Post by Jerome on Feb 6, 2015 1:42:51 GMT 4
Every now and then a client may visit a lawyer or tax advisor and describe the stock ownership (of record) in a foreign corporation. Based on the stock ledgers, the foreign corporation may not meet the definition of a controlled foreign corporation or "CFC". However, in digging a little deeper, one of the shareholders is simply the "nominee" or "straw party" for the true owner or beneficial owner who just happens to be a U.S. shareholder. There could be a voting arrangement where the nominee shareholder will vote at the direction of the beneficial owner. This latter situation came to the attention of Chief Counsel's office several years ago but since we are in tax return season, tax return preparers need to exercise due diligence in determining whether a client must file one or more CFC schedules on Form 5471.
CCA 201104034 (1/28/2011) is a reminder that the Service is "on guard" for finding "nominee" type shareholders in the CFC context. The facts in the CCA involved retained ownership through an "informal voting arrangement". The question from the field was "whether a person that transfers nominal or mere title ownership of stock in a foreign corporation could nevertheless be considered under the provisions of subpart F to be a U.S. shareholder of that foreign corporation (which would then be a CFC), as well as ...... the statute of limitations and penalties that would apply for failure to file a Form 5471 for such entity.
A CFC, as we all know, is any foreign corporation with more than 50% of either the total combined voting power of all classes of stock of the corporation entitled to vote or the total value of the stock of the corporation, is owned by United States shareholders on any day during the taxable year of such foreign corporation. § 957(a). Mere title ownership is not determinative of who holds the voting power of the stock; any arrangement to shift formal voting power away from U.S. shareholders will not be given effect if, in reality, voting power is retained. Treas. Reg. § 1.957-1(b)(2).
The regulations provide examples of when voting power will be considered to have been retained which in turn could result in CFC status. Indeed, CCA 201104034 directs the reader to consider Example 5 of Treas. Reg. § 1.957-1(c) to drive home the point that a foreign corporation may qualify as a CFC solely as a result of a U.S. shareholder actually owning more than 50% of the voting power of the corporation where nominal owner ship and voting power is vested in a non-resident alien.
In Example 5, N, a U.S. person owns 50% of the outstanding shares of foreign corporation R, foreign corporation S owns 48% of the outstanding shares, and the remaining 2% are nominally owned by a non-resident alien. However, because the non-resident alien regularly acts as an attorney for N, reduces fees in conjunction with dividends received on the shares, and permits N to borrow against the shares, the example finds an implied agreement for N to "hold dominion" over the stock and the corporation is determined to be a controlled foreign corporation because N "owns" a total of 52% of the stock. This is the case despite the fact that the non-resident alien actually votes his shares at shareholder meetings.
The regulations under § 957 have been applied by courts to find U.S. ownership in CFCs where only informal voting power was retained by a non-title owner. In Garlock v. Commissioner, 489 F.2d 197 (2nd Cir. 1973), a U.S. corporation reduced its title ownership in the voting stock of a Panamanian subsidiary from 100% to 50% in order to avoid tax under the CFC provisions in the Code. In the recapitalization, preferred shares were issued to foreign investors who nominally received 50% of the voting power. The Second Circuit held that the voting power of the stock was actually retained by the U.S. corporation, which was therefore required to include subpart F income from the subsidiary. In reaching its determination that the voting power of the preferred shareholders was illusory, the court considered that the stock had been deliberately placed with investors who would vote their stock as instructed, the transfer of shares was prohibited without prior written consent, and even though the investors could have technically voted independently, there was no evidence that they did, and the board in fact always consisted of the U.S. corporation's officers. Another case cited in this area is Koehring Co. v. Commissioner, 583 F.2d 313 (7th Cir. 1978). In Koehring, a foreign corporation was determined to be a CFC based on an informal side agreement granting actual voting power.
Filing Requirements and Penalties The Form 5471 filing requirements apply to all U.S. shareholders of a CFC. There is no exception for a person who is a U.S. shareholder as a result of informal voting power arrangements. The statute of limitations and penalty provisions that apply when a U.S. shareholder of a CFC fails to file Form 5471 will apply to an individual who, though not the nominal title owner of shares, is a U.S. shareholder as a result of an informal voting power arrangement. When a person who is a U.S. shareholder as a result of informal voting power arrangements fails to file Form 5471, the statute of limitations for assessing tax imposed with respect to any tax return, event, or period to which the information required to be reported on the form relates will not begin to run under § 6501(c)(8) until the shareholder files the required Form 5471. Similarly, a person who is a U.S. shareholder as a result of informal voting power arrangements is subject to the penalties under § 6038 for failure to file Form 5471.
CCA 201104034 (1/28/2011) is a reminder that the Service is "on guard" for finding "nominee" type shareholders in the CFC context. The facts in the CCA involved retained ownership through an "informal voting arrangement". The question from the field was "whether a person that transfers nominal or mere title ownership of stock in a foreign corporation could nevertheless be considered under the provisions of subpart F to be a U.S. shareholder of that foreign corporation (which would then be a CFC), as well as ...... the statute of limitations and penalties that would apply for failure to file a Form 5471 for such entity.
A CFC, as we all know, is any foreign corporation with more than 50% of either the total combined voting power of all classes of stock of the corporation entitled to vote or the total value of the stock of the corporation, is owned by United States shareholders on any day during the taxable year of such foreign corporation. § 957(a). Mere title ownership is not determinative of who holds the voting power of the stock; any arrangement to shift formal voting power away from U.S. shareholders will not be given effect if, in reality, voting power is retained. Treas. Reg. § 1.957-1(b)(2).
The regulations provide examples of when voting power will be considered to have been retained which in turn could result in CFC status. Indeed, CCA 201104034 directs the reader to consider Example 5 of Treas. Reg. § 1.957-1(c) to drive home the point that a foreign corporation may qualify as a CFC solely as a result of a U.S. shareholder actually owning more than 50% of the voting power of the corporation where nominal owner ship and voting power is vested in a non-resident alien.
In Example 5, N, a U.S. person owns 50% of the outstanding shares of foreign corporation R, foreign corporation S owns 48% of the outstanding shares, and the remaining 2% are nominally owned by a non-resident alien. However, because the non-resident alien regularly acts as an attorney for N, reduces fees in conjunction with dividends received on the shares, and permits N to borrow against the shares, the example finds an implied agreement for N to "hold dominion" over the stock and the corporation is determined to be a controlled foreign corporation because N "owns" a total of 52% of the stock. This is the case despite the fact that the non-resident alien actually votes his shares at shareholder meetings.
The regulations under § 957 have been applied by courts to find U.S. ownership in CFCs where only informal voting power was retained by a non-title owner. In Garlock v. Commissioner, 489 F.2d 197 (2nd Cir. 1973), a U.S. corporation reduced its title ownership in the voting stock of a Panamanian subsidiary from 100% to 50% in order to avoid tax under the CFC provisions in the Code. In the recapitalization, preferred shares were issued to foreign investors who nominally received 50% of the voting power. The Second Circuit held that the voting power of the stock was actually retained by the U.S. corporation, which was therefore required to include subpart F income from the subsidiary. In reaching its determination that the voting power of the preferred shareholders was illusory, the court considered that the stock had been deliberately placed with investors who would vote their stock as instructed, the transfer of shares was prohibited without prior written consent, and even though the investors could have technically voted independently, there was no evidence that they did, and the board in fact always consisted of the U.S. corporation's officers. Another case cited in this area is Koehring Co. v. Commissioner, 583 F.2d 313 (7th Cir. 1978). In Koehring, a foreign corporation was determined to be a CFC based on an informal side agreement granting actual voting power.
Filing Requirements and Penalties The Form 5471 filing requirements apply to all U.S. shareholders of a CFC. There is no exception for a person who is a U.S. shareholder as a result of informal voting power arrangements. The statute of limitations and penalty provisions that apply when a U.S. shareholder of a CFC fails to file Form 5471 will apply to an individual who, though not the nominal title owner of shares, is a U.S. shareholder as a result of an informal voting power arrangement. When a person who is a U.S. shareholder as a result of informal voting power arrangements fails to file Form 5471, the statute of limitations for assessing tax imposed with respect to any tax return, event, or period to which the information required to be reported on the form relates will not begin to run under § 6501(c)(8) until the shareholder files the required Form 5471. Similarly, a person who is a U.S. shareholder as a result of informal voting power arrangements is subject to the penalties under § 6038 for failure to file Form 5471.