Historically, disregarded U.S. entities (such as limited liability companies) wholly-owned by foreign persons were generally not required to file any U.S. tax or information returns. The implementation of final regulations to Section 6038A of the Internal Revenue Code issued on December 13, 2016 (the “Final Regulations”), has changed that.
Internal Revenue Bulletin 2017-3, issued on January 17, 2017, contains “final regulations that treat a domestic disregarded entity wholly owned by a foreign person as a domestic corporation separate from its owner for the limited purposes of the reporting, record maintenance and associated compliance requirements that apply to 25 percent foreign-owned domestic corporations under section 6038A of the Internal Revenue Code.”
Section 6038A of the U.S. Internal Revenue Code provides that if, at any time during a taxable year, a corporation is at least 25% foreign-owned, such corporation shall furnish the following information:
- the name, principal place of business, nature of business, and country or countries in which organized or resident, of each person which— (a) is a related party to the reporting corporation, and (b) had any transaction with the reporting corporation during its taxable year;
- the manner in which the reporting corporation is related to each person referred to in paragraph (1), and
- transactions between the reporting corporation and each foreign person which is a related party to the reporting corporation.
The effect of these regulations, according to the preamble of the final text, is to “enhance the United States’ compliance with international standards of transparency and exchange of information for tax purposes and (to) strengthen the enforcement of U.S. tax laws.” In practice, the information will give the Internal Revenue Service (IRS) tools to enforce tax laws and international treaties and agreements, including sharing information with foreign governments.
Information will be collected through Form 5472, which is an annual statement to the IRS of an entity which at least 25 percent of its capital is directly or indirectly foreign owned or a foreign corporation engaged in a business in the United States. The reporting obligation is imposed on all foreign-owned U.S. disregarded entities (including U.S. limited liability companies). Therefore, even foreign-owned disregarded U.S. entities that have no reportable transactions with related parties and have no U.S. assets or income will be obligated to file Form 5472 and report ownership information.
The Final Regulations also obligate foreign-owned disregarded U.S. entities to comply with the record maintenance requirements of Internal Revenue Code 6038A pertaining to related party transactions.
Disregarded entities which do not have a U.S. taxpayer identification number (EIN) will now have to obtain one, since this will be required for purposes of filing Form 5472. This is a process that can take up to several weeks.
Failure to file Form 5742 or comply with the record-keeping obligations subjects the U.S. entity in question to a penalty of USD $10,000 per violation, among other penalties.
Even though the effective date of the Final Regulations was December 13, 2016, the filing of Form 5472 will only be required for the 2017 taxable year.1 This means that the earliest Forms 5472 required under the final regulations would be due in early 2018. Therefore, if a foreign-owned disregarded U.S. entity terminates before December 13, 2017, such entity will not need to file Form 5472.
Owners of structures that contain one or more foreign-owned disregarded U.S. entities should have such structures reviewed to determine which additional obligations may come into place and whether any changes are necessary or advisable.