On December 9, 2009, the House of Representatives approved H.R. 4213, the Tax Extenders Act of 2009 (TEA), which includes portions of the Foreign Account Tax Compliance Act (H.R. 3933 and S. 1934) (FATCA), introduced on October 27, 2009, by Senator Max Baucus (D-Montana) and Representative Charles Rangel (D-New York). The measure, which would extend for one year numerous provisions that were set to expire at the end of 2009, would be paid for by taxing “carried interests” as ordinary income rather than as capital gains, as well as by a new version of the FATCA tax compliance and enforcement proposals.
The TEA adds a new Chapter 4 to the Code (Secs. 1471 through 1474) that would provide for withholding taxes to enforce new reporting requirements with respect to certain foreign accounts owned by specified U.S. persons and U.S.-owned foreign entities. It would do so by establishing rules for withholdable payments to foreign financial institutions and for withholdable payments to other foreign entities. The effective date for reporting and disclosure requirements has been pushed back two years (i.e., for withholdable payments made after December 31, 2012).
Revisions of Foreign Account Tax Compliance Act
The TEA made a number of significant changes to FATCA.
- FATCA required foreign financial institutions to agree that they would comply with extensive new reporting requirements with respect to U.S. individuals or foreign entities with “substantial U.S. owners” that maintain financial accounts. If they do not agree, they would be required to collect a 30 percent withholding tax on “withholdable payments.” The TEA exempts from the reporting and withholding regime U.S. depository accounts that are maintained by U.S. individuals if the aggregate value of the deposits held by such persons and maintained by the foreign financial institution does not exceed $50,000 (a $10,000 floor had been required under the FATCA).
- Under the TEA, withholding would also apply to “pass-thru payments” in situations in which foreign financial institutions cannot obtain the required information from so-called “recalcitrant taxpayers,” or where the income is paid to financial institutions that have not entered into an agreement with the IRS. In addition, a foreign financial institution can elect to have “withholdable payments” received by it withheld upon by a withholding agent to the extent allocable to “recalcitrant taxpayers” or foreign financial institutions that have not entered into an agreement with the IRS.
- Under the TEA, foreign financial institutions able to establish that they do not maintain U.S. accounts would be deemed to meet the requirements of the withholding section or would be exempted from its application altogether. The measure also includes a provision that is intended to avoid duplicative reporting requirements in situations where a U.S. account is held by another foreign bank that meets the requirements of the withholding section or is owned by a person already subject to information reporting that the Treasury Secretary determines is sufficient to exempt the account from the application of the withholding section.
- FATCA defined “withholdable payments” to include FDAP income from U.S. sources, as well as gross proceeds of sales of any income-producing assets that would produce income from U.S. sources. The TEA expressly exempts from the term any income effectively connected with a U.S. trade or business under Section 871(b)(1) or 882(a)(1). Further, in determining the source of a payment, section 861(a)(1)(B) (the rule for sourcing interest paid by foreign branches of domestic financial institutions) does not apply.
- The TEA removed a provision that required a foreign financial institution to affirmatively seek certification from its client base as to the tax status of each account holder and, instead, requires that a foreign financial institution obtain information regarding such account holders, presumably based on relevant “know-your-customer” or “anti-money laundering” account holder information in the bank’s files. In addition, worldwide branch and related entity due diligence requirements have been removed.
- The TEA also removed a provision that would have required “material advisers” to disclose the identities of any clients they assist in acquiring or establishing a foreign entity.
- The TEA sets forth a more detailed definition of a “dividend equivalent” to include “substitute dividends” and “specified” notional principal contracts and attempts to prevent over-withholding for chains of dividend equivalents subject to tax under Section 881.
Other provisions in the FATCA remain relatively unaltered, including the following:
- the repeal of certain foreign exceptions to registered bond requirements for obligations issued after two years after the date the TEA is enacted;
- the new disclosure of information requirements with respect to foreign financial assets;
- the new accuracy-related penalty for underpayments attributable to undisclosed foreign financial assets;
- the new six-year limitations period for assessment of tax on understatements of income attributable to foreign financial assets;
- the information reporting requirements for activities with respect to passive foreign investment companies;
- the new withholding requirements imposed on payments to non-financial foreign entities;
- the presumption that certain foreign trusts have U.S. beneficiaries and the $10,000 minimum failure-to-file penalty for certain foreign-trust-related information returns;
- the application of the withholding and reporting regime to all payments made to foreign financial investment vehicles owned by any specified U.S. person, regardless of that person’s actual ownership percentage in the entity; and
- the disallowance of credits and refunds on payments with respect to which a foreign financial institution is the beneficial owner, except to the extent the foreign financial institution is entitled to an exemption or a reduced rate of tax under a U.S. treaty.
Although the TEA is an improvement over the earlier proposed FATCA, it is still likely to impose heavy costs and burdens on financial intermediaries and, in any event, the extended information reporting regime may need more time for implementation in order for its provisions to be workable. Since foreign banks would be required to expend significant resources to implement the bill, it is hoped that a streamlined reporting and disclosure procedure would be adopted where possible. The Senate is expected to take up consideration of the TEA in early 2010.