Tax Dodgers Beware: New Foreign Account Tax Compliance Legislation

Jul 26, 2010   

The Foreign Account Tax Compliance ACT (FATCA) is Congresss newest attempt to tackle tax evasion, specifically that which occurs through the utilization of offshore accounts.  Nearly all provisions of the FATCA were incorporated into law with the enactment of the Hiring Incentives to Restore Employment Act (HIRE Act) in March of this year. The enacted FATCA provisions will become effective in 2013.

Douglas H. Schulman, Commissioner of the Internal Revenue Service, spoke about the newly enacted FATCA before the Organization for Economic Cooperation and Development (OECD).  During his speech, Commissioner Schulman described offshore tax evasion as “an issue of fundamental fairness.” “Wealthy people who unlawfully hide their money offshore arent paying the taxes they owe, while schoolteachers, firefighters and other ordinary citizens who play by the rules are forced to pick up the slack.” 

Commissioner Schulman attributed offshore tax evasion to bank secrecy jurisdictions, in which financial institutions essentially allow U.S. taxpayers to hide their money free of any possibility of disclosure to the IRS.  Many strategies have been employed to address bank secrecy, including international tax standards on information exchanges developed by the OECD and agreements with foreign governments regarding the release of information pertaining to U.S. account holders.  The IRS also developed a special voluntary disclosure program which provided incentives for U.S. persons who voluntarily disclosed their non-U.S. bank accounts through a temporary penalty framework.

Unlike the voluntary disclosure program, the FATCA is not based on an incentive system. The FATCA created new code sections to the Internal Revenue Code (I.R.C) which impose a 30 percent withholding tax to foreign financial institutions which do not take the appropriate measures to “avoid” the withholding tax.  These avoidance measures are included in 26 I.R.C. § 1471(b), which provides as follows:

(1) The requirements of this subsection are met with respect to any foreign financial institution if an agreement is in effect between such institution and the Secretary under which such institution agrees–
(A) to obtain such information regarding each holder of each account maintained by such institution as is necessary to determine which (if any) of such accounts are United States accounts,
(B) to comply with such verification and due diligence procedures as the Secretary may require with respect to the identification of United States accounts,
(C) in the case of any United States account maintained by such institution, to report on an annual basis the information described in subsection (c) with respect to such account,
(D) to deduct and withhold a tax equal to 30 percent of–
(i) any passthru payment which is made by such institution to a recalcitrant account holder or another foreign financial institution which does not meet the requirements of this subsection, and
(ii) in the case of any passthru payment which is made by such institution to a foreign financial institution which has in effect an election under paragraph (3) with respect to such payment, so much of such payment as is allocable to accounts held by recalcitrant account holders or foreign financial institutions which do not meet the requirements of this subsection,
(E) to comply with requests by the Secretary for additional information with respect to any United States account maintained by such institution, and
(F) in any case in which any foreign law would (but for a waiver described in clause (i)) prevent the reporting of any information referred to in this subsection or subsection (c) with respect to any united states account maintained by such institution”
(i) to attempt to obtain a valid and effective waiver of such law from each holder of such account, and
(ii) if a waiver described in clause (i) is not obtained from each such holder within a reasonable period of time, to close such account. 

The FATCA further requires all foreign entities to choose between a 30 percent withholding tax or compliance with reporting requirements. I.R.C. §1472 provides a withholding tax of 30 percent on the amount of any withholdable payment to a nonfinancial foreign entity.  In order to “avoid” this tax, the beneficial owner must comply with the requirements in subsection (b) which states:

(1) Such beneficial owner or the payee provides the withholding agent with either-
(A) a certification that such beneficial owner does not have any substantial United States owners, or
(B) the name, address, and TIN of each substantial United States owner of such beneficial owner,
(2) The withholding agent does not know, or have reason to know, that any information provided under paragraph (1) is incorrect, and
(3) The withholding agent reports the information provided under paragraph (1)(B) to the Secretary in such manner as the Secretary may provide.

The FATCA includes additional reporting requirements for passive foreign investment companies and foreign trusts, and also adds increased penalties for individuals who fail to furnish information regarding foreign assets.  

The FATCA does not waive or replace any reporting requirements already in place. Taxpayers are still required to comply with the requirements of Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR).  The FATCAs reporting requirements supplement the FBAR, and often impose reporting requirements where the FBAR does not.  Individuals and entities that were not in the scope of the FBAR may still be within the scope of the FATCA.

The drastic measures of the FATCA may result in foreign financial institutions deciding not to manage U.S. account holders.  Many Swiss banks have “thrown out” their American clients.  Other Swiss banks, such as Vontobel and Franck, have seen the legislation as a business opportunity and have launched separate banks dedicated to wealth management for U.S clients.  These banks are aimed at the “sine qua non” of being in perfect order with the IRS.

Other possible consequences include foreign financial institutions becoming reluctant to invest in U.S. stocks and bonds.  Also, foreign jurisdictions may pass reciprocal legislation requesting U.S. financial institutions to make a choice between paying a hefty withholding tax or incurring expenses associated with compliance with the reporting requirements. 

The FATCA is a significant effort to monitor offshore transactions.   Although the legislation may have some unintended consequences, it is very likely to achieve the goals of reducing tax evasion resulting from offshore accounts.   As stated by Stephanie Jarret, the head of the Wealth Management Practice Group at Baker & McKenzie in Geneva, “[m]anaging U.S. clients is complicated. . . [b]ut isnt the trend toward complexity inevitable?”

If you have any questions regarding the FATCA or any other tax provision, please contact Fuerst Ittleman, PL at contact@fidjlaw.com