US plans reporting requirements for foreign-owned disregarded entities

US disregarded entities owned by foreign persons would be treated as domestic corporations under regulations proposed by the US Internal Revenue Service (IRS) on Friday (REG-127199-15). The new rules would apply for purposes of the reporting, record maintenance, and other compliance requirements that apply to 25% foreign-owned domestic corporations under Internal Revenue Code Sec. 6038A.

The IRS is justifying the change as a necessary enforcement measure, as well as to give the tax collection agency better access to information it needs to satisfy US obligations under various tax treaties, tax information exchange agreements, and other international agreements.

Under the “check-the-box” regulations, a business entity with a single owner can be disregarded as separate from its owner for various tax purposes and may not be required to file a US tax return or obtain an employer identification number (EIN). As a result, the IRS may lack information about the entity. In a letter to the US Speaker of the House of Representatives, Paul Ryan, on May 5th, US Treasury Secretary Jack Lew described the current situation as a “loophole in our system that allows foreign persons to hide assets in US accounts”.

The IRS says that various international organisations, such as the Financial Action Task Force and the Organisation for Economic Co-operation and Development’s Global Forum on Transparency and Exchange of Information for Tax Purposes have noted that this lack of information about disregarded entities hinders US law enforcement efforts and makes US compliance with international tax transparency and information exchange standards difficult.

Therefore, the IRS is proposing to use the provisions of Sec. 6038A to impose reporting and recordkeeping requirements on certain disregarded entities. Sec. 6038A requires a domestic corporation that is 25% foreign owned to annually file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business (Under Sections 6038A and 6038C of the Internal Revenue Code), for its foreign owner and other foreign related parties with which the entity has a “reportable transaction”. The entity is also required to keep permanent books of account and other records under Sec. 6001.

The proposed regulations would amend US Treasury Regs. Sec. 301.7701-2(c) (part of the check-the-box regulations) to treat a domestic disregarded entity that is wholly owned by one foreign person as a domestic corporation that is separate from its owner for purposes of the Sec. 6038A reporting and records requirements. The proposed regulations are not intended to otherwise alter the existing framework of the entity classification regulations.

In addition to being required to file Form 5472 and to maintain records sufficient to establish the accuracy of the information reported on Form 5472 and the correct US tax treatment of the reported transactions, the disregarded entities would be required to obtain an EIN and provide information about their responsible party.

The proposed regulations would require the disregarded entity to report “any sale, assignment, lease, license, loan, advance, contribution, or other transfer of any interest in or a right to use any property or money” between the entity and its owner, “as well as the performance of any services for the benefit of, or on behalf of” another taxpayer. Normally, because they involve a disregarded entity, these transactions would not be considered reportable transactions for purposes of Sec. 6038A.

The proposed regulations would also provide that the exceptions from the record maintenance requirements for small corporations and de minimis transactions will not apply to affected entities.

The IRS also warns that it is considering requiring filers of corporate, partnership, and other tax information returns to identify all foreign and domestic disregarded entities that they own. In his letter to Ryan, the Treasury secretary urged Congress to pass beneficial ownership legislation that would require companies to disclose “the real person behind a company at the time of its creation”.

The proposed rules would apply to tax years ending on or after the date that is 12 months after they are published as final.