By: Coleman Jackson, Attorney, CPA
December 05, 2017
Pursuant to Internal Revenue Code Section 6038, U.S. persons (this term includes citizens and green card holders of the United States under U.S. Tax Law) holding controlling interest in foreign corporations must annually disclose certain ownership and financial information about the business and the U.S. taxpayer’s interest in the foreign business. This reporting requirement is not a substitute to filing requirements managed by the Financial Crimes Network that we have discussed in detail in previous blogs dealing with U.S. persons (whether U.S. citizen or Permanent Resident) holding ownership interest or signatory power of foreign bank account(s) with an account balance of $10,000 or more at anytime during a calendar year must file FINCEN Form 114 on April 15th of each year. The focus of this particular blog deals with IRC Sec. 6038 which requires information reporting with respect to certain foreign corporations and partnerships when U.S. Persons hold a controlling interest in those foreign businesses.
What information must be disclosed? In the case of an individual or domestic business entity, the statute requires disclosure of the foreign entity information in the tax reporting year of the U.S. person. The following type of information with respect to any foreign business entity must be filed with the Internal Revenue Service:
- The name, address, and employer identification number , if any, of the corporation;
- The principal place of business of the corporation;
- The date of incorporation and the country under whose laws incorporated;
- The name and address of the foreign corporation’s statutory or resident agent in the country of incorporation;
- The name, address, and identifying number of any branch office or agent of the foreign corporation located in the United States;
- The name and address of the person (or persons) having custody of the books of account and records of the foreign corporation, and the location of such books and records if different from such address;
- The nature of the corporation’s business and the principal places where conducted;
- As regards the outstanding stock of the corporation-
- A description of each class of stock, and
- The number of shares of each class outstanding at the beginning and end of the annual accounting period;
- A list showing the name, address, and identifying number of, and number of shares of each class of the corporation’s stock held by each United States person who owns five percent or more in value of any class of the corporation’s outstanding shares;
- Statement of the corporations earnings, profits and loss, distributions and so forth;
- A summary statement of transactions with related parties during the accounting period;
- Accrued payments and receipts financial statements, such as, balance sheet and so forth.
The current Internal Revenue Code was last updated in 1986; before that revision; it was the original IRC written back in the 1950’s. The Internal Revenue Code speaks in terms of corporations; but the Internal Revenue Code was written before the inception of certain business structures such as the adoption and passage by many states of limited liability company’s statutes. The LLC business entity type is not in the current Internal Revenue Code; so other tax sections or chapters of the code are applied to these entities even though the code does not expressly mention LLCs. IRC Sec. 6038’s provisions apply to partnerships, Limited Liability Companies and other entities structured under domestic laws of any State or structured under any foreign country’s laws. Code Sec. 6038 applies to entities that are not officially structured as ‘corporations’. It applies to U.S. persons holding controlling interests in foreign businesses. The disclosure made by U.S. Persons holding controlling interests in foreign businesses are made either on Form 5471 or Form 2952 for tax periods occurring after December 31, 1982.
A U.S. person is deemed to be in control of a foreign corporation if at any time during that person’s taxable year it owns stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or more than 50 percent of the total value of shares of all classes of stock of the foreign corporation. U.S. persons holding controlling interest in another entity whether domestic or foreign that holds controlling interest in another foreign corporation also meets the required disclosure requirements under IRC Sec. 6038. In the case of a business entity who owns a controlling interest in a foreign business, the statute requires disclosure of the foreign entity information in the tax reporting year of the U.S. domestic corporation, partnership or other domestic entity’s tax reporting year (could be calendar year basis or fiscal year depending upon the tax elections the domestic entity has made with respect its federal taxes). The exact same information listed above must be filed with the Internal Revenue Service on IRS Form 2952, in duplicate for each separate foreign business interest of the domestic entity. Treasury Regulations 1.6038-2 provides an example of the application of these tax rules as follows:
Example: Corporation A owns 51 percent of the voting stock in Corporation B. Corporation B owns 51 percent of the voting stock in Corporation C. Corporation C in turn owns 51 percent of the voting stock in Corporation D. Corporation D is controlled by Corporation A.
This example only touches the surface of the complexity of this tax topic. The statutes’ disclosure rules also apply to partnership interest, joint ventures and other types of business entities where controlling interest is held by U.S. Persons in foreign businesses.
Special rules apply to certain nonresident aliens. An individual who makes an IRC Sec. 6013(g) or 5013(h) election will be considered a United States person for purposes of IRC Sec. 6038 subject to various exceptions.
If any U.S. person, who is subject to the IRC Sec. 6038 disclosure requirements, fails to timely file and disclose the required information in compliance with IRC Sec. 6038, that U.S. person must pay a $10,000 penalty for each annual accounting period of each controlling interest in each foreign corporation with respect to which the failure occurs. Failure to comply with IRC Sec. 6038 after notice from the Internal Revenue Service subjects the U.S. person holding controlling interest in a foreign corporation to a maximum of $50,000 for each failure to disclose. The IRS could also assess other tax penalties under IRC Sections 7203, 7206 and 7207.
As with most other tax infractions, taxpayers failing to comply with IRC Sec. 6038 can raise lawfully valid reasonable cause defenses in seeking to abate these penalties. The reasonable cause defense must be written and it must set forth credible reasons why the taxpayer did not timely comply with IRC Sec. 6038. The reasonable cause defense must be made under the penalties of perjury and the validity of it is determined by the IRS District Director or the director of the service center having jurisdiction over the U.S. person’s tax return. Ultimately the judiciary, such as, the U.S. Tax Court or other appropriate federal court could be petitioned to make the final determination on the U.S. person’s reasonable cause defense.
This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader. You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.
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