2015-Issue 16—Many IRS compliance forms ask for a taxpayer to disclose the fair market value and adjusted basis of certain assets, specifically in the international tax compliance arena. This is a continuing trend with respect to reporting and transparency. The phrase “available upon request” has often been used by taxpayers and practitioners to satisfy these disclosure requirements when there is no readily available valuation or basis calculation. However, upon the release of the new gain recognition agreement (GRA) regulations, the use of the term “available upon request” may be problematic, resulting in adverse U.S. tax consequences. Additionally, the new GRA regulations are unclear as to how accurate these disclosures must be in order for taxpayers to be deemed compliant with their reporting obligations.
This edition of Tax Advisor Weekly discusses some of the potential U.S. tax consequences of failing to provide the fair market value and adjusted basis as required under the new GRA regulations, explains how the new GRA regulations may affect the reporting requirements for international tax reporting forms that are unrelated to outbound transfers of stock (which generally require a GRA), and provides some recommendations for avoiding potential adverse U.S. tax consequences for failing to provide adequate information to the IRS relating to the fair market value and adjusted basis of certain assets. In addition, this article provides high-level insight on key factors to consider in a fair market value tax valuation analysis.
Standard for Relief Under the New GRA Regulations
IRC Section 367 requires a U.S. taxpayer to recognize taxable gain on transfers of stock to a foreign subsidiary equal to the difference between the fair market value and adjusted basis of the stock unless an exception applies. A U.S. taxpayer may avoid triggering gain recognition for certain transfers of stock or securities to a foreign corporation by entering into a GRA. A GRA typically requires disclosures relating to the fair market value of the securities transferred, the adjusted basis of the securities and the gain that would be recognized if a GRA is not filed. Failure to file a GRA will typically trigger tax on the gain discussed above, as well as interest on the taxes payable that begin to run on the date the stock is transferred.
On November 18, 2014, the U.S. Department of the Treasury and IRS released final and temporary regulations (TD 9704) under Sections 367 and 6038B that grant relief for certain U.S. and foreign persons that fail to file GRAs, or file defective GRAs, or that fail to satisfy other reporting requirements associated with certain transfers of property to foreign corporations in non-recognition exchanges. If a taxpayer qualifies for relief, they may fix the defect by filing the proper information with the IRS. Under the new regulations, a U.S. transferor seeking to avoid recognizing gain due to a failure to file a GRA, or the filing of a defective GRA, is required to show that the failure was not willful. An example in these regulations specifically states that using the term “available upon request” for the fair market value disclosure on a GRA will be considered a willful failure to timely file the GRA and, thus, will preclude relief, triggering gain recognition and interest on the outbound transfer.
Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation” Filing Requirement Under the New GRA Regulations
In addition to the GRA disclosure requirement discussed above, the new GRA regulations no longer provide a coordination rule; therefore, requiring the U.S. transferor of stock or securities to a foreign subsidiary to also file a Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation” in addition to a GRA. The Form 926 must include the fair market value, adjusted tax basis and gain that would be recognized absent the GRA; Form 926 is attached to the taxpayer’s tax return that includes the date of transfer. The penalty for failure to satisfy this reporting requirement is 10 percent of the fair market value of the transferred property at the time of the exchange, up to a maximum of $100,000, unless the failure was due to intentional disregard, in which case the $100,000 maximum penalty does not apply. “Intentional disregard” exists if the U.S. transferor does not meet the reasonable cause exception and if the U.S. transferor knew of the rule or regulation that was disregarded. Taxpayers may avoid the penalty if they demonstrate the failure to comply was due to a reasonable cause and not willful neglect. Pursuant to the new GRA regulations, the terms “willful neglect” and “willful failure” are synonymous.
Revisiting our example above, if U.S. Parent uses the term “available upon request” to disclose fair market value, stock basis or potential gain on Form 926, the IRS will likely take the position that this failure to comply with the Form 926 filing requirement is due to willful neglect and implement a 10 percent penalty on the fair market value of the stock ($10).
Potential Extension of Statute of Limitations on Assessment for Non-GRA-Related Filing Requirements
Generally, the IRS has three years to assess additional tax once a taxpayer files a tax return. One exception to this general rule is found in Code Section 6501(c)(8), where a taxpayer fails to report certain information regarding foreign transactions outlined in the statute. If a taxpayer fails to report this information in an acceptable manner, the three-year statute of limitations does not begin to run until the information is furnished to the IRS if the failure is due to willful neglect. This statute can leave taxpayers unaware of which returns are open to IRS audit and could allow the IRS to assess additional taxes even after taxpayers believe their statute has closed. This code section relates to information encompassed on various forms including but not limited to:
- 8865 “Return of U.S. Persons With Respect to Certain Foreign Partnerships”
- 5471 “Information Return of U.S. Persons With Respect to Certain Foreign Corporations”
- 5472 “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business”
- 926 “Return by a U.S. Transferor of Property to a Foreign Corporation”
- 8938 “Statement of Specified Foreign Financial Assets”
- 3520-A “Annual Information Return of Foreign Trust With a U.S. Owner”
Many of these forms require disclosure of the fair market value and tax basis of certain assets. As stated above, the new GRA regulations state that using the term “available upon request” for the fair market value (and by association, the tax basis) disclosure on a GRA will be considered a willful failure to file the GRA. Additionally, as mentioned previously, the new GRA regulations state that the terms “willful failure” and “willful neglect” are synonymous. This raises an important question: What if the IRS asserts that the term “available upon request” similarly constitutes willful neglect for purposes of the forms listed above? This could lead to the extension of the statute of limitations for various disclosures that are unrelated to GRAs. Although it is unclear whether the IRS will make this assertion, it is certainly something that taxpayers and practitioners should be cognizant of.
Calculating Fair Market Value, Asset Basis and Potential Realized Gain Under the New GRA Regulations
As discussed above, the use of the term “available upon request” is unacceptable for disclosing the fair market value, asset basis and potential realized gain on a GRA. Furthermore, this term may be unacceptable for making these disclosures in the forms discussed above. This may cause one to ask, “what constitutes an adequate disclosure for these purposes?”
The IRS does not provide any guidance with regards to how accurate the amounts disclosed in the taxpayer’s tax return must be in order to comply with the disclosure requirements. In fact, the preamble specifically discusses a comment received requesting that the new GRA regulations provide a mechanism by which taxpayers may modify the fair market value of transferred securities in order to cure an inadequate disclosure. The IRS and Treasury declined to adopt the comment, reasoning that the proposed regulations adequately address the commentator’s concerns. The government’s response was that a taxpayer who fails to materially comply with the requirement to include the fair market value of the transferred stock or securities in a GRA may be eligible to correct the GRA by seeking relief based on a claim that the failure was not willful. However, neither the preamble nor the regulations state how accurate these figures must be in order to avoid a willful failure to comply.
Additionally, the applicable code sections discussed above relating to the potential extension of the statute of limitations for failing to provide the fair market value and basis on certain informational returns provide no specific guidance in this area. They do, however, provide that if the failure to provide the information is due to reasonable cause and not willful neglect, the associated penalties (including the extension of the statute of limitations) may be avoided. It seems that the standards for the accuracy of this information for GRAs and other informational returns discussed above are the same.
Some guidance in this area may be found in the rules covering penalties for negligence with regards to taxable income shown on a tax return. In general, these penalties will apply to any tax return that understates taxable income by 10 percent. As this penalty applies a negligence standard and the disclosures discussed above apply a “willful failure” or “willful neglect” standard, it seems clear that disclosures that are off by 10 percent or less cannot be considered inadequate for informational return or GRA purposes. However, how far the disclosures of fair market value, basis and unrecognized gain can differ from the actual numbers remains unclear. Until the IRS issues more guidance on this matter, it may be difficult to determine the level of diligence required to make sure these disclosures fulfill the tax reporting obligations.
The issue of determining fair market value of stock or securities is heightened, as many valuation complexities arise for multinational companies with legal entities located worldwide that provide a defined service or goods in part for related entities, which creates a need to focus on the treatment of intercompany transactions that must be addressed in a valuation for tax purposes. Furthermore, the transfer of an entity from the U.S. also encompasses nuances that should be considered as part of any GRA filing.
It is worth mentioning that when conducting a valuation of an entity for corporate tax purposes, specifically with regard to cross-border movement of an entity and/or the involvement of intercompany transfer pricing, several key factors should be considered when ascribing value.
These key factors — which are incorporated when conducting a detailed valuation analysis — include but are not limited to:
- Treatment of intercompany transactions
- Nature of the entity
- Transfer pricing/profit margin
- Entity risk
- IP ownership
- Tax rate
In the event a taxpayer prefers to implement a high-level approach to estimating fair market value rather than conducting a detailed valuation analysis, application of a multiple (i.e., revenue, EBITDA, etc.) to the relevant results may be an approach to consider.
For a more in-depth explanation, please see our October 2, 2012, Tax Advisor Weekly, “Understanding the Nuances of Valuations for Tax Purposes.”
Alvarez & Marsal Taxand Says:
- When complying with the GRA and Form 926 requirements on the transfer of stock from a U.S. company to a foreign company, do not use the phrase “available upon request” when disclosing the fair market value, asset basis and potential realized gain on the transferred stock.
- Although it is unclear whether the IRS will assert that the use of the phrase “available upon request” constitutes “willful neglect” pertaining to required disclosures of the fair market value, asset basis and potential realized gain causing an extension of the statute of limitations for assessment of tax, it may be wise not to use the term when making these disclosures.
- The final regulations provide that “willful” will be interpreted consistently with the meaning of that term in the context of other civil penalties, which would include a failure due to gross negligence, reckless disregard or willful neglect.
- Although it is unclear how close the figures disclosing the fair market value, asset basis and potential realized gain need to be under GRAs and the foreign informational forms discussed above, taxpayers will likely want to provide reasonable figures in order to gain some comfort that the IRS will not invalidate their GRAs or argue that their statute of limitations on assessment of tax remains open past three years.
- If conducting a valuation, ensure it specifically addresses the key factors that should be considered when valuing an entity for tax purposes.
- Finally, consideration needs to be given to any accruals potentially required under “FIN 48.”
Please note that these regulations apply generally to statements that are required to be filed on or after November 19, 2014, and to requests for relief submitted on or after November 19, 2014.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the US., and serves the U.K. from its base in London.Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisors in nearly 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.