Foreign Corporations Archives - MGO CPA | Tax, Audit, and Consulting Services

Importance of Operational Planning

Effective operational planning is the cornerstone of a successful expansion into the U.S. market, especially as FDI continues to drive economic growth in the region. This planning involves not only understanding the regulatory environment but also anticipating challenges related to employee management, supply chains, insurance, and financial operations. Inadequate planning can result in significant delays, increased costs, and potential legal issues — which can be particularly detrimental in a competitive market increasingly influenced by global investment.

Employee Benefits and Regulations

When expanding to the U.S., your company must navigate a complex landscape of employee benefits and regulations — which differ from those in your home country. In many sectors that are seeing increased FDI, such as manufacturing and technology, understanding and managing these benefits is critical to attracting and retaining top talent in the competitive U.S. job market.

Differences in Employee Benefits Between the U.S. and Other Countries: In many countries, such as those in the European Union, employee benefits like health insurance and retirement plans are often managed or mandated by the government. However, in the U.S., these benefits are typically the responsibility of the employer. This shift can be surprising for foreign companies, requiring a thorough understanding of U.S. labor laws and regulations.

Health Insurance, Retirement Plans, and Other Benefits: U.S. employers are generally expected to provide health insurance as a standard benefit — with medical, dental, and vision benefits often requiring contracts with separate insurance carriers. Employers must typically cover 50% of insurance costs (though minimum coverage varies by state). Many companies also offer retirement plans such as 401(k)s. Navigating the selection and administration of these benefits can be challenging, particularly for small- or medium-sized enterprises. You may need to consult with benefits professionals to stay compliant with U.S. regulations and remain competitive in the job market.

Logistics and Supply Chain Management

Managing U.S. operations efficiently requires careful consideration of location, coordination, and infrastructure needs. Strategic decisions about operational setup can have a notable impact on your overall business success.

Choosing the Right Location for Operations: The U.S. is a vast country with significant regional differences in cost, labor availability, and infrastructure. Selecting the right location for your operations can affect everything from shipping costs to employee satisfaction. For instance, companies focused on manufacturing might prefer regions with lower labor costs and favorable tax treatments; those in distribution might prioritize proximity to major logistics hubs.

Shipping and Inventory Management: Efficient shipping and inventory management are essential to support product flow and meet customer expectations. Foreign companies in the U.S. often rely on third-party providers to manage these aspects — especially if they lack a physical presence. However, this can create tax obligations in multiple states, as having inventory in a state may trigger state and local tax filing requirements.

Obtaining the Necessary Insurance Coverage: Foreign companies often discover their existing insurance policies do not cover their U.S. operations. It’s crucial to secure the appropriate insurance coverage — either through global policies that extend to the U.S. or by obtaining new policies tailored to U.S. risks. Your coverage needs may include general liability, property, product liability, workers’ compensation, and employment practices liability depending on the nature of the business.

Challenges in Opening Bank Accounts: Opening a bank account in the U.S. can be a complex process for foreign-owned businesses. Some banks may be hesitant to provide accounts or offer credit facilities to companies without a U.S. presence or substantial collateral. This can limit access to credit and other financial services, making it essential to plan financial operations carefully.

Setting Your Business Up for U.S. Success

Expanding into the U.S. market requires careful consideration of various operational factors — from employee benefits and logistics to insurance and banking. As the U.S. continues to attract substantial foreign direct investment, it is critical to understand and address these challenges to be competitive and position your business for successful growth. By planning accordingly, you can capitalize on the opportunities presented by this dynamic market.

Ready to launch your U.S. expansion? Reach out to our team today to learn how we can help support your operational planning efforts.

Setting up a business in the U.S. requires thorough planning and an understanding of various regulatory and operational challenges. In this series, we will delve into specific aspects of this process, providing guidance and practical tips. Our next articles will explore the complexities of navigating states and local taxes.

Executive Summary

In April 2023, the U.S. Tax Court made news when it ruled in favor of businessman Alon Farhy, who challenged the Internal Revenue Service (IRS)’s authority to assess penalties for the failure to file IRS Form 5471.
IRS Form 5471 is the Information Return of U.S. Persons With Respect to Certain Foreign Corporations.
In May 2024, the U.S. Court of Appeals for the D.C Circuit reversed the Tax Court’s initial ruling — underscoring the significance of context in assessing penalties for international information returns.

UPDATE (May 2024):

Recent developments in the Farhy v. Commissioner case have captured significant attention in the tax and legal sectors. On May 3, 2024, the U.S. Court of Appeals reversed the Tax Court’s initial decision, highlighting the importance of statutory context in penalty assessments for international information returns. This ruling emphasizes the need for a closer examination of statutory language, altering perspectives on penalty applicability for non-compliance.

The implications of this case extend to taxpayers and practitioners, as detailed in analyses by MGO (see below). The decision underscores the need for meticulous compliance practices and adept navigation of the complexities of U.S. international tax law, along with a deep understanding of judicial interpretations of tax regulations.

MGO’s professionals are well-positioned to assist clients in navigating the complexities arising from the recent Farhy v. Commissioner decision. With a comprehensive understanding of the changing landscape in penalty assessments for international information returns, we provide guidance to help companies adapt to new judicial interpretations and maintain compliance with evolving tax regulations.

ORIGINAL ARTICLE (published June 8, 2023):

On April 3, 2023, the U.S. Tax Court came to a decision in the case Farhy v. Commissioner, ruling that the Internal Revenue Service (IRS) does not have the statutory authority to assess penalties for the failure to file IRS Form 5471, or the Information Return of U.S. Persons With Respect to Certain Foreign Corporations, against taxpayers. It also ruled that the IRS cannot administratively collect such penalties via levy.

Now that the IRS doesn’t have the authority to assess certain foreign information return penalties according to the court, affected taxpayers may want to file protective refund claims, even if the case goes to appeals — especially given the short statute of limitations of two years for claiming refunds.

Our Tax Controversy team breaks down the Farhy case, as well as what it may mean for your international filings — and the future of the IRS’s penalty collections.

The IRS Case Against Farhy

Alon Farhy owned 100% of a Belize corporation from 2003 until 2010, as well as 100% of another Belize corporation from 2005 until 2010. He admitted he participated in an illegal scheme to reduce his income tax and gained immunity from prosecution. However, throughout the time of his ownership of these two companies, he was required to file IRS Forms 5471 for both — but he didn’t.

The IRS then mailed him a notice in February 2016, alerting him of his failure to file. He still didn’t file, and in November 2018, he assessed $10,000 per failure to file, per year — plus a continuation penalty of $50,000 for each year he failed to file. The IRS determined his failures to file were deliberate, and so the penalties were met with the appropriate approval within the IRS.

Farhy didn’t dispute he didn’t file. He also didn’t deny he failed to pay. Instead, he challenged the IRS’s legal authority to assess IRC section 6038 penalties.

The Tax Court’s Initial Ruling

The U.S. Tax Court then held that Congress authorized the assessment for a variety of penalties — namely, those found in subchapter B of chapter 68 of subtitle F — but not for those penalties under IRC sections 6038(b)(1) and (2), which apply to Form 5471. Because these penalties were not assessable, the court decided the IRS was prohibited from proceeding with collection, and the only way the IRS can pursue collection of the taxpayer’s penalties was by 28 U.S.C. Sec. 2461(a) — which allows recovery of any penalty by civil court action.

How This Decision Affects Your International Penalty Assessments

This case holds that the IRS may not assess penalties under IRC section 6038(b), or failure to file IRS Form 5471. The case’s ruling doesn’t mean you don’t have an obligation to file IRS Form 5471 — or any other required form.

Ultimately, this decision is expected to have a broad reach and will affect most IRS Form 5471 filers, namely category 1, 4, and 5 filers (but not category 2 and 3 filers, who are subject to penalties under IRC section 6679).

However, the case’s impact could permeate even deeper. For years, some practitioners have spoken out against the IRS’s systemic assessment of international information return (IIR) penalties after a return is filed late, making it impossible for taxpayers to avoid deficiency procedures. The court’s decision now reveals how a taxpayer can be protected by the judicial branch when something is deemed unfair. Farhy took a stand, challenged the system, and won — opening the door for potential challenges in the future.

It’s uncertain as to whether the IRS will appeal the court’s decision. But it seems as though the stakes are too high for the IRS not to appeal. While we don’t know what will happen, a former IRS official has stated he expects that, for cases currently pending review by IRS Appeals, Farhy will not be viewed as controlling law yet.

The impact of the ruling is clear and will most likely impact many taxpayers who are contesting — or who have already paid — IRC 6038 penalties. It may also affect other civil penalties where Congress has not prescribed the method of assessment in the future.

How You Should Respond to the Court’s Decision

You should move quickly to take advantage of the court’s decision, as there is a two-year statute of limitations from the time a tax is paid to make a protective claim for a refund. It’s likely this legislation wouldn’t affect refund claims since that would be governed by the law that existed when the penalties were assessed. Note that per IRC section 6665(a)(2), there is no distinction between payments of tax, addition to tax, penalties, or interest — so all items are treated as tax.

If you’ve previously paid the $10,000 penalty, it’s important to file your protective claim now, unless you’ve entered into an agreement with the IRS to extend the statute of limitations, which can occur during an examination. Requesting a refund won’t ever hurt, but some practitioners believe the IRS may try to keep any penalty money it collected, even if the assessment is invalid — because, in its eyes, the claim may not be. Just know, you can file your protective claim for a refund, but may not get it (at least not any time soon).

The Farhy decision could likewise be applied to other US IRS forms, such as 5472, 8865, 8938, 926, 8858, 8854. Some argue the Farhy decision may also be applied to IRS Form 3520.

How MGO Can Help

Only time will tell if the court’s decision will open the government up to additional criticisms for other penalty assessments. If you have paid your penalties and are wondering what your current options are, MGO’s experienced International Tax team can help you determine if you’re eligible to file a refund claim.

Topic: Foreign Corporations

Prepare for These Key Operational Challenges with Your U.S. Expansion