Jobs Bill Would Establish New Reporting Regime for Foreign Financial Institutions with US Investors, Including Hedge Funds and Private Equity Funds

The Chair of the Senate Finance Committee and the Ranking Member have agreed to the Hiring Incentives to Restore Employment Act (HIRE) and this legislation is on the fast track. The tax credits in the bill would be offset by creating a new reporting regime for foreign financial institutions with US accountholders, whether they are participants in the existing IRS Qualified Intermediary program or not. This legislation casts a wide net in search of undisclosed accounts and hidden income.

The legislation contains a broad definition of foreign financial institution that goes beyond traditional financial institutions and covers virtually every type of foreign investment entity. The definition includes any foreign entity engaged primarily in the business of investing or trading in securities, partnership interests, commodities or any derivative interests therein. According to the Joint Committee on Taxation, investment vehicles such as hedge funds and private equity funds among other entities will also fall within the scope of this regime. In addition, commentators are of the view that the measures will also extend to other investment vehicles, whether widely held or privately owned.

Many large U.S. financial institutions and other U.S. issuers derive billions of dollars of funding through the issuance of short-term debt instruments (such as commercial paper) in foreign markets, to entities that would be treated as foreign financial institutions under the legislation. A typical offshore securitization vehicle that holds U.S assets and issues its own equity and debt securities would also be considered a foreign financial institution under the bill.

The legislation would impose a thirty percent (30%) withholding tax on certain income from U.S. financial assets held by a foreign financial institution unless the foreign financial institution agrees to disclose the identity of any U.S. individual with an account at the institution (or the institution’s affiliates) and to annually report on the account balance, gross receipts and gross withdrawals and payments from such account. Foreign financial institutions would also be required to agree to disclose and report on foreign entities that have substantial U.S. owners. These disclosure and reporting requirements would be in addition to any requirements imposed under the Qualified Intermediary program. It is expected that foreign financial institutions would comply with these disclosure and reporting requirements in order to avoid paying this withholding tax.

Under present law, withholding agents are not required to look-through many foreign entities to determine whether such entity is owned by a U.S. individual. This aspect of present law has allowed U.S. individuals to evade their tax obligations in the United States by setting up foreign shell corporations, partnerships and trusts and investing overseas through these shell entities. The legislation would require the U.S. withholding agent to pierce the corporate veil, i.e., look through a foreign corporation to its underlying owners

Foreign persons sometimes seek to avoid the 30% withholding tax imposed on U.S. source dividends by temporarily converting U.S. stock into an economically equivalent derivative investments such as total return swaps. The bill would prevent this by treating dividend equivalent amounts as generally U.S. source, thereby subjecting them to the withholding tax.

Some commenters understand that, under the legislation, European funds that invest in US securities will be subject to 30% withholding on gross sales proceeds and other income, such as dividends, interest unless they can either show that the new provisions are not applicable in their precise circumstances, or they comply with the requirement to report underlying US holders to the US government.

The bill would also require any individual that holds more than $50,000 (in the aggregate) in (1) a depository or custodial account maintained by a foreign financial institution or (2) any foreign stock, interest in a foreign entity, or financial instrument with a foreign counterparty not held in a custodial account of a financial institution (collectively, “reportable foreign assets”) to report information about these accounts and/or assets to the U.S. Treasury Department with the individual’s annual tax return. The Treasury is authorized to set a higher dollar amount than $50,000.

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