Internal Revenue Bulletin 2016-21, issued May 23, 2016, by the Internal Revenue Service (IRS) and Treasury Department included a notice of proposed rulemaking altering the reporting requirements for US disregarded entities owned by non-US persons or entities.
A US disregarded entity is an entity with a single owner that is not treated as separate from its owner, for US tax purposes. In the case of a foreign owner, the foreign owner generally has no US tax filing obligations. As a result, the IRS does not generally receive ownership information for these types of structures. US disregarded entities wholly owned by foreign corporations, partnerships, trusts, or nonresident alien individuals only need to report information to the IRS if they generated US source income or operated a US trade or business, in which case its foreign parent would report the income.
Because of the lack of reporting of the ownership of these US disregarded entities, the IRS believes the lack of information hinders the IRS’s compliance requirements under international tax information exchange agreements as well as domestic and foreign law enforcement investigations.
To remedy this opacity, the proposed regulations amend “section 301.7701–2(c) to treat a domestic disregarded entity that is wholly owned by one foreign person as a domestic corporation separate from its owner for the limited purposes of the reporting and record maintenance requirements (including the associated procedural compliance requirements) under section 6038A”. Section 6038A requires disclosures of certain related party transactions between a US domestic corporation and 25% or greater foreign owners. While section 6038A and its regulations include de minimis and safe harbor rules the proposed regulations specifically excluded the reporting by US disregarded entities from the de minimis and safe harbor rules that apply to other transactions.
In addition, the proposed regulations expand the definition of reportable transactions from those included in section 6038A. The proposed regulations apply the definition of “transaction” found in Treas. Reg. 1.482-1(i)(7). This definition includes “any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented.” By both expanding the definition of transactions and removing the de minis and safe harbor exemptions, the proposed regulations effectively require that every financial transaction between a US disregarded entity and its foreign parent be disclosed on Form 5472.
The failure to file penalty for failing to file Form 5472 is up to $10,000 so it is important for businesses to understand these proposed regulations and determine if their US disregarded entities will be required to file Form 5472.