Recent media coverage, as it relates to U.S. tax in Canada, has almost entirely focused on the U.S. Tax Cuts and Jobs Act, in particular the deemed repatriation of foreign earnings provision. An important issue, that did not receive significant coverage, was that the U.S. Senate version of the tax reform legislation, had proposed increasing the penalty for a late, improperly filed, or incompletely filed, Form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business”. The penalty was to increase to $25,000 (per form; per year).
While the proposal was not included in the final legislation, it clearly highlights the importance of this form to U.S. legislators. Now maybe a good time to “play catch -up” as the proposed increase may be considered again in the future. The current penalty for non-compliance is $10,000 (per form; per year) which, while it is a high penalty, is significantly lower than what was proposed. In certain instances the IRS may abate penalties if the taxpayer has a reasonable cause for the infraction. Unlike Canada, many of the U.S. information returns do NOT have a de minimis level.
Form 5472 reports information that is required when reportable transactions occur during the tax year of a reporting corporation with a foreign or domestic related party. It is important that the Form (exceptions apply) needs to be filed for each reportable transaction with each related party.
Important change for tax year 2017: The definition of a reporting corporation was expanded to include 100% foreign- owned disregarded entities. This applies to tax years of entities beginning on or after 1 January 2017.
Who needs to file i.e. the Reporting Corporation?
There are three types of reporting corporations
a. New to 2017 tax year – 100% Foreign-Owned Domestic Disregarded Entities (including US LLCs)
These entities are disregarded for U.S. income tax purposes (unless they make an election to be taxed as a corporation). The LLC does not file a U.S. return at the entity level (as the income is reported by the 100% foreign owner on their U.S. return). These entities will now need to apply for an employer identification number (EIN) in order to complete the form. The owner of the LLC must now complete Form 5472 by the due date.
For example: Mr. X is a Canadian resident individual taxpayer who owns U.S. real estate in Orlando through a Florida LLC. He owns 100% of the LLC. Since Mr. X owns the LLC 100% (and assuming that he did not make an election for the LLC to be taxed as a corporation), Mr. X will report the gross income and expenses, from the U.S. real estate, on his U.S. personal income tax return, Form 1040NR, “U.S. Nonresident Alien Income Tax Return”. He was not required to file Form 5472 (as the LLC was a disregarded entity for tax purposes).
New rules: While Mr. X can continue to file Form 1040NR, to report the income and expenses from the U.S. real estate (the LLC still being a disregarding entity for income tax purposes), the LLC is no longer disregarded for purposes of Form 5472. The LLC now meets the definition of a reportable corporation. Mr. X will now be responsible to complete and file Form 5472 on behalf of the U.S. LLC. He will also be required to obtain an Employer Identification Number (EIN) for the LLC.
b. 25% Foreign-Owned Domestic Corporation (Form 1120 Filers)
A foreign corporation that is at least 25% foreign- owned (measured by votes or value of all classes of stock) that has a “reportable transaction during the year”. Attribution and constructive ownership rules will apply in determining the 25% threshold. While certain exceptions do apply, the IRS has in the past disregarded formal arrangements to shift voting-control, and takes a substance over form approach.
c. Foreign Corporations with U.S. Trade or Business (1120-F filers)
A foreign corporation engaged in a trade or business in the United States at any time during the year including foreign corporations that are partners in a partnership engaged in a U.S. trade or business. Certain exceptions apply to corporations that do not have permanent establishment in the U.S. (under applicable treaty).
What is a reportable transaction?
A reportable transaction is any monetary and certain non-monetary transactions that occur between the reporting corporation, the 25% foreign owner and any foreign or domestic party related to the owner. These transactions include, but are not limited, to sales of inventory, sale of property, cost sharing arrangements, rents, royalties, management fees, commissions, loans, capital contributions, distributions, services provided etc.
When is the form due?
Form 5472 should be attached to the reporting corporation’s income tax return and is due at the same date as the return itself (including extensions). A $10,000 penalty maybe assessed to the reporting corporation for non-compliance. The penalty applies to late, improperly filed and incomplete filings. In certain cases criminal penalties may also apply. Disregarded entities with no current filing obligation will need file a pro-forma Form 1120 and attach Form 5472 to it, by the due date of Form 1120 (15th day of the 4th month after the year end or April 15th, 2018)
How we can help?
At Cadesky U.S. Tax we understand what these rules are and how they may impact you or your clients. To determine whether this form applies to a corporation owned by or related to you please do not hesitate to contact us.
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The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.