New U.S. Reporting Requirements for Foreign Multinationals

This item provides an over-view of (1) new Regs. Sec. 301.6114-1, modifying the reporting requirements for treaty-based return positions, (2) the implications of a recent  Tax Court decision that declared invalid the “timely filing” rule for protective returns and (3) the IRS protective return and permanent establishment initiative.

Reporting Requirements for Treaty-Based Return Positions Modified

On March 13, 2006, the IRS issued final regulations that, in most cases, eliminate the need for foreign companies to file Forms 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), and 1120F, U.S. Income Tax Return of a Foreign Corporation, to disclose receipt of treaty-benefited payments of U.S.-source interest, dividends, royalties and other fixed or determinable annual or periodic  income from related companies, provided such payments are properly reported on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. The change is effective for tax years ending after Dec. 31, 2004.

Under Regs. Sec. 301.6114-1, taxpayers will not be required to report the following on Form 8833:

• Amounts properly reported on Form 1042-S by a withholding agent that is also a reporting corporation for purposes of filing Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation;

• Amounts properly reported on Form 1042-S by a withholding agent that is a U.S. financial institution, a qualified intermediary, a withholding foreign partnership or a withholding foreign trust, if the beneficial owner is a direct account holder or a direct beneficiary or owner, as applicable; or

• Amounts received by other taxpayers (that are not individuals or governments) that have been properly reported on Form 1042-S and do not exceed $500,000 (increased from $10,000) and are not received through an intermediary or flow-through entity.

According to Regs. Sec. 301.6114-1(b), these exceptions do not apply to the extent that reporting is specifically required under the instructions to Form 8833. The current instructions to that form require reporting based on the regulations previously in existence. Presumably, new instructions will be issued by the IRS on a timely basis.

Taxpayers should note that the regulations provide that these reporting exceptions may be modified at any time by changing the instructions to Form 8833, rather than by issuing new regulations. Consequently, they should carefully review these instructions every year to determine whether an exception to filing no longer applies.

Timely Filing Requirement for Foreign Corporations Declared Invalid

Sec. 882(c) requires a foreign corporation to file a true and accurate return “in the manner prescribed” by the Code to benefit from deductions and credits. Since 1990, the regulations under Sec. 882(c) have required a foreign corporation to file its income tax return generally within 18 months of the ordinary due date for filing the return, to protect against a denial of deductions and credits. In Swallows Holding, 126 TC No. 6 (2006), the Tax Court held that Regs. Sec. 1.882-4(a)(2) and -4(a)(3)(i) were invalid to the extent they imposed a timely filing requirement.

Taxpayers should note that if they do not file a return by its due date (including extensions), the foreign corporation may be subject to penalties, including late filing and late payment penalties based on the foreign corporation’s tax liability. The Service’s ability to assess these penalties under appropriate circumstances remains unaffected by the Swallows Holding decision.

Foreign corporations that do not have (or believe they do not have) any income subject to U.S. net income taxation nonetheless may decide to file Form 1120F for one (or more) of the following reasons:

• Unless one of the exceptions discussed previously is met, foreign corporations that claim reduced U.S. taxation based on certain treaty claims must disclose the treaty-based position on Form 8833, which must be attached to Form 1120F, even if Form 1120F would not otherwise  be required;

• The filing of a properly completed Form 1120F starts the statute of limitations (SOL), generally three years from the original due date of a return that otherwise would have been due; in the absence of a Form 1120F filing, the SOL remains open indefinitely;

• If there has been an overwithholding of U.S. tax, the foreign corporation may obtain a refund by filing Form 1120F; and

• Foreign corporations often file a protective Form 1120F pursuant to the regulatory provision partially declared invalid in Swallows Holding, to protect against possible loss of deductions and credits in the event of the IRS successfully alleging that the corporation is subject to net income taxation in the U.S.

IRS Protective Return and PE Initiative

Swallows Holding will have an uncertain effect on IRS enforcement efforts. The IRS’s Large and Mid-Size Business (LMSB) and Small Business/Self-Employed (SBSE) divisions have begun auditing approximately 160 taxpayers that filed protective Forms 1120-F, to determine whether those taxpayers are engaged in a U.S. trade or business or, in the treaty context, have a U.S. permanent establishment (PE). The IRS apparently began this project out of a concern that examiners may not have been adequately addressing the issue in prior years. Although these audits are in the early stages, agents appear to be aggressively pursuing documentation and other information in their Information Document Requests (IDRs). Documents and information typically being requested in the IDRs include:

• An organizational chart of the taxpayer’s worldwide operations, specifying all related entities located in the U.S. that the taxpayer has control over or the right to control.

• The physical address for any assets located in the U.S. that are owned (wholly or in part) by the taxpayer.

• All lease agreements for any items leased by the taxpayer in the U.S.

• All purchase agreements for any items purchased by the taxpayer in the U.S.

• The name and contact information for any U.S.-based person used to market or advertise the company’s products and any written agreements, as well as the details of any verbal agreements.

• The name and contact information for all the company’s U.S. clients in x years and the gross sales to each client.

• The rationale for the taxpayer’s filing a protective return, including the facts and basis on which the taxpayer believes it does not have a U.S. trade or business or PE.

The “best practices” gathered by the IRS from these examinations will be shared with LMSB and SBSE examiners across the country for use in their ongoing examinations. All information obtained will assist the IRS with performing its “functional analysis” regarding the foreign taxpayer and its U.S. business relationships.

From Steve Nauheim, J.D., Bernard Moens, LL.M., and Amy Boyd, J.D., LL.M., Washington, DC