The stripped down Reid jobs bill contains the Foreign Account Tax Compliance Act as a revenue offset to the tax credits contained elsewhere in the bill. The Reid bill, the Hiring Incentives to Restore Employment Act (HIRE) is included as Senate Amendment 3310 to HR 2847. This is the same Foreign Account Tax Compiance Act that the House included in its jobs bill.
The legislation creates a new reporting and taxing regime for foreign financial institutions with US account holders, whether they are participants in the existing Treasury Qualified Intermediary program or not. It casts a wide net in search of undisclosed accounts and hidden income. The legislation adds a new Chapter 4 to the Internal Revenue Code, which would essentially require foreign financial institutions to identify from among all of their customers any US persons and any US-owned foreign entities and then report to the IRS on all payments to, or activity in the accounts of, such persons.
The major focus of the legislation is tax compliance by U.S. persons that have accounts with foreign financial institutions. The legislation imposes substantial new reporting and tax withholding obligations on a very broad range of foreign financial institutions that could potentially hold accounts of U.S. persons. The reporting and withholding obligations imposed on the foreign financial institutions would serve as a backstop to the existing obligations of the U.S. persons themselves, who have a duty to report and pay U.S. tax on the income they earn through any financial account, foreign or domestic. These new reporting and withholding obligations for financial institutions would be enforced through the imposition of a 30 percent U.S. withholding tax on a very broad range of U.S. payments to foreign financial institutions that do not satisfy the reporting obligations.
The legislation provides substantial flexibility to Treasury and the IRS to issue regulations to fill in the numerous details on how the new reporting and withholding tax regime will work. It also provides Treasury with broad authority to establish verification and due diligence procedures with respect to a foreign financial institution’s identification of any U.S. accounts.
It is anticipated that thousands of foreign investment entities, including hedge funds, private equity funds, mutual funds, securitization vehicles and other investment funds, would be required to enter into agreements with the IRS pursuant to new Chapter 4. It is anticipated that implementation of new Chapter 4 will present many operational challenges and expenses for foreign financial institutions.
New Chapter 4 also provides for withholding taxes to enforce new reporting requirements on specified foreign accounts owned by specified US persons or by US-owned foreign entities. The provision establishes rules for withholdable payments to foreign financial institutions and for withholdable payments to other foreign entities.
The Foreign Account Tax Compliance Act would essentially present foreign financial institutions, foreign trusts, and foreign corporations with the choice of entering into agreements with the IRS to provide information about their U.S. accountholders, grantors, and owners or being subjected to 30 percent withholding.
The legislation would increase the disclosure of beneficial ownership. As a tax enforcement tool, U.S. financial institutions must file annual information returns disclosing and reporting on the activities of bank accounts held by U.S. individuals. Congress believes that many U.S. individuals looking to evade their tax obligations in the United States have sought to hide income and assets from the IRS by opening secret foreign bank accounts with foreign financial institutions. Some foreign financial institutions have voluntarily agreed to provide information on the U.S.-source income of U.S. accountholders as part of the Treasury’s Qualified Intermediary program since 2000.
The legislation would create a broad new definition of foreign financial institution and require that they enter into agreements with the IRS and provide annual information reporting in order to avoid a new U.S. withholding tax on U.S. source dividends, interest, and other income, as well as U.S.-related gross proceeds. It would also impose related information reporting and withholding requirements in respect of payments made to non-financial foreign entities.
The scope of application of the new regime would go beyond traditional financial institutions and cover virtually every type of foreign investment entity. The legislation broadly defines foreign financial institutions to comprise, not only foreign banks, but also 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 will also fall within the scope of this regime. The new regime also brings within its scope fund entities, and fund managers, who are not currently within the scope of the Qualified Intermediary regime.
Also affected by the legislation are typical offshore securitization vehicles that hold U.S assets and issue their own equity and debt securities, such as a collateralized debt obligation (CDO) issuer. They would presumably be considered foreign financial institutions under the legislation. As a result, such a securitization vehicle would be required to enter into an information reporting agreement with the IRS and report on U.S. holders of non-publicly traded debt and equity that it had issued, or otherwise be subject to the withholding tax on its U.S. investments. Foreign securitization vehicles currently in existence have invested billions of dollars in the United States, particularly in loans and other debt instruments issued by U.S. companies.
A typical CDO is structured as an offshore corporation that invests in loans and other debt instruments issued by U.S. companies. Such CDOs in turn issue several classes of non-publicly traded debt and equity securities themselves, which divide up the cash flows on the underlying U.S. investments. Another example of a typical securitization vehicle is a grantor trust that invests in U.S. debt or equity investments and in turn issues pass-through certificates representing the cash flows on those investments. Pass-through interests in U.S. investments could also be structured as shares of an offshore cell company.
The principal goal of the legislation is to collect tax from U.S. taxpayers who have been evading their responsibilities by investing through foreign financial institutions and foreign entities that have thus far been generally free of reporting obligations to the IRS. To achieve this goal, the legislation would impose the risk of a withholding tax on a very broad class of U.S.-related payments (including gross proceeds) to a broad class of foreign investors, unless the foreign financial institutions and foreign entities agree to provide information to the IRS regarding their U.S. account holders and owners.
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