Foreign corporations and US tax: Why timely Form 1120-F filing matters
Foreign corporations earning effectively connected income (“ECI”, essentially trade or business income from US sources) are required to timely file an annual Foreign Corporation Tax Return (Form 1120-F) reporting US income, deductions, and credits. However, failure to file on time can result in not only penalties and interest, but also more draconian, disallowance of deductions and credits against US income. This can result in US tax on gross income, rather than net taxable income. This is particularly relevant to non-US corporations that are unable to rely on the benefits of a tax treaty with the United States.
A real-world example: Adams Challenge (UK) Ltd. v. Commissioner
In Adams Challenge (UK) Ltd v. Commissioner (Dkt. No. 4816-15, Jan. 21, 2021), a UK-based company chartered a support vessel to a US entity, earning approximately $45 million. The company did not file Form 1120-F for the applicable tax years. The IRS issued a Notice of Jeopardy Assessment and Right to Appeal, asserting total tax liability, penalties, and interest of nearly $24 million, with the tax calculated on gross income without benefit of deductions.
The 18-month rule and filing deadlines
Under Internal Revenue Code (IRC) Section 882(c)(2), foreign corporations must file Form 1120-F within 18 months of the due date under IRC Section 6072 to claim deductions against income and credits against tax. This begs the question of when is the due date?
The applicable due date depends on the extent of the foreign corporation’s business activities in the United States:
- With an office or place of business in the US: Due by the 15th day of the fourth month after the close of the relevant year.
- Without an office or place of business in the US: Due by the 15th day of the sixth month after the close of the year.
If a foreign corporation was obligated but failed to file Form 1120-F for the previous year, the current year’s return is due within 18 months of the deadline for the current year or before the IRS mails the notice of the previous year’s failure to file, whichever is earlier. Thereafter, the return is considered delinquent for the purpose of claiming deductions and most credits. However, credits under IRC Section 33 for taxes withheld at source, as well as deductions for charitable contributions under IRC Section 170 (if claimed within the applicable statute of limitations period), may still be claimed, regardless of filing timeliness. A deduction for cost of goods sold can also still be claimed.
Can the 18-month deadline be waived?
Treasury Regulation 1.882-4(a)(3)(ii) allows the IRS to waive the filing deadline if the foreign corporation can demonstrate with compelling facts and circumstances that it acted reasonably and in good faith yet failed to file on time.
Waiver is not a rubber stamp. Since 2018, the IRS has followed a standardized Waiver Procedure Guideline to ensure consistency in how it evaluates waiver requests. If a late return or assessment response is not accompanied by a waiver request, the IRS may send the foreign corporation a Waiver Procedure Information Letter.
IRS examiners review waiver requests using six key factors:
- Did the taxpayer voluntarily disclose the failure to file?
- Was the taxpayer unaware of the protective return filing option?
- Is this the first time the taxpayer is filing a US return?
- Was the failure due to reasonable ignorance despite due diligence?
- Were there unexpected events beyond the taxpayer’s control?
- Are there other mitigating or aggravating factors?
If the examination team recommends approval, the case is routed to the IRS Cross Border Activities (CBA) Director of Field Operations (DFO), who either approves, denies, or seeks further review to a Waiver Committee made up of CBA managers and advisors from relevant legal and treaty teams. The CBA DFO makes the final decision and notifies the taxpayer. If approved, deductions and credits may be applied. If denied, the IRS will assess tax on gross income only.
In conclusion
Timely filing is always best. Protective returns allow taxpayers to claim the benefits of relevant tax treaties and ameliorate uncertainties as to filing obligations even when a treaty may not apply. Filing Form 1120-F on time within the 18-month grace period avoids the challenges inherent in waiver requests. Where a waiver request is indicated, thorough documentation must convincingly demonstrate reasonable cause.
When in doubt, foreign corporations should consult with counsel or a CPA who is familiar with US international inbound tax compliance.
For support with Form 1120-F filings or guidance on submitting a waiver request, please reach out to our US and Cross-Border Tax team.
About the authors
Jeffrey Brown is a Partner in our US and Cross-Border Tax group. He can be reached at jbrown@fullerllp.com.
Jason Shen is a Manager in our US and Cross-Border Tax group. He can be reached at sshen@fullerllp.com.