Seeking Clarity from the IRS for Foreign Entities

Today we welcome first-time guest blogger R. D. David Young of RDDY Consulting LLC. David specializes in transaction structuring and global tax planning. Here David explains IRS’s planned changes to the EIN application process, and proposes clarifications that would be helpful for foreign entities in need of an EIN. Christine

As the IRS prepares to update its Employer Identification Number (EIN) application process to enhance security, it should also update the process to add some needed clarity for foreign entities.

read more...

The IRS announced on March 27, 2019 that it is revising its EIN application process to enhance security. As part of that process, the IRS indicated that starting May 13 only individuals with tax identification numbers may request an EIN. The announcement indicated that the change will provide greater security to the EIN application process by prohibiting entities from being “responsible parties” and using their own EINs to obtain additional EINs. Interestingly, since December 2017, the only entities that have been permitted to utilize their own EIN to obtain additional EINs are government entities, so it is unclear what security issue the IRS is seeking to address.

Clarification for Responsible Parties Ineligible to Obtain SSN or ITIN

While the details of the specific changes to the EIN application process aren’t yet available, if the revised process will truly allow only individuals with tax identification numbers to request an EIN as the responsible party, the revised process could make obtaining EIN’s more challenging for many foreign entities. Under the current EIN application process, if a responsible party of an entity does not have and is ineligible to obtain a social security number (SSN) or individual taxpayer identification number (ITIN), as is the case for responsible parties of many foreign entities, the instructions provide that they should leave line 7b (which requests the SSN, ITIN, or EIN of the responsible party) blank. It is possible that the IRS will continue to allow a responsible party that does not have and is ineligible to obtain an SSN or ITIN to leave line 7b blank, but clarification on this point would be welcomed.

Clarification of “Foreign Equivalent” of a Limited Liability Company

While the IRS is revising the EIN application process, another clarification that would be welcomed is with respect to the definition “foreign equivalent” of a limited liability company. Line 8a of Form SS-4 asks the question, “Is this application for a limited liability company (LLC) (or a foreign equivalent)?” The term “foreign equivalent” is not defined in the instructions to Form SS-4 and an applicant is instructed to “see Form 8832 and its instructions.” Unfortunately, instructions to Form 8832 are no more enlightening.

The instructions to Form 8832 correctly provide that a foreign eligible entity’s default characterization is an association taxable as a corporation if all members have limited liability, and either a disregarded entity or a partnership if the single owner, or at least one member, does not have limited liability, respectively. However, the term “foreign equivalent” does not appear in the instructions to Form 8832, leaving one to divine what the IRS means by its use of the term “foreign equivalent” on Line 8a of Form SS-4.

Since the hallmark of an LLC formed in the United States is generally that no member is obligated personally for any liability of the LLC solely by reason of being a member of the LLC, one would be reasonable in concluding that the “foreign equivalent” of a domestic LLC must be a foreign entity in which no member is obligated personally for any liability of the foreign entity solely by reason of being a member of the foreign entity.  Applying the default classification rules to such an entity results in such “foreign equivalent” being treated as an association taxable as a corporation. However, where such a foreign entity (such as a Cayman Islands LLC or a UK Private Limited Company) intuitively answers “yes” to Line 8a and identifies the appropriate default classification of such an entity as a corporation on Line 9a, such entity will be surprised to receive an EIN acceptance letter indicating that the IRS has assigned the entity an EIN as a disregarded entity or a partnership depending on the number of members.

Surprisingly, when processing Forms SS-4, the IRS interprets the term “foreign equivalent” to refer to a foreign eligible entity in which the single owner or at least one member does NOT have limited liability (precisely not the “equivalent” to a domestic LLC). The IRS appears to interpret “foreign equivalent” to mean a foreign eligible entity that has a default classification that is equivalent to the default classification of a domestic LLC. This interpretation ignores the fact that the default classification of a foreign eligible entity in which all members have limited liability is not equivalent to the default classification of a domestic LLC in which all members have limited liability.

Given that the IRS applies such a strained and counterintuitive interpretation of the term “foreign equivalent” to processing applications for EINs, the IRS should update the instructions for Form SS-4 to clearly explain that the IRS interprets the term “foreign equivalent” to mean a foreign eligible entity in which the single owner or at least one member does NOT have limited liability.