What are the U.S. Tax Implications of Owning Interests in Foreign Corporations?August 23, 2021
Attention owners of interest in foreign corporations…are you aware of your tax responsibilities? The penalties for noncompliance are onerous…here’s what you should know.
Do you own interests in foreign corporations? The following is the first of a multi-part series discussing the US tax implications of owning interests in foreign corporations. The rules are complex, far reaching and contain onerous penalties for noncompliance. Let’s take a look at some FAQs.
Some helpful background
December 2017’s TCJA made numerous changes to international tax rules, including the U.S. shift from a worldwide corporate tax system to a territorial tax system. What does this mean exactly? Essentially, U.S. based multinational corporations must now pay income taxes only against U.S. earnings, rather than the corporate tax on worldwide earnings.
Additionally, the TCJA introduces various anti-deferral provisions, aimed at preventing companies from deferring foreign earnings to avoid paying taxes.
Isn't this just a concern for big business?
Unfortunately these rules, while originally directed at the big multi-national corporations, apply across the board. So for example, if you’re a consultant who incorporates a small entity in Switzerland to provide consulting services there, you are subject to the full force of the rules. This is of course counter-intuitive as your motive for setting up the Swiss entity was certainly not tax avoidance. Switzerland is not exactly a tax haven.
Even a nominal investment by an individual can trigger the same compliance obligations and potential penalties as a large investment by a major corporation.
I don’t have anything in my name but some of my close family members do. Am I in the clear?
Probably not out of the woods. The rules contain elaborate constructive ownership provisions which can cause family ownership to be attributed to you in many instances. For example, if you are a US citizen but your spouse owns an interest in a foreign corporation, that ownership interest will be attributed to you for certain reporting purposes. This will apply regardless of whether or not your spouse is a US person.
The investment fund in which I invested may have some foreign assets. Am I correct in assuming they’ve taken care of all the foreign stuff?
Sorry, no you’re not out of the woods. Typically, such funds are organized as partnerships or limited liability companies. For US tax purposes these are treated as “pass-through” entities, and guess what passes through to you? Most if not all the foreign reporting. This is why in recent years the Forms K-1 issued to hedge fund owners include a voluminous amount of footnotes regarding foreign disclosures for you and your tax preparer to sort out. Since tax returns tend to be delivered electronically these days, taxpayers lose sight of how the size of their returns are increasing exponentially year-to-year due to such reporting. As international investing continues to increase so will the compliance headaches.
Didn’t the tax reform package a couple of years ago simplify all these taxes?
Au contraire! While it was advertised as simplification, it significantly complicated the foreign rules by adding new taxes and reporting requirements for the shareholders of foreign corporations. So, if you think you’re going to fit it onto a postcard sized tax return, to paraphrase the movie, Jaws, you’re going to need a bigger postcard!
In future installments of this series, we’re going to take an in-depth dive into the rules as they impact various types of foreign investments. We will look at everything from having a small investment in a foreign mutual fund to buying a controlling interest in Novartis. We will take you through the alphabet soup of international related tax acronyms such as CFCs, GILTI, PFICS AND SUBPART F as well as all the related tax forms such as 8938, 5471, 926, 8621, etc.…
Also, we will discuss a number of planning techniques available to lessen the impact of the various provisions as well as what to do if you haven’t previously been in compliance.
If in the meantime you need assistance, please contact the International Tax Services Group here at KLR.