On December 13, 2016, the IRS issued T.D. 9796, new regulations that require U.S. disregarded entities owned by a foreign person to file U.S. Federal Form 5472. The new Form 5472 filing requirement applies for tax years beginning after December 31, 2016 and ending on or after December 13, 2017.
Form 5472 is required to be filed by a reporting corporation that engages in reportable transactions with a U.S. or foreign related party. For this filing requirement, a reporting corporation is defined as either a U.S. C Corporation owned directly or indirectly by a 25% foreign shareholder or a foreign corporation engaged in a U.S. trade or business. The new regulations now state that a reporting corporation for the Form 5472 will include a U.S. disregarded entity that is owned directly or indirectly by one foreign person. A U.S. disregarded entity is a company or a grantor trust which is owned 100% by one person that is treated as the owner of all assets, liabilities, and income of the entity. A U.S. disregarded entity is considered to be owned indirectly by a foreign person if it is owned through one or more other disregarded entities or grantor trusts. The new regulations also expand the scope of reportable transactions to include the foreign owner’s capital contributions to a U.S. disregarded entity and distributions from a U.S. disregarded entity to its foreign owner.
The IRS has not yet updated U.S. Federal Form 5472 to reflect the new changes beginning with the 2017 tax year. It is unclear whether a U.S. disregarded entity with reportable related party transactions will be required to file Form 5472 separately with the IRS apart from a U.S. tax return. Based on the new regulations, the U.S. disregarded entity is classified as a U.S. C Corporation solely for purposes of the Form 5472 filing requirement. The IRS has not yet announced whether the U.S. disregarded entity would be required to file a U.S. corporate income tax return with the Form 5472 attached to report transactions with related parties.
In order to file Form 5472 as a reporting corporation, the U.S. disregarded entity will be required to obtain a U.S. FEIN as a taxpayer identification number. When applying for a FEIN for the U.S. disregarded entity on the U.S. Federal Form SS-4, it is necessary to provide the name and U.S. FEIN, Social Security Number (SSN), or individual taxpayer identification number (ITIN) of the foreign owner as the responsible party. This will require a foreign nonresident individual owner of a U.S. disregarded entity to apply for an ITIN on U.S. Federal Form W-7. There are certain procedures that a nonresident individual must follow to file the Form W-7 ITIN application. The processing time for the Form W-7 ITIN application with the IRS can take several months.
The new regulations also exclude a U.S. disregarded entity with a foreign owner from certain regulatory exceptions to Form 5472 recordkeeping requirements. Those exceptions typically exempt small corporations from the recordkeeping requirements if the corporation has less than $10 million in gross receipts and $5 million or less of reportable related party transactions that are less than 10% of gross income. A U.S. disregarded entity with a foreign owner is not eligible for such exceptions.
Form 5472 is an important U.S. international tax reporting requirement that should not be overlooked. The failure to file or the late filing of the Form 5472 can result in a $10,000 USD penalty per related party, per year.
For more information, please contact Alison Dougherty at ADougherty@aronsonllc.com or 301.231.6290. Alison will be presenting a webinar on Form 5472 filing requirements and the new regulations on September 12, 2017. For more information and to register, please see visit the Strafford website.
There are some important U.S. international tax considerations to be aware of when a U.S. person transfers intangible property outside the United States. When a U.S. person contributes intangible property to a foreign corporation as a capital contribution in exchange for stock, a taxable event will generally occur for U.S. federal income tax purposes. The U.S. transferor is considered to have taxable income from a deemed sale of the intangible property in the form of annual deemed payments based on the productivity or use of the property for the lesser of the useful life of the property or 20 years.
This requirement is based on Section 367(d) of the U.S. Internal Revenue Code. For purposes of this rule, the definition of intangibles is provided under Section 936(h)(3)(B) to include patents, copyrights, trademarks, franchises, licenses, contracts and customer lists which have substantial value independent of the services of any individual.
Where the U.S. transferor is a parent or subsidiary of the transferee foreign corporation, Section 482 transfer pricing rules require that the deemed annual payments must be based on the arm’s length standard between uncontrolled taxpayers. This means that the U.S. transferor’s annual deemed payments from the deemed sale of the intangible property must be determined by the amount of income that is expected to be produced from the intangible property. The same rules also apply to a transfer of intangible property in an outbound corporate reorganization transaction that otherwise would be a nontaxable merger or acquisition.
A U.S. person also may consider structuring an offshore transfer of intangible property to a foreign company as a sale. In the case of a sale, the U.S. transferor is subject to U.S. taxation on the difference between the cost basis and the sale price of the intangible property. The source (U.S. or foreign source) and the character of the income (ordinary or capital gain) could vary depending on the situation and the terms of the sale.
Another way to transfer intangible property offshore is through a licensing agreement. In the case of a transaction between related parties such as a U.S. parent and a foreign subsidiary, the royalty for the use of the intangible property must be based on the Section 482 arm’s length standard. If the U.S. company is paying a royalty to a foreign company for the use of the intangible property in the United States, the royalty payment is subject to 30% U.S. nonresident tax withholding unless the royalty income is considered to be effectively connected with the foreign company’s U.S. trade or business.
Even though cost-sharing arrangements between related U.S. and foreign companies is an area where the IRS is currently increasing its scrutiny, they could also provide an opportunity for the cross-border co-development of intangible property.