The Bank Secrecy Act of 1970 authorizes the Secretary of the Treasury to establish recordkeeping and filing requirements for United States persons with financial interests in, or signature authority or other authority over, foreign financial accounts.1 These requirements were designed to gather information that could be useful in carrying out criminal, tax, or regulatory investigations, to allow enforcement officials to identify and track illicit funds and unreported income, in an effort to prevent money laundering, terrorism, and other crimes. The Treasury Department issued Form TD F 90- 22.1 (http://www.irs.gov/pub/irs-pdf/f90221.pdf), the “Foreign Bank and Financial Accounts Report,” or “FBAR” — as the reporting form for these foreign accounts.
FBARs for calendar year 2008 must generally be received by the IRS by June 30, 2009. However, in a revised Frequently Asked Questions regarding voluntary disclosures issued on June 24,2 the IRS announced that it will permit taxpayers that reported and paid tax on all their 2008 taxable income but only recently learned of their FBAR filing obligation and have insufficient time to gather the necessary information to complete the FBAR to file the FBAR by September 23, 2009, if they attach a statement explaining why the FBAR is filed late.3 The IRS has stated that “in this situation, the IRS will not impose a penalty for the failure to file the FBAR.”
An IRS official said during a June 12, 2009 conference call hosted by the American Bar Association and the American Institute of Certified Public Accountants that the definition of “foreign financial accounts” subject to FBAR reporting includes interests in foreign hedge funds, and on June 26, an IRS spokesman confirmed that “investments in foreign hedge funds and private equity funds are reportable for FBAR purposes.”4 Under this interpretation, FBARs are required to be filed for all (1) U.S. owners of foreign hedge fund interests, (2) U.S. managers of foreign hedge funds (and their individual U.S. employees with signature or other authority over the foreign hedge fund), and (3) U.S. financial institutions (and U.S. affiliates of foreign financial institutions) that either own interests in hedge funds or have “signature or other authority” over the hedge fund interests that their customers hold in such foreign hedge fund (as well as the individual employees of the financial institution with authority over the financial institution’s or the customers’ hedge funds).5 Moreover, an IRS official was recently reported as indicating that FBARs have always been required to be filed with respect to foreign hedge funds.6
Non-willful failure to file an FBAR is subject to a penalty of up to $10,000;7 willful failure to file an FBAR is subject to a penalty equal to the greater of $100,000 or 50% of the amount of the transaction or of the balance of the account at the time of the offense.8 Willful failure to file an FBAR is also potentially subject to criminal penalties of up to $250,000 and five years imprisonment.9 However, in a Frequently Asked Questions release issued on May 6, 2009, the IRS stated that penalties for failure to timely file FBARs for prior years will not be imposed in cases where taxpayers reported and paid tax on all of their taxable income for those prior years and file FBARs by September 23, 2009.
Although the instructions to the current FBAR form (revised in 2008) define “United States person” to include any “person in and doing business in the United States,” on June 5, 2009, the IRS temporarily suspended the requirement that foreign persons file the FBAR.10 Accordingly, foreign persons are not required to file the FBAR with respect to the 2008 calendar year.
This memorandum summarizes FBAR reporting requirements.
II. Examples of Potential Breadth of the FBAR Reporting Requirements.
1. U.S. Investor in a Foreign Hedge Fund. Assume that a U.S. individual or financial institution owns an interest in a foreign hedge fund. As mentioned above, an IRS official has said that an interest in a foreign hedge fund is a “foreign financial account” and therefore that the taxpayer should file an FBAR for the current year (and may wish to consider filing FBARs, before September 23, 2009, for the prior six years during which the taxpayer held the interest, in order to avoid penalties). The result would be the same if a U.S. affiliate of a foreign financial institution owns the hedge fund interest (even if the U.S. affiliate is a single member limited liability company that is disregarded for U.S. tax purposes).11
2. U.S. Investor in a Domestic Feeder Fund. Assume that a U.S. individual or financial institution owns an interest in a domestic feeder fund that, in turn, owns an interest in a foreign hedge fund. If the U.S. person owns more than 50% of the profits or capital of the domestic feeder, the person should file an FBAR with respect to the foreign hedge fund as well as any bank account of such fund. Moreover, it is unclear whether a domestic feeder fund could be treated as acting “on behalf of” all of its investors, in which case even a U.S. person that owns less than 50% of the profits or capital of a domestic feeder fund would be required to file an FBAR with respect to the foreign hedge fund.
3. U.S. Employees of Financial Institutions. The FBAR instructions suggest that each U.S. employee of any financial institution who has “signature or other authority” to control the disposition of funds or other property in a foreign account (which may include the ability to direct the redemption of an interest in a foreign hedge fund) should file an FBAR with respect to the account, including a foreign hedge fund, unless the employee qualifies for an exception.12
Therefore, if a U.S. employee of a financial institution has signature or other authority over (i) a foreign account of a customer, (ii) redemptions from a foreign hedge fund of a customer, or (iii) redemptions from foreign hedge funds of the financial institution, the U.S. employee may also be required to file an FBAR.
4. U.S. Investment Manager of a Foreign Hedge Fund. Assume that a U.S. limited liability company acts as the manager of a foreign hedge fund and therefore has the authority to control the disposition of funds or other property of the hedge fund. Because the IRS takes the position that the foreign hedge fund itself is a foreign financial account, the manager (i.e., the limited liability company) will likely have to file an FBAR (possibly even if all of the assets of the hedge fund are held in U.S. financial accounts). Moreover, each employee of the manager that has signature or other authority over the foreign hedge fund (which could conceivably include traders) may be required to file FBARs.
5. U.S. Broker-Dealer Holding a Foreign Hedge Fund Interest as Collateral or as Custodian. Assume that a U.S. broker-dealer holds rights over interests that customers have in foreign hedge funds as collateral or as custodian and has the ability to redeem, rehypothecate, or otherwise transfer the hedge fund interests. Although unclear, the U.S. broker-dealer may be required to file an FBAR, and each employee of the financial institution with signature or other authority that would allow that employee to redeem, rehypothecate, or otherwise transfer the hedge fund interests may also be required to file an FBAR.
6. U.S. Affiliate Maintaining Accounts at a Foreign Financial Institution. Assume that U.S. broker-dealer affiliate of a foreign financial institution maintains and has control over accounts at the foreign financial institution. The U.S. broker-dealer (and U.S. employees with signature or other authority over the foreign accounts) should file FBARs with respect to the foreign accounts.
III. FBAR Framework and Important Definitions.
1. IRS Form 1040; IRS Form 1120. Any person that is required to file an FBAR should indicate in Part III of Schedule B of IRS Form 1040 or Question 6 of Schedule N of Form 1120 that it had an interest in, or signature or other authority over a financial account in a foreign country, and any person that indicates in Part III of Schedule B of IRS Form 1040 and Question 6 of Schedule N of Form 1120 that it had an interest in, or signature or other authority over a financial account in a foreign country should file an FBAR.
2. FBAR. The FBAR must be received by the IRS no later than June 30 of the year following the calendar year to which it relates. As mentioned above, the IRS has granted an extension for certain U.S. persons until September 23, 2009 to file FBARs for calendar year 2008. A six-year statute of limitations applies to the assessment of penalty for a failure to file an FBAR.13
B. Persons Required to File.
1. General. The instructions to the FBAR provide that each United States person who has a financial interest in or signature or other authority over any foreign financial account must file an FBAR if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year. The underlined terms are each described below.
2. United States Person. For purposes of the FBAR, a “United States person” is a citizen or resident of the United States or any territory or possession of the United States, or any corporation, partnership, limited liability company, trust or estate, or any other entity that is recognized as a legal entity under the laws of any state, territory, or possession.14 For calendar years beginning in 2009, a United States person includes any foreign person in and doing business in the United States. The FBAR instructions provide that if a foreign company is engaged in a business in the United States through a branch, the branch itself (rather than the foreign company) should file the FBAR, even if the branch is not separately incorporated. A foreign subsidiary of a United States person that is not in or doing business in the United States is not required to file an FBAR.
C. Financial Account.
A financial account includes any bank, securities, securities derivatives, or other financial instruments accounts, and any savings, demand, checking, deposit, time deposit, or any other account (including debit card and prepaid credit card accounts) maintained with a financial institution or other person engaged in the business of a financial institution. The instructions to the FBAR also provide that a financial account generally includes 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). Individual bonds, notes, stock certificates, and unsecured loans to a foreign trade or business that is not a financial institution are not financial accounts. As mentioned above, however, the IRS has taken the position that an interest in a hedge fund also constitutes a “financial account,” despite the fact that a stock certificate is not.
D. Financial Interest.
The instructions to the FBAR provide that a person (the “potential filer”) has a financial interest in a financial account if:
- The potential filer is the owner of record or has legal title over the account, whether the account is maintained for his or her own benefit or for the benefit of others including non-United States persons.
- The owner of record or holder of legal title is (A) acting as an agent, nominee, attorney, or in some other capacity on behalf of the potential filer, (B) a corporation in which the potential filer owns directly or indirectly more than 50% of the total value of shares of stock or more than 50% of the voting power for all share of stock, (C) a partnership in which the potential filer owns an interest in more than 50% of the profits (distributive share of income, taking into account any special allocation agreement) or more than 50% of the capital of the partnership, or (D) a trust in which the potential filer either has a present beneficial interest, either directly or indirectly, in more than 50% of the assets or from which the potential filer receives more than 50% of the current income.
- The owner of record or holder of legal title is a trust, or a person acting on behalf of a trust, that was established by the potential filer and for which a person who is responsible for monitoring the activities of a trustee, with the authority to influence the decisions of the trustee or to replace, or recommend the replacement of, the trustee has been appointed.
E. Signature or Other Authority.
1. General. In general, under the instructions to the FBAR, a person has signature or other authority over an account if the person can control the disposition of money or other property in it by delivery of a document containing his or her signature (or his or her signature and that of one or more other persons) to the bank or other person with whom the account is maintained. The instructions also provide that other authority exists in a person who can exercise comparable power over an account by communication with the bank or other person with whom the account is maintained, either directly or through an agent, nominee, attorney, or in some other capacity, either orally or by some other means.
It is unclear how this definition applies to a foreign hedge fund. For example, it is unclear whether the traders and other U.S. employees of a foreign hedge fund are treated as having signature or other authority over a foreign account if they have authority to execute trades on behalf of the fund but all of the hedge fund’s assets are held in U.S. accounts. Equally, it is unclear if employees of a financial institution that owns an interest in a foreign hedge fund are treated as having signature or other authority over a foreign account merely by reason of having the power to dispose of shares of the hedge fund or to cause the hedge fund to redeem the institution’s shares.
2. Limited Exception for Certain Employees of Banks and Publicly-Traded U.S. Corporations. There are two limited exceptions for employees of banks and publicly-traded U.S. corporations who would otherwise be required to file an FBAR by reason of signature or other authority. First, an officer or employee of a bank that is currently examined by federal bank supervisory agencies for soundness and safety need not report that he or she has signature or other authority over a foreign bank, securities, or other financial account maintained by the bank, so long as the officer or employee has no personal financial interest in the account.
Second, an officer or employee of a domestic corporation whose equity securities are listed on any U.S. national securities exchange or that has assets exceeding $10 million and has 500 or more shareholders of record (or an officer or employee of a domestic subsidiary of such a domestic corporation or of a foreign subsidiary that is 50% owned by such a domestic corporation) need not file an FBAR concerning signature or other authority over a foreign financial account of the corporation so long as the officer or employee has no personal financial interest in the account and has been advised in writing by the chief financial officer or similar responsible officer of the corporation that the corporation has filed a current FBAR that includes that account. If a United States subsidiary is named in a consolidated FBAR of the parent, the subsidiary will be deemed to have filed an FBAR for purposes of this exception.