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Supplemental comments on Form 5471: deviations from GAAP.

Supplemental Comments on Form 5471: Deviations from GAAP


In our November 16 letter, we observed that 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 [GAAP] and in such form and detail as is customary for the corporation's accounting records." We stated that the instructions to the revised Form 5471 had deleted a statement essentially mirroring this regulatory requirement. The Institute expressed concern that the revised form requires the submission of information that may be inconsistent with GAAP principles. Your office requested additional information on how the information required on Schedules C through G differs from GAAP. We are also including several additional comments on the revised Form 5471.

General Comments

Although we continue to question the need for the information required on the schedules, the most significant problem involves the translation of foreign currency for purposes of Schedules C, D, F, and G. The instructions require the taxpayer to compute the relevant information in the foreign corporation's functional currency and then translate all amounts into U.S. dollars at the weighted average exchange rate set forth in Temp. Reg. [section] 1.989(b)-1T. That regulation defines "weighted average exchange rate" as the "simple average of the daily exchange rates . . . excluding weekends, holidays and any other nonbusiness days for the taxable year."

The use of a simple weighted average exchange rate deviates from GAAP which requires the translation of transactions at the exchange rate in effect for the date of the transaction. It also conflict with Treas. Reg. [section] 1.6038-2(g) which, when read in conjunction with Treas. Reg. [section] 1.6038-2(h), requires the financial information to be translated in accordance with GAAP.

Moreover, the requirement of a simple weighted average exchange rate imposes substantial administrative burden on taxpayers. Taxpayers will not be able to rely on financial statements prepared by their foreign affiliates (under GAAP) as required for the calculation of U.S. tax-basis earnings and profits, but instead will be required to unravel entire transactions to comply with the requirement. Such an horrendous chore is a costly duplication of effort, will not raise additional revenue, and is totally unnecessary with respect to an information return. Taxpayers using computer systems to facilitate preparing the information return will face severe obstacles in conforming to the new requirements, especially at such a late date.

Finally, we continue to believe that taxpayers should be permitted to submit GAAP financial statements in lieu of filling out the information required on Schedules C through G.

Schedule C: Income Statement

1. GAAP does not require the separate disclosure of revenues and expenses in de minimis amounts. Schedule C, however, contains no de minimis exclusion.

2. GAAP books will often report expenses on a functional basis. For example, a taxpayer is likely to report research and development (R&D), marketing, and general and administrative (G&A) expenses according to GAAP books. These expense categories would include compensation, rent, depreciatio, and other expenses. Requiring a breakdown of these expenses (as required on lines 10-16 of Schedule C) creates substantial administrative burden for taxpayers that are required to maintain such data for no other purpose.

Schedule D: Cost of Goods Sold

3. GAAP does not require purchases, wages and salaries, and other costs (lines 2, 3, and 4 of Schedule D) to be separately disclosed as components of cost of goods sold. Internal GAAP books are often prepared on a functional or product-line basis, rather than by the type of expenditure.

4. Non-deductible inventory reserves are generally deducted in arriving at beginning and ending inventory. IRS agents reviewing Schedule C may be confused by the use of net book inventory balances when doing computations such as the uniform capitalization calculations which require tax-basis balances. Inventory balances must agree with Schedule F (Balance Sheet).

Schedule F: Balance Sheets

5. GAAP does not require the separate disclosure of assets and liabilities in de minimis amounts. Schedule F, however, does not provide a de minimis exception.

Schedule G: Analysis of

Unappropriated Retained


6. GAAP requires the analysis of all retained earnings, not just unappropriated retained earnings. Therefore, this requirement is an additional unwarranted burden on taxpayers.

7. GAAP does not require that distributions be identified as being from any particular year. Further, distributions for GAAP and E&P purposes may differ. Because Financial Accounting Standard (FAS) No. 52 requires translation at different rates for different years, and because of differences between GAAP income and E&P for a single year, a company may have a deficit in GAAP income, but positive E&P (or vice versa). Distributions for GAAP purposes would be reflected as a reduction of paid-in-capital, not retained earnings.

Schedule H: Current Earnings

and Profits

8. Line 1 of Schedule H (current year net income or (loss) per foreign books of account) is clearly an after-tax figure. Taxpayers do not maintain such information in their financial accounting records since it has not been required in the past. Such a calculation would place additional burdens on large multinationals in retrieving data not required under Treas. Reg. [section] 1.6038-2.

On the old Form 5471, this figure was a pre-tax computation with taxes reported on line 8. We question the reason for such a change, since there is not now one schedule showing pre-tax E&P, taxes, and after-tax E&P which would make it easier for the IRS to audit the return.

9. It should be clarified in the instructions that line 2h of Schedule H refers to income taxes.

Schedule J: Accumulated

Earnings and Profits

10. The prior instructions for completing this schedule (formerly Schedule K) provided that reporting was required only if the taxpayer had Subpart F income or was required to complete Schedule O (reporting a change in ownership during the year). These instructions, however, have been deleted from the revised Form 5471. Thus, it appears that taxpayers are required to report cumulative E&P in U.S. dollars for each controlled foreign corporation -- a horrendous burden for multinationals with hundreds of subsidiaries. We fail to see any need for requiring this data in light of the fact that information on subsidiary distributions (i.e., Subpart F inclusions and cash dividends) is provided elsewhere in the tax return. Furthermore, the information on non-dividend companies is irrelevant to a determination of current year's tax liabilities. (1) We strongly suggest that the prior instruction be restored.

Schedule M: Transactions

Between Controlled Foreign

Corporations and Shareholders

or Other Related Persons

11. Former Schedule G (Loans to and from Shareholders and Other Related Persons) has been dropped in favor of lines 9 and 18 on Schedule M. The instructions to Schedule M should be clarified to indicate whether the amounts required to be shown on lines 9 and 18 are cumulative, year-end, average balances, or some other figure.


Tax Executives Institute appreciates this opportunity to supplement our views on the revised Form 5471. If you have any questions, please do not hesitate to call Ralph J. Weiland, chair of TEI's IRS Administrative Affairs Committee, at (708) 937-8523 or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at (20) 638-5601.

(1) Because cumulative earnings and profits are maintained in functional currency and, but for this requirement, are translated into U.S. dollars only when a dividend is paid or a Subpart F inclusion occurs, the value of the information to be gleaned from the schedule is questionable.
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Publication:Tax Executive
Date:Jan 1, 1991
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