Orrick Tax Law Update: Hiring Incentives to Restore Employment Act

April.01.2010

On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment Act into law (Public Law 111-147) (the "Act"). The provisions of the Act that address foreign account tax compliance are intended to improve taxpayer compliance by giving the Internal Revenue Service (the "IRS") new administrative tools to detect, deter, and discourage offshore tax abuses. In doing so, the Act imposes broad disclosure and reporting requirements on foreign financial institutions and other foreign entities including private equity funds, hedge funds, and certain investment vehicles (including foreign issuers of collateralized debt obligations or collateralized loan obligations), as well as entities engaged in banking or similar businesses. The international tax reform provisions in the Act are limited to provisions regarding withholding and information reporting. The language in the Act is based on proposals included in President Obama's 2010 Budget and legislation introduced in October 2009 as the Foreign Account Tax Compliance Act of 2009 ("FATCA") by Senate Finance Committee Chair Max Baucus (S. 1934) and then-House Ways and Means Committee Chair Charles Rangel (H.R. 3933). The Act excludes FATCA language contained in H.R. 3933 that would have required tax or investment advisers to disclose the identities of any clients they assist in buying offshore assets, as well as the assets purchased.

This client alert summarizes certain significant provisions of the Act that address foreign account tax compliance. Other provisions of the Act that address foreign account tax compliance (but that are not discussed here) deal with uncompensated use of trust property and reporting requirements of U.S. owners of foreign trusts. The Act also includes a number of provisions aimed at increasing hiring, such as (a) payroll tax forgiveness; (b) an employee retention credit, and (c) an increase in the limitation for initial-year expensing of certain depreciable business assets provided under Section 179 of the Internal Revenue Code of 1986 (the "Code").

The changes to withholding and reporting requirements described in this client alert represent fundamental changes. Generally, the broad withholding rules become effective on January 1, 2013. Pending the release of Treasury Regulations on this subject, persons who would be affected by the new withholding and reporting requirements should consider how they will comply with the new provisions well before they become effective. Likewise, the changes described in this client alert regarding notional principal contracts and securities lending transactions that are encompassed in the provision concerning dividend equivalent and substitute dividend payments are a reversal of prior law and, in the absence of prompt Treasury Regulations or clarifying legislative history, are likely to create compliance and operational issues for parties that are obligated to withhold. Parties to equity based notional principal contracts should evaluate whether existing notional principal contracts should be terminated and replaced with
Act-compliant transactions prior to September 14, 2010, when they become effective.

SUMMARY OF THE ACT

The foreign account tax compliance provisions in the Act:

  • Impose a 30% withholding tax on payments either to "foreign financial institutions" that fail to identify U.S. accounts and their owners and assets to the IRS, or to nonfinancial foreign entities (such as, corporations and trusts) that do not supply the name, address, and tax identification number of any U.S. individual with at least 10% ownership in the entity. This provision is effective for payments made after December 31, 2012, with some exceptions for grandfathered agreements.
  • Subject dividend equivalent payments included in notional principal contracts, and substitute dividend payments in certain securities-lending and sales-repurchase agreements, in each case, paid to non-U.S. persons, to the same 30% withholding tax levied on dividends paid to non-U.S. persons. This provision is effective for payments made on or after September 14, 2010.
  • Extend bearer-bond tax penalties to any such bonds marketed to non-U.S. investors, and prevent the U.S. government from issuing bearer bonds. This provision is effective after March 18, 2012.
  • Impose penalties as high as $50,000 on U.S. taxpayers who own at least $50,000 in offshore accounts or assets but fail to report the accounts on their annual income tax return. This provision is effective for tax years beginning after March 18, 2010.
  • Levy a 40% penalty on the amount of any understatement attributed to undisclosed foreign assets. This provision is effective for tax years after March 18, 2010.
  • Extend to six years the statute of limitations for omissions exceeding $5,000 and 25% of reported income derived from offshore assets. This provision is effective for returns filed after March 18, 2010, and for returns filed on or before March 18, 2010, if the applicable statute of limitations has not expired as of such date.
  • Require U.S. shareholders in passive foreign investment companies to file annual information returns. This requirement is in addition to the annual reporting requirements for a U.S. holder of an interest in a passive foreign investment company that such holder has elected to treat as a "qualified electing fund." This provision is effective as of March 18, 2010.
  • Permit the IRS to mandate that financial firms file U.S. withholding tax returns electronically, even if they file fewer than 250 returns annually. This provision is effective for returns due after March 18, 2010.
  • Codify U.S. Treasury regulations that treat foreign trusts as having U.S. beneficiaries if any current, future, or contingent beneficiary is a U.S. person. This provision is effective as of March 18, 2010.
  • Permit the IRS to presume that a foreign trust has U.S. beneficiaries if a U.S. person directly or indirectly transfers property to the foreign trust. This provision is effective for transfers of property after March 18, 2010.
  • Establish a $10,000 minimum failure-to-file penalty for some foreign-trust-related information returns. This provision is effective for notices and returns due after December 31, 2009.