Categories of Filers

Category 1 filer. A Category 1 filer is a U.S. person who controlled the foreign partnership at any time during the partnership's tax year. Control of a partnership is ownership of more than a 50% interest in the partnership. See the definition of 50% interest on page 4. There may be more than one Category 1 filer for a partnership for a particular partnership tax year.

Category 2 filer. A Category 2 filer is a U.S. person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while the partnership was controlled by U.S. persons owning at least 10% interests. However, if the foreign partnership had a Category 1 filer at any time during that tax year, no person will be considered a Category 2 filer. See the definition of a 10% interest on page 4.

Category 3 filer. A Category 3 filer is a U.S. person who contributed property during that person's tax year to a foreign partnership in exchange for an interest in the partnership (a section 721 transfer), if that person either:

1. Owned directly or constructively at least a 10% interest in the foreign partnership immediately after the contribution, or
2. The value of the property contributed (when added to the value of any other property contributed to the partnership by such person, or any related person, during the 12-month period ending on the date of transfer) exceeds $100,000.

If a domestic partnership contributes property to a foreign partnership, the domestic partnership's partners are considered to have transferred a proportionate share of the contributed property to the foreign partnership. If a foreign partnership contributes property to another foreign partnership, the partners of the contributing foreign partnership are not considered to have transferred a proportionate share of the contributed property.

Category 3 also includes a U.S. person that previously transferred appreciated property to the partnership and was required to report that transfer under section 6038B, if the foreign partnership disposed of such property while the U.S. person remained a direct or indirect partner in the partnership.

Category 4 filer. A Category 4 filer is a U.S. person that had a reportable event under section 6046A during that person's tax year. There are three categories of reportable events under section 6046A: acquisitions, dispositions, and changes in proportional interests.

Acquisitions. A U.S. person that acquires a foreign partnership interest has a reportable event if:

• The person did not own a 10% or greater direct interest in the partnership and as a result of the acquisition the person owns a 10% or greater direct interest in the partnership (e.g., from 9% to 10%). For purposes of this rule, an acquisition includes an increase in a person's direct proportional interest (see definition of change in proportional interest on page 4); or
• Compared to the person's direct interest when the person last had a reportable event, after the acquisition the person's direct interest has increased by at least a 10% interest (e.g., from 11% to 21%).

Dispositions. A U.S. person that disposes of a foreign partnership interest has a reportable event if:

• The person owned a 10% or greater direct interest in the partnership before the disposition and as a result of the disposition the person owns less than a 10% direct interest (e.g., from 10% to 8%). For purposes of this rule, a disposition includes a decrease in a person's direct proportional interest; or
• Compared to the person's direct interest when the person last had a reportable event, after the disposition the person's direct interest has decreased by at least a 10% interest (e.g., from 21% to 11%).

Changes in proportional interests. A U.S. person has a reportable event if compared to the person's direct proportional interest the last time the person had a reportable event, the person's direct proportional interest has increased or decreased by at least the equivalent of a 10% interest in the partnership.

Special rule for a partnership interest owned on December 31, 1999. If the U.S. person owned at least a 10% direct interest in the foreign partnership on December 31, 1999, then comparisons should be made to the person's direct interest on December 31, 1999. Once the person has a reportable event after December 31, 1999, future comparisons should be made by reference to the last reportable event.

Exceptions to Filing

Multiple Category 1 filers. If during the tax year of the partnership there is more than one Category 1 filer, instead of each Category 1 filer submitting a separate Form 8865, only one Form 8865 from one Category 1 filer is required. A person that is a Category 1 filer by reason of an interest in losses or deductions may not file the single Form 8865 if another U.S. person is a Category 1 filer by reason of an interest in capital or profits; only the latter may file the return. The U.S. person that files the Form 8865 must complete Item E on page 1 of the form.

The single Form 8865 to be filed must contain all of the information that would have been required if each Category 1 filer had filed a separate Form 8865. Specifically, a separate Schedule N and Schedule K-1 must be attached to the Form 8865 for each Category 1 filer. Also, questions B, C, and D on page 1 and Schedule A on page 2 of Form 8865 must be completed for each Category 1 filer not filing the form on a separate statement to be attached to the single Form 8865.

A Category 1 filer not filing Form 8865 must attach a statement entitled Controlled Foreign Partnership Reporting to that person's income tax return.

The statement must include the following information:

• A statement that the person qualified as a Category 1 filer, but is not submitting Form 8865 under the multiple Category 1 filers exception.
• The name, address, and identifying number (if any) of the foreign partnership of which the person qualified as a Category 1 filer.
• A statement that the filing requirement has been or will be satisfied.
• The name and address of the person filing Form 8865 for this partnership.
• The Internal Revenue Service Center where the Form 8865 must be filed.

A U.S. person who qualifies for this exception to the Category 1 filing requirement would still have to file a separate Form 8865 if that person is also subject to the filing requirements of Category 3 or 4. This separate Form 8865 would have to include all the information required for a Category 3 or 4 filer in addition to the Controlled Foreign Partnership Reporting statement.

Constructive owners. See the definition of constructive ownership on page 4. A Category 1 or 2 filer that does not own a direct interest in the partnership and that is required to file this form solely because of constructive ownership from a U.S. person(s) is not required to file Form 8865 if:

1. Form 8865 if filed by the U.S. person(s) through which the indirect partner constructively owns an interest in the foreign partnership,
2. The U.S. person through which the indirect partner constructively owns an interest in the foreign partnership is also a constructive owner and meets all the requirements of this constructive ownership filing exception, or
3. Form 8865 is filed for the foreign partnership by another Category 1 filer under the multiple Category 1 filers exception.

To qualify for the constructive ownership filing exception, the indirect partner must file with its income tax return a statement entitled Controlled Foreign Partnership Reporting.

This statement must contain the following information:

1. A statement that the indirect partner was required to file Form 8865, but is not doing so under the constructive owners exception;
2. The names and addresses of the U.S. persons whose interests the indirect partner constructively owns; and
3. The name and address of the foreign partnership for which the indirect partner would have had to have filed Form 8865 but for this exception.

Members of an affiliated group of corporations filing a consolidated return. If one or more members of an affiliated group of corporations filing a consolidated return qualify as Category 1 or 2 filers for a particular foreign partnership, the common parent corporation may file one Form 8865 on behalf of all of the members of the group required to report. Except for group members who also qualify under the constructive owners exception, the Form 8865 must contain all the information that would have been required to be submitted if each group member filed its own Form 8865.

Exception for certain trusts. Trusts relating to state and local government employee retirement plans are not required to file Form 8865.

Exception for certain Category 4 filers. If you qualify as a Category 3 and 4 filer because you contributed property to a foreign partnership in exchange for a 10% or greater interest in that partnership, you are not required to report this transaction under both Category 3 and 4 filing requirements. If you properly report the contribution of property under the Category 3 rules, you are not required to report it as a Category 4 filer. However, the acquisition will count as a reportable event to determine if a later change in your partnership interest qualifies as a reportable event under Category 4.

Example. Partner A does not own an interest in FPS, a foreign partnership. Partner A transfers property to FPS in exchange for a 15% direct interest in FPS. Partner A qualifies as a Category 3 filer because he transferred property to a foreign partnership and owned at least a 10% interest in FPS immediately after the contribution. Partner A is also a Category 4 filer because he did not own a 10% or greater direct interest in FPS and as a result of the acquisition of the FPS interest now owns a 10% or greater direct interest in FPS. If Partner A properly reports the contribution on Form 8865 as a Category 3 filer, Partner A is not required to report his acquisition of the 15% interest in FPS as a Category 4 filer.

Relief for Category 1 and 2 Filers When the Foreign Partnership Files Form 1065 or Form 1065-B

If a foreign partnership files Form 1065, U.S. Return of Partnership Income, or Form 1065-B, U.S. Return of Income for Electing Large Partnerships, for its tax year, Category 1 and 2 filers must use a copy of the completed Form 1065 or 1065-B schedules in place of the equivalent schedules of Form 8865.

The following Form 1065/1065-B schedules are equivalent to the following Form 8865 schedules:

Example. Partner A is a Category 1 filer with respect to FPS, a foreign partnership during the FPS 2001 tax year. FPS completes and files a Form 1065 for its 2001 tax year. Instead of completing Schedules B, D, K, L, M-1, M-2, and K-1 of Form 8865, Partner A must attach to its Form 8865 page 1 of Form 1065 and Form 1065 Schedules D, K, L, M-1, M-2, and K-1 (including the Schedules K-1 for Partner A and all other U.S. persons owning 10% or greater direct interests in FPS). Partner A also must complete the following items and schedules on Form 8865:

Example. Partner A is a Category 2 filer with respect to FPS, a foreign partnership. If FPS completes and files a Form 1065 for its 2001 tax year, Partner A must file with Form 8865 the Schedule K-1 (Form 1065) that it receives from the partnership instead of Schedule K-1 (Form 8865). Partner A also must complete the following items and schedules on Form 8865:

When and Where To File

Attach Form 8865 to your income tax return (or, if applicable, partnership or exempt organization return) and file both by the due date (including extensions) for that return. If you do not have to file an income tax return, you must file Form 8865 separately with the IRS at the time and place you would be required to file an income tax return (or, if applicable, a partnership or exempt organization return). See below for penalties that may apply if you do not file Form 8865 on time.

Definitions

Partnership. A partnership is the relationship between two or more persons who join to carry on a trade or business, with each person contributing money, property, labor, or skill and each expecting to share in the profits and losses of the business whether or not a formal partnership agreement is made.

The term partnership includes a limited partnership, syndicate, group, pool, joint venture, or other unincorporated organization, through or by which any business, financial operation, or venture is carried on, that is not, within the meaning of the regulations under section 7701, a corporation, trust, estate, or sole proprietorship.

A joint undertaking merely to share expenses is not a partnership. Mere co-ownership of property that is maintained and leased or rented is not a partnership. However, if the co-owners provide services to the tenants, a partnership exists.

Foreign partnership. A foreign partnership is a partnership that is not created or organized in the United States or under the law of the United States or of any state.

50% interest. A 50% interest in a partnership is an interest equal to 50% of the capital interest in the partnership, an interest equal to 50% of the profits interest in the partnership, or an interest to which 50% of the deductions or losses of the partnership are allocated. For purposes of determining a 50% interest, the constructive ownership rules below apply.

10% interest. A 10% interest in a partnership is an interest equal to 10% of the capital interest in the partnership, an interest equal to 10% of the profits interest in the partnership, or an interest to which 10% of the deductions or losses of the partnership are allocated. For purposes of determining a 10% interest, the constructive ownership rules below apply.

Constructive ownership. For purposes of determining an interest in a partnership, the constructive ownership rules of section 267(c) (excluding section 267(c)(3)) apply, taking into account that such rules refer to corporations and not to partnerships. Generally, an interest owned directly or indirectly by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its owners.

Also, an individual is considered to own an interest owned directly or indirectly by or for his family. The family of an individual includes only that individual's spouse, brothers, sisters, ancestors, and lineal descendants. An interest will be attributed from a nonresident alien individual under the family attribution rules only if the person to whom the interest is attributed owns a direct or indirect interest in the foreign partnership under section 267(c)(1) or (5).

U.S. person. A U.S. person is a citizen or resident of the United States, a domestic partnership, a domestic corporation, and any estate or trust that is not foreign.

Control of a corporation. Control of a corporation is ownership of stock possessing more than 50% of the total combined voting power, or more than 50% of the total value of shares of all classes of stock of the corporation. For rules concerning indirect ownership and attribution, see Regulations section 1.6038-2(c).

Change in a proportional interest. A partner's proportional interest in a foreign partnership can change as a result of changes in other partners' interests, for example, when another partner withdraws from the partnership. A partner's proportional interest can also change, for example, by operation of the partnership agreement (e.g., if the partnership agreement provides that a partner's interest in profits will change on a set date or when the partnership has earned a specified amount of profits, then the partner's proportional interest changes when the set date or specified amount of profits is reached).

Penalties

Failure to timely submit all information required of Category 1 and 2 filers.

• A $10,000 penalty is imposed for each tax year of each foreign partnership for failure to furnish the required information within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign partnership) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.
• Any person who fails to furnish all of the information required within the time prescribed, will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901, 902, and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038(c)(2) for limits on the amount of this penalty.
• Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file or for filing false or fraudulent information.

Additionally, any person that does file under the constructive owners exception may be subject to these penalties if all the requirements of the exception are not met. Any person required to file Form 8865 who does not file under the multiple Category 1 filers exception, may be subject to the above penalties if the other person does not file a correct and complete form and schedules. See Exceptions to Filing on page 3.

Failure to file information required of Category 3 filers. Any person that fails to properly report a contribution to a foreign partnership that is required to be reported under section 6038B and the regulations under that section (Form 8865, page 1, and Schedules A, A-1, A-2, and O), is subject to a penalty equal to 10% of the fair market value (FMV) of the property contributed. This penalty is subject to a $100,000 limit, unless the failure is due to intentional disregard. In addition, the transferor must recognize gain on the contribution as if the contributed property had been sold for FMV.

Failure to file information required of Category 4 filers. Any person who fails to properly report all the information requested by section 6046A (Form 8865, page 1, and Schedules A, A-2, and P), is subject to a $10,000 penalty. If the failure continues for more than 90 days after the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period (or fraction thereof) during which the failure continues after the 90-day period has expired. The additional penalty shall not exceed $50,000.

Treaty-based return positions. File Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), to report a return position that a treaty of the United States (such as an income tax treaty, an estate and gift tax treaty, or a friendship, commerce, and navigation treaty):

• Overrides or modifies any provision of the Internal Revenue Code and
• Causes (or potentially causes) a reduction of any tax incurred at any time.

Failure to make such a report may result in a $1,000 penalty ($10,000 in the case of a C corporation). See section 6712.

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