CFOs can exercise reasonable diligence to ensure that they have procedures in place to deal with some of the more common shortcomings in cross-border tax compliance. The following are some routine tax compliance situations that U. S. companies ($500 million or less in sales) with outbound activities are most likely to encounter:
Ensure that intercompany working capital accounts to the parent company and among foreign affiliates are settled every 120 days or that market interest is charged on overdue receivables. Buildups of intercompany payables to a foreign parent or affiliate, without regular and ongoing settlement, can cause the IRS to impute interest income to the creditor for U.S. tax purposes.
Document foreign payments at reduced or zero rates of withholding tax. The payer is liable for withholding tax that it fails to withhold and bears the burden of proof that the proper amount has been withheld. Prudent CFOs will periodically test to ensure that their accounts payable personnel are familiar with foreign withholding tax rules and are maintaining proper documentation for payments made overseas.
Address intercompany cross-border pricing issues. The ultimate protection against IRS tax assessments on pricing issues is an advanced pricing agreement (APA) whereby the IRS abides by intercompany pricing it has already reviewed with the taxpayer and its representatives (usually an economist, accountant or lawyer). The next level of security is a pricing study whereby a professional firm compiles and reviews a company’s intercompany pricing arrangements, analyzes them, and issues a report. Finally, a company can greatly reduce the exposure for routine transactions by finding comparable transactions with unrelated parties and ensuring that charges and costs for transactions among related companies are comparably priced.
Determine tax status of foreign affiliates. If a U.S. company owns shares in a foreign company, it may qualify as a passive foreign investment company if it has a high proportion of assets or income that is passive. For this purpose, cash is considered a passive asset, so newly formed companies are especially vulnerable. If a U.S. company owns 10% or more of a foreign corporation, it should evaluate whether other U.S. shareholders that each own a 10% or greater interest own in aggregate an additional 40%. If they do, the foreign affiliate likely is a controlled foreign corporation, subject to the anti-deferral regime of subpart F of the Internal Revenue Code.
Ensure that interest expense due to foreign affiliates is deducted on a cash basis on the U.S. tax return. For tax purposes, interest accrued to foreign affiliates is usually deductible, but only when actually paid.
Evaluate whether the company is obligated to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, and Form 8865, Schedule O, Transfer of Property to a Foreign Partnership (under section 6038B). If a U.S. company owns 10% or more of a foreign-organized affiliate or it has contributed more than $100,000 in property to a foreign partnership during any 12-month period, the company should evaluate whether it must file Form(s) 8865 and Schedule O.
File forms 5471 and 8865 with the tax return for each separate controlled foreign corporation or foreign partnership. Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, and Form 8865 are required for each separate legal entity, even if the companies are organized in the same country and even if a subconsolidation of financial information for two or more separate foreign entities is available.
—By James Collins (firstname.lastname@example.org), a senior manager at Friedman LLP in New York.