Stephanie E. Heilborn, Kathryn Keneally and Michelle Schwartz
April 16, 2010
On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment ("HIRE") Act (H.R. 2847) (the "Act"), which imposes additional tax and reporting requirements on foreign financial institutions, foreign financial assets, and foreign trusts. The Act is intended to permit the U.S. to more closely monitor financial outflows from the U.S. to foreign institutions as well as foreign investment in U.S. assets via trusts or other entities.
Overview: Key Concerns For U.S. Taxpayers
The Act raises immediate concerns for U.S. taxpayers and financial institutions. The Act signifies a shift in how the tax law views foreign trusts and investment entities and will certainly increase the cost of complying with U.S. tax obligations.
U.S. taxpayers should consider the following:
- U.S. beneficiaries of foreign trusts that own property available for the beneficiary's use must consult a tax advisor to determine how that use must be reported for income tax purposes. The Act now imposes a different rule for foreign trusts than for U.S. trusts in which the use of trust property does not give rise to imputed income.
- U.S. taxpayers also should note that the reporting requirements applicable to foreign financial assets in excess of $50,000 are in addition to, and not in lieu of, the FBAR filing requirements.
- Foreign financial institutions will need to determine whether and how to comply with the new withholding tax rules if they want to continue to do business with U.S. customers.
- Foreign non-financial institutions will need to start gathering information on their shareholders and informing them of the new reporting requirements.
- It is unclear how the IRS will apply the new rules on disclosure of foreign financial assets to domestic entities, such as limited liability companies and limited partnerships. Again, counsel should be consulted.
New Rules Applicable To Foreign Trusts with U.S. Beneficiaries
Effective March 18, 2010, the Act provides new guidelines for when a foreign trust is considered to have a U.S. beneficiary. A foreign trust is treated as having a U.S. beneficiary if any person has the discretion to make a distribution from the trust for the benefit of any other person, unless the terms of the trust identify the class of persons to whom distributions may be made and none of those persons is a U.S. person during the taxable year. The Act also imposes additional reporting requirements on the uncompensated use of trust property by a U.S. beneficiary.
If a transferor to the trust is involved (directly or indirectly) in any agreement or understanding that may result in trust income or corpus being paid to or accumulated for the benefit of a U.S. person, then such agreement is treated as a term of the trust. In general, a transferor's involvement is assumed.
The Act provides that if a U.S. person (directly or indirectly) transfers property to a foreign trust (other than certain deferred compensation trusts and charitable trusts), the trust is presumed to have a U.S. beneficiary for purposes of the grantor trust rules. Thus, the U.S. transferor will be treated as the owner of the trust property. This presumption will not apply if the U.S. person submits information demonstrating that no trust income or corpus may be paid or accumulated to or for the benefit of a U.S. person.
New Disclosure Requirements and Penalties for U.S. Taxpayers with More Than $50,000 in Specified Foreign Financial Assets
Effective March 18, 2010, the Act requires individual taxpayers holding "specified foreign financial assets" (including financial accounts, stock or securities issued by a non-U.S. person, interests in a foreign entity and investment contracts with a non-U.S. issuer or counterparty) during the taxable year to attach a disclosure statement to their income tax return for any year in which the total value of all such assets exceeds $50,000. The information required would be similar, but not identical, to the information disclosed on a Report of Foreign Bank and Financial Accounts ("FBAR").
Taxpayers who fail to make the required disclosures are subject to a penalty of $10,000 for the taxable year. Penalties will increase for delinquency, up to a maximum of $50,000. The Act imposes a new accuracy related penalty of 40% on any understatement attributable to an undisclosed foreign financial asset and authorizes a new six-year statute of limitations for understatements. Further, the Act gives the Secretary the power to apply the reporting requirements to any domestic entity that is used or formed to avoid the individual reporting requirement.
New Thirty Percent Withholding Tax and Reporting Requirements for Foreign Institutions with U.S. Customers
Any payment from a U.S. source (referred to as a "withholdable payment")—including, but not limited to, interest, dividends, profits, and sale proceeds—made after December 31, 2012 to a "foreign financial institution" generally will be subject to a U.S. withholding tax of 30% unless the foreign financial institution enters into an agreement with the Secretary of the Treasury (the "Secretary") agreeing to comply with certain reporting requirements.
The Act broadens the definition of a "foreign financial institution" ("FFI") to include traditional banks as well as hedge funds, private equity funds, and other offshore securitization vehicles that hold U.S. assets and issue their own equity or debt securities. A foreign branch of a domestic financial institution is not considered an FFI.
To avoid the 30% withholding tax, the FFI must agree to follow numerous verification and due diligence procedures. The FFI may elect to have a U.S. withholding agent (such as another FFI that has entered into a reporting agreement with the U.S.) withhold on certain payments made to the electing FFI. An electing FFI will continue to be subject to other notification and reporting requirements.
The 30% withholding tax also will apply to withholdable payments to all other foreign entities that are not financial institutions, unless the entity either provides the name and address of all of its U.S. owners or shows that it does not have any substantial U.S. owners.
New Information Return Filing Requirements for U.S. Shareholders of Passive Foreign Investment Companies
Effective March 10, 2010, except as otherwise provided by the Secretary, the Act mandates that each U.S. person who is a shareholder of a passive foreign investment company ("PFIC") must file an annual information return containing such information as the Secretary may require. Prior law required annual reporting only if the U.S. person received a distribution from or disposed of its interest in a PFIC, or made certain elections with regard to interests in a PFIC.
New Thirty Percent Withholding Tax On Dividend Equivalent Payments
Effective for payments made on or after the date that is 180 days after March 18, 2010, the Act treats dividend equivalents (such as substitute dividends on securities lending transactions and payments on contracts contingent upon the payment of dividends) as U.S. source income. Dividend equivalents paid to foreign persons are subject to a 30% U.S. withholding tax unless a treaty dictates otherwise.
This article was prepared by Stephanie E. Heilborn (email@example.com or 212 318 3207), Kathryn Keneally and Michelle Schwartz (firstname.lastname@example.org or 212 318 3110) from Fulbright's Tax Practice Group and Trusts, Estates and Beneficiaries Practice Group. For more information please contact one of the authors or a member of Fulbright's Tax Practice Group or Trusts, Estates and Beneficiaries Practice Group.
IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter[s].
Stephanie E. Heilborn