The Internal Revenue Service ("IRS") of the United States ("U.S") released the proposed regulations that would require domestic disregarded entity wholly owned by a foreign person to report their related parties and transactions between the entity and its foreign owner or other foreign related parties.

Current Treasury Regulation

Currently, U.S entities classified as corporations or partnerships, for tax purposes, are subject to reporting requirements to the IRS through the return filing and employer identification number ("EIN") application requirements.

The domestic corporations that are at least 25% foreign-owned are subject to specific information reporting and record maintenance requirements. They are required to file an annual return on Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business).

On the other hand, wholly owned disregarded entities are not obligated under current regulations to file a U.S. tax return or obtain an EIN. Its owner is treated as owning directly the entity's assets and liabilities, and the information available with respect to the disregarded entity depends on the owner's own return filings, if any are required.

For a disregarded entity that is formed in the United States and wholly owned by a foreign corporation, foreign partnership, or nonresident alien individual, generally no U.S. income or information return must be filed if neither the disregarded entity nor its owner received any U.S. source income or was engaged in a U.S. trade or business during the taxable year.

Proposed regulations

The proposed regulations would treat a domestic disregarded entity that is wholly owned by one foreign person as a domestic corporation separate from its owner, only for the purposes of the reporting, record maintenance and compliance requirements.

The new regulations intend to provide the IRS with improved access to information that it needs to satisfy its obligations regarding tax information exchange agreements and to strengthen the enforcement of U.S. tax laws.

Accordingly, the new requirements applicable to wholly foreign owned disregarded entity would be the following:

(i) To file the Form 5472 information return with respect to reportable transactions between the entity and its foreign owner or other foreign related parties;

(ii) To maintain records sufficient to establish the accuracy of the information return and the correct U.S. tax treatment of such transactions;

(iii) To obtain an EIN by filing a Form SS–4, that includes responsible party information.

Our comments

In case this proposed regulation is implemented as in the current text, it would affect inbound and outbound investments with Brazilian parties, as they would impose a substantial burden on them, to comply with the return filing obligations that are not currently required by the U.S treasury department.

For instance, Brazilian investments in the U.S to acquire real estate properties through U.S entities, as well the LLC companies that foreign investors own to make investments in Brazil would be subject to this rule, and as a consequence, would have to disclose their financial information to the IRS.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.