Scope of foreign trust provisions in the HIRE Act.

• Author: McNamara, Lawrence H., Jr.
• Position: Hiring Incentives to Restore Employment Act of 2010

The year 2010 saw the swift passage of the Hiring Incentives to Restore Employment Act (1) (the HIRE Act) to jump-start employment and the U.S. economy with revenue-raising provisions streamlined as new "offshore anti-abuse" compliance statute provisions. This article analyzes the foreign trust provisions and offers some practical guidance for practitioners to consider in their development of best practice procedures.

Foreign transactions continue to proliferate, especially with an increasingly mobile society and the growth in global family wealth. The former safe haven of foreign secrecy laws is slowly being eroded as tax treaty countries seek more transparency and exchange of tax information. Starting in 2001, more transparency resulted from nearly unilateral government initiatives, such as the U.S. qualified intermediary (QI) system. (2) The HIRE Act makes this trend more effective for Treasury and raises the bar for taxpayers and their advisers with stiffer penalties and information disclosure and reporting requirements. The HIRE Act was signed into law on March 18, one day after Congress passed it. It includes new and amended foreign trust statutory provisions.

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Foreign Account Tax Reporting

Increased Disclosure of Beneficial Owners

The HIRE Act created a new Chapter 4, Taxes to Enforce Reporting on Certain Foreign Accounts, in Subtitle A of the Code, Sees. 1471-1474 of which contain new reporting provisions.(3) Essentially, foreign financial institutions with U.S. account holders will now have the choice of entering into agreements with the IRS (similar to QIs) to provide information about their account holders or becoming subject to a 30% U.S. withholding tax on U.S. source payments to foreign financial institutions, foreign trusts, and foreign corporations. Under Sec. 1441, qualified intermediary program participants must comply with the new requirements as well. Under new Sec. 1471, foreign financial institutions will be subject to the 30% withholding tax on income from U.S. financial assets (withholdable payment made to foreign financial institutions) unless they agree to disclose the (1) identity (name, address, TIN) of any U.S. person, including the U.S. owner of any account holder that is a U.S.-owned foreign entity with an account at the foreign institution (or affiliate), (2) account number, (3) account balance or value, and (4) gross receipts and gross withdrawals or payments from the account. (4) New Sec. 1471 further authorizes Treasury to establish verification and due diligence procedures with each foreign institution.

Alternatively, the foreign financial institution can elect to report as if it were a U.S. person under Sec. 6041 (information at source), Sec. 6042 (returns regarding payments of dividends and corporate earnings and profits), Sec. 6045 (returns of brokers), and Sec. 6049 (returns regarding payments of interest). This election would require the foreign financial institution to report on each account holder that is a specified U.S. person or U.S.-owned foreign entity as if the holder were a natural person and citizen of the United States. (5) A foreign financial institution that meets the reporting requirements of Sec. 1471(b) can elect (under Sec. 1471(b)(3)) to have withholding apply to any withholdable payments made to the institution to the extent that payments are allocable to accounts of recalcitrant account holders. Recalcitrant account holders are those who do not provide the information required or a waiver of a foreign secrecy law needed for the institution to meet the Sec. 1471 reporting requirements. The taxes withheld would be allocated to the recalcitrant account holder's account balance(s).

The act defines a foreign financial institution as a foreign entity that (1) accepts deposits in the ordinary course of a banking or similar business, (2) is engaged (as a substantial portion of its business) in holding financial assets for the account of others, or (3) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities. (6) A payment subject to withholding is defined as any U.S.-source payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensation, remuneration, emoluments, and other fixed or determinable annual or periodical gains, profits, and income. (7)

Nonfinancial institutions, or foreign entities that are not financial institutions, will be exempt from the 30% withholding tax if the payee or beneficial owner of the payment provides the withholding agent with either (1) proper certification that the beneficial owner does not have a substantial U.S. owner or (2) the name, address, and TIN of each U.S. substantial owner.(8) The withholding agent must not know (or have reason to know) that the certification or information provided regarding the substantial U.S. owner(s) is incorrect, and the agent reports the name, address, and TIN of each substantial owner to the IRS. (9) These new Chapter 4 provisions are generally effective for payments after December 31, 2012.

Reporting on Owners of Foreign Trusts

The HIRE Act defines "substantial owner" of a foreign trust as a grantor or holder, directly or indirectly, of more than 10% of the beneficial interest of such trust. (10) The statute authorizes Treasury to issue new regulations to coordinate the tax withholding with other withholding provisions (i.e., Sec. 1441). (11)

Practice tip: Practitioners should, in the interest of their foreign trustee clients, monitor tax withholding (such as on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons) by advising that Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, be completed satisfactorily with each payer to enable the trust entity to enjoy a reduced U.S. tax treaty withholding rate, if applicable, instead of the higher 30% rate.

Foreign Financial Asset Reporting

New Sec. 6038D imposes new reporting requirements on individuals who hold more than $50,000 in (1) any financial account maintained by a foreign financial institution or (2) any foreign stock, interest in a foreign entity (including a foreign trust), or financial instrument with a foreign counterpart that is not held in a custodial account of a financial institution. The penalty for failure to disclose such information, if...