Why is this Topic Important to Wealth Managers? Continues the discussion on what FATCA is and how it will affect clients including a number of topics of current interest with regards to this new legislation.

The Federal Government has estimated that the “United States loses an estimated $345 billion in tax revenues each year as a result of offshore tax abuses primarily from the use of concealed and undeclared accounts held by U.S. taxpayers or their controlled foreign entities.” [1]

In consideration of the goal of eliminating this gap, “it is not surprising that the government recently ratcheted up its pressure on taxpayers who structured their activities, in many cases, with the active help and assistance of promoters and facilitators to avoid reporting their taxable income on their tax returns or hide these offshore accounts from the government.” [2] This increased “pressure” came in the form of the HIRE Act passed in the first quarter of 2010. [3]

As was discussed earlier this week,[4] the new law provides for reporting requirements by foreign financial institutions with U.S. accountholders about the status, specifically identity and balance, of their account. [5]

“The touchstone of the new law is to impose upon a foreign financial institution a 30-percent withholding tax if it fails to provide the information required under the so-called ‘Code Sec. 1471(b)’ agreement.” [6] The agreement is between a foreign financial institution and the IRS which states the financial institution will comply with reporting requirements generally regarding U.S. taxpayers and the IRS will not enforce a 30% withholding tax on payments by U.S. persons to the financial institution. [7]

A foreign financial institution means a foreign entity that (i) accepts deposits in the ordinary course of a banking or similar business; (ii) holds financial assets for the account of others as a substantial portion of its business; or (iii) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities interests in partnerships, commodities or any interest (including a futures or forward contract or option) in such securities, partnership interests or commodities. [8] This broad definition includes not only traditional banks, but could also include but is not necessarily limited to, insurance companies, investment trusts, mutual funds, hedge funds and pension plans. [9]

“The idea behind the new regime is to coerce foreign financial institutions to report information about their U.S. customers and account holders to the IRS.” [10] To avoid the withholding tax by the U.S. withholding agent on payments made to foreign financial institutions, “a foreign financial institution can elect to comply with ‘Form 1099’ reporting after applying the assumption that each account holder who is a specified U.S. person or a U.S.-owned foreign entity is a U.S. citizen.” [11]

Interestingly, because information disclosure and compliance is sought from international financial entities that themselves may not be subject to U.S. law or tax, “the information reporting cannot be mandated in a rule of law but must be incentivized”, and hence the 30% withholding, which occurs for non complying foreign financial institutions at the U.S. source by the withholding agent (who are subject to U.S. law and tax). [12]

Moreover, the new law provides that “a withholding agent will be required to withhold 30 percent” from most payments made to “a nonfinancial foreign entity that fails to obtain from the beneficial owner or the payee a certification that the beneficial owner does not have any substantial U.S. owners, or otherwise satisfies the information reporting requirements”. [13] This obligation of the new law, like that to foreign financial institutions, “is intended to require a nonfinancial foreign entity receiving U.S.-source income to report information about its beneficial owners to the IRS.” [14]

Commentators are now suggesting that the above described, incentivized, “‘foreign tax piggy-back legislation’ can be just as invasive as the U.S. model.” [15] In other words, since the U.S. is now asking to know the identities and account balances of Americans that own U.S. accounts, a foreign financial institution will have to know whether or not its accounts are owned by U.S. persons, or if the intended beneficiaries are U.S. persons.  “To that end, [foreign entities] will be asking global account owners to certify or provide documentation acceptable to the Treasury whether they are specified U.S. persons.” [16]

Tomorrow’s blogticle will continue the discussion of international tax compliance.

We invite your questions and comments by posting them below, or by calling the Panel of Experts

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[1] CCH. Taxes—The Tax Magazine. July 2010. At 28. Citing, Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance, U.S. Department of the Treasury, July 8, 2009; U.S. Senate, Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, Tax Haven Banks and U.S. Tax Compliance, Staff Report (July 17, 2008).

[2] CCH. Taxes—The Tax Magazine. July 2010. At 28

[3] Hiring Incentives to Restore Employment Act. H.R. 2847. 2010. (available: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h2847enr.txt.pdf)

[4] AdvisorFYI: How Foreign Account Tax Compliance Act May Impact Your Business and Clients

[5] See generally Section 1471. HIRE Act. H.R. 2847. 2010.

[6] CCH. Taxes. At 40.

[7] See generally Section 1471. HIRE Act.

[8] Section 1471(d)(5). HIRE Act.

[9] Deloitte Touche Tohmatsu. Aisa Pacific Dbref- U.S. FATCA Requirements.  October 2010.

[10] CCH. Taxes. At 40.

[11] Id.

[12] Id. at 41.Citing, New York State Bar Association Tax Section comments dated January 10, 2010, entitled, Comments on the Foreign Account Tax Compliance Legislation (hereinafter “NYSBA Tax Section Comments”).

[13] CCH. Taxes. At 41.

[14] Id.

[15] Id.

[16] Id.

Why is this Topic Important to Wealth Managers? Discusses legislation passed earlier this year that affects wealth managers whose clients have offshore accounts.  This discussion is presented so that wealth managers have more than enough time to discuss alternative solutions to meet long-term planning objectives.

During the first quarter of 2010, President Obama signed into law H.R. 2847, the Hiring Incentives to Restore Employment Act. “The act provides incentives for job creation, but in order to pay for the incentives, the act also contains significant changes that will affect foreign financial institutions that choose to do business with U.S. persons.” [1] Half of the “U.S. Congressional Record that contains the act” is “dedicated to foreign account tax compliance.” [2]

Therefore, “although the act is commonly referred to as the HIRE Act for its focus on job creation, one of its main purposes is to target tax dodgers’ use of foreign accounts.” [3] The act is basically a model of the 2009 Foreign Account Tax Compliance Act (FATCA) which was introduced by the Senate.   “The act incorporates substantially all of FATCA, with one important exception: FATCA would have imposed reporting requirements on material advisors, including attorneys, accountants, and other professionals, who advise on acquisitions or formations of foreign entities.” [4]

One professional journal states “[a]lthough this provision did not make it into the act, practitioners should take note that the U.S. Congress and the U.S. Treasury tried to bring attorneys, accountants, and other professionals into their information gathering police force.” [5]

“The focus of the foreign account compliance provisions of the act is to increase transparency in the international banking world.” [6] “[T]ax dodgers conceal billions of dollars in assets within secrecy-shrouded foreign banks, dodging taxes and penalizing those of us who pay the taxes we owe.”[7]

The Act specifically creates a new 30 percent withholding tax on “withholdable payments” on foreign financial institutions with U.S. account holders. [8]

Foreign financial institutions may avoid the 30 percent withholding tax, as it relates to “witholdable payments”, by either 1) entering into a reporting agreement with the IRS, or 2) be deemed to have met the reporting requirements. [9] The new withholding tax comes into effect on January 1, 2013. [10]

To avoid the withholding, a foreign financial institution will be required to report with respect to “each U.S. account maintained by such institution: 1) The name, address, and TIN of each account holder; 2) account number; 3) account balance; and 4) gross receipts and gross withdrawals from the account.” [11]

A similar provision in the Act creates a similar withholding tax and reporting, albeit a somewhat less intensive, scheme for nonfinancial foreign entities. [12]

In addition, the Act creates new reporting requirements for individuals and domestic entities. The new law states that “[a]ny individual who holds an interest in a ‘specified foreign financial asset’ must attach to his or her tax return certain information if the aggregate value of all such assets exceeds $50,000.” [13] A specified foreign financial asset generally means a financial account held in a foreign financial institution or any stock or security or interest in a foreign entity. [14]

The IRS has increased the statute of limitations to six years instead of the normal three, along with the “normal 20 percent underpayment penalty to 40 percent for any portion of an underpayment that is attributable to any undisclosed foreign financial asset.” [15]

“The act will increase transparency in the international financial world, but at increased compliance costs by foreign financial institutions.” [16] It is no surprise given the experience of domestic financial institutions’ efforts to comply with financial reporting measures, that foreign institutions will “likely need to spend significant sums of money to create operating systems to comply with the act.” [17] The Federal government has created an ultimatum for foreign financial institutions; “[t]his bill offers foreign banks a simple choice — if you wish to access our capital markets, you have to report on U.S. account holders.” [18]

Experience has already shown that “[s]ome foreign financial institutions may determine that the cost of compliance will outweigh the benefits of managing U.S. account holders” and therefore the “banks no longer want to manage U.S. accounts and have forced the clients out of their institution, notwithstanding the clients’ significant account balances.” [19]

“In addition, in order to avoid complications, some foreign financial institutions will likely avoid investing in U.S. stocks and bonds altogether. Thus, an unintended result of the act may be to drive capital away from the United States to more user-friendly jurisdictions.” [20]

“In summary, the act creates significant legislation that will affect almost every foreign financial institution. The act is also a significant step toward a more transparent international financial world.” [21]

The new individual reporting requirements are in addition to the required FBAR report, which is the topic of tomorrow’s blogticle.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Abrahm W. Smith.  Florida Bar Journal.  84-AUG Fla. B.J. 52

[2] Congressional Record — Senate, February 11, 2010 (Tax Analyst Doc. 2010-3117).

[3] 84-AUG Fla. B.J. 52

[4] Id.

[5] 84-AUG Fla. B.J. 53

[6] Id.

[7] Id. Citing, Statement by Senator Carl Levin, D-Mich, made on March 17, 2010, with respect to the act.

[8] 26 U.S.C. §1471.

[9] 26 U.S.C. §1471.

[10] Id.

[11] Id.

[12] 26 U.S.C. §1472.

[13] Id.

[14] 26 U.S.C. § 6038D.

[15] 84-AUG Fla. B.J. 53-54.

[16] 84-AUG Fla. B.J. 55.

[17] Id at 56.

[18] Id. Citing, Statement by the Global Financial Integrity in response to the act, dated March 19, 2010.

[19] 84-AUG Fla. B.J. 56. Citing, Senator Rangel. (United States Congress News Release, dated October 27, 2009).

[20] 84-AUG Fla. B.J. 56.

[21] Id.