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The IRS has power to issue summonses "for the purpose of… determining the liability of any person for any internal revenue tax." (Code Sec 7602(a)(2)) If the taxpayer doesn't comply, IRS may bring an enforcement action in district court. (Code Sec 7604(a)).

To obtain a court order enforcing a summons, IRS must first establish good faith by showing that the summons: (1) is issued for a legitimate purpose; (2) seeks information relevant to that purpose; (3) seeks information that is not already in IRS's possession; and (4) satisfies all of the administrative steps set forth in the Code. (U.S. v. Powell, (S Ct 1964) 14 AFTR 2d 5942).

Article 27 of the U.S.-France income tax treaty (the Treaty) provides that the competent authorities of the U.S. and France may exchange information "as may be relevant for carrying out the provisions of this Convention or to the administration or enforcement of the domestic laws concerning taxes of every kind and description imposed on behalf of the Contracting States." The exchange of information provisions of the Treaty also provide that the provisions should not be construed to impose on a Contracting State the obligation "to supply information which is not obtainable under the laws or in the normal course of the administration" of either Contracting State.

Here the taxpayer, Mr. Hanse, was the subject of an investigation by the French tax authorities relating to his potential income tax and wealth tax liabilities. Pursuant to the Treaty, the French tax authorities sent IRS an exchange-of-information request seeking information related to these investigations. Specifically, the French tax authorities requested information relating to transfers of funds totaling over 500,000 euros from Hanse to a client trust account maintained by the Sherman law firm.

Hanse's petition to quash the summons and the court denied their petition to quash. The court first noted, citing Stuart (S Ct 1989) 63 AFTR 2d 89-681, that IRS may issue summonses to obtain information for any treaty partner.

The court then noted that, in resolving a motion to quash an IRS summons, the government bears the initial burden to make a prima facie case that IRS issued the summons in good faith. (2121 Arlington Heights, (CA 7 1997) 109 F.3d 1221) To meet this burden, IRS must satisfy the four factors articulated by the Supreme Court in Powell. Once IRS makes its prima facie case, the burden shifts to the party seeking to quash the summons to come forward with specific facts that disprove any of the Powell factors or otherwise show that IRS issued the summons in bad faith or in a manner that constitutes an abuse of process.

The court quickly determined that IRS met its initial burden. Hanse then raised several objections to the IRS summons; the court rejected all of his objections.

1. Hanse argued that the French tax authorities were not entitled to the information sought by the summons to Sherman under French law. Specifically, Hanse argued that he was a resident of Switzerland, not France, during the relevant tax years and, as a non-resident French citizen, he did not have to pay tax on income earned outside of France. and

2. He argued that the French tax authorities should be required to resolve the question of his residency status before IRS procures information to assist in the French investigation.

The court said that this appeared to be a challenge to the first Powell factor requiring that the summons be issued for a legitimate purpose. It concluded that Hanse's arguments on this point failed because IRS was not required to assess the good faith of France’s tax investigation into Hanse before issuing the summons to Sherman.

3. Hanse then argued that the U.S. is not required under the Treaty to provide any information to France that France could not obtain under its own laws.

The court said that this argument was also of no help to Hanse. The Treaty states that its provisions should not be construed to impose on a Contracting State the obligation "to supply information which is not obtainable under the laws or in the normal course of the administration" of either Contracting State. But, the court said, "even though it does not mandate the exchange of information at variance with French law, neither does the plain language of the Treaty forbid compliance with an otherwise proper treaty request."

4. Hanse then objected to the IRS summons on the basis that IRS did not comply with the notice requirements of Code Sec 7602(c)(1) and Code Sec 7609(a).

The court said that Hanse's argument regarding Code Sec 7602(c)(1) failed because he is not entitled to any advance notice of a third-party summons under this section of the Code.

According to Hanse, as the "taxpayer," he should have been notified, pursuant to that Code section, by IRS that a third party would be contacted in connection with an investigation into his tax liability. But "tax liability" for purposes of this section "does not include the liability for any tax imposed by any other jurisdiction." (Reg 301.7602-2(c)(3)(C)) The summons was issued to Sherman in relation to Hanse's potential tax liability in France, not the U.S., and therefore it did not fall into the relevant definition of "tax liability" for purposes of this section. Therefore, IRS was not required to notify Hanse in advance of a third party summons under Code Sec 7602(c)(1).

And, the court said, IRS presented ample evidence, that Hanse did not challenge, of compliance with Code Sec 7609(a). The summons at issue was served on Sherman on June 1, 2017. Notice was sent to the two parties identified within the summons via certified mail on June 2, 2017. The notice to Hanse was sent to the French address for Hanse provided by the French government in its request, after IRS searched its own databases for an alternative address and found none. No more was required of IRS to properly serve Hanse.

5. Finally, Hanse stated that Sherman is a law firm and therefore some of the summoned materials were protected from disclosure by attorney-client privilege. The court said that Hanse's blanket assertion of privilege was insufficient to challenge the validity of the summons. The party asserting the privilege has the burden to "on a document-by-document basis at least identify the general nature of that document, the specific privilege he is claiming for that document, and facts which establish all the elements of the privilege he is claiming." In addition, Hanse did not even assert that Sherman was retained as his attorney; he merely stated that Sherman was a law firm.
   

Quoting Douglas O’Donnell, IRS Assistant Deputy Commissioner, Large Business & International (LB&I) from 2013:“These summonses reflect our continuing efforts to work with our international partners on offshore tax evasion,” said  “By using effectively our existing network of bilateral agreements, countries can help one another put an end to the global practice of evading taxation by hiding assets abroad.”

 

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The Tax Cuts and Jobs Act 2017 (TCJA) changed many things, including reporting and taxing requirements for US taxpayers living abroad. While the plan was marketed as a much needed tax simplification for Americans; the TCJA did not provide much relief, let alone simplification, for U.S. taxpayers living abroad (Expats).

Listed below are 12 items about TCJA that U.S. Expats need to know:

1. The Most Important Tax Code Provisions for Expats Remain. The Foreign Earned Income Exclusion and the Foreign Tax Credit help expats avoid double taxation and are included in the tax reform. However, the amount of the FEIE that can be excluded from taxes each year is indexed to inflation, which brings us to our second point.

2. Tax Brackets, Exemptions and Deductions Have Been Modified. Tax brackets are now larger, meaning taxpayers may now be in a lower bracket than they were previously, and the standard deduction has nearly doubled. For those considering a move to or from the U.S., two new issues should be considered. First, the moving deduction has been completely eliminated. Second, the individual mandate part of the Affordable Care Act has been eliminated. Unfortunately, the Net Investment Income Tax was not eliminated and will still impact expats.  

3. Inflation Calculations Have Changed. The tax reform law has changed the measure of inflation from the “regular consumer price index” to the “chained consumer price index,” and changing the way inflation is calculated will affect a number of tax-related issues. The end result is a lower rate of inflation used to calculate tax figures, which will increase taxes over time.

4. The Foreign Information Reporting Requirements are Generally Unchanged. The burdensome reporting requirements expats are required to submit in addition to their tax returns are unchanged. The Foreign Bank Account Report, also known as FinCEN 114, the FATCA requirements, Form 8938 (Statement of Foreign Financial Assets), Form 5471 (Report of Certain Foreign Corporations), and Form 3520 (Report of Foreign Trusts), are here to stay. This means that many expats will continue having trouble banking abroad and face onerous penalties if they fail to file.
  
5. Elimination of the CFC 30 Day Ownership Requirement. The TCJA eliminates the requirement that a U.S. shareholder must control a non-U.S. corporation for an uninterrupted 30-day period before Subpart F inclusions apply (the so-called "30 day rule"). This change is relevant for U.S. individuals that receive gratuitous transfers of foreign stock, such as individuals who inherit shares from non-U.S. family members. A popular technique that will no longer be as effective as it was in the past is to liquidate an inherited foreign corporation within 30 days of the decedent's death.
 
6. Elimination of the CFC Downward Attribution.  TCJA eliminates Section 958(b)(4), which prevents downward attribution of stock from certain non-U.S. partnerships, estates, trusts, and corporations to U.S. persons for purposes of determining whether the CFC and U.S. shareholder tests are satisfied. This repeal may result in unintended tax and reporting consequences.
 
7. Expands the CFC Definition of US Shareholder. The TCJA expands the definition of "United States shareholder" to include any U.S. person who owns 10 percent or more of the total vote or value of all shares of all classes of stock of a foreign corporation. Under current law, the definition of United States shareholder required a U.S. shareholder to hold 10% or more of the voting power of the CFC. Therefore, individuals that own non-voting shares in a foreign corporation that were not previously considered United States shareholders, should determine if their non-voting shares will cause them to become United States shareholders and also cause the entity to become a CFC.  
 
8. Corporate Taxes Have Changed Significantly. The tax reform bill has transitioned the U.S. to a territorial system of corporate taxation. Before, the U.S. operated using worldwide taxation, meaning that corporations had to pay taxes on the income they earned abroad. This change will affect expats who own corporations outside the U.S., because they will face a one-time deemed repatriation tax of 15.5 percent of any previously untaxed overseas profits as the U.S. transitions to a territorial system for corporations instead of a worldwide system (See Forced Repatriation Below).  

The individual reporting requirements are, for the most part, the same. U.S. expats who own small businesses abroad may find their situation is worse under the TCJA than under the old system. Most American Taxpayers living abroad will not find their taxes streamlined by the provisions of the TCJA. 
 
9. Forced Repatriation of CFC Deferred E&P (Post 1986 Retained Earnings). The bill's forced repatriation rule applies to U.S. individuals who own CFCs, or non-U.S. corporations that have at least one 10 percent U.S. shareholder that is a U.S. domestic corporation. It does not apply to individuals who own non-CFC PFICs. The tax applies as a Subpart F inclusion on all of the CFC's pre-effective date foreign earnings at an individual rate of approximately 9.05% for non-cash earnings and profits and 17.5% for earnings and profits held in cash. Individuals will not be afforded the benefit of foreign tax credits for any foreign tax imposed on the CFC's earnings.
 
The new provision will allow for an 8-year deferral on payment of the tax owed, meaning the majority of payments will be owed in the later part of the 8-year period. If the CFC was owned by an S corporation, there is an indefinite deferral of the tax that may apply until one of the following triggering events is met: 

1. The first type of triggering event is a change in the status of the corporation as an S corporation.
2. The second category includes liquidation, sale of substantially all corporate assets, termination of the company or end of business, or similar event, including reorganization in bankruptcy.
3. The third type of triggering event is a transfer of shares of stock in the S corporation by the electing taxpayer, whether by sale, death or otherwise, unless the transferee of the stock agrees with the Secretary to be liable for net tax liability in the same manner as the transferor.

10. Create an Alternative Methods for Taxing CFC Global Intangible Low-Taxed Income (GUILTI). The GILTI regime may cause income of a CFC that is not otherwise caught by the existing Subpart F rules to be includable in the gross income of its U.S. shareholders. This regime will affect almost all U.S. individuals that own CFCs, unless the CFC has incurred significant investment in tangible assets.
 
This GILTI tax would apply to U.S. shareholders of foreign IP Heavy CFCs, service provider CFCs, and CFCs with low basis assets, and which otherwise would not cause Subpart F inclusions for its U.S. shareholders.  

If a U.S. individual owns the CFC directly or through a pass-through entity, then the GILTI inclusion will be subject to ordinary U.S. federal tax rates of up to 37%. Furthermore:

• The individual will not be able to apply a tax credit against the income for taxes paid by the CFC. 
• The CFC will be subject to tax in the foreign country plus
• The individual will be subject to an immediate 37% tax on GILTI income. and
• Finally, the dividend withholding by the CFC's country of incorporation will likely not be able to be offset by foreign tax credits.

There are several options to improve the tax position of U.S. individual shareholders holding non-U.S. investments, such as forming a U.S. corporation to own the shares of a non-U.S. corporation. This can be especially beneficial to U.S. individual shareholders that own non-U.S. corporations in jurisdictions that do not have a treaty with the United States.

An alternative is for the shareholder to make an election under Section 962(b) to treat the CFC as if it were owned by a domestic C corporation. The 100% foreign source dividends exemption will not apply to dividends from passive foreign investment companies ("PFICs") even if the U.S. shareholder is a corporation. 

12. Expatriation Rules for Relinquishing US Citizenship and/or US Green Card Remain the Same. Congress did not touch Sections 877A or 2801 of the Internal Revenue Code. Those are the two special-purpose statutes that impose tax on people who renounce US citizenship or abandon their green cards. Therefore, someone who expatriates in 2018 will face the same tax laws that applied to someone expatriating in 2017, 2016, or before.  
 

Sources:

TCJA

taxproToday

Baker & McKenzie

On June 21, 2016 we posted  US Taxpayers Are Receiving Automated $10,000 Penalty Assessments For Late Filed Form 5471's & 5472's - We Can Help! where we discussed that we have been receiving a lot of calls from businesses who have recently received penalty notices regarding late filed or non-filed Form 5471 & 5472's. The Internal Revenue Service imposes an automatic penalty of $10,000 whenever an individual or company is late in filing an information return disclosing their interest in a foreign corporation, regardless of whether there is any associated underreported of income or tax deficiencies.

Now in a recently updated International Practice Unit (IPU), IRS has explained the Code Sec. 6679 penalty for certain U.S. persons that are required to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, but fail to file, fail to file on time, or file an incomplete form. The IPU includes, among other things, insight as to what constitutes reasonable cause for failing to file.

A Category 2 filer is a U.S. citizen or resident who is an officer or director of a foreign corporation in which a USP has acquired, in one or more transactions:

• . . . stock which meets the 10% stock ownership requirement (described below) with respect to the foreign corporation, or
• . . . an additional 10% or more (in value or voting power) of the outstanding stock of the foreign corporation.

For purposes of both Categories 2 and 3, the stock ownership threshold is met if a USP owns 10% or more of the (i) total value of the foreign corporation's stock, or (ii) total combined voting power of all classes of stock with voting rights. (Reg. § 1.6046-1(a), Reg. § 1.6046-1(c) ). A USP is treated as having acquired stock in a foreign corporation when the person has an unqualified right to receive it. (Reg. § 1.6046-1(f)(1))

A Category 3 filer is:

• . . . A USP who acquires stock in a foreign corporation which, when added to any stock owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation,
• . . . A USP who acquires stock which, without regard to stock already owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation,
• . . . A person who is treated as a U.S. shareholder under Code Sec. 953(c) with respect to the foreign corporation,
• . . . A person who becomes a USP while meeting the 10% stock ownership requirement with respect to the foreign corporation, or
• . . . A USP who disposes of sufficient stock in the foreign corporation to reduce his or her interest to less than the 10% stock ownership requirement. (Code Sec. 6046, Reg. § 1.6046-1(c))

There are a number of exceptions to the filing requirement for Category 2 and 3 filers, including when multiple persons are required to file Form 5471 and applicable schedules with respect to the same foreign corporation for the same period (in which case the form may be jointly filed).

Guidance for examiners. IRS examiners are instructed to determine whether a taxpayer who is required to file Form 5471 in fact filed a timely and accurate form. As noted above, the Form 5471 is due when the USP's income tax return is due, with extensions (and taking into account if the last day for filing was a weekend or legal holiday), and must be filed with that return. If one was not timely filed, or it wasn't complete, then penalties may be asserted unless the failure was due to reasonable cause.

While identifying Forms 5471 that were required, but not filed, for the exam year(s), examiners are instructed to consider reviewing whether similar failures occurred in earlier tax years. The IPU notes that the related income tax returns for the prior years are not required to be under exam to assess penalties under Code Sec. 6679.

There are ways to defend against these automatic assessments and request penalty abatement. These four defenses should be considered when your receive a $10,000 penalty for filing an international information return after the due date.