Written by Max Reed Canadian residents who aren’t U.S. citizens may be surprised to know that U.S. estate tax can apply to them. Newly enacted U.S. tax rules have increased...
In tax year 2018, the coverage of Form 8858 was expanded to require the reporting of not only interests related to foreign disregarded entities (“FDEs”), but also foreign branches (“FBs”). This revision to Form 8858 to expand its coverage to FBs have given rise to questions as to when such a requirement to file would be triggered.
In particular, the instructions to the revised Form 8858 define an FB as essentially any integral business option carried on by a US person outside the United States,1 or any foreign activity constituting a trade or business for which a separate set of books and records is maintained.2 This expansive definition raises questions as to whether US citizens who are owners of controlled foreign corporations (“CFCs”), who earn foreign rental income, or who earn foreign self-employment income would now have a Form 8858 filing requirement. The short answer is no as to the first (assuming the CFC does not itself then own a FDE or operate a FB), and likely yes as to the second and third. However, it should be noted that in case of a failure to file Form 8858 for a foreign rental property or self-employment, no section 6038(b) $10,000 penalty and section 6038(c) foreign tax credit reduction penalty should apply. The reason being that in the case of US persons who directly possess an FBE or FB without an intervening foreign corporation or partnership, the Form 8858 filing requirement is imposed under section 6011 (General requirement of return, statement, or list), section 6012 (Persons required to make returns of income), and section 6031 (Return of partnership income), as opposed to section 6038. The failure to file Form 8858 in regards to a general obligation to file as imposed under these sections is not subject to any penalties. However, as explained below, an explanation provided by the IRS as to the expansion of the Form 8858 requirement relates to the administration of the new foreign branch income foreign tax credit basket, therefore, a potential risk of the failure to file Form 8858 may be the possible denial of the foreign branch income foreign tax credit for insufficient information to support the claim.
The expanded Form 8858 filing requirement to include foreign branches does not arise out of any changes made to section 6038, the Code section requiring a US person to file an information return relating to a foreign business entity which they control. As defined under section 6038(e), a foreign business entity for the purposes of that section means only either a foreign corporation or a foreign partnership. This definition has not changed. The only change which was made to section 6038 in the 2017 tax reform was to remove references to section 902 which had been repealed. Similarly, the regulations to Section 6038 have not been changed.
This is an important point, as on their own, neither FDEs nor FBs are generally foreign corporations nor foreign partnerships and are therefore not foreign business entities for which a filing requirement is created under section 6038. Specifically, a disregarded entity is excluded from the definition of a corporation or a partnership.3 Similarly, a foreign branch cannot itself be a corporation as a foreign branch is defined as an integral business operation carried on by a US person outside the United States4 or an activity of the US person which constitutes a trade or business and for which separate books and records are kept.5 A foreign branch also cannot be a partnership unless it has two or more members.6,7 Therefore, in the case where a US person is the owner of a rental property or self-employed, the individual is likely to have a foreign branch by virtue of carry on an integral business operation outside the US and for which separate books and records are kept, but such foreign branch would normally neither constitute a foreign corporation nor partnership for which a filing requirement would be imposed under section 6038. The same should be applicable where a US person is the sole owner of a Canadian ULC which is treated as a disregarded entity for US tax purposes. The ULC would be a foreign business entity as defined under section 6038(e).
The mixed use of Form 8858 is acknowledged by the IRS. As noted in the Purpose of Form section of the instructions to Form 8858, the form and schedules are used not only to satisfy the reporting requirements of section 6038 but also sections 6011, 6012, and 6031. In its notice and request for comments for the changes to Form 8858, the IRS also noted that some of the changes made were relevant for the purposes of the implementation of the new foreign tax credit category for foreign branch income.8 In the case of those taxpayers who own a foreign rental property or earn foreign sourced self-employment income, their new requirement to file Form 8858 should arise under these other sections and new reasons. The failure to file Form 8858 where no intervening foreign corporation or partnership exists should not be subject to the section 6038(b) $10,000 penalty or the section 6038(c) reduction in foreign tax credit penalty. However, it would be prudent to file Form 8858 nonetheless, especially where the taxpayer is claiming a foreign branch basket foreign tax credit.
1 Treas. Reg. 1.367(a)-6T.
2 Treas. Reg. 1.989(a)-1(b)(2)(ii).
3 Treas. Reg. 301.7701-2(a).
4 Treas. Reg. 1.367(a)-6T.
5 Treas. Reg. 1.989(a)-1(b)(2)(ii).
6 Treas. Reg. 301.7701-2(a).
7 For the purposes of Form 8858, the instructions provide that a foreign branch is as defined under Treas. Reg. 1.367(a)-6T(g) and also includes a qualified business unit (“QBU”) as defined in Treas. Reg. 1.989(a)-1(b)(2)(ii). Under the Treas. Reg. 1.367(a)-6T(g), the definition implies that a partnership should not itself be considered to be a foreign branch, as for the purposes of that definition, a partnership is itself a person which may have a foreign branch. Furthermore, Treas. Reg. 1.989(a)-1(b)(2)(ii) then provides that the “activities of a corporation, partnership, trust, estate, or individual qualify as a QBU if – (A) The activities constitute a trade or business; and (B) A separate set of books and records is maintained with respect to the activities.” Therefore, under this definition, the activities of a partnership would also create a QBU for the partnership itself rather than its partners. Note, while Treas. Reg. 1.989(a)-1(b)(2)(i)(C) defines a partnership itself as a per se QBU, QBUs as defined under Treas. Reg. 1.989(a)-1(b)(2)(i) are not included into the definition of a foreign branch for the purposes of Form 8858.
As a result, a US person who is a partner of a foreign partnership should not automatically be required to file Form 8858 on account of a foreign branch, unless the partnership itself operates an FB. However, the US person may be required to file Form 8865 (Return of US Persons With Respect to Certain Foreign Partnerships) with respect to that foreign partnership interest.
8 83 FR 27376