Often times, it proves troublesome for a foreign corporation to decide whether to file a US income tax return in order to report U.S. income. They can claim the possible tax credits and deductions; or disclose it as tax-exempt income under an existing tax-treaty to avoid double taxation.
The US Internal Revenue Service (IRS) requires foreign corporations, with branches or subsidiaries carrying out business in the United States to comply with certain tax filing requirements. In this article, we will be discussing the filing of Form 1120F, U.S. Corporation Income Tax Return.
U.S. Taxation of Foreign Corporations
Foreign corporations are taxed in two ways, income is separated into two categories. Firstly, income that is effectively connected with a U.S. trade or business. This income is subject to tax at graduated rates of tax and is reported on a net basis. That is, expenses related to the production of the income will be allowed as a deduction. Tax is calculated on the same basis as U.S. corporations. If a corporation is engaged in a U.S. trade or business but has no permanent establishment in the U.S., it may be exempt from tax under a treaty.
The second category is fixed, annual, determinable, periodic income. This income is subject to a flat 30% tax, a treaty may apply to reduce this rate. Types of income in this category include interest, dividends, rentals, and capital gains. An election may be made to include rental income as “effectively connected” allowing benefits of deduction for expenses and the graduated rate of tax on the income.
What is Form 1120-F?
Form 1120-F is a form that foreign corporations file to report its income, gains, losses, deductions, and credits that are effectively connected with the United States, and determine its U.S. income tax liability.
This filing is also required if there is any expected refund, to calculate and pay a foreign corporation’s branch profits tax liability and tax on excess interest, if any. Also, to disclose any exemption under a treaty by attaching Form 8833, Treaty-Based Return Position Disclosure under Section 6114 or 7701(b).
Who should file Form 1120-F?
Usually, a foreign corporation should file Form 1120-F for a tax year, if during that tax year, the corporation:
- Was carrying out a trade or business in the United States regardless of whether they generated income, was effectively connected to a US trade or business or the trade or business is exempt from US taxes under a tax treaty;
- Had income, gains, or losses treated as if they were effectively connected with the conduct of a U.S. trade or business;
- Was not engaged in a U.S. trade or business, but had income from a U.S. source, and the tax liability (30% or lesser treaty rate) has not been fully satisfied by the tax withheld;
- Is making a claim for refund of an over payment of tax for the tax year
- Wants to claim the benefit of any deductions or credits.
- Wants to make an election to report rental income as effectively connected to a U.S. trade or business.
- Makes a claim that an income treaty overruled or modified any provision of the IRS Code with respect to income derived by the foreign corporation and this disclosure is made on Form 8833.
How to Comply with Form 1120-F filing requirement?
A foreign corporation will be required to file a complete Form 1120-F including any schedules required in the instructions to report the income from U.S. sources.
There are certain situation in which the taxpayer does not need to file a complete Form 1120-F:
- If the corporation is filing Form 1120-F only to claim refund or credit of tax paid or withheld at source, a simplified procedure applies. Under the Simplified procedure, the taxpayer only needs to provide their name, address, and employer identification number (EIN) of the corporation, along with the expected refund amount. An authorized officer of the corporation, such as the president, vice president, treasurer, assistant treasurer, chief accounting officer or any other corporate officer with signing authority must sign the form and send it to the IRS.
- If the corporation does not have any gross income for the tax year they are required to file Form 1120-F as they are claiming an exemption under the existing tax treaty. The corporation should only complete the page requiring identification information, and attach a Form 8833.
- A corporation may wish to file a protective return. If a foreign corporation conducts limited activities in the United States in a tax year and the foreign corporation determines not to rise gross income which is effectively connected with the conduct of a trade or business within the United States. The foreign corporation may wish to file a protective return to safeguard its right to receive the benefit of the deductions and credits attributable to that gross income in the event that it is subsequently determined that the original determination was incorrect. A foreign corporation should also file a protective return if it determines initially that it has no U.S. tax liability under the provisions of an applicable income tax treaty (for example, because its income is not attributable to a permanent establishment in the United States). Complete only the identification information and tick the box that this is a “protective” return.
What is the deadline for filing Form 1120-F?
The deadline for the Form 1120-F return is the 15thof the third month after year end (e.g. March 15 of the following year for a calendar year corporation). If the foreign corporation does not have an office or fixed place of business in the US, the due date is the 15th date of the sixth month (June 15 for a calendar year corporation. A six-month extension of time to file the return is available.
What are the penalties that apply in case of non-compliance?
Monetary penalties for late-filing, late payment can be up to 50% of the tax owing. In addition, failure to file certain forms can result in penalties of up $10,000 per year of non-disclosure. There are other monetary penalties that may be imposed for negligence, substantial understatement of tax, reportable transaction understatements, and fraud.
In addition to monetary penalties, the foreign corporation may lose its right to take deductions against U.S. taxable income when filing the U.S. income tax return. This leads to many foreign corporations filing a protective 1120-F to avoid such penalties.
Filing a U.S. return for a foreign corporation can be complex as tax rules differ between different countries. Determining whether the corporation is subject to U.S. tax is very important In addition, tax liabilities may exist in two countries. Mechanisms are available to ensure the corporation is not subject to double taxation. It is advised that you consult a U.S. tax professional to assist with the preparation.
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 US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- US 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:
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