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taxmanrog
taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 392
Experience:  Licensed CPA, MA, MST with 29 year's experience. Teach Accounting and Tax courses at Masters level.
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On 1st July 2013, I acquired a 67% interest in a UK located

Customer Question

On 1st July 2013, I acquired a 67% interest in a UK located and registered corporation. I became a director. This is a CFC. The corporation only has rental income and bank interest as earnings. I need to complete a Form 5471. However, the UK company's accounts are made up in British pounds, according to UK accounting standards, and the next year end is 30 April 2014. To complete the form 5471 I am somehow supposed to produce accounts in US$, based on US GAAP, for the period 1 July 2013 to 31 December 2013? Seems a tall order, anyway out?
Submitted: 10 months ago.
Category: Tax
Expert:  taxmanrog replied 10 months ago.

Welcome to Just Answers! The expert you requested is not online now, so with your permission, I will assist you. I will do my best to help! This is actually an area that I am extremely familiar with, as I used to file over 100 Forms 5471 each year.

 

You do not need any way out, nor do you need any special financial statements. If you just acquired the company in July 2013, you do not have a reporting requirement yet. You report the acquisition of the CFC in the US tax year that includes the foreign corporation's year-end. You acquired the CFC during the year when the CFC's next year-end is April 30, 2014. That year-end will be in YOUR tax year that ends on December 31, 2014. So you will not have to report anything until NEXT year. You will always be a year in arrears, or behind, as long as you own the CFC.

 

If the company is a UK company, not only are the statements in UK Pounds, but they are also prepared in accordance with IFRS, International Financial Reporting Standards. You will have to convert not only to US$, but also to US GAAP basis

 

I hope this answers your question. If you have any more, please feel free to ask! I will be happy to answer. If you have found my answer helpful, please rate me highly. I would appreciate it!

 

Thanks again! Have a great weekend!

 

Roger

 

 

Customer: replied 10 months ago.


Thanks, XXXXX XXXXX and just saved me a ton of work. Also I would be interested to know if the IRS may deem the UK company to be a US person, and be fully taxable in the US, since I am now the majority shareholder, and I reside in the US.

Expert:  taxmanrog replied 10 months ago.
No, the IRS won't view the UK company as US in any way. You are the majority owner, but it is still a foreign corporation. The only way it would be taxable in the US is if it actually started doing business here through a permanent establishment.

You will have many issues that you need to be aware of, however. First, you have to track the Earnings & Profits as well as the taxes each year, and keep them in a "pool". If the UK company ever pays a dividend to you, you will have both a dividend as well as a "deemed dividend" in the amount of the taxes that were in the pool.

For example, if the company earns $10, $15, and $25 after tax for its first three years, and it paid taxes in each of the years in the amount of $3, $5, and $8, there would be $50 in the earnings "pool" and $16 in the "tax" pool. If the company then paid a $20 dividend, it would be paying out $20/$50, or 40% of the earnings pool, so there would be a "deemed dividend" of 40%, or $6.40 of taxes from the "tax pool". So your total dividend would be $26.40 with $6.40 "Gross-up" of foreign taxes that you could use as a foreign tax credit on Form 1116.

You also have to be careful about borrowing any money from the UK company. If you borrow anything, and have not repaid it by 12/31 of any tax year, it is also a "deemed dividend" or Subpart F income, under Internal Revenue Code §956. So if you borrowed $50 from the UK company in August 2014, and had not paid it back by December 31, 2014, you would be considered to have a $50 dividend. It would come with a gross-up of foreign taxes as well.

As you can see, owning a foreign company can be complex. But follow the rules starting early, and you can be a step ahead, and make it not that difficult. I am not sure what the new rules are as far as customer contact, but I believe we can now offer additional services, so if any of this comes to pass, you could contact me if you wish and we could help you with this.

I hope this answers your questions. If you have any more, ask away! I know I may have opened a can of worms, but I like you to be aware of what future implications you might have before they happen. If you have found this helpful, please rate me highly.

Again, thanks!

Roger
taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 392
Experience: Licensed CPA, MA, MST with 29 year's experience. Teach Accounting and Tax courses at Masters level.
taxmanrog and other Tax Specialists are ready to help you
Customer: replied 10 months ago.


Thank you for your very helpful answers. I just wanted to clarify something. I was led to believe that my share of profits (67%) would be taxable in my 1040 as subpart F income. So if the company made $10, $15 and $25 in the first three years, I would include my share of profits of $6.67 (67% of 10), $10 (67% of $15) and & $16.67 (67% of $25) in my 1040 as schedule C income. I would also take credit for my share of the taxes paid which be $2 (67% of $3), $3.33(67% of $5), and $6 (67% of $8). From what you say I was misled, and that I would only account for profits when I receive dividends.

Expert:  taxmanrog replied 10 months ago.
This is not correct. If the UK company is a corporation, the income would only be Subpart F if the UK company is operating outside of its' country of incorporation, or if it is insurance, oil, or shipping income. So, if it is a normal UK operating company, the income is NOT going to be Subpart F. Furthermore, if it IS Subpart F income, the income is NOT reported on Schedule C! Subpart F income is a "deemed dividend", and as such is reported on Schedule B of the tax return. And, as I said in my first answer, any dividend, regular or deemed, carries with it a "gross-up" of foreign tax, so your dividend will carry its own Foreign Tax Credit with it, to be reported on Form 1116.

Whoever told you that the income is reported on Schedule C is wholly wrong! Schedule C income is ONLY for self-employment income. The UK corporation does NOT generate self-employment income.

I hope this helps! Feel free to ask any more questions if anything is not clear.

Again, thanks!

Roger
Customer: replied 6 months ago.

Hi,


 


I hope you are fit and well. I still would appreciate clarification of you last answer.


 


1. A UK Corporation (formed in the UK under the rules of the UK).


2. No business presence or investments in the US,


3. The UK Corporation ONLY earns real estate rental income from properties only from situated in UK.


4. US individual owns 67% of the UK Corporation and is a Director


5. The US Individual needs to complete Form 5471


6. There is no subpart F income to report


7. Dividends are reported when paid with specific rules for earnings pools and tax pools.


 


Would 6 and 7 be correct?


Expert:  taxmanrog replied 6 months ago.
You are correct for #5. For #6, Subpart F income is defined in IRC §952 . One of the items that is taxable as Subpart F income is "Foreign Base Company Income" (FBCI) in §954. Under that section, among all the definitions of things that are FBCI, is the following exception:

"§954(c)(2) Exception for certain amounts (A) Rents and royalties derived in active business Foreign personal holding company income shall not include rents and royalties which are derived in the active conduct of a trade or business and which are received from a person other than a related person (within the meaning of subsection (d)(3)). For purposes of the preceding sentence, rents derived from leasing an aircraft or vessel in foreign commerce shall not fail to be treated as derived in the active conduct of a trade or business if, as determined under regulations prescribed by the Secretary, the active leasing expenses are not less than 10 percent of the profit on the lease."

This means that as long as the rental income is received from someone who is NOT a related party, it is not FBCI, and therefore is not Subpart F.

Dividends are paid together with a "gross-up" for taxes that will be deemed paid. You maintain a "pool" of both earnings and taxes. When a dividend is paid, it takes with it a like percentage of the "tax pool" as it has of the dividend pool. For example, if the dividend pool has $5,000 of E&P, and a $1,000 dividend is paid, the ratio of dividend to total E&P is 20%. If there were $550 in the taxes pool, the dividend would trigger an additional $110 "deemed dividend" (20% times the $550 tax pool). So the total dividend would be $660, and there would be $110 of foreign taxes to offset this.

I hope this answers your questions. If you have any more please let me know.

Thanks!

Roger


taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 392
Experience: Licensed CPA, MA, MST with 29 year's experience. Teach Accounting and Tax courses at Masters level.
taxmanrog and other Tax Specialists are ready to help you
Customer: replied 4 months ago.

My partner (33% shareholder) and I (67% shareholder) wish to inject further monies into the CFC to expand the business. We prefer to make loans (rather than equity) since loans can repatriated from cashflow as opposed to equity are repatriated from profits (dividends) or capital. Capital repatriation requires long legal process (UK) to repatriate. However, charging interest on the loans is counter productive since it means we would just have to put more loans in to cover paying the interest paid by the CFC. We have two solutions:


 


(1) Charge no interest and make loans directly proportional to shareholding percentages _ therefore there is no transfer of value -


(2) Charge interest at the end of the term of the loan.


 


(1) is infinitely better because interest paid by a UK corporation to a an individual is subject to 25% withholding tax. AS a US shareholder I can recover that in my taxes but there is obviously a cashflow/paperwork issue. Secondly, I can request the withholding tax to be reduced to 0% under the US/UK double tax treaty, however, again that is a lot of paperwork, and as the amount of the loan is no more than $200,000 and the annual interest at 3% would be 6,000 pa - its not worth all the work. If I charge no interest would the IRS deem an interest charge - albeit as a cash taxpayer I have not received the money.

Expert:  taxmanrog replied 4 months ago.
The problem I see with #1 is that the IRS will say this is not an arm's length loan, as the rules state you must charge a minimum of the AFR rate. Charging less can lead to recharacterization of the loan (i.e., call it capital and try to get a deemed dividend on the repayment).

If you charged interest at the end of the term, the payment would be larger, and may make the paperwork worth the effort. How much effort is it in the UK? Here in the US, all you would have to do is to fill out a Form W-8, and list the treaty provision you are relying on, and the payor would not withhold. It is that simple on this end. I can't imagine that Inland Revenue would make it too much more difficult. But then again, they do drive on the wrong side of the road!

Let me sleep on it and see if I can come up with something else.

Thanks!

Roger
Customer: replied 4 months ago.

I wonder whether you had any ideas? I also heard that if no interest is charged the deemed interest could also be treated as a gift to the recipient. The truth is, that in my situation it is perfectly commercial, and sensible not to charge interest. I can see a transfer of value from me to the company but that value is only going to come back to me in the form of higher dividends or capital gains.

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