IRS Tax Forms  
Instructions for Form 1120-F 2001 Tax Year

U.S. Income Tax Return of a Foreign Corporation

Line 30b. Special Deductions

See the instructions for Schedule C.


Schedule A - Cost of Goods Sold

Generally, inventories are required at the beginning and end of each tax year if the production, purchase, or sale of merchandise is an income-producing factor. See Regulations section 1.471-1.

However, if the corporation is a qualifying taxpayer, it may adopt or change its accounting method to account for inventoriable items in the same manner as materials and supplies that are incidental. A qualifying taxpayer is a taxpayer (a) whose average annual gross receipts for the 3 prior tax years is $1 million or less and (b) whose business is not a tax shelter (as defined in section 448(d)(3)). In addition, for tax years ending on or after December 31, 2001, this rule applies to an eligible business of a qualifying small business taxpayer. A qualifying small business taxpayer includes a corporation with average annual gross receipts of more than $1 million but less than or equal to $10 million and that is not prohibited from using the cash method under section 448. For more details, including the definition of an eligible business, see Notice 2001-76.

Under this accounting method, inventory costs for raw materials purchased for use in producing finished goods and merchandise purchased for resale are deductible in the year the finished goods or merchandise are sold (but not before the year the corporation paid for the raw materials or merchandise, if it is also using the cash method). Enter amounts paid for all raw materials and merchandise during the tax year on line 2. The amount the corporation can deduct for the tax year is figured on line 8. For additional guidance on this method of accounting for inventory items, see Rev. Proc. 2001-10 and Pub. 538.

All filers not using the cash method of accounting should see Section 263A uniform capitalization rules on page 11 before completing Schedule A.

Line 1. Inventory at beginning of year. If the corporation is changing its method of accounting for the current tax year, it must refigure last year's closing inventory using its new method of accounting and enter the result on line 1. If there is a difference between last year's closing inventory and the refigured amount, attach an explanation and take it into account when figuring the corporation's section 481(a) adjustment (explained on page 5).

Line 4. Additional section 263A costs. An entry is required on this line only for corporations that have elected a simplified method of accounting.

For corporations that have elected the simplified production method, additional section 263A costs are generally those costs, other than interest, that were not capitalized under the corporation's method of accounting immediately prior to the effective date of section 263A but are now required to be capitalized under section 263A. For details, see Regulations section 1.263A-2(b).

For corporations that have elected the simplified resale method, additional section 263A costs are generally those costs incurred for the following categories.

  • Off-site storage or warehousing.
  • Purchasing; handling, such as processing, assembling, repackaging, and transporting.
  • General and administrative costs (mixed service costs).

For details, see Regulations section 1.263A-3(d).

Enter on line 4 the balance of section 263A costs paid or incurred during the tax year not included on lines 2, 3, and 5.

Line 5. Other costs. Enter on line 5 any costs paid or incurred during the tax year not entered on lines 2 through 4.

Line 7. Inventory at end of year. See Regulations section 1.263A-1 through 1.263A-3 for details on figuring the amount of additional section 263A costs to be included in ending inventory.

If the corporation accounts for inventoriable items in the same manner as materials and supplies that are not incidental, enter on line 7 the portion of its raw materials and merchandise purchased for resale that are included on line 6 and were not sold during the year.

Line 9a. Inventory valuation methods. Inventories can be valued at:

  • Cost,
  • Cost or market value (whichever is lower), or
  • Any other method approved by the IRS that conforms to the requirements of the applicable regulations cited below.

However, if the corporation is using the cash method of accounting, it is required to use cost.

Corporations that account for inventoriable items in the same manner as materials and supplies that are not incidental may currently deduct expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs.

The average cost (rolling average) method of valuing inventories generally does not conform to the requirements of the regulations. See Rev. Rul. 71-234, 1971-1 C.B. 148.

Corporations that use erroneous valuation methods must change to a method permitted for Federal income tax purposes. To make this change, use Form 3115.

On line 9a, check the method(s) used for valuing inventories. Under lower of cost or market, the term market (for normal goods) means the current bid price prevailing on the inventory valuation date for the particular merchandise in the volume usually purchased by the taxpayer. For a manufacturer, market applies to the basic elements of cost - raw materials, labor, and burden. If section 263A applies to the taxpayer, the basic elements of cost must reflect the current bid price of all direct costs and all indirect costs properly allocable to goods on hand at the inventory date.

Inventory may be valued below cost when the merchandise is unsalable at normal prices or unusable in the normal way because the goods are subnormal because of damage, imperfections, shop wear, etc., within the meaning of Regulations section 1.471-2(c). The goods may be valued at a current bona fide selling price, minus direct cost of disposition (but not less than scrap value) if such a price can be established.

If this is the first year the Last-in, First-out (LIFO) inventory method was either adopted or extended to inventory goods not previously valued under the LIFO method provided in section 472, attach Form 970, Application To Use LIFO Inventory Method, or a statement with the information required by Form 970. Also check the LIFO box on line 9c. On line 9d, enter the amount or the percent of total closing inventories covered under section 472. Estimates are acceptable.

If the corporation changed or extended its inventory method to LIFO and had to write up its opening inventory to cost in the year of election, report the effect of this write up as other income (Section II, line 10, on page 3) proportionately over a 3-year period that begins with the year of the LIFO election (see section 472(d)).

For more information on inventory valuation methods, see Pub. 538.


Schedule C - Dividends and Special Deductions

For purposes of the 20% ownership test on lines 1 through 7, the percentage of stock owned by the corporation is based on voting power and value of the stock. Preferred stock described in section 1504(a)(4) is not taken into account.

Line 1, Column (a)

Enter dividends (except those received on debt-financed stock acquired after July 18, 1984 - see section 246A) that:

  • Are received from less-than-20%-owned domestic corporations subject to income tax and
  • Qualify for the 70% deduction under section 243(a)(1).

Also include on line 1:

  • Taxable distributions from an IC-DISC or former DISC that are designated as eligible for the 70% deduction and certain dividends of Federal Home Loan Banks. See section 246(a)(2).
  • Dividends (except those received on debt-financed stock acquired after July 18, 1984) from a regulated investment company (RIC). The amount of dividends eligible for the dividends-received deduction under section 243 is limited by section 854(b). The corporation should receive a notice from the RIC specifying the amount of dividends that qualify for the deduction.

Report so-called dividends or earnings received from mutual savings banks, etc., as interest. Do not treat them as dividends.

Line 2, Column (a)

Enter on line 2:

  • Dividends (except those received on debt-financed stock acquired after July 18, 1984) that are received from 20%-or-more-owned domestic corporations subject to income tax and that are subject to the 80% deduction under section 243(c) and
  • Taxable distributions from an IC-DISC or former DISC that are considered eligible for the 80% deduction.

Line 3, Column (a)

Enter dividends that are:

  • Received on debt-financed stock acquired after July 18, 1984, from domestic and foreign corporations subject to income tax that would otherwise be subject to the dividends-received deduction under section 243(a)(1), 243(c), or 245(a). Generally, debt-financed stock is stock that the corporation acquired by incurring a debt (e.g., it borrowed money to buy the stock).
  • Dividends received from a RIC on debt-financed stock. The amount of dividends eligible for the dividends-received deduction is limited by section 854(b). The corporation should receive a notice from the RIC specifying the amount of dividends that qualify for the deduction.

Line 3, Columns (b) and (c)

Dividends received on debt-financed stock acquired after July 18, 1984, are not entitled to the full 70% or 80% dividends-received deduction. The 70% or 80% deduction is reduced by a percentage that is related to the amount of debt incurred to acquire the stock. See section 246A. Also, see section 245(a) before making this computation for an additional limitation that applies to dividends received from foreign corporations. Attach a schedule that shows how the amount on line 3, column (c) was figured.

Line 4, Column (a)

Enter dividends received on the preferred stock of a less-than-20%-owned public utility that is subject to income tax and is allowed the deduction provided in section 247 for dividends paid.

Line 5, Column (a)

Enter dividends received on preferred stock of a 20%-or-more-owned public utility that is subject to income tax and is allowed the deduction provided in section 247 for dividends paid.

Line 6, Column (a)

Enter the U.S.-source portion of dividends that:

  • Are received from less-than-20%-owned foreign corporations and
  • Qualify for the 70% deduction under section 245(a). To qualify for the 70% deduction, the corporation must own at least 10% of the stock of the foreign corporation by vote and value.

Line 7, Column (a)

Enter the U.S.-source portion of dividends that are received from 20%-or-more- owned foreign corporations and that qualify for the 80% deduction under section 245(a).

Line 8, Column (c)

Limitation on dividends-received deduction. Generally, line 8, column (c), may not exceed the amount from the worksheet on page 17. However, in a year in which an NOL occurs, this limitation does not apply even if the loss is created by the dividends-received deduction. See sections 172(d) and 246(b).

Line 9, Column (a)

Enter foreign dividends that are not reportable on lines 3, 6, or 7 of column (a).

Line 10, Column (a)

If the corporation claims the foreign tax credit, enter the tax that is deemed paid under sections 902 and 960. See sections 78 and 906(b)(4).

Line 11, Column (a)

Enter taxable distributions from an IC-DISC or former DISC that are designated as not eligible for a dividends-received deduction.

No deduction is allowed under section 243 for a dividend from an IC-DISC or former DISC (as defined in section 992(a)) to the extent the dividend:

  • Is paid out of the corporation's accumulated IC-DISC income or previously taxed income or
  • Is a deemed distribution under section 995(b)(1).

Line 12, Column (a)

Include the following:

  • Dividends (other than capital gain distributions and exempt-interest dividends) that are received from RICs and that are not subject to the 70% deduction.
  • Dividends from tax-exempt organizations.
  • Dividends (other than capital gain distributions) received from a REIT that qualifies, for the tax year of the trust in which the dividends are paid, under sections 856 through 860.
  • Dividends not eligible for a dividends- received deduction because of the holding period of the stock or an obligation to make corresponding payments with respect to similar stock.

    Two situations in which the dividends- received deduction will not be allowed on any share of stock are:

    1. If the corporation held it less than 46 days during the 90-day period beginning 45 days before the stock became ex-dividend with respect to the dividend (see section 246(c)(1)(A)) or
    2. To the extent the corporation is under an obligation to make related payments for substantially similar or related property.
  • Any other taxable dividend income not properly reported above (including distributions under section 936(h)(4)).

If patronage dividends or per-unit retain allocations are included on line 12, identify the total of these amounts in a schedule and attach it to Form 1120-F.

Line 13, Column (c)

Section 247 allows public utilities a deduction of 40% of the smaller of:

  • Dividends paid on their preferred stock during the tax year or
  • Taxable income computed without regard to this deduction.

In a year in which an NOL occurs, compute the deduction without regard to section 247(a)(1)(B). See section 172(d).

Worksheet for Schedule C and Tax Computation Worksheet for Members of a Controlled Group

11475L05


Schedule J - Tax Computation

Lines 1 and 2

Members of a controlled group. A member of a controlled group, as defined in section 1563, must check the box on line 1 and complete lines 2a and 2b of Schedule J.

Line 2a. Members of a controlled group are entitled to one $50,000, one $25,000, and one $9,925,000 taxable income bracket amount (in that order) on line 2a.

When a controlled group adopts or later amends an apportionment plan, each member must attach to its tax return a copy of its consent to this plan. The copy (or an attached statement) must show the part of the amount in each taxable income bracket apportioned to that member. See Regulations section 1.1561-3(b) for other requirements and for the time and manner of making the consent.

Unequal apportionment plan. Members of a controlled group may elect an unequal apportionment plan and divide the taxable income brackets as they want. There is no need for consistency among taxable income brackets. Any member may be entitled to all, some, or none of the taxable income bracket. However, the total amount for all members cannot be more than the total amount in each taxable income bracket.

Equal apportionment plan. If no apportionment plan is adopted, members of a controlled group must divide the amount in each taxable income bracket equally among themselves. For example, Controlled Group AB consists of Corporation A and Corporation B. They do not elect an apportionment plan. Therefore, each corporation is entitled to:

  • $25,000 (one-half of $50,000) on line 2a(1);
  • $12,500 (one-half of $25,000) on line 2a(2); and
  • $4,962,500 (one-half of $9,925,000) on line 2a(3).

Line 2b. Members of a controlled group are treated as one group to figure the applicability of the additional 5% tax and the additional 3% tax. If an additional tax applies, each member will pay that tax based on the part of the amount used in each taxable income bracket to reduce that member's tax. See section 1561(a). If an additional tax applies, attach a schedule showing the taxable income of the entire group and how the corporation figured its share of the additional tax.

Line 2b(1). Enter the corporation's share of the additional 5% tax on line 2b(1).

Line 2b(2). Enter the corporation's share of the additional 3% tax on line 2b(2).

Line 3. Income Tax

Most corporations should figure their tax using the Tax Rate Schedule below. Exceptions apply to members of a controlled group (see the worksheet above) and qualified personal service corporations (see instructions on page 18). Members of a controlled group must attach to Form 1120-F a statement showing the computation of the amount entered on line 3.

Tax Rate Schedule

Tax Rate Schedule
If its taxable income (Section II, line 31) is: Tax is: Of the amount over -
Over - But not over -
$0 $50,000 15% $0
50,000 75,000 $ 7,500 + 25% 50,000
75,000 100,000 13,750 + 34% 75,000
100,000 335,000 22,250 + 39% 100,000
335,000 10,000,000 113,900 + 34% 335,000
10,000,000 15,000,000 3,400,000 + 35% 10,000,000
15,000,000 18,333,333 5,150,000 +38% 15,000,000
18,333,333 - - - - - 35% 0

Qualified personal service corporation. A qualified personal service corporation is taxed at a flat rate of 35% on its taxable income. If the corporation is a qualified personal service corporation, check the box on line 3, Schedule J, even if the corporation has no tax liability.

A corporation is a qualified personal service corporation if it meets both of the following tests:

  • Substantially all of its activities involve performing services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting and
  • At least 95% of its stock, by value, is owned, directly or indirectly, by (a) employees performing the services; (b) retired employees who had performed the services listed above; (c) any estate of an employee or retiree described above; or (d) any person who acquired the stock of the corporation as a result of the death of an employee or retiree (but only for the 2-year period beginning on the date of the employee or retiree's death). See Temporary Regulations section 1.448-1T(e) for details.

Additional tax under section 197(f). A corporation that elects to pay tax on the gain from the sale of an intangible under the related person exception to the anti-churning rules should include any additional tax due under section 197(f)(9)(B) in the total for line 3. On the dotted line next to line 3, write Section 197 and the amount. For more information, see Pub. 535, Business Expenses.

Line 4. Alternative Minimum Tax

Unless the corporation is treated as a small corporation exempt from the alternative minimum tax (AMT), it may owe the AMT if it has any of the adjustments and tax preference items listed on Form 4626, Alternative Minimum Tax-Corporations. The corporation must file Form 4626 if its taxable income (loss) combined with these adjustments and tax preference items is more than the smaller of $40,000 or the corporation's allowable exemption amount (from Form 4626).

For this purpose, taxable income does not include the NOL deduction. See Form 4626 for details.

Exemption for small corporations. A corporation is treated as a small corporation exempt from the AMT for its tax year beginning in 2001 if that year is the corporation's first tax year in existence (regardless of its gross receipts) or:

  1. It was treated as a small corporation exempt from the AMT for all prior tax years beginning after 1997 and
  2. Its average annual gross receipts for the 3-tax-year period (or portion thereof during which the corporation was in existence) ending before its tax year beginning in 2001 did not exceed $7.5 million ($5 million if the corporation had only 1 prior tax year).

Line 6a. Foreign Tax Credit

A foreign corporation engaged in a U.S. trade or business during the tax year can take a credit for income, war profits, and excess profits taxes paid, accrued, or deemed paid to any foreign country or U.S. possession for income effectively connected with the conduct of a trade or business in the United States. See section 906 and Form 1118, Foreign Tax Credit - Corporations.

Line 6b

If the corporation can take either of the following credits, check the appropriate box(es) and include the amount of the credits in the total for line 6b.

Nonconventional source fuel credit. A credit is allowed for the sale of qualified fuels produced from a nonconventional source. Section 29 contains a definition of qualified fuels, provisions for figuring the credit, and other special rules. Attach a separate schedule to the return showing the computation of the credit.

Qualified electric vehicle (QEV) credit. Use Form 8834, Qualified Electric Vehicle Credit, if the corporation can claim a credit for the purchase of a new qualified electric vehicle. Vehicles that qualify for this credit are not eligible for the deduction for clean-fuel vehicles under section 179A.

Line 6c. General Business Credit

Check the Form 3800 box, complete Form 3800, General Business Credit, and enter the total of the credit on line 6c if the corporation has any of the following:

  • More than one of the general business credits listed below (other than the empowerment zone employment credit),
  • General credits from an electing large partnership shown in box 7 of Schedule K-1 (Form 1065-B),
  • A credit carryforward or carryback of any of these credits (other than the empowerment zone employment credit),
  • A trans-Alaska pipeline liability fund credit, or
  • Any of these credits (other than the low-income housing credit and the empowerment zone employment credit) that is from a passive activity.

Note: A corporation filing Form 3800 and Form 8844, Empowerment Zone Employment Credit, would check both the Form 3800 box and the Form(s) box, write 8844 in the space provided, and enter the total of the credits on line 6c.

If the corporation is not required to file Form 3800, attach the applicable form(s) listed in parentheses below. Check the Form(s) box, write the attached form number(s) in the space provided, and include the total of the credit(s) on line 6c.

  • Investment Credit (Form 3468).
  • Work Opportunity Credit (Form 5884).
  • Credit for Alcohol Used as Fuel (Form 6478).
  • Credit for Increasing Research Activities (Form 6765).
  • Low-Income Housing Credit (Form 8586).
  • Orphan Drug Credit (Form 8820).
  • Disabled Access Credit (form 8826).
  • Enhanced Oil Recovery Credit (Form 8830).
  • Renewable Electricity Production Credit (Form 8835).
  • Empowerment Zone Employment Credit (Form 8844). While the empowerment zone employment credit is part of the general business credit, it is figured separately on Form 8844 and never carried to Form 3800.
  • Indian Employment Credit (Form 8845).
  • Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips (form 8846).
  • Credit for Contributions to Selected Community Development Corporations (Form 8847).
  • Welfare-to-Work Credit (Form 8861).
  • New Markets Credit (Form 8874).

Line 6d. Credit for Prior Year Minimum Tax

To figure the minimum tax credit and any carryforward of the credit, use Form 8827, Credit for Prior Year Minimum Tax - Corporations. Also see Form 8827 if any of the corporation's 2000 nonconventional source fuel credit or qualified electric vehicle credit was disallowed solely because of the tentative minimum tax limitation. See section 53(d).

6e. Qualified Zone Academy Bond Credit

Enter the amount of any credit from Form 8860, Qualified Zone Academy Bond Credit.

Line 9. Other Taxes

Include any of the following taxes and interest in the total on line 9. Check the appropriate box(es) for the form, if any, used to compute the total.

Recapture of investment credit. If the corporation disposed of investment credit property or changed its use before the end of its useful life or recovery period, it may owe a tax. See Form 4255, Recapture of Investment Credit, for details.

Recapture of low-income housing credit. If the corporation disposed of property (or there was a reduction in the qualified basis of the property) for which it took the low-income housing credit, it may owe a tax. See Form 8611, Recapture of Low-Income Housing Credit.

Interest due under the look-back methods. If the corporation used the look-back method for certain long-term contracts, see Form 8697 for information on figuring the interest the corporation may have to include.

The corporation may also have to include interest due under the look-back method for property depreciated under the income forecast method. See Form 8866.

Other. Additional taxes and interest amounts may be included in the total entered on line 9. Check the box for Other if the corporation includes any of the taxes and interest discussed below. See How to report, below, for details on reporting these amounts on an attached schedule.

  • Recapture of qualified electric vehicle (QEV) credit. The corporation must recapture part of the QEV credit it claimed in a prior year if, within 3 years of the date the vehicle was placed in service, it ceases to qualify for the credit. See Regulations section 1.30-1 for details on how to figure the recapture.
  • Recapture of Indian employment credit. Generally, if an employer terminates the employment of a qualified employee less than 1 year after the date of initial employment, any Indian employment credit allowed for a prior tax year because of wages paid or incurred to that employee must be recaptured. For details, see Form 8845 and section 45A.
  • Interest on deferred tax attributable to (a) installment sales of certain timeshares and residential lots (section 453(l)(3)) and (b) certain nondealer installment obligations (section 453A(c)).
  • Interest due on deferred gain (section 1260(b)).

How to report. If the corporation checked the Other box, attach a schedule showing the computation of each item included in the total for line 9 and identify the applicable Code section and type of tax or interest.


Section III - Branch Profits Tax and Tax on Excess Interest

Part I - Branch Profits Tax

Section 884(a) imposes a 30% branch profits tax on the aftertax earnings of a foreign corporation's U.S. trade or business (i.e., effectively connected earnings and profits (ECEP)) that are not reinvested in a U.S. trade or business by the close of the tax year, or are disinvested in a later tax year. Changes in the value of the equity of the foreign corporation's U.S. trade or business (i.e., U.S. net equity) are used as a measure of whether earnings have been reinvested in, or disinvested from, a U.S. trade or business. An increase in U.S. net equity during the tax year is generally treated as a reinvestment of earnings for the current tax year. A decrease in U.S. net equity is generally treated as a disinvestment of prior year's earnings that have not previously been subject to the branch profits tax.

The amount subject to the branch profits tax for the tax year is the dividend equivalent amount. See Regulations section 1.884-1(b).

Exempt corporations. A foreign corporation is exempt from the branch profits tax on its dividend equivalent amount if:

  • It is a qualified resident of a country with which the United States has an income tax treaty in effect for the year in which the dividend equivalent arises and
  • The income tax treaty with that country has not been modified on or after January 1, 1987.

See Regulations section 1.884-1(g)(3) for a list of the qualifying countries. See Item X on page 20 for the definition of qualified resident.

If the foreign corporation is exempt from the branch profits tax, do not complete Part I. However, be sure to complete Items W and X at the bottom of page 5.

Other entities subject to the branch profits tax.

  • A foreign corporate partner of a partnership engaged in a U.S. trade or business is subject to the branch profits tax on its ECEP attributable to its distributive share of effectively connected income.
  • A foreign government is subject to both the branch profits tax and the branch-level interest taxes. However, no branch profits tax or branch-level interest taxes will be imposed on ECEP and interest accrued prior to September 11, 1992. See Regulations section 1.884-0.

Line 2

Attach a schedule showing the following adjustments (based on the principles of section 312) to the corporation's line 1 effectively connected taxable income (ECTI) (before the NOL deduction and special deductions) to get ECEP:

  • Positive adjustments for certain effectively connected income items that are excluded from ECTI but must be included in computing ECEP (such as tax-exempt interest income).
  • Positive adjustments for certain items deducted in computing ECTI but cannot be deducted in computing ECEP. Include adjustments for certain deductions claimed in computing ECTI, such as:
    1. Excess of percentage depletion over cost depletion,
    2. Excess of accelerated depreciation over straight line depreciation (but only if 20% or more of the foreign corporation's gross income from all sources is U.S. source), and
    3. Capital loss carrybacks and carryovers.
  • Negative adjustments for certain deductible items (that are allocable to effectively connected income) that cannot be deducted in computing ECTI but must be deducted in computing ECEP (e.g., Federal income taxes, capital losses in excess of capital gains, and interest and expenses that are not deductible under section 265).

Note: Do not reduce ECEP by any dividends or other distributions made by the foreign corporation to its shareholders during the year.

See Temporary Regulations section 1.884-2T for any adjustments to ECEP due to a reorganization, liquidation, or incorporation.

Exceptions. Do not include the following types of income when computing ECEP:

  • Income from the operation of ships or aircraft exempt from taxation under section 883(a)(1) or (2).
  • FSC income and distributions treated as effectively connected income under section 921(d) or section 926(b) that are not otherwise effectively connected income.
  • Gain on the disposition of an interest in a domestic corporation that is a U.S. real property interest under section 897(c)(1)(A)(ii) if the gain is not otherwise effectively connected income.
  • Related person insurance company income that a taxpayer elects to treat as effectively connected income under section 953(c)(3)(C) if the income is not otherwise effectively connected income.
  • Income that is exempt from tax under section 892.
  • Interest income derived by a possession bank from U.S. obligations if the interest is treated as effectively connected income under section 882(e) and is not otherwise effectively connected income.

Note: Deductions and other adjustments attributable (under the principles of Regulations section 1.861-8) to the types of income not includible in ECEP listed above do not reduce ECEP.

Lines 4a and 4b. U.S. Net Equity

U.S. net equity is U.S. assets reduced by U.S. liabilities. U.S. net equity may be less than zero. See Temporary Regulations section 1.884-2T for specific rules regarding the computation of the foreign corporation's U.S. net equity due to a reorganization, liquidation, or incorporation.

U.S. asset. In general, property is a U.S. asset if all income from its use and all gain from its disposition (if used or sold on the last day of the tax year) are or would be effectively connected income. The amount of property taken into account as a U.S. asset is the adjusted basis (for purposes of computing earnings and profits) of the property. Special rules exist for specific types of property, such as depreciable property, inventory, and installment obligations. Special rules also exist to determine the amount of a partnership interest that is treated as a U.S. asset. See Regulations section 1.884-1(d).

U.S. liabilities. In general, U.S. liabilities are U.S.-connected liabilities of a foreign corporation (determined under Regulations section 1.882-5), computed as of the end of the tax year, rather than as an average, as required under Regulations section 1.882-5. Special rules may apply to foreign insurance companies. For more details, see Regulations section 1.884-1(e).

If the corporation is electing to reduce liabilities under Regulations section 1.884-1(e)(3), attach a statement that it is making the election and indicate the amount of the reduction of U.S. liabilities and the corresponding reduction in interest expense.

Reporting requirements. In the schedules required for lines 4a and 4b, report U.S. assets according to the categories of U.S. assets in Regulations section 1.884-1(d). For U.S. liabilities, show the formula used to calculate the U.S. liabilities figure.

Line 6. Branch Profits Tax

Qualification for treaty benefits. In general, a foreign corporation must be a qualified resident (see Item X on page 20 for definition) in the tax year in which it has a dividend equivalent amount to obtain treaty benefits for the branch profits tax. It must also meet the requirements of any limitation on benefits article in the treaty. However, a foreign corporation is not required to be a qualified resident if it meets the requirements of a limitation on benefits article that entered into force after December 31, 1986. Treaties other than income tax treaties do not exempt a foreign corporation from the branch profits tax.

Note: If a foreign corporation claims to be a qualified resident based on the two-part stock ownership and base erosion test, a special rule governs the period during which it must be a qualified resident. (See the instructions for Item X on page 20.)

Rate of tax. If treaty benefits apply, the rate of tax is the rate on branch profits specified in the treaty. If the treaty does not specify a rate for branch profits, the rate of tax is the rate specified in the treaty for dividends paid by a wholly owned domestic corporation to the foreign corporation. See Regulations section 1.884-1(g) for applicable rates of tax. Benefits other than a rate reduction may be available under certain treaties, such as the Canadian income tax treaty.

Effect of complete termination. If the foreign corporation has completely terminated its U.S. trade or business (within the meaning of Temporary Regulations section 1.884-2T(a)) during the tax year, enter zero on line 6, and complete Item V at the bottom of page 5.

In general, a foreign corporation has terminated its U.S. trade or business if it no longer has any U.S. assets, except those retained to pay off liabilities. The foreign corporation (or a related corporation) may not use assets from the terminated U.S. trade or business or the proceeds from their sale in a U.S. trade or business within 3 years after the complete termination.

Coordination with withholding tax. If a foreign corporation is subject to the branch profits tax in a tax year, it will not be subject to withholding at source (sections 871(a), 881(a), 1441, or 1442) on dividends paid out of earnings and profits for the tax year.

Part II - Tax on Excess Interest

If a foreign corporation is engaged in a U.S. trade or business, has effectively connected gross income, or has U.S. assets for purposes of Regulations section 1.882-5, it is subject to the tax on excess interest.

Excess interest is the interest apportioned to effectively connected income of the foreign corporation (including capitalized and nondeductible interest) under Regulations section 1.882-5, less branch interest. Branch interest is the interest paid by the U.S. trade or business of the foreign corporation (including capitalized and other nondeductible interest).

Important: See the instructions for line 10 below to determine if the foreign corporation is exempt from the tax on excess interest. If it is exempt from the tax, and not simply subject to a reduced rate of tax, do not complete Part II of Section III. However, be sure to complete Items W and X on page 5.

Line 8. Branch Interest

Foreign banks. In general, branch interest of a foreign bank is limited to:

  • Interest paid for branch liabilities that are reported to bank regulatory authorities;
  • Interest paid for offshore shell branches, if the U.S. branch performs substantially all the activities required to incur the liability; and
  • Interest on liabilities that are secured predominantly by U.S. assets or that cause certain nondeductible interest (such as capitalized interest) related to U.S. assets.

All other foreign corporations. In general, branch interest of foreign corporations (other than banks) includes:

  1. Interest on liabilities shown on the books and records of the U.S. trade or business for purposes of Regulations section 1.882-5;
  2. Interest on liabilities that are secured predominantly by U.S. assets or that cause certain nondeductible interest (such as capitalized interest) related to U.S. assets; and
  3. Interest on liabilities identified as liabilities of the U.S. trade or business on or before the earlier of the date on which the first interest payment is made or the due date (including extensions) of the foreign corporation's income tax return for the tax year.

However, a liability may not be identified under 3 if the liability is incurred in the ordinary course of the foreign corporation's trade or business, or if the liability is secured predominantly by assets that are not U.S. assets. The interest on liabilities identified in 3 that will be treated as interest paid by the U.S. trade or business is capped at 85% of the interest of the foreign corporation that would be excess interest before considering interest on liabilities identified in 3 above. See Regulations section 1.884-4.

Interbranch interest. Any interest paid for interbranch liabilities is disregarded in computing branch interest of any corporation.

Eighty-percent rule. If 80% or more of a foreign corporation's assets are U.S. assets, the foreign corporation's branch interest will generally equal the interest reported on line 7. However, any interest included on line 7 that has accrued but has not been paid will not be treated as branch interest on line 8 unless an election is made under Regulations section 1.884-4(c)(1) to treat such interest as paid in that year for all purposes of the Code. If this 80% rule applies, check the box on line 8.

Note: Branch interest of a foreign corporation is treated as if paid by a domestic corporation. A foreign corporation is thus required to withhold on interest paid by its U.S. trade or business to foreign persons (unless the interest is exempt from withholding under a treaty or the Code) and is required to file Forms 1042 and 1042-S for the payments as required under Regulations sections 1.1461-2 and 35a.9999-5.

Special treaty shopping rules apply if the recipient of the interest paid by the U.S. trade or business is a foreign corporation.

Line 9b

A foreign bank may treat a percentage of its excess interest as if it were interest on deposits and thus exempt from tax. Multiply the amount on line 9a by the greater of 85% or the ratio of the foreign bank's worldwide interest-bearing deposits to its worldwide interest-bearing liabilities as of the close of the tax year.

Line 10. Tax on Excess Interest

The rate of tax on excess interest is the same rate that would apply to interest paid to the foreign corporation by a wholly owned domestic corporation. The tax on excess interest is not prohibited by any provision in any treaty to which the United States is a party. The corporation may qualify for treaty benefits if it meets certain requirements. See Line 6. Branch Profits Tax, on page 19 and Item X below. The corporation is exempt from the tax on excess interest if the rate of tax that would apply to interest paid to the foreign corporation by a wholly owned domestic corporation is zero and the foreign corporation qualifies for treaty benefits.

Additional Information Required

Be sure to complete all additional information on page 5 that applies to the corporation.

Item X

Qualified resident. A foreign corporation is a qualified resident of a country if it meets one of the three tests explained below. See the regulations under section 884 for details on these tests and certain circumstances in which a foreign corporation that does not meet these tests may obtain a ruling to be treated as a qualified resident.

Two-part ownership and base erosion test. A foreign corporation meets this test if:

  • More than 50% of its stock (by value) is owned (directly or indirectly) during at least half the number of days in the tax year by qualifying shareholders and
  • Less than 50% of its income is used (directly or indirectly) to meet liabilities to persons who are not residents of such foreign country or U.S. citizens or residents. For this test, individuals resident in the foreign country, U.S. citizens and residents, governments of foreign countries, and foreign corporations that meet the publicly traded test (described later) are treated as qualifying shareholders.

In general, stock owned by a corporation, partnership, trust, or estate is treated as proportionately owned by the individual owners of such entities.

In order to satisfy the 50% stock ownership test described above, a foreign corporation must, before filing Form 1120-F for the tax year, obtain certain written documentation from the requisite number of its direct and indirect shareholders to show that it meets the test, including a certificate of residency from each foreign individual resident signed by the Competent Authority of the individual's country of residence. See Regulations sections 1.884-5(a) through (c).

If a foreign corporation is a qualified resident under this test and a portion of its dividend equivalent amount for the tax year is from ECEP earned in prior tax years, the foreign corporation will be entitled to treaty benefits for the entire dividend equivalent amount only if:

  1. The foreign corporation was a qualified resident for all tax years within the 36-month period that includes the tax year of the dividend equivalent amount or
  2. The foreign corporation was a qualified resident for the tax year of the dividend equivalent amount, and for the years in which the ECEP included in the dividend equivalent amount were earned.

If the foreign corporation fails the 36-month test but is a qualified resident for the tax year, the portion of the dividend equivalent amount for ECEP from any prior tax year will not be entitled to treaty benefits if the foreign corporation was not a qualified resident for the tax year in which the ECEP was earned. Thus, in some instances, more than one rate of tax may apply to the dividend equivalent amount reported on line 5, Section III. See Regulations section 1.884-1(g)(2).

Publicly traded test. A foreign corporation meets this test if:

  1. Its stock is primarily and regularly traded on one or more established securities markets in its country of residence or the United States or
  2. 90% or more of its stock is owned (directly or indirectly) by another corporation that meets the requirements of 1 and is a resident of the same country or is a domestic corporation.

See Regulations section 1.884-5(d).

Active trade or business test. A foreign corporation meets this test if it has a substantial presence in its country of residence and its U.S. trade or business is an integral part of an active trade or business conducted by the foreign corporation in its country of residence. See Regulations section 1.884-5(e).

Item Z

If the corporation owned at least a 10% interest, directly or indirectly, in any foreign partnership, attach a statement listing the following information for each foreign partnership:

  • Name and EIN (if any) of the foreign partnership;
  • Identify which, if any, of the following forms the foreign partnership filed for its tax year ending with or within the corporation's tax year: Form 1042, 1065 or 1065-B, or 8804;
  • Name of tax matters partner (if any); and
  • Beginning and ending dates of the foreign partnership's tax year.


Schedules L, M-1, and M-2

A foreign corporation may limit Schedules L, M-1, and M-2 to:

  1. The corporation's U.S. assets and its other assets effectively connected with its U.S. trade or business and liabilities reported on its U.S. books and records and
  2. Its effectively connected income and its other U.S. source income.

Do not complete Schedules M-1 and M-2 if total assets at the end of the tax year (line 15, column (d) of Schedule L) are less than $25,000.

Schedule L
Balance Sheets per Books

The balance sheet should agree with the corporation's books and records. Include certificates of deposit as cash on line 1.

Line 5. Tax-exempt securities. Include:

  • State and local government obligations, the interest on which is excludable from gross income under section 103(a) and
  • Stock in a mutual fund or other regulated investment company that distributed exempt-interest dividends during the tax year of the corporation.

Line 26. Adjustments to shareholders' equity. Some examples of adjustments to report on this line include:

  • Unrealized gains and losses on securities held available for sale.
  • Foreign currency translation adjustments.
  • The excess of additional pension liability over unrecognized prior service cost.
  • Guarantees of employee stock (ESOP) debt.
  • Compensation related to employee stock award plans.

If the total adjustment to be entered on line 26 is a negative amount, enter the amount in parenthesis.

Schedule M-1

Reconciliation of Income (Loss) per Books With Income per Return

Line 5c. Travel and entertainment expenses. Include any of the following.

  • Meals and entertainment expenses not deductible under section 274(n).
  • Expenses for the use of an entertainment facility.
  • The part of business gifts over $25.
  • Expense of an individual over $2,000, that are allocable to conventions on cruise ships.
  • Employee achievement awards over $400.
  • The cost of entertainment tickets over face value (also subject to the 50% limit under section 274(n)).
  • The cost of skyboxes over the face value of nonluxury box seat tickets.
  • The part of luxury water travel expenses not deductible under section 274(m).
  • Expenses for travel as a form of education.
  • Other nondeductible travel and entertainment expenses.

For more information, see Pub. 542.

Line 7a. Tax-exempt interest. Include any exempt-interest dividends received as a shareholder in a mutual fund or other regulated investment company.

11475L10

Codes for Principal Business Activity

11475L11

Code for Principal Business Activity (con't)

11475L12

Code for Principal Business Activity (con't)


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