It snuck up on us like a fire ant in your underwear. A little-known, little-followed, late added provision of the new U.S. Tax Cuts and Jobs Act that has the unintended consequence of forcing a foreign company to file detailed information with the IRS about all its non-US subsidiaries. The offending provision states simply: “Section 958(b) is amended—by striking paragraph (4).”
That single deletion will now cause many of a foreign company’s affiliates to be considered “controlled foreign corporations” if the foreign company has a US subsidiary. Follow me for a moment. The change in the law now means that a US subsidiary of a foreign company will be deemed to own all the stock that is owned by the US subsidiary’s foreign parent. This is important because US tax law imposes onerous requirements on a non-US corporation that is owned (or deemed to be owned) by a US corporation. In the jargon of US tax law, a non-US corporation that is over 50% owned by “US shareholders” is considered a “controlled foreign corporation” and must file detailed information returns (forms 5471) with the IRS.
So let’s say that FCo, a non-US company owns all the stock of its US subsidiary USCO, Inc. The change in the law now imposes a fiction—that USCO, Inc. is considered to own all the shares of stock that are held by FCo. If FCo owns corporate subsidiaries outside of the US all of those subsidiaries are considered to be owned by USCO, Inc. And since all those non-US subsidiaries are now considered to be owned by USCO, Inc., all those non-US subsidiaries would be considered controlled foreign corporations and USCO, Inc. would be required to file forms 5471 every year for every non-US subsidiary USCO, Inc. is deemed to own. Unfortunately it gets worse.
If FCo has any United States shareholders that hold over 10% of the stock of FCo, those US shareholders may face a significant tax bill thanks to the new mandatory repatriation tax and those US shareholders will now have a continuing obligation to pay tax every year on certain types of income (subpart F) earned by all FCo’s foreign subsidiaries that are now considered controlled foreign corporations.
Listen to what I am saying…this is a big deal! Thanks to the one sentence change in the new tax law, foreign companies may now be required to spend significant money to conduct the “earnings and profits” studies and compile other information that is necessary to file the form 5471 for their “new” controlled foreign corporation subsidiaries.
One last thing. Since the law is retroactive to January 1, 2017, there is not much you can do now to avoid this result. Whatever the corporate structure of FCo and its foreign and US subsidiaries in 2017 that structure is now frozen in time and your 2017 US tax return is required to reflect that structure with application of the new law and its glorious consequences.
The really sad thing here is that Congress didn’t intend this result. The legislative history of the statute indicates the change in the law is intended to combat a specific type of abuse—a “de-controlling transaction.” But the law change now affects every non-US company with a US subsidiary, not just those guilty of performing “de-controlling” transfers of shares. Tax professionals are already calling this change the “Permanent Employment for Tax Professionals Act.” Thank you U.S. Congress.