International Tax Compliance - Foreign Partnerships
For foreign partnerships, control means direct or indirect ownership of a more than 50 percent interest in partnership profits, capital, or deductions or losses. It also includes certain groups of U.S. Persons, who collectively own more than a 50 percent and individually own more than a 10 percent interest in the foreign partnership.
Attribution and constructive ownership rules apply (a taxpayer with no direct ownership in the foreign partnership could potentially have a reporting obligation).
A violation of the Control Rule-, (i.e., failure to timely file a Form 8865) has a double-penalty impact. First, the U.S. Person's foreign tax amount used to compute the foreign tax credit is reduced by 10 percent. Second, the U.S. Person is subject to a flat $10,000 penalty.
Additional penalties apply if the violation continues for 90 days after IRS notice: (i) the foreign tax reduction increases by five percent for each three-month period, and (ii) there are additional $10,000 penalties for each 30-day period, up to $60,000 ($10,000 initial penalty and $50,000 maximum additional penalties). When both penalties apply, however, the foreign-tax penalty is reduced by the amount of the fixed-dollar penalty imposed.
The IRS must follow deficiency procedures and issue a notice of deficiency to the taxpayer with respect to the foreign tax credit reduction. The IRS may summarily assess the other penalties and collect them upon notice and demand.
These penalties may be avoided when the taxpayer proves that the failure was due to reasonable cause and not willful neglect.
Rules For Property Transfers
Transfers by U.S. Persons to foreign partnerships are subject to reporting. A reportable transfer occurs when (1) immediately after the transfer, the person holds, directly or constructively, a 10 percent or greater interest in the partnership, or (ii) the value of the property transferred, when added to the value of the property previously transferred by the person (or related person) to the foreign partnership over the last 12 months, exceeds $100,000. IRC §6038B. The U.S. Person must report the transfer on a Form 8865, which is filed with the person's timely filed federal tax return (including extensions).
If a domestic partnership contributes property to a foreign partnership, the partners of the domestic partnership are each treated as transferring their proportionate share of the contributed property. Each partner has an obligation to file a Form 8865. Unlike the Form 926 discussed above, however, the domestic partnership itself may file the Form 8865 and satisfy the reporting requirements of its partners.
The penalty for failure to file a Form 8865 is equal to 10 percent of the fair market value of the property at the time of the exchange/ transfer. The penalty will not apply if the failure to comply is due to reasonable cause and not willful neglect. The penalty is also limited to $100,000 unless the failure to comply was due to intentional disregard.
Rules For Ownership Transfers
Reporting rules apply to the transfer of ownership in a foreign corporation or foreign partnership.
A U.S. Person must file a Form 8865 if during the tax year (1) the person acquires or disposes of an interest in the foreign partnership, and before or after the transfer the person holds (directly or indirectly) a 10 percent interest in the partnership, or (2) the person's proportional interest in the partnership changes by 10 percent or more. (IRC §6046A.)
Form 8865 must be filed with the U.S. Person's timely filed tax return (including extensions).
A fixed $ 10,000 penalty is imposed on any failure to disclose a reportable transfer. If the failure continues for more than 90 days after IRS notice, an additional penalty of$ 10,000 will apply for each 30-day period (or fraction thereof) during which the failure continues, up to $50,000. IRC §6679.