Proposed Legislation Would Subject Offshore Investments and Foreign Entities to Significant New Reporting and Withholding Requirements

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January 07, 2010

The Foreign Account Tax Compliance Act of 2009 (H.R. 3933 and S. 1934) was introduced on October 27 by Senate Finance Committee Chair Max Baucus (D-Mont.) and Ways and Means Committee Chair Charles B. Rangel (D-NY). The proposed legislation, which is projected to raise $8.5 billion over 10 years, revitalizes previously introduced anti-tax haven legislation that aims to prevent the use of offshore entities to avoid U.S. taxation of income and assets. President Obama and Treasury Secretary Geithner have already endorsed the proposal.

The proposed legislation generally would subject offshore investment funds (including hedge funds, private equity funds, and venture capital funds) and foreign financial institutions, as well as foreign entities other than financial institutions that are more than 10% owned by a U.S. person, to a 30% U.S. withholding tax unless they enter into an agreement with the Internal Revenue Service (IRS). The agreement would require the foreign entity either to agree to be subject to reporting requirements applicable to U.S. financial institutions or to provide the identity of any account holder (including any fund investor) who is a U.S. person or a foreign entity with substantial U.S. owners. Disclosure would not be required with respect to certain U.S. persons, including tax exempt institutions, federal and state governments, banks, real estate investment trusts, and publicly traded corporations. Withholding would apply to numerous categories of payments, including U.S. source interest (apparently without the application of the portfolio interest exemption from withholding), dividends, royalties, and other payments that currently are subject to withholding when paid to non-U.S. persons, as well as the gross proceeds from the sale of equity and debt instruments of U.S. companies (or that can produce U.S.-source income).

One of the more significant changes proposed would be that dividend equivalent payments that are paid to offshore corporations pursuant to a notional principal contract (including most swaps) would be treated as U.S.-source dividends. Accordingly, a 30% withholding tax would apply.

The bill would also require disclosure by a material advisor, which is broadly defined as any person who provides any material aid, assistance, or advice in forming or, directly or indirectly, acquiring any foreign entity and is paid more than $100,000 in any calendar year for such services. The disclosure would include, among other things, the identity of the foreign entity and of certain U.S. citizen or residents involved in the acquisition and/or formation. An advisor that fails to provide the required disclosure would be subject to severe penalties (equal to the greater of $10,000 and 50% of the gross income derived by the advisor from the transactions). The disclosure requirements appear to apply to ordinary course transactions, such as a routine acquisition of a foreign entity.

The proposed legislation includes numerous provisions that would expand the scope of the IRS’s foreign bank account reporting (FBAR) requirements. (For additional information about the FBAR requirements, see our LawFlashes published on August 10, 2009 and September 22, 2009.)1 Among other things, the bill would broaden the coverage of FBAR to include any foreign financial asset (broadly defined, in general, to include any financial instrument or contract held for investment and any stock or security issued by a foreign person), require any individual who holds an interest in a foreign financial asset that has a value in excess of $50,000 to disclose the asset and certain other identifying information relating to the asset and, in some cases, the counterparties associated with the asset, and increase the penalties and statute of limitations that applies for failure to comply with the FBAR requirements.

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The bill would create new information reporting requirements that would require each shareholder of an offshore corporation that is a passive foreign investment company (PFIC) to file an annual information return. The proposed legislation also includes several other provisions relating to additional information reporting requirements, repeals bearer bond exceptions to registered bond requirements for foreign persons, and provides new rules with respect to foreign trusts.

For more information regarding any of the issues discussed in this LawFlash, please contact any of the following Morgan Lewis attorneys:

New York
Richard S. Zarin 212.309.6879 [email protected]

William P. Zimmerman 215.963.5023 [email protected]
Wendy C. Unglaub 215.963.5281 [email protected]

San Francisco
Gary A. Herrmann 415.442.1380 [email protected]
Barton W.S. Bassett 415.442.1268 [email protected]

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1 The two LawFlashes are available online at and, respectively.

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