Enforcement of U.S. Tax Rules Abroad

1. Enforcement of U.S. Tax Rules Abroad Professor Stafford Smiley Georgetown Law Center Washington, DC Европейско-Азиатский правовой конгресс Ekaterinburg, Russian Federation May 2_, 2011

2. Background: The Domestic Context Declaration of U.S. Tax Status – Form W-9 Wage Withholding -- Form W-2 Information Reporting – Forms 1099 Backup Withholding

3. The Foreign Context:U.S. Persons – Foreign Accounts • Box on Individual Tax Return -- Form 1040 • Various Special IRS Forms • Form 5471 – Foreign Affiliates • Form 8865 – Foreign Partnerships • Form 3520 – Foreign Trusts • Treasury Department FBAR Rules • FBAR = Foreign Bank Account Reporting • Form TC F 90-221 • New Rules – October 2008

4. The Foreign Context:Foreign Persons – U.S. Accounts • FDAP Withholding at 30% • Not limited to passive income • Applies to most U.S. source income other than active business income • Statutory Exceptions • Bank deposits • Portfolio debt • Proceeds of Sale • Effectively Connected Income (ECI) • FIRPTA rules for U.S. Real Property Interests

5. The Foreign Context:Identification Requirements • Registration-Required Bonds: • Deduction of interest • Qualification as “portfolio debt” • Foreign targeted obligation exception • Aimed at traditional “Eurobond” market • Form W-8 Ben • Establishes right of recipient to: • Statutory Exclusions • Treaty Benefits • Form 2244 – No withholding on ECI

6. The Foreign Context:Foreign Persons – Foreign Accounts • Many foreign investors invest in U.S. securities through foreign financial institutions • Qualified Intermediary (QI) Program • Agreement between foreign financial institution and IRS • Imposes due diligence requirements on foreign institution • KYC (Know Your Customer) rules in 59 countries • Requires reporting by foreign institution to IRS • Form W-IMY • “Pool” reporting • Based on self-reporting by customers • QI can generally rely on W-8Ben filed by foreign customer

7. IRS Audit Tools • Requirement of return from every taxpayer, domestic or foreign, with U.S. source income • Broad powers to investigate returns • Subpoenas for documents • Written interrogatories • Depositions of potential witnesses • Civil penalties • Substantial understatement penalty • Criminal penalties

8. United Bank of Switzerland (UBS) • UBS operated in U.S. through branch in Miami • Justice Department brought suit in U.S. District Court, sought discovery through all available means • U.S. District Court ignored possible Swiss repercussions and ordered UBS officials to respond • Settlement eventually involved the Justice Department, UBS and the Swiss Government • Led to protocols amending the treaties with Switzerland and Luxembourg

9. Liechtenstein Lists of Customers • Ex-employee of Liechtenstein bank sold lists of bank customers to German tax authorities • German tax authorities shared lists under tax information exchange agreements with other tax authorities, including the IRS • Made headlines throughout U.S. based on sheer numbers of U.S. “tax cheats” • Led to unprecedented tax information exchange agreement between the United States and Liechtenstein (and Monaco, Gibraltar, ....)

10. The FBAR Crisis • Treasury Department issued new, more stringent rules in October 2008 • Many taxpayers became, or discovered that they had long been, required to file FBARs each year • Traditional IRS voluntary disclosure program too strict • IRS developed special FBAR amnesty program • Extraordinary volume of amnesty requests

11. The Foreign Account Tax Compliance Act (“FATCA”) March 2010

12. Withholding on Payments to “Foreign Financial Institutions” (FFIs) FATCA subjects all “withholdable payments” from U.S. sources to FFIs to 30% withholding, regardless of documentation provided by the FFI, unless the FFI enters into an agreement with the IRS.

13. Definition of “Foreign Financial Institutions” (FFIs) • FFIs include all non-U.S. resident entities that: • Accept deposits in the ordinary course of a banking or similar business; • Engage in the business of holding financial assets for the account of others; or • Engage primarily in the business of investing, reinvesting, or trading in securities or partnership interests, including hedge funds.

14. Definition ofFinancial Account Includes: • Any depository account maintained by the FFI; • Any custodial account maintained by the FFI; and • Any debt or equity interest in an FFI that is not regularly traded on an established securities market; BUT ONLY IF there is a direct or indirect U.S. owner.

15. Definition ofWithholdable Payment • Any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments and other fixed or determinable annual or periodical gains, profits and income from sources within the United States; • Interest paid on deposits by foreign branches of domestic banks (861(a)(1)(B) does not apply for this purpose); and • Gross proceeds from the sale or other disposition of property which can produce U.S. source dividends or interest • Exception for effectively connected income

16. Withholding Agreements with Foreign Financial Institutions To avoid withholding, the FFI must agree with the U.S. IRS to: • Obtain information regarding each holder of each account maintained by the FFI so as to determine which accounts are held by one or more U.S. persons; • Annually report, with respect to U.S. HOLDERS, names, other identifying information, account numbers, account balances, and total receipts or withdrawals from each account; • Deduct and withhold 30% of any payment to any “recalcitrant account holder” (i.e., one who has not complied with documentation requests) or to any FFI not subject to an agreement with the IRS; • Comply with IRS information requests; and • If, under FFI’s domestic law, FFI would be prohibited from reporting the required information, the FFI must either obtain a waiver of such prohibition or close the account.

17. Withholding on Payments to Entities other than Foreign Financial Institutions Withholding Agents must withhold 30% of any withholdable payment to a non-FFI, regardless of the identity of the beneficial owner of the payment, unless all three of the following requirements are met: • The payee provides a certification that the beneficial owner does not have any substantial United States owners (i.e., >10% ownership, or >0% ownership in any entity engaged primarily in business of trading) or provides the name, address, and TIN of the beneficial owner(s); • the withholding agent has no reason to know that the certification is false; and • the withholding agent reports relevant information on beneficial owners to the IRS.