The US Treasury and IRS have issued proposed regulations (REG-127199-15) that would treat domestic disregarded entities that are wholly owned by foreign persons as domestic corporations solely for purposes of making them subject to the reporting requirements under Section 6038A that apply to 25% foreign-owned domestic corporations. The proposed regulations are part of a larger effort announced by the Treasury to increase financial transparency and combat tax evasion. Entities subject to these regulations would continue to be treated as disregarded for other federal tax purposes.

Background

Under US tax regulations, an entity, such as a US limited liability company (LLC), that has a single owner and is not classified as a corporation is generally disregarded as separate from its owner (a disregarded entity). Such disregarded entities are generally not subject to US tax filing requirements, which means they also generally do not need to obtain an employer identification number (EIN) unless they are filing an entity classification election. Entities that do need to obtain EINs do so by filing Form SS-4, on which they must identify a responsible party (generally the individual with control over, or entitlement to, the entity's assets) unless the sole reason for applying for an EIN is to make an entity classification election and the entity is foreign-owned.

Unlike disregarded entities, domestic corporations and partnerships, as well as foreign corporations engaged in a trade or business in the US, must file annual income tax returns. Domestic corporations that are 25% or more foreign-owned are subject to additional specific information reporting and record maintenance requirements under Section 6038A. Specifically, such corporations must file an annual return on Form 5472 for each related party with which the corporation has had any "reportable transactions." Such corporations must also keep records sufficient to establish the accuracy of the return, including information relating to related parties to the extent relevant.

In the case of foreign-owned US disregarded entities, generally no US reporting obligations apply unless the entity is engaged in a US trade or business or has certain types of US-source income. Without such requirements, Treasury states that it can be difficult to identify a "responsible party" for such disregarded entities. As a result, Treasury reports it has difficulty complying with obligations under tax treaties, tax information exchange agreements and other international agreements.

Explanation of provisions

To improve access to information for purposes of complying with international agreements, as well to enhance US tax enforcement, the proposed regulations would treat US disregarded entities wholly owned by one foreign person as a domestic corporation separate from its owner solely for purposes of Section 6038A. This would make such otherwise disregarded entities subject to the reporting and record-keeping requirements that currently apply to 25% foreign-owned US corporations. The regulations would not affect the entity's classification for other purposes. As a result, such entities would be required to file Form 5472, and maintain related records, for reportable transactions with the entities' foreign owners or other foreign related parties. To complete such filing, these entities would also need to obtain EINs by filing a Form SS-4 with responsible party information, including the responsible party's social security number (SSN), individual taxpayer identification number (ITIN) or EIN.

The proposed regulations would further add a new reportable category to ensure affected entities report all transactions with foreign related parties. Specifically, they would add as reportable transactions any transaction within the meaning of Treas. Reg. Section 1.482-1(i)(7), including any sale, assignment, lease, license, loan, advance, contribution or other transfer of any interest in or a right to use any property or money, as well as the performance of any services for the benefit of, or on behalf of, another taxpayer. Accordingly, for example, any contributions or distributions between such entities and their foreign owners would be considered reportable transactions for these purposes.

Applicable penalty provisions would apply to failures to file Form 5472 or maintain adequate records. In addition, under the proposed regulations, exceptions to record maintenance requirements for small corporations and de minimis transactions would not apply. Because the proposed regulations would apply in some cases when reporting is already required (e.g., a foreign-owned disregarded entity engaged in a US trade or business), Treasury also requests comments on alternative reporting methods in such circumstances.

According to the preamble to the proposed regulations, Treasury and IRS are also considering modifying corporate, partnership, and other tax and information returns to require filers to identify all the foreign and domestic disregarded entities that they own.

The new regulations would apply to tax years ending on or after the date that is 12 months after the date of publication of final regulations.

Implications

Whereas some disregarded entities and their foreign owners may not have obligations to file a tax return or obtain an EIN currently, the proposed regulations would impose new filing requirements as well as obligations to maintain sufficient records. Such disregarded entities would be required, for example, to file Form 5472. To complete such filing, these entities would also need to obtain EINs by filing a Form SS-4 with responsible party information, including the responsible party's SSN, ITIN or EIN, which may require the ultimate individual owner to obtain an ITIN, a potentially time-consuming and burdensome process. While these regulations are not yet effective, taxpayers should be mindful of the increased burden that these regulations could place upon them, and consider what changes to their internal processes may be required to comply with the additional reporting.

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