On Tuesday, May 23, 2017, the Internal Revenue Service (IRS) Large Business and International Division (LB&I) hosted its sixth in a series of eight webinars regarding LB&I Campaigns. Our previous coverage of LB&I Campaigns can be found here. The webinar focused on two cross-border activities campaigns: (1) the Repatriation Campaign and (2) the Form 1120-F Non-Filer Campaign. Below, we summarize LB&I’s comments on the new campaigns.
In general, the active earnings of foreign subsidiaries are not subject to tax until repatriated to the United States. Typically, those repatriations would be treated as dividends and would be subject to tax. LB&I stated that, through examination experience, it has observed that some taxpayers have engaged in techniques to permit repatriation from such entities while inappropriately avoiding US taxation.
LB&I developed the Repatriation Campaign with three goals in mind. First, LB&I was concerned with developing better objective techniques to identify risks across the broad taxpayer population. Second, LB&I is trying to improve sightlines into a broader segment of the LB&I population beyond the largest taxpayers under continuous audit. Third, LB&I intends to address any compliance risks related to repatriation in a way that increases voluntary compliance.
Unlike other campaigns, LB&I is not focused on a specific structure or techniques. LB&I is instead trying to identify objective indicators of opportunities to implement questionable planning (in the IRS’s view). Per LB&I, returns with those indicators are more likely to present compliance risks and are more likely to be selected. LB&I stated that it does not believe publicly identifying those indicators will increase voluntary compliance. Historically, when LB&I selected a return for examination, it did not necessarily start with any particular issue; any issue could be examined. If a return is selected under this campaign, LB&I’s initial focus will be narrower, but other compliance issues, if discovered, can still be added to the audit. Repatriation issues can also be raised outside of the Repatriation Campaign—possibly in a continuous audit or in an audit relating to another LB&I campaign.
LB&I has already identified a small population of returns that it believed presented the greatest concentration of indicators of repatriation risk. LB&I is performing examinations on these returns and is focused primarily on identifying repatriation risks and closely-related issues. The results of these examinations, LB&I hopes, will help identify LB&I’s next steps for this campaign. LB&I noted that issues related to repatriation may include corollary adjustments for subpart F income and tax credits. Also, LB&I noted that other significant international tax issues, such as transfer pricing, could be identified when examining a particular return.
LB&I is using cross-border revenue agents, who have significant experience with international issues, for this campaign. Therefore, LB&I does not anticipate a need to create training materials or an international practice unit. LB&I believes that its existing training materials will provide sufficient guidance for its agents. If, however, LB&I discovers that a particular structure or technique is not adequately covered by its existing training materials, LB&I could reassess its training needs.
Form 1120-F and Non-Filer Campaign
In general, a foreign corporation is required to file a US tax return if it is engaged in a US trade or business, even if that business has no income that is effectively connected with a US trade or business or its income is exempt from tax under a tax treaty. Historically, determinations of US trade or business have involved functional analysis that can be factually intensive. LB&I has determined, based on data sources available to LB&I, that some foreign companies engaged in a US trade or business are not filing required tax returns. The goal of the campaign is to use data sources more efficiently to encourage filing of the tax returns.
LB&I will be using internal and external data to identify potential non-filers. Examples of the data sources include Forms W-8 ECI provided to US withholding agents, state sales and use tax data, state business registrations, and US customs filing. If data suggests that a company has a US trade or business, then LB&I will attempt to map that data to a record already on file with the IRS. If LB&I cannot identify an IRS filing, LB&I will attempt to determine whether there is any additional data that suggests an obligation to file a US tax return. If so, a soft letter would be sent to the foreign company to advise of its potential filing requirements and to request a response as to whether they are required to file a return.
If a business has no last-known address to send a soft letter, LB&I will use the best-available address in various databases that it employs. LB&I believes that it will most likely be able to find an appropriate address, because most of the data it employs comes from government records. Should additional address verification be necessary, LB&I could use the Internet or exchange information with a foreign country treaty partner.
A soft letter is not an examination. Yet LB&I still expects responses to its soft letters—either an explanation as to why the company did not file or the submission of the missing tax return. Depending on the response to a soft letter, LB&I may conduct further investigation and, if necessary, initiate an examination. LB&I stated that the first batch of soft letters either was sent last week or will be sent this week. There will be two different types of soft letters: one that will reference a Form W-8 ECI as the source of data and one that will not mention the particular source of data. LB&I intends to publish the soft letters at some point, although the publication location has not been determined yet.
LB&I may also consider additional outreach—beyond soft letters—if necessary. LB&I mentioned a voluntary disclosure program as being a potential additional outreach tool in the future.
LB&I is applying a centralized process for sending out soft letters and evaluating responses. In particular, cross-border practice area employees will be directly involved. If appropriate, based on the response, LB&I may refer the response to LB&I employees with more familiarity with the particular issue.
Practice Tip: As with other LB&I campaign issues, LB&I is prioritizing tax-free repatriations and non-filing of Form 1120-F. Taxpayers should understand that LB&I is being more focused and strategic with these campaigns than it has with examinations in the past. Companies should consider in earnest whether they may have risk in these areas and plan accordingly.