Recent Offshore Tax Haven Legislation
Since 2007, numerous attempts have been made at passing targeted tax haven legislation. Although none of these initiatives has progressed in any meaningful way thus far, under the Obama Administration there is a much higher likelihood that this type of legislation will be promoted. The most current proposal, the Foreign Account Tax Compliance Act of 2009 (H.R. 3933, S. 1934), follows on the heels of, and greatly draws upon, its predecessor, the Stop Tax Haven Abuse Act (H.R. 1265, S. 506). President Barack Obama and Treasury Secretary Timothy Geithner have both hailed this legislation; in fact, the Obama Administration worked closely with Congress on drafting this bill. Although the bill has not yet been brought to the floor, the likelihood of its passage seems higher than in the past.
The Foreign Account Tax Compliance Act of 2009 (H.R. 3933, S. 1934)
On October 27, 2009, the Foreign Account Tax Compliance Act of 2009 was introduced in the House of Representatives by Ways and Means Committee Chair Charles B. Rangel (D-NY), and in the Senate by Finance Committee Chair Max Baucus (D-MT) (the Rangel-Baucus Bill). The Rangel-Baucus Bill incorporates various provisions from the Stop Tax Haven Abuse Act but omits other fundamental components of that proposed legislation. Importantly, the Rangel-Baucus Bill does not include provisions regarding offshore secrecy jurisdictions or "blacklist" countries, nor does it seek to treat foreign companies which are actively managed from the United States as domestic companies for U.S. income tax purposes.
The elements of the Rangel-Baucus Bill include: (1) considerable changes to U.S. withholding and information reporting requirements for cross-border investments; (2) an imposition of penalties up to $50,000 on U.S. taxpayers who own significant assets in offshore accounts but fail to report the same; (3) the application of a 40-percent penalty on the amount of any understatement of undisclosed foreign assets; (4) an extension of the statute of limitations to six years for "substantial" omissions derived from offshore assets; (5) a requirement that tax or investment advisors provide the IRS with identifying information and account information of U.S. clients who they assist in transactions involving foreign entities; (6) broad requirements of shareholders in passive foreign investment companies (PFICs) to file annual returns; (7) new rules imputing income to U.S. beneficiaries of foreign trusts who use property owned by the trust; (8) the application of a 30-percent withholding tax on dividend equivalent payments attributable to notional principal contracts paid to foreign corporations; and (9) a lower standard of presumption concerning when foreign trusts are deemed to have U.S. beneficiaries as well as a lower minimum failure-t o-file penalty for certain information returns on foreign trusts.
Foreign Trusts Provisions (Sec. 401 through Sec. 405)
The Rangel-Baucus Bill claims to clarify when, for purposes of Section 679, a foreign trust should be treated as having a U.S. beneficiary. As such, an amount is treated as accumulated for the benefit of a U.S. person even if such U.S. person is a contingent beneficiary and, in the setting of a discretionary trust, the trust shall be treated as having a U.S. beneficiary unless (i) the terms of the trust specifically identify the class of persons to whom such distributions may be made, and (ii) none of said persons is a U.S. person during the applicable taxable year.
Additionally, the Bill creates a presumption that a foreign trust to which a U.S. person has transferred property will be treated as having a U.S. beneficiary unless the transferor proves, to the satisfaction of the Treasury Department, that (i) under the trust’s terms, no part of the income or principal of the trust may be paid or accumulated during the taxable year to or for the benefit of the U.S. person, and (ii) if the trust were terminated during the taxable year, no part of the income or principal could be paid to or for the benefit of a U.S. person. 1
The Bill also expands Section 643(i) such that any uncompensated use of foreign trust property (e.g., real estate or personal use property) by a U.S. grantor, U.S. beneficiary or any U.S. person related to such grantor or beneficiary is treated as a distribution to the grantor or beneficiary equal to the fair market value of the use of such property.2 Any return of property deemed distributed is disregarded for tax purposes.3 The use or loan of property will not be treated as a distribution to the extent that the U.S. person repays any loan at market rate or makes a payment equal to the fair market value of the use of the trust property within a reasonable period of time. Under current law, the rent-free use of real estate by a trust beneficiary does not constitute a distribution that would carry out distributable net income (DNI) to that beneficiary.
The Bill would also broaden the current trust reporting requirements and modify the current trust reporting penalty assessment scheme. A U.S. person who is treated as the owner of any portion of a foreign trust under grantor trust provisions must provide information as required with resp ect to the trust, in addition to ensuring that the trustee of the trust complies with its reporting obligations. If such reporting obligations are not met, a minimum penalty of $10,000, or 35 percent of the gross reportable amount, may be imposed. Such a requirement that a U.S. person ensure that a foreign trustee complies with U.S. reporting requirements may, in practice, be unworkable.
Modifications to U.S. Withholding and Information Reporting Requirements (Sec. 101 and 102)
The Rangel-Baucus Bill requires foreign financial institutions to disclose customer identity and account information for any U.S. individual or accounts held by a foreign entity with “substantial” U.S. owners.4 Similarly, any non -financial foreign entities must provide withholding agents with the name, address and tax identification number of any U.S. person who has at least 10-percent ownership in the entity. If these information reporting requirements are not met, such entities will face a 30- percent withholding tax. Additionally, if withholding tax is imposed under these rules, nonresident alien withholding or Foreign Investment Real Property Tax Act (FIRPTA) withholding requirements would not apply.5
The Bill repeals current provisions of I.R.C. Section 163(f)(2)(B), which exempt foreign targeted obligations from general TEFRA requirements such that any interest paid to a foreign person on a bearer-bond that is not issued in registered form will be subject to a 30-percent U.S. withholding tax. This rate may be adjusted if the withholding agent can show that the beneficial owner of the amount is eligible for another exemption from withholding or a reduced rate of withholding under a relevant income tax treaty.
Penalties for Failure to Report Significant Assets in Offshore Accounts (Sec. 201)
U.S. taxpayers who, at any time in a taxable year, hold “specified foreign financial assets” totaling $50,000 or more must include a disclosure statement with their annual income tax return. Under this bill, “specified foreign assets” include accounts held at a foreign financial institution, and assets held outside of a foreign financial institution which include (i) stock or security issued by a non-U.S. person, (ii) a financial instrument or contract (if the contracting party is a non-U.S. person), or (iii) any interest in a foreign entity (possibly including holding U.S. publicly traded stock in a foreign corporation). Though the nature of the information requested is similar to that required on a Report of Foreign Bank and Financial Accounts (FBAR), this requirement does not eliminate the need for a foreign account holder to file an FBAR. The Rangel-Baucus Bill’s requirement is supplementary, and broadens the disclosure requirements by applying to certain persons who may not meet the current levels of ownership to require an FBAR filing. Because the reporting threshold under this rule is value based, there will be instances in which a U.S. person may be required to file both a disclosure statement and an FBAR and other instances in which a U.S. person’s interest may not meet the FBAR reporting threshold but may be great enough so as to require disclosure under this Bill.
If such a disclosure statement is not timely filed, the Bill applies a $10,000 penalty.6 An additional $10,000 penalty is due for every 30 days the failure to file persists longer than 90 days after the taxpayer is informed of such failure.7
Penalties on Understatements Attributable to Undisclosed Foreign Assets (Sec. 202)
Under the Bill, if a U.S. person understates income which is related to an “undisclosed foreign financial asset,” such person will be subject to a 40-percent penalty.8 An “undisclosed foreign financial asset” is defined as any asset for which information was not properly provided but is required to be disclosed as a “specified foreign asset” or under any other provisions of the Code.9
Extension of Statute of Limitations for "Substantial" Omissions (Sec. 203)
For purposes of the Rangel-Baucus Bill, any “substantial omission” of income which is derived from “specified foreign assets” in an amount exceeding $5,000 in any taxable year shall be subject to an extended statute of limitations of six years.10 Under the current law, this exception only applies to a “substantial omission” of an amount equal to 25 percent of the gross income reported. The Rangel-Baucus Bill significantly lowers this requirement for purposes of foreign assets. The failure to report more than $5,000 income from foreign assets is a complete and separate ground for extending the statute of limitations to six years. Thus, if a U.S. taxpayer has one million dollars of income in 2010, which is all correctly reported, but the taxpayer mistakenly fails to report income of over $5,000 from an undisclosed foreign account, the statute of limitations applicable to the taxpayer's entire 2010 return is six years.
Tax or Investment Advisors’ Disclosure Requirements (Sec. 301)
This Bill adds a new Section 6116 which requires information reporting of assistance to a U.S. person involving a “foreign entity transaction.” A “foreign entity transaction” is defined as acquiring a direct or indirect interest in a foreign entity, including the creation of a foreign entity, if, in connection with such transaction, such U.S. person would be required to file a report under Sections 6038 (certain foreign corporations and partnerships), 6038B (certain transfers to foreign persons), 6046 (organization or reorganization of foreign corporations and acquisitions of their stock), 6046A (interests in foreign partnerships) or 6048 (information regarding certain foreign trusts).11
Any person who provides material aid, assistance or advice in the course of a “foreign entity transaction” and derives gross income in excess of $100,000 as a result is deemed a “material advisor.”12 Such “material advisor” who provides assistance to a U.S. individual will be required to file an information return setting forth the identity of the foreign entity, the identity of the U.S. citizen or resident acquiring an interest in a foreign entity, and any other information as the Secretary may require. Failure to timely file such information return will result in a penalty of the greater of $10,000 or 50 percent of the gross income derived by the material advisor in the course of the transaction.
Shareholders’ Annual Return Requirements for Interests in PFICs (Sec. 302)
Generally, a U.S. person who is a shareholder in a passive foreign investment company (PFIC) must file a “Return by a Shareholder of a Passive Foreign Investment Company or Qualifying Electing Fund” (Form 8621) for each tax year such person (i) recognizes gain on a direct or indirect disposition of PFIC stock, (ii) receives certain direct or indirect distributions from a PFIC, or (iii) makes a reportable election.13 The Rangel-Baucus Bill expands this requirement so as to require annual filings from any U.S. person who is a PFIC shareholder.14
Dividend Equivalent Payments Subject to Withholding Tax (Sec. 501)
This bill expands the withholding tax to apply to certain income received from a notional principal contract.15 The provision subjects any dividend equivalent—a payment made under a notional principal contract—that directly or indirectly is contingent upon, or determined by reference to, the payment of a dividend from U.S. sources to withholding taxes applicable to foreign persons.16 It is in the Secretary’s discretion to apply this provision and the Secretary may exclude any payments under a contract which he or she determines does not lead to a potential avoidance of U.S.-source dividend taxes.