The US market is a promising one for foreign investors and companies, but complicated issues must be addressed to avoid fines and penalties. One of these issues involves the completion of Form 5472.
US companies that are at least 25% owned by non-US shareholders and foreign companies that are engaged in a US trade or business must disclose information to the Internal Revenue Service (IRS) on this somewhat confusing form. IRS uses the Form 5472 in developing information about the company and its related parties. Information provided on the form helps the IRS identify potential audit issues. Certain information on the Form 5472 might raise bright red flags for the IRS, too.
In today’s world of global fiscal transparency, one issue that is very important to keep in mind when preparing the Form 5472 is whether the foreign shareholder or foreign related party has reported the income from the listed transactions in its home jurisdiction. Remember the US has entered into numerous tax treaties and tax exchange information agreements. With the run up to full implementation to FATCA compliance, the IRS is anxious to be gathering information that can be traded with those countries agreeing to be FATCA compliant. For those who are not in the know, FATCA stands for the “Foreign Account Tax Compliance Act”. You can learn more about it on my blog post here.
Form 5472 is required to be filed in two types of cases. This blog post will cover the first type of case – that is, when a foreign shareholder owns 25% or more of a US corporation. The second case, involving situations when a foreign corporation is engaged in a US trade or business, will follow in Part II, next week.
1. Foreign Shareholder Owns 25% or More of US Corporation
Form 5472 must be filed when a US corporation, having direct or indirect non-US shareholders who own 25% or more of the stock of that US corporation, has a so-called “reportable transaction” with the foreign shareholder(s). In general, a “reportable transaction” is any exchange of money or property with the foreign shareholder such as a payment for sales, rents, royalties, interest. A “reportable transaction” does not include the payment of dividends. “Reportable transactions” are listed in Part IV of the Form and are detailed in the instructions to the Form.
Reportable transactions can easily be overlooked – frequently overlooked are loans by the corporation to foreign shareholders, or loans from foreign shareholders to the corporation. Such loans can have very significant tax consequences. For example, when the corporation is the debtor, the interest paid to the shareholder can be tax deductible to the corporation. The interest paid to the foreign shareholder can be subject to US taxation through withholding at a 30% or lower treaty rate. Withholding will be required unless the interest can meet an exception, such as the exception for “portfolio interest”. Very specific requirements must be satisfied in order to meet this exception, including an up-to-date completed Form W8 BEN. If the loan is interest-free or bears a below market rate of interest per IRS rules (applying the so-called “Applicable Federal Rate”), then the IRS will impute a proper interest rate. Further, the IRS will characterize the transaction in accordance with its substance. For example, payments of interest to the foreign shareholder by the corporation on a “loan” may really be disguised distributions of the corporation’s earnings and profits to that shareholder. In contrast to payments of interest, payment of dividends cannot be deducted by the corporation and are taxable to the shareholder at a 30% or lower treaty rate.
A separate Form 5472 must be filed for each foreign shareholder who is a 25%-or-greater owner of the US corporation. The form is not required when various foreign persons own, in the aggregate, 25% or more of the corporation. It is required only when a single non-US entity or individual owns 25% or more of the corporation.Thus, if two or more foreign shareholders each own 25% or more of a US corporation, then multiple Forms 5472 will have to be filed.
Form 5472 generally requires the following information with regard to each 25%-or-greater foreign shareholder: name, address and country of citizenship (or in the case of an entity-shareholder, the country where it was organized or incorporated); the nature and amount of the reportable transaction with the foreign shareholder; names of the countries under whose laws the foreign shareholder files an income tax return as a resident; and names of the principal countries where that shareholder conducts business.
Penalty for Failure to File
The penalty for failure to file Form 5472 is $10,000 per year, but remember, the devil is in the details! Filing a substantially incomplete Form 5472 constitutes a failure to file the Form with the result that the penalty can be imposed. Furthermore, each member of a group of corporations filing a consolidated information return is a separate reporting corporation subject to a separate $10,000 penalty for which each member will be jointly and severally liable. Perhaps more troublesome than penalties is that once a failure to file is discovered by the IRS, this can place the company under the IRS’ microscope for continued monitoring and/or audits.
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