Applying Form 5472 Attribution Rules to Example 2 from Rev. Proc. 91-55March 24, 2023 - Phil HodgenMinimultinationals
We need to identify the shareholders of a “reporting corporation” and if we find one or more “25% foreign shareholders” they are listed in Form 5472, Part II.
This discussion deals entirely with the problem of family attribution: when do you pretend that one family member’s stock is constructively owned by another family member?
Let’s start with the basic definitions.
Who is a 25% Foreign Shareholder
The people we want to identify are the “25% foreign shareholders.” Later, we will classify them as direct, indirect, or ultimate indirect 25% foreign shareholders.
The minimum ownership percentage is defined in IRC §6038A(c)(1):
IRC §6038A(c)(1) 25-Percent Foreign-Owned — A corporation is 25-percent foreign-owned if at least 25 percent of—
(A) — the total voting power of all classes of stock of such corporation entitled to vote, or
(B) — the total value of all classes of stock of such corporation,
is owned at any time during the taxable year by 1 foreign person (hereinafter in this section referred to as a “25-percent foreign shareholder”).
To keep this discussion brief(er), let’s skip the definition of “foreign.”
“Direct” 25% Foreign Shareholder
A 25% foreign shareholder is either a direct 25% foreign shareholder or an indirect 25% foreign shareholder.
“Direct” is easy. Who owns the stock?
IRC §1.6038A-1(c)(3)(iii) Direct 25-Percent Foreign Shareholder. — A foreign person is a direct 25-percent foreign shareholder if it owns directly at least 25 percent of the stock of the reporting corporation, either by vote or by value.
Indirect 25% Shareholder
“Indirect” means you apply the attribution rules to figure out how much stock the shareholder owns.
IRC §1.6038A-1(c)(3)(iv) Indirect 25-Percent Foreign Shareholder. — A foreign person is an indirect 25-percent foreign shareholder if it owns indirectly (or under the attribution rules of section 318 is considered to own indirectly) at least 25 percent of the stock of the reporting corporation, either by vote or by value.
Apply IRC §318 Attribution Rules…
The attribution rules are those found in IRC §318, with some modifications, none of which will make a difference in the analysis below.
IRC §6038A(c)(5) Section 318 To Apply — Section 318 shall apply for purposes of paragraphs (1) and (2), except that—
(A) — “10 percent” shall be substituted for “50 percenrdquo; in section 318(a)(2)(C), and
(B) — subparagraphs (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person.
…And Apply IRC §267(c) Attribution Rules
But not so fast! In addition to the IRC §318 attribution rules, you ALSO apply the attribution rules of IRC §267(c).
IRC §1.6038A-1(e)(1) Attribution Under Section 318. — For purposes of determining whether a corporation is 25-percent foreign-owned and whether a person is a related party under section 6038A, the constructive ownership rules of section 318 shall apply, and the attribution rules of section 267(c) also shall apply to the extent they attribute ownership to persons to whom section 318 does not attribute ownership. However, “10 percent” shall be substituted for “50 percent” in section 318(a)(2)(C), and section 318(a)(3)(A), (B), and (C) shall not be applied so as to consider a U.S. person as owning stock that is owned by a person who is not a U.S. person. Additionally, section 318(a)(3)(C) and section 1.318-1(b) shall not be applied so as to consider a U.S. corporation as being a reporting corporation if, but for the application of such sections, the U.S. corporation would not be 25-percent foreign owned.
Family Attribution Under Both Sets of Rules
OK. Let’s apply IRC §§318 and 267(c) to Example 2 from Rev. Proc. 91-55 to demonstrate how IRC §267(c) can lead to surprising results.
IRC §318(a) Family Attribution
Section 318(a)(1)(A) attributes stock ownership among family members up the bloodline to parents, down to grandchildren, and sideways to a spouse.
IRC §318(a)(1) Members Of Family
(A) In General — An individual shall be considered as owning the stock owned, directly or indirectly, by or for—
(i) — his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and
(ii) — his children, grandchildren, and parents.
(B) Effect Of Adoption — For purposes of subparagraph A)(ii), a legally adopted child of an individual shall be treated as a child of such individual by blood.
IRC §267(c)(2) Family Attribution
IRC §267(c)(2) imposes family attribution, and IRC §267(c)(4) tells you what a family is.
IRC §267(c) Constructive Ownership Of Stock — For purposes of determining, in applying subsection (b), the ownership of stock—
(2) — An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family.
IRC §267(c)(4) defines “family” as the bloodline (without limit), spouse, and siblings.
IRC §267(c)(4) — The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants[.]
There is no reattribution of stock from one individual to another. If you are treated as owning your father’s stock in a corporation, we do not turn around and re-pretend that your brother owns the stock that you are treated as owning via your father.
IRC §267(c)(5) — Stock constructively owned by a person by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1), (2), or (3), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock.
Summary of IRC §318(a)(1)(A) and IRC §267(c)(2), (4)
Here is a table that shows family relationships that cause stock attribution in IRC §318 or in IRC §267.
Demonstration: Rev. Proc. 91-55, Example 2
Let’s apply the family attribution rules to determine stock ownership by using Example 2 of Rev. Proc. 91-55, Section 5.
EXAMPLE 2. H, W, C1, C2, and GC, husband, wife, child 1, child 2 and grandchild, each own 20 percent of FC, a foreign corporation, which in turn wholly owns RC, a reporting corporation. (Under the attribution rules of section 318(a)(1), each of H, W, C1, C2, and GC are treated as if each owned all of the stock of FC.) Each of H, W, C1, C2, and GC is an ultimate indirect 25-percent foreign shareholder of RC. FC is a direct 25-percent foreign shareholder. Any one of the individuals H, W, C1, C2, or GC may be reported in Part II of the current Form 5472. Information with respect to the individuals not reported in Part II, plus information with respect to FC as the direct 25-percent foreign shareholder, should be provided in an attachment to Form 5472.
The Family Tree
The family tree for the family looks like this:
Example 2 does not identify the parent of Grandchild–it could be Child 1 or Child 2. Or perhaps Grandchild is the offspring of a deceased sibling to Child 1 and Child 2 — the late and lamented Child 3. We don’t know. All we can infer from the example is that Husband and Wife are the grandparents of Grandchild, and Grandchild must have a parent.
I pick Child 2 as the Grandchild’s parent for the purposes of this analysis because the diagrams are easier to make.
Example 2 tells us how much stock each individual owns in a foreign parent/domestic subsidiary structure.
Example 2 says that every person is treated as a 100% owner of stock of Foreign Corporation.
EXAMPLE 2. H, W, C1, C2, and GC, husband, wife, child 1, child 2 and grandchild, each own 20 percent of FC, a foreign corporation, which in turn wholly owns RC, a reporting corporation. (Under the attribution rules of section 318(a)(1), each of H, W, C1, C2, and GC are treated as if each owned all of the stock of FC.)
The Example is 60% correct.
- Three of the five individuals are treated as owning 100% of FC’s stock.
- Two family members only own 80% of FC stock after application of the IRC §318 and IRC §267 attribution rules.
Husband and Wife: Example 2 is Correct
“Husband” and “Wife” (in Example 2) are the oldest generation in this family. They have two children: Child 1 and Child 2, and Child 2 has a child — their grandchild.
Husband and Wife each own 20% of FC stock directly, and 80% of FC stock constructively, through the family attribution rules of IRC §318(a)(1)(A).
I show the attribution of stock from family members to Husband in the illustration below.
Husband owns 100% (directly and constructively) of FC stock.
The analysis for Wife is the same. I will not add a diagram to show the attribution of stock to her, but here is what the math looks like.
My numbers agree with Example 2, which says that both Husband and Wife own “all” of the stock of FC.
Child 1: Example 2 is Wrong
Example 2 says that Child 1 owns “all” of the stock of FC. The attribution rules supported by application of IRC §318(a) and IRC §267(c), as required by Reg. §1.6038A-1(e)(1), say 80%. There is no aunt/uncle attribution from a niece/nephew.
Child 1 owns 20% of FC stock directly and 60% constructively for a total of 80%.
Example 2 asserts that Child 1 owns “all” of FC stock under the principles of IRC §318(a). That is wrong on the math and wrong on the applicable law.
- Child 1 only owns 40% of FC stock constructively by operation of IRC §318(a)(1)(A)(ii).
- Child 1 owns an additional 20% of FC stock constructively by operation of IRC §267(c)(2) (the family attribution rule) and IRC §267(c)(4) (the definition of a family).
Combining the 20% of FC stock owned directly with the 60% of FC stock owned constructively, Child 1 owns 80% of FC stock, not 100% as asserted by Example 2 in Rev. Proc. 91-55.
Child 2: Example 2 is Correct
Example 2 says Child 2 owns “all” of the stock of FC. Correct:
- 60% of FC stock is attributed to Child 2 by application of the rules of IRC §318(a)(1)(A)(ii), from Husband (Child 2’s father), Wife (Child 2’s mother), and Grandchild (Child 2’s child).
- 20% of FC stock is attributed to Child 2 from Child 1 (Child 2’s sibling) by application of IRC §§267(c)(2), 267(c)(4).
Combined with the 20% of FC stock directly owned by Child 2, we can see that Child 2 indeed owns 100% — “all” — of FC’s stock.
Grandchild: Example 2 is Wrong
Grandchild is deemed to own 80% of FC stock by attribution from other family members. Child 2 is Grandchild’s parent, so Child 1 is Grandchild’s aunt or uncle. There is no aunt/uncle attribution anywhere in the Code that I am aware of.
The table showing stock ownership by Grandchild looks like this:
Conclusion About Example 2: Nearly Correct
This little exercise demonstrates nicely how the attribution rules work, and how IRC §267(c) will add sibling and grandparent attribution to your analysis.
We learned something else by dissecting Example 2:
- The math was wrong (two of the shareholders do not own “all” of FC stock); and
- The given legal authority for the math was incomplete (Exhibit 2 claims that IRC §318 causes the 100% stock ownership, and does not make reference to IRC §267(c)).
Don’t trust everything you read — even from the IRS.
The Real Problem: How Much Stock of RC Will Each Shareholder Own?
The real problem we want to solve is not “how much FC stock does each individual own?” That is only one step in the journey toward what we really want to know: “How much RC stock does each individual own?”
It is RC stock ownership that matters: any foreign individual who owns 25% or more of the stock of RC will be a 25% foreign shareholder (whether direct or indirect) and will need to be identified in Form 5472 filed by RC.
Three of the five individuals own 100% of FC stock, and two own 80% of FC stock, after application of the attribution rules of IRC §§318(a) and 267(c).
How much of RC stock will each individual be treated as owning?
Attribution to FC Shareholders
For this, we turn to IRC §318(a)(2)(C), which describes when shareholders of a corporation (FC in our case) are treated as if they own shares of stock in corporations (RC in our case) owned by that corporation (FC).
IRC §318(a)(2)(C) From Corporations — If 10 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.
As modified, the attribution rule requires each individual shareholder who owns more than 10% of FC to be deemed to own a proportional amount of the stock of RC owned by FC. IRC §6038A(c)(5)(A) — the operative Code section that requires Form 5472 filing — modifies IRC §318(a)(2)(C) by reducing 50% to 10%.
All Five Individuals are 25% Foreign Shareholders of RC
This means that the three 100% FC shareholders (Husband, Wife, and Child 2) will be deemed to own 100% (their ownership percentage in FC stock) multiplied by 100% (FC’s ownership percentage of RC stock) = 100% of RC stock.
The two FC shareholders who own 80% of the FC stock (Child 1 and Grandchild) will be deemed to own 80% (stock ownership in FC) multiplied by 100% (FC’s ownership of RC stock) = 80%.
All of these numbers are well above the 25% threshold, so all five individuals are 25% foreign shareholders of RC, and therefore are candidates for reporting on Form 5472.
Attribution rules are hard.
They’re especially hard (I’m whining here) when the government starts clean and simple (IRC §6038A(c) says “just use IRC §318”) but adds stealth modifications (Reg. §1.6038A-1(e) says “oh yeah, apply IRC §267(c) on top of IRC §318(a)”).
Read The Code, Regulations, and applicable Revenue Procedures/etc. Go slowly. When you’re in a hurry, you’re apt to skip something important.