In a paper I presented to the BNA Tax Management Advisory Board Meeting on August 20, 2009, on President Obama's International Tax Enforcement Proposals, I highlighted and analyzed a number of President Obama's international tax enforcement proposals as described in the Green Book.1
Here is an abbreviated and updated version.
1. A QI would be required to identify and report on U.S. beneficial owners and to do Form 1099 reporting with respect to both U.S.- and foreign-source income of such persons. In addition, in order for any one affiliate within a commonly controlled group to be a QI, each entity within the group must agree to either report on the existence of any U.S. beneficial owners or agree to become a QI itself.
2. With exceptions for low-risk situations and exceptions for possible capital markets disturbances, payments of fixed or determinable annual or periodical income (FDAP) to non-QIs would suffer 30% withholding, subject to refund.
3. Payments of “gross proceeds” to non-QIs located in jurisdictions with which the United States does not have a satisfactory comprehensive income tax treaty would suffer 20% withholding, subject to refund.
4. With exceptions for public companies, widely held investment vehicles, and entities engaged in active trades or businesses, payments of FDAP to foreign entities would be subject to 30% withholding unless the foreign entity discloses its U.S. beneficial owners.
5. U.S. persons (or their controlled entities) would be required to report on transfers to or receipts from foreign financial accounts (with the exception of transfers to or from QIs).
6. U.S. persons would be required to disclose FBAR information directly on their tax returns (in addition to the normal June 30 separate FBAR filing).
7. All financial institutions and QIs would be required to report on the establishment of foreign financial accounts and on transfers and disbursements to and from such accounts.
8. There would be a presumption in civil and administrative proceedings that a foreign financial account contains enough funds to warrant the filing of an FBAR.
9. With exceptions for officers and directors with a de minimis financial interest in the account, there would be a presumption that the failure to file an FBAR with respect to an account held with a non-QI is willful if the account contains over $200,000.
10. The accuracy-related penalty would be doubled to 40% if the understatement relates to a foreign financial account.
11. All U.S. persons and QIs would be required to report on the establishment of an offshore entity on behalf of a U.S. person (or his/her controlled entity).
12. The special §6501(c)(8) statute of limitations would be increased from three to six years after the filing of the relevant information return, which would also include returns made with respect to a QEF election, and proposed information returns with respect to foreign financial accounts.
13. There would be increased penalties with respect to transfers to foreign trusts.
Many of these proposals are “no-brainers.” It's hard to imagine any credible arguments being made opposing the various self-certifications and filings, except for an argument that the proposals result in duplicative and time-consuming information return requirements. On the other hand, third-party information return requirements, although a reliable cross-check initiative for self-certification, can readily be seen as costly and burdensome.
In the case of QIs, requiring 1099 reporting on both U.S.-source and foreign-source income of U.S. owners can be seen as an extension of the duties and obligations that the QIs had not originally bargained for. Indeed, the foreign financial institution QIs have argued that the QI Agreement should not be used as a tool to enforce U.S. tax laws.
This is a big-ticket issue for the IRS given the potential under-reporting by U.S. taxpayers. In fact, this is a key driver in the proposal to require all commonly controlled entities to report on U.S. beneficial owners or to become QIs themselves in order for any one QI in the group to maintain its status as such. The IRS is quite concerned that customers of a QI could be steered to non-QI affiliates who would not be required to report on U.S. beneficial owners, especially because, in that case, the proposals for 30% withholding on FDAP paid to non-QIs and for 20% withholding on gross proceeds paid to certain non-QIs would be levied only with respect to U.S.-source income. Thus, the potential for unreported foreign-source income could be enormous.
The second area, that of 30% withholding on FDAP and 20% withholding on gross proceeds, is a clear departure from our current self-certification system and has the potential to be quite disruptive to the free and easy flow of capital markets transactions, as well as one heck of a nightmare. In addition, the 20% withholding on gross proceeds would significantly impact foreign investors who hold their investments in non-QIs and for whom gross proceeds withholding is not normally required. This would be a tremendous inconvenience and would certainly rattle the marketplace.
It should be quite clear even to the uninitiated that the aggregate of these QI proposals would have an overall effect of forcing foreign financial institutions to “go QI.” To be sure, under the Obama proposals, what once was a benefit to becoming a QI is now turning into a detriment of not becoming a QI. The focus has shifted significantly under these proposals.
Subsequent to the delivery of my paper, the Congressional Joint Committee on Taxation released its report (“Report”) on the Green Book proposals.2
A number of the concerns expressed in the Report echo those highlighted above.
For example, the Report, while clearly supportive of many of the proposals, acknowledges:
• the need for a transition period before many of the proposals would become effective;
• the significant administrative burdens on QIs with the potential for foreign financial institutions to leave the QI system altogether;
• that the costs of compliance could be determined by QIs to outweigh the benefits of remaining in QI status;
• that a more limited and simplified set of reporting requirements for QIs should be implemented;
• that requiring all commonly controlled affiliates to become QIs may be unduly burdensome for smaller financial institutions or those with a relatively small number of U.S. customers;
• that a case-by-case ad hoc approach to those issues would be more appropriate;
• that in determining and reporting on “beneficial owners,” a workable approach to the due diligence and information gathering process should be adopted to contain costs and burdens to the QIs while, at the same time, providing the IRS with the ability to track potential U.S. tax evasion;
• that the departure from our current “relief at source” rules in favor of a refund procedure in the case of FDAP and gross proceeds payments to certain non-QIs be thought through carefully in terms of their effect on the capital markets and their creation of a disincentive for foreign investment into the United States (especially in the areas of bearer bonds, commercial paper, and bank deposits); and
• that withholding on gross proceeds paid to certain non-QIs could have a significant adverse effect on non-U.S. persons in terms of timing, delays, compliance costs, etc.
A number of the concerns reflected in the Report, as well as those articulated by interested parties, seems to have come to a head in the latest iteration of international tax enforcement. On October 27, 2009, Senator Max Baucus (D-Mont.) and Representative Charles Rangel (D-N.Y.) introduced the Foreign Account Tax Compliance Act of 2009 (H.R. 3933, S. 1934) (the “Bill”) in the U.S. Congress. The Bill is a new version of legislation that incorporates some, but not all, past proposals contained in President Obama's 2010 Budget proposals, the Stop Tax Haven Abuse Act introduced by Senator Carl Levin (D-Mich.) and Representative Lloyd Doggett (D-Tex.), and draft legislation released by Senator Baucus targeting individuals and corporations that shelter income and assets overseas. According to a statement released by the House Ways and Means Committee, the Bill “is intended to clamp down on tax evasion and improve taxpayer compliance by giving the IRS new administrative tools to detect, deter and discourage offshore tax abuses.”
Conspicuously absent from the Bill are provisions dealing with reporting of offshore asset transfers, Foreign Bank and Financial Accounts Report (FBAR) matters, a blacklist of offshore secrecy jurisdictions, treatment of foreign companies as domestic companies if they are managed from the U.S., and the codification of the economic substance doctrine (some of which, however, appear in pending health care bills).
The Bill has taken a number of cues from the comments received in response to the Green Book proposals. For example, under the Bill, QIs would no longer be required to do 1099 reporting. In addition, affiliates would not, themselves, be required to enter into QI Agreements in order for any one affiliate group member to be a QI. Also gone is the automatic 20% and 30% withholding on gross proceeds and FDAP paid to non-QIs. However, in its place, the Bill forges ahead with mandatory 30% withholding on payments of both FDAP and gross proceeds to certain foreign financial institutions and foreign entities which fail to enter into an agreement to report U.S. account holders.
The Bill would impose withholding tax on payments made to foreign financial institutions and other foreign entities that do not disclose holdings by U.S. persons (or foreign entities owned by certain U.S. persons) and would create several new information-reporting requirements. A key feature of the legislation is the requirement that foreign financial institutions report information about U.S. account holders or face a 30% withholding tax on FDAP and gross proceeds from sales of assets that would generate U.S.-source income. Stephen Shay, Treasury deputy assistant secretary for international tax affairs, characterized the Bill's approach as an “alternative to a blacklist approach”: Rather than focusing on specific countries in terms of tax haven activity, the Bill focuses directly on foreign financial institutions and other foreign entities, offering them incentives and possible penalties depending on their individual actions regarding tax evasion.
The Bill would:
• require foreign financial institutions and their affiliates (including Qualified Intermediaries) to enter into an agreement with the IRS pursuant to which they would be required to provide the identity of U.S. individuals or foreign entities with “substantial U.S. owners” (i.e., U.S. persons owning directly or indirectly more than 10% of the foreign entity) that maintain financial accounts, provide relevant account information, comply with verification and due diligence procedures, and report annually certain information to the Treasury or face a 30% withholding tax on withholdable payments;
• define withholdable payments to include not only FDAP income from U.S. sources, but also gross proceeds of sales of any income-producing assets from U.S. sources;
• permit withholding agents to rely on certification provided by an account holder so long as there is no reason to know (rather than no actual knowledge) that the information is incorrect;
• require non-financial institutions to provide withholding agents with the name, address, and tax identification number of any U.S. individual with more than 10 percent ownership in the entity or face a 30 percent withholding tax;
• eliminate the favorable tax treatment for bearer-bonds marketed to offshore investors, and stop the issuance of bearer bonds by the U.S. government;
• impose penalties as high as $50,000 on U.S. taxpayers who own at least $50,000 in offshore accounts or assets but who fail to report the assets on their annual income tax return;
• levy a 40% penalty rather than the usual 20% on the amount of any understatement attributed to undisclosed foreign assets;
• extend from three years to six years the statute of limitations for “substantial” omissions of income exceeding $5,000 attributable to offshore assets;
• require “material advisers” to disclose the identities of any clients they assist in buying offshore assets, as well as the assets purchased;
• require shareholders in passive foreign investment companies to file annual returns;
• make it easier for the Treasury to presume that foreign trusts have U.S. beneficiaries, and establish a $10,000 minimum failure-to-file penalty for certain foreign-trust-related information returns; and
• subject dividend equivalent payments included in notional principal and similar types of contracts that are paid to overseas companies to the same 30% withholding tax levied on dividends paid to foreign investors.
Treasury Secretary Timothy Geithner endorsed the measure, saying in a release that it “fits well into the Administration's dual-track strategy of improving our domestic tax laws while increasing global cooperation on tax information exchange.” But some lawmakers suggested that the Bill, as written, would not go far enough in curbing abusive offshore transactions.
The proposed legislation would dramatically change the withholding tax rules as we know them today. It remains to be seen whether this or an amended version will properly balance the needs of the government to chase U.S. tax evaders and the needs of foreign financial institutions and other foreign entities to have workable guidelines at a minimum of cost and burden. Given the enormous administrative burdens and costs and challenges pursuant to making the Bill's provisions manageable, these foreign institutions and entities could ultimately respond by opting out of the system (and disinvesting from the U.S. for purely commercial reasons), causing major disruption in the U.S. capital markets.
This commentary also will appear in the December 2009 issue of theTax Management International Journal. For more information, in the Tax Management Portfolios, see Tello, 915 T.M., U.S. Withholding and Reporting Requirements for Payments of U.S. Source Income to Foreign Persons, and in Tax Practice Series, see ¶7150, Withholding and Compliance.
Treasury Department, General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals
(May 11, 2009).