Amid the Panama Papers leak and international concern that foreign persons were concealing assets through U.S. entities that are disregarded for U.S. federal income tax purposes, the Internal Revenue Service (IRS) and the Department of the Treasury (Treasury) proposed and, on December 12, finalized regulations (the Final Regulations) that require U.S. tax reporting for certain foreign-owned domestic disregarded entities (TD 9796). Specifically, the regulations treat domestic disregarded entities wholly owned, directly or indirectly, by foreign persons as domestic corporations separate from their owner solely for purposes of triggering reporting, record maintenance, and associated compliance requirements that apply to 25% foreign-owned domestic corporations under section 6038A. The Final Regulations are substantially similar to the proposed regulations and are effective as to the taxable years of domestic disregarded entities beginning on or after January 1, 2017, and ending on or after December 13, 2017, and taxable years thereafter.
The Final Regulations impose an obligation on domestic disregarded entities wholly owned by foreign persons to report identified related-party transactions on Form 5472 (the filing of which would require such entities to obtain an EIN) and comply with related record maintenance requirements. The penalty for failure to file a Form 5472 is $10,000 for each such disregarded entity to which these rules apply. Form 5472 is normally filed by attaching the form to the reporting corporation’s U.S. income tax return. Since disregarded entities whose foreign owners do not file a U.S. tax return currently are not required to file a U.S. income tax return, presumably new instructions for Form 5472 will provide guidelines on filing the form for the entities that are required to file as a result of the Final Regulations.
The Final Regulations are intended to be broad, and certain exceptions otherwise available under section 6038A do not apply to domestic disregarded entities subject to these rules. Specifically, the following exceptions do not apply: (i) the small corporation exception under Treasury regulation section 1.6038A-1(h); (ii) the de minimis exception under Treasury regulation section 1.6038A-1(i); (iii) the exception under Treasury regulation section 1.6038A-3(e)(3), under which a reporting corporation is not required to file Form 5472 with respect to a related foreign corporation when a U.S. person controls the related foreign corporation and files a Form 5471 containing the required information with respect to reportable transactions between the reporting corporation and the related foreign corporation; and (iv) the exception under Treasury regulation section 1.6038A-2(e)(4), under which a reporting corporation is not required to file Form 5472 with respect to a related foreign corporation that qualifies as a foreign sales corporation for a taxable year for which the foreign sales corporation files Form 1120-FSC. For purposes of the Final Regulations, a foreign person will be considered to own a domestic disregarded entity if it owns the entity directly or indirectly entirely through one or more disregarded entities or grantor trusts, regardless of whether any such disregarded entity or grantor trust is domestic or foreign.
The Final Regulations provide that if the foreign owner of a domestic disregarded entity files a U.S. tax return, the domestic disregarded entity will have the same tax year as the foreign owner. If the foreign owner does not file a U.S. tax return, the domestic disregarded entity will have a calendar tax year.