The Tax Court Reminds Foreign Corporations of the Disastrous Consequences of Failing to File Forms 1120-F U.S. Income Tax Returns
By: Heather L. Marello, Esq.
I.R.C. § 6012(a)(2) imposes an income tax return filing requirement on “every corporation subject to taxation under subtitle A.” The Treasury Regulations clarify that a foreign corporation is not exempt from U.S. taxation if it is engaged in a U.S. trade or business, even if it has no effectively connected U.S. income or its income is exempt from U.S. taxation under a treaty. I.R.C. § 882(c)(2) affords a foreign corporation deductions and credits relating to its effectively connected income, however those deductions and credits are expressly contingent upon the filing of a “true and accurate return.” Treas. Reg. § 1.882-4(a)(3)(i) sets forth the specific requirements that must be met to be entitled to deductions and credits against the foreign corporation’s income. For an in-depth discussion of these requirements, see our prior discussion here.
The Tax Court recently issued an opinion reminding taxpayers of the disastrous, expensive consequences of failing to abide by these rules. In Adams Challenge (UK) Limited v. Commissioner, 156 T.C. No. 2 (Jan. 21, 2021), the taxpayer was a corporation organized under the laws of the United Kingdom, which assisted in decommissioning oil and gas wells and removing debris from portions of the U.S. Outer Continental Shelf in the Gulf of Mexico during the 2009-2011 taxable years. Adams Challenge failed to file any tax returns with the United States reporting its income or corresponding deductions related to those activities, and in October 2013, IRS issued a Notice of Jeopardy Assessment and Right of Appeal for the taxpayer’s 2009 through 2011 taxable years. The taxpayer appealed, and the jeopardy assessment was abated.
Thereafter, in December 2013, Adams Challenge filed a protective Form 1120-F for its 2011 taxable year, claiming that it did not have a permanent establishment in the United States and its income was not effectively connected income as defined by the U.S./U.K. tax treaty. Adams Challenge did not file similar protective returns for its 2009 or 2010 taxable years, so the IRS prepared substitutes for returns (SFRs) in April, 2014 and issued a Notice of Deficiency for all three years in November, 2014. The Notice of Deficiency determined that Adams Challenge had effectively connected income of $13,595,167, $19,135,125, and $9,897,975 for its 2009, 2010, and 2011 taxable years, respectively. The Notice further contended that Adams Challenge was not entitled to any corresponding deductions or credits for their 2009-2010 years, but conceded that the taxpayer timely filed a protective return for its 2011 year and was therefore allowed deductions to the extent substantiated. Adams Challenge petitioned the U.S. Tax Court with respect to the proposed assessments, and submitted protective Forms 1120-F for its 2009 and 2010 taxable years in February, 2017.
The Tax Court noted that Section 882(c)(2) does not contain an “express time limit,” and therefore phrased the task at hand as determining the “cutoff” point under Section 882(c)(2) – specifically, the date “after which it is too late for a foreign corporation to file a return and benefit from deductions and credits.” Noting the difficulty that the Commissioner has finding foreign corporations that fail to file returns, the Court determined that, at the very least, a cutoff must be the “date on which the Commissioner prepares and subscribes a return for the taxpayer under section 6020(b).” This rule makes sense, as the Tax Court aptly noted that allowing a foreign corporation to benefit from deductions or credits by filing a protective or original return after IRS prepares an SFR would render the statute toothless – if that were the case, then every foreign corporation would play the audit lottery and, if discovered, would file a late return and be afforded all protections under the statute.
Under this holding, since Adams Challenge did not file Forms 1120-F for its 2009 or 2010 taxable years until almost four years after the Jeopardy assessments were made – and over two years after the Notice of Deficiency was issued based on the Commissioner’s SFRs – the Court found it was not entitled to the benefit of any deductions or credits under the Code. Instead, the foreign corporation was subject to tax on its gross income.
A timely protective return can be a critical tool in tax planning for foreign corporations – it not only provides the opportunity for repose through the statute of limitations on assessment, but also preserves the right to claim deductions and credits if the IRS asserts that a taxpayer has a permanent establishment or effectively connected income with the United States. Andreozzi Bluestein LLP is experienced in assisting taxpayers with compliance with Form 1120-F requirements. Specifically, our firm facilitates voluntary disclosures of taxpayers needing to make delinquent filings, assists in preparing protective returns to protect a taxpayer’s right to deductions and credits, and conducts mock audits to assess a company’s risk of having a permanent establishment or effectively connected income with the United States under relevant treaty provisions. If you think that you or your client may have an issue related to a delinquent 1120-F filing, or are interested in our mock-audit service, please contact the attorneys at Andreozzi Bluestein, LLP for a no-obligation consultation.
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