The Internal Revenue Service ("IRS") and the Department of the Treasury ("Treasury") issued final regulations on December 13, 2016 for the Internal Revenue Code ("IRC") Sections 6038A and 7701. These regulations take effect for tax years beginning after January 1, 2017 and make way for additional filing requirements for domestic disregarded entities (DREs) that are wholly owned by foreign persons.
Under the new rules, foreign-owned Disregarded Entities (DREs) are required to file Form 5472, Information Return of a 25 percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. For many foreign-owned DREs, this new requirement has added implications. In order to file Form 5472, these entities are now required to obtain an Employer Identification Number (EIN) if they have not yet established one. When applying for an EIN, the foreign-owned DRE must identify the owner or name of a responsible party. If the foreign owner or responsible party does not have a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN) potential complications can arise.
Another nuance under these regulations is a requirement for foreign-owned DREs to maintain books and records that would allow them to accurately file Form 5472 and follow US tax treatment with respect to reportable transactions. Reportable transactions under these regulations include sales, assignments, leases, licenses, loans, advances or any other transfer that constitutes a right to use property or money in addition to the performance of any services for the benefit of or on behalf of another taxpayer. In addition, contributions and distributions are also considered reportable transactions under IRC 6038A.
To facilitate compliance with the additional requirements of Section 6038A and the required reporting under Form 5472, a foreign-owned DRE that has a U.S. filing requirement is required to have the same taxable year as the foreign owner; and similarly, if the foreign owner has no U.S. filing requirement, the taxable year of the entity is the calendar year unless otherwise indicated.
The penalties for failure to file are steep. Not filing Form 5472 could cost a taxpayer $10,000. This penalty can also be assessed for failure to maintain proper records. In fact, filing a substantially incomplete Form 5472 would constitute a failure to file Form 5472 and the $10,000 penalty can be assessed. However, there is no guidance provided by the IRS or any other regulatory agency as to what constitutes filing a substantially incomplete Form 5472. Criminal penalties may also apply for failure to submit information or for filing false or fraudulent information. Lastly, foreign-owned DREs cannot electronically file Form 5472.
If you have any questions regarding the new filing requirements, please reach out to a member of the Tax Advisory Group (TAG) at HBK.