In the 2009 Tax Extenders package proposed last December in the US, Congressional leaders included a novel legislative approach to dramatically curtail tax evasion by wealthy US investors. The legislation was proposed by key leaders of the House Ways and Means and Senate Finance committees, who were intent on action in the wake of the UBS scandal in which the Swiss bank admitted to aiding US individuals in hiding more than $20bn in offshore accounts.
The language included in the Extenders Bill draws heavily from an October 2009 bill dubbed the Foreign Account Tax Compliance Act of 2009, or Fatca. The surviving Fatca provisions include a significant withholding tax on foreign financial and non-financial entities that refuse to disclose detailed client account information and the identity of substantial US shareholders. The Extenders Bill also includes rules intended to end the issuance of bearer bonds by US issuers.
Rather than expend precious resources trying to identify unknown evaders or impose new sanctions to punish them, the Fatca provisions protect the US Foreign Intelligence Surveillance Court by exacting a withholding tax on foreign financial institutions that enable US taxpayers to hide their money offshore without the fear of disclosure to the Internal Revenue Service (IRS).
The mechanism used to plug the leak is a 30% withholding tax on US source fixed, determinable, annual, periodical payments and any gross proceeds from the sale or disposition of property producing US source interest or dividends (a ‘withholdable payment’) made to foreign financial institutions that choose not to provide detailed information on their US account-holders and on other foreign entities that do not disclose identifying information regarding substantial US owners (owners with an interest greater than 10%).
The use of a withholding approach to compel disclosure is innovative and pragmatic because foreign financial institutions and other foreign entities frequently operate outside of the US taxing jurisdiction. The withholding approach addresses this jurisdictional problem because it shifts the collection burden to parties within US taxing jurisdiction (known as withholding agents) and accessible to IRS examiners.
Withholding agents have a significant incentive to comply with these rules because failure to do so causes the economic burden to shift to the withholding agent itself and, in some cases, the individual financial executives responsible for the withholding failures. Accordingly, in order for a foreign financial institution to be willing to serve US investors without making disclosures to the IRS, the financial institution must be willing to absorb a significant economic hit to its US investment yield. In this regard, the legislation creates a ‘pay-to-play’ system for foreign institutions that wish to maintain a US client base.
To avoid the withholding taxes imposed under the Fatca provisions, foreign financial institutions must agree to provide significant and detailed information to the IRS regarding their US clients and withhold a 30% tax on any pass-through payments from their own ‘recalcitrant account-holders’ (those who fail to comply with reasonable requests for identifying information).
Information to be reported on US accounts includes: the name, address and taxpayer identification number (TIN) of each account-holder; the name, address and TIN of each substantial US owner of any account-holder that is a US-owned foreign entity; the account number(s); the account balance or value; and the gross receipts and gross withdrawals or payments from the account for the period.
Foreign financial institutions may alternatively elect to report on their US account-holders as if the foreign financial institution were a US person. That is, the institution may report on each of its US account-holders – whether the account-holder is an US individual or a US-owned foreign entity – as if the account-holders were natural born US citizens. Under this approach, all amounts are subject to the standard information-reporting requirements of US financial institutions without regard to the source of the income.
In addition, foreign financial institutions making this election must also report with respect to each US account-holder: the name, address and TIN of each US individual; the name, address and TIN of each substantial US owner of any account-holder that is a US-owned foreign entity; and the account number.
Foreign financial institutions may utilise other approaches to comply with these rules, such as electing to have all withholdable payments subjected to withholding or entering into an agreement with the IRS not to maintain US accounts.
Non-public, non-financial foreign entities must agree to separate disclosure requirements under the Fatca provisions, or similarly face 30% withholding on withholdable payments. In particular, non-financial foreign entities must either certify that they do not have any substantial US owners (a greater than 10% owner) or report the name, address and TIN of each substantial US owner to the withholding agent.
The Fatca reporting provisions with respect to withholdable payments apply to payments made on or after January 1, 2013. The Fatca provisions effectively end the issuance of bearer bonds by US issuers. These restrictions apply to all US issuers (including the US government) and will apply to obligations issued two years after the date of enactment of the Extenders Bill. The operative provision repeals an exception under current law that allows interest deductions for bearer bonds targeted towards foreign investors.
Budgetary pressure has caused Congress and the IRS to consider pragmatic approaches to close the US tax gap. The methods to be employed include increased enforcement of existing withholding and reporting rules for outbound payments of US source income as well as the rules included in the Fatca provisions of the Extenders Bill. The result will be more onerous yet more effective enforcement.
Michael M Lloyd is an attorney at Miller & Chevalier Chartered, practising in the areas of tax and employee benefits.
Compliance with proposed Fatca provisions
If the Extenders Bill passes in its current form, foreign financial institutions and other foreign entities face detailed disclosure rules beginning January 1, 2013, or face a 30% withholding tax. Generally, information required to be reported by foreign financial entities regarding their US account-holders includes the following:
- The name, address and taxpayer identification number (TIN) of each account-holder;
- The name, address and TIN of each substantial US owner (a greater than 10% owner) and of any account-holder that is a US-owned foreign entity;
- The account number(s) for each account-holder;
- The account balance or value; and
- The gross receipts and gross withdrawals or payments from the account for the period.
Similarly, any non-public, non-financial foreign entity must agree to either:
- Certify that it does not have any substantial US owners; or
- Report the name, address and TIN of each substantial US owner.