Part I of the topic exploring Form 5472, was posted last week and covered the situation when Form 5472 must be filed by a US corporation that is at least 25% owned by a foreign shareholder. Today’s post covers the other type of case requiring the filing of this form – when a foreign corporation that is engaged in a US trade or business (USTB) has a “reportable transaction” with either a US or a foreign related party.
Generally, the purpose of the form is to disclose the nature and amount of foreign and domestic transactions that occur with related-parties, since these types of transactions can give rise to abuse (for example, in transfer-pricing or in attempts to siphon off taxable earnings and profits in disguised non-taxable forms). The Internal Revenue Service, (IRS), uses Form 5472 to develop information about the company and its related parties and assists the IRS in identifying potential audit issues.
Foreign Corporation is “Engaged in a US Trade or Business”
Another situation when Form 5472 must be filed is when a foreign corporation, engaged in a USTB, engages in a “reportable transaction” with a related party, whether foreign or US. Generally, a “reportable transaction” occurs when there is any exchange of money or property 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 5472 and are detailed in the instructions to the Form.
Engaged in a US Trade or Business
A new concept is introduced in this second category of filers – that is, when is a foreign corporation “engaged in a US trade or business?” Neither the US Internal Revenue Code nor Treasury Regulations clearly define what is meant by being engaged in a USTB. The case law indicates that business activity will not constitute a USTB unless the activity is considerable, continuous and carried out on a regular basis. Unfortunately, the cases are old and ambiguous and despite the case law language requiring considerable, continuous and regular activity, some of the cases find that lower levels of activity satisfy the standard, leaving little real guidance. The IRS has taken a very strict position in published rulings that activities beyond mere passive receipt of income, if conducted in the United States, are sufficient to constitute engaging in a USTB.
While there are various exceptions to filing this form, professional advice should be taken to make sure the exception applies. For example, an exception exists if the foreign corporation does not have a so-called “permanent establishment” in the United States under an applicable income tax treaty and timely files Form 8833, Treaty-Based Return Position Disclosure. What is meant by a “permanent establishment”? Suffice to say, it is best to rely on a competent tax advisor with significant international experience to assist with such issues. Penalties apply for failure to file the form, and if the form is deemed substantially incomplete, the penalty can also apply. The penalty is $10,000 per year.