On January 30, 2017, the Internal Revenue Service (IRS) released an International Practice Unit (IPU) on the use of a summons under IRC Section 6038A (IRC Section 6038A Summons) when a US corporation is 25-percent owned by a foreign shareholder. See IPU here. The IPU describes the steps that the IRS should take when issuing an IRC Section 6038A Summons, and what to do when the US corporation does not substantially comply with the summons.
In general, IRC Section 6038A imposes reporting and recordkeeping requirements (together with certain procedural compliance requirements) on domestic corporations that are 25-percent foreign-owned, which the regulations refer to as a domestic reporting corporation (DRC). Among other requirements, a DRC is required to keep permanent books of account or records per IRC Section 6001 that are sufficient to establish the correctness of the federal income tax return of the DRC, including information, documents, or records to the extent they may be relevant to determine the correct US tax treatment of transactions with related parties. See Treas. Reg. Section 1.6038A-3.
The IRS may issue an IRC 6038A Summons when: (i) the taxpayer under exam is a DRC; (ii) there was a transaction between the DRC and the 25 percent foreign shareholder or any foreign person related to the DRC or to such 25 percent foreign shareholder; and (iii) the DRC is appointed to act as a limited agent with respect to any request by the IRS to examine its records or produce testimony that may be relevant to the tax treatment of any transaction between the DRC and a foreign related party. If the DRC does not substantially comply in a timely manner with the IRC 6038A Summons, the IRS has sole discretion to determine the amount of the DRC’s deductions related to transactions with, and the cost of property purchased from (or transferred to), the foreign related party.
The IPU is particularly relevant in light of final regulations published in the Federal Register on December 13, 2016 (TD 9796) which treat a domestic disregarded entity wholly owned by a foreign person as a domestic corporation for purposes of the reporting, record maintenance and associated compliance requirements under IRC Section 6038A. The regulations are effective for tax years beginning after December 31, 2016, and ending on or after December 13, 2017. The IPU refers to these regulations in describing the criteria which must be met before the IRS issues an IRC Section 6038A Summons.
Practice Point: For US entities that are owned by foreign entities and file US tax returns, it is crucial to have all of the relevant information for the entity in the US. US taxpayers are required to support all of the positions claimed on a return. For example, if there are expenditures of the US entity that are paid for by the foreign affiliate, there should be adequate documentation in the US to support those payments.