New US Offshore Tax Evasion Legislation ‘Could Reach Obama’s Desk By May’

The latest attempt by US lawmakers to crack down on Americans who have offshore income they do not report stands a good chance of being signed into law within months – or even weeks – people who are monitoring the situation in Washington say.

Although the final wording of the legislation has yet to be hammered out, it is expected to have important implications for Americans who receive income from assets in non-US jurisdictions, such as the Cayman Islands, the Channel Islands or the UK – and for trustees in these places who look after such assets on behalf of American clients.

Says Josh Matthews, managing partner of the London-based Maseco Financial advisory firm, which specialises in looking after American expatriates: “The implications could be major. If it passes, it will be important to make sure, if you’re a non-US-based trustee who has American clients or green card holders, that you are compliant.”

Richard Cassell, a London-based lawyer with Withers LLP, says the legislation is also expected to introduce a number of provisions that would significantly modify the US withholding tax and information reporting regimes in a way that would affect non-US banks, financial intermediaries and their affiliates, non-US hedge and private equity funds, and certain other non-US investment structures.

A promised tax break that would allow US multinationals to write off their world-wide income from US income for tax purposes would also be postponed.

“Arguably, certain provisions of the bill could be considered inconsistent with the US government’s previously-stated goal of making US capital markets more attractive to non-US investors,” Cassell notes, adding that part of the bill’s appeal for lawmakers is that such provisions make it “a revenue raiser” – with foreigners, foreign institutions and Americans with offshore financial interests providing the bulk of these revenues.

‘Major Overhaul’

For non-US investors in US securities and other US investments, Cassell says, HR 2847 – or the ‘Hiring Incentives To Restore Employment (HIRE) Act’ as it is formally known – “represents a major overhaul” of America’s withholding tax rules.

"A new system of IRS information agreements may provide some help for the withholding tax hit, but we have yet to see what these will require,” he says.

“The US currently boasts at least two main systems of withholding tax, but soon there could be a third.

“This new system, which incorporates the usual 30 per cent withholding tax on dividends and interest, would apply a 30 per cent withholding tax on the gross proceeds of sale of securities and other investments.”

Under the new system, as currently drafted, non-resident alien investors in the US would suffer a withholding tax on the proceeds of a sale of assets that could be reclaimed only by filing a US income tax return, Cassell notes. He adds that this is a move away from the exemption system of withholding tax to a refund system – and a change to US tax policy in this area.

Little Coverage

The potential ramifications for American investments overseas and for non-US financial institutions of the $15bn HIRE Act, also known simply as the jobs bill, have received little press coverage thus far. This is probably because the bill’s focus is on providing and protecting American jobs.

That this 361-page draft jobs bill contains a hidden crackdown on so-called tax evaders at all reflects the fact that at some point it subsumed an earlier piece of legislation known as the Foreign Account Tax Compliance Act, which in turn evolved out of the Stop Tax Haven Abuse Act of 2007.

That original bill was much publicised, in part because one of its two initial sponsors was then-Senator Barack Obama, who went on to make periodic references to offshore tax havens in some of his presidential campaign speeches.

The press coverage of the current legislation’s potential effects on offshore entities is almost certain to increase, though, following the passage by the House of Representatives on Thursday of a tweaked version of the bill that the Senate originated and late last month approved. The House vote was 217-201.

The Senate will have to vote on it again before President Obama can sign it into law, in order to ensure that both houses have agreed the same terms. Once this is done, the President’s signature is considered a formality.

‘A Simple Choice’

In a statement last October, House Ways and Means Chairman and New York Senator Charles Rangel, one of the Foreign Account Tax Compliance Act’s sponsors, said it offered foreign banks “a simple choice – if you wish to access our capital markets, you have to report on U.S. account holders". Senate Finance Committee chairman and Montana Senator Max Baucus was the Foreign Account Tax Compliance Act’s s co-sponsor.

Ironically, Sen Rangel has come in for some criticism in recent weeks for, among other things, allegedly failing to report income from a condominium he owns in the Dominican Republic.

For Maseco’s Matthews, one of the key concerns in the HIRE Act for his American ex-pat clients are its provisions having to do with so-called passive foreign investment companies (PFICs). These are legal entities defined for tax purposes as foreign companies, which receive mainly investment income or which are primarily intended to generate it, and they are already treated less favourably by the US Internal Revenue Service than their equivalent US-based equivalents.

Maseco already provides its clients with US tax-efficient alternatives, which enable them to avoid the highest US tax rate of 35% in favour of a 15% long-term capital gains rate, but Matthews notes that not all advisers are clued in to this possibility, or even the need for it to be done.

“It is a very simple solution if you know it is an issue, but most people don’t,” he says.

Some of the HIRE Act’s other key provisions for offshore investors and trustees:

• Increased disclosure of ‘beneficial owners’, that is, the person who actually enjoys the benefits of owning a security or property, regardless of the name of the entity holding it

• New requirements concerning the holding of “foreign financial assets”,  including penalties for underpayments attributable to undisclosed foreign financial assets and a modification of the statute of limitations covering “significant omission of income in connection with foreign assets”

• New provisions and clarifications having to do with foreign trusts, including one covering the “uncompensated use of trust property”. If enacted, this would mean trustees of Americans with lived-in properties outside the US might have to see that rent was charged, reported and taxed; longer term, they might consider restructuring foreign trusts that own houses and other property on behalf of Americans, either as US domestic trusts or another form which does not incur US tax obligations

• As a result of an anomaly, the US federal estate tax has been abolished for 2010 only. Although this is seen as a benefit for many, it carries an unforeseen price tag for US testators, or will writers, who leave gifts of assets or trust interests to non-US beneficiaries, according to Cassell.

Senate version of HR 2847, or Hiring Incentives to Restore Employment Act (Foreign Account Tax Compliance Act is outlined on pages 5 and 6, and explained in detail on pages 191 - 243) 

Most recent House amendments to HR 2847:
http://thomas.loc.gov/cgi-bin/query/D?c111:4:./temp/~c111IVM6Dc::