Selected US Tax Developments

Transcription

1 caadia tax joural / revue fiscale caadiee (2016) 64:4, Selected US Tax Developmets Co-Editors: Peter A. Glicklich* ad Michael J. Miller** ONEROUS US REPORTING REQUIREMENTS FOR US MEMBERS OF NON-US FAMILY-CONTROLLED ENTITIES: IT S ALL IN THE FAMILY Peter A. Glicklich* ad Gregg M. Beso* Family wealth ad busiess plaig ofte gives rise to structures that come with burdesome reportig obligatios for miority US shareholders. We poit out some of the cases where the burde is much larger tha it should be, requirig iformatio that would ot ordiarily be shared with the youger geeratio. KEYWORDS: REPORTING INFORMATION TAX PLANNING FAMILY ATTRIBUTION CONTENTS Itroductio 930 Uexpectedly Burdesome US Reportig Requiremets 930 Geeral 930 Typical Example of Uexpected Triggerig of Reportig Obligatios 931 Pealties 932 Key Poits 932 Coclusios 933 Appedix Overview of US Reportig Requiremets 934 US Owers of No-US Corporatios 934 Category Category Category Category Exceptios from Filig 937 US Owers of No-US Parterships 938 Category Category * Of Davies Ward Phillips & Vieberg LLP, New York. ** Of Roberts & Hollad LLP, New York ad Washigto, DC. 929

2 930 caadia tax joural / revue fiscale caadiee (2016) 64:4 Category Category Costructive Owership Rules 939 Exceptios from Filig 939 INTRODUCTION As part of our practice, we frequetly advise private cliets, alog with their families, i family plaig for their closely held ivestmets ad busiess operatios. Owig to the iteratioal ature of these families, this practice gives rise to fasciatig cross-border tax issues. Somewhat less fasciatig ad more frustratig is dealig with the US iformatio-reportig obligatios applicable to US persos that ow iterests i o-us corporatios or o-us parterships. These otherwise basic US iformatio-reportig rules iclude some rather startlig ad uexpected US filig obligatios by, for example, US citizes (frequetly residig abroad) or US residets i youger geeratios who hold relatively small iterests i their families busiesses after a commo equity freeze ad whose o- US family members hold the rest of such busiesses. Uderstadig the broad scope ad applicatio of these iformatio-reportig rules is ecessary to avoid sigificat pealties, ad the potetial compliace burde should be cosidered i choosig certai trasactios ad structures. 1 UNEXPECTEDLY BURDENSOME US REPORTING REQUIREMENTS Geeral The US Iteral Reveue Service (IRS) has a particular iterest i the reportig requiremets applicable to US persos 2 with operatios or ivestmets outside the Uited States. Such operatios or ivestmets ca sigificatly affect the US tax liability of a US perso, but without requirig such US perso to report to the IRS iformatio relatig to its icome or operatios outside the Uited States, it would be challegig for the IRS to obtai the ecessary iformatio with respect to such overseas operatios or ivestmets to determie the accuracy of the US tax liability reported by such US perso. The Code ad the regulatios promulgated thereuder cotai the reportig requiremets applicable to US persos ivestig i o-us corporatios ad o-us parterships, with the former beig reported o form 5471, Iformatio Returs 1 The discussio cotaied herei does ot focus o structurig ad reportig as it relates to gift tax. 2 US persos refers to persos described i sectio 7701(a)(30) of the Uited States Iteral Reveue Code of 1986, as ameded (herei referred to as the Code ), ad icludes US residets ad citizes, as well as domestic corporatios, parterships, trusts, ad estates.

3 selected us tax developmets 931 of U.S. Persos with Respect to Certai Foreig Corporatios, ad the latter beig reported o form 8865, Retur of U.S. Persos with Respect to Certai Foreig Parterships. These reportig requiremets have become eve more importat as the IRS has become icreasigly focused o esurig proper iteratioal tax compliace. The appedix to this article provides a detailed discussio of the complex ad burdesome reportig requiremets, icludig the various owership thresholds that trigger higher ad higher levels of reportig obligatios, the costructive owership rules that will potetially attribute stock held by a o-us perso to a US family member, ad the limited exceptios from reportig. As a result of this potetial attributio from o-us persos to US family members, a US perso with a miority iterest i a o-us etity may be subject to oerous reportig obligatios. Obtaiig the ecessary iformatio for a US perso with a miority iterest i a o-us etity to properly report its iterest i such o-us etity ca be challegig, particularly where the o-us family member is resistat, whether because of a desire ot to disclose to the IRS or because the US perso is estraged from the cotrollig o-residet family member. Typical Example of Uexpected Triggerig of Reportig Obligatios These types of uexpected reportig obligatios ofte come up i commo familyplaig arragemets, such as preferred stock freeze trasactios. I a typical preferred stock freeze trasactio, the equity i a family busiess is recapitalized ito a preferred class of stock ad a commo class of stock. The preferred stock, which will be retaied by the older geeratio ad may retai votig cotrol of the compay, represets most of the value of the family busiess, while the commo stock, which will be trasferred to the youger geeratio, represets a sliver of the curret value, but ay future appreciatio i the family busiess will flow to the commo stock. I this situatio, if the busiess is orgaized ad operated outside the Uited States ad oe of the family members are US persos, the reportig obligatios discussed herei geerally will ot apply. If a member of the youger geeratio decided to move to the Uited States, the expectatio might be that these filig obligatios would ot be triggered because he or she ows such a small sliver of the busiess. The above-metioed family attributio rules, however, would potetially cause the shares held by the older geeratio to be attributed to the youger US perso, thereby triggerig these reportig requiremets. The ability of the US perso that lacks cotrol of the busiess ad holds just a sliver of the busiess to obtai the iformatio ecessary to comply with the reportig obligatios is questioable at best, particularly without the cooperatio of the cotrollig o-us family members. I additio, these uexpected reportig obligatios ca occur eve if the o-us corporatio or partership is held idirectly through a trust or holdig compay as a result of the broad costructive owership rules that apply to determie whether a US perso has a reportig obligatio.

4 932 caadia tax joural / revue fiscale caadiee (2016) 64:4 Pealties Betwee the varyig filig category requiremets ad costructive owership rules (discussed i the appedix), the ususpectig US perso ca fid himself or herself with a uexpected form 5471 or form 8865 filig obligatio. Failure to meet such obligatio could subject the o-compliat US perso to sigificat pealties. Specifically, a $10,000 pealty is imposed for each aual accoutig period of each o-us corporatio or partership for failure to timely file a properly completed form 5471 or form 8865, uless the failure to file is due to reasoable cause. If the failure to file cotiues for more tha 90 days after the date o which the IRS mails otice of the failure, there is a additioal pealty of $10,000 for each 30-day period durig which the failure to file cotiues after the 90-day period has expired (up to a maximum of $50,000 for each failure). I additio, a US perso that fails to file a properly completed form 5471 or form 8865 may, i certai circumstaces, lose the beefit of foreig tax credits. KEY POINTS As discussed above, the broad attributio rules relatig to o-us family members ca give rise to uexpected reportig obligatios for US persos with miority iterests i o-us busiesses, ad compliace with these obligatios may be challegig at best. Specifically, i the o-us corporatio cotext ad the o-us partership cotext, a US perso with a small iterest i a o-us etity that has a filig obligatio as a result of attributio from a o-us family member eeds to obtai the ecessary iformatio to facilitate completio ad reportig of a icome statemet ad a balace sheet of the o-us etity. I the corporate cotext, the US perso will also eed to provide a descriptio of each class of stock of the o-us corporatio, ay taxes paid by the o-us corporatio, ad iformatio regardig certai other US persos that ow shares of the o-us corporatio. I the o-us partership cotext, the US perso will eed to provide iformatio about certai other parters of the o-us partership, iformatio regardig certai parterships owed by the o-us partership, ad a recociliatio of book icome or loss to taxable icome or loss. We recommed reasoable modificatios to these reportig rules to reflect the practicality of whether a US perso would be able to or should be required to comply with these reportig obligatios, ad to help the IRS to more arrowly focus its iformatioal retur requests to facilitate compliace by US persos where such US persos will actually have or be able to obtai the required iformatio. For example, does it really make sese that a US perso owig o shares of a family-owed busiess would have o reportig obligatios, but a US perso owig 1 percet of a family busiess would be required to provide the IRS with detailed fiacial iformatio for the busiess? I Estate of N.S. Miller v. Commissioer, 3 the Tax Court held that for the purposes of the repealed foreig persoal holdig compay rules, the costructive owership 3 43 TC 760 (1965).

5 selected us tax developmets 933 rules should ot cause shares i a Caadia corporatio held by two Caadia sisters to be attributed to a US siblig for the purposes of treatig the Caadia corporatio as a foreig persoal holdig compay, where the US siblig did ot directly ow ay shares of the Caadia corporatio. Although the costructive owership rules would have required such attributio, o the basis of cocepts of fairess, the Tax Court uderstood that such broad attributio rules would give rise to uexpected ad overly burdesome tax costs ad compliace issues. The foreig persoal holdig compay rules cosidered i Estate of N.S. Miller o loger exist. Ideed, the cotrolled foreig corporatio (CFC) rules 4 (ad the subpart F icome regime applicable to US shareholders of a CFC) 5 that remai geerally prevet attributio to a US perso from his or her o-residet-alie family members. Reportig is ofte techically required despite this limitatio o the operatio of the subpart F rules. Oe area that could be used as a poit of compariso is the applicatio of the passive foreig ivestmet compay (PFIC) rules. 6 The PFIC rules are a US ati-deferral regime that geerally requires a US perso that ows shares of a PFIC to be subject to tax at ordiary icome rates o certai distributios from ad dispositios of a PFIC, with such amouts beig subject to a iterest charge based o the US perso s holdig period i such shares. The PFIC rules apply to US persos that are direct or idirect shareholders i a PFIC. For the purposes of determiig whether a US perso is a idirect shareholder of a PFIC, (1) if a perso ows 50 percet or more i value of the stock of a o-us corporatio that is ot a PFIC, such perso is treated as owig his or her proportioate share of ay stock owed directly or idirectly by that corporatio; ad (2) if a perso ows stock of a PFIC, such perso is treated as owig his or her proportioate share of ay stock held by such PFIC (without regard to the 50 percet requiremet). Therefore, for PFIC purposes, lower-tier reportig is ot required if the top-tier etity is ot a PFIC ad the US perso ows less tha 50 percet of the top-tier etity. By aalogy, limitig detailed o-us-etity reportig requiremets of US persos to (1) etities i which the US perso ows a direct 50 percet or greater iterest ad (2) ay etity owed by such top-tier etity would be reasoable from a compliace perspective sice the US perso would have the ability to obtai the desired iformatio or cotrol the ivestmets of the toptier etity. CONCLUSIONS I a perfect world, we would say that the IRS has idetified the compliace challeges that the iformatio-reportig requiremets are creatig for US persos that ow miority iterests i o-us etities ad is i the process of addressig them. Perhaps these challeges could be addressed by modifyig the rules to reflect somethig more similar to the idirect shareholder rules i the PFIC cotext, extedig 4 Sectio 957(a) of the Code. 5 Sectio 951(a) of the Code. 6 Sectio 1297 of the Code.

6 934 caadia tax joural / revue fiscale caadiee (2016) 64:4 the o-residet attributio exceptio for CFC purposes to the other filig categories for o-us corporatios ad o-us parterships, or expadig the exceptio from o-residet attributio for US family members that do ot ow a direct iterest i the o-us etity to iclude US family members that ow less tha a certai threshold iterest (for example, 10 percet). But we do ot live i a perfect world; i fact, i the world we live i, the IRS is lookig to expad, ot limit, reportig requiremets, particularly as they relate to o-us persos ad etities. The poit of this discussio is really to icrease awareess of the various ways i which family ivestmets i o-us etities that are ot cotrolled by US persos ca create oerous ad uexpected US filig obligatios ad, if ot complied with, give rise to potetially costly US tax pealties. Makig sure that families uderstad these potetial US obligatios ahead of time ca allow families to pla for whether they wat to eter ito a structure that will give rise to such obligatios, ad if so, whether miority US family members will be provided with the iformatio ecessary to comply with these reportig obligatios. There are may reasos to reach out to estraged family members to resolve issues ad heal wouds. Although admittedly low i priority, perhaps we ca add to that list the importace of esurig that o-us cotrollig iterest holders are willig to provide etity iformatio to US family members ecessary for those family members to comply with US reportig requiremets. I that way, we ca thik of these US reportig requiremets as brigig families together, oe form 5471 or form 8865 at a time. APPENDIX OVERVIEW OF US REPORTING REQUIREMENTS US Owers of No-US Corporatios A brief overview of the form 5471 filig categories applicable to US persos that ow shares of a o-us corporatio is set forth below. 7 Category 2 Geeral Rules A US perso will have a category 2 filig obligatio if such US perso is a citize or residet of the Uited States that is a officer or director of the o-us corporatio, ad, durig the time that such US perso is a officer or director, ay US perso (that is, ot ecessarily the officer or director) (1) acquires outstadig stock that whe added to such US perso s stock represets 10 percet or more of the total value or votig power of such corporatio ( the 10 percet stock owership requiremet ) or (2) acquires additioal stock that o its ow satisfies the 10 percet stock owership requiremet. 7 There were previously five categories of form 5471 filers, but oe such category, category 1, became obsolete with the 2004 repeal of the foreig persoal holdig compay rules.

7 Costructive Owership Rules selected us tax developmets 935 For the purposes of determiig whether the 10 percet stock owership requiremet is satisfied, the followig costructive owership rules apply: Etity attributio. Stock owed directly or idirectly by or for a o-us corporatio or a o-us partership is cosidered to be owed proportioately by its shareholders or parters. Family attributio. A US perso is cosidered to ow the stock owed directly or idirectly by his or her sibligs, spouse, acestors, ad lieal descedats (but there is o reattributio uder this family attributio rule). Category 3 Geeral Rules Category 3 imposes a filig obligatio o a US perso that (1) acquires outstadig stock that whe added to such US perso s stock meets the 10 percet stock owership requiremet; (2) acquires additioal stock that o its ow satisfies the 10 percet stock owership requiremet; (3) is treated as a US shareholder of such corporatio for subpart F purposes solely because of the related-party isurace rules applicable to captive isurace compaies; 8 (4) becomes a US perso while meetig the 10 percet stock owership requiremet; or (5) disposes of sufficiet stock i the corporatio to reduce such US perso s iterest to less tha the 10 percet stock owership requiremet. Costructive Owership Rules For the purposes of determiig whether the 10 percet stock owership requiremet is satisfied, the followig costructive owership rules apply: Etity attributio. Stock owed directly or idirectly by or for a o-us corporatio or a o-us partership is cosidered to be owed proportioately by its shareholders or parters. Family attributio. A US perso is cosidered to ow the stock owed directly or idirectly by his or her sibligs, spouse, acestors, ad lieal descedats (but there is o reattributio uder these family attributio rules). Category 4 Geeral Rules Category 4 imposes a filig obligatio o a US perso that has cotrol of a o-us corporatio for a uiterrupted period of at least 30 days durig the aual accoutig period of such corporatio. A US perso is treated as havig cotrol of a 8 A discussio of these rules is beyod the scope of this article.

8 936 caadia tax joural / revue fiscale caadiee (2016) 64:4 o-us corporatio if such perso ows (1) stock possessig more tha 50 percet of the total combied votig power of all classes of stock etitled to vote or (2) more tha 50 percet of the total value of shares of all classes of stock of the o-us corporatio. If a US perso is i cotrol of a corporatio, ad such perso is i cotrol of a lower-tier corporatio, the US perso will be treated as beig i cotrol of such lower-tier corporatio. Costructive Owership Rules For the purposes of determiig whether a US perso has cotrol of a o-us corporatio, the followig costructive owership rules apply: Attributio from etities Stock owed by a partership or a estate is cosidered to be owed proportioately by its parters or beeficiaries. Stock owed by a trust geerally is cosidered to be owed by the trust s beeficiaries i proportio to their actuarial iterest i the trust. Stock owed by a grator trust is cosidered to be owed by the ower of the grator trust. Stock owed directly or idirectly by or for a o-us corporatio or a o- US partership is cosidered to be owed proportioately by its shareholders or parters. Stock owed by a corporatio is cosidered to be owed proportioately by ay shareholder that holds stock represetig at least 10 percet of the value of the corporatio. Attributio to etities. Except to the extet that the attributio rules below would apply to treat a US perso as owig stock of a perso that is ot a US perso, stock owed by a parter or beeficiary of a estate is cosidered to be owed by the partership or the estate; stock owed by a beeficiary of a trust geerally is cosidered to be owed by the trust; ad stock owed by a perso that ows stock of a corporatio represetig at least 50 percet of the value of such corporatio will be treated as beig owed by such corporatio. Family attributio. A US perso is cosidered to ow the stock owed directly or idirectly by his or her spouse, childre, gradchildre, ad parets. Category 5 Geeral Category 5 imposes a filig obligatio o every Uited States shareholder ( US shareholder ) that ows stock of a cotrolled foreig corporatio (CFC) for a uiterrupted period of 30 days or more durig ay tax year of such corporatio, ad that owed such stock o the last day of that year. A US shareholder is a US perso that ows directly, idirectly, or costructively 10 percet or more of the total combied votig power of all classes of votig stock of a CFC. A CFC is a o-us corporatio

9 selected us tax developmets 937 that has US shareholders that ow (directly, idirectly, or costructively) o ay day of the tax year of such o-us corporatio, more tha 50 percet of (1) the total combied votig power of all classes of its votig stock or (2) the total value of the stock of such corporatio. Costructive Owership Rules For the purposes of determiig whether a o-us corporatio is a CFC ad whether a US perso is a US shareholder, the followig costructive owership rules apply: Attributio from etities Stock owed by a partership or a estate is cosidered to be owed proportioately by its parters or beeficiaries. Stock owed by a trust geerally is cosidered to be owed by the trust s beeficiaries i proportio to their actuarial iterest i the trust. Stock owed by a grator trust is cosidered to be owed by the ower of the grator trust. Stock owed directly or idirectly by or for a o-us corporatio, a o- US partership, a o-us trust, or a o-us estate is cosidered to be owed proportioately by its shareholders, parters, or beeficiaries, respectively. Stock owed by a corporatio is cosidered to be owed proportioately by ay shareholder that holds stock represetig at least 10 percet of the value of the corporatio. Attributio to etities. Except to the extet that the attributio rules below would apply to treat a US perso as owig stock of a perso that is ot a US perso, stock owed by a parter or beeficiary of a estate is cosidered to be owed by the partership or the estate; stock owed by a beeficiary of a trust geerally is cosidered to be owed by the trust; ad stock owed by a perso that ows stock of a corporatio represetig at least 50 percet of the value of such corporatio will be treated as beig owed by such corporatio. Family attributio. A US perso is cosidered to ow the stock owed directly or idirectly by his or her spouse, childre, gradchildre, ad parets, except that stock owed by a o-residet alie idividual will ot be attributed to a US perso uder this family attributio rule. Exceptios from Filig The reportig regulatios provide certai exceptios iteded to grat relief from filig i situatios where filig is ot feasible or to elimiate the eed for duplicate filigs. Oe such exceptio provides that a US perso that would otherwise be required to file uder category 3, category 4, or category 5 will ot be so required if (1) the US perso does ot ow a direct iterest i the o-us corporatio; (2) the US perso s filig requiremet is solely due to costructive owership through aother US

10 938 caadia tax joural / revue fiscale caadiee (2016) 64:4 perso; ad (3) the US perso through which the idirect shareholder costructively ows a iterest i the o-us corporatio files form 5471 reportig all of the required iformatio. Aother exceptio worth otig applies with respect to category 4 ad category 5. Uder this exceptio, a US perso that would otherwise be required to file uder category 4 or category 5 will ot be so required if the US perso (1) does ot ow a direct or idirect iterest i the o-us corporatio ad (2) is required to file form 5471 solely because of costructive owership through a o-residet alie (that is, pursuat to the family attributio rules). This exceptio is of limited value with respect to category 5 filers because the category 5 costructive owership rules already provide that the family attributio rules will ot apply to cause a US perso to be treated as owig stock held by a o-us family member. However, because category 4 cotais o such o-residet alie attributio prohibitio, this exceptio does provide some relief for US persos that would otherwise have a category 4 filig obligatio as a result of attributio of shares held by o-us family members. US Owers of No-US Parterships A brief overview of the form 8865 filig categories applicable to US persos that ow shares of a o-us corporatio is set forth below. Category 1 A US perso will have a category 1 filig obligatio if such US perso is a cotrollig fifty-percet parter, which is to say that such US perso cotrolled the o-us partership at ay time durig the partership s taxable year. For the purposes of this category, cotrol is defied as owership of more tha 50 percet of the capital or more tha 50 percet of the profits, or owership of a iterest to which more tha 50 percet of the deductios or losses are allocated. Category 2 A US perso will have a category 2 filig obligatio if (1) such US perso at ay time durig the taxable year of the o-us partership ows at least 10 percet of the capital or profits of the partership or is allocated at least 10 percet of the losses ad deductios of the partership (a 10 percet partership iterest ); ad (2) more tha 50 percet of the capital or profits of the partership are owed by, or more tha 50 percet of the losses ad deductios of the partership are allocated to, oe or more US persos each of whom satisfies the 10 percet partership iterest requiremet. Category 3 A US perso will have a category 3 filig obligatio if such US perso cotributed property durig the taxable year to a o-us partership i exchage for a iterest i the partership ad either (1) the US perso owed directly or costructively at least a 10 percet partership iterest i the o-us partership immediately after the cotributio; or (2) the value of the property cotributed by that perso, whe

11 selected us tax developmets 939 added to the value of ay other property cotributed to the partership by such perso (or ay related perso) durig the 12-moth period edig o the date of trasfer, exceeds $100,000. Category 4 A US perso will have a category 4 filig obligatio if such US perso egages i certai reportable evets with respect to a o-us partership durig the year, icludig (1) a acquisitio by the US perso of a 10 percet partership iterest i a o-us partership (without regard to ay iterest already owed); (2) a acquisitio by the US perso that does ot have a 10 percet partership iterest if followig such acquisitio, the US perso has a 10 percet partership iterest (takig ito accout ay iterest already owed); (3) a dispositio of a 10 percet partership iterest by a US parter; or (4) a dispositio that causes a US parter that held a 10 percet partership iterest prior to the dispositio to o loger have a 10 percet partership iterest after the dispositio. Costructive Owership Rules A sigle set of costructive owership rules applies to determie whether a US perso has a form 8865 filig obligatio. These rules provide as follows: Attributio from etities. Partership iterests owed directly or idirectly by a corporatio, partership, estate, or trust are cosidered to be owed proportioately by its shareholders, parters, or beeficiaries, respectively. Attributio to etities. There is o attributio of partership iterests held by a shareholder, parter, or beeficiary to a corporatio, partership, estate, or trust, respectively. Family attributio. A US perso is cosidered to ow partership iterests owed directly or idirectly by his or her spouse, childre, gradchildre, ad parets, except that attributio from a o-residet family member to a US perso ca apply oly if the US perso ows a direct or a idirect iterest i the partership. Exceptios from Filig As i the case of the form 5471 filig requiremets, the reportig regulatios provide certai exceptios to the form 8865 filig requiremets. Oe such exceptio provides that a US perso that would otherwise be required to file uder category 1 or category 2 will ot be so required if (1) the US perso does ot ow a direct iterest i the o-us corporatio; (2) the US perso s filig requiremet is solely due to costructive owership through aother US perso; ad (3) aother US perso satisfies the form 8865 filig requiremet. This exceptio, however, is limited to attributio through a US perso that will otherwise be able to comply with the US reportig requiremets, ad provides o relief for a US perso where a iterest i the o-us partership is attributed through a o-us family member.

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