Earlier this week, the "Foreign Account Tax Compliance Act of 2009" (the "bill") was introduced in the Senate and the House. The bill is another effort aimed at curbing tax evasion through use of foreign financial accounts and investments by United States persons, although many of the provisions apply more broadly, and if passed in its current form, the bill will have significant implications beyond offshore bank accounts and their equivalents, in particular for hedge funds and private equity funds that are formed offshore.
The bill was introduced in the Senate by Senator Baucus of Montana and Senator Kerry of Massachusetts, and in the House by Representative Rangel of New York and Representative Neal of Massachusetts. The bill is a successor in part to the "Stop Tax Haven Abuse Act" introduced earlier in the year by Senator Levin of Michigan, which we discussed in our client memorandum dated March 5, 2009, entitled " Recent Tax Proposals of Interest to Funds and Fund Managers."1
The bill's main feature is a new withholding tax that incentivizes foreign recipients of certain US source payments to comply with a variety of disclosure requirements relating to ownership by US persons. The bill also contains some companion reporting requirements for US investors with offshore accounts or financial interests and a separate withholding provision designed to tax dividend equivalent payments. A summary of the key provisions is set out below:
- All US source payments of interest (including OID), dividends, and other items traditionally subject to withholding, as well as the gross proceeds from the sale of any equity or debt of US issuers (collectively, "withholdable payments") which are made to a "foreign financial institution" would be subject to US withholding tax at a 30% rate, unless the foreign financial institution enters into an agreement with the IRS to obtain and report information about its US account holders/investors. There are limited exceptions to this reporting requirement, the most notable of which is that no disclosure is required with respect to US tax-exempt entities. In addition to disclosure of direct US account holders/investors, a foreign financial institution must also disclose certain indirect US account holders/investors.2 For purposes of this proposal, a foreign financial institution includes not only banks, but also any other foreign entity that is engaged primarily in the business of investing or trading in securities, commodities or partnership interests; this definition would include most offshore hedge funds and private equity funds (whether managed from the US or elsewhere).
- All withholdable payments to any foreign entity that is not a foreign financial institution would be subject to US withholding tax at a 30% rate, unless such non-financial foreign entity discloses to its relevant counterparties the identity of all of its substantial (more than 10%) direct or indirect US owners (other than US tax-exempt entities and certain other US owners) and such counterparties disclose such information to the IRS. If the non-financial foreign entity does not have any substantial US owners, a certification to that effect will satisfy this disclosure requirement. This provision would generally include any offshore hedge fund and private equity fund that does not qualify as a foreign financial institution.
- US individual taxpayers would be subject to expanded reporting obligations (and substantial penalties for failure to satisfy such reporting obligations) with respect to investments in any "specified foreign financial assets," which generally would include any account maintained by, or any equity or debt interest in, any foreign financial institution (i.e., most offshore hedge funds and private equity funds), as well as stocks, securities, or other interests in, or financial instruments or contracts issued by, a foreign entity.
- Advisors that provide any material aid, assistance, or advice to US persons with respect to the formation or acquisition of interests in foreign entities would, in certain cases, be obligated to disclose information about such transactions to the IRS.
- Similar to previous proposals, dividend equivalent payments would be subject to withholding tax in the same manner as their corresponding US source dividends. Specifically, any payments made to a non-US person pursuant to a notional principal contract that are contingent upon, or determined by reference to, the payment of a dividend from sources within the United States, or that are substantially similar thereto, would be subject to US withholding tax at a rate of 30% unless otherwise reduced by an applicable income tax treaty.
Footnotes
1 The bill does not contain the controversial provision which would tax any foreign entity that was managed or controlled from the United States as a US entity. Additionally, the bill does not contain many of the procedural aspects of the Stop Tax Haven Abuse Act, such as legal presumptions, burdens of proof, etc., although it is possible these will be added as the bill progresses through Congress.
2 Disclosure of indirect US account holders/investors is generally required (i) in the case of a US person owning, directly or indirectly, more than 10% of any direct foreign investor and (ii) in the case of all US persons owning, directly or indirectly, any interest in a direct foreign investor that itself is engaged primarily in the business of investing or trading in securities, commodities or partnership interests (i.e., without regard to the 10% test.)
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