The Foreign Account Tax Compliance Act and foreign insurance companies: better to comply than to opt out.

Author:Van Heukelom, Mark R.
 
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  1. Introduction II. Background A. FATCA B. Income Tax Collection Through Voluntary Compliance C. Income Tax Enforcement Prior to FA TCA D. FATCA as a Response to Ineffective Tax Enforcement E. Foreign Financial Institution Compliance with FATCA F. Filling in FATCA's Statutory Gaps 1. Preliminary Notices 2. Proposed Regulations 3. Final Regulations III. ANALYSIS A. FATCA Implementation Costs B. Bilateral Agreements C. FATCA and Insurance Companies 1. Foreign Insurance Company Compliance with FATCA 2. Foreign Insurance Companies as Domestic Corporations IV. RECOMMENDATION A. Limitations of the Section 953(d) Election B. Company-Specific Considerations V. CONCLUSION I. INTRODUCTION

    As corporations continue to engage in international commerce, they must remain ever cognizant of the myriad tax laws with which they must comply. In response to the recession that was sparked by the global financial crisis of 2007-08, the United States implemented the Hiring Incentives to Restore Employment (HIRE) Act of 2010. (1) Included in this legislation is a new tax scheme to capture unpaid overseas tax. (2) Known as the Foreign Account Tax Compliance Act (FATCA), this law requires foreign financial institutions to either provide extensive client documentation and reporting to the Internal Revenue Service (IRS) or withhold a large percentage of each payment these financial institutions make to clients covered by FATCA. (3) While this law imposes new requirements on many foreign corporations, it poses particular issues for foreign insurance companies. (4)

    This Note examines the influence FATCA will have on foreign insurance companies. Specifically, Part II of this Note introduces FATCA, reviews the ineffectiveness of prior U.S. laws to capture duly owed offshore taxes, and discusses how FATCA aims to overcome the shortcomings of prior laws. It also details clarifications to FATCA that the IRS has provided. Next, Part III analyzes the costs of FATCA on foreign corporations and provides various means by which foreign corporations can comply with the law. Part III continues by introducing how foreign insurance companies can satisfy FATCA's requirements. It also examines Internal Revenue Code Section 953(d), a unique statutory alternative to FATCA compliance that is available solely to foreign insurance companies. Finally, Part IV recommends against this statutory alternative for most foreign insurance companies based on the limited scope of the alternative and the countless expenditures the alternative requires.

  2. BACKGROUND

    On March 18, 2010, Congress enacted the HIRE Act of 2010. (5) Totaling $17.5 billion in tax reductions and subsidies, the HIRE Act created lucrative hiring incentives for employers in an effort to combat the national decline in employment stemming from the recent economic downturn. (6) One major incentive the Act created is a $13 billion "Hire Now Tax Cut," which provided payroll tax breaks for employers that hired new employees. (7) The Act also offered tax credits for employers that continued to employ new hires for a period of one year. (8) In addition to providing employment tax breaks, the HIRE Act also sought to improve national employment figures by allowing small businesses to take additional one-time write-offs on equipment investments and by modifying municipal bonds to induce investment in education. (9)

    The HIRE Act partially offsets the expenses of its tax breaks by generating revenue from new offshore tax regulations. (10) This portion of the HIRE Act is known as FATCA. (11) This Part discusses FATCA as a response to previous statutory shortcomings and introduces Internal Revenue Service (IRS) commentary to provide clarity to this far-reaching Act.

    1. FATCA

      FATCA is intended to address tax evasion committed through the use of foreign accounts and continues President Obama's ongoing battle against foreign tax avoidance. (12) During Mr. Obama's presidency, the U.S. Justice Department brought causes of action against many large foreign banks for their roles in assisting American taxpayers to fraudulently limit their tax liabilities, including UBS, HSBC, and Deutsche Bank. (13) UBS, for instance, paid $780 million in fines and provided client names to the U.S. government in 2009 to settle such claims. (14)

      Tax evasion through the use of foreign accounts significantly reduces federal tax revenue every year. (15) The deficit between tax owed to the IRS on international transactions and the tax that the IRS actually collects each year from these sources is the international tax gap. (16) "Non-IRS" sources estimate the international tax gap to be anywhere between $40 billion and $123 billion per year. (17)

    2. Income Tax Collection Through Voluntary Compliance

      The United States collects federal income tax primarily through "voluntary compliance," a process by which a taxpaying entity is responsible for assessing its own tax liability and making sufficient tax payments to cover such liability. (18) Three important problems that stem from voluntary compliance are: "non-filing, underpayment, and underreporting of taxes due." (19) Together, these problems form the tax gap. (20)

      The IRS has combatted these problems within the voluntary compliance system through civil and criminal penalties, withholding procedures, and information reporting. (21) For instance, withholding procedures require the payer of a particular taxable payment--such as an employer making a wage payment--to submit a portion of the payment to the IRS, which then applies against the payee's tax obligation. (22) In fact, "[withholding has proven to be the single most effective enforcement mechanism for collecting taxes on income from labor." (23)

      However, these responses, aimed at overcoming the shortcomings of voluntary compliance, are less effective in international than domestic taxation environments. (24) National differences in tax assessment requirements and banking secrecy laws can create favorable conditions for tax fraud, as one country may struggle to acquire necessary taxpayer information for a person located in another country. (25) Taxpayers can take advantage of asymmetric information--the fact that they have more complete knowledge of their financial affairs than does the IRS--to create a major hindrance to effective tax law enforcement. (26) Noncompliant taxpayers can utilize national tax law variations to create information voids, whereby the IRS cannot always reliably determine the accuracy of a tax filing. (27)

    3. Income Tax Enforcement Prior to FATCA

      Prior to FATCA, the IRS had chiefly relied on the voluntary disclosure of foreign bank account holders to determine tax liabilities on foreign-held money. (28) One of the IRS's main enforcement tools for such accounts had been the Report of Foreign Bank and Financial Accounts (FBAR), a form that certain taxpayers (29) had to complete annually and file directly with the Department of the Treasury. (30) The FBAR requires subjected taxpayers to report certain information about their foreign financial accounts. (31) Taxpayer consequences for failing to timely and accurately file an FBAR include severe financial penalties and imprisonment. (32) However, as a form of voluntary compliance, (33) the FBAR filing requirement--and its related civil and criminal punishments--has not effectively curtailed taxpayer noncompliance. (34)

      In 2000, as another measure to improve foreign account information disclosure, the IRS implemented a Qualified Intermediary scheme. (35) In this arrangement, participating foreign financial institutions (FFIs) voluntarily agreed with the IRS to serve as Qualified Intermediaries and to "withhold and report" tax on subjected income in exchange for certain benefits. (36) While this scheme induced foreign banks to cooperate with the IRS, the complicated and often indirect nature of international financial transactions has limited the scheme's effectiveness. (37) In particular, much of the foreign income subject to U.S. taxation does not pass through Qualified Intermediaries, but through U.S. withholding agents instead. (38) Thus, previous attempts to increase the accuracy of tax filings for foreign account-holders have not satisfactorily closed the international tax gap.

    4. FATCA as a Response to Ineffective Tax Enforcement

      Congress enacted FATCA as a means to address the complications of foreign tax compliance. (39) It became effective on January 1, 2013, and has worldwide fiscal implications. (40) FATCA enacts Chapter 4 of Subtitle A of the Internal Revenue Code and consists of Internal Revenue Code Sections 1471 to 1474. (41) It obligates FFIs to either enter into FFI Agreements with the IRS to report certain information about their American account-holders, or face a heavy 30% withholding requirement on all of their withholdable payments. (42) Examples of withholdable payments include "[i]nterest income earned on a US Treasury bond ... and the gross proceeds from the sale or other disposition of a US Treasury bond." (43) The statute defines FFIs as foreign entities that meet any of the following three conditions: they either (a) collect deposits in the fashion of a bank; (b) maintain financial assets for others as a "substantial portion" of their business; or (c) are primarily in the business of investing in a wide range of securities or other interests. (44)

      Entities that qualify as FFIs under FATCA through one of these three categories are wide-ranging. First, deposit-collecting entities that qualify as FFIs include "banks, savings banks, commercial banks, savings and loan associations, thrifts, credit unions, building societies and other cooperative banking institutions." (45) The second category of FFIs, comprised of institutions that derive a "substantial portion" of their business from maintaining financial assets for others, qualify as FFIs under FATCA if maintaining financial assets for others accounts for 20% of their gross income over the...

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