U.S. FATCA Information Reporting: Fishing for Forsaken Tax Revenues

* by Lawrence A. Kogan, Esq.

FATCA's Objective

The Foreign Account Tax Compliance Act ("FATCA"), which added new Chapter 4 to Subtitle A of the Internal Revenue Code (comprising Sections 1471, 1472, 1473, and 1474) was signed into law on March 18, 2010 by President Obama as part of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-47.

FATCA's objective is to help "plug" the portion of the federal tax gap that is attributable to US taxpayers' failure to voluntarily report and pay taxes on earnings they derived directly and indirectly from a large variety of investment-based assets held in offshore accounts. Congressional and Treasury Department investigations have estimated that US individual (citizen and resident) and corporate taxpayers, with professional and foreign banking assistance, have successfully evaded payment of approximately $100 billion in US federal taxes each year, "represent[ing] a substantial portion of the annual U.S. tax gap".

Several studies have revealed that the federal tax gap surrounding offshore accounts was exacerbated, in part, by the information self-reporting systems in place prior to FATCA's enactment, including the Report of Foreign Bank and Financial Accounts (FBAR) enacted under the U.S. Bank Secrecy Act and the Qualified Intermediary (QI) program enacted under Subchapter 3 of the Internal Revenue Code (IRC Section 1441)...

... FATCA... aims to... [require] financial conduits to establish tiered reporting and payment systems that trace for the IRS U.S. source cross-border portfolio income remittances to individual offshore financial accounts directly or beneficially held by US persons...

FATCA's emphasis on transparency builds upon Treasury Department findings that "compliance is highest where parties other than the taxpayer are required to file information reports and withhold taxes from payments made." For example, to facilitate greater transparency, the IRS has clarified that mandatory FATCA foreign financial institution ("FFI") reporting obligations apply in addition to those imposed under IRC Section 1441 in connection with the QI program [see IRC Section 1471(c)(3) Notwithstanding these potentially duplicative reporting obligations, the FATCA proposed regulations ensure coordination between FATCA's withholding provision and those of Subchapter 3 of the Internal Revenue Code (Sections 1441-1443, 1445) in order to prevent over-withholding. See Prop. Reg. Sec. 1.1474-6] as well as those imposed on both US and foreign financial institutions under IRC Section 6049 with respect to accounts held by nonresident aliens. [See IRC Section 6049(b)(5)(A) (relating to amounts subject to withholding under subchapter A of chapter 3 - i.e., concerning withholding of tax on nonresident aliens and foreign corporations); Prop. Reg. Sec. 1.6049-4(b)(5), T.D. 9584 (Payors of interest aggregating $10 or more to nonresident alien individuals must "make an information return on Form 1042-S, 'Foreign Person's U.S. Source Income Subject to Withholding'".)]...

FATCA's Antecedents

... FATCA is largely premised on and expands upon the practices of other (taxpayer residence) countries which require third-party payors located in third countries (income source countries) to report certain income items paid to their nationals (citizens and residents). ["[A]s is the case in many countries, third-party payors of certain items are required to report these amounts to the IRS. Such reporting serves as an important and long-standing check on voluntary compliance." See Prop. Reg. Sec. 1.1471-1, Section I at p. 3]...

 FATCA is also based partially on recent multilateral taxpayer information exchange initiatives at the Organization for Economic Cooperation and Development ("OECD") designed to correct the perceived ineffectiveness of the OECD's 2002 Model Agreement on Information Exchange on Tax Matters ("TIEA") and the 2005 and 2008 updates to the information exchange provisions of the OECD Model Tax Convention on Income and Capital the requirements of which do not appear to be deemed incompatible with bank secrecy...

FATCA's General Framework

Building upon these reference points, FATCA empowers the IRS to unilaterally deputize third party foreign financial institutions ("FFIs"). [See 26 USC1471(d)(4).] to serve as the IRS' extraterritorial information reporting and withholding agents [FATCA defines the term 'withholding agent' to include "all persons, in whatever capacity acting, having the control, receipt, custody, disposal, or payment of any withholdable payment." 26 USC 1473(1)(C)(4)] for purposes of securing essential information about, and potentially collecting long forsaken taxes with respect to, many different types of U.S. source payments destined for the offshore accounts of U.S. individuals and certain U.S. beneficially owned non-financial foreign entities ("NFFEs"). [FATCA refers to these accounts as 'United States Accounts', which are defined as "any financial account which is held by one or more specified United States persons or United States owned foreign entities."]... FFIs, including FFIs serving as intermediaries, can either enter into a disclosure compliance agreement with the IRS to undertake due diligence necessary and sufficient to secure correct U.S. account and account holder information (based on the "knows or has reason to knows" standard), to file related information reports, to withhold a 30% tax from US source "withholdable payments" made directly to recalcitrant US account holders or indirectly to US account holders through non-deputized or otherwise uncooperative FFIs or NFFEs, and to close US accounts in the absence of a waiver providing the FFI a derogation from bank secrecy nondisclosure laws, or they can accept the imposition of a 30% withholding tax upon certain of their own US source income... [A]n intergovernmental approach to FATCA implementation... permits FFIs to submit such information indirectly to the IRS vis-à-vis their own government's competent tax authority in accordance with the terms of one of several Treasury Department intergovernmental (bilateral) FACTA-related taxpayer information exchange agreements...

FATCA's Progeny

... [O]n February 15, 2011, the EU adopted Council Directive 2011/16/EU...[, which] provides for the compulsory automatic exchange of available information which cannot be refused solely on bank secrecy grounds. Unlike the EUSD [European Union Savings Directive], however, this information exchange obligation initially covers five types of income [income from employment, directors' fees, pensions, life insurance products not covered by other Union legal instrument on exchange of information and other similar measure, ownership of and income from immovable property] which can be expanded to include dividend, capital gain and royalty income as part of a broader EU-wide automatic exchange of information initiative comprising EU Member States interested in participating, but which does not encourage non-EU Member State participation...

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Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.

* Lawrence A. Kogan, Esq. is Managing Attorney of The Kogan Law Group, P.C., a New York City-based multidisciplinary professional services firm focusing on identifying, assessing and addressing cross-border regulatory and trade risk for multinational business assets and operations.

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Lexis users can view the entire commentary HERE. Additional fees may apply. (Approx. 21 pages)

RELATED LINKS: For more information on FATCA, see these 2012 Emerging Issues Analysis commentaries:

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