Constructive Ownership of Foreign Stock – Attribution Reporting Rules
Constructive Ownership of Foreign Stock – Attribution Reporting Rules
IRS form 5471 is difficult – even for the most experienced international tax professionals. It encompasses both international tax law and international business – along with bookkeeping and accounting.
What is Form 5471?
The goal of form 5471 is to provide the IRS sufficient information regarding interest in a foreign corporation that a US person may have. While there are various categories and instructions provided by the IRS, they seem to have a tendency to make it unnecessarily tedious and difficult to digest.
Therefore, we have tried our best to prepare our own instruction tips to assist you with attribution, constructive ownership, and direct shares.
**This is intended to introduce you to the issues and the potential exceptions. We do not recommend going forward without first speaking with an experienced International Tax Lawyer.
Constructive Ownership & Attribution
We are focusing this particular post on the concept of constructive ownership and attribution, as it impacts ownership in a foreign corporation. Namely, if a person has attribution, but either has no direct shares or less than 10% direct shares, do they still have to file the form 5471?
Constructive Ownership Through Attribution
Let’s assume for the moment that the individual contemplating filing a 5471 for in this particular situation does not own any shares. But, his family members own shares – upwards of 90% – as it is a family business located in a foreign country.
Example: Darren is originally from Hong Kong but now resides in the United States. His parents own a company in Hong Kong, of which they own 90%. Darren does not own any direct portion of the company. Even though Darren does not own any portion of the company, under IRS rules he may be considered a constructive owner through attribution.
In other words, even though Darren does not have actual ownership of any shares, he is considered to have “constructive” ownership of the shares that are attributed to him through family members.
Attribution – What Is It?
Attribution means a person has ownership of something as a result of being related to another person – usually a relationship such as a spouse, sibling or parent (or subsidiary, sister or brother corporation). The main reason behind it, is to avoid hiding income and other tax purposes. The typical situation is designating one spouse or family member as the 100% owner of the foreign business, which the other spouse or other family members are actually benefiting or operating – but avoiding any reporting or income tax related issues because they do not have actual ownership.
If you think the concept of constructive ownership is a bit difficult, if not tedious and boring, then the specific code section and accompanying regulations will put you fast to sleep. (Note: Specific attribution rules may vary based on the specific code section)
Specifically, it is regulation CFR 1.958-2, which contains the information necessary to determine whether a certain relationship is considered to be attributed to constructive ownership of stock.
While there are always exceptions,the family attribution rules work as follows:
1.958-2 Constructive ownership of stock.
(1 ) In general. Except as provided in subparagraph (3) of this paragraph, an individual shall be considered as owning the stock owned, directly or indirectly, by or for –
– His spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance); and (ii) His children, grandchildren, and parents.
(2) Effect of adoption. For purposes of subparagraph (1)(ii) of this paragraph, a legally adopted child of an individual shall be treated as a child of such individual by blood.
(3) Stock owned by nonresident alien individual. For purposes of this paragraph, stock owned by a nonresident alien individual (other than a foreign trust or foreign estate) shall not be considered as owned by a United States citizen or a resident alien individual.
**However, this limitation does not apply for purposes of determining whether the stock of a domestic corporation is owned or considered as owned by a United States shareholder under section 956(b)(2) and § 1.956-2(b)(1)(viii). See section 958(b)(1).
Family Attribution Summary
If the constructive ownership of stock of a family member involves the spouse, children, grandchildren, and parents, the other family members are attributed ownership. But, an important limitation is that if the stock is owned by nonresident alien, it should not be considered owned by a US citizen or resident Alien.
In other words, if the stock is owned by a nonresident alien individual that will not be attributed to a US person for that US person to determine whether they have constructive ownership.
Unfortunately, unlike this code section and accompanying regulations which are general — Form 5471 is more specific. When dealing with form 5471 instructions, it provides that individuals (scoring categories 3,4, or 5) must file a form 5471 when they have constructive ownership, unless they meet all these requirements:
– The U.S. person does not own a direct interest in the foreign corporation,
– The U.S. person is required to furnish the information requested solely because of constructive ownership (as determined under Regulations section 1.958-2, 1.6038-2(c), or 1.6046-1(i)) from another U.S. person, and
– The U.S. person through, which the indirect shareholder constructively owns an interest in the foreign corporation files Form 5471 to report all of the required information.
Foreign Person and U.S. Attribution
This is a very important concept and one we deal with relatively often. Before doing an analysis as to whether a person has attribution regarding form 5471, it is important to note that the regulations determine that a nonresident alien is not considered a person for attribution.
Therefore, assuming that a person is only attributing constructive ownership because of a family member who is a non-resident alien, the U.S. Person may not have to file form 5471 (at least if this attribution to the Foreign Person is the only basis for filing) Why? Because you cannot have attribution with a nonresident alien. (Important to note, that the rules do not say US citizen or US person, but rather individual, nonresident alien)
The U.S. Person Does Not Own a Direct Interest in the Foreign Corporation
Assuming that the person has attribution with another US person which would otherwise require filing form 5471, if the potential filer does not have any direct ownership in the foreign corporation, then he or she has met prong one. Unfortunately, the instructions/exceptions does not indicate how much direct ownership is required to meet “direct ownership.”
In other words, technically, even if it was one or two shares of stock the IRS may argue that there is some sort of direct ownership – and even though without direct ownership a person does not otherwise meet the requirements to file form 5471 (because the person does not need any of the category of filing thresholds), the exception does not go that far into the description of what is considered direct ownership. (aka, minimal threshold for having direct ownership).
Thus, any direct ownership may limit the ability to avoid filing (presuming that the person has the file because of constructive ownership)
The U.S. Person is Required to File Solely Because of Constructive Ownership
Building upon prong 1, the IRS goes on to say that if the person does not have any other independent need to file form 5471 beyond the mere fact that they have constructive ownership through attribution, then they do not have to file. This can get a bit confusing, because it presumes that if a person has very minor direct ownership (not sufficient to file a Form 5471) but has constructive ownership sufficient to file, then the person has to file. Thus, as a result, even minimal or fractional ownership, when combined with constructive ownership may require a person to file — which does not seem to follow the spirit of the intended exception.
The U.S. Person Through, Which There is Constructive Ownership Files Form 5471
All this means, is that the person of which are filing has attribution/constructive ownership group must file a form 5471. Something else to keep in mind, is typically only one 5471 must be filed per Corporation (although typically all US persons seem to want to file their own form 5471).
Under this particular exclusion, it would still require the person of which there is attribution/constructive ownership through to file a form 5471 – even if another form 5471 for the same corporation had already been filed by another person.
We hope not. All in all, all this exception is really saying is that if you have attribution through a U.S. Person, leading to constructive ownership of a foreign corporation, that you do not have to file a form 5471 as long as you do not have any direct ownership of the foreign corporation, and that the person through which you do have attribution filed a form 5471.
IRS Offshore Voluntary Compliance
If you are considering getting into IRS offshore compliance through voluntary disclosure, this gives you a glimpse into how hard it can actually get. It is important to use an experienced offshore disclosure attorney to bring you into compliance.
At Golding & Golding, IRS offshore disclosure is all we do!
OVDP Attorney Credentials
Experienced IRS Offshore Disclosure Representation is crucial for a successful OVDP disclosure. There are only a handful of Law Firms that focus their entire tax practice on IRS Offshore Voluntary Disclosure (We are one of them!). We have represented several hundred clients in OVDP, Streamlined and Offshore Disclosure.
You will want to make sure you use an OVDP Attorney who has:
- Litigation Experience
- IRS Audit Experience
- At Least 15-20 years of Attorney Experience
- An advanced Master’s of Tax Law Degree (LL.M.); and
- Either a CPA or Enrolled Agent (EA) license.
Why? Because you never know how the OVDP or Streamlined submission will go. Sometimes, a person is already under IRS investigation and may not know it. Then, when the person submits to OVDP they are rejected. In this type of situation, you need an Attorney with all the above required experience.
Using a CPA or Junior Attorney with no real experience, is not going to help (and you will then realize why the fees they charged were so low). We know this, because each year we receive many inquiries from clients seeking to retain our services after their initial OVDP or Streamlined junior tax attorney (without the experienced mentioned above) flubbed their submission and made numerous mistakes in the submission process.
Alternatively, once you are in OVDP, you may want to:
- Make an MTM Election
- Argue FAQ 55 Penalty Reductions
As a result, for this highly specialized area of law, you need an OVDP Attorney who is experienced specifically in OVDP, but also has the background and experience to fight on your behalf.
OVDP Attorney Fees
If you receive an OVDP Fee Quote from a CPA or Attorney that seems too Low…you should be careful.
That is not to say you should resign yourself to mortgaging your house for representation, but there are many CPAs and Attorneys who see a frightened human being as little more than a “Mark” or “Target.”
They will provide artificially low fee quotes to bait you in, only to request more money down-the-line. Most of the these Attorneys do not have real experience, and do not understand the comprehensive nature of an OVDP.
Golding & Golding, A PLC
At Golding & Golding, we have successfully handled numerous OVDP (Offshore Voluntary Disclosure Program) and IRS Streamlined Program applications for individuals and businesses around the globe with outstanding unreported foreign accounts ranging from $50,000.00 to nearly $40,000,000.00 in a single disclosure.
In order to assist you to better understand the distinction between the two different IRS offshore/foreign account disclosure programs, we are providing the following summary for your reference.