By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
Coming on the heels of the Foreign Account Tax Compliance Act (FATCA) and the "new era" of international tax enforcement, it did not take too long for the IRS to finalize its regulations on the reporting of bank deposit interest paid to nonresident aliens (limited in this context to individuals).
Interestingly, these regulations have had a somewhat tortured history. Prior to the finalization of the current regulations, reporting of bank deposit interest paid to nonresident aliens applied only to U.S. persons and Canadian residents.
In 2001, Treasury and IRS proposed regulations1 under §6049 that would have provided for such reporting with respect to payments made to any nonresident aliens. However, persuaded by the views of many commentators at the time that there would be significant administrative burdens that would far outweigh the additional benefits obtained by the IRS through such reporting (especially in light of the long-standing U.S. policy of exempting from tax bank deposit interest of nonresident aliens in order to encourage foreign investment in U.S. banks) and concerned that the proposed regulations could have a negative impact on the U.S. banking industry, the IRS withdrew the 2001 proposed regulations and in 2002 issued new proposed regulations2 that would require reporting with respect to bank deposit payments made to nonresident aliens of only certain designated countries (in addition to Canada).3 The theory was that this struck a good balance between improving U.S. tax compliance and permitting appropriate information exchange without imposing undue burdens on the banks.
However, in 2011, the IRS withdrew the 2002 proposed regulations and issued new proposed regulations,4 requiring once again the reporting of bank deposit interest paid to nonresident aliens of any country. To be sure, this change in mindset was attributable to FATCA and, according to the Preamble, a "growing global consensus regarding the importance of cooperative information exchange…." The IRS further stated that routine reporting of bank deposit interest to nonresidents would strengthen its exchange of information program and improve voluntary compliance by U.S. taxpayers by "making it more difficult to avoid the U.S. information reporting systems (such as through false claims of foreign status)." In April 2012, the IRS finalized its 2011 proposed regulations but, once again, added a few significant limitations and twists.5
The final regulations under Regs. §§1.6049-4(b)(5)(i) and 1.6049-8 require U.S. financial institutions to report certain deposit interest aggregating $10 or more paid to nonresident aliens, commencing on or after January 1, 2013. In response to concerns raised by interested persons about the potential misuse of information required to be reported (e.g., that deposit interest information may be shared with a country that does not have laws in place to protect the confidentiality of the information exchanged or that would use the information for purposes other than the enforcement of its tax laws), the final regulations define "interest" subject to reporting to mean interest paid on deposits as defined under §871(i)(2)(A), maintained at an office within the United States and paid to a nonresident alien who is a resident of a country that is identified as a country with which the United States has in effect an income tax or other convention or bilateral agreement relating to the exchange of tax information.
The new rules apply to deposits with commercial banks, savings institutions, credit unions, securities brokerages, and insurance companies that maintain deposit accounts for nonresident aliens. In the case of reportable interest aggregating $10 or more paid to a nonresident alien, the payor is required to file Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, for the calendar year in which interest is paid. The final regulations also clarify that a payment of interest to a nonresident alien who is subject to reporting under the final regulations is not subject to backup withholding under §3406 if the payor may treat the payee as a foreign beneficial owner or foreign payee. A payor or middleman can rely on Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, to determine where a taxpayer lives unless there is evidence that it is unreliable or incorrect.
Rev. Proc. 2012-24,6 published contemporaneously with the final regulations, provides a list of the countries whose residents will be subject to reporting under the final regulations. The revenue procedure specifically states that the listed countries are those with which the United States has in effect an income tax or other convention or bilateral agreement relating to the exchange of information pursuant to which the United States agrees to provide, as well as to receive, information, and under which the Competent Authority is the Secretary of Treasury or his delegate.
Accordingly, bank deposit information reported pursuant to the final regulations will be exchanged only with foreign governments with which the United States has an agreement providing for the exchange of information and only when certain additional requirements are satisfied. The IRS noted that, even when such an agreement exists, the IRS is not compelled to exchange information, including information collected pursuant to these regulations, if there is concern regarding the use of the information or other factors exist that would make exchange inappropriate.
The revenue procedure also includes a second list identifying the countries with which the IRS has determined it is appropriate to have an automatic exchange relationship regarding interest subject to reporting under the final regulations. The IRS currently exchanges deposit interest information on an automatic basis with Canada and will not enter into a new automatic exchange relationship with a country unless the IRS determines that an automatic exchange relationship is appropriate and the other jurisdiction is willing and able to reciprocate effectively. The revenue procedure will be updated as new income tax treaties and information exchange agreements are signed.
Residents of countries not on the information sharing agreement list published in the revenue procedure are not subject to reporting under the final regulations. However, the IRS notes that banks can elect to report interest payments to all of their nonresident alien depositors as a way to address any potential burden associated with determining which depositors are subject to reporting. Thus, residents of non-sharing countries can become subject to reporting even though their country of residence is not listed in the revenue procedure.
According to Treasury and the IRS, the extension of the reporting requirement is considered appropriate because of the importance of cooperative information exchange for tax purposes. The information gathered, as a result of information exchange relationships with other jurisdictions, can be utilized by the United States to identify potential U.S. taxpayers that evade tax by hiding income and assets offshore. Further, the reporting to the IRS of U.S. bank deposit interest supposedly paid to nonresident aliens will help improve compliance by U.S. taxpayers by making it more difficult for U.S. persons to avoid the U.S. information reporting system by falsely claiming to be nonresident aliens. Finally, and quite significantly, the revised information reporting rules are seen as critical in the context of the enactment of FATCA, which, in part, mandates that foreign financial institutions report to the IRS regarding their U.S. customers. In light of the FATCA intergovernmental framework being negotiated between the United States and certain countries that, in part, will require foreign governments to cooperate to overcome legal restraints on their resident financial institutions to identify U.S. accounts and report information to the IRS, the final regulations are important in that the new rules enable the United States to have information to trade with foreign governments that are also interested in detecting offshore tax evasion by their own residents.
This commentary also will appear in the July 2012 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Tello, 915 T.M., Payments Directed Outside the United States - Withholding and Reporting Provisions Under Chapters 3 and 4, and in Tax Practice Series, see ¶7170, U.S. International Withholding and Reporting Requirements and FATCA.
1 REG-126100-00, 66 Fed. Reg. 3925 (1/17/01).
2 REG-133254-02, 67 Fed. Reg. 50386 (8/2/02).
3 Australia, Denmark, Finland, France, Germany, Greece, Ireland, Italy, The Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, and United Kingdom.
4 REG-146097-09, 76 Fed. Reg. 1105 (1/7/11).
5 T.D. 9584, 77 Fed. Reg. 23391 (4/19/12).
6 2012-20 I.R.B. 913.
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