United States: Regulations Proposed by US Treasury Department and Internal Revenue Service Require Financial Institutions to Report Interest Paid to Nonresident Aliens

Originally published January 10, 2011

Keywords: Internal Revenue Service, information reporting, nonresident alien, interest payments

On January 7, 2011, the US Treasury Department (Treasury) and the Internal Revenue Service (IRS) issued proposed regulations that would impose information collection and reporting requirements on US financial institutions with respect to bank deposit interest paid to non-US persons (the "2011 proposed regulations").1 These regulations are quite similar to regulations first proposed in 2001, which were substantially revised in 2002 due to widespread concerns over the associated burden imposed on US financial institutions, privacy rights and the fact that such information would be likely transmitted to foreign countries without any reciprocal exchange of tax information.

In 2001, the Treasury and the IRS published proposed regulations under section 6049 of the Internal Revenue Code (the "Code") that would have required that US bank deposit interest paid to any nonresident alien individual be reported annually to the IRS (the "2001 proposed regulations").2 After obtaining this information from the reporting financial institution, the IRS would have the discretion to transmit the information to the non-US jurisdiction associated with the nonresident depositor.3 US federal income tax law does not tax bank deposit interest derived by a nonresident; accordingly, the collection of such information does not further US tax collection or administration efforts. However, once collected, it would be much easier for foreign governments to obtain such information from the IRS under the terms of many double taxation treaties.

A substantial number of comments were submitted to Treasury and the IRS with respect to the 2001 proposed regulations. These comments criticized the administrative burden the 2001 proposed regulations would have imposed on US financial institutions and noted that such burden would have significantly outweighed any benefit obtained by the IRS from the additional information collected. In addition, commentators noted that the 2001 proposed regulations would have resulted in significant capital flight from the United States with corresponding adverse effects to US financial institutions, particularly those with a deposit base that included a significant number of nonresident alien individuals. There were also privacy concerns raised on behalf of nonresident depositors that information collected by the IRS under the 2001 proposed regulations might have been misused by the foreign jurisdictions to whom such information would be provided or otherwise increase their risk of being targets for extortion or kidnapping.

After considering these comments, Treasury and the IRS concluded that the 2001 proposed regulations were overly broad and on August 2, 2002 withdrew the 2001 proposed regulations. Simultaneously, Treasury and the IRS re-issued proposed regulations (the "2002 proposed regulations") that imposed similar information reporting requirements, albeit in narrower form, limiting the information collection and reporting obligations only to citizens of certain jurisdictions, generally those of OECD countries and certain US income tax treaty partners.4 Following the election of President George W. Bush, no action was taken to finalize the 2002 proposed regulations.

The 2011 proposed regulations would require information reporting in substantially the same manner as the regulations that were originally proposed in 2001. US financial institutions would be obligated to conduct information reporting with respect to bank deposit interest derived by all nonresident alien individuals. The 2011 proposed regulations will apply to payments made after December 31 of the year in which the final regulations are published in the Federal Register.

The Preamble to the 2011 proposed regulations contains several reasons explaining why Treasury and the IRS now consider it appropriate to broaden the information reporting requirements imposed on bank deposit interest derived by nonresident alien individuals. It describes certain developments in the area of information exchange, including the "growing global consensus" regarding cooperative tax information exchange and the proliferation of tax information exchange agreements and income tax treaties, which are not limited by banking secrecy laws or a domestic tax interest for collecting such information.5 Treasury and the IRS also indicate that this information reporting obligation will "strengthen the U.S. exchange of information program, consistent with adequate provisions for reciprocity, usability, and confidentiality in respect of this information."6

Finally, Treasury and the IRS maintain that collecting this information will reduce the incidence of improper avoidance of US taxation by US taxpayers through improper claims of foreign status. Notwithstanding the statements made in the Preamble to the 2011 proposed regulations (which echo the claims of the 2001 and 2002 proposed regulations), those constituencies that opposed the 2001 and 2002 proposed regulations are likely to continue to view these claims skeptically.

The recent enactment of sections 1471-1474 of the Code (the so-called "FATCA" provisions), which generally require non-US financial institutions to disclose information regarding US persons who hold accounts at such financial institutions, has caused some commentators to question whether the timing of issuing these proposed regulations is intended to mute concerns from abroad that the United States is acting in a unilateral manner in compelling such disclosures and demonstrate a US inclination toward reciprocity at the same time that foreign banks and governments are voicing skepticism with respect to the implementation of FATCA.

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1. 76 Fed. Reg. 1105 (January 7, 2011).

2. Prop. Treas. Reg §§ 1.6049-4 and -8.

3. Prop. Treas. Reg. § 1.6049-6.

4. The proposed regulations would have only required information reporting with respect to nonresidents that were citizens of Australia, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden and the United Kingdom.

5. 76 Fed. Reg. 1105, 1106.

6. Id.

Copyright 2011. Mayer Brown LLP, Mayer Brown International LLP, Mayer Brown JSM and/or Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. All rights reserved.

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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