An Inquiry into the Factors Aiding Clemency for Foreign Corporations Requesting Protective Tax Return Filing Deadline Waivers
By Anthony Malik1
Foreign corporations ("FCs") often have varying degrees of U.S. business activities which in turn subject them to varying degrees of U.S. tax exposure. Depending on a given FC’s country of incorporation, size, business model, and activities it can be difficultâeven for seasoned international tax specialistsâto accurately assess the FC’s U.S. tax position without diligently analyzing the facts and circumstances. Despite said difficulty, it is not uncommon for such FCs to receive advice regarding their U.S. tax positions from their foreign or U.S. generalist tax advisors. Unfortunately this often leads such FCs to have a false sense of their U.S. tax exposure thereby potentially putting them at severe risk of adverse action by the various U.S. tax authorities.
Given the fact-intensive nature of U.S. taxability determination, it is often in a FC’s best interest to consider the advantages of filing protective tax returns.2 In practice, however, many FCs are either unaware of the option, or are specifically advised not to, file protective tax returns. This may be, depending on the factual situations, perfectly harmless, less so, or flat-out unwise. The reason being that protective tax returns, as do virtually all (if not all) U.S. tax returns, have legally prescribed due dates3 by which they must be filed with the Internal Revenue Service ("IRS" or "Service"). Much more importantly, apart from the open-ended statute of limitations under Internal Revenue Code ("IRC" or "Code") Section 6501 and the potentially applicable penalties under IRC Section 6651, that most U.S. tax practitioners are familiar with, the real peril for non-filing FCs is the potential disallowance of otherwise allowable deductions and credits4 for purposes of computing their U.S. taxable incomes5 if it is later determined that such FCs derived income that was effectively connected ("ECI")6 with the conduct of a U.S. trade or business ("USTB").7 Consequently FCs that do not file, when the prevailing facts and circumstances warrant the filing of, protective tax returns are at undue risk of being taxed on their gross incomes from U.S. sources.8