Revenue Procedure 2019-40 & the IRS

Revenue Procedure 2019-40 & the IRS

Rev Proc 2019-40 & CFC Downward Attribution 

Rev Proc 2019-40: CFC Downward Attribution Safe Harbor: In early October, 2019 the IRS issued a new Revenue Procedure 2019-40 involving guidance for reporting of certain controlled foreign corporations. There are many components to the Revenue Procedure, but one important aspect is the issue of Downward Attribution and determining if a foreign company is A CFC (Controlled Foreign Corporation). CFC status is crucial in determining issues involving Subpart F Income.

The Rev. Proc. introduces safe harbors, and summarizes:

  • CFC Exceptions to Reporting
  • IRC 965
  • Penalty Waiver

We will summarize key portions of the revenue procedure 2019-40 for you.

Downward Attribution & CFC

What is Downward Attribution?

Attribution means, a person who does not directly own shares of a company, may be held to constructively or indirectly “own” the shares – even though the ownership is not “direct.”

Attribution Example

Michelle  a U.S. person owns 54% of a Sociedad Anonima. Her husband David has no direct ownership, but under the concept of “attribution,” David is now attributed the 54% ownership as well, since David is her spouse — and now David has FATCA, FBAR and probably Form 5471 reporting requirements.

In a more complicated scenario, a U.S. company may own various subsidiaries. These subsidiary sister companies have no relation, and there was no attribution “attributed” between them.

With the repeal of Section 958(b)(4), the protection against this type of “downward attribution” was seemingly gone.

Section 958(b)(4)

Under the TCJA, Section 958 (b)(4) was repealed.

Prior to the repeal, the goal of this section was to protect against “downward attribution.”

As provided by the IRS:

As in effect before repeal, section 958(b)(4) provided that subparagraphs (A), (B), and (C) of section 318(a)(3) (providing for downward attribution) were not to be applied so as to consider a U.S. person as owning stock owned by a person who is not a U.S. person (“foreign person”).

Repeal of Section 958 (b)(4)

With the introduction of the Tax Cuts and Jobs Act (TCJA), came the repeal of Section 958 (4). Before the TJCA was introduced, section 958(4) was used to help determine if certain stock ownership was considered a CFC (Controlled Foreign Corporation).

Section 958(b)(4) benefitted non-U.S. persons, because it prevented or “blocked” a U.S. person from getting caught in an attribution situation with a U.S. Person – thereby resulting in certain ownership.

Even the IRS realizes the ability of the U.S. person to obtain that information will, in many cases, be extremely limited.

Rev Proc 2019-40 (Section 2 Background)

As a result of this repeal, stock of a foreign corporation owned by a foreign person can be attributed to a U.S. person under section 318(a)(3) for purposes of determining whether the U.S. person or another U.S. person is a U.S. shareholder of the foreign corporation and, therefore, whether the foreign corporation is a CFC.

As a result, U.S. persons that were not previously treated as U.S. shareholders may be treated as U.S. shareholders, and foreign corporations that were not previously treated as CFCs may be treated as CFCs.

The Treasury Department and the IRS are aware that, in certain circumstances, taxpayers are required to include in gross income amounts under sections 951 (“subpart F inclusion amounts”) and 951A (“GILTI inclusion amounts”) attributable to, and report amounts with respect to, foreign corporations that are CFCs solely because of the repeal of section 958(b)(4), even though those taxpayers may have limited ability to determine whether such foreign corporations are CFCs and to obtain the information necessary to accurately determine these amounts.

Section 4. CFC Safe Harbor

In General

“For the reasons discussed in section 4.01 of this revenue procedure, the IRS will accept a U.S. person’s determination that a foreign corporation does not meet the section 957 ownership requirements and, therefore, that the foreign corporation is not a CFC with respect to the U.S. person if the conditions described in section 4.02(b) of this revenue procedure are satisfied.”

4.02(b) Conditions

” (i) The U.S. person does not have actual knowledge, statements received, and/or reliable publicly available information sufficient for the U.S. person to determine that the section 957 ownership requirements are met. For purposes of applying this condition, actual knowledge, statements received, and/or reliable publicly available information as of a given date shall be treated as true for all subsequent dates, unless subsequent information rebuts the original information. 11

(ii) If the U.S. person directly owns stock of, or an interest in, a foreign entity (“top-tier entity”), the U.S. person inquires of the top-tier entity whether it meets the section 957 ownership requirements, whether, how, and to what extent such top-tier entity directly or indirectly owns (within the meaning of section 958(a)) stock of one or more foreign corporations, and whether, how, and to what extent such top-tier entity owns directly or indirectly (determined under the principles of section 958(a)(2)) stock of, or an interest in, one or more domestic entities.”

What does this Mean?

If a U.S. person does not have actual knowledge and/or information is not readly available to determine if 957 (Controlled Foreign Corporation) ownership requirements are met, if the person tries to obtain the information in accordance with conditions of 4.02(b) above.

Section 5. General Safe Harbor for ALternative Information

Only relevant portions have been referenced:

“In order to determine a subpart F inclusion amount or GILTI inclusion amount of a U.S. shareholder with respect to a CFC, the U.S. shareholder needs to determine the gross and taxable income, as well as the qualified business asset investment (within the meaning of section 951A(d)) and specified interest expense (as defined in §1.951A1(c)(3)(iii)), of the CFC.

In addition, in order to determine whether the E&P limitation in section 952(c)(1)(A) on subpart F income applies, the U.S. shareholder needs to determine the E&P of the CFC.

Under §1.952-2(a) and (b), the gross and taxable income of a foreign corporation are generally determined by treating the foreign corporation as a domestic corporation and by applying the principles of sections 61 and 63 and the regulations thereunder.

However, the Treasury Department and the IRS recognize that certain U.S. shareholders may be unable to obtain information necessary for the U.S. shareholder to calculate a subpart F inclusion amount or GILTI inclusion amount in the case of a foreign corporation that is a foreign-controlled CFC or report amounts on Form 5471 consistent with the requirements in §1.952-2 and section 964 and the regulations thereunder.

Accordingly, the Treasury Department and the IRS believe that it is reasonable for taxpayers to choose to use alternative information for determining a subpart F inclusion amount and GILTI inclusion amount or related recordkeeping or reporting on a Form 5471 with respect to a foreign-controlled CFC in the circumstances described in this section 5.

The IRS will accept the use of alternative information by a taxpayer in the circumstances described in section 5.02 of this revenue procedure.”

Safe Harbor

In the case of a foreign-controlled CFC with respect to which there is no related section 958(a) U.S. shareholder, if information satisfying the requirements of §1.952- 2(a), (b), and (c)(2) and section 964 and the regulations thereunder is not readily available to an unrelated section 958(a) U.S. shareholder with respect to the foreign  controlled CFC, a subpart F inclusion amount or a GILTI inclusion amount or an amount in a record required to be maintained under section 964(c), §1.964-3, or §1.964-4 may be determined by the unrelated section 958(a) U.S. shareholder on the basis of alternative information (without adjustments other than those described in sections 3.01(b) and 3.10 of this revenue procedure) with respect to the foreign-controlled CFC.

IRC 965: (General) Safe Harbor 

“The Treasury Department and the IRS recognize that certain U.S. shareholders may have been unable to obtain information necessary for the U.S. shareholder to 14 calculate an amount included under section 951 by reason of section 965 or a deduction under section 965(c) (each a “section 965 amount”) in the case of certain SFCs consistent with the requirements of section 964 and the regulations thereunder and thus may have used alternative information.

Accordingly, the Treasury Department and the IRS believe that it is reasonable in such circumstances for such taxpayers to use an approach consistent with the approach outlined in section 5 of this revenue procedure for purposes of the determination of section 965 amounts. Thus, the IRS will accept the use of alternative information by a taxpayer in the circumstances described in section 6.02 of this revenue procedure.

In the case of an SFC, other than either a foreign-controlled CFC with respect to which there is a related section 958(a) U.S. shareholder or a U.S.-controlled CFC, if information satisfying the requirements of §1.952-2(a), (b), and (c)(2) and section 964 and the regulations thereunder is not readily available to an unrelated section 958(a) U.S. shareholder with respect to the SFC, a section 965 amount may be determined by the section 958(a) U.S. shareholder on the basis of alternative information (without 15 adjustments other than those described in sections 3.01(b) and 3.10 of this revenue procedure) with respect to the SFC, provided the section 958(a) U.S. shareholder reports such amount on a return both due and filed before October 1, 2019, or a return both due and filed after October 1, 2019.

6038 & 6662 Penalty Waiver

Background

Under section 6038(b) and (c), penalties can be imposed if any person fails to timely furnish information required under section 6038(a)(1), which information is required to be reported on Form 5471. Under section 6038(c)(4)(B), for purposes of determining such penalties, the time for furnishing such information is treated as not earlier than the last day on which reasonable cause existed for failure to furnish such information.

Under section 6662, penalties can be imposed on any portion of an underpayment (as defined in section 6664(a)) of tax required to be shown on a return 16 that is attributable to one of the items listed in section 6662(b), which include negligence or disregard of rules or regulations and a substantial understatement of income tax. Under section 6664(c)(1), penalties will generally not be imposed under section 6662 with respect to any portion of an underpayment if it is shown that there was reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion

Inapplicability of Penalty 

Taking into account that the IRS will accept taxpayers’ positions based on sections 4.02, 5.02, and 6.02 of this revenue procedure and the availability of reasonable cause relief, penalties under sections 6038 and 6662 will not be applied to the extent such penalties would be attributable to:

(a) A U.S. person determining that a foreign corporation does not meet the section 957 ownership requirements consistent with section 4.02 of this revenue procedure,

(b) A U.S. person determining a subpart F inclusion amount or GILTI inclusion amount, an amount in a record required to be maintained under section 964(c), §1.964- 3, or §1.964-4, or an amount reported on a Form 5471 on the basis of alternative information consistent with section 5.02 of this revenue procedure, or

(c) A U.S. person determining a section 965 amount on the basis of alternative information consistent with section 6.02 of this revenue procedure.

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