IRS Form 5472 on Foreign-Owned Domestic Disregarded Entities
IRS Form 5472 − new requirements for foreign-owned US companies
An easy-to-understand guide to IRS Form 5472
Despite the political turnaround that took place in The White House at the end of 2016 and the associated geopolitical instability that some would say was caused by it, the United States was, is and will continue to be a very attractive market for doing business. The US economy has been on a roll throughout much of the Trump presidency, and the corporate tax rate is at one of its lowest levels in history.
There are currently many strong sectors and bullish trends being buoyed, and also guiding, the expanding US economy. They include, but are not limited to, the metallurgical, banking sector, life insurers, oil services, paper and mobile telecommunications, as well as other sectors that enjoy very positives growth prospects such as industrial engineering, financial services, transportation, technological hardware, electronic products, aerospace, media, automotive, travel and leisure, chemical and technological software companies. In addition to that, there are still some pro-business states in the U.S. where it is simple, easy and cheap to set up a company with relative privacy.
The US is a market full of business opportunities, but it also has a legal policy and tax code that can become complicated and problematic, requiring a full knowledge of it and its caveats if one is to avoid fines and sanctions. Foreigners doing business in the USA are required to file an annual submission of the Internal Revenue System (IRS) Form 5472, reporting any foreign holdings of a US company. In this article, we provide an IRS Form 5472 help guide and the new rules that have come into force since December 2016, so that those interested can easily understand what they are, and whether they are responsible for filing the form.
What is IRS Form 5472?
IRS Form 5472 “Information Return of Foreign-Owned US Corporation or Foreign Corporation Engaged in a US Trade or Business” is an annual statement to the Internal Revenue Service (IRS) of an enterprise which at least 25 percent of its capital is directly or indirectly American foreign-owned or a foreign corporation engaged in a business in the United States. Like many forms of the IRS, the information requested can be daunting.
The purpose of IRS Form 5472 is to avoid abuses and income tax evasion in local and foreign transactions between US corporations and their foreign shareholders, by presenting information about the company and its related parties and to audit the nature and amounts of such trades.
Following the amendment of IRS Form 5472 rules that came into effect on December 13, 2016, the IRS prevents domestic disregarded entities (DDEs), such as LLCs that are wholly owned by foreign natural or legal persons, from benefiting from certain exemptions from the filing of Form 5472. DDEs will be treated as national corporations, separate from their owners for reporting, record-keeping and other mandatory requirements.
What is a Reportable Transaction?
Reportable transactions are listed in IRS Form 5472 Part IV and detailed in the instructions of IRS Form 5472. A reportable transaction for IRS is understood as the exchange of money or property with a foreign shareholder, such as payments for sales, rent, royalties or interests. Reportable transactions include loans between the corporation and the foreign shareholders in both directions.
With shareholder loans to the corporation, interest paid by the corporation may be tax deductible to the corporation, while, on the part of the shareholder, the interest charged may be subject to US taxation, with a withholding tax of a maximum of 30%, unless it meets the portfolio interest exemption, which in turn must meet certain specific requirements (Form W8 BEN). In the case that the interest rate applied to the loan is lower than the market rate (the Applicable Federal Rate) or free of interest, the IRS may charge an appropriate interest rate. The IRS will analyze the transaction according to its content to avoid disguised distributions of benefits, which are subject to a tax at a maximum of 30% and are not deductible.
When filling out IRS Form 5472, it is noteworthy to take into account that the US has signed many tax treaties and agreements to exchange tax information with other countries, so if the foreign shareholder resides fiscally in a jurisdiction that complies with the FATCA (Foreign Account Tax Compliance Act) and has reported revenues related to transactions made in the US territory, they may be exposed to fines and penalties if the statements do not match.
Who is required to file the IRS Form 5472?
Below are detailed all the aspects to take into account for the three cases in which the filing of Form 5472 is required.
1. US Entity with 25% or more ownership by a foreign shareholder
Each of the foreign shareholders (entities or individuals) who directly or indirectly own at least 25% of the company’s property and have a reportable transaction with it, must submit form 5472 separately. The required information is name, address, and country of citizenship/incorporation, nature and total of the reportable transaction with the shareholder, countries where the shareholder declares their taxes as resident and countries where they carry out economic activities.
2. Domestic Disregarded entity wholly owned by foreign natural or legal person
As mentioned previously, on December 13, 2016, the IRS issued a final regulation, which is subject to organizations beginning their fiscal year on December 31, 2016 or ending after December 12, 2017, by which transactions between domestic disregarded entities (DDE) that are wholly owned by foreign natural or legal persons and their foreign owner are considered a reportable transaction. These entities are treated as national corporations, separate from their foreign owner, and are thus obligated to report, maintain record-keeping and fulfill other requirements for assessing the accuracy of the IRS form, the right US Tax treatment and to determine taxable income and their income tax return obligation.
Any LLC that has a reportable transaction with its foreign owner must have filed IRS Form 5472 and is required to obtain a US Tax Identification number, and have an Employer Identification Number (EIN), by filing the SS-4 Form. Another change in regulations is that the foreign-owned DDE fiscal year will coincide with that of the foreign owner if they have a US tax return obligation; otherwise, the natural calendar will be applied.
3. The foreign corporation conducts economic activities in the US or has a reportable transaction with an American or Foreign-related party
The third case in which it is necessary to complete and fill IRS Form 5472 is the participation of a foreign entity in a US Trade or Business (USTB), which involves any foreign company that has income derived from any economic activity in the United States. If that foreign company involved in a USTB makes a reportable transaction with a related party, either foreign or U.S., it must have also filed IRS Form 5472.
IRS Form 5472 – penalties for non-submission or incomplete filing
Regarding foreign shareholders required to report and file transactions according to IRS Form 5472 rules. those who do not file it or file incompletely may incur a penalty of USD 10,000.00 per year, in addition to presumably placing the company under the IRS’ sites, with possible audits and follow-ups over the following years.
This article is not intended to be legal advice. If you would like more information and guidance on what your U.S. tax responsibilities may be, and how to fulfil them, contact us and we can refer you to a qualified attorney who can give you the proper assistance according to your corporate and personal specific circumstances.