US Internal Revenue Service: i1120f--1998

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1998 Department of the TreasuryInternal Revenue ServiceInstructions for Form1120-FU.S. Income Tax Return of a Foreign CorporationSection references are to the Internal Revenue Code unless otherwise noted.

Changes To Noteq The new principal business activity (PBA)codes beginning on page 18 of theseinstructions are based on the North AmericanIndustry Classification System (NAICS), whichwas developed by the statistical agencies ofCanada, Mexico, and the United States incooperation with the Office of Management andBudget. The NAICS-based codes replace thePBA codes previously based on the StandardIndustrial Classification (SIC) system.

The Taxpayer Relief Act of 1997 (The Act)made changes to the tax law for corporations.Some of the changes are discussed below.q For tax years beginning after December 31,1997, corporations may be entitled to anincreased charitable contribution deduction forgifts of computer technology and equipment toschools. For details, see Contributions ofcomputer technology and equipment toschoolson page 11.q Certain corporations may take the qualifiedzone academy bond credit (section 1397E). Formore information, see Form 8860, QualifiedZone Academy Bond Credit.q For tax years beginning after December 31,1997, the alternative minimum tax has beenrepealed for corporations that qualify as smallcorporations. For more information, see theinstructions on page 15 and Form 4626,Alternative Minimum TaxCorporations.q

The Act changed the tax year to whichunused general business credits may becarried. Unused general business credits thatarise in tax years beginning after 1997 arecarried back 1 year and then forward to eachof the 20 years following the unused credityear. For more information, see section 39(a).

How To Get Forms andPublicationsPersonal computer. Access the IRS'sInternet web site at www.irs.ustreas.gov todo the following:q Download forms, instructions, andpublications.q See answers to frequently asked taxquestions.

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Buy the CD-ROM on the Internet atwww.irs.ustreas.gov/cdorders from theNational Technical Information Service (NTIS)for $13 (plus a $5 handling fee) and save 35%,or call 1-877-CDFORMS (1-877-2336767)toll-free to buy the CD-ROM for $20 (plus a $5handling fee).By phone and in person. You can orderforms and publications 24 hours a day, 7 daysa week, by calling 1-800-TAX-FORM(1-800-829-3676). You can also get most formsand publications at your local IRS office.

General Instructions

Purpose of FormUse Form 1120-F to report the income, gains,losses, deductions, credits, and to figure theU.S. income tax liability of a foreigncorporation. Also, use Form 1120-F to claimany refund that is due.

Who Must FileUnless one of the exceptions in Who Does NotFile Form 1120-F below applies, every foreigncorporation must file Form 1120-F if, during thetax year, it:q

Overpaid income tax that it wants refunded.q Engaged in a trade or business in the UnitedStates, whether or not it had income from thattrade or business.q Had income, gains, or losses treated as ifthey were effectively connected with that U.S.trade or business. See Section II on page 7 forthe definition of effectively connected income.q Had income from any U.S. source (even if itsincome is tax exempt under an income taxtreaty or code section).

Others that must file Form 1120-F:q A Mexican or Canadian branch of a U.S.mutual life insurance company. The branchmust file Form 1120-F on the same basis as aforeign corporation if the U.S. company electsto exclude the branch's income and expensesfrom its own gross income.q A receiver, assignee, or trustee in dissolutionor bankruptcy, if that person has or holds titleto virtually all of a foreign corporation's propertyor business. Form 1120-F is due whether ornot the property or business is being operated.q An agent in the United States, if the foreigncorporation has no office or place of businessin the United States when the return is due.Treaty Exemption. If the corporation does notowe any tax because it is claiming a treatyexemption, it must still file Form 1120-F toshow that the income was exempted by treaty.However the corporation should only completethe identifying information at the top of page 1and Item W at the bottom of page 5.

If the foreign corporation does not owe thebranch profits tax or the tax on excess interestbecause it is claiming a treaty exemption,complete Item W and attach a statementexplaining why the corporation is a qualifiedresident or otherwise qualifies for treatybenefits.Note: An exemption from tax under Section IIbased on the permanent establishment articleof an income tax treaty does not necessarilyexempt the corporation from the branch profitstax.

Consolidated returns. A foreign corporationcannot belong to an affiliated group ofcorporations that files a consolidated returnunless it is a Canadian or Mexican corporationmaintained solely for complying with the lawsof Canada or Mexico for title and operation ofproperty.

Who Does Not File Form 1120-F

A foreign corporation does not need to fileForm 1120-F if any of the following apply:q Its only income is not subject to U.S. taxationunder section 881(d).q It is a beneficiary of an estate or trustengaged in a U.S. trade or business, but woulditself otherwise not need to file.q It files Form 1120-L, U.S. Life InsuranceCompany Income Tax Return, as a foreign lifeinsurance company, or Form 1120-PC, U.S.Property and Casualty Insurance Company

Income Tax Return, as a foreign property andcasualty insurance company.q It did not engage in a U.S. trade or businessduring the year, and its full U.S. tax waswithheld at source.q It has filed Form 8279, Election To BeTreated as a FSC or as a Small FSC, and theelection is still in effect. These corporationsmust file Form 1120-FSC, U.S. Income TaxReturn of a Foreign Sales Corporation.

When To File

Foreign Corporation With An Office inThe U.S.

A foreign corporation that maintains an officeor place of business in the United States must

file Form 1120-F by the 15th day of the 3rdmonth after the end of its tax year, OR get anextension of time to file.Extension of time to file. The corporationmay EITHER:

1. File Form 7004, Application forAutomatic Extension of Time To FileCorporation Income Tax Return, by the 15thday of the 3rd month after the end of its taxyear to obtain a 6-month extension.Note: The extension granted by the timelyfiling of Form 7004 does not extend the time forpayment of the tax. If the tax is paid after the15th day of the 3rd month following the closeof the corporation's tax year, the corporationmust pay interest on the late payment and is

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subject to the penalty for late payment of tax.OR

2. Get a 3-month extension by attaching toForm 1120-F the statement described inRegulations section 1.6081-5. If additional timeis needed beyond the 3 month extension, thenfile Form 7004 before the end of the 3-monthextension period to obtain up to an additional3 months to file. If Form 7004 is not filed by theexpiration of the 3-month extension period, andthe corporation files its income tax return aftersuch period, it may be liable for the penalty forlate filing of return described on page 4. In noevent may the total extension period exceed 6

months from the original due date of the return(i.e., the return must be filed by the 15th dayof the 9th month after the end of its tax year).See Rev. Rul. 93-85, 1993-2 C.B. 297.

Note: The corporation is still required to paythe tax due by the 15th day of the 3rd monthafter the end of its tax year. If it does not, thecorporation must pay the interest on the latepayment but is not subject to the penalty forlate payment of tax if it pays the tax due by the15th day of the 6th month after the end of itstax year.Important: The options described in1 and2above are mutually exclusive. If a corporationchooses the option described in1 to extend thetime to file, it maynotlater choose the optiondescribed in2.

No Office or Place of Business in TheU.S.

If the foreign corporation does not maintain anoffice or place of business in the United Statesit must:q File Form 1120-F by the 15th day of the 6thmonth after the end of its tax year; ORq File Form 7004 to request a 6-monthextension of time to file.Note: The extension does not extend the timefor payment of tax. If the tax is paid after the15th day of the 6th month after the end of itstax year, the corporation must pay interest onthe late payment and a penalty for latepayment of tax may apply. SeeInterest andPenaltieson page 4.

Other Filing Requirementsq A new corporation filing a short-period returnmust generally file by the 15th day of the 3rdmonth after the short period ends.q A corporation that has dissolved mustgenerally file by the 15th day of the 3rd monthafter the date it dissolved.q If the due date of any filing falls on aSaturday, Sunday, or legal holiday, thecorporation may file on the next business day.q Form 1120F must be filed on a timely basisand in a true and accurate manner in order fora foreign corporation to take deductions andcredits against its effectively connectedincome. For these purposes, Form 1120-F isgenerally considered to be timely filed if it isfiled no later than 18 months after the due dateof the current year's return. An exception may

apply to foreign corporations that have yet tofile Form 1120-F for the preceding tax year.q A foreign corporation is allowed the followingdeductions and credits regardless of whetherForm 1120-F is timely filed:

1. The charitable contributions deduction(page 3, Section II, line 19);

2. The credit from Form 2439 (page 1, line6f);

3. The credit for Federal tax on fuels (page1, line 6g); and

4. U.S. income tax paid or withheld atsource (page 1, line 6h).See Regulations section 1.882-4 for details.

Private Delivery Services

You can use certain private delivery servicesdesignated by the IRS to meet the timelymailing as timely filing/paying rule for taxreturns and payments. The IRS publishes a listof the designated private delivery services inSeptember of each year. The list published inSeptember 1998 includes only the following:q Airborne Express (Airborne): Overnight AirExpress Service, Next Afternoon Service,Second Day Service.q DHL Worldwide Express (DHL): Same DayService, DHL USA Overnight.

q Federal Express (FedEx): FedEx PriorityOvernight, FedEx Standard Overnight, FedEx2 Day.q United Parcel Service (UPS): UPS Next DayAir, UPS Next Day Air Saver, UPS 2nd DayAir, UPS 2nd Day Air A.M.

The private delivery service can tell you howto get written proof of the mailing date.

Where To FileFile Form 1120-F with the Internal RevenueService Center, Philadelphia, PA 19255.

Who Must SignThe return must be signed and dated by:q The president, vice president, treasurer,

assistant treasurer, chief accounting officer; orq Any other corporate officer (such as taxofficer) authorized to sign.

Receivers, trustees, or assignees must alsosign and date any return filed on behalf of acorporation.

If a corporate officer completes Form1120-F, the Paid Preparer's space shouldremain blank. Anyone who prepares Form1120-F but does not charge the corporationshould not sign the return. Generally, anyonewho is paid to prepare the return must sign itand fill in the Paid Preparer's Use Only area.

The paid preparer must complete therequired preparer information andq Sign the return, by hand, in the spaceprovided for the preparer's signature (signaturestamps or labels are not acceptable).q Give a copy of the return to the taxpayer.

Other Forms, Returns,Schedules, and StatementsThat May Be RequiredA foreign corporation may have to file some ofthe following forms. See the forms for moreinformation.

Information Returns

Form 1098, Mortgage Interest Statement, isused to report the receipt from any individualof $600 or more of mortgage interest andpoints in the course of the corporation's tradeor business for any calendar year.

Forms 1099-A, B, C, DIV, INT, LTC, MISC,MSA, OID, PATR, R, and S. Use these formsto report the following:q Acquisitions and abandonments of securedproperty through foreclosure;q Proceeds from broker and barter exchangetransactions;q Cancellation of a debt;q Certain dividends and distributions;q Interest income;q Certain payments made on a per diem basisunder a long-term care insurance contract, andcertain accelerated death benefits;q Miscellaneous income (e.g., payments tocertain fishing boat crew members, payments

to providers of health and medical services,miscellaneous income payments, andnon-employee compensation;q Distributions from a medical savings account;q Original issue discount;q Distributions from cooperatives to theirpatrons;q Distributions from retirement or profit-sharingplans, IRAs, SEPs, SIMPLEs, and insurancecontracts;q Proceeds from real estate transactions.Form W-2, Wage and Tax Statement (andForm W-3, Transmittal of Wage and Tax

Statements), is used to report withheld income,social security, and Medicare taxes for anemployee.Form 5498, IRA, SEP or SIMPLE RetirementPlan Information, is used to report contributions(including rollover contributions) to an IRA,SEP or SIMPLE, and the value of an IRA, SEP,or SIMPLE account.5498MSA, Medical Savings AccountInformation, is used to report contributions(including rollover contributions) to a medicalsavings account (MSA).Form 8300, Report of Cash Payments Over$10,000 Received in a Trade or Business, isfiled to report the receipt of more than $10,000in cash or foreign currency in one transactionor a series of related transactions.

Note: To transmit Forms 1098, 1099, and5498, getForm 1096, Annual Summary andTransmittal of U.S. Information Returns.

Employment Tax Returns

Form 940 or Form 940EZ, Employer's AnnualFederal Unemployment (FUTA) Tax Return, isused to report annual Federal unemployment(FUTA) tax. The tax applies if the corporationeither:q Paid wages of $1,500 or more in anycalendar quarter in 1997 or 1998; orq Had at least one employee who worked forthe corporation for some part of a day in any20 or more different weeks in 1997 or 20 ormore different weeks in 1998.Form 941, Employer's Quarterly Federal TaxReturn (or, for agricultural employers, Form

943, Employer's Annual Tax Return forAgricultural Employees), is filed quarterly byemployers to report payroll income tax withheldand employer and employee social securityand Medicare taxes. Also, see Trust fundrecovery penalty on page 4.Form 945, Annual Return of Withheld FederalIncome Tax, is filed to report income taxwithholding from nonpayroll distributions (e.g.,pensions, annuities, IRAs, military retirement,gambling winnings, Indian gaming profits, andbackup withholding). Also, see Trust fundrecovery penalty on page 4.Form 720, Quarterly Federal Excise TaxReturn, is used to report and pay:q The luxury tax on passenger vehicles;q Environmental excise taxes;q Communications and air transportation

taxes;q Fuel taxes;q Manufacturers' taxes;q Ship passenger taxes; andq Certain other excise taxes.

International Forms

Form 1042, Annual Withholding Tax Return forU.S. Source Income of Foreign Persons, andForm 1042-S, Foreign Person's U.S. SourceIncome Subject to Withholding, are used toreport and send withheld tax on payments ordistributions made to nonresident alienindividuals, foreign partnerships, or foreigncorporations. Also, see sections 1441 and

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1442, and Pub. 515, Withholding of Tax onNonresident Aliens and Foreign Corporations.Form 5471, Information Return of U.S.Persons With Respect to Certain ForeignCorporations, is filed by certain officers,directors, and shareholders of foreign personalholding companies to report the informationrequired by sections 551(c) and 6035. Formore information, see Form 5471 and itsinstructions.Form 5472, Information Return of a 25%Foreign-Owned U.S. Corporation or a ForeignCorporation Engaged in a U.S. Trade orBusiness, is filed by a foreign corporationengaged in a U.S. trade or business that hadcertain reportable transactions with a relatedparty. See Form 5472 for filing instructions andinformation for failure to file and maintainrecords.Form 5713, International Boycott Report, mustbe filed if the corporation had operations in orrelated to a boycotting country, company, ornational of a country.Form 8288, U.S. Withholding Tax Return forDispositions by Foreign Persons of U.S. RealProperty Interests, and Form 8288-A,Statement of Withholding on Dispositions byForeign Persons of U.S. Real PropertyInterests. Use these forms to report andtransmit withheld tax on the sale of U.S. realproperty by a foreign person. However, fordistributions described in Regulations section1.1445-8, use Forms 1042 and 1042-S. Seesection 1445 and the related regulations foradditional information.Form 8621, Return by a Shareholder of aPassive Foreign Investment Company orQualified Electing Fund, is filed by acorporation that was a shareholder in a passiveforeign investment company (under section1297) at any time during the tax year.

Other Forms

Form 8264, Application for Registration of aTax Shelter, is used to apply for a tax shelterregistration number (used by tax shelterorganizers).Form 8271, Investor Reporting of Tax ShelterRegistration Number, is used to report a

registered tax shelter's registration number.This form must be filed with any return onwhich a deduction, loss, credit, or other taxbenefit is claimed or reported (or any incomeis reported) from an interest in a tax shelter.The requirement applies to all returns, includingapplications for tentative refund (Form 1139)and amended returns.Form 8275, Disclosure Statement, and Form8275R, Regulation Disclosure Statement, areused to disclose items or positions taken on atax return that are not otherwise adequatelydisclosed on the tax return, or that are contraryto Treasury regulations (to avoid parts of theaccuracy-related penalty or certain preparerpenalties).Form 8594, Asset Acquisition Statement UnderSection 1060, is used to report the purchase

or sale of a group of assets that constitute atrade or business if goodwill or going concernvalue attach to the assets.Form 8697, Interest Computation Under theLook-Back Method for Completed Long-TermContracts, is used to figure the interest due orto be refunded under the look-back method ofsection 460(b)(2). The look-back methodapplies to certain long-term contractsaccounted for under the percentage ofcompletion or percentage ofcompletion-capitalized cost method.Form 8810, Corporate Passive Activity Lossand Credit Limitations, is used to figureallowable passive activity loss and credit forclosely-held or personal service corporations.

Form 8817, Allocation of Patronage andNonpatronage Income and Deductions, is usedto figure and report patronage andnonpatronage income and deductions (used bytaxable cooperatives).Form 8842, Election to Use DifferentAnnualization Periods for Corporate EstimatedTax, is used to elect one of the annualizationperiods in section 6655(e)(2) to figureestimated tax payments under the annualizedincome installment method.Form 8849, Claim for Refund of Excise Taxes,is used to claim a refund of excise taxesreported on Forms 720, 730, or 2290.Schedule PH (Form 1120), U.S. PersonalHolding Company Tax. See Line 4. PersonalHoldingCompany Tax, on page 6.

Statements

Stock ownership in foreign corporations.Attach the statement required by section 551(c)if:q The foreign corporation owned 5% or morein value of the outstanding stock of a foreignpersonal holding company; andq The corporation was required to include in itsgross income any undistributed foreignpersonal holding company income from aforeign personal holding company.Transfers to a corporation controlled by thetransferor. If a person receives stock of a

corporation in exchange for property, and nogain or loss is recognized under section 351,the person (transferor) and the transferee musteach attach to their tax returns the informationrequired by Regulations section 1.351-3.Statements instead of schedules. If theforeign corporation has no gross income for thetax year, do not complete the Form 1120-Fschedules. Instead, attach a statement to thereturn showing the types and amounts ofincome excluded from gross income.

Attachments

Attach Form 4136, Credit for Federal Tax Paidon Fuels, after page 6, Form 1120-F. Attachschedules in alphabetical order and other formsin numerical order after Form 4136.

Complete every applicable entry space on

Form 1120-F. Do not write See attachedinstead of completing the entry spaces. If morespace is needed on the forms or schedules,attach separate sheets, using the same sizeand format as on the printed forms. Show thetotals on the printed forms. Attach theseseparate sheets after all the schedules andforms. Be sure to put the corporation's nameand EIN on each sheet.

Accounting MethodsAn accounting method is a set of rules used todetermine when and how income andexpenses are reported.

Figure taxable income using the method ofaccounting regularly used in keeping the

corporation's books and records. Generally,permissible methods include:q Cash,q Accrual, orq Any other method authorized by the InternalRevenue Code.

In all cases, the method used must clearlyshow taxable income.

Generally, a corporation (other than aqualified personal service corporation) mustuse the accrual method of accounting if itsaverage annual gross receipts exceed $5million. See section 448(c). A corporationengaged in farming operations must also use

the accrual method. For exceptions, seesection 447.

Under the accrual method, an amount isincludible in income when:q All the events have occurred that fix the rightto receive the income, andq The amount can be determined withreasonable accuracy.See Regulations section 1.451-1(a) for details.

Generally, an accrual basis taxpayer candeduct accrued expenses in the tax year when:q All events that determine the liability haveoccurred,

q The amount of the liability can be figured withreasonable accuracy, andq Economic performance takes place withrespect to the expense.

There are exceptions to the economicperformance rule for certain items, includingrecurring expenses. See section 461(h) and therelated regulations for the rules for determiningwhen economic performance takes place.

Long-term contracts (except for certain realproperty construction contracts) must generallybe accounted for using the percentage ofcompletion method described in section 460.See section 460 for general rules on long-termcontracts.Mark-to-market accounting method fordealers in securities. Generally, dealers insecurities must use the mark-to-market

accounting method described in section 475.Under this method, any security that isinventory to the dealer must be included ininventory at its fair market value. Any securityheld by a dealer that is not inventory and thatis held at the close of the tax year is treatedas sold at its fair market value on the lastbusiness day of the tax year. Any gain or lossmust be taken into account in determininggross income. The gain or loss taken intoaccount is generally treated as ordinary gainor loss.

For details, including exceptions, seesection 475, the related regulations, and Rev.Rul. 94-7, 1994-1 C.B. 151.Note: Dealers in commodities and traders insecurities and commodities may make theelection to use the mark-to-market accounting

method. See section 475(e) and (f).Change in accounting method. Generally,the corporation may change the method ofaccounting used to report taxable income (forincome as a whole or for any material item)only by getting consent on Form 3115,Application for Change in Accounting Method.For more information, get Pub. 538,Accounting Periods and Methods.

Accounting PeriodsA corporation must figure its taxable incomeon the basis of a tax year. The tax year is theannual accounting period the corporation usesto keep its records and report its income andexpenses. Generally, corporations can use acalendar year or a fiscal year. Personal service

corporations, however, must generally use acalendar year unless they meet one of theexceptions discussed in Item OPersonalService Corporation on page 7. Special rulesapply to specified foreign corporations. SeeSpecified Foreign Corporations on page 4.

For more information about accountingperiods, see Temporary Regulations sections1.441-1T, 1.441-2T, and Pub. 538.Calendar year. If the calendar year is adoptedas the annual accounting period, thecorporation must maintain its books andrecords and report its income and expenses forthe period from January 1 through December31 of each year.

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Fiscal year. A fiscal year is 12 consecutivemonths ending on the last day of any monthexcept December. A 5253 week year is afiscal year that varies from 52 to 53 weeks.Adoption of tax year. A corporation adoptsa tax year when it files its first income taxreturn. It must adopt a tax year by the due date(not including extensions) of its first income taxreturn.Change of tax year. Generally, a corporationmust get the consent of the IRS beforechanging its tax year by filing Form 1128,Application To Adopt, Change, or Retain a TaxYear. However, under certain conditions, acorporation (other than a personal servicecorporation) may change its tax year withoutgetting the consent. See Regulations section1.442-1 and Pub. 538.

Specified Foreign Corporations

The annual accounting period of a specifiedforeign corporation is generally required to bethe tax year of its majority U.S. shareholder.For more information, see section 898.

A specified foreign corporation is any foreigncorporation:q That is treated as a controlled foreigncorporation under subpart F (sections 951through 964), or is a foreign personal holdingcompany (as defined in section 552); andq In which more than 50% of the total voting

power or value of all classes of stock of thecorporation is treated as owned by a U.S.shareholder (section 898(b)(2)).

If the specified foreign corporation made anelection under section 898(c)(1)(B) or changedits tax year to conform to the tax year requiredby section 898, see Rev. Proc. 90-26, 1990-1C.B. 512.

Any specified foreign corporation that wishesto change to any U.S. tax year (or to changeto its pre-change year), must get the consentof the IRS using the procedures of section 442and the related regulations. For more details,see Notice 95-13, 1995-1 C.B. 296.

Rounding Off to Whole DollarsThe corporation may show amounts on thereturn and accompanying schedules as wholedollars. To do so, drop amounts less than 50cents and increase amounts from 50 centsthrough 99 cents to the next higher dollar.

RecordkeepingKeep the corporation's records for as long asthey may be needed for the administration ofany provision of the Internal Revenue Code.Usually, records that support an item ofincome, deduction, or credit on the return mustbe kept for 3 years from the date the return isdue or filed, whichever is later. Keep recordsthat verify the corporation's basis in property foras long as they are needed to figure the basisof the original or replacement property.

The corporation should keep copies of allfiled returns. They help in preparing future

returns and amended returns.

Payment of Tax DueThe requirements for payment of tax dependon whether the foreign corporation has anoffice or place of business in the United States.

Foreign corporations that do not maintainan office or place of business in the UnitedStates must pay the tax due (page 1, line 8) infull when they file their tax return, but not laterthan the 15th day of the 6th month after theend of the tax year.

The tax must be paid directly to the IRS (i.e.,do not use the depository method of taxpayment described below). The tax may bepaid by check or money order, payable to theUnited States Treasury. To help ensure propercrediting, write the corporation's employeridentification number (EIN), Form 1120-F,and the tax period to which the paymentapplies on the check or money order. Enclosethe payment when the corporation files Form1120-F with the Internal Revenue ServiceCenter, Philadelphia, PA 19255.

Foreign corporations that do maintain anoffice or place of business in the United States

must pay the tax due (page 1, line 8) in fullwhen they file their tax return, but not later thanthe 15th day of the 3rd month after the end ofthe tax year.

Depository Method of Tax Payment

Electronic Deposit Requirement

The corporation must make electronic depositsof all depository tax liabilities that occur after1998 if it:q Maintains an office or place of business inthe U.S.;q Was required to electronically deposit taxesin prior years;q Deposited more than $50,000 in socialsecurity, Medicare, railroad retirement, andwithheld income taxes in 1997; orq It did not deposit social security, Medicare,railroad retirement, or withheld income taxes in1997, but it deposited more than $50,000 inother taxes under section 6302 (such as thecorporate income tax) in 1997.

See Regulations section 31.6302-1(h) formore information.

The Electronic Federal Tax Payment System(EFTPS) must be used to make electronicdeposits. If the corporation is required to makeelectronic deposits and fails to do so, it maybe subject to a 10% penalty.Note: A penalty will not be imposed prior toJuly 1, 1999, if the corporation was firstrequired to use EFTPS on or after July 1, 1997.

Corporations that are not required to makeelectronic deposits may voluntarily participate

in EFTPS. To enroll in EFTPS, call1-800-945-8400 or 1-800-555-4477. Forgeneral information about EFTPS, call1-800-829-1040.

Deposits With Form 8109

If the corporation maintains an office or placeof business in the United States and does notuse EFTPS, deposit corporate income taxpayments (and estimated tax payments) withForm 8109. Do not send deposits directly to anIRS office. Mail or deliver the completed Form8109 with the payment to a qualified depositaryfor Federal taxes or to the Federal Reservebank (FRB) servicing the corporation'sgeographic area. Make checks or moneyorders payable to that depositary or FRB. Tohelp ensure proper crediting, write thecorporation's EIN, the tax period to which thedeposit applies, and Form 1120-F on thecheck or money order. Be sure to darken the1120 box on the coupon. Records of thesedeposits will be sent to the IRS.

A penalty may be imposed if the depositsare mailed or delivered to an IRS office ratherthan to an authorized depositary or FRB.

For more information on deposits, see theinstructions in the coupon booklet (Form 8109)and Pub. 583, Starting a Business andKeeping Records.Caution: If the corporation owes tax when itfiles Form 1120-F, do not include the paymentwith the tax return. Instead, mail or deliver the

payment with Form 8109 to a qualifieddepositary or FRB or use EFTPS, if applicable.

Estimated Tax PaymentsGenerally, the following rules apply to a foreigncorporation's payments of estimated tax.q The corporation must make installmentpayments of estimated tax if it expects itsestimated tax to be $500 or more.q The installments are due by the 15th day ofthe 4th, 6th, 9th, and 12th months of the taxyear. If any date falls on a Saturday, Sunday,or legal holiday, the installment is due on the

next regular business day.q Use Form 1120-W, Estimated Tax forCorporations, as a worksheet to computeestimated tax.q If the foreign corporation maintains an officeor place of business in the United States, anddoes not use EFTPS, use the deposit coupons(Forms 8109) to make deposits of estimatedtax.

For more information on estimated taxpayments, including penalties that apply if thecorporation fails to make required payments,see Line 7. Estimated Tax Penalty on page6.Overpaid estimated tax. If the corporationoverpaid estimated tax, it may be able to get aquick refund by filing Form 4466, CorporationApplication for Quick Refund of Overpaymentof Estimated Tax. The overpayment must beat least 10% of the corporation's expectedincome tax liability and at least $500. File Form4466 before the 16th day of the 3rd month afterthe end of the tax year, but before thecorporation files its income tax return. Do notfile Form 4466 before the end of thecorporation's tax year.

Interest and PenaltiesInterest. Interest is charged on taxes paid late,even if an extension of time to file is granted.Interest is also charged on penalties imposedfor failure to file, negligence, fraud, grossvaluation overstatements, and substantialunderstatements of tax from the due date(including extensions) to the date of payment.

The interest charge is figured at a ratedetermined under section 6621.Penalty for late filing of return. A corporationthat does not file its tax return by the due date,including extensions, may be penalized 5% ofthe unpaid tax for each month or part of amonth the return is late, up to a maximum of25% of the unpaid tax. The minimum penaltyfor a return that is over 60 days late is thesmaller of the tax due or $100. The penalty willnot be imposed if the corporation can show thatthe failure to file on time was due to reasonablecause. Corporations that file late must attacha statement explaining the reasonable cause.Penalty for late payment of tax. Acorporation that does not pay the tax when duemay be penalized 1/2 of 1% of the unpaid tax foreach month or part of a month the tax is not

paid, up to a maximum of 25% of the unpaidtax. The penalty will not be imposed if thecorporation can show that the failure to pay ontime was due to reasonable cause.Trust fund recovery penalty. This penaltymay apply if certain excise, income, socialsecurity, and Medicare taxes that must becollected or withheld are not collected orwithheld, or these taxes are not paid. Thesetaxes are generally reported on Forms 720,941, 943, or 945. (See Other Forms, Returns,Schedules, and Statements That May beRequired on page 2.) The trust fund recoverypenalty may be imposed on all persons whoare determined by the IRS to have beenresponsible for collecting, accounting for, and

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paying over these taxes, and who acted willfullyin not doing so. The penalty is equal to theunpaid trust fund tax. See the instructions forForm 720, Pub. 15 (Circular E), Employer'sTax Guide, or Pub. 51 (Circular A), AgriculturalEmployer's Tax Guide, for details, including thedefinition of responsible persons.Other penalties. Other penalties can beimposed for negligence, substantialunderstatement of tax, and fraud. See sections6662 and 6663.

Claim for Refund or Credit

If a foreign corporation has only income that isnot effectively connected with the conduct of aU.S. trade or business and Form 1120-F isbeing used as a claim for refund or credit of taxpaid or withheld at source, attach Form(s)1042-S, 8805, 8288-A, etc., to the return toverify the amount(s) of withholding creditreported. Include all income from U.S. sourceson the return, even though all tax due on it waspaid or withheld at source.

If the refund results from tax that waswithheld at source, a statement from thepayer/withholding agent (or from anintermediate nominee acting on thecorporation's behalf as the foreign recipient ofthe income) may be substituted for Form1042-S. The statement should show:q The amount(s) of tax withheld;q The name(s) and address(es) of the U.S.withholding agent(s);q The U.S. tax identification number of the U.S.withholding agent;q The name in which the tax was withheld, ifdifferent from the name of the taxpayerclaiming the refund or credit; andq If applicable, enough information to show thatthe taxpayer was entitled to a reduced tax rateunder a treaty.

Special Rules for ForeignCorporations

Source Of Income Rules

The source of income is important indetermining the extent to which income istaxable to foreign corporations. Each type ofincome has its own sourcing rules.

Interest Income

The source of interest income is usuallydetermined by the residence of the obligor.

Example. Interest paid by an obligor who isa resident of the United States is U.S. sourceincome, and interest paid by an obligor who isa resident of a country other than the UnitedStates is foreign source income.Exceptions. The following types of interestincome are treated as foreign source income:q Interest income received from foreignbranches of U.S. banks and savings and loanassociations.

q Interest income received from a U.S.corporation or a resident alien individual, if 80%or more of the U.S. corporation's (or residentalien individual's) gross income is active foreignbusiness income during the testing period.

Active foreign business income is incomefrom sources outside the United Statesattributable to the active conduct of a trade orbusiness in a foreign country or U.S.possession.

The testing period is generally the 3 taxyears of the U.S. corporation or resident alienindividual preceding the tax year during whichthe interest is paid. If the payer existed forfewer than 3 years before the tax year of the

payment, the testing period is the term of thepayer's existence before the current year. If thepayment is made during the payer's first taxyear, that year is the testing period.q The interest allowable as a deduction to aforeign corporation (under Regulations section1.882-5) in figuring its effectively connectedtaxable income is treated as paid by a domesticcorporation. This interest is treated as U.S.source interest, although the actual payer ofthe interest is a foreign corporation. For moredetails, see Part IITax on Excess Intereston page 16.Look-thru rule. If the foreign corporation is arelated person to a U.S. corporation orresident alien individual that meets the 80%rule described above, the foreign corporationwill have foreign source income only when theincome of the payer was from foreign sources.See section 861(c)(2)(B) for more information.

Dividend Income

The source of dividend income is usuallydetermined by the payer.Example. Dividends paid by a corporation thatwas incorporated in the United States are U.S.source income; and dividends paid by acorporation that was incorporated in a foreigncountry are foreign source income.Exceptions. Dividends paid by a U.S.corporation are foreign source income:q

If the U.S. corporation has made a validelection under section 936 (or section 30A),relating to certain U.S. corporations operatingin a U.S. possession, orq To the extent the dividends are from qualifiedexport receipts described in section 993(a)(1)(other than interest and gains described insection 995(b)(1)).

Dividends paid by a foreign corporation areU.S. source income:q If the dividend is treated under section 243(e)as a distribution from the accumulated profitsof a predecessor U.S. corporation; orq To the extent the foreign corporation'seffectively connected gross income for thetesting period (defined below) bears to all of theforeign corporation's gross income for thetesting period, but only if 25% or more of the

foreign corporation's gross income during thetesting period was effectively connected withthe conduct of a U.S. trade or business.

The testing period is generally the 3 taxyears of the foreign corporation payerpreceding the tax year during which it declaredthe dividend. If the foreign corporation existedfor fewer than 3 years before the tax year ofdeclaration, the testing period is the term of theforeign corporation's existence before thecurrent year. If the foreign corporation declaredthe dividend in its first tax year, that year is thetesting period. Regardless of source, however,there is no tax imposed on any dividends paidby a foreign corporation out of earnings andprofits for a tax year in which the foreigncorporation was subject to the branch profitstax (determined after application of any income

tax treaty).Rent and Royalty Income

The source of rent and royalty income for theuse of property is determined based on wherethe property is located.

Income From the Sale or Exchange of RealEstate

The source of this income is determined basedon where the property is located.

Income From the Sale or Exchange ofPersonal Property

Income from the sale of personal property bya foreign corporation is sourced as follows:

q Income from the purchase and sale ofinventory property is generally sourced undersections 861(a)(6) and 862(a)(6);q Income from the production and sale ofinventory property is generally sourced undersection 863(b)(2);q Income from the sale of depreciable propertyis generally sourced under section 865(c); andq Income from the sale of intangibles isgenerally sourced under section 865(d).Foreign corporations with an office or fixedplace of business in the United States.Income from the sale of personal property

attributable to such office or fixed place ofbusiness is U.S. source income regardless ofany of the above rules relating to the sourceof income from the sale or exchange ofpersonal property unless the foreigncorporation is an export trade corporation (seesections 865(e)(2)(A) and 971).Exception. Income from the sale of inventoryproperty is foreign source income if the goodswere sold for use, disposition, or consumptionoutside the United States and a foreign officeof the corporation materially participated in thesale.

Other Special Rules

Basis of Property and Inventory Costs forProperty Imported by a Related Person

If property is imported into the United Statesby a related person in a transaction and theproperty has a customs value, the basis orinventory cost to the importer cannot exceedthe customs value. For more information, seesection 1059A.

Income of Foreign Governments andInternational Organizations

Income of foreign governments andinternational organizations from the followingsources is generally not subject to taxation:q Investments in the United States in stocks,bonds, or other domestic securities owned bysuch foreign government or internationalorganization.q Interest on deposits in banks in the UnitedStates of money belonging to such foreign

government or international organization.q Investments in the United States in financialinstruments held (by a foreign government) inexecuting governmental financial or monetarypolicy.Note: The income described in section892(a)(2) that is received directly or indirectlyfrom commercial activitiesis subject to tax. (Itis also subject to withholding.)

Specific Instructions

Period CoveredFile the 1998 return for calendar year 1998 andfiscal years that begin in 1998 and end in 1999.

For a fiscal year, fill in the tax year space at thetop of the form.Note: The 1998 Form 1120-F may also beused if:q The corporation has a tax year of less than12 months that begins and ends in 1999, andq The 1999 Form 1120-F is not yet availableat the time the corporation is required to file itsreturn.The corporation must show its 1999 tax yearon the 1998 Form 1120-F and incorporate anytax law changes that are effective for tax yearsbeginning after December 31, 1998.

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AddressInclude the suite, room, or other unit numberafter the street address. If a preaddressed labelis used, include this information on the label. Ifthe Post Office does not deliver mail to thestreet address and the corporation has a P.O.box, show the box number instead of the streetaddress.

If a foreign address, enter the informationin the following order: city, province or state,and country. Follow the country's practice forentering the postal Code. Please do notabbreviate the country's name.

If the corporation's address has changedfrom the last time Form 1120-F was filed, checkthe box at the top of page 1.Note: If a change in address occurs after thereturn is filed, useForm 8822, Change ofAddress, to notify the IRS of the new address.

Employer Identification Number(EIN)Show the corporation's correct EIN. If thecorporation does not have an EIN, it shouldapply for one on Form SS-4, Application forEmployer Identification Number. Form SS-4can be obtained at Social SecurityAdministration (SSA) offices or by calling1-800-TAX-FORM. If the corporation has notreceived its EIN by the time the return is due,

write Applied for in the space for the EIN. SeePub. 583 for details.

Computation of Tax Due orOverpayment

Line 4. Personal Holding Company Tax

If the corporation is a personal holdingcompany (as defined in section 542) but not aforeign personal holding company, it must fileSchedule PH (Form 1120) with Form 1120-Fand report the personal holding company taxon line 4. See section 542 and Schedule PH(Form 1120) for details.

Line 6b. Estimated Tax Payments

Enter any estimated tax payments thecorporation made for the tax year.Beneficiaries of trusts. If the corporation isthe beneficiary of a trust, and the trust makesa section 643(g) election to credit its estimatedtax payments to its beneficiaries, include thecorporation's share of the payment in the totalfor line 6b. Write T and the amount on thedotted line next to the entry space.

Line 6f. Credit for Tax Paid onUndistributed Capital Gains

Enter the credit (from Form 2439, Notice toShareholder of Undistributed Long-TermCapital Gains) for the corporation's share of thetax paid by a regulated investment companyor a real estate investment trust onundistributed long-term capital gains included

in the corporation's income. Attach Form 2439to Form 1120-F.

Line 6g. Credit for Federal Tax onFuels

Complete Form 4136 if the corporation qualifiesto take this credit.Credit for ozone-depleting chemicals.Include on line 6g any credit the corporation isclaiming under section 4682(g)(2) for tax paidon ozone-depleting chemicals. Write ODC onthe dotted line to the left of the entry space.

Line 6i. Total Payments

Backup withholding. If the corporation hadincome tax withheld from any payments itreceived, because, for example, it failed to givethe payer its correct EIN, include the amountwithheld in the total for line 6i. This type ofwithholding is called backup withholding. Showthe amount withheld in the blank space in theright-hand column between lines 5 and 6i, andwrite backup withholding.

Line 7. Estimated Tax Penalty

A corporation that does not make estimated tax

payments when due may be subject to anunderpayment penalty for the period ofunderpayment. Generally, a corporation issubject to the penalty if its tax liability is $500or more, and it did not timely pay the smallerof:q 100% of its tax liability for 1998, orq 100% of its prior year's tax.See section 6655 for details and exceptions,including special rules for large corporations.

Use Form 2220, Underpayment ofEstimated Tax by Corporations, to see if thecorporation owes a penalty and to figure theamount of the penalty. Generally, thecorporation does not have to file this formbecause the IRS can figure any penalty andbill the corporation for it. However, even if thecorporation does not owe the penalty, complete

and attach Form 2220 if:q The annualized income or adjusted seasonalinstallment method is used; orq The corporation is a large corporationcomputing its first required installment basedon the prior year's tax. (See the Form 2220instructions for the definition of a largecorporation.)

If you attach Form 2220, check the box online 7 of Form 1120-F and enter any penaltyon this line.

Section I.Certain Gains,Profits, and Income From U.S.Sources That Are NOT

Effectively Connected With theConduct of a Trade or Businessin the United StatesInclude in Section I amounts received by theforeign corporation that meet all of thefollowing conditions:q The amount received is fixed ordeterminable, annual or periodic (FDAP). Seeexamples below.q The amount received is includible in thegross income of the foreign corporation.q The amount received is from U.S. sources(see Source of Income Rules on page 5).q The amount received is not effectivelyconnected with the conduct of a U.S. trade orbusiness. See Section II on page 7.q The amount received is not exempt from

taxation.For more information, see section 881(a)

and Regulations section 1.881-2.Amounts fixed or determinable, annual

or periodic include:1. Interest (other than original issue

discount (OID) as defined in section 1273),dividends, rents, royalties, salaries, wages,premiums, annuities, compensation, and otherFDAP gains, profits, and income.

2. Gains described in section 631(b) or (c),relating to disposal of timber, coal, or domesticiron ore with a retained economic interest.

3. On a sale or exchange of an OIDobligation, the amount of the OID accruing

while the obligation was held by the foreigncorporation, unless this amount was taken intoaccount on a payment.

4. On a payment received on an OIDobligation, the amount of the OID accruingwhile the obligation was held by the foreigncorporation, if such OID was not previouslytaken into account and if the tax imposed onthe OID does not exceed the payment receivedless the tax imposed on any interest includedin the payment received. This rule applies topayments received for OID obligations issuedafter March 31, 1972.

5. Gains from the sale or exchange ofpatents, copyrights, and other intangibleproperty if the gains are from payments that arecontingent on the productivity, use, ordisposition of the property or interest sold orexchanged.

For rules that apply to other OID obligations,see Pub. 515, Withholding of Tax onNonresident Aliens and Foreign Corporations.Note: Certain portfolio interest and OID arenot taxable for obligations issued after July 18,1984. See section 881(c) for more details.

Important: For purposes of determiningwhether its income is taxable under section881(a), a corporation created or organized inGuam, American Samoa, the Northern MarianaIslands, or the U.S. Virgin Islands will not betreated as a foreign corporation if it meets the

rules of section 881(b).Line 9. Gross Transportation Income

A 4% tax is imposed on a foreign corporation'sU.S. source gross transportation income for thetax year. U.S. source gross transportationincome generally is any gross income that istransportation income if such income is treatedas from U.S. sources.

Transportation income is any income fromor connected with:q The use (or hiring or leasing for use) of avessel or aircraft, orq The performance of services directly relatedto the use of a vessel or aircraft. (The termvessel or aircraft includes any container usedin connection with a vessel or aircraft.)

Generally, 50% of all transportation income

that is attributable to transportation that eitherbegins or ends in the United States is treatedas from U.S. sources. See section 863(c)(2)(B)for a special rule for personal service income.

U.S. source gross transportation incomedoes not include income that is:q Effectively connected with the conduct of aU.S. trade or business, orq Taxable in a possession of the United Statesunder the provisions of the Internal RevenueCode as applied to that possession.

Transportation income of the corporation willnot be treated as effectively connected incomeunless:q The corporation has a fixed place of businessin the United States involved in the earning oftransportation income, andq Substantially all of the corporation's U.S.source gross transportation income(determined without regard to the rule that suchincome does not include effectively connectedincome) is attributable to regularly scheduledtransportation (or, in the case of income fromthe leasing of a vessel or aircraft, is attributableto a fixed place of business in the UnitedStates).For more information, see section 887.

Enter the foreign corporation's U.S. sourcegross transportation income on line 9, column(b). Also, attach a statement showing the datesthe vessels or aircraft entered or left the UnitedStates and the amount of gross income foreach trip.

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Additional Information RequiredBe sure to complete all items on page 2 thatapply to the corporation.

Item OPersonal Service Corporation

A personal service corporation is a corporationwhose principal activity for the testing period(defined below) for the tax year is theperformance of personal services. The servicesmust be substantially performed byemployee-owners. Employee-owners must own

more than 10% of the fair market value of thecorporation's outstanding stock on the last dayof the testing period.Testing period. Generally, the testing periodfor a tax year is the prior tax year. The testingperiod for a new corporation starts with the firstday of its first tax year and ends on the earlierof:q The last day of its first tax year, orq The last day of the calendar year in which thefirst tax year began.Principal activity. The principal activity of acorporation is considered to be theperformance of personal services if, during thetesting period, the corporation's compensationcosts for the performance of personal services(defined below), are more than 50% of its totalcompensation costs.

Performance of personal services. Personalservices are those performed in the health, law,engineering, architecture, accounting, actuarialscience, performing arts, or consulting fields(as defined in Temporary Regulations section1.448-1T(e)). The term performance ofpersonal services includes any activityinvolving the performance of personal servicesin these fields.Substantial performance byemployee-owners. Personal services aresubstantially performed by employee-owners if,for the testing period, more than 20% of thecorporation's compensation cost for theperformance of personal services are forservices performed by employee-owners.Employee-owner. A person is considered tobe an employee-owner if the person:q Is an employee of the corporation on any dayof the testing period, andq Owns any outstanding stock of thecorporation on any day of the testing period.

Stock ownership is determined under theattribution rules of section 318 (except thatany is substituted for 50% in section318(a)(2)(C)).Accounting period. A personal servicecorporation must use a calendar tax yearunless:q It can establish a business purpose for adifferent tax year (see Rev. Proc. 87-32,1987-2 C.B. 396, and Rev. Rul 87-57, 1987-2C.B. 117), orq It elects under section 444 to have a tax yearother than a calendar year. To make theelection, get Form 8716, Election To Have aTax Year Other Than a Required Tax Year.

Personal service corporations that want tochange their tax year must also file Form 1128.

If a corporation makes the section 444election, its deduction for certain amounts paidto employee-owners may be limited. GetSchedule H (Form 1120), Section 280HLimitations for a Personal Service Corporation(PSC) to figure the maximum deduction.

If a section 444 election is terminated andthe termination results in a short tax year, typeor print at the top of the first page of Form1120F for the short tax year, SECTION 444ELECTION TERMINATED. See TemporaryRegulations section 1.444-1T(a)(5) for moreinformation.

For more information about personal servicecorporations, see Temporary Regulationssection 1.441-4T.Other rules. For other rules that apply topersonal service corporations, see Passiveactivity limitations on page 9 andContributions of property other than cashon page 10.

Item P

Show any tax-exempt interest received oraccrued. Include any exempt-interest dividendsreceived as a shareholder in a mutual fund orother regulated investment company.

Item R

Check this box if the corporation elects undersection 172(b)(3) to forego the carrybackperiod for a net operating loss (NOL). If this boxis checked, do not attach the statementdescribed in Temporary Regulations section301.9100-12T(d).

Item S

Enter the amount of the NOL carryover to thetax year from prior years, even if some of theloss is used to offset income on this return. Theamount to enter is the total of all NOLsgenerated in prior years but not used to offsetincome (either as a carryback or carryover) ina tax year prior to 1998. Do not reduce theamount by any NOL deduction reported onpage 3, Section II, line 30a.

Pub. 536, Net Operating Losses, has aworksheet for figuring a corporation's NOLcarryover.

Item T

Check the Yes box if the corporation is asubsidiary in a parent-subsidiary controlledgroup. The Yes box must be checked even ifthe corporation is a subsidiary member of onegroup and the parent corporation of another.Note: If the corporation is an excludedmember of a controlled group (see section1563(b)(2)), it is still considered a member ofa controlled group for this purpose.

A parent-subsidiary controlled group isone or more chains of corporations connectedthrough stock ownership (section 1563(a)(1)).Both of the following requirements must bemet:

1. 80% of the total combined voting powerof all classes of stock entitled to vote or at least80% of the total value of all classes of stockof each corporation in the group (except theparent) must be owned by one or more of theother corporations in the group.

2. The common parent must own at least80% of the total combined voting power of allclasses of stock entitled to vote or at least 80%of the total value of all classes of stock of atleast one of the other corporations in the group.Stock owned directly by other members of thegroup is not counted when computing thevoting power or value.

See section 1563(d)(1) for the definition ofstock for purposes of determining the stockownership above.

Section II.Income EffectivelyConnected With the Conduct ofa Trade or Business in theUnited States

Foreign Corporations Engaged in aU.S. Trade or Business

These corporations are taxed on theireffectively connected income using the samegraduated tax rate schedule (see page 14) that

applies to domestic corporations. Effectivelyconnected income can be U.S. source orforeign source.

U.S. Source Effectively Connected Income

Fixed or determinable, annual or periodic(FDAP) items are generally effectivelyconnected income (and are therefore includiblein Section II) if one or both of the following testsis met.Asset-use test. The FDAP items are fromassets used in, or held for use in, the conductof U.S. trade or business. For example, thefollowing items are effectively connectedincome:q Income earned on a trade or note receivableacquired in the conduct of the U.S. trade orbusiness.

q Interest income earned from the temporaryinvestment of funds needed in the foreigncorporation's U.S. trade or business.Business-activities test. The activities of theU.S. trade or business were a material factorin the realization of the FDAP items.

If neither test is met, FDAP items aregenerally not effectively connected income(and are therefore includible in Section Iinstead of Section II).

For more information, see section 864(c)(2)and the examples in Regulations section1.864-4(c).

U.S. source income other than FDAP itemsis effectively connected income.

Foreign Source Effectively ConnectedIncome

Foreign source income is generally noteffectively connected income. However, if theforeign corporation has an office or other fixedplace of business in the United States, thefollowing types of foreign source income itreceives from that U.S. office are effectivelyconnected income:q Rents or royalties received for the useoutside the United States of intangible personalproperty described in section 862(a)(4) if fromthe active conduct of a U.S. trade or business;q Dividends or interest from foreign sources iffrom the active conduct of a U.S. banking,financing, or similar business, OR if theprincipal business of the foreign corporation istrading in stocks or securities for its ownaccount; orq Income from the sale or exchange ofinventory outside the United States through theU.S. office, unless the property is sold orexchanged for use, consumption, or dispositionoutside the United States and an office of theforeign corporation in a foreign countrymaterially participated in the sale.

See section 864(c)(5)(A) and Regulationssection 1.864-7 for definition of office or otherfixed place of business in the United States.See sections 864(c)(5)(B) and (C) andRegulations section 1.864-6 for special rulesfor determining when foreign source incomereceived by a foreign corporation is from anoffice or other fixed place of business in theUnited States.

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Foreign insurance companies. Foreignsource income of a foreign insurance companythat is attributable to its U.S. trade or businessis effectively connected income.Exceptions. Foreign source income thatwould otherwise be effectively connectedincome under any of the above rules for foreignsource income is excluded if:q It is foreign source dividends, interest, orroyalties paid by a foreign corporation in whichthe taxpayer owns or is considered to own(within the meaning of section 958) 50% ormore of the total combined voting power of allclasses of stock entitled to vote; orq The taxpayer is a controlled foreigncorporation (as defined in section 957) and theforeign source income is subpart F income (asdefined in section 952).

For more information, see section 864(c)(4)and Regulations section 1.864-5.

Foreign Corporations NOT Engaged ina U.S. Trade or Business

Report income in Section II only if thesecorporations:q Had current year income or gain from a saleor exchange of property or from performingservices (or any other transaction) in any othertax year and would have been effectivelyconnected income in that other tax year (seesection 864(c)(6));

q Had current year income or gain from adisposition of property that is no longer usedor held for use in conducting a U.S. trade orbusiness within the 10-year period before thedisposition and would have been effectivelyconnected income immediately before suchcessation (see section 864(c)(7));q Elected to treat real property income aseffectively connected income (see below);q Were created or organized and areconducting a banking business in a U.S.possession, and receive interest on U.S.obligations that is not portfolio interest (seesection 882(e)); orq Had gain or loss from disposing of a U.S. realproperty interest (see below).

Election to Treat Real Property Income

as Effectively Connected IncomeA foreign corporation that receives, during thetax year, any income from real property locatedin the United States, or from any interest insuch real property, may elect, for the tax year,to treat all such income as effectivelyconnected income. Income to which thiselection applies includes:q Gains from the sale or exchange of realproperty or an interest therein;q Rents or royalties from mines, wells, or othernatural deposits; andq Gain described in sections 631(b) or (c).

The election may be made whether or notthe corporation is engaged in a U.S. trade orbusiness during the tax year for which theelection is made or whether or not the

corporation has income from real property that,for the tax year, is effectively connected withthe conduct of a U.S. trade or business.

To make the election:q Figure the tax on this income in Section II.q Attach a statement that includes theinformation required in Regulations section1.871-10(d)(1)(ii) to Form 1120-F for the firsttax year for which the election is to apply.

Disposition of U.S. Real PropertyInterest by a Foreign Corporation

A foreign corporation that disposes of a U.S.real property interest (as defined in section897(c)) must treat the gain or loss from the

disposition as effectively connected income,even if the corporation is not engaged in a U.S.trade or business. Figure this gain or loss onSchedule D (Form 1120), Capital Gains andLosses. Carry the result to Section II, line 8,on page 3 of Form 1120-F.

A foreign corporation may elect to betreated as a domestic corporation for purposesof sections 897 and 1445. See sections 897(i)and 882(d).

See Temporary Regulations section1.897-5T for the applicability of section 897 toreorganizations and liquidations.

If the corporation had income tax withheldon Form 8288-A, Statement of Withholding onDispositions by Foreign Persons of U.S. RealProperty Interests, include the amount withheldin line 6h, page 1.

Income

Line 1. Gross Receipts

Enter gross income effectively connected withthe conduct of a U.S. trade or business (exceptthose income items that must be reported onlines 4 through 10). For reporting advancepayments, see Regulations section 1.451-5. Toreport income from long-term contracts, seesection 460.Installment sales. Generally, the installmentmethod cannot be used for dealer dispositions

of property. A dealer disposition means anydisposition of personal property by a personwho regularly sells or otherwise disposes ofproperty of the same type on the installmentplan. The disposition of property used orproduced in the farming business is notincluded as a dealer disposition. See section453(l) for details and exceptions.

Enter on line 1 (and carry to line 3) the grossprofit on collections from installment sales forany of the following:q Dealer dispositions of property before March1, 1986.q Dispositions of property used or produced inthe trade or business of farming.q Certain dispositions of timeshares andresidential lots reported under the installmentmethod.

Attach a schedule showing the followinginformation for the current and the 3 precedingyears: (a) gross sales, (b) cost of goods sold,(c) gross profits, (d) percentage of gross profitsto gross sales, (e) amount collected, and(f) gross profit on the amount collected.

For sales of timeshares and residential lotsreported under the installment method, thecorporation's income tax is increased by theinterest payable under section 453(l)(3). Toreport this addition to the tax, see theinstructions for Schedule J, line 11 on page 15.Non-accrual experience method. Accrualbasis taxpayers do not need to accrue certainamounts to be received from performingservices that, on the basis of their experience,will not be collected (section 448(d)(5)). Thisprovision does not apply to any amount if

interest is required to be paid on that amountor if there is any penalty for failure to timely paythat amount. Corporations that fall under thisprovision should attach a schedule showingtotal gross receipts, the amount not accruedas a result of the application of section448(d)(5), and the net amount accrued. Enterthe net amount on line 1a. For moreinformation and guidelines on this non-accrualexperience method, see TemporaryRegulations section 1.448-2T.

Line 2. Cost of Goods Sold

See the instructions for Schedule A on page12.

Line 4. Dividends

See instructions for Schedule C beginning onpage 12.

Line 5. Interest

Enter taxable interest on U.S. obligations andon loans, notes, mortgages, bonds, bankdeposits, corporate bonds, tax refunds, etc.

Do not offset interest expense againstinterest income.

Line 6. Gross Rents

Enter the gross amount received for the rent

of property. Deduct expenses such as repairs,interest, taxes, and depreciation on the properlines for deductions. A rental activity held by aclosely held corporation or a personal servicecorporation may be subject to the passiveactivity loss rules. See Form 8810 and itsinstructions.

Line 8. Capital Gain Net Income

Every sale or exchange of a capital asset mustbe reported in detail on Schedule D (Form1120), Capital Gains and Losses, even thoughno gain or loss is indicated. In computing theadjustments to the accumulated earnings taxunder section 535(b)(6), foreign corporationsmust only include capital gains and losses thatare effectively connected with a U.S. trade orbusiness.

Line 10. Other IncomeEnter any other taxable income not reportedon lines 1 through 9. List the type and amountof income on an attached schedule. If thecorporation has only one item of other income,describe it in parentheses on line 10. Examplesof other income to report on line 10 are:q Any adjustment under section 481(a)required to be included in income during thecurrent tax year due to a change in a methodof accounting.q Recoveries of bad debts deducted in prioryears under the specific charge-off method.q The credit for alcohol used as fuel(determined regardless of the limitation basedon tax) that was entered on Form 6478, Creditfor Alcohol Used as Fuel.

q Refunds of taxes deducted in prior years ifthey reduced income subject to tax in the yeardeducted (see section 111). Do not offsetcurrent year taxes against tax refunds.q The amount of any deduction previouslytaken under section 179A that is subject torecapture. The corporation must recapture thebenefit of any allowable deduction forclean-fuel vehicle property (or clean-fuelvehicle refueling property), if the property laterceases to qualify. See Regulations section1.179A-1 for details.q Ordinary income from trade or businessactivities of a partnership (from Schedule K-1(Form 1065), line 1).

Deductions

Important. In computing the taxable incomeof a foreign corporation engaged in a U.S.trade or business, deductions are allowed onlyif they are connected with income effectivelyconnected with the conduct of a trade orbusiness in the United States. Charitablecontributions, however, may be deductedwhether or not they are so connected. Seesection 882(c) and Regulations section1.882-4(b) for more information.

Apportionment of Expenses

Expenses that are directly related to a class ofgross income (including tax-exempt income)must be allocated to that class of gross income.Expenses not directly related to a class of

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gross income should be allocated to all classesof income based on the ratio of gross incomein each class of income to total gross income,or some other ratio that clearly relates to theclasses of income. See Regulations section1.861-8 and Temporary Regulations section1.861-8T for more information.

Attach a schedule showing each class ofgross income, and the expenses directlyallocable to each class. For expenses that arenot directly allocable to a class of grossincome, show the computation of the expenseallocated to each class.

Limitations on DeductionsSection 263A uniform capitalization rules.The uniform capitalization rules of section 263Arequire corporations to capitalize or include ininventory certain costs incurred in connectionwith:q The production of real and tangible personalproperty held in inventory or held for sale in theordinary course of business.q Personal property (tangible and intangible)acquired for resale.q The production of property constructed orimproved by a corporation for use in its tradeor business or in an activity engaged in forprofit.

Tangible personal property produced by acorporation includes a film, sound recording,

video tape, book, or similar property.Corporations subject to these rules arerequired to capitalize not only direct costs butan allocable portion of most indirect costs(including taxes) that benefit the assetsproduced or acquired for resale. SeeRegulations section 1.263A-1(e) for indirectexpenses that must be capitalized and thosethat may be currently deductible.

Interest expense paid or incurred duringthe production period must be capitalized andis governed by special rules. For moreinformation, see Regulations sections 1.263A-8through 1.263A-15.

The costs required to be capitalized undersection 263A are not deductible until theproperty to which the costs relate is sold, used,or otherwise disposed of by the corporation.

Exceptions. Section 263A does not apply to:q Personal property acquired for resale if thecorporation's annual average gross receipts forthe 3 prior tax years are $10 million or less;q Timber;q Most property produced under a long-termcontract;q Certain property produced in a farmingbusiness;q Research and experimental costs undersection 174;q Intangible drilling costs for oil, gas, andgeothermal property;q Mining exploration and developmental costs.

For more details on the uniformcapitalization rules, see Regulations sections1.263A-1 through 1.263A-3.

Transactions between related taxpayers.Generally, an accrual basis taxpayer may onlydeduct business expenses and interest owedto a related party in the year the payment isincluded in the income of the related party.See sections 163(e)(3), 163(j), and 267 forlimitations on deductions for unpaid interestand expenses.Section 291 limitations. Corporations may

be required to adjust deductions for depletionof iron ore and coal, intangible drilling andexploration and development costs, certaindeductions for financial institutions, and theamortizable basis of pollution control facilities.See section 291 to determine the amount ofadjustment. Also see section 43.

Golden parachute payments. A portion ofthe payments made by a corporation to keypersonnel that exceeds their usualcompensation may not be deductible. Thisoccurs when the corporation has an agreement(golden parachute) with these key employeesto pay them these excessive amounts if controlof the corporation changes. See section 280G.Business startup expenses. Business

startup expenses must be capitalized unlessan election is made to amortize them over aperiod of 60 months. See section 195.Passive activity limitations. Limitations on

passive activity losses and credits undersection 469 apply to personal servicecorporations as defined in TemporaryRegulations section 1.441-4T (see ItemOPersonal Service Corporation on page7), and closely held corporations (definedbelow).

Generally, two kinds of passive activitiesare:q Trade or business activities in which thecorporation did not materially participate for thetax year (see Temporary Regulations section1.469-1T(g)(3)); andq Rental activities regardless of itsparticipation.

For exceptions, see Form 8810.An activity is a trade or business activity if

the activity is not a rental activity, and involves:

q The conduct of a trade or business (i.e.,deductions from the activity would be allowableunder section 162 if other limitations, such asthe passive loss rules, did not apply); orq Research and experimental costs that aredeductible under section 174 (or would bedeductible if the corporation chose to deductrather than capitalize them).

Corporations subject to the passive activitylimitations must complete Form 8810 tocompute their allowable passive activity lossand credit. Before completing Form 8810, seeTemporary Regulations section 1.163-8T,which provides rules for allocating interestexpense among activities. If a passive activityis also subject to the earnings stripping rulesof section 163(j) or the at-risk rules of section465, those rules apply before the passive loss

rules. For more information, see section 469,the related regulations, and Pub. 925, PassiveActivity and At-Risk Rules.

Closely held corporations. For thispurpose, a corporation is a closely heldcorporation if:q At any time during the last half of the tax yearmore than 50% in value of its outstanding stockis owned, directly or indirectly, by or for notmore than five individuals; andq The corporation is not a personal servicecorporation.Certain organizations are treated as

individuals for purposes of this test. (Seesection 542(a)(2).) For rules of determiningstock ownership, see section 544 (as modifiedby section 465(a)(3)).Reducing certain expenses for which

credits are allowable. For each credit listedbelow, the corporation must reduce theotherwise allowable deductions for expensesused to figure the credit by the amount of thecurrent year credit:q Work opportunity credit.q Research credit.q Enhanced oil recovery credit.q Disabled access credit.q Empowerment zone employment credit.q Indian employment credit.q Employer credit for social security andMedicare taxes paid on certain employee tips.q Orphan drug credit.

q Welfare-to-work credit.If the corporation has any of these credits,

be sure to figure each current year creditbefore figuring the deduction for expenses onwhich the credit is based.

Line 12. Compensation of Officers

Complete Schedule E if total receipts (line 1a,plus lines 4 through 10, on page 3 of Form1120-F) are $500,000 or more. Do not includecompensation claimed elsewhere on the return,such as amounts included in cost of goodssold, elective contributions to a section 401(k)cash or deferred arrangement, or amountscontributed under a salary reduction SEPagreement or a SIMPLE retirement plan(savings incentive match plan).

Include only the deductible part of officers'compensation on Schedule E. (SeeDisallowance of deduction for employeecompensation in excess of $1 millionbelow.) Complete line 1, columns (a) through(f), for all officers. The corporation determineswho is an officer under the laws whereincorporated.Disallowance of deduction for employeecompensation in excess of $1 million.Publicly held corporations may not deductcompensation to a covered employee to theextent that the compensation exceeds $1million. Generally, a covered employee is:q The chief executive officer of the corporation(or an individual acting in that capacity) as ofthe end of the tax year; orq An employee whose total compensation mustbe reported to shareholders under theSecurities Exchange Act of 1934 because theemployee is among the four highestcompensated officers for that tax year (otherthan the chief executive officer).

For this purpose, compensation does notinclude the following:q Income from certain employee trusts, annuityplans, or pensions; orq Any benefit paid to an employee that isexcluded from the employee's income.

The deduction limit does not apply to:q Commissions based on individualperformance;

q Qualified performance-based compensation;andq Income payable under a written, bindingcontract in effect on February 17, 1993.

The $1 million limit is reduced by amountsdisallowed as excess parachute paymentsunder section 280G.

For details, see section 162(m) andRegulations section 1.162-27.

Line 13. Salaries and Wages

Enter the amount of salaries and wages paidfor the tax year, reduced by any:q Work opportunity credit from Form 5884,q Empowerment zone credit from Form 8844,q Indian employment credit from Form 8845,andq

Welfare-to-work credit from Form 8861.See the instructions for these forms for moreinformation. Do not include salaries and wagesdeductible elsewhere on the return, such asamounts included in cost of goods sold,elective contributions to a section 401(k) cashor deferred arrangement, or amountscontributed under a salary reduction SEPagreement or a SIMPLE retirement plan(savings incentive match plan).Caution: If the corporation provided taxablefringe benefits to its employees, such aspersonal use of a car, do not deduct as wagesthe amount allocated for depreciation and otherexpenses claimed on lines 20 and 27.

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Line 14. Repairs and Maintenance

Enter the cost of incidental repairs andmaintenance not claimed elsewhere on thereturn, such as labor and supplies, that do notadd to the value of the property or appreciablyprolong its life. New buildings, machinery, orpermanent improvements that increase thevalue of the property are not deductible. Theymust be depreciated or amortized.

Line 15. Bad Debts

Enter the total debts that became worthless inwhole or in part during the tax year. A small

bank or thrift institution using the reservemethod of section 585 should attach aschedule showing how it arrived at the currentyear's provision.Caution: A cash basis taxpayer may not claima bad debt deduction unless the amount waspreviously included in income.

Line 16. Rents

If the corporation rented or leased a vehicle,enter the total annual rent or lease expensepaid or incurred during the year. Also completePart V of Form 4562, Depreciation andAmortization. If the corporation leased avehicle for a term of 30 days or more, thededuction for vehicle lease expense may haveto be reduced by an amount called theinclusion amount. The corporation may havean inclusion amount if:

If the lease term began before January 1,1994, or the corporation leased an electricvehicle, get Pub. 463, Travel, Entertainment,Gift, and Car Expenses, to find out if thecorporation has an inclusion amount. Also seePub. 463 for instructions on figuring theinclusion amount.

Line 17. Taxes and Licenses

Enter taxes paid or accrued during the tax year,but do not include the following:q Federal income taxes.q Foreign or U.S. possession income taxes ifa tax credit is claimed.q Taxes not imposed on the corporation.q Taxes, including state or local sales taxes,that are paid or incurred in acquiring ordisposing of property (these taxes must betreated as a part of the cost of the acquiredproperty or, in the case of a disposition, as areduction in the amount realized on thedisposition).q Taxes assessed against local benefits thatincrease the value of the property assessed(such as for paving, etc.).q Taxes deducted elsewhere on the return,such as those reflected in cost of goods sold.

See section 164(d) for apportionment of

taxes on real property between seller andpurchaser.See section 906(b)(1) for rules concerning

certain foreign taxes imposed on income fromU.S. sources that may not be deducted orcredited.

Line 18. Interest

Important: In determining the amount ofinterest expense disallowed under section 265or 163(j), deferred under section 163(e) or267(a)(3), or capitalized under section 263Afrom a U.S. trade or business, take intoaccount only the amount of interest expense

allocable to effectively connected income underRegulations section 1.882-5.

Also, the deduction for interest is limitedwhen the corporation is a policyholder orbeneficiary with respect to a life insurance,endowment, or annuity contract issued afterJune 8, 1997. For details, see section 264(f).Attach a schedule showing the computation ofthe deduction.

All foreign corporations (includingcorporations that are residents of countries withwhich the U.S. has an income tax treaty) mustuse the 3-step process described inRegulations 1.882-5 to allocate interest. Inaddition, all corporations must attach aschedule showing how the deduction wasdetermined, using the exclusive rules outlinedin the regulations.

The interest expense allocable to effectivelyconnected income is the sum of:q The interest paid or accrued by the foreigncorporation on its liabilities booked in the U.S.,adjusted under the 3-step process described inRegulations section 1.882-5; andq Any interest directly allocated to income froman asset (see Regulations section1.882-5(a)(1)(ii)).

In determining the amount of interestexpense allocable to effectively connectedincome (Step 3 of the process), the corporationmay use either:q

The adjusted booked liabilities method(Regulations section 1.882-5(d)), orq The separate currency pools method(Regulations section 1.882-5(e)).

Generally, once a method is elected, it mustbe used for a consecutive 5- year period.Indicate the method used.

If the separate currency pool method isused, attach a schedule showing the following:

1. The currency denomination of eachcurrency pool in which U.S. assets aredenominated;

2. The amount of U.S.-connected liabilitiesin each currency pool; and

3. The average rate of interest paid onliabilities by all branches and offices of theforeign corporation world-wide in each currencypool. The corporation may convert any

currency pool in which it holds less than 3% ofits U.S. assets for the year in U.S. dollars, andapply the U.S. dollar interest rate. SeeRegulations 1.882-5(e).

Line 19. Charitable Contributions

Note: This deduction is allowed for allcontributions, whether or not connected withincome that is effectively connected with theconduct of a trade or business in the UnitedStates (see section 882(c)(1)(B)).

Enter contributions or gifts actually paidwithin the tax year to or for the use of charitableand governmental organizations described insection 170(c) and any unused contributionscarried over from prior years.

Corporations on the accrual basis may electto deduct contributions paid by the 15th day ofthe 3rd month after the end of the tax year if thecontributions are authorized by the board ofdirectors during the tax year. Attach to thereturn a declaration, signed by an officer,stating that the resolution authorizing thecontributions was adopted by the board ofdirectors during the tax year. Also attach acopy of the resolution.Limitation on deduction. The total amountclaimed may not exceed 10% of taxableincome (Section II, line 31) computed withoutregard to the following:q Any deduction for contributions;q The special deductions on line 30b;

q The deduction allowed under section 249;q Any net operating loss (NOL) carryback tothe tax year under section 172; andq Any capital loss carryback to the tax yearunder section 1212(a)(1).

Charitable contributions over the 10%limitation may not be deducted for the tax yearbut may be carried over to the next 5 tax years.

Special rules apply if the corporation has anNOL carryover to the tax year. In figuring thecharitable contributions deduction for the taxyear, the 10% limit is applied using the taxableincome after the deduction for the NOL.

To figure the amount of any remaining NOLcarryover to later years, taxable income mustbe modified (see section 172(b)). To the extentthat contributions are used to reduce taxableincome for this purpose and increase an NOLcarryover, a contributions carryover is notallowed. See section 170(d)(2)(B).Substantiation requirements. Generally, nodeduction is allowed for any contribution of$250 or more unless the corporation gets awritten acknowledgment from the doneeorganization that shows the amount of cashcontributed, describes any propertycontributed, and gives a description and a goodfaith estimate of the value of any goods orservices provided in return for the contribution.The acknowledgment must be obtained by thedue date (including extensions) of the

corporation's return, or if earlier, the date thereturn is filed. Do not attach theacknowledgment to the tax return, but keep itwith the corporation's records. These rulesapply in addition to the filing requirements forForm 8283 described below.

For more information on substantiation andrecordkeeping requirements, see theregulations under section 170 and Pub. 526,Charitable Contributions.Contributions to organizations conductinglobbying activities. Contributions made to anorganization that conducts lobbying activitiesare not deductible if:q The lobbying activities relate to matters ofdirect financial interest to the donor's trade orbusiness, andq The principal purpose of the contribution was

to avoid Federal income tax by obtaining adeduction for activities that would have beennondeductible under the lobbying expenserules if conducted directly by the donor.Contributions of property other than cash.If a corporation (other than a closely held orpersonal service corporation) contributesproperty other than cash and claims over a$500 deduction for the property, it must attacha schedule to the return describing the kind ofproperty contributed and the method used todetermine its fair market value. Closely heldcorporations and personal service corporationsmust complete F

US Internal Revenue Service: i1120f--1998

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