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After the Success of the Offshore Voluntary Disclosure Program,
the Federal Government Aims to Consolidate its Financial
and Public Relations Momentum with New Tax Legislation

Congress Passes Legislation Extending First-Time Homebuyer Credit
and Lengthening Net Operating Loss Carryback Period

Legislative language recently was introduced in Congress to address offshore foreign tax compliance. Identical language was introduced in the House by Chairman of the House Committee on Ways and Means Charles Rangel (D.-N.Y.) and his Subcommittee on Select Revenue Measures Chairman Richard Neal (D.-Mass.), and in the Senate by Chairman of the Senate Finance Committee Max Baucus (D.-Mont.) and Chairman of the Senate Foreign Relations Committee John Kerry (D.-Mass.), who also sits on the Senate Finance Committee.

The bill, the “Foreign Account Tax Compliance Act of 2009” (H.R. 3933 and S. 1934, respectively) has the full support of the Administration. The Treasury Department worked closely with Congress in developing the bill, which was drawn from previous proposals of Senator Carl Levin (D.-Mich.) and Representative Lloyd Doggett (D.-Tex.), Senator Baucus, and the Administration’s 2010 Budget. In the most recent talks, the most aggressive proposals were pared away, including the creation of a “tax haven country blacklist” and certain negative presumptions arising from entering into (or failing to report) certain transactions, leaving a large core of proposals that may have widespread Congressional support.

It is possible that the bill could be combined with a larger general tax reform effort in 2010, but it also may be pushed through the Congress in 2009 as a stand-alone bill or with estate tax reform and certain tax “extenders.” Representative Neal, who held a subcommittee hearing on the bill on November 5, stated that it could be enacted by the end of 2009 and that it would raise $8.5 billion over 10 years. The Administration’s Budget package in this area was estimated to raise approximately $10 billion. It is possible that aspects of the bill could be changed before it is enacted.

The following is a summary of the provisions of the Foreign Account Tax Compliance Act of 2009, as they stood on November 13, 2009:

Information Returns, Increased Disclosure and Electronic Filing

• The most complex provision of the bill adds a new chapter 4 to the Code that requires a foreign financial institution (including a hedge or private equity fund) to enter into an agreement with the IRS under which the institution must either (i) identify and report certain information with respect to accounts owned (directly or indirectly) by U.S. persons, or (ii) report as if the institution were a U.S. institution. If these requirements are not met by a foreign financial institution, U.S. payors must withhold 30 percent from any “withholdable” payment made to that institution. If the beneficial owner of such a payment is entitled to a reduced rate of withholding under an income tax treaty, that beneficial owner must file for a credit or refund. A withholdable payment includes not only payments of U.S. source interest, dividends, and other fixed or determinable income (i.e., payments of a type generally subject to U.S. withholding under present law), but also gross proceeds from the sale of any property of a type which can produce U.S. source interest or dividends. The foreign financial institution may generally rely on an account holder’s certification, but must comply with know-your-customer, anti-money laundering, anti-corruption and similar non-tax rules in making this tax status determination. The provision is subject to a minimum per-holder account threshold of $10,000 per account ($50,000 for existing accounts). The rules generally do not apply to beneficial owners which are publicly traded corporations, banks, REITs, RICs, certain common trust funds or exempt trusts. The requirements of the bill apply to all foreign financial institutions and are in addition to those which may be imposed under a qualified intermediary agreement. It is expected that foreign financial institutions will agree to provide the required information rather than be subject to withholding. In addition, under the bill, a U.S. withholding agent is required either (i) to report certain information with respect to each substantial U.S. owner of the beneficial owner of any withholdable payment made to a foreign entity (except a publicly traded corporation) that is not a financial institution, or (ii) to withhold 30 percent tax from such a payment. The provision applies to payments made after December 31, 2010, subject to certain transition rules.
• Under the bill, certain foreign-targeted obligations of a type currently exempt from registration requirements (i.e., certain bearer bonds) would no longer be exempt, and thus interest paid on such obligations would not be deductible. Also, such unregistered obligations would no longer be eligible for the portfolio interest exemption from 30 percent withholding (but could qualify for a lower treaty rate). The purpose of this provision is to force issuers of these types of obligations to register them. The provision applies to debt obligations issued 181 days after the date of enactment.
• The bill requires an additional statement to be attached to the tax return disclosing interests in specified foreign financial assets. This requirement is in addition to the requirement to file a Report of Foreign Bank and Financial Accounts (FBAR) under present law, and appears largely -- but not completely -- to overlap that requirement. The penalty for failure to make the required disclosure in a taxable year is $10,000, plus additional penalties up to $50,000 after notice. The provision is expected to have the practical effect of permitting the IRS to invoke the relatively well-understood and robust procedural tax rules in applying FBAR penalties. The provision is effective for taxable years beginning after date of enactment.
• The provision requires a shareholder of a passive foreign investment company (“PFIC”) to file an annual information return containing information to be specified by the IRS. The provision is effective on the date of enactment.
  The bill requires a “material advisor” to file an information return disclosing assistance to a U.S. individual in acquiring or forming a foreign entity, if the individual is required to file certain specified information returns with respect to such a transaction. A material advisor is any person who provides any material aid, assistance, or advice with respect to carrying out such a transaction, and who directly or indirectly derives gross income in excess of $100,000 during a calendar year for providing such aid, assistance, or advice. A penalty of up to 50 percent of the advisor’s gross income with respect to the transaction is imposed for failure to file the information return. The $100,000 threshold includes all advice related in any way to the transaction. The provision is effective with respect to aid, assistance, and advice provided after the date of enactment.
• The provision permits the IRS to require electronic filing for any return filed by a financial institution, even if the institution is presently excepted from such filing under present law because it is under the 250 return-per-year filing threshold.

Penalties and Statute of Limitations

• The bill imposes a new accuracy-related penalty of 40% for any understatement attributable to any transaction involving an undisclosed foreign financial asset, which is, in general, a foreign financial asset which is required to be disclosed under present law and this bill, but which is not so disclosed. The provision is effective for taxable years after the date of enactment.
• The bill suspends the limitations period on assessment of taxes until required disclosures are made with respect to foreign financial assets or PFICs. The bill also increases the statute of limitations to six years for understatements attributable to omission of gross income in excess of $5,000 with respect to foreign financial assets, even if the amount omitted from the return is less than 25 percent of gross income (which is the threshold for applying a six-year statute under present law). The provision is effective for returns filed after the date of enactment, and for filed returns for which the present-law assessment period has not expired as of the date of enactment.

Foreign Trusts

• In general, under present law, a U.S. person that directly or indirectly transfers property to a foreign trust is treated as the owner of the portion of the trust comprising the transferred property for any taxable year in which there is a U.S. beneficiary of any portion of the trust. There are certain exceptions to that general rule, including if, under the terms of the trust, for that taxable year, no U.S. person may receive any income or corpus from the trust and no U.S. person would receive any benefit if the trust were to terminate. The bill more specifically defines this exception. Under the bill, a U.S. person is deemed to have an interest in such a trust even if the interest is contingent on a future event. In addition, if any person has discretion to make a distribution from a trust for the benefit of any person, the trust is treated as having a U.S. beneficiary unless the trust terms specifically identify the class of distributees and none of those persons is a U.S. person during the taxable year. Finally, any written, oral, or other side agreement by a U.S. grantor that may result in income or corpus being paid for the benefit of any U.S. person is treated as one of the terms of the trust. A U.S. grantor of a foreign trust must annually submit certain information, including information that demonstrates to the IRS that the grantor meets the exception noted above, as modified by the bill; otherwise, the trust is presumed to have a U.S. beneficiary for the taxable year. This is in addition to any reporting required to be made by the trust itself under present law. The provision is effective on the date of enactment.
• Under present law, a loan of cash or marketable securities by a foreign trust to a U.S. grantor (or related person), or U.S. beneficiary is treated as a distribution. The bill expands this rule to any use of trust property. The provision is effective for loans made and property used after the date of enactment.
• The bill also modifies the penalties for failure to report information with respect to certain foreign trusts. Currently, an initial penalty is imposed based on the “gross reportable amount,” which in some cases may be difficult to determine. A continued penalty is fixed at $10,000 for every 30 days the report is delinquent after 90 days but is limited in aggregate to the gross reportable amount. The bill provides minimum fixed penalties, in most cases $10,000, even in cases where the gross reportable amount is not determinable, and places the burden on the taxpayer to provide information sufficient to determine the gross reportable amount. The provision is effective for filings required after December 31, 2009.

Dividend Equivalent Payments

• The bill also provides that dividend equivalent payments are treated as U.S. source. Such payments are, therefore, subject to U.S. income tax withholding if paid to a foreign person. A dividend equivalent payment is a payment made under a notional principal contract, including a total return swap, that is contingent upon, or determined by reference to, a dividend from U.S. sources. A dividend-based amount in a swap is separately subject to U.S.-source treatment even if it is partially or fully offset by a counterparty payment. The provision grants regulatory authority to the Treasury Department to expand this category to substantially similar payments, and to provide certain exceptions. The provision is effective for payments made 90 days after the date of enactment.

The Worker, Homeownership, and Business Assistance Act of 2009

On November 6, 2009, President Obama signed the Worker, Homeownership, and Business Assistance Act of 2009 into law as Public Law No. 111-92. The most significant provisions of the new law are, in general:

• Unemployment benefits are generally extended, up to a potential maximum aggregate period of up to 99 weeks. The 0.2 percent unemployment tax surcharge currently in effect is extended until June 30, 2011.
• The expiring first-time homebuyer credit of $8,000 is extended through April 30, 2010. In addition, certain long-time residents of the same principal residence are entitled to a credit of up to $6,500 as if they were first-time homebuyers.
• The carryback period for net operating losses (NOL) arising in one (and, in general, only one) taxable year beginning or ending in either 2008 or 2009 is extended from two to five years, as elected by the taxpayer, for all businesses. However, the amount of the NOL that may be carried back to the fifth year is limited to 50 percent of that year’s taxable income. Under present law, an eligible small business may make an election to carry back a 2008 NOL from two to five years, with no limitation on a carryback made to the fifth year. Such a eligible small business may also elect to carryback a 2009 NOL under the provision.
• The revenue losses from the homebuyer credit and NOL provisions are offset mostly by delaying the effective date of the worldwide interest allocation rules for seven years, until taxable years beginning after 2017. These rules are applicable primarily for determining the foreign tax credit of U.S.-based multinationals.

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