The IRS requires the use of U.S. Generally Accepted Accounting Practices (GAAP) for the information returns that must be prepared for U.S. owned foreign corporations, foreign partnerships and even for foreign disregarded entities.

There was an extensive article in USA Today (Tuesday, Jan. 6, 2009)
about the eventual conversion from U.S. GAAP accounting to International
Financial Reporting Standards (IFRS). I strongly recommend it for
anyone who is involved in dealing with foreign subsidiaries or
controlled foreign corporations or foreign partnerships.

According to USA Today, there are 25,000 pages of standards (rules)
for U.S. GAAP compared to (only) 2,500 pages for IFRS.

And here's the insanity of it. If these information returns are not
prepared in accordance with U.S. GAAP, the returns can be deemed to be
incomplete by the IRS, and therefore not filed on time. The IRS could
then impose a late filing penalty of $10,000 per return. As far as I
know, they have never done this and I'm convinced it would be a
serious abuse of their discretion that could be overturned on appeal,
but that's what the law permits.

The American Institute of CPAs is working on a project to encourage
the IRS to accept IFRS in lieu of GAAP and to also permit a cash basis
or modified cash basis of accounting for smaller enterprises. Thus,
far the IRS has not commented on their intentions.

Meanwhile, tax preparers of information returns for foreign
corporations, partnerships or even disregarded entities are required
to somehow be familiar with 25,000 pages of rules that define U.S. GAAP
in addition to all the unique tax rules that apply to foreign entities.

But wait. There's more. 

If the financial records of a foreign entity are kept in a foreign country with different accounting rules, the tax preparer must be able to convert the foreign accounting information into U.S. GAAP.  And if (as is most likely), the books and records are kept in a foreign currency, the numbers must be converted to U.S. dollars. Then, the final step is to convert this information into a required tax accounting method by eliminating any unrealized income or deductions and by eliminating various deductions that are limited by the tax law.

And, if you are dealing with a foreign trust, the financial statements must be based on "fair market value" because the tax law presumes that the sole function of a trust is to manage investments and that the investments will consist only of publiclly traded securities. But when a foreign trust owns a controlling interest (usually 100%) of a foreign corporation or foreign partnership, the corporations and partnership must utilize GAAP accounting rather than fair market value accounting.

Why does the IRS require U.S. GAAP accounting for the information returns of foreign corporations, partnerships and disregarded entities? As far as I can determine, the focus of this rule was initially on whether a multi-national corporation with foreign subsidiaries could utilize the accounting procedures of the foreign country. Because nearly all of the U.S. multi-national companies are publicly held and are required to use U.S. GAAP by the SEC, the IRS adopted U.S. GAAP as a standard to avoid having to deal with multiple accounting procedures in different countries.

The IRS reports that in 1990 there were only about 3,000 U.S. companies with foreign operations. In 2007 there were about 63,000. And many of these are small privately held U.S. companies that don't use U.S. GAAP for their domestic accounting or the foreign entities are owned by individuals rather than by corporations. But they are still required to convert the financial information from their foreign operations into U.S. GAAP -- which forces the tax return preparer to delve into a lot of details that are not normally available in the foreign accounting system.  And a great many U.S. tax preparers who don't do any work for publicly held companies haven't had to stay up to date on GAAP rules -- which are spelled out in about 25,000 pages of instructions.

Be Prepared For Much Higher Accounting Fees

A small business in the U.S. doesn't have to deal with U.S. GAAP.  In many cases, a small corporation in the U.S. can use a cash receipts method of accounting with some modifications to comply with various tax rules.

But if that same corporation is moved overseas, the accounting costs could easily be three to five times as much. First, the time required to convert the records from the foreign accounting system into U.S. GAAP can be twice as much as doing the accounting in the U.S.  Then, there may be additional time required to convert foreign currencies into U.S. dollars. Finally, the billing rate for international accounting work is generally higher than for domestic accounting work.

Tax Specialists Often Aren't GAAP Specialists

Because of the size and increasing complexity of the U.S. tax laws, a lot of accountants have had to choose between being general practitioners and being tax specialists. Even among tax specialists, those who deal with international (cross-border) tax matters tend to specialize in that part of the tax law. Those who specialize in tax often have less and less contact with the changing rules for U.S. GAAP.

That describes me and the work I do. For nearly 30 years I was a tax specialist instead of a general practitioner and had little need to stay up to date on the GAAP rules that mostly applied to publicly held companies -- and I didn't do any work for those companies.  Starting in 1992, I began to delve deeper and deeper into the somewhat obscure rules for international/cross-border taxation. By 1995 I was no longer taking on any domestic tax clients and by 1998 I no longer did any tax work other than cross-border related work. Because I was working with very small companies, I didn't worry much about GAAP. (But I did convert foreign records into an accrual method of accounting.)

But then I took on a client that has the potential to be a fairly sizable enterprise and began to discover the requirement for preparing their foreign tax information returns based on U.S. GAAP. The deeper I delved into the rules for GAAP, the more I realized that I wasn't ever going to able to be knowledgeable on U.S. GAAP and on cross-border tax rules. There just aren't enough hours in the day, or even in a year to keep up with both.

So I contacted a close friend (a CPA) who doesn't like tax work but he's a really good accountant and he has done a lot of work for large corporations. He has agreed to do the accounting work for my offshore clients - subject to my oversight in terms of what is required for me to prepare the returns.

Similar services are available in very large public accounting firms that have offices in multiple countries. However, they often are not interested in taking on clients that don't represent hundreds of hours of potential annual billings.

My friend and I can't handle the work for a large company by ourselves, but we can help taxpayers who have a smaller foreign corporation or partnership and who want to comply with the IRS requirements.

Vernon K. Jacobs
Certified Public Accountant

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Vernon K. Jacobs, All rights reserved.