On Feb. 8, 2012, the Treasury and Service issued a notice of proposed regulations (REG 164712-10) implementing new information reporting and withholding provisions under sections 1471-1474, in accordance with changes made in the foreign account tax compliance act (FATCA) enacted in 2010 as part of the Hiring Incentives to Restore Employment Act. The Treasury release, available here, indicates that these rules lay out a "step-by-step process for U.S. account identification, information reporting, and withholding requirements for foreign financial institutions (FFIs), other foreign entities, and U.S. withholding agents. "
When I first arrived at Cleary Gottlieb as a fresh-out-of-law-school lawyer in the mid-90s, one of the first "firm memoranda" that I had the pleasure of working on dealt with newly released "qualified intermediary" rules for withholding agents under sections 1441, 1442 and other provisions. Foreign banks would sign "qualified intermediary" agreements, and be permitted to use their own "know your customer" rules to determine withholding requirements. Before those regulations were passed, each person or entity in a chain passing along payments was supposed to verify the beneficial owner of the payment and receive the applicable withholding certificate, but that rule was honored in the breach. Supposedly, the new qualified intermediary rules would work better. After all, the big banks had commented on the rules and worked with Treasury to develop appropriate "protections" for their businesses.
But those new rules weren't enough. Big banks like UBS with longstanding reputations to uphold entered into qualified intermediary agreements but still actively sought out tax avoidance clients in the US and skirted with criminal prosecution in order to make a fast buck from wealthy but nontax-compliant Americans. Smuggling diamonds in toothpaste tubes, no less. A small swiss bank used its US correspondence account to hide its US clients' transfers into the US from their offshore bank accounts.
The Treasury and Service officials must have felt like they'd been had when the information on the steps some foreign banks took to assist US taxpayers in hiding their assets and income from the IRS began to surface.
Ultimately this is a fairness issue. As Emily McMahon comments inthe release: "When taxpayers overseas avoid paying what they owe, other Americans have to bear a disproportionate share of the tax burden." Or as the preamble to the proposed regulations states:
This information reporting strengthens the integrity of the voluntary compliance system by placing U.S. taxpayers that have access to international investment opportunities on an equal footing with U.S. taxpayers that do not have such access or otherwise choose to invest within the United States.
These new regs on foreign financial institutions expand reporting and withholding to FFIs that have US accounts. They are long and complicated, but they have had extensive commentary. FFIs may still use "know your customer" rules and rely on their own customer intake information in certain cases. Institutions subject to the rules, however, will need to register through an online system that is supposed to be open on Jan. 1, 2013, whereby they will enter into an agreement with the IRS if they want to avoid having withholding apply to payments made to them: under the agreement, they will identify U.S. accounts, report certain information about those accounts to the IRS, and withhold 30% on payments to noncomplying FFIs or accountholders who are unwilling to provide information.
The regulations provide rules regarding the interaction of the chapter 3 withholding rules relating to qualified intermediaries (QIs) with these new chapter 4 withholding rules for foreign financial institutions (FFIs).
Generally, a participating FFI that is a QI may make an election under section 1471(b)(3) to be withheld upon rather than to withhold only with respect to a payment that is U.S. source FDAP income and only if the participating FFI has not assumed primary withholding responsibility under chapter 3. A participating FFI that is a QI and that does not make the election under section 1473(b)(3) with respect to U.S. source FDAP income must assume primary withholding responsibility under chapter 3.
The proposed regulations have built in ample room for additional comment and time for transitions. The full rules won't be in effect until several years down the road. As the release notes,
The proposed regulations implement FATCA’s obligations in stages to minimize burdens and costs consistent with achieving the statute’s compliance objectives. The rules and implementation schedule are also adjusted to allow time for resolving local law limitations to which some FFIs may be subject.
The IRS's news release, IR-2012- 15(Feb. 8, 2012), calls for written comments by April 20, 2012. A hearing will be held May 15.
Perhaps the most interesting aspect of this expansion of the withholding and information reporting requirements is the evidence of a move towards international agreement among developed countries that a system of this sort is needed. At the same time that the regulations were released, the Treasury released a joint statement with Germany, France, U.K., Spain and Italy supporting governmental cooperation in efforts to ensure tax compliance. The expression of a willingness for reciprocity from the U.S.--"domestic reporting and reciprocal automatic exchange"-- is a good step towards global reporting of accounts to home countries, a necessary move to combat the potential for tax avoidance in the age of electronic finance.
France, Germany, Italy, Spain and the United Kingdom are supportive of the underlying goals of FATCA. FATCA, however, has raised a number of issues, including that FFIs established in these countries may not be able to comply with the reporting, withholding and account closure requirements because of legal restrictions.
An intergovernmental approach to FATCA implementation would address these legal impediments to compliance, simplify practical implementation, and reduce FFI costs.
[T]he United States is willing to reciprocate in collecting and exchanging on an automatic basis information on accounts held in US financial institutions by residents of France, Germany, Italy, Spain and the United Kingdom.
BNA reports that "the European Commission, which hailed the proposals, expressed hope that the agreement would provide an incentive for countries such as Luxembourg and Austria to drop their opposition to revisions to the European Union Savings Tax Directive. Officials from Denmark, which holds the rotating EU presidency, hinted that the FATCA approach could be used in the EU relations with other third countries including Switzerland." At the same time, commenters expressed concern that various bilateral treaties, rather than an overarching approaching involving multiple jurisdicitons, would lead to confusion, incoherence, and additional costs. Moreover, financial institutions might have to "implement FATCA twice"--in 2013 under these new rules and again later when a bilateral accord is concluded for their jurisdiction. 27 DTR GG-1.
It will be interesting to see how this develops.