VII.   Foreign Businesses Owned By US Citizens

The transfer of property to a foreign corporation will have US tax consequences. These can be partly avoided when the transferor, just after the transfer, owns at least 80 percent of the voting power, either actually, or constructively. However, absent exceptions below, the transfer will be subject to income recognition. Alternative: outright sale, transfer, or license of individual assets to the branch of the US Corporation. There is a special rule for intangible transfers which the IRS will expect to see: the transferor is treated as having sold the property for contingent payments, and income reflecting those payments recognized over the life of the property. In most situations, this is not a very good outcome. Particularly in the case of intangibles, a license or sale should be considered rather than a "contingent payment" sale. A sale may result in capital gains, which may be preferable in certain cases. What is intangible depends on facts (non-sale transfers of intangibles to corporations. are also taxable in domestic situations).

The income recognition rule above does not apply to transfers of property which will be used in the active conduct of a trade or business outside the US. However, inventory, property to be leased and oil and gas interests are subject to special rules and may not be transferred free of tax, even if they are used in the active conduct of a trade or business. Planning point: if possible, sell or dispose of inventory before the transfer, or try to justify sale of the inventory at less than retail. Additionally, a US person must recognize gain on the transfer of certain "hot" assets to a foreign Corporation where tax avoidance is presumed (i.e., certain stock or securities of a domestic Corporation). The "active conduct of trade or business" rule above may not apply, in whole or in part, where the assets of a US person's foreign "branch" are transferred to a foreign corporation, to the extent that certain losses (less certain adjustments) were incurred by that branch, each branch being accounted for separately. A foreign "branch" is any integral business carried on by a US person outside the US. The IRS Regulations deem a permanent establishment to be a foreign branch. Any US person may have a foreign branch.

A transferor of "US depreciated property" to a foreign corporation recognizes ordinary income under certain recapture rules as if the property had been sold at fair market value. Only property that has been used in the US and subject to US depreciation is subject to recapture. There is a 35 percent excise tax on certain transfers of property by US persons to foreign corporations. It is limited in application. It does not apply to transfers of property in exchanges as described above (so-called Sec. 351/367 transfers), and it does not apply to a sale of property. It applies only if the transfer occurs "as paid-in surplus or as a contribution to capital" outside the provisions of Sec. 351. Certain events may trigger a deemed capital contribution subject to this tax, i.e., sale of one controlled corporation to another controlled corporation. It is important to correctly define and fix any transaction as a sale, Sec. 351/367 transfer, etc.

Companies that do business in more than one country may wish to have a base company which directs activities in all locations. The country chosen for the base may have attractive tax attributes. By careful selection of a location, through which base company operations may be conducted and various types of income and expense allocated, the effect of positive and negative tax effects may be controlled resulting in lower overall costs. However, one must be cognizant of the related-party rules of Sec. 482; the business purpose test rules of Sec. 267; the income-stripping and anti-abuse provisions; applicability of various US tax treaties and incentives (for example, foreign sales corporation provisions) together with second, third and fourth country treaty provisions and incentives; "controlled foreign corporation" status and subpart F income (see below); and withholding rates on dividends and services in the respective jurisdictions.

A US corporate stockholder may receive dividends from offshore that are presumably subject to US corporate dividends-received deduction. One needs to be aware that the corporate dividends-received deduction is available only on dividends paid by domestic corporations. Exception: foreign sales corporations, dividends create no taxable income because the dividends will be excludable from income of the U.S. affiliate. A key rule in tax planning is to avoid, as much as possible, very long term commitments or permanent fixes, and remain flexible so that future planning may address future circumstances.

A foreign corporation (or more precisely the US person owning stock in it) are subject to US reporting requirements, these include:

•926 Return by a US Transferor of Property to a Foreign Corporation, Foreign Estate, or Foreign Partnership

The title is self-explanatory, it has to be filed when the property is transferred. It applies to both property transferred as capital or paid in surplus and like-kind exchanges of property. In some cases there may be an excise tax on the transfer, usually the appreciation on appreciated property transferred abroad.

Transfers of property with gains cannot be offset against property with losses.

Under the KISS principal, it is usually easier to make capital contributions in cash and make the transfer in US dollars.

Transfers of unappreciated property to foreign corporations are required to be reported or the 10% penalty will apply. 

A U.S. person who transfers cash to a foreign corporation must report the transfer if:

• (1) immediately after the transfer, the person directly or indirectly holds at least a 10% interest in the foreign corporation or
• (2) the value of the property transferred (when added to the value of other property transferred by the person or any related person within the preceding 12 months) exceeds $100,000. This rule would apply to transfers from the U.S. taxpayer "or any related person" to the foreign corporation "or a related foreign corporation."

A husband and wife may file a joint form 926 so long as they a joint return.

If a partnership makes a transfer to a foreign corporation, it is the individual partners who are responsible for filing form 926, not the partnership.

•5471 Information Return of US Persons With Respect to Certain Foreign Corporations

This is a relatively complex form including details of:

• Ownership

•Income statement and balance sheet (calculated according to US Generally Accepted Accounting Principles (GAAP). This must be reported in US dollars translated from functional currency in accordance with US GAAP translation rules.

• Current earnings and profits (that is, results per foreign books adjusted to conform with US tax and accounting standards)
• Accumulated earnings and profits (adjustment of accumulated earnings and profits for distributions)
• Summary of shareholder's pro rata share of income under subpart F (that is the CFC's income which is subject to current personal or corporate taxation)
• Transactions between the CFC and related parties
•Return of officers, directors, and 10% or more shareholders of a foreign personal holding company
•Organization or reorganization of foreign corporation, and acquisitions and dispositions of its stock (this is in addition to form 926 relating to transfers to a foreign entity).

It has to be filed with the US personal tax returns or if appropriate, the corporation owing the CFC..

The form must be filed annually by those owning more than 50% of a CFC and those owning between 10% and 50% of stock in a foreign corporation which is a CFC for more than 30 days of the foreign company's tax year.

Directors and officers are required to file when a US person acquires 5% or more in a CFC. US persons are required to file when they acquire or dispose of 5% or more of a CFC.

Again using the KISS principal, try to avoid reportable transactions with related parties; try to avoid generating subpart F income (including income from property in USA); try to avoid having a place of business in the USA.

Interests in foreign partnerships

•8865 Income and assets of foreign partnership.

Income and assets of the partnership as well as certain transactions and other specified information must appear on Form 8865. Also, the form has to be filed with the U.S. taxpayer's income tax return for the tax year in which the partnership's annual accounting period ends.

Transfers to foreign partnerships. U.S. persons transferring property to a foreign partnership after August 5, 1997, must report the transfers. .

A U.S. person who transfers property (including cash) in an Code Sec. 721 contribution to a foreign partnership in exchange for a partnership interest, generally must report the transfer on Form 8865. However, the contribution need be reported only if:

• (1) immediately after the transfer, the person directly or indirectly holds at least a 10% interest in the partnership or
• (2) the value of the property transferred (when added to the value of all other property transferred by the person within the preceding 12 months) exceeds $100,000 (including the value of transactions not described in Code Sec. 721 if their principal purpose was to avoid reporting requirements).

Built-in gain information.

To determine whether built-in gain has been properly allocated to and recognized by a U.S. person who has transferred property to a foreign partnership, the person, if still a partner, must notify the IRS when the foreign partnership has disposed of the contributed property.

Penalties.

Failure to file the required information under the Code Sec. 6038B regulations could potentially exceed the penalties under the Code Sec. 6038 regulations. Failure to properly report a transfer is subject to a penalty of 10% of the fair market value of the property transferred, with a cap of $100,000 under Code Sec. 6038B(c)(3), unless the failure was intentional.

A reasonable cause exception applies. In addition, any adjustments to the basis of the partnership or any partner (direct or indirect) as a result of the gain recognized under this provision will be made as though the gain was recognized in the year when the failure to report was finally determined.

Effective date.

The proposed Code Sec. 6038B regulations are effective for tax years beginning after final regulations appear in the Federal Register. 

Code Sec. 6046A

U.S. persons who acquire or dispose of a foreign partnership interest or whose interests in a foreign partnership change substantially must report these acquisitions, dispositions, or changes only when the interest acquired, disposed of, or substantially changed is at least a 10% interest in the partnership. The rules require a U.S. person to report the Code Sec. 6046A information on Form 8865 when a "reportable event" occurs.

Reportable event.

A "reportable event" refers to:

• (1) an acquisition or disposition by a U.S. person of at least a 10% interest in a foreign partnership or
• (2) a change in a U.S. person's proportional interest in a foreign partnership that is equivalent to at least a 10% or greater interest in the foreign partnership.

Exceptions.

Three exceptions are provided:

• The term "reportable event" doesn't apply to an acquisition of an interest, or a change in a proportional interest, in a foreign partnership that results from a transfer by a partner who is subject to reporting requirements under Code Sec. 6038B
• Exception for some international satellite partnerships, such as the International Telecommunications Satellite Organization, the International Mobile Satellite Organization, and their successors.
• Don't apply to foreign partnerships that have elected out of Subchapter K partnership taxation..

 Effective date.

The Code Sec. 6046A rules are to be effective for reportable events occurring after 1997 and would, therefore, relieve a U.S. person from having to file a return under Code Sec. 6046A for otherwise reportable events occurring before 1998.

In addition, the return period would generally be extended for one full tax year with regard to reportable events occurring on or before the date when the final regulations appear in the Federal Register. Most of the requirements will be if effect for 2000 and all for 2001.