The Internal Revenue Service and the Department of Treasury are moving ahead with new rules that will greatly expand the reporting and disclosure requirements for payments made to foreign financial institutions—but they are also taking unusual steps to solicit public comment on the new rules along the way.
The request for comment is the first formal communication from the IRS to taxpayers since Congress passed the Hiring Incentives to Restore Employment Act on March 18. The HIRE Act includes a provision titled the Foreign Account Tax Compliance Act (FACTA), aimed at finding offshore accounts used to shelter income from U.S. tax. Its intention is to identify tax cheats, but it may also be a potential compliance headache for U.S. businesses with foreign operations swept up in the reporting requirements.
During an April 13 Webcast on compliance with the law, Dominick Dell’Imperio, a partner at PricewaterhouseCoopers, said the provisions “leave the Treasury with a lot of latitude to provide regulations.” At the end of the day, he said, FATCA “is just another tool in the arsenal of the IRS to ensure compliance.”
At issue is the addition of a new Chapter 4 to the federal tax code that requires foreign financial institutions—banks, private equity and hedge funds, and qualified intermediaries, for example—to report information about their U.S. account holders. “U.S. account” is defined as any financial account held by “specified” Americans or American-owned foreign entities. Those entities can include:
Publicly traded corporations;
Regulated investment companies such as banks, real estate investment trusts, and mutual funds;
Tax-exempt organizations;
Individual retirement plans;
Certain charitable or partially charitable trusts;
Common trust funds; and
The United States itself, any of the 50 states, or any of their government agencies.
Failure to comply with the law carries tough consequences: a 30 percent withholding tax on not only U.S. income, but also on gross proceeds from sales of assets that would generate U.S. income. Then comes a 40 percent penalty—up from 20 percent—on the amount of any understatement of tax attributable to an undisclosed foreign financial asset, and penalties as high as $50,000 on U.S. taxpayers who own at least $50,000 in offshore accounts or assets but fail to report them on their tax returns.
The provision ‘leaves the Treasury with a lot of latitude to provide regulations.’
—Dominick Dell’Imperio,
Partner, Tax Practice,
PricewaterhouseCoopers
Critics say that FATCA’s compliance burdens will turn off foreign entities from investing in the United States or with U.S. citizens, but “that’s not the whole story,” Dell’Imperio said during the Webcast. “If you’re a true multinational entity, it’s going to be very hard to avoid the U.S. in its entirety,” he said.
Still, Maria Murphy, a director of the IRS service team at PwC, stressed that the real targets are errant taxpayers, not foreign lenders. John Mattos, another tax partner at PwC, noted that FACTA gives the Treasury Department “quite a bit of discretion” to determine which companies or classes of payments pose a low risk of tax evasion, and may be exempt from Chapter 4 withholdings.
And as Compliance Week previously reported, the 30 percent withholding also doesn’t apply to a foreign financial institution that enters into an agreement with the IRS and satisfies certain reporting requirements. These include:
Obtaining information from U.S. account holders to determine which are U.S. accounts;
Deducting and withholding a 30 percent tax on any “pass-thru payment” to “recalcitrant account holders” or other foreign financial institution that don’t comply;
Complying with IRS information requests;
Attempting to obtain a waiver of applicable bank secrecy or other information disclosure limitations or close the U.S. account; and
Complying with any required due diligence or verification procedures.
Exactly what the IRS expects of due diligence and verification procedures has yet to be seen. Murphy said she anticipates the procedures to be similar to what is currently in the qualified intermediaries regime, “but of course, only time will tell,” she said.
Other Amendments
FATCA also doubles the statute of limitations for substantial omissions of gross income (exceeding $5,000 attributable to offshore assets) from three to six years. This is an area where people will likely ask for more guidance, Dell’Imperio predicted. He said some people believe that the extension applies only to transactions that omitted required information; in fact, FACTA clarifies that the extension applies to the entire return, beyond any connection to the missing information.
FATCA also addresses “dividend equivalent” payments, an area that both Treasury and Congress have been “extremely concerned about in recent years,” said Ann Fisher, another PwC tax partner. Dividend equivalents are any payments made that are directly or indirectly contingent upon, or determined by reference to, U.S. source dividends, and that are either substitute dividends under securities lending or sale-repurchase transaction or made under certain notional principal contracts, such as swaps. Under FATCA, a dividend equivalent will be treated as a dividend from U.S. sources, and therefore will be subject to non-resident withholding and FATCA withholding.
First Steps
FACTA FACTS
The following excerpt from the PwC Webcast provides the key points of FACTA:
Generally, FATCA provides:
Reporting and withholding on certain foreign accounts
Disclosure of information on foreign financial assets
Increasing the statute of limitations in a number of scenarios
Repeal of certain foreign exceptions to registered bond requirements
Authority to the Treasury Secretary to expand electronic filing of information returns
Treatment of substitute dividends and dividend equivalent payments received by foreign persons as dividends
Amounts subject to the new withholding regime include gross proceeds from the sale of securities that produce U.S. source dividends or interest
Source
What Financial Services Companies Need to Know (April 13, 2010)
Ultimately, the implications of Chapter 4 will depend upon what goes into the IRS’s forthcoming guidance. Dell’Imperio said many companies will likely struggle with making the information about their U.S. account holders available at the end of the year—which means tax compliance executives should start thinking today about how the guidance may apply to them, he warned. That, in turn, should color your thinking about what changes or comments you may want to submit to the IRS during its comment period, he said.
Companies should consider these questions, Dell’Imperio said: Am I a foreign financial institution? Who do I do business with that’s a foreign financial institution? What kind of withholdable payments do I make? Can I find where these U.S. account holders are?
Then look at your systems: What stored data do you have in your systems to tell who your U.S. account holder are? Are you allowed to file your return electronically, as granted by the IRS? Many who are used to filing in paper form will find that change challenging, Dell’Imperio said.
In the end, Dell’Imperio said, if the United States succeeds with the results of these changes, more countries will follow in its path with similar types of regimes. With the gloomy economy and revenue shortfalls everywhere, it’s “inevitable” that other nations will mull whether that’s the route they want to take as well.
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