Rev. Proc. 2019-40: CFC Relief, Form 5471, and Section 965

Revenue Procedure 2019-40 gives U.S. shareholders caught in the expanded controlled foreign corporation rules three forms of relief: a safe harbor for concluding that a foreign corporation is not a CFC when ownership information is out of reach, a ranked list of alternative financial data you may use to calculate Subpart F and GILTI income when U.S. tax accounting books do not exist, and reduced Form 5471 filing obligations that, for some shareholders, eliminate the form entirely.¹

The relief exists because the Tax Cuts and Jobs Act repealed Internal Revenue Code Section 958(b)(4) for tax years of foreign corporations beginning after December 31, 2017. That repeal unblocked “downward attribution” under Section 318(a)(3), and stock owned by a foreign parent could suddenly be treated as owned by its U.S. subsidiary. Foreign corporations that no U.S. person actually controlled were reclassified as CFCs, and minority U.S. investors were treated as U.S. shareholders with reporting obligations they had no practical way to meet.² The IRS acknowledged that these taxpayers “may have limited ability to determine whether such foreign corporations are CFCs and to obtain the information necessary to accurately determine” their income inclusions under Sections 951 and 951A.¹

Which CFCs Qualify for the Relief

The relief turns on one classification. A U.S.-controlled CFC is one that meets the Section 957(a) threshold — U.S. shareholders owning more than 50 percent of voting power or value — through direct and indirect ownership under Section 958(a). A foreign-controlled CFC meets that threshold only because of constructive ownership through downward attribution. Strip the attribution away, and U.S. shareholders would not own enough to trigger CFC status.³

Revenue Procedure 2019-40 is available only for foreign-controlled CFCs. If the corporation is a U.S.-controlled CFC, the IRS assumes U.S. shareholders have enough influence to obtain records and determine status without help.

Safe Harbor for Concluding a Foreign Corporation Is Not a CFC

Section 4 of the revenue procedure lets a U.S. person conclude that a foreign corporation is not a CFC when definitive ownership information is unavailable. If the conditions are met, the IRS will not challenge that determination.

Two conditions apply, and both must hold. First, the U.S. person must lack actual knowledge, statements received, or reliable publicly available information sufficient to determine that the foreign corporation meets the Section 957 ownership requirements. Once actual knowledge exists as of a given date, it is treated as continuing for all later dates unless later information rebuts it. Second, a U.S. person who directly owns stock in a foreign entity must inquire of that entity whether it meets the CFC ownership requirements, how and to what extent it owns stock of other foreign corporations under Section 958(a), and whether it owns stock in any domestic entities.¹

One limit on the inquiry is worth pinning down. You are not required to ask an unrelated foreign person whether that person owns stock in a domestic entity. If someone unrelated to you holds stock in the same foreign corporation and their ownership chain would create the attribution problem, your failure to trace their holdings will not disqualify you from the safe harbor. The IRS keeps the authority to verify the steps you took, and the safe harbor never applies to U.S.-controlled CFCs.

Alternative Information for Calculating Income

Once you know you are a U.S. shareholder of a foreign-controlled CFC, the next problem is arithmetic. Section 5 of Revenue Procedure 2019-40 allows the use of alternative information to calculate Subpart F income and GILTI inclusions when standard records under Section 964 and its regulations are not readily available. This part of the relief is limited to foreign-controlled CFCs that have no related Section 958(a) U.S. shareholder. If someone related to you owns direct stock in the CFC, that related party presumably has access to standard financials and the alternative route is not needed.

The sources are ranked, and you may only use a lower-ranked source if no higher-ranked source is readily available:

Tier 1: audited separate-entity financial statements prepared under U.S. GAAP
Tier 2: audited separate-entity financial statements prepared under IFRS
Tier 3: audited separate-entity financial statements prepared under the local-country GAAP of the corporation’s home jurisdiction
Tier 4: unaudited separate-entity financial statements prepared under U.S. GAAP
Tier 5: unaudited separate-entity financial statements prepared under IFRS
Tier 6: unaudited separate-entity financial statements prepared under local-country GAAP
Tier 7: separate-entity records the corporation uses for tax reporting in its home country
Tier 8: separate-entity records used for internal management controls, regulatory compliance, or similar purposes

If you switch tiers, or move from alternative information to standard U.S. tax accounting records, in a later year, you must use reasonable efforts to adjust amounts so that no material items are duplicated or omitted across tax years. A transition from audited IFRS to U.S. GAAP records, for example, requires careful reconciliation in the changeover year.¹

Form 5471 Filing Modifications

Section 8 of the revenue procedure is the piece most filers actually use. It reduces the schedules a Category 5 filer must complete for a foreign-controlled CFC, and how much it reduces them depends on the filer’s relationship to the CFC.

Unrelated Section 958(a) U.S. Shareholders

A Category 5 filer who directly or indirectly owns stock under Section 958(a) and is not related to the foreign-controlled CFC files a stripped-down Form 5471: the identifying information on page 1 above Schedule A, plus Schedules I, I-1, and P. If the filer claims deemed-paid foreign income taxes under Section 960, Schedules E and E-1 are also required. Schedules B (Part II), G, H, and J are not required. Balance sheet detail, intercompany transactions, and accumulated earnings reporting drop out.

Related Constructive U.S. Shareholders

A Category 5 filer who is a U.S. shareholder only through constructive ownership but is related to the CFC files the page 1 identifying information, Part II of Schedule B, and Schedules E, G, and I-1. Schedules E-1, H, I, J, and P are not required.

Unrelated Constructive U.S. Shareholders

This is the broadest piece of relief. A Category 5 filer who is a U.S. shareholder only through constructive ownership and is not related to the foreign-controlled CFC is not required to file Form 5471 at all with respect to that CFC. Minority investors pulled into shareholder status by the mechanics of downward attribution alone owe nothing on this form.¹

Category 1b Filers

The Form 5471 instructions extend equivalent relief to similarly situated Category 1 filers through the Category 1b classification. A Category 1b filer is an unrelated Section 958(a) U.S. shareholder of a foreign-controlled Section 965 specified foreign corporation — an SFC that would not have been an SFC without downward attribution.⁴

Form 5471 is attached to the taxpayer’s annual income tax return and is due when that return is due, including extensions.⁵ When relying on Revenue Procedure 2019-40, check the current Form 5471 instructions for checkboxes or indicators that signal the safe harbor is being used.

Section 965 Transition Tax

Section 6 of the revenue procedure extends the alternative-information relief to the Section 965 transition tax for specified foreign corporations that became SFCs solely because of downward attribution. Unrelated Section 958(a) U.S. shareholders may use the same tier hierarchy to determine their Section 965 amounts. The transition tax itself is a one-time event now well in the past, but taxpayers who filed using alternative information should retain their documentation in case of examination.¹

What Noncompliance Costs

Under Section 6038, failure to file a complete and correct Form 5471 by the due date triggers a $10,000 penalty for each annual accounting period. If the failure continues more than 90 days after the IRS mails a notice, an additional $10,000 penalty accrues for each 30-day period the noncompliance persists, up to a maximum additional penalty of $50,000. Total exposure for a single annual accounting period can reach $60,000.⁶ Penalties run per foreign corporation, per year, so a taxpayer caught in multiple attribution chains faces multiplicative risk. A well-documented reasonable inquiry, or a properly filed Form 5471 using alternative information, gives you a defensible position.

What the Relief Does Not Do

Revenue Procedure 2019-40 has firm boundaries. It applies only where CFC status flows from the repeal of Section 958(b)(4) and the resulting downward attribution. U.S.-controlled CFCs get no relief.

The alternative information rules change only the source data used to calculate income. Subpart F income is still Subpart F income, and GILTI inclusion amounts are still GILTI inclusion amounts. The underlying tax rules for those calculations do not shift, and the revenue procedure does not waive the obligation to determine whether amounts paid by the CFC qualify as creditable foreign income taxes under Sections 902 and 960.

A person who qualifies as a United States shareholder under Section 951(b) — 10 percent or more of the voting power or value — remains a U.S. shareholder whether ownership is real or constructive.⁷ Revenue Procedure 2019-40 reduces the burden of that status; it does not erase it, with the single exception of the complete Form 5471 filing exemption for unrelated constructive U.S. shareholders of foreign-controlled CFCs.

1
Internal Revenue Service. Rev. Proc. 2019-40
2
Office of the Law Revision Counsel. 26 U.S. Code 318 – Constructive Ownership of Stock
3
Office of the Law Revision Counsel. 26 USC 957 – Controlled Foreign Corporations; United States Persons
4
Internal Revenue Service. Instructions for Form 5471
5
Internal Revenue Service. About Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations
6
Office of the Law Revision Counsel. 26 USC 6038 – Information Reporting With Respect to Certain Foreign Corporations and Partnerships
7
Office of the Law Revision Counsel. 26 U.S. Code 951 – Amounts Included in Gross Income of United States Shareholders