Complying With the Often Misunderstood International Boycott Reporting Requirements
The Internal Revenue Code, while primarily used to generate tax revenue for the government, is often used to incentivize or penalize various U.S. policy decisions. Section 999 is one such section that is driven by broader U.S. policy goals.
Section 999 imposes reporting obligations on taxpayers that have operations in, or related to, a boycotting country. Section 999 also penalizes, but does not prohibit, participation in international boycotts. The requirements of Section 999 are satisfied by filing Form 5713. The willful failure to file Form 5713 can result in a $25,000 fine, imprisonment for no more than one year, or both. Thus, most taxpayers should simply report any connection with the listed boycott countries (see below) rather than risk potential willful failure to file penalties.
In the 1970s, the U.S. adopted commercial and tax laws which seek to counteract the participation of U.S. citizens in other nation’s economic boycotts or embargos. One such law is the 1976 Tax Reform Act (TRA), which was passed to encourage U.S. firms to refuse to participate in foreign boycotts that the U.S. does not sanction.
The main foreign economic boycott that U.S. companies must be concerned with today is The Arab League boycott of Israel. However, the rules below apply to any boycott imposed by a foreign country that is unsanctioned by U.S. laws. These laws do not include operations with foreign countries if the primary boycott is approved by U.S. laws, regulations, or an executive order.
Accurate Reporting Using Form 5713
A taxpayer that has “operations” in or related to a boycotting country, or with a government, a company, or a national of a boycotting country must file Form 5713 with their U.S. income tax return (including extensions). The term “operations” is defined as all forms of business or commercial activities and transactions (or parts of transactions) whether or not productive of income. This definition of “operations” includes, but is not limited to: selling, purchasing, leasing, licensing, banking, financing, and similar activities; extracting, processing, manufacturing, producing, constructing, and transporting as well as services provided to support any of these activities.
If a taxpayer has operations in or related to a boycotting country, Form 5713 must be filed. However, if a taxpayer also cooperates or participates in an international boycott (rather than merely having operations in or related to a listed boycott country), Section 999 will be applied and result in the loss of the following tax benefits:
- Reduction or loss of foreign tax credit
- Loss of deferral of taxation on CFC earnings
- Loss of deferral of taxation on IC-DISC income
- Loss of exemption of foreign trade income of a FSC
- Loss of exclusion of extraterritorial income
Note that if a U.S. controlled group or a U.S. partnership has activities in boycott countries, and the individual member or partner does not have boycott operations independent of the group or partnership, the common parent and/or partnership may file Form 5713 on behalf of other members and the partners in a partnership.
Foreign corporations with a U.S. subsidiary or sister corporation may waive the requirement to file Form 5713 if the U.S. subsidiary or sister corporation agrees to forfeit the tax benefits listed in the bulleted list above. A foreign corporation with a U.S. branch that would be required to file Form 5713 must file on behalf of the U.S. branch, or, again, the U.S. branch must give up the listed tax benefits.
The size of the lost tax benefits is based on one of two methods to determine boycott-tainted income. The first is by applying the taxpayer’s International Boycott Factor (IBF) to the affected item (i.e. foreign taxes available for credit). The IBF is the percentage determined by purchases, sales and payroll in boycott countries in relation to the total of the same factors in all foreign countries. The IBF cannot exceed 100%. The second method is for the U.S. taxpayer to specifically identify the boycott-tainted items of income and foreign taxes and determine how such items impact the tax attributes (listed above) impacted by boycott-tainted amounts.
Current Boycott Countries
As of Jan. 30, 2020 (list updated quarterly), the U.S. Treasury publishes a list of countries that are considered to participate in a non-sanctioned boycott called the “Listed Countries:”
- Saudi Arabia
- United Arab Emirates
There are various ways a taxpayer can be considered to have “cooperated with or participated in” an international boycott. These actions include agreements that make compliance with local boycott laws a requirement of doing business with a listed country. Agreement to comply with these boycott laws may be specifically spelled out in the business contract or there may be an implied agreement. Both types of agreement must be disclosed on Form 5713. Any of the following actions indicate cooperation and participation:
- Refraining from doing business with or in a country that is the object of the boycott
- Refraining from doing business with any U.S. person engaged in a trade or business in a country that is the object of the boycott
- Refraining from doing business with any company whose ownership or management is made up, in whole or in part, of individuals of a particular nationality, race, or religion – this includes removal of corporate directors
- Refraining from employing individuals of a particular nationality, race, or religion
- As a condition of the sale of a product to the government, a company, or a national of a country, to refrain from shipping or insuring products on a carrier owned, leased, or operated by a person who does not participate in or cooperate with an international boycott
The completion of Form 5713 requires taxpayers to report information related to: 1, operations in a boycotting country; 2, any requests received by the taxpayer to participate in an international boycott; and 3, the taxpayer’s actual participation in an international boycott.
Note that a key element of boycott participation is active agreement on the taxpayer’s part to refrain from transactions with boycotted persons. Contractual agreements that require the participant to perform a contract simply “subject to laws, regulations, requirements, or administrative practices” of a host country does not indicate boycott participation.
However, contracts that state the participant “will comply with the laws, regulations, requirements or administrative practices” of a country that has laws, regulations, requirements, or administrative practices designed to carry out an international boycott would need to be disclosed on Form 5713 and could result in loss of the tax benefits listed above.
One technique to avoid specific participation in an international boycott is to insert a “savings clause” into the local contract. The savings clause states that the taxpayer will conform to the requirements of the contract “except to the extent such compliance is penalized under laws of the United States.” The request for participation in an international boycott must still be disclosed on Form 5713, however, by not participating, the U.S. taxpayer is not subject to the limitation or loss of tax benefits.
It’s important to correctly and accurately report all operations in any listed country in order to avoid very punitive consequences. The key is to be proactive and disclose even the appearance of a connection. To discuss concerns or questions about having a connection to a listed country, please contact a KSM advisor.
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