part4-8

4.1.8 
Special Examination Features and Programs

4.1.8.1 
(10-24-2006)
Overview

  1. This chapter provides guidance and instruction on the classification
    and assignment of returns with international issues.

4.1.8.2 
(10-24-2006)
Standards for Classification

  1. In selecting returns for examination, consider the objectives of the
    International Enforcement Program. Select returns that contain significant
    international issues that are:

    1. Likely to result in tax changes

    2. Require examination to achieve voluntary compliance
      by an identifiable group

  2. General procedures in this IRM, and in the Law Enforcement
    Manual,    are applicable to international classifiers.

4.1.8.2.1 
(10-24-2006)
General Information

  1. Generally, returns received for classification for international potential
    will already have been classified for domestic issues. The international examiner,
    subject to Area instructions to the contrary, will not screen returns for
    domestic issues.

  2. Returns accepted as filed for international features during centralized
    classification that have not been previously classified for domestic issues
    will be routed through regular classification at the campus.

  3. Returns selected for international features will be routed to the PSP
    Territory Manager in the Area office. These returns will be filed in Central
    Files, Priority Suspense Files, or assigned to groups following Area procedures.

  4. Review the attached Form 5546, Examination Returns Charge-Out. This document contains information
    that may be beneficial when deciding whether to select or accept a return.

  5. AIMS—Use of Forms and Special Handling Notices
    Handbook    highlights areas of the Form 5546used
    for classification. It contains a detailed explanation of all items on the
    Form 5546.

  6. In classifying a return, if the classifier determines the taxpayer is
    part of an identified LMSB coordinated examination, transfer to the appropriate
    LMSB industry.

  7. International classifiers separate returns into six categories:

    1. Domestic issues not classified—selected for
      International

    2. Domestic issues not classified—accepted for
      International

    3. Accepted on classification for domestic issues—selected
      for International

    4. Accepted on classification for domestic issues—accepted
      for International

    5. Open in Area

    6. Transfers (show transferee Area)

  8. Classification stamps provided for selected and accepted international
    returns are:

    1. Returns not having international potential are stamped
      as follows:
      “
      International—Accepted
      as Filed Referral Not Mandatory
      ”

    2. Returns having International potential, or meeting
      mandatory selection criteria, are stamped as follows:
      “
      International—Selected
      ”

4.1.8.2.2 
(10-24-2006)
Procedures for Processing International Returns During Classification

  1. With returns meeting mandatory selection criteria and/or selected for
    examination based on international features, international classifiers will:

    1. Affix AIMS status update labels to
      Form 5348(Examination Update).

      If a
      return has:       		Then
      Tax Haven
      issues       		Place
      a red “T”
      for Tax Haven in the lower left-hand corner
      of the AIMS status date label.
      A Form 5713 Place
      a red “B”
      for Boycott in the lower left-hand corner of
      the AIMS status update label.

    2. Stamp “

      International—Selected
      ”
      on the face of return.

  2. For returns
    accepted as filed
     during
    international classification, classifiers will:

    1. Affix AIMS status update label to
      Form 5351Nonexamined Closing.

    2. Place a red “B”
      in the lower
      left-hand corner of labels if returns have a Form 5713
      .

    3. Stamp returns:
      “
      International—Accepted as Filed Referral Not Mandatory
      ”

  3. Chief, Classification Section will ensure that:

    1. Copies of Form 5348 and
      Form 5351 are forwarded to the Unit Manager
      of Central Files and Scheduling..

    2. Selected cases, except returns with tax havens,
      are updated to Project Code 090 before forwarding to Area PSP Territory Managers.

4.1.8.2.3 
(10-24-2006)
Procedures for Processing Form 1120F Returns During Classification

  1. Form Form 1120F returns are filed
    at the Ogden Campus.

  2. All returns with assets < $ 10 million are the jurisdiction of SBSE
    and are classified by SBSE international examination personnel.

  3. All returns with assets > $10 million are the jurisdiction of LMSB and
    are to be classified by international examiners.

  4. The returns selected for examination will be updated to Project Code
    0162.

4.1.8.2.4 
(10-24-2006)
Procedures for Processing Form 1040 Returns with Form 2555 During
Classification

  1. Returns claiming the foreign earned income exclusion on
    Form 2555 are filed at the Ogden Campus and are under the jurisdiction
    of SBSE International.

  2. The following factors must be considered when classifying these returns:

    1. Is the income from all foreign sources reported
      on the U.S. income tax return?

    2. Has the taxpayer used the proper exchange rate for
      converting the foreign income?

    3. Is the taxpayer an employee of the U.S. Government?

    4. Is there a Form 1116Computation of Foreign Tax Credit—Individua, Fiduciary, or
      Non-Resident Alien Individual)       attached to the return?

    5. If Form 1116is
      attached to the return, determine if the credit claimed is at the treaty rate
      or at the foreign country’s statutory rate. A citizen or resident claiming
      the treaty benefit from a foreign country is limited to the treaty rate as
      a foreign tax credit or deduction on the tax return.
      Rev. Rul. 57–116, 1957–1, C.B. 245,, states in part
      the allowance of a credit for taxes paid to a foreign country is limited to
      the tax that is a legal and actual liability. Tax withheld at the source is
      merely an advance collection of what may or may not be an actual tax liability.

4.1.8.2.5 
(10-24-2006)
Classifying or Screening Foreign Corporate Returns (Form 1120F)

  1. Every foreign corporation, whether a resident or nonresident, which
    is subject to tax under Subtitle A of the Internal Revenue Code must file
    a Form 1120F, regardless of whether it has
    taxable income or gross income. If it has no gross income for the taxable
    year, it is not required to complete the return schedules. However, it must
    attach a statement to the return showing the nature of any exclusions claimed
    and the amount of such exclusions to the extent they are readily determinable.

  2. A Form 1120F is similar to Form 1120 filed by a U.S. corporation. The major difference
    is an additional section on Form 1120F for
    U.S. source income not effectively connected with a U.S. trade or business.
    Unlike a U.S. corporation, which is required to include worldwide gross income
    on Form 1120, a foreign corporation includes
    on Form 1120F only:

    1. U.S. source income not effectively connected with
      a U.S. trade or business ( IRC §881)

    2. Gross income effectively connected with a U.S. trade
      or business, regardless of the source IRC §8812
      )

4.1.8.2.6 
(10-24-2006)
Identification of Issues on Form 1120F Returns

  1. Effectively connected income is income generated from the active conduct
    of a trade or business in the United States. During classification:

    1. Review questions “A”
      through “L”
      on page 1 and questions “M”
      through “P”
      on page 5. Pay particular attention to location of books
      and records, type of business, and foreign country.

    2. Foreign-sourced business profits are taxable in
      the United States, if they are attributed (effectively connected) to the U.S.
      business.

    3. Check to see if interest, dividend, or other passive
      type income is being reported as effectively connected income
       (Section II of Form 1120F) as opposed
      to not effectively connected income (Section I of Form 1120F) and, therefore, subject to tax at a flat
      rate with no deduction allowed, particularly if the return is showing a loss
      in Section II. Check the balance sheet to see if there are investments that
      should be paying interest or dividends.

    4. Check foreign-sourced income that is being excluded
      on Schedule M–1. Are deductions being allocated to U.S. sourced and
      foreign sourced income? Are the allocated deductions being excluded in Schedule
      M–1.

    5. Review IRC §864(c)(4)
      for the definition of other types of income from sources outside
      the United States

  2. Review the definition in Treasury Reg. 1.864–2. Note those activities
    that are not included in the general definition of a trade or business. Review
    questions “A”
    through “F”
    on page
    1 of the tax return and “M”
    through “P”
    on
    page 5. Does the taxpayer meet the treaty definition of a trade or business?
    Indications of a U.S. place of business are:

    • The return address

    • Rents being paid and deducted on page 3

    • Property taxes paid and depreciation schedule deductions

    • Salaried employees

    • Location of books and records

  3. Treaty Benefits:

    1. Check tax rates on income reported on page 2, which
      is not effectively connected income.

    2. If a treaty country is involved, rates could be
      different.

  4. Schedule M–1 or M–2:

    1. If foreign sourced income or tax-exempt income is
      excluded for tax purposes, are there corresponding adjustments to deductions?
      Is income excluded reasonable in relation to the type of business?

    2. Are there any distributions that may be subject
      to IRC §1042withholding?

  5. IRC §1042 Liability:

    1. Check Schedule M–2 for any distributions that
      may be subject to withholding.

    2. Is the taxpayer paying interest, rent, royalties,
      or contract labor to foreign sources that could be subject to withholding?
      Besides Schedule II deductions, consider excluded deductions on Schedule M–1,
      or expenses used in the computation of a foreign tax credit.

  6. Home Office Expense or General and Administrative Expense:

    1. Review the method of allocating home office expense
      to the U.S. operation.

    2. Is the allocation made among U.S. source, foreign
      source, and tax exempt income?

  7. Banks must report U.S. and foreign sourced income if effectively connected
    with a U.S. business, unless the income is excluded by treaty.

    1. Check treaty provisions if income is excluded on
      the return.

    2. If income is excluded under the treaty, or is tax
      exempt, check for allocation of expenses to the excluded income.

    3. Check for computation of interest expense under
      Treas Reg. 1.882–5, Determination of interest deduction.

    4. Check allocation of home office expenses to U.S.
      trade or business including allocation to excluded income.

    5. Computation of Reserves for Bad Debts— If
      the percentage method is used, verify allowable percentage of eligible loans;
      eligible loans at year end [Treas.Reg. 1.585-1]; loans applicable to foreign
      sourced income for purposes of minimum tax preference items; and write-offs.

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