Posted by Stephanie L. Chapman, CPA
By now, you’re probably familiar with FATCA… similar to the OECD’s Common Reporting Standards (CRS), FATCA is the mechanism the US created for enforcing global tax transparency. To ensure its notification of assets held offshore by US taxpayers, the US entered into intergovernmental agreements with other countries to “share” information about assets held within each other’s borders by the others’ taxpayers. The US first created the mechanism to learn about US taxpayers’ assets abroad, but fell under harsh criticism for not having adequate tools in place to share the other way around… about US assets held by foreign taxpayers. Here’s why:
An LLC created in the US by a single foreign taxpayer is disregarded for tax purposes (unless electing otherwise). For these taxpayers, an income tax return is only required if there is Effectively Connected Income (ECI). Furthermore, instances can also arise where the US-source income may be exempt by US statute (in the case of portfolio interest), or no filing is necessary because the income is fully withheld against. In none of these cases would said US entity be required to file a US income tax return, much less report the foreign ownership of its assets in any way. Essentially, the US would know very little about this entity within its borders. Thus, it couldn’t share back.
Along comes the 6038A Regulations! Under these and the new 7701 Regulations, any entity disregarded for income tax purposes that is wholly owned by a non-US “person” is considered a corporation only for the purposes of filing of, and associated record-keeping for, the US Form 5472. These Regulations apply to tax years starting on or after January 1, 2017 so the first priority for affected entities is to establish their record keeping, if not already done so. Secondly, the LLC will now be required to obtain an EIN, if not already done so. Then, early in 2018, the reporting will begin to be required for 2017 transactions.
There are a couple notable exceptions to filing. As always, transactions among US entities are not reportable, and no 5472 is ever needed if there are no reportable transactions at all. However, for the new Regulation covering foreign owned single member LLCs (SMLLC), a 5472 is also not required where the owner is a resident of a treaty country, has no Permanent Establishment in the US, and has made the proper Treaty Position Disclosure with the IRS. Finally, in circumstances where the US SMLLC is owned by a foreign corporation that is, in turn, controlled by a US person (and thus the reportable transactions are already being reported on that person’s 5471), the 5472 is not required by the SMLLC. That would be duplicative reporting.
Practitioners and taxpayers familiar with the 5472 may recall that the former version of the form reported transactions between related entities that were particular to an operating entity (purchases of stock in trade, receipt of commission income, interest paid, etc). Under this format, certain entities formed for holding assets (and have no income tax reporting requirements, as suggested above) would not have had reportable transactions, thus 5472 would still have been required under the new Regs. To close this loophole, a new form of reportable transaction is added for these such entities for equity payments, specifically “amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.”
What is the US hoping to learn from these new forms? Well, the Form 5472 had been used in the past to report transactions between related parties of a “More-Than-25% Foreign Owned US Corporation” as well as those of a Foreign Corporation Doing Business in the US (i.e. those that operated in the US via an LLC). But the 5472 is only required if there is an income tax return to file. This new Regulation extends to all forms of owners, including individuals and those Foreign Corporations “doing business in the US” (i.e. holding a SMLLC that holds US assets) but had no income tax filing requirement.
Penalties remain steep; failing to file the Form 5472 remains at $10,000 each, as does the failure to maintain adequate records to support the 5472 or to disclose a Treaty-Based Tax Position. Foreign owners of US LLCs should consult their tax advisor to determine how and if these new Regulations apply to them.