Revised Form 5471 creates uncertainties.

With little fanfare, the IRS earlier this year released a revised version of Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. This release marked the first time the Service has exercised its authority (granted by recent legislative changes to Sec. 6038) to impose new information reporting requirements simply by issuing a new form. Perhaps for this reason, the accompanying guidance has not been viewed as adequate by taxpayers and practitioners.

Revised Form 5471 (along with revised Schedules M and O and revised instructions) takes into account numerous changes to subpart F and related provisions brought about through recent legislation, including:

* Repeal of Sec. 956A, which required U.S. shareholders to include in income their share of the excess passive assets of a controlled foreign corporation (CFC);

* The temporary exceptions from the definition of foreign personal holding company income for active financial services income under Sec. 954(h);

* Other modifications to the definition of foreign personal holding company income (relating to notional principal contracts, securities dealers, etc.);

* The new "appropriate exchange rate" for translating a CFC's functional currency into U.S. dollars, generally the average exchange rate for the CFC's tax year; and

* The increase in the threshold for stock ownership that results in an information reporting obligation under Sec. 6046 from 5% to 10% (for Category 2 and 3 filers).

Also, the principal business activity codes on the new form are based on the new North American Industry Classification System, which has replaced the Standard Industrial Classification system.

The "Changes to Note" section of the revised instructions cites all these changes, but fails to mention that the revised form also requires taxpayers to provide certain new information. In particular, transactions between the CFC and partnerships (both foreign and domestic) controlled by a U.S. person filing the Form 5471 must now be reported on Schedule M.

In the past, such a change would have required prior regulatory authority to become effective. The IRS's process of drafting and releasing regulations explaining modified reporting requirements would have given taxpayers and practitioners some notice that new or additional information would be needed. This process has changed fundamentally, however, as a result of little-noticed amendments to Sec. 6038.

Prior to the Taxpayer Relief Act of 1997 (TRA '97), Sec. 6038(a)(1) required U.S. persons to furnish, for foreign corporations they controlled, "such information as the Secretary may prescribe by regulations." The TRA '97, among other changes, struck the phrase "by regulations." The Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) made corresponding changes to Sec. 6038(a)(2) and (3). In effect, the Service now has authority to impose additional reporting requirements simply by issuing a new form.

Failure to highlight additional information called for in a revised form (especially when new information-gathering processes will be required for most taxpayers) creates a trap for the unwary. To avoid such traps, taxpayers and practitioners now must carefully compare each new version of a form with the prior version, to uncover any new requirements that may have been imposed but not announced.

The information required on new 1999 Form 5471--relating to transactions between CFCs and certain partnerships--should not have caught many taxpayers and practitioners by surprise. After all, Congress mandated the collection of this information in the TRA '97 through an amendment to Sec. 6038(a)(1)(D)(ii). But not every taxpayer or practitioner has time to track closely such legislative changes. The failure of the 1999 revised instructions to mention the new information requirement sets a precedent that should put taxpayers and practitioners on guard.

The 1999 revised Form 5471 and instructions also fail to mention when taxpayers must begin using the new version. Under Sec. 6038(a)(3) (as in effect prior to amendment by the IRSRRA '98), new information could not be required for an annual accounting period unless the IRS had prescribed by regulations for the furnishing of such information on or before the first day of such annual accounting period, and taxpayers generally could count on the regulations to provide a clear effective date. Now that the Service no longer needs to issue regulations, the form itself, its instructions or an accompanying announcement should provide an explicit effective date.

Based on Sec. 6038(a)(3) (as amended), it can be argued that the IRS cannot require new information for a CFC'S tax years that begin before the new requirements are announced. Under this argument, calendar-year taxpayers need not use the 1999 revised form or report the additional information until 2000.

From a practical perspective, the Service has put many taxpayers in a difficult logistical position by issuing the new version at the end of January 1999 and not providing guidance on its effective date. Rather than face uncertainty and possible penalties for failure to provide required information, many taxpayers have redesigned their internal information-reporting packages, which in many cases already had been sent to foreign subsidiaries, to include questions pertaining to the new information. Taxpayers that had already begun working on their most recent Forms 5471 were faced with the perhaps more vexing issue of whether to start over using the new version. In many cases, a switch to the new version of Form 5471 would have required an entirely new software program to be designed--an option often not viable given the time frame.

In the interest of fairness and good tax administration, the Service (now that it has authority to require reporting of additional information under Sec. 6038 without first issuing regulations outlining the requirements) should indicate clearly the new information required on each new version of Form 5471 and when the new version should be used.

FROM CARL A. DUBERT, J.D., LL.M., AND DAVID B. BADDOUR, CPA, WASHINGTON, DC