S. person should consider the potential effect of Sec. 704(c), requiring allocation of pre-contribution gain to the contributing partner.

Deemed contributions. Regs. Sec. 1.6038B-2(g) modifies the reporting requirements for deemed contributions. Service-initiated transfer-pricing adjustments resulting in a deemed contribution do not require reporting. However, taxpayers initiating Sec. 482 adjustments that result in deemed contributions must disclose the transaction on Form 8865 in the year the adjustment is made.

Effective dates. Regs. Sec. 1.6038B-2 applies to transfers made after Aug. 5, 1997. Transfers that occurred between Aug. 6 and Dec. 31, 1997, must be reported on Form 8865 (see special transition rule, below) or in accordance with Notice 98-17.

Transfers to a foreign partnership between Jan. 2 and Dec. 31, 1998, must be reported on Form 8865 with the taxpayer's return for the first tax year beginning after 1998.

Special transition rule. All transfers that occurred before 2000 will be considered timely reported if Form 8865 is attached to an amended tax return for the U.S. person's tax year in which the transfer occurred, provided that the amended return is filed by Sept. 15, 2000.

Sec. 6046A

General rule. Regs. Sec. 1.6046A-1(a)(1) requires U.S. persons to file Form 8865 when they acquire or dispose of an interest in a foreign partnership or their proportional interest in a foreign partnership changes substantially. Reporting is required if the U.S. person, directly or indirectly, holds at least a 10% interest either before or after the transfer, or if the change in interest is greater than or equal to 10%.

Under Regs. Sec. 1.6046A-1, a U.S. person may be required to file Form 8865 in one year but not another (analogous to a U.S. shareholder of a foreign corporation possibly having to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, in some years but not others).

Sec. 6038B overlap. U.S. persons that acquire an interest in a foreign partnership may be required to report the transaction under Secs. 6038B and 6046A. However, if the U.S. person properly reports the transaction under Sec. 6038B, Sec. 6046A reporting is not required. U.S. persons failing to properly report a transaction applying to both sections are subject to both sections' penalties.

Effective date. Regs. Sec. 1.6046A-1 is effective for reportable events after 1999.

Penalties

Secs. 6038, 6038B and 6046 penalties are independent of each other; failure to comply with any one of the sections could result in multiple penalties.

Under Sec. 6038, failure to comply could result in a $10,000 penalty per person, per accounting period. Failure to comply after formal IRS notification results in additional penalties, up to a total of $50,000 for each partnership.

Failure to comply with Sec. 6038B reporting requirements may result in a penalty equal to 10% of the contributed property's fair market value. As a general matter, the penalty cannot exceed $100,000, unless the failure was due to intentional disregard. Additionally, U.S. persons may be required to recognize gain as if the contributed property had been sold.

Under Sec. 6046A, failure to comply with the reporting requirements results in civil penalties of $10,000. Failure to comply after formal Service notification carries an additional penalty of up to $50,000 and, possibly, criminal penalties.

Form 8865 Phase-In

In December 1999, Form 8865 was finalized with instructions. The instructions classify filers into specific categories, much like the Form 5471 instructions. U.S. persons required to file Form 8865 may fall into more than one category.

Current filing season (U.S. partners in a foreign partnership). U.S. persons who contribute property from Aug. 6, 1997-Dec. 31, 1999, to a foreign partnership under Sec. 721 are required to file Form 8865 with their 1999 U.S. tax return. However, no Form 8865 is required for a U.S. person that filed a modified Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, in accordance with Regs. Sec. 1.6038B-2(j) or Notice 98-17, for a transfer that occurred before 1999.

Any transfers that occurred before 2000 will be considered timely reported if Form 8865 is attached to an amended return for the tax year in which the transfer occurred, provided the amended return is filed no later than Sept. 15, 2000.

A reportable event under Sec. 6046A that takes place after 1999 must be reported on Form 8865. Therefore, a fiscal year-end U.S. person with a reportable event after 1999 is required to file Form 8865.

2001 filing season (U. S. partners in a foreign partnership). The filing requirements under Secs. 6038 and 6046A are effective for tax years ending on or after Dec. 31, 2000. U.S. persons required to file under either provision must attach Form 8865 to their 2000 U.S. tax return.

Foreign partnerships (Form 1065). Kegs. Sec. 301.6031(a)-1 was finalized with no changes on Nov. 10,1999. Foreign partnerships required to file under Sec. 6031, because of U.S.-source income, U.S. effectively connected income or a need to make a partnership-level election to determine partnership taxable income, must continue to file Form 1065.

FROM ERIC NELSON, MINNEAPOLIS, MN