As part of the U.S. tax reform bill that was signed in late December, a change was made to the rules regarding determination of which non-US corporations are “controlled foreign corporations” (CFCs). Without a change in IRS guidance, this change will require US funds that are treated as partnerships for income tax purposes to file many additional information returns.
Under the new legislation, many more non-US corporations will be classified as CFCs. A US partnership will be deemed to own all of the non-US corporations owned by its foreign investors and will be classified as a “US shareholder” of those foreign corporations. For example, in the case of an investor that is a foreign company that itself has foreign subsidiaries, the US fund would be a US shareholder of all of the foreign subsidiaries, and such foreign subsidiaries would be classified as CFCs.
The change is retroactive to CFC years beginning in 2017.
Absent any change to current IRS filing requirements, the fund could be required to file information returns with respect to each of those CFCs—that is, all of the subsidiaries of its foreign investors—even though the fund would be unlikely to have the required information.
Specifically, a US person in “control” of a CFC is required to file an information return (Form 5471) with the IRS with respect to that CFC each year. Furthermore, the IRS can require any person that is a “US shareholder” to file a Form 5471 with respect to a CFC. The current Form 5471 in fact generally includes US shareholders as a required, “category 5” filer. Thus, without a change in the instructions to Form 5471, a US fund may be required to file Forms 5471 for all of the foreign subsidiaries of its foreign investors. Penalties apply where a Form 5471 is required to be filed but is not.
Consistent with legislative intent, the IRS should be encouraged to revise Form 5471 such that a US person is not required to file Form 5471 for a CFC where the US person has no direct or indirect ownership in the CFC, but rather only constructively owns the CFC through a foreign investor. As noted above, the main obligation to file an information return applies where a US person has control over a CFC. For purposes of determining control, no downward attribution is allowed from a foreign investor to a US partnership. Notably, the conference report to the tax reform bill provides that Congress specifically retained this prohibition for purposes of the filing obligation, presumably so that there would not be a flood of new Forms 5471 for all of the newly created CFCs. However, the IRS is permitted to require any “US shareholder” to file a Form 5471, and the new legislation expands the definition of “US shareholder.” As a result, the current state of Form 5471 and the changes in the tax law work to create (likely unintended) additional filing burdens.