Presidential Fiscal Year 2011 Revenue Proposals President Releases Fiscal Year 2011 International Taxation Proposals SUMMARY On February 1, 2010, the Obama Administration (the Administration ) released the General Explanations of the Administration s Revenue Proposals (commonly known as the Green Book ). Although the Administration has not released proposed statutory language, the Green Book includes significant detail about the Administration s Fiscal Year 2011 budget proposals. If enacted, the proposals contained in the Green Book would affect many aspects of U.S. federal income taxation, including individual, corporate, partnership and international taxation. This memorandum discusses key aspects of the Green Book that relate to international taxation. We are concurrently distributing two additional memoranda addressing Green Book proposals affecting (1) corporate and partnership taxation, and (2) individual, estate and gift taxation that we anticipate may be of interest to our clients, which may be obtained by following the instructions at the end of this memorandum. In regards to international taxation, the Green Book would adjust key aspects of (1) the deductibility of expenses allocated to certain foreign activities, (2) the foreign tax credit, (3) international transfers of intangibles, (4) the treatment of interest paid to inverted entities, (5) the deductibility of payments made to foreign reinsurers, (6) the rules governing so-called 80/20 Companies, (7) equity swaps and (8) the rules governing so-called dual-capacity taxpayers. Moreover, the Green Book proposals include a number of international tax enforcement provisions and proposals that would change the U.S. federal income tax treatment and reporting obligations of certain trusts. Many of the changes included in the Green Book are similar to other recent legislative proposals, including the General Explanations of the New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
Administration s Fiscal Year 2010 Revenue Proposals 1 (the 2009 Green Book ) and the Tax Extenders Act of 2009 2 (the Extenders Bill ). Importantly, however, the Green Book does not include the 2009 Green Book provision that would have prevented foreign eligible entities (other than first-tier entities that are wholly owned by U.S. taxpayers) from making a check-the-box election to be treated as disregarded entities unless they were organized in the same jurisdiction as their parent entities. ANALYSIS The Green Book, if enacted in its current form, would make significant changes to both the substantive law and enforcement procedure governing international taxation. Many of the Green Book s provisions are similar to proposals contained in either the 2009 Green Book, the Extenders Bill or other proposed legislation that has not yet been enacted. Although the 2009 Green Book appears to have been the basis for many Green Book proposals, significant differences between the 2009 Green Book and the Green Book include: The absence of a proposal equivalent to the provisions of the 2009 Green Book that would have changed the entity classification rules to prevent foreign eligible entities (other than first-tier entities that are wholly owned by U.S. taxpayers) from being treated as disregarded entities unless they were organized in the same jurisdiction as their parent entities; A new provision that would treat the amount equal to the excessive return resulting from a U.S. person s transfer of an intangible to a controlled foreign corporation ( CFC ) that is subject to low foreign tax rates as subpart F income in a separate foreign tax credit limitation basket; A new proposal to limit the ability of U.S. insurance companies to deduct premiums paid to affiliated foreign reinsurance companies with respect to U.S. risks; Potentially different language imposing a tax on equity swaps and other equity derivative transactions than had previously been proposed in the 2009 Green Book or the Extenders Bill; Significantly revised withholding and information reporting provisions, which generally appear intended to reflect the changes to these rules that would be made by the Extenders Bill; and Several new proposals relating to trusts that are not in the 2009 Green Book, but which appear to be adapted from the Extenders Bill and related legislation. A. SUBSTANTIVE PROVISIONS As noted above, amendments to the Internal Revenue Code that are similar to many of these substantive provisions have been proposed in previous legislation, including the 2009 Green Book and the Extenders 1 2 A further discussion of the 2009 Green Book can be found in the Sullivan & Cromwell LLP publication entitled Presidential Proposal on International Taxation: President Releases Fiscal Year 2010 International Taxation Proposals (May 15, 2009), which may be obtained by following the instructions at the end of this publication. H.R. 4213, 111th Cong (2009). The Extenders Bill was passed by the House of Representatives on December 7, 2009 and remains pending in the Senate. A further discussion of the Extenders Bill can be found in the Sullivan & Cromwell LLP publication entitled Revised FATCA Plus Carried Interest Taxation: Tax Extenders Act of 2009 Introduced to Congress and Passed by House (Dec. 10, 2009), which may be obtained by following the instructions at the end of this publication. -2-
Bill. The substantive provisions of the Green Book described below would generally become effective for taxable years beginning after December 31, 2010, and the Green Book states that these proposals are expected to raise more than $116 billion between Fiscal Year 2011 and Fiscal Year 2020. 1. Deferral of Expenses Related to Deferred Income The Green Book would require taxpayers to defer deductions for expenses that are apportioned to foreign-source income to the extent that such income is not currently subject to U.S. tax. Current Treasury regulations 3 would generally govern whether an item of expense is allocated to foreignsource income or domestic-source income, although the Green Book anticipates that the Treasury Department will revise the existing regulations and propose other statutory changes as necessary to prevent inappropriate decreases in the amount of interest expense that is apportioned to foreign-source income. Deferred deductions under this aspect of the Green Book would be carried forward and could become deductible in a subsequent taxable year in proportion to the amount of previously deferred foreign-source income that becomes subject to U.S. tax in that later year. The 2009 Green Book included a proposal which was similar to the Green Book proposal but: (i) exempted research and development expenditures from its expense deferral requirement and (ii) did not anticipate the changes to the current Treasury regulations expected by the Green Book. In addition, an earlier bill that was proposed in the 110th Congress but not enacted 4 would have permitted foreignrelated deductions to be claimed currently only to the extent that such deductions are allocable to currently taxed foreign income 5 and would have required that other foreign-related deductions be deferred until the associated income was repatriated. 2. Foreign Tax Credit Provisions Under current law, a U.S. taxpayer may generally claim a credit for income taxes paid to a foreign jurisdiction either directly by the taxpayer 6 or indirectly, in the case of certain corporate taxpayers. 7 Current law also provides that taxpayers may generally cross-credit foreign taxes paid to high-tax jurisdictions against U.S. tax that would otherwise be due on other foreign-source income. 3 4 5 6 7 Presumably, such allocations would be made under the regulations issued under Section 861, which generally provide, with many special rules and exceptions, that deductions are allocated to the activity producing the related income, e.g., deductions allocable to producing rental income are sourced to the location of the rented property. H.R. 3970, 110th Cong. 3201 (2007). Id. See generally Section 901. Foreign taxes paid by partnerships and other entities that are not considered corporations under U.S. tax law are generally treated as taxes paid directly by the U.S. taxpayer holding interests in those entities. See generally Section 902. -3-
The Green Book proposal includes two separate adjustments to the rules governing the foreign tax credit. Under the first, U.S. taxpayers would be required to determine their indirect foreign tax credits on a consolidated basis by combining the earnings and profits of all foreign subsidiaries. A taxpayer s indirect foreign tax credit would then be creditable only to the extent that such aggregated earnings and profits are repatriated to the United States in that year. Although the Green Book includes limited detail about the mechanics of the anticipated limitation on the foreign tax credit, it is possible that the Administration will ultimately recommend language similar to the language included in H.R. 3970, which limited a taxpayer s ability to claim the foreign tax credit by reference to the percentage of foreign-source income that was repatriated. 8 For example, a U.S. taxpayer might have two foreign subsidiaries, one of which had $100 of income, $100 of earnings and profits, and paid $5 of foreign tax, and the second of which had $200 of income, $200 of earnings and profits, and paid $60 of foreign tax. If the second subsidiary paid a $200 dividend to the U.S. parent, under the Green Book, the U.S. parent would only be able to credit $43.33 ($65 x $200 earnings and profits from the distributing subsidiary / $300 aggregate earnings and profits between both subsidiaries) of the foreign tax paid against its U.S. tax liability, even though it repatriated all of the available cash from a subsidiary that paid $60 in tax. The second foreign tax credit change in the Green Book proposal would adopt a matching rule that would require taxpayers claiming the foreign tax credit under Section 901 9 to match items of income and foreign tax. In contrast, current law provides that an entity is deemed to have paid a foreign tax if, under foreign law, that entity is legally liable for the foreign tax. 10 In response to Guardian Industries v. United States, 11 the Treasury Department has published proposed regulations 12 intended to prevent mismatches of tax credits and income inclusions by requiring that tax credits be apportioned in accordance with income among members of a unitary group, even if foreign law does not explicitly impose joint and several liability for tax on members of consolidated groups, and placing several limitations on reverse hybrid entities. However, the proposed regulations apportion foreign tax credits among related entities by reference to how foreign law, rather than U.S. law, apportions the associated income. The proposed regulations therefore may permit significant planning opportunities. The Green Book, which would adopt a matching rule, appears to contemplate a somewhat broader approach than these proposed regulations, possibly including an apportionment of credits by reference to how the U.S. apportions the associated income. 8 9 10 11 12 See H.R. 3970, 110th Cong. 3201 (2007). It is noteworthy, however, that H.R. 3970 made this determination by reference to income, while the Green Book and 2009 Green Book appear to make this determination by reference to earnings and profits. Unless otherwise indicated, all references to Section in this memorandum are to the Internal Revenue Code of 1986, as amended. See Treas. Reg. 1.901-2(f). 65 Fed. Cl. 50 (Ct. Cl. 2005); aff d, 477 F.3d 1368 (Fed. Cir. 2007). See Prop. Treas. Reg. 1.902-2(f), 71 Fed. Reg. 44,240 (Aug. 4, 2006). -4-
Both foreign tax credit provisions are generally equivalent to their counterparts in the 2009 Green Book, but contain minor clarifying changes. 3. Provisions Relating to Intangible Property Transfers Current law requires that income with respect to a transfer or license of intangible property be commensurate with the income attributable to the intangible and permits the IRS to allocate items of income, credit and deduction in cases where such an allocation is necessary to clearly reflect income or prevent tax avoidance under Section 482. Additionally, certain transfers of intangible property through nonrecognition transactions are treated as sales of that property for a series of contingent payments that relate to the income recognized from the use or sale of that property under Section 367(d). In other words, Section 367(d) can create deemed periodic payments that would reduce income in the offshore entity that may otherwise be deferred, and increase income in the U.S. entity, thereby increasing the amount of U.S. tax that is due on a current basis. The Administration believes that the current rules lack clarity, and that the current state of these provisions may lead to inappropriate avoidance of U.S. tax. a. Limitations on Income Shifting Through Intangible Property Transfers To prevent inappropriate shifting of income outside the United States, the Green Book proposal would clarify that workforce in place, going concern value and goodwill are within the definition of intangible property under Sections 367(d) and 482, meaning that, (i) the sale of such property can be included in determining the amount of payments deemed to arise from a deemed contingent sale of such assets under Section 367(d) and (ii) the transfer of such assets is subject to the provisions of Section 482. Additionally, the Green Book would clarify that the Commissioner may value the intangible property taking into consideration the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction undertaken. This aspect of the Green Book is functionally similar to the equivalent provision in the 2009 Green Book, but makes minor clarifying changes. For example, instead of the language described above, the 2009 Green Book would have clarified that intangible property must be valued at its highest and best use, as it would be transferred at arm s length. b. Current Taxation of Excessive Returns Associated with the Expatriation of Intangible Property In addition, the Green Book would treat any excessive returns realized by a U.S. person who transfers an intangible to a related CFC that is subject to a low effective tax rate in circumstances that evidence excessive income shifting as subpart F (i.e., as income that must be currently recognized by a certain U.S. shareholder of a controlled foreign corporation even if not distributed) income that is in a separate foreign tax credit limitation basket. In its current form, the Green Book does not define either: (i) what constitutes an excessive return or (ii) what circumstances would evidence excessive income shifting. This aspect of the Green Book is new and does not have a counterpart in the 2009 Green Book. -5-
4. Disallowance of the Deduction for Excess Nontaxed Reinsurance Premiums Paid to Affiliates Under current law, insurance companies are generally permitted to deduct premiums paid for reinsurance, including premiums paid to foreign affiliates. Although subpart F limits the ability of domestic insurance companies to use foreign affiliates to avoid current U.S. taxation, foreign-owned insurance companies without a U.S. trade or business are generally not subject to the subpart F regime. Current law provides for an excise tax on reinsurance policies issued by foreign reinsurance companies; however, the Administration believes that this excise tax is not always sufficient to offset the tax advantages enjoyed by foreign-owned domestic insurance companies that reinsure their U.S. risks through foreign affiliates. The Green Book proposal would deny deductions to U.S. insurance companies for certain reinsurance premiums paid to affiliated foreign insurance companies with respect to U.S. risks insured by the insurance company or its U.S. affiliates. In particular, such U.S. insurance companies would not be allowed deductions to the extent that (i) the foreign reinsurers or their parent companies are not subject to U.S. income tax with respect to premiums received and (ii) the amount of reinsurance premiums, net of ceding commissions, paid to foreign reinsurers exceeds 50% of the total direct insurance premiums received by the U.S. insurance company and its U.S. affiliates for a line of business. Alternatively, a foreign corporation that receives a premium from an affiliate that otherwise would not be deductible under this provision of the Green Book would be permitted to opt out of the Green Book s nondeductibility rule by electing to treat the premium (and the associated investment income) as income effectively connected with a U.S. trade or business. This provision of the Green Book is new and does not have an equivalent in the 2009 Green Book. However, legislation related to this provision was introduced in the House in both the current Congressional session 13 and in 2008. 14 5. Limitations on the Deductibility of Interest Paid to Inverted Entities The so-called earnings stripping rules of Section 163(j) currently limit the ability of a corporation to deduct interest paid to related parties. In general, however, the earnings stripping rules permit corporations that have a debt-to-equity ratio of less than 1.5:1 to deduct all interest (including disqualified interest, a category that includes interest paid to related parties that do not owe U.S. tax on such interest or unrelated parties if no U.S. tax is owed on such interest and the debt is guaranteed by a related foreign party), and continue to allow all interest that constitutes 50% or less of the corporation s adjusted net taxable income to be deducted. 13 14 H.R. 3424, 111th Cong. (2009). H.R. 6969, 110th Cong. (2008). -6-
The Administration has expressed concern that inverted entities (i.e., where a U.S. parent corporation has been replaced by a newly created non-u.s. parent corporation) are inappropriately reducing the U.S. tax liability by using related-party debt. Accordingly, the Green Book includes a provision that would eliminate the debt-to-equity safe harbor described in the preceding paragraph for most inverted corporations 15 and, moreover, would limit the amount of disqualified interest paid to related parties that could be deducted by such taxpayers to the excess of (i) 25% of the taxpayer s adjusted taxable income over (ii) the interest paid on unrelated debt. The 2009 Green Book contained a similar proposal, which would have generally been equivalent, but which would have exempted interest paid to unrelated parties that was guaranteed by a related foreign party, which would have continued to be limited to 50% of the taxpayer s adjusted taxable income. 16 6. Repeal of the 80/20 Rules Under current law, interest paid by a U.S. corporation that derives at least 80% of its income from foreign sources in an active trade or business (an 80/20 Company ) is treated as foreign-source income and, accordingly, is not subject to U.S. withholding tax. 17 Additionally, dividends paid by an 80/20 Company, although U.S.-source, are proportionally exempted from U.S. withholding tax to the extent that the 80/20 Company s income is derived from non-u.s. sources. The Administration has proposed repealing these rules. This aspect of the Green Book is identical to the provision in the 2009 Green Book that would have repealed the 80/20 rules. 7. Equity Swaps and Securities Lending Transactions Current law generally requires withholding agents to collect a 30% withholding tax on payments of U.S.- source dividends and other fixed or determinable annual or periodical income ( FDAP ), 18 although this 15 16 17 18 This provision of the Green Book proposal would apply to a corporation that would be an expatriated entity under Section 7874 if Section 7874 had been effective for taxable years beginning after July 10, 1989. However, this aspect of the Green Book proposal would not apply to any inverted entity that is treated as a domestic corporation under Section 7874. Proposals to further restrict the deductibility of interest under Section 163(j) of the Internal Revenue Code have surfaced in Congress in the past. For example, in 2002, a bill was proposed that would have eliminated the 1.5:1 debt-to-equity safe harbor and reduced the percentage threshold to 35% for all taxpayers. See H.R. 5095, 107th Cong. (2002). The Green Book proposal appears to specifically target corporations that have engaged in inversion transactions, apparently because, as noted in the 2009 Green Book, a Treasury Department study did not find conclusive evidence of earnings stripping by foreign-controlled domestic corporations that have not expatriated. The approach taken by the Green Book appears consistent with a similar provision that was included in S.1637 7874(d)(2), 107th Cong. (2004), which was passed by the Senate but was not included in the final, enacted version of the American Jobs Creation Act of 2004. See Section 861(a)(1)(A). See Section 1441(a). Fixed or determinable annual or periodical income generally includes interest (other than portfolio interest), dividends, rents, salaries, wages, premiums, annuities, compensation and other items of annual or periodical gain, profit, or income. -7-
rate may be reduced by a tax treaty. While current law generally does not impose withholding tax on equity swap payments, current law does impose withholding tax on substitute dividend payments made in connection with a securities loan. In 1997, the IRS and the Treasury Department issued final regulations governing withholding on securities lending transactions. Shortly thereafter, in response to concerns that cascading withholding tax could become due on interest or dividend payments made on securities that were lent more than once, the IRS issued Notice 97-66, 19 which generally provides limitations on the extent to which the United States will impose its withholding tax on substitute dividend payments made between foreign persons. In September 2008, Congressional hearings were held addressing concerns that Notice 97-66 was being used to permit tax avoidance transactions, including transactions in which a foreign person would: (i) lend U.S. stock to a foreign financial institution, which would then sell that stock to a related U.S. person, and (ii) simultaneously enter into a total return equity swap with respect to the loaned stock with the related U.S. person, either directly or indirectly. The hearings also addressed concerns that foreign investors (including foreign hedge funds) were avoiding U.S. withholding tax by transferring U.S. stocks to U.S. broker-dealers (either directly or indirectly) shortly before a dividend payment date, entering into economically equivalent equity swaps during the dividend payment period and then reacquiring the relevant U.S. stocks after the dividend was paid. The Green Book would generally treat income received by a foreign person on a swap over a U.S. equity that is attributable to (or calculated by reference to) dividends paid by a U.S. corporation as U.S.-source income subject to withholding, but would exempt swaps which are unlikely to reflect avoidance of U.S. gross-basis taxation. Although the Green Book does not include statutory language, the Administration anticipates rules that ensure that economically equivalent transactions are subject to similar tax treatment and prevent avoidance of dividend withholding taxes by reforming the existing rules applicable in a securities loan or sale-repurchase transaction, while minimizing instances of over-withholding. Under the Green Book, the Treasury Department would be delegated authority to provide guidance establishing additional exceptions to the Green Book s withholding rules. The Green Book s equity swap provision would, if enacted, become effective for payments made after December 31, 2010. The Green Book s dividend withholding provisions may be similar to related proposals in the 2009 Green Book and the Extenders Bill; however, the Green Book contains comparatively little detail. 20 19 20 1997-2 C.B. 328. The Extenders Bill would, if enacted into law, treat dividend equivalent payments as U.S.-source dividends. Under the Extenders Bill, a dividend equivalent would include (i) any substitute dividend (ii) any payment made pursuant to a specified notional principal contract that is directly or indirectly contingent upon, or determined by reference to, the payment of a U.S.-source dividend and (iii) any payment determined by the Treasury Department to be substantially similar to either a substitute dividend or a payment made on a specified notional principal contract that is contingent on or determined by reference to a U.S.-source dividend. For this purpose, a specified notional principal -8-
8. Modified Tax Rules for Dual-Capacity Taxpayers Current law limits the ability of a dual-capacity taxpayer (a taxpayer who both pays a tax to a non-u.s. jurisdiction and receives an economic benefit from that jurisdiction) to claim the foreign tax credit for such payments. Such taxpayers in jurisdictions that impose a general income tax are generally permitted to treat any amount paid to a foreign jurisdiction that does not exceed that jurisdiction s general levy as a creditable income tax. Additionally, current law permits dual-capacity taxpayers to treat an amount paid to a foreign jurisdiction that does not impose a general income tax as a creditable foreign tax, provided that amount does not exceed the applicable federal net income tax rate. The Green Book proposal would permit dual-capacity taxpayers to claim the foreign tax credit only to the extent that the foreign levy does not exceed the foreign tax that would be due if the taxpayer were not a dual-capacity taxpayer. Additionally, the Green Book would create a separate basket for purposes of computing the amount of foreign tax credit available to taxpayers 21 for taxes paid or accrued on certain oil and gas income, although the Green Book also intends to leave intact treaty obligations to permit a credit for taxes paid on certain oil and gas income. The Green Book is similar to a related provision on the 2009 Green Book. In contrast to the Green Book proposal, however, the provision in the 2009 Green Book would have permitted dual-capacity taxpayers to claim the foreign tax credit if the foreign country to which the tax was paid imposed a general income tax that had substantial application to non-dual-capacity taxpayers and to citizens or residents of the jurisdiction imposing the tax. 21 contract is defined under the Extenders Bill as (A) any notional principal contract if (i) in connection with entering into such contract, any long party transfers the underlying security, (ii) in connection with the termination of such contract, any short party transfers the underlying security to any long party, (iii) the underlying security is not readily tradable on an established securities market, (iv) in connection with entering into such contract, the underlying security is posted as collateral by any short party to the contract, or (v) such contract is identified by the Secretary as a specified notional principal contract, and (B) in the case of payments made after the date which is 2 years after the date of the enactment of this subsection, any notional principal contract unless the Secretary determines that such contract is of a type which does not have the potential for tax avoidance. The Extenders Bill provides that dividend equivalent payments are to be computed on a gross basis and would permit the Treasury Department to administratively determine that a payment is substantially similar to either a substitute dividend payment or a payment made on a specified notional principal contract. Additionally, the Extenders Bill contains a section permitting the IRS to reduce withholding in chains of dividends and dividend equivalents to the extent that the taxpayer can establish that such tax has been paid with respect to another dividend equivalent in such chain. In contrast to its counterpart in the Green Book, portions of the dividend withholding provision of the Extenders Bill would take effect 90 days after any date on which the Extenders Bill is enacted. The amount by which a taxpayer can reduce its U.S. tax with foreign tax credits is generally limited to the percentage of the taxpayer s income from foreign sources. This limitation is calculated separately for certain types of income and the foreign taxes on such income (i.e., the limitation is calculated by reference to separate baskets ). -9-
B. ENFORCEMENT PROVISIONS The Green Book recommends significant changes to the current provisions governing information reporting and withholding. Although the Green Book was released without statutory language or, in some cases, detailed descriptions, many of the Green Book s provisions appear consistent with equivalent provisions in the 2009 Green Book, the Extenders Bill or both proposals. The Administration has estimated that these new enforcement provisions, if enacted, would raise more than $5 billion between Fiscal Year 2011 and Fiscal Year 2020. 1. Increased Reporting on Certain Foreign Accounts Under current law, in addition to the 30% withholding tax on FDAP as discussed above, payments made to U.S. exempt recipients that do not provide the payor with a taxpayer identification number and make certain other certifications are subject to backup withholding at the rate of 28%. Current Treasury regulations 22 provide that a non-u.s. financial institution may agree to become a qualified intermediary that collects documentation from customers, files information and withholding tax returns and is subject to periodic audits. The Green Book would require withholding agents to withhold a 30% tax on payments made to a foreign financial institution (an FFI ) of either (i) U.S.-source fixed or determinable, annual or periodical income or (ii) gross proceeds from the sale of property that can give rise to U.S-source interest or dividends, unless the FFI has entered into an agreement with the IRS. 23 Such agreements would generally require foreign financial institutions to either (i) report the name, address and taxpayer identification number of each United States accountholder (and of each substantial U.S. owner 24 in the case of an account held by a foreign entity with one or more substantial U.S. owners ) and also the account number, the account balance or value, and the gross receipts and gross withdrawals that have been made from the account; or (ii) comply with the information-reporting rules that govern U.S. financial institutions accounts of a U.S. 22 23 24 See generally Treas. Reg. 1.1441-1(e)(5). For this purpose, an FFI would include certain entities engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities or any interest in the foregoing. A substantial U.S. owner is not defined in the Green Book. However, under the Extenders Bill, a substantial United States owner was typically a U.S. person with a 10% or greater interest in the entity (measured, in the case of a corporation, by vote or value, and in the case of a partnership, by capital or profits) or, in the case of a trust, a person treated as an owner of any portion of the trust. However, a U.S. person who owns any portion of an entity engaged primarily in the business of investing, reinvesting, or trading in securities, interests in partnerships, commodities, or any interests (including futures or forward contracts or options) in such securities, interests or commodities would be a substantial United States owner under the Extenders Bill. The Extenders Bill also provides that a substantial United States owner includes, to the extent provided by the Treasury Department in regulations or other guidance, any specified United States person that holds, directly or indirectly, more than 10% of the beneficial interests of a trust. -10-
citizen. 25 In addition to requiring the relevant financial institution to report information about its own accountholders, such agreements would generally require reporting with respect to accounts held at financial institutions in the expanded affiliated group 26 of the subject financial institution. Under the Green Book, payments beneficially owned by a foreign government, an international organization, a foreign central bank or any other class of persons that the Treasury Department concludes presents a low risk of tax evasion would be exempt from the new rules, and the Treasury Department would be permitted to publish regulations to implement the purposes of the [p]roposal. Foreign beneficial owners of payments that were withheld upon, other than FFIs that do not qualify for the benefits of an income tax treaty with the United States would be permitted to apply for a refund of any tax withheld in excess of their income tax liability. If enacted, this aspect of the Green Book would become effective for payments made after December 31, 2012. The Green Book s recommendations with respect to foreign accounts represent a sharp break from the 2009 Green Book, which instead recommended an enhanced qualified intermediary program, but appear to be generally consistent with equivalent provisions in the Extenders Bill. One potential discrepancy between the Green Book and the Extenders Bill is that the Green Book may permit FFIs that qualify for the benefits of an income tax treaty with the United States, as a general matter, to claim a refund of 100% of the tax withheld under the Green Book s new withholding program regardless of whether the refund is required by the treaty, whereas the Extenders Bill would only permit a refund or credit to the extent a credit or refund is actually required by a treaty obligation of the United States. It is not clear, however, whether this is an intentional distinction or an ambiguity introduced by the abbreviated drafting of the Green Book s proposals. 2. Withholding on Payments of FDAP Made to Foreign Entities Current law permits payments of U.S.-source FDAP to be paid free of withholding (or subject to a reduced rate of withholding) to a qualified resident of a country with which the U.S. maintains a treaty providing for zero or reduced-rate withholding, if the non-u.s. person to whom the payment is made certifies its eligibility for treaty benefits and the withholding agent does not have knowledge or reason to know that the recipient s certification is inaccurate. The Administration has expressed concern that some parties 25 26 These rules require information reporting on wages, rent and other fixed or determinable annual or periodical income made in the course of a trade or business (Section 6041), dividends (Section 6042), broker proceeds (Section 6045) and interest (Section 6049). The term expanded affiliated group is not defined in the Green Book. However, under the Extenders Bill, a financial institution generally would be part of an expanded affiliated group that includes another financial institution if: (i) one financial institution controls the other financial institution directly or through a chain of controlled entities or (ii) they are both under the common control (directly or through a chain of controlled entities) of a single corporation (whether or not such corporation is a financial institution itself). -11-
who are not eligible for a zero or reduced rate of withholding are using this self-reporting system to inappropriately avoid U.S. withholding tax. Under the Green Book proposal, payments of U.S.-source FDAP and gross proceeds from the sale of property that can produce U.S.-source interest or dividends to non-financial foreign entities would generally be subject to 30% gross-basis withholding unless either (i) the foreign entity certifies that no U.S. person holds a direct or indirect interest of more than 10% in the entity or (ii) the entity provides the name, address and TIN of each substantial U.S. owner and the withholding agent does not have knowledge or reason to know that the information provided is inaccurate. The Green Book would exempt payments made to publicly traded companies and their subsidiaries, foreign governments, international organizations, foreign central banks, certain entities organized in a possession of the United States along with other payments identified by the Treasury Department as posing a low risk of tax evasion. If enacted, these rules would become effective for payments made after December 31, 2012. These provisions differ substantially from the enhanced qualified intermediary proposals of the 2009 Green Book. However, although, as noted above, the Green Book was released without statutory language, these recommendations generally appear equivalent to comparable rules in the Extenders Bill. 3. Bearer Bonds The Green Book also includes a proposal that is intended to repeal the current exemption from the socalled TEFRA rules for foreign-targeted obligations. The current so-called TEFRA rules generally (i) deny interest deductions to the issuer of a registrationrequired obligation that is not issued in registered form; (ii) impose an excise tax on the issuers of such obligations equal to 1% of the obligation s principal amount for each year that the obligation is potentially outstanding; and (iii) deny to foreign holders of such obligations the exemption from the 30% U.S. withholding tax on interest that is generally available for portfolio interest paid on debt of U.S. issuers. 27 Under current law, however, foreign-targeted bearer obligations that comply with certain requirements with respect to their offer and sale outside the United States are not considered registration-required obligations. 28 The Green Book would repeal the interest deduction for foreign-targeted bearer obligations. Additionally, the Green Book proposes to provide that bearer obligations (i) give rise to ordinary, rather than capital, gain and (ii) would be subject to the loss disallowance rules, even if they were foreign 27 28 See Sections 163(f), 871(h)(2) & 4701. See Section 163(f)(2)(B). Under this provision, interest must be payable only outside the United States and its possessions, a legend must appear on the obligation stating that a United States person who holds the obligation will be subject to limitations under U.S. income tax laws and arrangements reasonably designed to ensure that such obligation will be sold (or resold in connection with the original issue) only to a person who is not a United States person, must be in place. See also Sections 871(h)(2)(A) & 881(c)(2)(A). -12-
targeted, although U.S. holders of bearer obligations, even if they are foreign-targeted, are typically subject to these rules under existing law. 29 Moreover, the Green Book would provide that interest paid on obligations (i) not issued in registered form and (ii) for which the beneficial owner has not provided the withholding agent with a statement certifying its foreign status (unless the Treasury Department determines that such a statement is not necessary ), would not be treated as portfolio interest exempt from withholding. The bearer bond rules of the Green Book would apply to any obligation issued more than two years from the date on which the provision is enacted. Although the 2009 Green Book does not have a provision equivalent to this proposal, it appears similar to the proposals in the Extenders Bill. 4. Self-Reporting of Foreign Financial Accounts The Green Book includes a variety of other new provisions that would, if enacted, significantly increase the level of information reporting that is required with respect to foreign financial accounts. The current instructions to the Report of Foreign Bank and Financial Account ( FBAR ) require U.S. citizens and residents, as well as persons in and doing business in the United States, to file an FBAR if such persons have a financial interest in, or signature or other authority over, a foreign financial account and the aggregate value of all such foreign financial accounts exceeds $10,000 at any time during a calendar year. 30 A financial interest generally includes an account held by an entity, where a U.S. person directly or indirectly owns more than 50% of the corporation or partnership, or has a beneficial interest in over 50% of the assets or income of a trust that owns a non-u.s. account. Under the Green Book, U.S. individuals who own an interest in (i) a foreign financial account, (ii) a foreign entity or (iii) a financial instrument or contract held for investment that is held for investment and issued by a foreign person would be required to file an information return along with their tax returns if the aggregate value of all such assets is more than $50,000. If enacted, the Green Book would impose a $10,000 penalty on U.S. persons who fail to make such a report unless the failure was due to reasonable cause, and not willful neglect. 31 The Green Book would enact a rebuttable presumption in civil 29 30 31 In general, any gain recognized by a U.S. holder of a bearer form obligation that would have been a registration-required obligation had it not been issued in compliance with the foreign-targeting rules is treated as ordinary income, see Section 1287, and owners of such foreign-targeted obligations are not permitted to claim loss deductions on the sale or exchange of the instrument, see Section 165(j). The IRS, in Announcement 2009-51, suspended the reporting requirement with respect to FBARs due on June 30, 2009 for persons who are not U.S. citizens, residents or domestic entities, and announced its intent to issue additional guidance with respect to FBARs due in subsequent years. In Notice 2009-62, the IRS suspended filing requirements until June 30, 2010 for persons with signature authority over, but no financial interest in, a foreign financial account, and announced its intention to issue regulations and requested comments with respect to FBAR filing requirements. The Green Book would, however, retain the separate requirement that U.S. persons who own financial accounts subject to these reporting requirements file an FBAR. Under the Green Book, a U.S. person that fails to report a foreign financial account on its tax return would be subject to consequences under the Internal Revenue Code, including penalties and an extended statute of -13-
proceedings that any non-u.s. financial account held by a U.S. person or non-u.s. account over which a U.S. person has signature authority (other than accounts held through qualified intermediaries) contains at least $50,000. 32 This aspect of the Green Book proposal would take effect for taxable years beginning after the date of enactment. The Green Book proposal would also require U.S. individuals to report transfers both to and from non- U.S. bank and financial accounts. Further, under the Green Book, entities in which a U.S. individual holds a direct or indirect interest of more than 25% would generally be required to report both (i) any transfer of money or property made to or from a foreign bank or financial account by the entity and (ii) the name, address and TIN of any U.S. individual with a 25% or greater interest in the entity. The Green Book would exempt individual taxpayers and entities from the above requirements if the cumulative amount transferred for a given year is less than $50,000 and would permit the Treasury Department to issue guidance that could both expand and limit the group of transfers subject to the Green Book s reporting requirements. The Green Book would, if enacted, impose a penalty equal to the lesser of $10,000 or 10% of the aggregate value of such transfers on taxpayers who fail to make such a report (unless the failure was due to reasonable cause). This provision of the Green Book would, if enacted, take effect for transfers made after December 31, 2012. The Green Book draws on, but contains material differences from, the 2009 Green Book. To begin, the reporting thresholds in the 2009 Green Book were $10,000, rather than $50,000. This figure appears to be derived from the Extenders Bill, which imposes an obligation on U.S. individual taxpayers to self-report foreign financial accounts on their tax returns to the extent the aggregate value of such accounts exceeds $50,000. In addition, the 2009 Green Book included provisions similar to the Green Book s provisions requiring self-reporting of transfers; however, the ownership threshold for transfer reporting in the 2009 Green Book was 50%, rather than 25%, and the transfer self-reporting provision in the 2009 Green Book would have taken effect for transfers made after December 31 of the year of enactment, rather than December 31, 2012. The Extenders Bill does not include a requirement that transfers to and from foreign financial accounts be self-reported by the holder of the account. Moreover, the 2009 Green Book created a negative evidentiary presumption for failing to file an FBAR, while the Green Book creates this presumption for failing to make the required tax return disclosure. The Extenders Bill, in its current form, does not include an equivalent evidentiary presumption. 32 limitations, but not Title 31. The penalties prescribed by Title 31 would continue to apply to U.S. persons who fail to file an FBAR. A similar presumption was included in legislation introduced by Senator Carl Levin in 2009. See S. 506, 111th Cong. (2009). The Proposal appears to be broader than the presumption in S. 506, which applied to accounts located in offshore secrecy jurisdictions, rather than all accounts that are held through non-qualified intermediaries. -14-
5. Extended Statute of Limitations for Cross-Border Transactions and in Situations Where Taxpayers Fail to Timely Make Required Disclosures In general, the Code imposes a three-year statute of limitations on the collection of any tax. 33 In cases where a taxpayer fails to report certain information about cross-border transfers and foreign entities to the IRS, however, current law extends this general statute of limitations for three years after the required report is made. 34 The Administration has expressed concern that this three-year period may not give the IRS adequate time to make a proper assessment in certain cases. Accordingly, the Green Book would, if enacted, extend the statute of limitations to six years for collecting taxes attributable to an omission of income that exceeds $5,000 if the understatement is attributable to one or more foreign assets that is covered by the Green Book s foreign asset disclosure requirements. Whether the statute of limitations would be extended would be determined without regard to whether the taxpayer s holdings met the dollar thresholds that determine whether the Green Book s foreign asset disclosure requirements actually apply to a particular taxpayer. The extended statute of limitations in the Green Book would become effective for returns filed after the Green Book is enacted, and if the statute of limitations was still open for the return on the Green Book s enactment date, for a return filed before the Green Book was enacted. Although the 2009 Green Book included an extended statute of limitations provision, the comparable provision in the current Green Book, which draws heavily on the Extenders Bill, 35 appears to be somewhat narrower in scope. 6. Third-Party Reporting of Transfers Made to Foreign Financial Accounts and Accounts Maintained by U.S.-Owned Entities Although, as discussed above, current law requires U.S. persons who own or have signature authority over a non-u.s. financial account to self-report certain information about that account on an FBAR, intermediaries are not required to report any information about such accounts to the IRS or the Treasury Department. The Green Book would supplement the self-reporting regime by requiring U.S. financial intermediaries to report, on an information return, any transfer in excess of $50,000 that is made to or from a foreign bank, brokerage or other financial account for the benefit of a U.S. individual or an entity that is more than 25% owned, directly or indirectly, by a U.S. individual. The Green Book also would impose a requirement on U.S. financial institutions to generally report when a new foreign bank or financial account is opened on behalf of a U.S. individual or on behalf of an entity that is more than 25% owned, directly or indirectly, by a U.S. individual. These provisions would, if enacted, become effective for amounts transferred and accounts opened after December 31, 2012. 33 34 35 See Section 6501(a). See Section 6501(c)(8). In contrast to the Extenders Bill, however, the Green Book does not require self-reporting of passive foreign investment company interests, and accordingly does not include failure to self-report an interest in a passive foreign investment company within the events that could trigger a tolling of the statute of limitations. -15-
These provisions are generally similar to the third-party transfer reporting provisions in the 2009 Green Book, but, as with other provisions, raise the dollar threshold for reportable transfers to $50,000 (from $10,000) while reducing the ownership threshold with respect to U.S.-owned entities to 25% (from 50%). In addition, while the 2009 Green Book would have made these provisions effective for taxable years beginning after the year of enactment, the comparable requirements of the Green Book do not become effective until 2013. The Extenders Bill does not impose a similar third-party reporting requirement on U.S. financial institutions. 36 7. Other Enforcement Provisions The Green Book would, in addition, double the current 20% accuracy-related penalty imposed on certain understatements of income when that understatement is attributable to undisclosed foreign financial assets. Under the Green Book, undisclosed foreign financial assets would include assets required to be disclosed under the Bill s self-reporting provisions. In addition, an asset would be an undisclosed foreign financial asset if the taxpayer failed to make a proper disclosure under certain provisions of the Code relating to: (i) controlled foreign corporations and partnerships, 37 (ii) transfers to foreign corporations and partnerships, 38 (iii) certain acquisitions, dispositions of, and substantial changes to, interests in foreign partnerships, 39 and (iv) certain transactions involving foreign trusts (generally including the creation or transfer of property to a foreign trust and the death of a U.S. person who was treated as the owner of a foreign trust or whose estate includes any portion of a foreign trust). 40 As under current law, a reasonable cause exception would exist for this penalty. The IRS would be able to assess this new penalty starting in taxable years beginning after the year when the Green Book is enacted. This provision is similar to enhanced penalties prescribed in the 2009 Green Book but has an earlier effective date (taxable years beginning after the date of enactment, rather than the comparable provision in the 2009 Green Book) and includes a reasonable cause exception, which was absent from the 2009 Green Book. In addition, this provision is similar to the penalty provisions of the Extenders Bill, but omits reports that must be filed under Section 6046 41 from the list of disclosures that would trigger the Green Book s 40% accuracy-related penalty. 36 37 38 39 40 41 However, under the Extenders Bill, FFIs entering into an agreement with the IRS would be required to report, among other information, the gross receipts to and gross withdrawals or payments from any account maintained by a U.S. person. See Section 6038. See Section 6038B. See Section 6046A. See Section 6048. Section 6046 requires that reports be filed with respect to certain organizations, reorganizations and acquisitions of stock in foreign corporations. -16-