Last week, Representative Charles Rangel and Senator Max Baucus introduced the Foreign Account Tax Compliance Act of 2009 (H.R. 3933/S. 1934) in the House and Senate (the “Bill”). If enacted, the Bill would, among other things, impose significant new compliance burdens on non-U.S. private investment funds and other “foreign financial institutions,” expand reporting of foreign financial accounts held by U.S. persons, and treat dividend equivalent payments on equity swaps as U.S. source income.
A. New Withholding Tax and Compliance Provisions
The Bill would impose a new 30% withholding tax on non-U.S. private investment funds and other “foreign financial institutions,” including banks and brokers. The new withholding tax would apply to payments of U.S. source investment income, such as dividends and interest, as well as capital gains from the sale of stocks or securities issued by a U.S. person, unless the “foreign financial institution” enters into an agreement with the U.S. Treasury to report certain information about its accounts owned by a U.S. person or by a non-U.S. entity substantially owned by a U.S. person (such accounts, “U.S. accounts”).
The agreement with the U.S. Treasury would require the “foreign financial institution” to (1) determine whether each of its accounts is a U.S. account, (2) comply with verification and due diligence procedures with respect to its U.S. accounts, (3) annually report certain information about its U.S. accounts (as described in more detail below), (4) comply with requests by the Treasury for additional information with respect to its U.S. accounts, and (5) obtain a waiver of any foreign law confidentiality provisions with respect to its U.S. accounts from the U.S. account holder (or to close the account if such waiver is not obtained).
With respect to each U.S. account, a “foreign financial institution” entering into an agreement with the Treasury would be required to report to the Internal Revenue Service (the “IRS”): (1) the name, address and tax identification number of the U.S. account holder, (2) the account number, (3) the account balance and (4) the gross receipts and gross withdrawals or payments from the account.
A “foreign financial institution” would not be required to report accounts maintained by, among others, U.S. tax-exempt entities (including pension plans and endowments); individual retirement accounts; publicly traded corporations; federal, state and local governments; regulated investment companies; real estate investment trusts, and banks. As such, the reporting obligations would only apply with respect to certain U.S. taxable investors in a fund.
These new withholding tax provisions will dramatically increase the compliance burden for non-U.S. private investment funds as well as prime brokers and other paying agents. Although most non-U.S. private investment funds do not have a significant number of U.S. taxable investors, funds will still be required to enter into agreements with the U.S. Treasury in order to avoid the imposition of a withholding tax. In addition, prime brokers and other paying agents will be required to determine whether a payee fund has entered into such an agreement. As with other withholding taxes, in the event that a prime broker or other paying agent fails to properly withhold the 30% tax, the prime broker or paying agent will be liable for such tax.
The Bill’s provisions related to “U.S. accounts” held at “foreign financial institutions” would generally be effective for payments made after December 31, 2010.
B. New Foreign Account Reporting Obligations
The Bill would also clarify and expand reporting of foreign financial assets held by U.S. persons. Under current law, a U.S. person who has a “financial interest” or “signature authority” over a “foreign financial account” is required to annually file Form TD F 90-22.1 with the U.S. Treasury (the “FBAR regime”). Over the past several months, the IRS has taken the position that this reporting obligation applies to interests in non-U.S. private investment funds and mutual funds, although the statutory or other authority for this position is unclear.
The Bill would make create an entirely new reporting regime, requiring that a U.S. person who holds an interest in a “specified foreign financial asset” is required to provide certain information about such assets to his tax return. A “specified foreign financial asset” would include an equity or debt interest in a offshore private investment fund. In particular, the Bill would require any individual that holds more than $50,000 (in the aggregate) in (i) a depository or custodial account maintained at a “foreign financial institution,” or (ii) any foreign stock, interest in a foreign entity or financial instrument with a foreign counterparty not held in a custodial account of a financial institution, to report information about those accounts and/or assets to the U.S. Treasury with the individual’s annual income tax return. As currently draft, these requirements would be in addition to the current FBAR regime. It is unclear whether reporting would ultimately be required under both the provisions of the Bill and the current FBAR regime.
The Bill would also increase penalties on the underpayment of tax related to a failure to report an interest in a “specified foreign financial asset” and extend the statute of limitations for assessment of tax to six years (from three years) with respect to unreported income from a “specified foreign financial asset.”
The Bill’s new foreign account reporting provisions would be effective for taxable years beginning after the Bill’s date of enactment.
C. Dividend Equivalent Payments on U.S. Equities
The Bill would treat dividend equivalent payments received on swaps on U.S. equities as U.S. source income for U.S. federal income tax purposes. Under current law, such payments are sourced to the swap holder’s residence and, therefore, in the case of a non-U.S. holder, are not subject to U.S. withholding tax. If the Bill is enacted, such payments would be subject to a 30% U.S. withholding tax in the hands of non-U.S. investors, such as offshore private investment funds. This provision would reduce the attractiveness of using equity swaps to avoid withholding on U.S. source dividend income.
The Bill’s provisions related to dividend equivalent payments would be effective for payments made on or after the date that is 90 days after the Bill’s enactment.
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We will continue to monitor the progress of the Bill and its impact on the private investment fund industry. If you have any questions regarding this memorandum, please call Peter Pront at (212) 574-1221, Ron Cima at (212) 574-1471, Dan Murphy at (212) 574-1210, or Jim Cofer at (212) 574-1688.
