Link to the full Act
By Carolyn Betts
The Hiring Incentives to Restore Employment Act (“HIRE Act”) was passed by both houses of Congress and signed by the President into law on March 18, 2010. Although it is portrayed by the corporate media as primarily a jobs bill, this legislation also includes the Foreign Account Tax Compliance Act (“FATCA”), a separate bill that was introduced into Congress but not adopted in November 2009, under the section entitled “Foreign Account Tax Compliance — Taxes to Enforce Reporting on Certain Foreign Accounts.” A reason for the inclusion of the FATCA provisions in the jobs bill is that expected additional IRS collections as a result of the foreign account tax compliance requirements provided the projected revenues needed to fund the projected costs of the jobs portion of the Act.
FATCA is primarily an enforcement provision that allows the IRS to closely monitor, on an annual basis, investments by US taxpayers in foreign financial assets. Because the US has no legal power to impose requirements on foreign financial institutions and other foreign companies, it achieves the same effect by imposing draconian measures (in the form of a 30% withholding tax on funds flowing into such institutions from the US) on foreign financial institutions and certain foreign non-financial entities that accept US-source payments (direct or indirect, including from foreign companies with “substantial”
US ownership). With certain exceptions, the withholding tax on such institutions can be avoided only if they enter into agreements with the IRS to provide information about US account holders. In other words, the US government withholds 30% on payments to foreign financial institutions like hedge funds, private equity funds, mutual funds and banks unless they agree to report information to the IRS about their US account holders’ investments. The probable practical effect of the withholding is that many foreign financial institutions either will enter into the required information-sharing agreement with the IRS, stop investing in US securities and properties or cease accepting investments, deposits or custody from US investors.
The complex mechanisms for achieving its purposes and the many new defined terms (like “recalcitrant account holder” and “withholdable payments”) are probably not so important to most individual investors. More important to the law-abiding US investor with foreign holdings is:
• How does the new law affect individual US investors who hold foreign investments?
• Does the 30% withholding apply to individual US investors?
• What is a “foreign financial institution” under the new law?
• What types of foreign investments are covered?
• How will the new law affect existing and new foreign financial institution accounts?
• What information about US accounts is required to be provided to the IRS by foreign financial institutions?
• What if a foreign financial institution is located in a country that forbids disclosure of accountholder information or otherwise decides not to report US holdings to the IRS?
• What are the penalties for failing to report, as the result of either an accounting or tax-preparer error or a disagreement with the IRS over whether some of the more exotic foreign investments not expressly addressed in the legislation are subject to such reporting?
• When do the various new requirements take effect?
Since the passage of FATCA as part of the jobs bill was largely unexpected and great attention has been focused on the recently-adopted health care legislation, relatively little has been written about the practical effects of the foreign account tax compliance section to individual investors. Links to professional analyses of the complex provisions of FATCA we found helpful in understanding the genesis and purpose of some of the more difficult statutory provisions appear at the end of the article. We are still in the process of digesting this legislation and, in the absence of regulatory guidance, cannot provide any assurance that our interpretations will be consistent with IRS interpretations.
Regulations required to be promulgated to interpret this legislation can be expected to shed light on some of the more elusive and ambiguous provisions. In an effort to address questions we have received, however, we provide the following initial summary of our understanding of the new law in Q&A form. This summary does not substitute for personal tax or legal advice. Readers who have foreign accounts or are considering investing abroad are encouraged to seek counsel on their individual situations.
Q&A
Q 1: How does the new law affect individual US investors with foreign investments?
A: US investors who already are already required to report their holdings in Private Foreign Investment Companies (“PFICs”) are subject to new annual reporting even if their holdings have not changed. Individuals holding more than an aggregate of $50,000 in foreign reportable assets1 during a tax year
must report the following information about such assets on their tax returns:
(i) Name and address of the foreign financial institution in which an account is maintained and the filer’s account number
(ii) Name and address of the issuer of a foreign security and information necessary to identify the class or issue of the security
(iii) In the case of any other reportable instrument, contract or interest, information necessary to identify it and the names and addresses of all issuers and counterparties
(iv) Maximum value of the asset during the taxable year
(b) US investors may become ineligible to invest in “foreign financial institutions” that choose not to comply with IRS reporting and withholding requirements or their accounts in such institutions may be closed
(c) FBAR filing requirements are not affected by the FACTA provisions of HIRE. Investors who have made FBAR filings during the past should continue to do so as they have done before.
Q 2: Does the 30% withholding provision apply to US account holders in foreign financial institutions?
A: No, not unless US account holders are categorized as “recalcitrant account holders” because they refuse to provide information about their status as a US account holders and other information necessary for the foreign financial institution in which they hold covered accounts to satisfy its IRS disclosure obligations (see Q 7 below).
The 30% withholding requirement generally applies to US-source payments to foreign financial institutions and to certain foreign non-financial entities of (a) dividends, interest (including original issue discount), rents, salaries, wages, rents, premiums, annuities, compensations, remunerations, emoluments and other fixed or determinable annual or periodic gains, profits and income and (b) gross proceeds from sale or other disposition of any property of a type that can produce interest or dividends but only if such institutions do not sign agreements with the IRS to provide information about their US
account holders. 2 These US payments to foreign financial institutions and other covered foreign non-financial entities are called “withholdable payments.”
Q 3: What is a “foreign financial institution” under the new law?
A: The term “foreign financial institution” is defined to include any entity that:
(a) Accepts deposits in the ordinary course of a banking or similar business;
(b) As a substantial portion of its business, holds financial assets for the account of others; or
(c) Is engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities (including futures, forward contracts or options thereon) or any interest in such securities, partnership interests or commodities
Q 4: What types of foreign accounts are covered?
A: The term “United States account” (herein referred to as a “US account”) refers to any financial account held by one or more specified United States persons3 or a foreign entity that has one or more “substantial US owners” (generally, a 10% or higher direct or indirect interest except in the case of foreign investment entities, where no substantial ownership need be established). Depository accounts of $50,000 or less held 100%, in whole or in part, by one or more natural persons at a single FFI (including all members of the FFI’s “expanded affiliated group”) are exempted from the definition of US accounts unless the FFI elects not to have this exemption apply. In this regard, it appears that a
given individual is entitled to only a single $50,000 exemption at a given institution (or expanded affiliated group) if he or she holds joint accounts or holds a partial interest in an account with third parties, but all of his or her accounts are aggregated. IRS regulations will be required to deal with complex situations involving webs of joint, partnership, individual and other accounts with multiple owners.
The term “financial account” includes any depository or custodial account maintained by a financial institution and any equity or debt interest of a financial institution unless regularly traded on an established securities market.
The statute includes safeguards to prevent duplicative reporting of financial accounts.
Q 4: What types of foreign investments are covered by the IRS reporting agreement?
A: “Financial accounts” in foreign financial institutions must be reported under the IRS agreement. Except as otherwise provided by the Secretary (presumably, in regulations), “financial account” is defined as any (a) depository account, (b) custodial account or (c) equity or debt interest (if not traded on an established securities market) in the financial institution or covered foreign non-financial entity. Note that King & Spalding’s summary interprets this to mean that a loan to a foreign private equity fund
would qualify as a “financial account.”
Q 5: Does the new law apply to US investor holdings of the following:
*Foreign hedge funds
Foreign hedge fund issuers are “foreign financial institutions” because they are in the business of investing, reinvesting and trading in securities and/or commodities and interests therein. Therefore, they must report US accounts to the IRS, close their US accounts or become subject to the 30% withholding requirement on their withholdable payments.
*Foreign mutual funds
Foreign mutual funds are “foreign financial institutions” because they are in the business of investing, reinvesting and trading in securities and/or commodities and interests therein. Therefore, they must report US accounts to the IRS, close their US accounts or become subject to the 30% withholding requirement on their withholdable payments.
*Foreign private equity funds
Foreign private equity funds are “foreign financial institutions” because they are in the business of investing, reinvesting and trading in securities. Therefore, they must report US accounts to the IRS, close their US accounts or become subject to the 30% withholding requirement on their withholdable payments.
*Exchange-listed equity and debt investments in foreign companies
These are not covered as foreign accounts because an exemption exists for listed stocks and debt instruments.
*Unlisted equity and debt investments in foreign companies that are not foreign financial institutions
Unless it can be established that these investments are regularly traded on an established securities market, they qualify as “financial accounts” and their issuers are subject to similar reporting and withholding requirements to those that apply to foreign financial institutions.
*Precious metals or other personal property held in foreign bank vaults
Foreign banks, as foreign financial institutions, are subject to the 30% withholding requirements unless they enter into IRS reporting and disclosure agreements. Custodial accounts are “financial accounts” that they must report, if held by US account holders, but it is difficult to know how a bank would report the value of the contents of a safe deposit box to which it does not have access. If the custodial
account agreement involves acquisition, valuation, and liquidation services in connection with commodities, securities or other valuables or the bank otherwise is in possession of information enabling it to report values and receipts and withdrawals of commodities or stocks, bonds, other securities or other valuables, we would expect the bank could comply with IRS reporting and disclosure requirements. We can imagine other circumstances, however, under which compliance on the part of the bank would be difficult, if not impossible. IRS regulations to be issued before the withholding requirements go into effect may provide more guidance on the questions raised by the inclusion of custodial accounts in the definition of “financial accounts.”
*Precious metals or other personal property held in a foreign non-bank vault
A non-bank entity that rents vaults to US investors may not be a “foreign financial institution” required to enter into an IRS agreement in order to avoid 30% withholding on its withholdable payments if it does not hold “financial assets” for the account of others as a substantial part of its business and does not engage in trading, investing or reinvesting in commodities or securities as its primary business. If the non-bank entity offering vaults is a foreign financial institution, it must report on US accounts and the same valuation and other reporting issues presented in the case of foreign bank vaults as described above would apply.
*Shares of Central Fund of Canada (CEF), foreign ETFs (e.g., SLV and GLD)
and GoldMoney
CEF and precious metals and other ETFs should be exempt from the IRS agreement withholding and reporting requirements because they are exchange-listed and therefore regularly traded on a securities market, thus qualifying for an exemption from the definition of “financial accounts” subject to reporting requirements.
Since GoldMoney holdings are not traded regularly on an established securities market, this exemption would not apply to GoldMoney accounts. In the absence of regulatory guidance, we do not think it is clear whether GoldMoney would qualify as a foreign financial institution under the law. The IRS could take the position that GoldMoney, is a foreign financial institution primarily in the business of investing in commodities. Its accounts could (but might not) be considered “financial accounts” under the theory they are custodial in nature or constitute a type of equity interest. We think GoldMoney does not neatly fall into any of the definitional provisions, however, and regulatory guidance would be useful in determining the status of this investment under the new law. It is worthy of note that newly issued proposed regulations governing “FBAR” reporting requirements appear not to include foreign
commodities holdings of this type.4
*CDs, checking and savings accounts and credit cards of foreign banks
These accounts would be covered by the IRS reporting requirements because foreign banks accept deposits as part of a regular banking business and are therefore foreign financial institutions. Such accounts are deposit accounts and/or financial accounts.
*CDs, checking and savings accounts and credit cards of foreign banks with US branches
These accounts would not be subject to reporting under any foreign financial institution IRS reporting and disclosure agreement because US branches are not foreign financial institutions, since they are regulated by US authorities as domestic financial institutions.
Q 6: How will the new law affect existing and new foreign financial institution accounts?
A: This is difficult to know, particularly since there are no regulations yet, but some legal analysts have predicted that some foreign investment funds may close out their existing US accounts and cease opening new accounts for investment by US investors. Whether existing and new accounts are treated the same is also unclear. It is hard to imagine that some Swiss funds will not close to US investment (or require waivers by US investors as a condition to continued investment – see, Q 9), given the Swiss laws that prohibit disclosure of information on accountholders. Others have noted that the withholding provision may cause some foreign investment vehicles to cease investing in US properties and securities. We can imagine that foreign banks that wish to retain US accounts and continue to invest in the US may attempt to create new entities that are not part of the same “expanded affiliated group” as the deposit-taking and custodial entity for the purpose of investing in the US, so that the 30% withholding does not apply to the investment entity. At least some pooled investment funds with significant numbers of US accounts and the desire to continue investing in the US can be expected to enter into disclosure agreements with the IRS. Some foreign financial institutions may take no
action in the short term, pending the promulgation of regulations.
Q 7: What are foreign financial institutions required to do if they sign IRS disclosure and reporting agreements?
Each foreign institution that enters into an agreement with the IRS is required to:
(a) obtain information regarding each account holder as necessary to determine which accounts are US accounts
(b) comply with verification and due diligence procedures regarding identification of US accounts [i.e., financial accounts] as required by the IRS
(c) provide annual information about US accounts
(d) deduct and withhold 30% tax on any “passthru payment” made by the institution to
(v) a “recalcitrant account holder” (i.e., one who refuses to provide sufficient information to an FFI to enable it to carry out its obligations under its IRS agreement ) or
(vi) another FFI that does not sign an IRS agreement or
(vii) an FFI that has an IRS agreement to the extent of payments allocable to accounts of (A) recalcitrant account holders and (B) FFIs that do not have IRS agreements
(e) comply with IRS requests for additional information on US accounts
(f) where foreign law would prohibit the reporting of this information,
(i) attempt to obtain a waiver or
(ii) if no waiver is obtained, close the account
Foreign non-financial entities in which US accountholders hold covered US accounts will be subject to similar IRS withholdable payment tax withholding on covered US source payments unless they make arrangements with qualified intermediaries to provide information to the IRS or enter into IRS reporting agreements themselves with respect to their US accounts (recall that “US accounts” includes debt and equity holdings in foreign non-financial entities).
Q 8: What information about US accounts is required to be provided to the IRS by foreign financial institution?
A: A foreign financial institution in compliance with its IRS agreement is required to provide the following on an annual basis:
(i) name, address, tax identification number of each holder of a US account and of each substantial (substantial being defined as 10% except when the FFI is an investment fund) US owner of a foreign entity;
(ii) account number of each such account;
(iii) account balance or value;
(iv) gross receipts and withdrawals or payments from the account.
Q 9: What if a foreign financial institution is located in a country that forbids disclosure of accountholder information or otherwise decides not to report US holdings to the IRS?
A: In that case, the institution must either obtain a waiver from its US account holders to make required disclosure to the IRS or close all of its US accounts.
Q 10: What are the penalties for failing to report, as the result of either an accounting or tax-preparer error or a disagreement with the IRS over whether some of the more exotic foreign investments not expressly addressed in the legislation are subject to such reporting?
A: A $10,000 penalty applies if an individual fails to report required information about a foreign reportable asset on his or her tax return as required and additional penalties apply, for a total penalty of up to $50,000, in the case of taxpayer failure to provide information after notification by the IRS. A 40% penalty applies to any tax underpayments due to undisclosed foreign assets.
Q 11: When do the various new requirements take effect?
A: The following effective dates apply:
(a) The 30% withholding requirements on withholdable payments to foreign entities goes into effect for payments made after December 31, 2012,5 but there is skepticism among tax practitioners (King & Spalding, e.g.) that the implementation of these provisions and the issuance of necessary regulations
can be achieved by then.
(b) Enhanced PFIC reporting is effective upon enactment (March 18, 2010).
(c) Requirements to report foreign assets on an individual’s tax return are effective for tax years after the date of enactment.
Q 12: Does this Q&A cover all of the foreign account tax compliance provisions of HIRE?
A: No. There are many other provisions that may be of interest to some sophisticated investors and companies, including, without limitation, provisions dealing with foreign trusts, qualified intermediaries, bearer bonds, swap arrangements that substitute for dividends, and ownership of equity and debt interests in foreign entities that are not financial institutions. We also have not yet digested the reporting and withholding requirements of foreign financial institutions as they apply to the relationships of such institutions with other foreign entities that receive withholdable payments from the institutions and do not themselves enter into IRS reporting agreements.
Footnotes:
1 Foreign reportable assets include (1) financial accounts in foreign financial institutions (see discussions below for these definitions), (2) shares or securities issued by any foreign person, (3) financial instruments or contracts with a foreign issuer or counterparty held for investment, and (4) any interest in a foreign entity.
2 Foreign financial institutions are not subject to this withholding if they certify that they have no US accountholders or they already are subject to international treaties that would permit them to provide the required information in the absence of a direct agreement with the IRS.
3 The term “specified United States persons” excludes publicly traded corporations, 501(a) tax-exempt organizations and individual retirement plans, federal and state governments and agencies thereof, banks, registered investment companies, real estate investment trusts, common trust funds and certain tax-exempt trusts.
4 Subject to a grandfathering provision that exempts payments on and gross proceeds from disposition of obligations outstanding on the date two years after enactment (i.e., March 18, 202).
Related reading:
Hiring Incentives to Restore Employment Act at Wikipedia
Summaries of the Hiring Act:
KPMG Flash International Executive Alert 2010-066 (March 19, 2010)
Mark Nestman, “Congress Enacts Obama’s Anti-Offshore Jobs Bill”
