New legislation to tackle tax evasion has been proposed by the US Senate Finance Committee Chairman Max Baucus and the House Ways and Means Committee Chairman Charles Rangel together with several other Democrats. The Foreign Account Tax Compliance Act aims to give the IRS new administrative tools to detect and discourage offshore tax abuses.

The proposed legislation would impose a tax on foreign banks that refuse to disclose the identity of US offshore account holders and corresponding account data.

The bill would levy a 30 per cent withholding tax on income that foreign financial institutions receive from US financial assets, unless they name US account holders and annually report balances and fund transfers.

“This bill offers foreign banks a simple choice – if you wish to access our capital markets, you have to report on US account holders,” said Mr Rangel.
“I am confident that most banks will do the right thing and help to make bank secrecy practices a thing of the past.”

Eduardo d’Angelo Silva, managing director of Sul America International Bank (Cayman), does not believe the final format and the regulatory framework will ultimately be as drastic as it appears now. The application of withholding tax to banks holding US assets would make holding these assets less attractive and cause a flight of capital from the US, Mr Silva stated.

He is aware of recommendations made by US and international banking associations which would “achieve the desired results without making the US unattractive to investors”.

Mr Silva suspects that the new legislation will be combined with “a review of the Qualified Intermediary regime which is already underway in order to take advantage of the experience gained by the IRS and the QI banks during the ten years of existence of this programme”.

In this case, the Cayman financial industry would be in very good shape, said Mr Silva, because Cayman was the first offshore jurisdiction to have its know-your-customer rules reviewed and approved by the IRS in 2000 in order for Cayman banks to obtain QI status.

In addition “banks in Cayman that applied for and obtained the QI status have always complied with the QI rules and requirements, submitted to regular audits of their internal procedures and provided the IRS with information required under the regime”, added Mr Silva.

Cayman also has put in place a Tax Information Exchange Agreement with the US government that can assist the IRS in investigating cases of tax evasion, making it clear that the Cayman financial industry is not part of any arrangement to facilitate the evasion of US tax obligations, he stated.

Under the bill, US individuals and entities would be required to report any offshore accounts, shares and interests in foreign entities or financial instruments with foreign counterparties exceeding an aggregated value of US$50,000 on their tax return. Failure to report foreign assets would carry a penalty of up to US$50,000 and a 40 per cent penalty would apply to cases of understated foreign assets.

The bill would also provide the US Internal Revenue Service with more time to investigate tax evasion by extending the statute of limitations from currently three years to six years.

In addition the legislative proposal targets advisors who assist US citizens and entities in setting up offshore accounts or in acquiring a direct or indirect interest in a foreign entity. Advisors would have to disclose their activities and file an information return on the US citizen and entities involved or face a penalty under the legislation.

With regard to foreign trusts the bill attempts to tighten rules to determine if distributions from such trusts are going to US beneficiaries. It would also require the reporting of US transfers to foreign trusts.

The bill further intends to tackle foreign investors who use derivatives, such as total return swaps, to disguise dividend payments that would be subject to a 30 per cent withholding tax, unless reduced under a double taxation treaty. The bill would authorise the Treasury department to develop rules so that the withholding tax would also apply to dividend equivalent payments. 

The bill was passed by the US House of Representatives on 9 December 2009 and goes now to the Senate.