US Outbound Tax Issues

US companies do business overseas using many forms and structures, e.g., controlled foreign corporations (CFC's), partnerships, trusts, hybrid entities, etc. A typical form of doing business outside the U.S. is through a corporation that is organized in a foreign country. The amount of stock owned by U.S. persons determines whether such corporation is a CFC. By definition, a foreign corporation is a corporation that is not created or organized in the U.S. A CFC is foreign corporation where more than 50% of the total combined voting power of all classes of stock of the corporation entitled to vote or the total value of the stock is owned by U.S. shareholders on any day during the foreign corporation's tax year.

A U.S. shareholder is a US person that owns 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. The term U.S. person includes: a citizen/resident of the U.S.; a domestic partner; a domestic corporation; a U.S. estate; and a U.S. trust.

To determine whether a U.S. person is a U.S. shareholder under these rules, the U.S. person is considered to own stock when the U.S person owns such stock directly, indirectly through foreign entities or constructively under certain rules that attribute stock ownership from one entity to another.

Taxing U.S. Shareholders on CFC Profits

Under the application of Subpart F of the Internal Revenue Code, US shareholders must include in their income actual distributions from a the CFC as well as their share of certain undistributed income from the CFC. Subpart F includes in gross income: passive investment income; income from the purchase or sale of goods to certain related entities; certain types of shipping and oil-related income; insurance income; income from "bad conduct" activities. A U.S. shareholder also must include his/her share of the CFC's increase in earnings that is invested in U.S. property as set forth in Section 956 of the Internal Revenue Code. Additionally, a U.S. shareholder of a CFC is likely liable for U.S. taxation and must therefore maintain records establishing gross income amounts, credits and deductions.

Reporting Foreign Ownership

A U.S. shareholder of a CFC must file IRS Form 5471 if: the U.S. person owns more than 50% of the CFC; is an officer or director of the CFC and since the last time Form 5471 was filed, a U.S. person acquired five percent or more of the CFC's stock; the U.S. person acquires five percent or more in stock of the CFC or acquires an additional five percent or more of stock or owns five percent or more in stock when the CFC is reorganized the person becomes a U.S. person while owning five percent or more of the CFC's stock; the U.S. shareholder owns between 10% to 50% of the CFC's stock for an uninterrupted period of 30 days or more on the last day of the foreign corporation's tax year; the U.S. shareholder owns any stock of the CFC that is a "captive insurance company" on the last day of the foreign corporation's tax year. The U.S. taxpayer must file Form 5471 for each CFC by the due date of the taxpayer's income tax return. Civil and criminal penalties may apply if the taxpayer fails to file the return or fails to report all of the information required on Form 5471.

International Boycotts

Section 999 of the Internal Revenue Code penalizes companies that enter into secondary and tertiary boycotts. The boycott provisions authorize: the reduction of foreign tax credits; an increase in Subpart F income; the reduction of foreign sales corporation and domestic international sales; and penalties for the willful failure to report boycott activities. IRS Form 5713 must be filed if a person has operations in a boycotting country. This form is filed with the taxpayers annual return and is due by the due date of that return.

Foreign Income Taxes and Credits

A limited amount of the foreign income taxes paid by a U.S. taxpayer may be credited against the U.S. taxpayer's tax liability or deducted in calculating taxable income on the U.S. taxpayer's income tax return. It is usually more advantageous to claim the credit rather than the deduction. To claim foreign income tax credit, IRS Form 1116 must be completed and attached to the U.S. taxpayer's income tax return. There are no limits on the amount of foreign taxes for which a U.S. taxpayer may claim a foreign tax credit. The credit, however, cannot exceed the part of the U.S. taxpayer's U.S. income tax liability that is allocable to his/her taxable income from sources outside of the U.S. Thus, if the U.S. taxpayer has no U.S. income tax liability, the taxpayer will not be able to claim a foreign tax credit. Note that if the foreign taxes paid by the U.S. taxpayer during the year exceed the limit of the taxpayer's credit for the current year, the taxpayer can carry back the unused credits to two prior tax years and forward for five years.

Outbound Transfers of Property

IRS Form 926 must be filed if the taxpayer: transfers property to a CFC as paid-in surplus or contributions to capital; or transfers property to a CFC in an exchange describe in Sections 367(a) or (d) or if the taxpayer elects to apply principles similar to those under Section 367 to the transfer. Form 926 is due on the day the taxpayer makes the transfer and the form is filed with the IRS Service Center where the taxpayer is required to file his/her income tax return.

Annual Withholding Tax Reporting

IRS Form 1042 must be filed to report tax withheld on certain payments to a CFC or other foreign person.

Consolidated Reporting

IRS Form 1122 must be provided by the CFC and attached to the taxpayer's income tax return. The benefit of having the CFC's return filed as part of the taxpayer's domestic consolidated income tax return is only available if the taxpayer owns 100% of the CFC and the CFC is organized in Canada or Mexico and it was incorporated solely to comply with local foreign law.

Passive Foreign Investment Company Reporting

IRS Form 8621 must be filed if the taxpayer is a shareholder of a CFC that also meets the definition of a passive foreign investment company.

U.S. Personal Holding Company Reporting

Form 1120 is required of every CFC that is a personal holding company who has to file a U.S. tax return.

Tax Treaty

The main objective of all U.S. tax treaties is the avoidance of double taxation. Income tax treaties prevent double taxation by allowing one country to tax a particular type of income.

Treaty Objectives

The main objective of all U.S. tax treaties is the avoidance of double taxation. Income tax treaties prevent double taxation by allowing one country to tax a particular type of income.

Treaty Definitions

The terms "fixed base" and "permanent establishment" generally mean a fixed place of business through which an enterprise conducts its business. A common treaty principle is the right to tax the income of a permanent establishment by the country in which the PE is located. To claim the benefits of a treaty, the taxpayer must have the U.S. government certify that the taxpayer has filed a U.S. tax return.

Treaty-Based Return Positions

When a U.S. taxpayer takes the position that any U.S. tax is reduced by a U.S. tax treaty, the taxpayer must disclose this position on the taxpayer's U.S. tax return.

US offshore tax issues