In an International Practice Unit (IPU), IRS has set out for its auditors the steps they should take when issuing a summons under Code Sec. 6038A and the steps to take if the domestic corporation to which it issues the summons does not substantially comply with the summons. Code Sec. 6038A requires reporting by domestic corporations that are at least 25% foreign owned.
Background. Subject to exceptions not relevant here, if, at any time during the tax year, a corporation is a “reporting corporation,” it must furnish certain information with respect to transactions with “related parties” (Code Sec. 6038A(a)), by filing an annual information return (Form 5472 or any successor). (Reg. § 1.6038A-2(a)(1); Reg. § 1.6038A-1(b))
A reporting corporation, also referred to as a domestic reporting corporation (DRC), is a domestic corporation that is 25% foreign-owned. (Code Sec. 6038A(a)) A corporation is 25% foreign-owned if any one foreign person owns at any time during the tax year at least 25% of: (1) the total voting power of all classes of stock entitled to vote, or (2) the total value of all classes of stock. (Code Sec. 6038A(c)(1)) That person is referred to as a “25% foreign shareholder.” (Code Sec. 6038A(c)(1)) A related party (foreign related party; FRP) is a direct or indirect 25% foreign shareholder of the DRC or a person who is related to the DRC or to a 25% foreign shareholder. (Code Sec. 6038A(c)(3))
Generally, a summons issued by the U.S. government is not legally enforceable when the subject of the summons resides in a foreign country. However, Code Sec. 6038A(e)(1) provides that a DRC may be designated by an FRP as its agent with respect to any IRS request or summons (IRC 6038A Summons) for records.
Where (1) an FRP doesn’t authorize the DRC to act as its agent under Code Sec. 6038A(e)(1), (2) the DRC doesn’t substantially comply with an IRS summons with respect to a transaction between an FRP and the DRC, or (3) the summons is quashed because the requested records haven’t been properly maintained, IRS, at its sole discretion and based on its own knowledge or on information that it may get, will determine: (A) the amount of deductions allowed for any amount paid or incurred by the DRC in a transaction with the FRP, (B) the cost to the DRC of any property acquired from the FRP in the transaction, and (C) the cost to the DRC of any property transferred to the FRP in the transaction. This is known as the “noncompliance penalty.” (Reg. § 1.6038A-7(a))
The IPU. The IPU sets out the steps IRS auditors should take when considering issuing an IRC 6038A Summons, when they actually issue such a summons, and if the DRC does not substantially comply with the summons.
… Steps to take when considering an IRC 6038A Summons. The IPU sets out a series of steps that an auditor should take when considering issuing an IRC 6038A Summons, including:
- The auditor should consider whether a request pursuant to an income tax treaty or a tax information exchange agreement, with a country where the records are located, could secure the information sought. When records of an FRP are obtainable within 180 days of an information exchange request pursuant to a tax treaty or tax information exchange agreement, generally IRS will use such procedures before issuing an IRC 6038A Summons.
- IRS has the authority to examine any books, paper, records, or other data that may be relevant to ascertain the correctness of a return, make a return (when none was made), or determine the proper tax liability. The language “may be relevant” allows IRS to obtain documents of potential relevance to an ongoing investigation. IRS cannot be expected to know that a document is relevant until it is obtained and reviewed. Thus, IRS generally will not be required to establish that the documents sought are actually relevant in any technical, evidentiary sense. The Second Circuit’s relevance standard (see, for example, Foster (CA 2 1959) 3 AFTR 2d 9483 AFTR 2d 948), that the material sought “might have thrown light upon the correctness of the return,” is widely accepted.
- IRS may summon the testimony of an officer or employee of a FRP under oath. Like records requested, the testimony requested must be relevant to the tax treatment of an examined item. (Chief Counsel Advice 200950044)
… Steps to take when issuing an IRC 6038A Summons. The IPU sets out a series of steps that an auditor should take when issuing an IRC 6038A Summons, including:
- The proper form for the summons is Form 2039 (Summons), revised October 2010.
- Generally, the place for the summoned person’s appearance will be the IRS office located nearest the summoned person. IRS and the summoned person can agree (in a letter separate from the summons) that a summons seeking only records may be satisfied by mailing those records to IRS.
- The date for appearance must be no less than ten calendar days from the date the summons is issued.
- When issuing an IRC 6038A Summons, the auditor should consider issuing another summons for records that are in the custody or control of the DRC.
… Steps to take if the DRC does not substantially comply with the summons. The IPU sets out a series of steps that an auditor should take if the DRC does not substantially comply with the summons, including:
- If the DRC did not provide any foreign-based documentation requested by the due date, then the DRC did not substantially comply with the IRC 6038A Summons. The auditor should prepare a Notice of Proposed Adjustment with reasonable adjustments based on the information currently known.
- If the DRC provides some documentation but does not substantially comply with the IRC 6038A Summons, the auditor should send the DRC notice, by certified or registered mail, that substantial compliance was not met.
- Any records provided to IRS in response to an IRC 6038A Summons must be translated into English within 30 days of a request from IRS for such translation. (Reg. § 1.6038A-3(b)(3)) When a taxpayer submits a foreign document in response to an IRC 6038A Summons, the auditor should consider issuing an information document request (IDR) for the English translation; the IDR should specify the date the English translation is due.
- In exercising its discretion with respect to the noncompliance penalty, IRS must consider the information provided by the DRC and related parties unless, in IRS’s discretion, such information is insufficient to prove relevant facts. Such discretion is subject only to limited judicial review.
- There is no reasonable cause exception to the noncompliance penalty.
- The noncompliance penalty cannot be overturned in court merely because the amount of deductions (or cost of property) as determined by IRS (a) differs from the actual costs incurred by the DRC or (b) does not clearly reflect income. And the following is not a sufficient reason to redetermine the penalty: the information to prove that the penalty is clearly erroneous is not within IRS’s knowledge or possession.
References: For the Code Sec. 6038A noncompliance penalty, see FTC 2d/FIN ¶ V-1936; United States Tax Reporter ¶ 60,38A4.
IRS LB&I International Practice Service Process Unit “Using an IRC 6038A Summons when a U.S. Corporation is 25% Foreign Owned.”