Form 5471 reporting for resident aliens complicated by family attribution rules.
These reporting rules may have a significant impact on foreign individuals who become U.S. residents and whose families own foreign businesses, because of the various ownership attribution rules contained in the applicable regulations.
Example: Executive E is a national of country X. E is transferred to oversee the U.S. operations of company A, a family business, while his parents and siblings remain in X to conduct A's business activities there, including the activities of several other X affiliates. E owns a minority interest in A, and also has minority ownership interests in some, but not all, of A's foreign affiliates (all of whose activities are conducted in X); his parents and siblings own the other outstanding shares of these companies. Several of the companies are holding companies or investment companies, whose use is common in X.
Although prudent tax planning may dictate the use of such holding companies and investment companies in X, these types of companies may trigger the application of very unfavorable U.S. tax rules applicable to controlled foreign corporations (CFCs), foreign personal holding companies (FPHCs) and passive foreign investment companies (PFICs), as well as onerous reporting rules.
FPHC reporting rules
Sec. 6035 and the related regulations require U.S. officers, directors and 10% shareholders of FPHCs to file information reports on such companies with their personal U.S. income tax returns. Regs. Sec. 1.6035-1(b)(2)(i) provides that the term 10% shareholder "means any individual who owns directly or indirectly (within the meaning of section 554) 10 percent or more in value of the outstanding stock of a foreign corporation." Ownership of stock in an FPHC must be attributed to an individual from his spouse, ancestors, lineal descendants, and brothers and sisters (Sec. 554(a)(2)). Under Sec. 554(c), special rules limit the attribution of stock from nonresident alien family members to a U.S. citizen or resident who is not the spouse of the nonresident individual. This limitation applies, however, only if the resident individual owns no stock in the FPHC directly. Thus, if a U.S. individual owns even one share of stock in a company that meets the FPHC definition, stock ownership must also be attributed to him from nonresident family members, and such attributed stock can cause the greater-than-50%-ownership requirement for FPHC status to be satisfied. Executive E in the example will consequently face a reporting requirement for all of the family companies in which he directly owns any stock, if they otherwise meet the FPHC definition.
Although beyond the scope of this article, the resident alien must also consider the rules applicable to his interest in any entity that meets the definition of a PFIC under Secs. 1291-1297. It is likely that these rules will apply to most foreign holding and investment companies, as well as to many businesses that might normally be considered active. Although the PFIC rules do not attribute stock ownership top an individual from other family members, they apply even to minority U.S. shareholders in foreign companies that are controlled by foreign persons. Consequently, the PFIC rules are also potentially applicable to any of the foreign companies in which a transferred executive owns even one share of stock.
General foreign corporation
Sec. 6046 imposes an information return filing requirement for a foreign corporation any time it undergoes a 5% or greater ownership change that involves a U.S. person. Under Regs. Sec. 1.6046-1(c)(3)(ii)(b), a nonresident alien shareholder is treated as having "acquired" the stock of a foreign company on the date he becomes a U.S. resident. As a result, a foreign person who moves to the United States and becomes a resident under Sec. 7701(b) must file Form 5471 for each foreign corporation in which the individual owns 5% or more of the outstanding stock. For an individual whose family owns several foreign businesses, this requirement can be onerous. Furthermore, under Sec. 6046(c), the individual must take into account any stock owned by other family members when applying the 5% ownership test. For this purpose, an individual's family includes brothers and sisters, as well as the individual's spouse, ancestors and lineal descendants (Regs. Sec. 1.6046-1(i)(2)).
The only exception to the attribution rules under Sec. 6046 is contained in Regs. Sec. 1.6046-1(e)(4)(iii). Persons who do not directly own interests in a foreign corporation are exempt from the filing rules if they must file solely by reason of attribution of stock ownership from another U.S. person. There are no exceptions under Sec. 6046 or the related regulations to eliminate attribution from nonresident alien family members, however. As a result, the new U.S. resident in the example above may be required to file Form 5471 to report information regarding foreign corporations in which he does not have any direct ownership.
Although it is difficult to believe that a new U.S. resident must request financial information from other family members on corporations in which he has no direct ownership interest solely to report such information to the IRS, the regulations appear to require this result. What makes the reporting rules even more nonsensical is that the activities of such companies will not directly affect the resident alien's U.S. tax liability; the anti-avoidance rules (i.e., the subpart F, PFIC and FPHC rules) do not attribute income to persons who are only indirect owners because of family attribution, even though such ownership may trigger reporting rules.
A U.S. person, including a resident alien, is also required to file a Form 5471 for any corporation in which the U.S. person owns more than 50% of either the voting power or value, as well as for any foreign corporation that meets the definition of a CFC for an uninterrupted period of 30 days or more during its fiscal year, and in which the U.S. person owns 10% or more of the voting stock (Regs. Sec. 1.6038-2). The attribution rules under Sec. 6038 generally incorporate the ownership attribution rules of Sec. 318, which include attribution from spouses, children, grandchildren and parents. Under these rules, no distinction is made between family members who are U.S. citizens or residents and those who are nonresident aliens. Consequently, executive E in the example will be attributed with the ownership of any stock held by his parents, and will be required to file Form 5471 on an ongoing basis report the activities of any corporation that his parents "control" within the meaning of Sec. 6038(e).
It is likely that E will be required to file information returns not only for A, which he is representing in the United State, but also for all A's X affiliates, including those in which he owns no stock, at least in the year in which he becomes a U.S. resident. The information reporting rules. may become even more burden-some if the foreign person remains in the United States for an extended period of time, but not permanently. In such situations, it will probably be undesirable, particularly from a foreign tax standpoint, to attempt to permanently restructure the ownership of the companies to accommodate the peculiarities of the U.S. tax rules applicable to U.S. owners of foreign entities.
Although ignoring U.S. reporting requirements might be tempting in these circumstances, various penalties for nonfiling may apply, including a $1,000 penalty for each separate failure, and possible criminal penalties under Secs. 7203, 7206 and 7207. As a result, the new U.S. resident (and his tax advisers) may have to simply "grin and bear it" during his stay in the United States.
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|Author:||Smaston, Carla M.|
|Publication:||The Tax Adviser|
|Date:||Dec 1, 1992|
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