The United States has maintained a longstanding policy of not taxing bank deposit interest of nonresident aliens as a way in which to encourage foreign investment in U.S. banks. Furthermore, except with respect to nonresident aliens from Canada, the United States has not required the reporting of such bank deposit interest income to the IRS. On April 19, 2012, however, the IRS reversed this policy of the non-reporting of bank deposit interest. Pursuant to new final regulations under Sec. 6049 (T.D. 9584) (the “final regulations”), deposit interest income will still not be taxed, but when paid to certain nonresident aliens, it must soon be reported to the IRS. The final regulations under Treasury Regulations § 1.6049-4(b)(5)(i) and § 1.6049-8 will require U.S. financial institutions to report certain deposit interest aggregating $10 or more paid to nonresident alien individuals commencing on or after January 1, 2013.
Regulations Address Concern about Potential Misuse of Information
In response to concerns raised by interested persons about the potential misuse of information required to be reported (e.g., that deposit interest information may be shared with a country that does not have laws in place to protect the confidentiality of the information exchanged or that would use the information for purposes other than the enforcement of its tax laws), the final regulations define “interest” subject to reporting to mean interest paid on deposits as defined under Section 871(i)(2)(A), maintained at an office within the United States and paid to a nonresident alien individual who is a resident of a country that is identified as a country with which the United States has in effect an income tax or other convention or bilateral agreement relating to the exchange of tax information.
The new rules apply to deposits with commercial banks, savings institutions, credit unions, securities brokerages and insurance companies that maintain deposit accounts for nonresident aliens. In the case of reportable interest aggregating $10 or more paid to a nonresident alien individual, the payor is required to file Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, for the calendar year in which interest is paid. The final regulations also clarify that a payment of interest to a nonresident alien individual that is subject to reporting under the final regulations is not subject to backup withholding under Internal Revenue Code § 3406 if the payer may treat the payee as a foreign beneficial owner or foreign payee. A payor or middleman can rely on Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, to determine where a taxpayer lives unless there is evidence that it is unreliable or incorrect.
Residents Subject to Reporting Listed in Revenue Procedure
Revenue Procedure 2012- 24, published contemporaneously with the final regulations, provides a list of the applicable countries whose residents will be subject to reporting under the final regulations. The revenue procedure specifically states that the listed countries are those with which the United States has in effect an income tax or other convention or bilateral agreement relating to the exchange of information pursuant to which the United States agrees to provide, as well as to receive, information, and under which the competent authority is the Secretary of Treasury or his delegate.
Accordingly, bank deposit information reported pursuant to the final regulations will be exchanged only with foreign governments with which the United States has an agreement providing for the exchange of information and only when certain additional requirements are satisfied. The IRS noted that, even when such an agreement exists, the IRS is not compelled to exchange information, including information collected pursuant to these regulations, if there is concern regarding the use of the information or other factors exist that would make exchange inappropriate.
The Revenue Procedure also includes a second list identifying the countries with which the IRS has determined it is appropriate to have an automatic exchange relationship regarding interest subject to reporting under the final regulations. The IRS currently exchanges deposit interest information on an automatic basis with Canada and will not enter into a new automatic exchange relationship with a country unless the IRS determines that an automatic exchange relationship is appropriate and the other jurisdiction is willing and able to reciprocate effectively. The Revenue Procedure will be updated as new information exchange agreements are signed.
Residents of countries not on the information sharing agreement list published in the Revenue Procedure are not subject to reporting under the final regulations. However, the IRS notes that banks can elect to report interest payments on all of their nonresident alien individual depositors as a way to address any potential burden associated with determining which depositors are subject to reporting. Thus, residents of non-sharing countries can become subject to reporting even though their country of residence is not listed on the Revenue Procedure.
Information Exchange Important
According to the IRS and Treasury, the extension of the reporting requirement is considered appropriate because of the importance of cooperative information exchange for tax purposes. The information gathered, as a result of information exchange relationships with other jurisdictions, can be utilized by the United States to identify potential U.S. taxpayers that evade tax by hiding income and assets offshore. Further, reporting to the IRS of all U.S. bank deposit interest paid to any nonresident alien individual will help improve voluntary compliance by U.S. taxpayers by making it more difficult for U.S. persons to avoid the U.S. information reporting system by falsely claiming to be nonresident aliens. Finally, and quite significantly, the revised information reporting rules are seen as critical in the context of the enactment of the Foreign Account Tax Compliance Act (FATCA), which, in part, mandates that foreign financial institutions report to the IRS regarding their U.S. customers. In light of the FATCA intergovernmental framework being negotiated between the United States and certain countries that, in part, will require foreign governments to cooperate to overcome legal restraints on their resident financial institutions to identify U.S. accounts and report information to the IRS, the final regulations are important in that the new rules enable the United States to have information to trade with foreign governments that are also interested in detecting offshore tax evasion by their own residents.