Congress is now considering the Foreign Account Tax Compliance Act (the Bill)—a legislative proposal that includes a provision of enormous significance to any foreign financial institution (FFI) that invests or is planning to invest in US stocks and securities.
FFIs that invest in US stocks and securities on behalf of account holders or for their own account would be required to report financial account information of US persons to the US Internal Revenue Service or be subject to a 30 percent US withholding on all payments of (i) US source passive income, to include interest or dividends income, and (ii) gross proceeds from the sale of US stocks and securities (the New US Withholding Regime). The purpose of this provision is to enable the IRS to obtain information from abroad about US account holders in order to enforce compliance with US tax laws.
This provision would apply to all payments of US source income or gross sales proceeds made to FFIs after December 31, 2010. It is highly likely that the Bill (or a modified version) may move quickly through Congress, because revenues raised by enactment of the Bill are likely to be considered as a means of paying for a part of the cost of extending certain tax benefits that would otherwise expire at the end of this year.
FFI Information Reporting
The New US Withholding Regime will not apply to an FFI if it reports US account information under one of two alternative regimes:
IRS Agreement Information Reporting. Under this regime, the FFI enters into an agreement with the IRS whereby it agrees to (i) obtain information from each account holder as is necessary to determine which accounts are US accounts; (ii) comply with IRS verification and due diligence procedures with respect to the identification of US accounts; (iii) annually report information (with respect to the identity of the account holder, the account balance and payments into and out of the account, as prescribed by IRS); and (iv) attempt to obtain a waiver in any case in which any foreign law would (but for the waiver) prevent the reporting of information as required under the Bill, and if a waiver is not obtained, close the account.
Information Reporting as if US Financial Institution. Alternatively, the FFI may elect to report information with respect to US accounts (to include account holder identity, worldwide dividends/interest gross proceeds) to the IRS as if the FFI were a US financial institution.
The foregoing new information reporting requirements would be in addition to the existing obligations that an FFI would have if it had entered into a qualified intermediary withholding and reporting agreement with the IRS.
FFI. Broadly defined to include banks, brokers, hedge funds, private equity funds and Foreign Investment Entities.
Financial Account. A depository or custodial account and an FFI’s non-publicly traded debt or equity. Thus, a US person’s ownership of an FFI’s non-publicly traded stock or securities would be required to be reported.
Exception. A depository account would not be treated as a financial account if (i) all holders are individuals and (ii) the aggregate value of all depository accounts held in whole or in part by each holder does not exceed $10,000 ($50,000 if the account were in existence at the date of enactment).
Election. An FFI may elect, for administrative convenience, to include all depository accounts held by US individuals as US accounts.
Foreign Investment Entity. A foreign entity (such as a private equity fund or a hedge fund) engaged, or holding itself out to be engaged, primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities or other interests, including derivatives.
Specified US Persons. US citizens and residents, domestic corporations (other than publicly traded companies and their controlled affiliates); domestic partnerships, and domestic trusts, but excluding certain other US entities.
US Account. A financial account held by a Specified US person or a US-Owned Foreign Entity.
US Owned Foreign Entity. A foreign entity (to include foreign corporations, partnerships, or certain trusts) more than 10 percent of which is owned by Specified US Persons
A Foreign Investment Entity that is owned by a Specified US Person is a US Owned Foreign Entity, irrespective of the level of ownership in that entity by the Specified US Person, and thus is subject to reporting.
Certification and Verification
An FFI may rely on certification from an account holder as to whether an account is a US Account and with respect to identifying information of a US Account holder only if the FFI does not have reason to know that any information provided by the account holder is incorrect. An FFI, in obtaining and verifying account holder information, likely would utilize know-your-customer, anti-money laundering, anti-corruption or other similar rules as well as procedures that the IRS may prescribe.
Foreign Persons Excepted
Foreign beneficial owners that are considered unlikely to represent a risk of tax evasion, such as foreign governments, international organizations or foreign central banks, would be excluded from application of this provision.
FE Information Reporting
Under a companion provision, a foreign entity (to include a foreign company, partnership or trust) other than an FFI (an FE) that derives US source income or gross proceeds can avoid the New US Withholding Regime if the FE (or a beneficial owner of the payment) provides the withholding agent either with a certification that the FE does not have Substantial US Owners (i.e., a Specified US person that owns more than 10 percent of the foreign entity) or provides the name, address and taxpayer identification number of each Substantial US Owner to the IRS. The withholding agent must not know or have reason to know that the certification or information provided regarding Substantial US Owners is incorrect. FE reporting would not require that the FE enter into an agreement with the IRS.
Foreign beneficial owners that are considered unlikely to represent a risk of tax evasion would be excluded from application of this provision.
US Withholding and Refunds
If an FFI or an FE were to fail to comply with its reporting obligations, it would be subject to the New US Withholding Regime, whether or not the item of income or gain were exempt from US withholding tax under current statutory US tax law or a US bilateral income tax treaty.
A beneficial owner (other than an FFI) subject to the New US Withholding Regime could obtain a refund with appropriate documentary support. An FFI, however, only could obtain a refund if it were a treaty beneficiary, but interest would not be paid on the refund.
Comments on New Reporting/Withholding Provision
- The provision would apply to any FFI (to include a Foreign Investment entity) that invests in the United States.
- Every FFI would be required to enter into an agreement with the IRS if it derives, directly or indirectly, US source income or gross sales proceeds, whether it has any US Account holders or not. Absent entering into an agreement or reporting, an FFI or FE would be subject to the New US Withholding Regime.
- The provision would therefore affect FFIs that heretofore may never have had any US tax obligations that required filing documents with the IRS and would encompass FFIs obtaining information from retail depositors/customers, counterparties in securities and derivative trading and lenders. The amount of information to be provided could be staggering.
- FFIs would have to implement new compliance systems to identify, verify and report with respect to US Account holders.
- It is unclear how an FFI would determine, identify and verify that an account holder is a US person.
- Similarly, it has not been spelled out how a withholding agent would determine that an entity is an FFI and if so, that it has entered into an agreement with the IRS or adopted the alternative reporting regime.
- The legislation is intended to force FFIs to provide reporting of US Account holders and thereby avoid application of the expansive New US Withholding Regime.
- The New US Withholding Regime imposes a 30 percent tax on amounts that either are not taxable under current law or do not represent income or gain.
- Debt obligations. Under current law, only certain categories of interest payments are subject to US withholding tax ,and the repayment of principal on a debt is not subject to US taxation whatsoever.
- Sale of stock. Gain derived by a foreign investor from the sale of US stock (unless US real estate related) generally is not subject to US income taxation.
- Significantly, under the proposal, the gross proceeds from the sale of privately held debt or equity would be subject to US withholding taxation, and a non-treaty protected FFI could not obtain a refund even if the proceeds would not have been subject to US income taxation.
- Because of the broad definition of the term “withholding agent, ”an FFI or FE could be considered a withholding agent and thus be required to make US withholding payments to other FFIs or FEs unless the recipient furnishes the requisite information.
For a version of this article in Chinese, please click here.