On December 13, 2016 the Treasury Department and the IRS issued final regulations that require certain foreign-owned limited liability companies (LLCs) to report their transactions with related parties and to obtain an employer-identification number (EIN). These regulations are a part of a larger effort by the Obama Administration to improve access to information about foreign investment in the United States. The finalized regulations will generally apply to tax years beginning on or after January 1, 2017 and will include monetary penalties for non-compliance.
Under existing law, US corporations that are 25% foreign-owned (and foreign corporations that are engaged in a US trade or business) are required to file an annual information return on Form 5472 to report transactions with related parties. In addition, such corporations are generally required to keep books and records that can establish the accuracy of any US tax filings (including transactions with related persons) and make them available to the IRS upon request. Applicable regulations limit the ability to keep any such records outside the US.
Wholly-owned LLCs are generally disregarded for US income tax purposes unless the LLC elects to be treated as a corporation. Disregarded entities were previously not required to file Form 5472 (or comply with the record-keeping requirements) even if the owner of the entity is a foreign person. In addition, disregarded entities were not generally required to obtain EINs.
The new regulations treat a domestic disregarded entity that is wholly-owned by a foreign person as a domestic corporation separate from its owner for the reporting, record maintenance, and compliance requirements that apply to 25% foreign-owned domestic corporations.
Under the regulations, a domestic disregarded entity that is wholly-owned by a foreign person is required to file Form 5472 to report its transactions with related persons. In addition, the record maintenance rules noted above also apply to such a disregarded entity. The regulations expand the types of transactions that must be reported on Form 5472. The expanded list of reportable transactions includes contributions and distributions between a disregarded entity and its owner (transactions that would ordinarily be disregarded for US income tax purposes).
In determining whether a US disregarded entity is wholly-owned by a foreign person, indirect ownership through domestic or foreign disregarded entities or grantor trusts is taken into account. As a result, the regulations appear to require separate filings (and separate record keeping requirements) for groups of affiliated disregarded entities.
EXAMPLE: If a foreign corporation forms two domestic wholly-owned LLCs and the two entities own 100% of a third domestic LLC, all three LLCS will have separate obligations to file Form 5472 and maintain records.
The finalized regulations do not specify the time and manner for a disregarded entity to file Form 5472. These will be prescribed by the IRS in later guidance.
In addition, disregarded entities that are required to file Form 5472 will need to obtain an EIN, if they don't already have one. An existing requirement for an entity to obtain an EIN is the disclosure of a responsible person for the entity (i.e., an individual who has a level of control over the affairs of the entity), and changes to the responsible person for an entity must be reported to the IRS. As such, disregarded entities will be required to disclose the individual who is a responsible person upon the request for an EIN and disclose subsequent changes.
Penalties for Non-Compliance
Taxpayers who are required to file Form 5472 are subject to penalties of $10,000 per form for non-compliance, including late filing. Since a separate form needs to be filed for each related person, the penalties can add up.
EXAMPLE: If a corporation borrows money from four related parties, the corporation would be required to file four forms per taxable year. The penalty could be $40,000 if the forms are filed late. The IRS has been aggressive about assessing penalties for late filed Forms 5472. The penalties can be abated if there is reasonable cause for noncompliance (or late filing); however, the IRS rarely agrees with taxpayers that there is reasonable cause sufficient to abate the penalty.
The regulations state that reporting corporations will be subject to the above-described penalties if there is non-compliance with the requirements to file Form 5472 on time and to maintain records.
As under the proposed version of these regulations, the exceptions to the record keeping requirements for small corporations (i.e., less than $10 million in gross receipts) and for de minimis transactions (i.e., transactions with related foreign parties that are $5 million or less) do not apply to domestic disregarded entities that are reporting corporations.
In addition, under the final regulations, the exceptions to the filing requirements when a US person who controls the related foreign corporation and files Form 5471, or when a foreign corporation that qualifies as a foreign sales corporation and files Form 1120-FSC, do not apply to domestic disregarded entities that are reporting corporations.
The final regulations also state that reporting corporations will be treated as having the same tax year as their foreign owner, if the foreign owner has a US return filing obligation. If the foreign owner does not have a US return filing obligation, then the tax year of the reporting corporation will be treated as the calendar year. Once again, the finalized regulations do not specify the time and manner for a disregarded entity to file Form 5472. These will be prescribed by the IRS in later guidance.
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