The United States Department of Treasury issued proposed regulations that, if promulgated, would impose new disclosure obligations on domestic disregarded entities wholly owned by foreign persons (i.e., single-member limited liability companies). Most notably, an affected entity would be required to identify its beneficial owner to the IRS on an annual basis. Such an obligation would constitute a reversal in the IRS’s longstanding practice of treating a single-member LLC as an entity disregarded as separate from its owner for reporting purposes.
The proposed regulations, issued May 6, 2016, are intended to strengthen US civil and criminal tax enforcement as well as to assist foreign tax authorities in obtaining information regarding their own taxpayers pursuant to tax treaties and tax information exchange agreements.
Under the proposed regulations, any domestic disregarded entity owned by a foreign person would be subject to the provisions of Section 6038A of the Internal Revenue Code, which currently imposes annual reporting, recordkeeping, and other compliance requirements on certain foreign owned US corporations.
First, as mentioned above, an affected entity would be required to file an annual information return (Form 5472) that discloses the identity of its foreign owner and certain “reportable transactions” between the entity and its foreign owner or other foreign related parties. A separate Form 5472 would be required to report each related party with which the affected entity had a reportable transaction during a taxable year. “Reportable transaction” for this purpose is defined broadly to include “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.” The proposed regulations specifically provide that any contributions or distributions would be considered a reportable transaction with respect to such affected entities.
Second, an affected entity would be required to maintain permanent books of accounts and records sufficient to establish the accuracy of the information annually reported to the IRS on the Form 5472. Failure to file a Form 5472 or maintain the supporting records as required could result in a $10,000 civil penalty for each failure. Criminal penalties could also apply for failure to submit information or filing false or fraudulent information.
Third, because an affected entity has a filing obligation, it would be required to obtain a US taxpayer identification number (an employer identification number, or EIN) to identify itself on its filing. Accordingly, the affected entity would be required to file a Form SS-4 to apply for an EIN, which identifies responsible party information to the IRS.
These proposed regulations represent the US government’s latest step to expand disclosure by foreign investors, in response to international pressure on the US to collect and disclose information to foreign tax authorities. For example, the US Financial Crimes Enforcement Network (FinCEN) recently issued “Geographic Targeting Orders” that require the disclosure of the identities of foreign persons behind entities used to purchase high-end real estate in New York and Miami in all cash transactions. FinCEN has also issued rules, which are effective beginning on July 11, 2016, that require US financial institutions to identify any individual who owns 25 percent or more of an entity owning a domestic bank account. Publicity surrounding the leak of the so-called Panama Papers has also heightened attention to the potential abuse of offshore structures.
The IRS is also considering additional “modifications to corporate, partnership, and other tax or information returns” that would require US taxpayers to disclose ownership interests in foreign and domestic disregarded entities.