Controlled Foreign Corporations - Form 5471
Key issues relating to shareholdings in UK limited companies and other foreign corporations
There are many rules designed to discourage US taxpayers from using foreign accounts, assets or corporations to avoid or reduce their US tax liability which many US expats can be impacted by, often just by operating as a normal resident in the UK. One of these such rules relates to the holding of an interest in a Controlled Foreign Corporation, or "CFC". A CFC is any foreign corporation that is owned (see below) more than 50% by US persons on any day of the tax year.
It is very common for UK-based US expats to hold shares in a UK limited company. They may, for example, be the 100% sole shareholder; own 10% of the shares in their non-US citizen spouse's company; own a small stake in their employer’s business; or be a 50% shareholder with a business partner. The rules regarding CFCs are very complex, and all of the above scenarios have different implications for IRS reporting requirements.
Congress (and thus the IRS) wants to know if US taxpayers are involved with a CFC and this is done primarily via Form 5471. This form is filed alongside the taxpayer’s Form 1040 tax return for the year. Previously, Form 5471 was simply an information return used to report the taxpayer's relationship with the CFC, rather than a tax return, i.e. there was generally no tax due on the numbers reported; from Tax Year 2018, however, Form 5471 has become a material component in a US person's tax return - see below regarding GILTI - and has become substantially more complicated year-on-year.
Form 5471 is a lengthy and complex form which requires the filer to file different schedules depending on the filer's "categories", which depend primarily on the taxpayer’s overall shareholding in the company and any changes in ownership during the tax year. At its full length, the form must report (among other things): the identifying details of the company; the share structure and shareholdings of its US shareholders; US directors and officers; the full income statement and balance sheet; any financial transactions between US shareholders and the corporation; and changes in ownership of any US shareholders.
Of frequent relevance for US taxpayers living in the UK are the "constructive ownership" rules regarding the control of shares in a foreign corporation owned by a non-US citizen spouse (or other related person). If a US taxpayer owns any shares in a foreign corporation, they are also deemed to control all of the shares in that same corporation that are owned by their spouse or any close family members. In this case, even though the company may not be a Controlled Foreign Corporation, the US taxpayer would still have a "Category 4" Form 5471 filing requirement each year - even if the US taxpayer only holds a single share.
Tax Year 2018 saw the introduction of the "Global Intangible Low Taxed Income" (GILTI) regime, which effectively mandates that any 10%+ US shareholder of a CFC will be subject to personal income tax on their share of any income earned by the company from its intangible assets. This is a major change to the taxation of CFCs which was enacted to discourage profit shifting via the movement of intangible assets (such as intellectual property rights) to low-tax jurisdictions. Unfortunately, the GILTI regime also affects CFCs owned by ordinary taxpayers living outside the US who are simply trying to operate a business in their country of residence and, without mitigating efforts, can result in substantial additional tax.
Furthermore, the income of certain foreign corporations can be categorized as "Subpart F" income; in this case, the corporation must be "looked-through" and the Subpart F income reported on the Form 1040, even if it has not been distributed to the shareholder. US taxpayers in the UK are most commonly deemed to have Subpart F income where they operate a "personal service contract company" or receive "foreign personal holding company income". The former is designed to discourage the use of a foreign corporation to defer tax on what is in effect employment income, and the latter is to avoid the use of a CFC to hold investment assets offshore. In these cases, the Subpart F income is declared on the Form 5471 and carried through to the Form 1040 as taxable income.
The above is a very brief overview of key issues. For more details on CFCs, the Form 5471, Subpart F income and how these issues might affect you please get in contact with us.
There are many rules designed to discourage US taxpayers from using foreign accounts, assets or corporations to avoid or reduce their US tax liability which many US expats can be impacted by, often just by operating as a normal resident in the UK. One of these such rules relates to the holding of an interest in a Controlled Foreign Corporation, or "CFC". A CFC is any foreign corporation that is owned (see below) more than 50% by US persons on any day of the tax year.
It is very common for UK-based US expats to hold shares in a UK limited company. They may, for example, be the 100% sole shareholder; own 10% of the shares in their non-US citizen spouse's company; own a small stake in their employer’s business; or be a 50% shareholder with a business partner. The rules regarding CFCs are very complex, and all of the above scenarios have different implications for IRS reporting requirements.
Congress (and thus the IRS) wants to know if US taxpayers are involved with a CFC and this is done primarily via Form 5471. This form is filed alongside the taxpayer’s Form 1040 tax return for the year. Previously, Form 5471 was simply an information return used to report the taxpayer's relationship with the CFC, rather than a tax return, i.e. there was generally no tax due on the numbers reported; from Tax Year 2018, however, Form 5471 has become a material component in a US person's tax return - see below regarding GILTI - and has become substantially more complicated year-on-year.
Form 5471 is a lengthy and complex form which requires the filer to file different schedules depending on the filer's "categories", which depend primarily on the taxpayer’s overall shareholding in the company and any changes in ownership during the tax year. At its full length, the form must report (among other things): the identifying details of the company; the share structure and shareholdings of its US shareholders; US directors and officers; the full income statement and balance sheet; any financial transactions between US shareholders and the corporation; and changes in ownership of any US shareholders.
Of frequent relevance for US taxpayers living in the UK are the "constructive ownership" rules regarding the control of shares in a foreign corporation owned by a non-US citizen spouse (or other related person). If a US taxpayer owns any shares in a foreign corporation, they are also deemed to control all of the shares in that same corporation that are owned by their spouse or any close family members. In this case, even though the company may not be a Controlled Foreign Corporation, the US taxpayer would still have a "Category 4" Form 5471 filing requirement each year - even if the US taxpayer only holds a single share.
Tax Year 2018 saw the introduction of the "Global Intangible Low Taxed Income" (GILTI) regime, which effectively mandates that any 10%+ US shareholder of a CFC will be subject to personal income tax on their share of any income earned by the company from its intangible assets. This is a major change to the taxation of CFCs which was enacted to discourage profit shifting via the movement of intangible assets (such as intellectual property rights) to low-tax jurisdictions. Unfortunately, the GILTI regime also affects CFCs owned by ordinary taxpayers living outside the US who are simply trying to operate a business in their country of residence and, without mitigating efforts, can result in substantial additional tax.
Furthermore, the income of certain foreign corporations can be categorized as "Subpart F" income; in this case, the corporation must be "looked-through" and the Subpart F income reported on the Form 1040, even if it has not been distributed to the shareholder. US taxpayers in the UK are most commonly deemed to have Subpart F income where they operate a "personal service contract company" or receive "foreign personal holding company income". The former is designed to discourage the use of a foreign corporation to defer tax on what is in effect employment income, and the latter is to avoid the use of a CFC to hold investment assets offshore. In these cases, the Subpart F income is declared on the Form 5471 and carried through to the Form 1040 as taxable income.
The above is a very brief overview of key issues. For more details on CFCs, the Form 5471, Subpart F income and how these issues might affect you please get in contact with us.
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