Insights Vol. 1 No. 7: F.A.T.C.A. 24/7

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FOREIGN FINANCIAL INSTITUTIONS: WHO DEALS WITH THE I.R.S. ON F.A.T.C.A.?

On August 1, the Internal Revenue Service (“I.R.S.”) clarified in its F.A.T.C.A. Frequently Asked Questions (“F.A.Q.”) that the I.R.S.’s main contact with a foreign financial institution (“F.F.I.”) will be the “responsible officer” identified under Question 10 of the registration form (i.e., Form 8957, which should be completed on the I.R.S. F.A.T.C.A. portal and not in paper form). However, the I.R.S. reiterated that the responsible officer can authorize as many as five additional points of contact to receive F.A.T.C.A.-related information regarding the F.F.I. and to take other F.A.T.C.A.-related actions on behalf of the F.F.I.

Additionally, the responsible officer will receive an automatic e-mail notification to check the F.F.I.’s F.A.T.C.A. message board when certain messages are posted. For example, when the F.F.I.’s registration status changes, the responsible officer will receive an e-mail notification. Such e-mail notifications will include the last several characters of the F.F.I.’s F.A.T.C.A. identification number so that the officer can identify which F.A.T.C.A. account is being referred to. If no e-mail notifications are received, the responsible officer must verify that the e-mail address entered in Question 10 of the registration form is correct, as well as ensure that their spam blocker is not preventing e-mail notifications from getting through. Note that the responsible officer can only list one e-mail address on Question 10 of the registration form.

I.R.S. LIST OF REGISTERED F.F.I.’S

On August 1, the I.R.S. also updated its F.A.Q. on the list of registered F.F.I.’s. (“F.F.I. List”). The I.R.S. stated that it is possible that an F.F.I. that appears in the search tool on the I.R.S.’s website will not appear in a downloaded F.F.I. List in C.S.V. format.

Because some C.S.V.-compatible spreadsheet and database applications may only display a maximum number of records, an F.F.I. that is located on the list beyond that maximum limit may not be seen. To address this problem, the I.R.S. suggests that taxpayers try to use another spreadsheet and database application or text editor to open the downloaded C.S.V. file.

Insights Vol. 1 No. 6: Updates & Other Tidbits

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THINK TWICE BEFORE EVADING TAXES (PART II) FOLLOW UP TO CREDIT SUISSE GUILTY PLEA

As we noted last month, Credit Suisse AG pleaded guilty to conspiracy to aid and assist U.S. taxpayers with filing false income tax returns and other documents with the I.R.S. Following Credit Suisse’s guilty plea to helping American clients evade taxes, New York State’s financial regulator is said to have picked Mr. Neil Barofsky as the corporate monitor for Credit Suisse Group AG. Monitors are chosen to act as the government’s post-settlement proxy, shining a light on the inner workings of corporations and suggesting steps to bolster compliance procedures.

Credit Suisse agreed to two years of oversight by New York’s financial regulator as part of its $2.6 billion resolution with the U.S. Credit Suisse’s settlement is the first guilty plea by a global bank in more than a decade, and the penalty agreed to is the largest penalty in an offshore tax case.

Tax 101: Taxation of Foreign Trusts

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INTRODUCTION: WHAT IS A FOREIGN TRUST?

In General

A trust is a relationship (generally a written agreement) created at the direction of an individual (the settlor), in which one or more persons (the trustees) hold the individual's property, subject to certain duties, to use and protect it for the benefit of others (the beneficiaries). In general, the term “trust” as used in the Internal Revenue Code (the “Code”) refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.

Trusts can be characterized as grantor trusts or ordinary trusts. Ordinary trusts can be characterized as simple trusts or complex trusts; U.S. tax laws have special definitions for these concepts. A simple trust is a trust that is required to distribute all of its annual income to the beneficiaries. Beneficiaries cannot be charitable. A complex trust is an ordinary trust which is not a simple trust, i.e., a trust that may accumulate income, distribute corpus, or have charitable beneficiaries. Ordinary trusts are “hybrid” entities, serving as a conduit for distributions of distributable net income (“D.N.I.”), a concept defined in the Code,52 to beneficiaries and receiving a deduction for D.N.I. distributions, while being taxed on other income (e.g., accumulated income, income allocated to corpus).

A trust can be domestic or foreign. This article will focus on the U.S. tax consequences with respect to “foreign grantor trusts” (“F.G.T.”) and “foreign nongrantor trusts” (“F.N.G.T.”).

Insights Vol. 1 No. 4: Updates & Other Tidbits

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PASSIVE FOREIGN INVESTMENT COMPANY: RELAXATION OF RULES APPLICABLE TO TAX-EXEMPT SHAREHOLDERS

The passive foreign investment company (“P.F.I.C.”) rules can have an adverse impact on any U.S. person that may invest in a foreign company classified as a P.F.I.C. A P.F.I.C. can include an investment in an offshore investment company that owns investment assets such as stocks and securities. While ownership by a taxable U.S. investor can produce adverse tax results, ownership by a U.S. taxexempt entity, such as a retirement plan or an individual retirement account (“I.R.A.”), usually will not result in adverse tax results. This situation is helpful since many tax-exempt entities invest in offshore investment companies. The one exception is if the U.S. tax-exempt investor borrows money to make its investment in the P.F.I.C. then the U.S. tax exempt may recognize unrelated business taxable income (“U.B.T.I.”) from this investment. Despite its tax-exempt status, U.B.T.I. is taxable to a U.S. tax-exempt investor under Code §511.

The P.F.I.C. rules, as do many tax rules, include extensive constructive ownership rules whose purpose is to make sure that the statutory purpose behind the rules are not undercut by use of intermediate holding companies or other means. One lurking issue was whether these constructive ownership rules could possibly apply where a beneficiary of a retirement plan or I.R.A. or a shareholder of a tax-exempt entity gets a distribution from the entity that is attributed to its investment in a P.F.I.C. The I.R.S. recently issued Notice 2014-28 that alleviated this concern. As a result, a shareholder of a tax-exempt organization or a beneficiary of a tax exempt retirement plan or I.R.A. is not subject to the P.F.I.C. rules. This notice alleviates not only possible adverse tax results, but also the need to file any relevant P.F.I.C. tax forms such as Form 8621, Information Return for a shareholder of a P.F.I.C.

New York Enacts Major Corporate Taxation Reforms

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New York enacted major corporate tax reforms on March 31, 2014 when Governor Andrew Cuomo signed the final New York State budget legislation for Fiscal Year 2014-2015. Generally, the provisions are effective for tax years beginning on or after January 1, 2015. The new law changes do not automatically affect New York City taxes; conformity by New York City will require additional legislation. Significant changes are outlined below:

NEW NEXUS STANDARD

Historically, New York State taxed out-of-state corporations that had a physical nexus with the state, although physical nexus could be indirect or attenuated. The reform abandons the concept of physical nexus and adopts a new economic standard based on an annual dollar threshold of receipts derived from the state. By doing so New York significantly expands the number of corporations that will be subject to tax in the state. Corporations will now be taxable in New York for purposes of the corporation franchise tax and the metropolitan transportation business tax (“M.T.A.”) surcharge if they have $1 million or more of receipts from activity in New York. Furthermore, a corporation that is part of a combined reporting group and has receipts derived from New York of less than $1 million but more than $10,000 satisfies the threshold requirement if the New York receipts of all group members who individually exceed $10,000 equal $1 million or more in the aggregate.

FOREIGN (NON-U.S.) CORPORATIONS

Foreign (non-U.S.) corporations, referred to as alien corporations, will only be subject to New York tax if they are considered as U.S. domestic corporations under Internal Revenue Code (I.R.C.) §7701 or have effectively connected income under I.R.C. §882 for the tax year. This may have the effect of reducing the tax base of those foreign corporations that are subject to New York tax.

Tax 101: Financing A U.S. Subsidiary - Debt vs. Equity

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INTRODUCTION

When a foreign business contemplates operating in the U.S. through a U.S. subsidiary corporation, it must take into account the options available for funding the subsidiary. As a practical matter, a foreign-owned subsidiary may encounter difficulty in obtaining external financing on its own, and thus, internal financing is often considered. It is a common practice for a foreign parent corporation to fund its subsidiary through a combination of equity and debt.

Using loans in the mixture of the capital structure is often advisable from a tax point of view. Subject to the general limitations under the Internal Revenue Code (the “Code”), financing the operations with debt will result in a U.S. interest expense deduction, often with a meaningful reduction of the overall tax rate applicable to the operation. (It should be noted that the U.S. has one of the highest corporate tax rates in the world.) Additionally, repayment of invested capital (in the form of debt principal) will be free of U.S. withholding tax if the investment qualifies as a debt instrument for U.S. tax purposes. If the lender is a resident of a treaty jurisdiction and eligible for treaty benefits, the interest payments will be subject to a reduced rate of taxation – or a complete elimination of taxation – under the treaty. Another reason multinational entities use debt to finance their subsidiaries is the possibility for tax arbitrage resulting from the differing treatment in various countries of debt and equity.

Tax 101: Form 5471 - How to Complete the Form in Light of Recent Changes

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INTRODUCTION

As part of the obligation to file income tax returns, U.S. persons owning 10% or more of the stock of a foreign corporation – measured by voting power or value of the stock that is owned – are obligated to provide information on the foreign corporation. Ownership is determined by reference to stock directly held, indirectly held through foreign entities, and deemed held through attribution from others. The scope and detail of the information to be reported is dependent on the percentage of ownership maintained by the U.S. taxpayer. As the degree of ownership increases, the amount of information increases. The reporting vehicle is Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations). For returns that report on tax year 2013, this form also reports on the net investment income tax (“N.I.I.T.”) arising through a controlled foreign corporation (“C.F.C.”).

Great emphasis is put on international tax compliance, and from 2009, the I.R.S. systematically assesses penalties for late filing of Form 5471. In addition, the 2010 Foreign Account Tax Compliance Act (“F.A.T.C.A.”) extended the statute of limitations for the I.R.S. to examine a tax return if certain information returns, including Forms 5471, were not timely or properly filed. The statute of limitations will remain open on the entire tax return and not only on Form 5471 if Form 5471 is not timely filed. Once the form is filed the statute of limitation will begin to run. To assist the I.R.S. to spot inconsistencies, beginning in tax year 2012, the I.R.S. assigned a unique reference identification number to each foreign entity, which allows the I.R.S. to compare forms filed with respect to a certain company over several years.

Non-Resident Alien Interest Reporting Rules Upheld

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On January 13, 2014, the District Court for the District of Columbia dismissed the Florida Bankers Association and the Texas Bankers Association (collectively, the “Plaintiffs”) lawsuit that challenged the 2012 regulations requiring U.S. banks (including U.S. offices of non-U.S. financial institutions) to report to the I.R.S. the amount of interest paid to certain non-residents.

Pursuant to the United States’ relentless fight against offshore tax evasion, the I.R.S. finalized regulations requiring U.S. banks to report certain information on non-U.S. account holders. These regulations are necessary, in part, for countries that request reciprocal information on their resident account holders who have U.S. financial accounts as a precondition to signing an I.G.A. with the U.S. In particular, the regulations require reporting of deposit interest aggregating $10 or more paid to N.R.A.s on Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding) for the calendar year in which interest is paid. Interest is reportable even if there is no withholding requirement. The regulations apply to all payments of interest made after January 1, 2013, and the first Form 1042-S must be filed with the I.R.S. by March 15, 2014. The reporting will be made with respect to an N.R.A. who is a resident of a country that is identified as a country with which the U.S. has in effect an income tax agreement relating to the exchange of tax information.