The Report of Foreign Bank and Financial Accounts (Form TD F 90-22.1, or the “FBAR”) is required to be filed annually by U.S. persons who have a financial interest in a foreign financial account. The filing deadline for the 2008 calendar year is June 30, 2009. While the filing instructions are unclear, it appears that the Internal Revenue Service (“IRS”) believes that certain offshore funds, including foreign hedge funds and private equity funds, meet the definition of a “financial account” for purposes of these rules. In the absence of clear authority, we would advise U.S. persons holding interests in offshore funds to seriously consider making an FBAR filing, particularly in light of both the low cost of compliance and the severe penalties for failing to make such a filing if required.
FBAR filings are required by U.S. persons with financial interests, or signature or other authority, in foreign financial accounts if the aggregate value of such person’s foreign financial accounts exceeds $10,000 at any time during the calendar year to which the filing relates.
For purposes of these rules, “U.S. persons” includes both citizens and residents of the United States, as well as domestic entities.
A “financial interest” includes direct ownership as well as indirect ownership through a partnership, corporation or trust. A U.S. person is also considered to have a financial interest when such person acts through an agent or owns more than 50% of the (1) total profits of a partnership; (2) total value or voting power of shares of stock in a corporation; or (3) present beneficial interest in a trust’s assets (or receives more than 50% of the current income).
Interests in Offshore Hedge Funds and P.E. Funds as “Financial Accounts”
A “financial account” is defined in the FBAR instructions as including “. . . any bank, securities, securities derivatives or other financial instruments accounts,” and generally, “any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund (including mutual funds).”
The language specifically addressing interests in mutual funds is a recent addition to the FBAR instructions, incorporated during revisions made in October 2008. It is unclear how the term may apply by analogy to the hedge fund or investment fund context. There is no express discussion of investment funds in the FBAR instructions or any applicable regulations, but a foreign entity that holds stocks and securities could potentially be understood as a commingled fund that meets the definition of a financial account for these purposes.
On June 12, 2009, a teleconference was hosted by the American Bar Association and the American Institute of Certified Public Accountants. IRS panelists on the call suggested that the definition of financial account does include an interest in a foreign hedge fund, and that FBAR filing would be required if the hedge fund were serving a function similar to a mutual fund. While no specific reference was made to private equity funds, or to other types of investment funds, including foreign feeder funds, there is reason to believe that other types of funds might also be viewed by the IRS in a similar manner to a mutual fund and that FBAR filing requirements might therefore apply to investors in these funds.
Penalties for failure to make required FBAR filings are severe (up to $10,000 for each violation without reasonable cause, and the greater of $100,000 or 50% of the balance of the account for willful violations). Criminal penalties may also be imposed. Until further guidance is issued by the IRS, we would advise the following categories of investors to seriously consider making an FBAR filing:
- U.S. investors, including U.S. tax-exempt entities, in an offshore investment fund (including both offshore investment funds and offshore feeders in master/feeder investment fund structures);
- U.S. feeder funds that invest in offshore master funds, and U.S. investors that own more than 50% of such U.S. feeder funds;
- Direct U.S. investors in an offshore master fund; and
- Investment managers with financial interests (through carried interest, structured as a partnership allocation) in offshore investment funds (whether stand-alone, feeder or master).
The FBAR for the 2008 calendar year must be filed by June 30, 2009. The IRS has advised that taxpayers who failed to file the FBAR for prior years but reported and paid tax on all taxable income should file FBARs for the prior six years by September 23, 2009, with an attachment providing the reason why the FBARs were not timely filed, together with copies of their tax returns. In such cases, the IRS has advised that no penalties will be imposed for the late filing of FBARs.1
The FBAR is available online at http://www.irs.gov/pub/irs-pdf/f90221.pdf