In the overview of the series, we advised that in addition to filing income tax returns, U.S. citizens residing outside the U.S. need to file various reports in respect of foreign holdings. Failure to file these reports can result in onerous penalties. In part III of the series, we will discuss the requirements to file the Form 5471: Interest in Foreign (Canadian) Corporation.
I. Foreign Bank and Financial Account Report, FBAR -Form 114
II. Statement of Foreign Financial Assets, Form 8938
III. Interest in Foreign Canadian Corporation, Form 5471
IV. Interest in Foreign Partnerships, Form 8865
V. Interest in Foreign Trust, Form 3520
VI. Interest in Mutual Funds, Form 8621
The following is a brief overview of when a taxpayer needs to file Form 5471, along with the information that they should provide.
Form 5471: Interest in Foreign (Canadian) Corporation
Form 5471 is an information return for U.S. Persons with respect to certain foreign corporations. It includes ways in which the IRS can tax foreign profits as income during the current year rather than as dividends when actually distributed.
Form 5471 is comparatively one of the most complex and confusing of all IRS forms. Therefore, AG Tax recommends that taxpayers should seek professional assistance in completing this form.
What is a foreign corporation, and controlled foreign corporation (CFC)?
To determine if a business falls under the title “corporation”, one can refer to the U.S. check-the-box regulation. A corporations is considered to be a “foreign corporations if it is created of organizer outside of the United States. A foreign corporation is considered a Controlled Foreign Corporation (CFC) if, on any day during the foreign corporation’s taxable year, U.S. shareholders own more than 50% of the total value of the foreign corporation. A U.S. shareholder is any U.S. person owning at least 10% of the total combined voting power of all classes of voting stock of the foreign corporation. If a foreign corporation is a CFC, for an uninterrupted period of 30 days or more during the taxable year, all U.S. shareholders of the CFC will be subject to an additional reporting requirement to prevent the deferral of certain types of income.
Who must file Form 5471?
A U.S. person needs to file Form 5471, if he/she:
- Owns 10% or more of a foreign corporation, or
- Is a U.S. officers or directors of a corporation in which a U.S. person owns 10% or more shares.
This filing, usually depends on the percentage of ownership and transactions within the corporation, but it can get confusing since the ownership is not limited to direct ownership. Constructive ownership, (i.e. attribution of ownership of other entities that are controlled by the taxpayer or certain family members) can equally lead to Form 5471 reporting requirement.
What information should the taxpayer report on Form 5471?
Basically, the information reported on Form 5471 depends on the category of the filer.
However, in most cases, the taxpayer needs to report the following:
- Percentage of ownership in the corporation;
- Data on transactions between the foreign corporation and U.S. person;
- Original capital contributions;
- Subpart F income; and
- Other relevant data.
While reporting, the U.S. person must include a copy of the corporation’s annual balance sheet and schedule of income and expenses.
Form 5471 comprises of four pages on the whole, but several other schedules (depending on requirement), may extend it to six or seven pages.
What is ‘Subpart F Income’, and how to report it?
‘Subpart F income’ generally, includes dividends, interest, rental income, insurance income, offshore shipping income and personal service income. However, the rules to determine whether the income of a CFC is subpart F income or not are so complex, that it is best to consult a tax professional regarding them.
Subpart F income is included on the tax return of the U.S. shareholder. This causes them to pay tax on that income during the current year rather than when distributed as dividend. This will lead to Subpart F income being subject to taxes as ‘ordinary income’, while dividends from foreign corporations located in a country that has a treaty with the U.S., are taxed at the lower rate available for qualified dividends.
A CFC’s operating business income will not be taxed until distributed to the shareholders as dividends.
What are the penalties in case of Form 5471 non-compliance?
A penalty of up to $10,000 USD is applicable on each Form 5471 that is filed after the due date of the income tax return (including extensions). Likewise, this penalty can also apply if the form lacks complete and accurate information.
In addition to the above penalty, if the taxpayer fails to file Form 5471 when due, he/she may need to reduce by 10% or more all foreign taxes that is used for the foreign tax credit claim.
AG Tax LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of U.S. and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax associates are dedicated to assist you with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
- 604-538-8735 (Greater Vancouver Area, BC)
- 780-702-2732 (Greater Edmonton Area, AB)
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
