Foreign Owned Domestic Disregarded Proposed Regulations

Currently, a foreign-owned US disregarded entity generally owes no US tax reporting unless the entity is engaged in a US trade or business or has certain types of US-source income. However, such a disregarded entity can disguise its owners, allowing for abuses like tax evasion. To combat these abuses, as well as live up to US treaty obligations, the US Treasury and Internal Revenue Service have issued proposed regulations (REG-127199-15).

The proposed regulations, for certain purposes, treat as a domestic corporation any domestic disregarded entity wholly owned by a foreign person. Specifically, the rules treat such a disregarded entity as a domestic corporation solely for purposes of applying Internal Revenue Code section 6038A, which requires special reporting, record maintenance and compliance for 25 percent foreign-owned domestic corporations. As a result, these disregarded entities become required to:

  1. Obtain an EIN via a Form SS–4, which must include information about its responsible party (generally the individual with control over, or entitlement to, the entity’s assets).
  2. Use the EIN and other information to 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. This form reports on “reportable transactions” between the entity and its foreign owner or other foreign related parties. Solely for Form 5472, “reportable transactions” 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 impose this filing obligation even if the foreign owner or disregarded entity already has another obligation to report income from these reportable transactions.
  3. Maintain permanent records sufficient to establish the accuracy of the information return and the correct U.S. tax treatment of such transactions.

The proposed regulations penalize disregarded entities for failure to file Form 5472 or maintain corresponding records, just as domestic corporations are currently penalized. However, the proposed regulations do not allow disregarded entities the exceptions to the record maintenance requirements in section 1.6038A–1(h) and (i) (regarding small corporations and de minimis transactions).

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

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Roger Royse

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City.
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