This Week at McGill Law: Tax Justice and Human Rights Symposium #TJHR

This week I am so pleased to welcome to the McGill Faculty of Law an international group of students, academics, researchers, and activists to collaborate on the topic of tax justice: what is it, how is tax connected to human rights or how could it be, and what research needs to be done to further this emerging field. You can find info about the symposium, including the full program and speaker bios, here. I hope that this collaboration will raise interesting questions, inform, educate, and inspire future work on this emerging topic.

I will post each day's program as we get to it this week; we will be on twitter at #TJHR and welcome input from participants whether they are virtual or on the premises.

IBFD Seeking two Tax Research Fellows

This is a great opportunity and an interesting project: IBFD, a European publisher well known for its tax research and publishing, has two post-doctoral tax research fellowships available in Amsterdam, on Human Rights and Taxation and on Tax Treaty Related Issues. Each is a half-time position. Neither description says anything about the substance of the research, but simply notes:

The research activity will be carried out in the framework of the specific guidelines set by the Academic Chairman. Candidates applying for the position must be able to make themselves available to be at the IBFD headquarters in Amsterdam for 50% of the working days in the period of one year (reduced by holidays and other entitlements that may apply). The IBFD welcomes the application of professors and other candidates that have already positions in universities or research centres and that are enjoying sabbaticals, temporary or other leaves or that can organize their schedule in order to be present in the IBFD for the period mentioned above.

Application are due before 21 August 2014 to Recruitment at ibfd dot org.

The World According to FATCA, In 3 Maps

As of 8 June 2014, this is the world according to FATCA:

Countries that have actually signed an intergovernmental agreement.

Countries treated as having signed an intergovernmental agreement.

Countries with no agreement, actual or implied; FATCA applies unilaterally.

There really isn't any doubt that some of the poorest countries in the world will be most unfairly treated in any multilateral regime for global information exchange which excludes the United States because it acts unilaterally to attain solely its own goals, with no regard for the price others must pay or the appropriateness of imposing that cost where no wrong has ever been accused much less proven.

Prof. Karen Brown wrote an important and influential article in 2002 called Missing Africa on the topic of US tax and trade policy toward developing countries in general, Sub-Saharan Africa in particular. Her article starts with a quote: "We're the... United States. Do we need Africa?"' (from a former World Health Organization official who resigned over the lack of commitment to control AIDS in Africa).

Here the pattern repeats itself: even if they wanted to, many of the countries in the third map cannot forestall the present threat of economic sanctions. The United States simply doesn't need them. Yet many, many of these countries suffer far more from bank secrecy provided by the US and elsewhere than the other way around.

The unjustified and virtually-ignored perfection of US citizenship taxation is one part of FATCA's unexamined legacy, the dismantling of comity in international taxation another; so, too, the repeated exclusion of the developing world from an institutional order that is becoming increasingly unjust.

Koskinen: Tough as Nails on Individuals; Cautious and Worrisome on US Multinationals

Further to the last post, below are the full remarks from Commissioner Koskinen, with a few key remarks in bold. The remarks are long but I think worth reading in their entirety if only for the marked contrast between the IRS' divergent approaches to "cracking down" on individuals versus US multinational companies. These approaches will most certainly diverge further in the future, if Commissioner Koskinen's statements reflect hardening policy positions. 

I don't want to spend too much time analyzing what is, in the main, a plea for Congress to give the IRS more money, and secondarily some cheerleading for the hard work put in by the IRS and the financial industry to get FATCA operational. Still, it is worth noting that there is much unstated here, for instance: what is meant by "home" jurisdiction--a question no one seems too keen to ask or answer even as we rush headlong into global automatic information exchange. If we actually care about getting these things right we have got to have a global conversation about who owes what to whom as a matter of justice and as a matter of rights, and most importantly: who is going to make those decisions. 

When we don't have those conversations it is all too easy for someone to wax enthusiastically about the project of demanding the bank account numbers and balances of millions of people who don't reside in their country while in the next breath advising caution and restraint when it comes to other countries taxing "their" corporations.

PREPARED REMARKS OF

JOHN A. KOSKINEN

COMMISSIONER

INTERNAL REVENUE SERVICE

BEFORE THE

U.S. COUNCIL FOR INTERNATIONAL BUSINESS-OECD INTERNATIONAL TAX CONFERENCE

WASHINGTON, D.C.

JUNE 3, 2014

Thank you to the U. S. Council for inviting me to be here today. I’m honored to have the opportunity to participate in this important discussion about international tax issues.
Although I have been IRS Commissioner for only a few months, I have quickly come to appreciate the great importance of focusing on the international tax compliance of both business and individual taxpayers. And I’ve come to understand that it is not possible to overstate the challenge that globalization poses to tax administration for the United States and I’m sure for many other jurisdictions as well. Rapid and extensive globalization of markets, business models, and financial systems has presented taxpayers and tax administrations with challenges and opportunities of all sorts.

As you know, the United States government is attempting to respond to the global challenges -- sometimes aggressively and sometimes cautiously and collaboratively, but hopefully always with thoughtfulness, perspective, and a sense of global responsibility. It seems we are in a critical time in these respects, as all of you know well, and this makes it a very exciting time for global tax administration, a time in which rapid and dramatic changes are afoot. For example, it was only a few years ago that tax administration officials were talking about the need to pierce the veil of bank secrecy, and today it seems that veil is being shredded as we move toward a cooperative environment based on tax transparency.

One of the most exciting aspects of our current times is to see governments working so closely together to ensure that taxpayers comply with the tax obligations of their home jurisdictions. With respect to individual tax compliance, we see this collaboration in the process by which FATCA will soon go into effect, and its younger but already bigger sister, the Common Reporting Standard, or CRS, will soon be adopted globally. The cornerstone of these efforts, of course, is the automatic, multilateral exchange of information, which signals quite clearly that international tax transparency is no longer a distant hope, but rather an immediate reality.

But as far as we have come on this road, there is still a great deal of work to be done. Although the policy issue has been settled and tax transparency is the common goal, tax administrators still must answer the question of how we make automatic information sharing work well as a practical matter. We must devise brand new systems, processes, and protocols that maximize efficiencies, minimize burden on taxpayers and financial intermediaries, and ensure the safety and security of the information being transmitted. But before talking about these, I would like to step back for a moment and look at where the U.S. is today on offshore tax compliance and how we got to this point.

The IRS’ serious efforts to combat offshore tax evasion, which had long been a problem, began in 2008 with our efforts to address specific situations brought to our attention in part by whistleblowers. The most notable example of this was the situation with UBS. The IRS realized that the globalization of investment opportunities, and the marketing of those opportunities, could do serious harm to the integrity of the U.S. tax system if complete tax transparency was not part of the equation. This is especially true because our tax system is built on the notion of voluntary compliance. Allowing wealthy individuals to use overseas accounts without paying taxes not only erodes the home jurisdiction’s tax base, but it also is an affront to the vast majority of taxpayers who play by the rules and expect their neighbors to be doing likewise. So from the outset, the IRS adopted a clear message: International tax evasion was, and would continue to be, a top priority for the agency, and people hiding assets offshore would find themselves increasingly at risk of enforcement actions.

A turning point in our enforcement efforts came in 2009 with the agreement reached with UBS. This agreement represented a major step toward global tax transparency and helped build a foundation for our future enforcement efforts. Importantly, the agreement sent the message that the IRS would pursue tax evasion around the world, wherever it might be based, and would also focus on those facilitating tax evasion practices. The agreement also showed the IRS’ keen interest in working cooperatively with other governments to obtain the information needed to bring evaders to justice.

Since 2009, the IRS has taken a multifaceted approach to the offshore noncompliance problem. This has included working diligently and cooperatively with other governments to obtain information on U.S. owners of offshore accounts, as well as banks and other promoters of tax evasive techniques, and using that information to prosecute those willfully evading the law. We have mined the information we’ve obtained for future leads, and have shared our findings with other governments to help them enforce their own laws.

While maintaining strong enforcement programs, the IRS has also sought to encourage taxpayers to come into compliance voluntarily. In 2009, the agency first made available a special Offshore Voluntary Disclosure Program, or OVDP. This program has allowed U.S. citizens with undisclosed offshore accounts to voluntarily disclose those accounts, pay a monetary penalty, and avoid criminal prosecution. Because of this program’s success, modified voluntary programs were made available in 2011 and again in 2012. Since 2009, these programs have resulted in more than 43,000 voluntary disclosures from individuals who paid more than $6 billon in back taxes, interest, and penalties, and the numbers continue to rise. In fact, we have noted a significant uptick in participation since the Department of Justice announced its program for Swiss banks last August. So we have clear evidence that our enforcement efforts are working together with our voluntary programs, and we are hopeful that this dynamic will flourish until the offshore problem is stamped out completely.

Now, while the 2012 OVDP and its predecessors have operated successfully, we are currently considering making further program modifications to accomplish even more. We are considering whether our voluntary programs have been too focused on those willfully evading their tax obligations and are not accommodating enough to others who don’t necessarily need protection from criminal prosecution because their compliance failures have been of the non-willful variety. For example, we are well aware that there are many U.S. citizens who have resided abroad for many years, perhaps even the vast majority of their lives. We have been considering whether these individuals should have an opportunity to come into compliance that doesn’t involve the type of penalties that are appropriate for U.S.-resident taxpayers who were willfully hiding their investments overseas. We are also aware that there may be U.S.-resident taxpayers with unreported offshore accounts whose prior non-compliance clearly did not constitute willful tax evasion but who, to date, have not had a clear way of coming into compliance that doesn’t involve the threat of substantial penalties.

We are close to completing our deliberations on these respects and expect that we will soon put forward modifications to the programs currently in place. Our goal is to ensure we have struck the right balance between emphasis on aggressive enforcement and focus on the law-abiding instincts of most U.S. citizens who, given the proper chance, will voluntarily come into compliance and willingly remedy past mistakes. We believe that re-striking this balance between enforcement and voluntary compliance is particularly important at this point in time, given that we are nearing July 1, the effective date of FATCA. We expect we will have much more to say on these program enhancements in the very near future. So stay tuned.

Now, I’ve mentioned FATCA a couple of times and let me talk about it more directly. With FATCA, Congress took a significant stride towards global tax transparency by calling for automatic information reporting on financial accounts held by U.S. taxpayers, no matter where those accounts are located. And so, as everyone knows, FATCA’s enactment has had a dramatic impact on the global financial system, as financial intermediaries all around the world have had to modify their systems and processes to carry out what FATCA calls for. We know that this implementation has been difficult and costly, to say the least, and I’d like to thank the financial community for working so closely with us to ensure that, in the future, all international investors are also tax-compliant investors. In a truly global economy, this is fundamental, of course, and I believe at some point in the future all of us, in both the private and public sectors, will look back with not only a strong sense of accomplishment, but also with wonder at how it ever could have been otherwise.

I’ll also note that the U.S. government’s preparations for FATCA have not exactly been easy. Since enactment, the IRS and Treasury have been working extremely hard to solidify the legal framework, global relationships, and infrastructure necessary to convert FATCA from a concept into a practical reality, and this has been no small task. For four years now, FATCA implementation has demanded a tremendous amount of hard work and dedication on the part of a relatively small group of public servants, without whom offshore tax evasion might still be considered a viable practice. These folks have diligently worked on issuing guidance that is clear and eases the FATCA compliance burden as much as possible, and they have made a herculean effort to take into account the extensive stakeholder comments we’ve received in order to get there. I know there are still a few more things to do, but I should take the time, midstream, to thank the IRS and Treasury FATCA team for the work they have completed so far, because that work has been monumental.

And beyond the legal and regulatory framework that’s been created, you’ll find a number of other very novel elements of the FATCA implementation effort that are important in their own right.
First, so that we can identify and interact with our stakeholders in the global financial community, we had to create a new Global Intermediary Identification Number, or GIIN, and develop a unique registration system. This system allows financial intermediaries around the world to establish their FATCA-compliant status and obtain a GIIN to prevent FATCA withholding when receiving payments from U.S. sources. The FATCA registration system opened several months ahead of schedule and has performed flawlessly to date. So far, tens of thousands of financial institutions have established FATCA accounts and received their GIINs. And just yesterday in fact, we successfully made available to all potential withholding agents the so-called “IRS FFI List” of Foreign Financial Institutions, so those agents can download the database of IRS-issued GIINs to their own systems and use that data to determine which of their account holders are FATCA-compliant and thus free from FATCA withholding.

Second, we had to be very mindful that FATCA data will be coming to us from a wide variety of sources and in a variety of ways. So we had to reach intergovernmental consensus, with extensive input from the financial sector, on a common data format, or schema, that will allow us to process and interpret all FATCA data, no matter its source, once we receive it. This hard work was guided by the OECD, and for that effort that I would like to extend my special thanks to the OECD representatives here in the room today, as well as to the individual members of the OECD Secretariat staff and the private sector financial community not with us who diligently worked through a tremendous amount of detail to ensure that FATCA information reports can be used efficiently and effectively, not only by the IRS but by our reciprocal FATCA partners as well.

Third, the automatic exchange of bulk information contemplated by FATCA will require a modern mode of data transmission, one that, frankly, is not available at the moment. This too has presented a challenge for IRS like no other faced in the past. So, working again with our partners in tax administration around the world, we have had to design a new system for electronic data exchange that will allow FATCA data to be transmitted quickly and securely. So far, we are pleased with the resulting design of this new “International Data Exchange System,” which we refer to as IDES. We believe it will accomplish our goals, and anticipate it will be available to users by January of the coming year so that FATCA data can flow on time.
In this regard, I also want to emphasize that we take very seriously the need to ensure that the financial data transmitted through IDES will be transmitted securely, kept confidential, and used only for tax purposes. Protecting this information and assuring its intended use must be our number-one goal. Toward that end, we designed IDES to include state-of-the-art encryption protocols, and we developed a set of safeguard standards addressing the security and use of data once it is received by a government.

Lastly and importantly, during the past several months, we have been conducting bilateral meetings with each one of our reciprocal FATCA partners to ensure that our safeguard needs are understood and that we and our partners achieve a high level of comfort that FATCA data will be kept confidential and used only for tax purposes, as our treaty and information exchange agreements contemplate.

Before I leave the subject of FATCA implementation, I want to mention our resource limitations at the IRS. The agency continues to be in a very difficult budget environment. Since Fiscal Year 2010, IRS funding has been reduced by more than $850 million, or about 7 percent, and we have 10,000 fewer employees, even as our responsibilities have continued to expand. In the absence of additional resources, our ongoing funding shortfall has major, negative implications for the agency’s ability to continue to adequately fulfill its dual mission of excellent taxpayer service and robust tax compliance programs.

Having said that, it is also important to point out that Congress has mandated that the IRS implement FATCA. Whatever else we are going to do, the IRS must move forward with our non- discretionary legislative mandates, and FATCA is at the top of that list. So I want to assure those of you dealing with FATCA implementation in other ways and in other realms that the IRS will continue to find the necessary resources for FATCA, and implementation will not be disrupted by our budget constraints.

Let me also offer a few words on FATCA enforcement. First, as I have already said, we realize that FATCA implementation is challenging not only for the IRS, but also for the financial institutions that are covered by it. We understand there is a great deal of complexity in FATCA, and that financial institutions must make substantial modifications to their processes and systems to implement it. And we understand that complying with the letter of these requirements, down to the final dotting of “I”s and crossing of “T”s, will take some time. As we announced publicly in an IRS Notice last month, we intend to view 2014 and 2015 as a so-called “transitional” enforcement period during which we will take into account a financial institution’s good-faith efforts to comply in our evaluation of what constitutes acceptable FATCA compliance.

Second, we’re well aware that our offshore enforcement resources going forward will need to be dedicated not to small-scale issues that those trying to be FATCA compliant may have, but rather to broader-scale problems presented by those who choose to seek new ways to evade their tax obligations. That is, we recognize that compliance with FATCA by those trying to comply, and with the new Common Reporting Standard when it goes into effect, will improve and be fine- tuned over time. Problems in this area will be corrected by the compliance-minded. The IRS and other enforcement agencies around the world will be able to focus on the structures and arrangements that, unfortunately but inevitably, will be devised to stay in the shadows in a new world of tax transparency. And in that new world, governments will need to work closely together to shine light into those shadowy spaces until they no longer exist.

Now, although I’m suggesting here that FATCA will not put a complete end to the offshore problem we face, I am telling a very positive story, not a bleak one. FATCA and CRS clearly will make it much more difficult and costly to hide assets, so that those who still seek to do so will be forced to spend money to devise more complex structures, turn to riskier jurisdictions and riskier forms of investment, and face far greater certainty of prosecution when found. FATCA will also de-stigmatize those holding offshore accounts for legitimate purposes, as those accounts will be both reported and reported upon in the normal course, while tax administrations focus their enforcement efforts against those truly seeking to evade taxation.

Interestingly, we can already begin predicting that governments will be working on these future problems completely in concert. In fact, because our interests are aligned and the new instruments of transparency and enforcement we are developing together will be shared, I believe the melody of our total success will be sweet and come quickly.

Now, before I conclude, I would like to say a few words about the topic that is front and center at this conference – that is, Base Erosion and Profit Shifting, or BEPS. 

For some time now, the IRS and the U.S. Treasury have been active participants in the OECD’s project to address BEPS on a global scale. We fully support the goal of developing a coordinated and comprehensive action plan to update our international tax rules to reflect modern business practices. Hopefully, this coordinated work will help prevent, rather than exacerbate, the double taxation disputes that could arise if countries unilaterally attempt to address these issues without consensus-based principles. And of course, consensus-based principles are also critically important to ensuring that businesses have the tax certainty they need to operate efficiently around the globe.

That said, I have one point that I believe needs to be considered in the context of these important discussions. I urge that your policy and legal determinations not be made without thoroughly considering the practical implications of these decisions, not only for businesses, but for tax administrations. Let me provide just one example to illustrate what I mean.

I understand that among the reforms being considered is a process known as “country-by-country reporting,” under which multinational businesses would be required to provide, to the tax authorities in each country in which they do business, certain financial information, broken down by country (hence the term, “country-by-country reporting”). I also understand that one possibility for disseminating this data is for all the information reports to be provided to the tax administration in the business’s headquarters country and then shared by that tax administration with the other jurisdictions through the vehicle of treaty-based information exchange. Lastly, I’ve heard it is contemplated that these reports would be exchanged for general risk assessment purposes, not for purposes of an existing audit, which is the current, well-established information exchange standard.

So, given all this, let’s assume that the IRS receives 2,000 of these reports from U.S.- headquartered businesses (although the number could easily be much higher than that) and let’s assume that an average of just five other countries ask for each of these 2,000 reports in any given year. This would mean 10,000 new annual requests for exchange of information coming into our competent authority’s office. And this is just the initial requests. If the proposed new risk assessment standard would justify follow-on requests for additional specific or clarifying information to further the risk assessment, the demand could grow even greater on our Exchange of Information program, or EOI, which is the conduit used by foreign governments to request tax information from us.

So, I ask that this type of simple impact be taken into account as you go forward on this issue and the others you are working to address. One possible way to exchange “country-by-country” reports would be to require that they be automatically exchanged electronically, perhaps through the IDES system I mentioned earlier. Automatic exchange would eliminate the need for a person to evaluate whether or not a requesting country really has a legitimate interest in the information for risk assessment purposes. Together with this might be an agreement that there would be no follow-on requests unless an audit is begun. If this type of care were not taken, then tax administrations with a significant number of headquarters companies would have to reallocate our already dwindling resources to our EOI programs so that we can deal with just this one aspect of the BEPS project.

So again, I urge you in your policy discussions to carefully consider the administrative impact of your decisions. In order for your policy goals to be achieved, any new regime needs to be workable not only from the perspective of taxpayers but also from a tax administration standpoint. 

Let me close now by saying that the IRS looks forward to working with our tax administration partners around the world as we move together toward greater tax transparency and greater coordinated efforts to address common compliance challenges. Thank you for letting me spend this time with you today, and I would be happy to take your questions. 

IRS to Unveil Compliance Program for U.S. Expats Not Willfully Evading Taxes

From Lydia Beloud at Bloomberg's Daily Tax RealTime:

U.S. citizens abroad who are noncompliant with their tax obligations but aren't willfully evading taxes may be able to come into compliance under a new program to be announced by the Internal Revenue Service in a matter of weeks, IRS Commissioner John Koskinen said June 3. “We are well aware that there are many U.S. citizens who have resided abroad for many years, perhaps even the vast majority of their lives. We have been considering whether these individuals should have an opportunity to come into compliance that doesn't involve the type of penalties that are appropriate for U.S.-resident taxpayers who were willfully hiding their investments overseas,” Koskinen said during an Organization for Economic Cooperation and Development forum in Washington. Koskinen told reporters following the event that program details will be issued in the next few weeks.

We'll see.

It Isn't Just about Greece: Domestic Politics, Transparency and Fiscal Gimmickry in Europe

Here is an interesting article by James Alt, David Dreyer Lassen and Joachim Wehner that might help explain why it's hard for governments to contend with the problem of tax planning (or base erosion, or however one might like to categorize the issue): governments themselves are inclined toward playing around with numbers, too, or what the authors call engaging in gimmickry. It's also another compelling argument for more transparency in governance coupled with an example of why governments are ambivalent about meeting that goal. Abstract:

This article analyzes the political origins of differences in adherence to the fiscal framework of the European Union (EU). It shows how incentives to use fiscal policy for electoral purposes and limited budget transparency at the national level, combined with the need to respond to fiscal rules at the supranational level, interact to systematically undermine the Economic and Monetary Union through the employment of fiscal gimmicks or creative accounting. It also explains in detail how national accounts were manipulated to produce electoral cycles that were under the radar of the EU budget surveillance system, and concludes with new perspectives on the changes to (and challenges for) euro area fiscal rules.

And here are some observations from the paper:

We show that: (1) despite reporting rules and an elaborate monitoring mechanism (including Eurostat), political incentives resulting from the electoral cycle and the state of the economy systematically undermined compliance with SGP fiscal rules; (2) under such rules, the scale of gimmickry depends on the degree of fiscal transparency in the domestic budget process; (3) incentives for fiscal gimmickry grew with the adoption of these fiscal rules, and tampering with accounting related to subsidies was not the only way in which countries evaded the SGP and Eurostat supervision; and (4) contrary to a good deal of contemporary discussion, non-compliance with the SGP was not 'all about Greece'. Greece was indeed an extreme case, the least transparent of the countries we study. However, the patterns we identify appear whether or not we include Greece in the data.

Countries with higher fiscal transparency generally observed SGP requirements for fiscal reporting, but occasionally violated the deficit limits.

When larger deficits loomed in an economic downturn, low-transparency countries also systematically circumvented the reporting rules using creative accounting.

Our result – that despite common supranational rules and monitoring, domestic institutions (budget transparency), politics (elections) and economic cycles (recessions) explain much of the variation in outcomes – reinforces the argument that 'the source of fiscal discipline is at the domestic level'.

...asymmetric information in an economic union is not only of academic interest, but has serious, real-world consequences for sustaining co-operation among national governments.

...Why would governments choose to misrepresent the state of their public finances? Euro member countries generally face three audiences: domestic voters, bond markets and the EU itself. Conceptually, countries projecting deficits or debt levels that violate the SGP rules can – for a given level of budget transparency – do three things. Each involves a different trade-off. First, they can observe the fiscal rules and make real adjustments to tax and expenditure levels, which will placate bond markets and Eurostat, but will be costly if the resulting policies are unpopular with voters at the national level. Secondly, they can forego fiscal consolidation, break the rules outright, and post deficits and debts in excess of SGP thresholds. This also can come at a price. Greece's entry into the common currency was delayed due to too-high deficits and, after the introduction of the euro, the system had penalties that made it potentially costly for countries to violate the rules. Thirdly, countries can resort to gimmickry, leaving real outcomes (especially spending) unchanged.8 Voters are unharmed in the short run, and gimmicks fool bond markets and supranational authorities to the extent they are undetected. Here the trade-off is intertemporal: if undetected, gimmickry keeps governments on good terms with everyone in the present, but may entail considerable costs, if deficits and debts later accumulate, in the form of high bond yields and even political unrest. Strategic choice could involve more than one of these avenues for action.

...If countries face costly constraints – either politically, from voters, or economically, from supranational fiscal rules or markets – why would countries not simply reduce transparency in order to facilitate fiscal gimmickry? They could, but making governance structures less transparent is visible, carries substantial reputational costs and, in our context, is penalized by bond markets.

...how can we make gimmickry observable and quantified, when the point of misrepresenting fiscal quantities is to avoid detection? We next show how gimmickry can be inferred from traces left in the national accounts, even after Eurostat scrutiny.

...One measure of gimmickry that is reasonably well known to practitioners is the stock-flow adjustment (SFA). The SFA is a statistical residual, an accounting item defined to reconcile the difference between a change in a government's debt (the total face value of the 'debt-like' or 'fixed' claims held against it) and budget deficit (the excess of spending over revenue)

...shares and other equity' transactions become gimmicks when, for instance, payments to cover recurring losses by a state-owned company are treated as equity purchases instead of current transfers.

...A government's electoral incentives are captured by years left in its term of office, ending in zero in the election year: there should be more gimmickry when fewer years are left

...Panel A clearly reveals an electoral cycle in gimmicks which is conditional on transparency. But increasing transparency reduces or eliminates the electoral cycle.

... Appendix 8 presents estimates with different measurements and coding of rules, transparency and other variables, varied samples and including a lagged dependent variable. Those tests qualitatively support our main results: the presence of an electoral cycle in gimmicks, more pressure from hard times and recourse to gimmicks exacerbated by rules – all of which are conditional on limited transparency.

Moreover, supranational fiscal rules that are intended to sustain co-operation instead exacerbate incentives for national governments to manipulate reported data rather than fix fiscal policy.

These are systematic tendencies, rather than the actions of any single country. Budget process transparency can reduce the incentives to manipulate, even those that would otherwise intensify in times of economic stress. Warnings that have been raised in policy and research papers since the early 1990s about the risks of moral hazard in economic policy making for countries in economic unions remain a concern.

 The following observation meshes with other work on the tendency of governments (such as here and here and here) to deficit-finance more generally:

In democracies, even advanced ones, politicians' incentives to employ gimmicks get stronger as elections approach.

And finally the punchline:

...The results show that Greece was not a special case; rather, it was the extreme case of a general, and comprehensible, pattern.

The appendices contain rich details and references.

Partnerships and the problem of Inversions

The Levin brothers (one in Senate, one in the house), have proposed a bill to increase the possibility for tax penalties for companies that start out as American and then 'invert' by merging with a foreign company, when too many of their shareholders are still American (existing rule: 20%, they want to go to 50%). But with the below ruling in place, one can imagine avoiding the inversion rule and getting to the intended result anyway, which is moving income-producing assets offshore at low or no cost and then having all the future income be foreign-source and therefore tax-deferred, ideally forever. 

LTR 201305006

Third Party Communication: None

Date of Communication: Not Applicable

Person To Contact: * * *, ID No. * * *

Telephone Number: * * *

Index Number: 7701.02-02

Release Date: 2/1/2013

Date: October 15, 2012

Refer Reply To: CC:PSI:B01 - PLR-140969-11

LEGEND:

Taxpayer = * * *

Parent = * * *

Affiliate = * * *

State = * * *

Country = * * *

Entity = * * *

Region = * * *

X = * * *

Courts = * * *

Dear * * *:

This letter responds to a letter, dated September 30, 2011, written by Taxpayer's authorized representative on behalf of Taxpayer, requesting a private letter ruling concerning the classification for federal tax purposes of a joint venture between Taxpayer and Affiliate.

According to the information submitted, Taxpayer is a corporation organized under the laws of State, and is a wholly-owned subsidiary of Parent. Affiliate is an Entity organized under the laws of Country A and is wholly owned by Taxpayer.

Taxpayer intends to enter into a joint venture with Affiliate by executing a Profit Participation Agreement (the "Agreement") under which Affiliate will acquire a X% interest in the capital of all of Taxpayer's branches in Region in return for a cash investment equal to X% of the overall fair market value of the Region branches. Affiliate will also acquire a X% interest in the profits and losses from all business operations of the branches in the Region.

No separate juridical legal entity will be created as a result of the agreement and thus Taxpayer will retain legal ownership of all assets, liabilities, and contractual obligations of the Region branches.

Taxpayer has provided the following representations in connection with its request for a private letter ruling.

(a) The Agreement will be signed outside the United States.

(b) The Agreement will provide that it will be governed by the laws of Country (the "Governing Law Provision").

(c) The Agreement will provide that Taxpayer and the Affiliate consent to the exclusive jurisdiction of Courts with respect to any matter or action arising out of or in connection with the Agreement (the "Exclusive Jurisdiction Provision").

(d) The rights and obligations of Taxpayer and the Affiliate under the Agreement will be legally binding under the laws of Country and will be enforceable in Courts. The performance of such obligations will not conflict with the laws of Country.

(e) The Governing Law Provision will be valid and legally binding under the law of Country and would be recognized by the courts of Country in a legal action brought by Taxpayer or Affiliate against the other party.

(f) The Exclusive Jurisdiction Provision will be valid and legally binding under the law of Country and would be recognized by the courts of Country in a legal action brought by Taxpayer or Affiliate against the other party.

(g) The Affiliate will be entitled to nominate one member of a 10-member committee that will oversee the operations and management of the Region branches (the "Management Committee"). All meetings of the Management Committee will take place outside of the United States.

(h) Taxpayer will elect to treat the resulting separate business entity as a corporation pursuant to § 301.7701-3(c).

(i) For all applicable federal tax purposes, Taxpayer will report the formation of the resulting separate business entity and its ongoing operations in a manner consistent with the rulings set forth below, including, but not limited to, the filing of, and furnishing of all required information on, Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation) and Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations).

Section 301.7701-1(a)(1) provides, in part, that whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

Section 301.7701-1(a)(2) provides, in part, that a joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom.

Section 301.7701-2(a) provides in part, that a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code.

Section 301.7701-5(a) provides in part, that a business entity (including an entity that is disregarded as separate from its owner under § 301.7701-2(c)) is domestic if it is created or organized as any type of entity (including, but not limited to, a corporation, unincorporated association, general partnership, limited partnership, and limited liability company) in the United States, or under the law of the United States or of any State. A business entity that is created or organized both in the United States and in a foreign jurisdiction is a domestic entity. A business entity (including an entity that is disregarded as separate from its owner under § 301.7701-2(c)) is foreign if it is not domestic. The determination of whether an entity is domestic or foreign is made independently from the determination of its corporate or non-corporate classification.

A joint venture or separate business entity may exist for federal tax purposes where business is not carried out in the name of the separate entity, property of the business is not held in the name of the separate entity, and one of the participants in the venture is not disclosed to third parties. Taxpayer and Affiliate plan to execute the Agreement in order to engage in an active business in Region, sharing in the profits and losses as well as the management of all activities in Region.

Accordingly, based solely on the facts submitted and the representations made, we find that:

1. The Agreement between Taxpayer and Affiliate will create a separate business entity within the meaning of § 301.7701-2.

2. All items of income and expense properly allocable to the business carried on by the separate business entity created by the Agreement will be treated as the income and expense of the separate business entity for federal income tax purposes.

3. The separate business entity created by the Agreement will be a foreign business entity within the meaning of § 301.7701-5.

Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of any aspect of any transaction or item discussed above under any other provision of the Internal Revenue Code and the regulations thereunder. Specifically, no opinion is expressed as to: (1) how § 367 of the Code and the regulations thereunder apply to the facts described in this ruling or (2) whether the separate business entity created by the Agreement is an eligible entity under § 301.7701-3.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

David R. Haglund

Branch Chief, Branch 1

Office of Associate Chief Counsel

(Passthroughs & Special Industries)

Enclosures (2)

Copy of this letter

Copy for § 6110 purposes

New GAO Report on Exemption for Foreign Earnings of Nonresident "US Persons"

The GAO likes to call the foreign earned income exemption a tax expenditure, on grounds that a deviation from the norm of income inclusion is in effect a subsidy. Under this theory, exempting a nonresident US person's foreign earned income constitutes a deviation from the normal rule that for US persons, income means "income from whatever source derived."

But exempting foreign income earned by nonresident persons is absolutely not a tax expenditure. 

This is because the potential inclusion of foreign income earned by nonresident individuals in the first place is itself an anomaly that exists only in the US income tax. All other countries exempt foreign income earned by nonresident individuals as a foundational principle. It is only the US that does not do this. If the US sensibly followed the rest of the world, it would have no need for a foreign earned income exemption.

The anomaly of taxing nonresidents as if resident is what falsely leads the GAO to the conclusion that an exemption for foreign income constitutes a deviation from the normative baseline. When the true source of the deviation is correctly located in the extraterritorial definition of resident instead, it is clear that an exemption of foreign income earned by a nonresident individual does not constitute a subsidy or expenditure but rather a limited correction of a category error. 

In any event, read the whole report here. 

Are Sole Executive Agreements Next on the Roberts Court Chopping Block?

Peter Spiro has a post up over at opinio juris on a pending US constitutional challenge to FATCA, of interest. No surprise, I agree with him that the strongest case is likely to be found in the violation of the treaty power (and not just because he points to my own work on the subject!) He says:

The Treaty Clause argument is a plausible one, the doctrinal terrain at least unsettled. The FATCA agreements enjoy implied congressional authorization, at best, in the form of prior tax treaties. ...There is a lot of history behind sole executive agreements but not much judicial precedent. ... Could this be another platform for the Supreme Court to advance its formalist turn in foreign relations law?

A very good question.

Next Tuesday: Appearance at Parliamentary Committee on Finance to Discuss FATCA

I will appear in front of the Standing Committee on Finance to discuss Canada's undertakings with respect to FATCA as presented in Bill C-31, next Tuesday at 3:30 pm or thereabouts. You can find the information here.

Here are links to the meetings so far in which Bill C-31 has been discussed:

May 1 2014

• Minutes
• Recording

May 6 2014

• Minutes
• Recording 

May 8 2014

• Recording

I have not found transcripts to these.

You can read some of the submissions people have made regarding Bill C-31 here. Submissions are limited to five pages. I hope to make a submission soon, as the submission that I made with Prof. Cockfield is too long. But please read it anyway.

It's like the left hand does not know what the right hand is doing

But that might be too charitable.

Global business tax clamp-down could sting U.S. -IRS official

The FATCA Tax Hunt is for Anyone – not just the Rich!

Ireland To Analyse Tax System's Impact on Developing Nations

This is a story to watch: Ireland is going to "review the impact its tax system may have on the economies of developing countries" with a "spillover analysis" research project that "will be conducted by consultants and overseen by a steering group consisting of officials from the Finance and Foreign Affairs Departments."

This is a fascinating development. I have long argued that tax competition is as much or more a supply side phenomenon as a demand side one, that is, it is nonsense to tell developing countries to lay off the tax incentives and get serious about taxing multinationals without looking at those MNC's home countries that are not effectively taxing these flagship companies and are therefore sending them out into the world looking for the best tax deals they can find. It seems patently obvious that anyone who is thinking about the connection between taxation and development really has to look at taxation as a globally integrated system even though it's more or less a Hobbesian war of all against all when it comes to setting national tax policy.

As a result, Ireland's request for research proposals is of great interest. From the story linked above:

The Government has published a request for Proposal/Tender outlining its aims and asking that prospective consultants provide details of suitable methodologies for their work. A public consultation document has also been released, and invites interested parties to make submissions. The initiative forms part of a broader effort to clarify Ireland's approach to international corporate tax issues. ... Ireland is further pledged to support such countries in raising domestic tax revenues in an efficient way, to promote good governance and equitable development, and enable them to eventually exist independently from official development assistance. The Department has also described the spillover analysis as a response to calls from the Group of 20 nations and civil society groups for all countries to be aware of these issues when formulating their own tax policy.

I look forward to watching this unfold.

FATCA non-delay delay

Treasury playing a little game here: keep driving forward yet refrain from actually imposing FATCA's sanctions, except in those countries it is publicly acceptable to sanction. As an important aside, if there was ever any doubt as to the nature of FATCA's "withholding tax" before, that should now finally be put to rest. This is not a tax, it is an economic sanction to coerce persons outside the jurisdiction to comply with domestic information gathering goals, which can also be used to inflict punishment for other, unrelated offences. But what does it mean for the rule of law and for taxpayer expectations to have the threat of economic sanctions held steady with the release trigger depending on the IRS' 'sense' of taxpayer efforts? How will withholding agents interpret their obligations as of July 1? The below notice will require some very close reading by a great number of people.

Notice 2014-33; 2014-21 IRB 1 

Further Guidance on the Implementation of FATCA

and Related Withholding Provisions

I. PURPOSE

This notice announces that calendar years 2014 and 2015 will be regarded as a transition period for purposes of Internal Revenue Service (IRS) enforcement and administration with respect to the implementation of FATCA by withholding agents, foreign financial institutions (FFIs), and other entities with chapter 4 responsibilities, and with respect to certain related due diligence and withholding provisions under chapters 3 and 61, and section 3406, that were revised in regulations issued earlier this year as referenced in section II of this notice. This notice also announces the intention of the Department of the Treasury (Treasury) and the IRS to further amend the regulations under sections 1441, 1442, 1471, and 1472, as applicable, to provide: (i) that a withholding agent or FFI may treat an obligation (which includes an account) held by an entity that is opened, executed, or issued on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of sections 1471 and 1472, subject to certain modifications described in section IV of this notice; (ii) additional guidance under section 1471 concerning the requirements for an FFI (or a branch of an FFI, including a disregarded entity owned by an FFI) that is a member of an expanded affiliated group of FFIs to be treated as a limited FFI or limited branch, including the requirement for a limited FFI to register on the FATCA registration website; (iii) a modification to the standards of knowledge for withholding agents under § 1.1441-7(b) for accounts documented before July 1, 2014; and (iv) a revision to the definition of a reasonable explanation of foreign status in § 1.1471-3(e)(4)(viii). Prior to the issuance of these amendments, taxpayers may rely on the provisions of this notice regarding these proposed amendments to the regulations.

The transition period and other guidance described in this notice is intended to facilitate an orderly transition for withholding agent and FFI compliance with FATCA's requirements, and responds to comments regarding certain aspects of the regulations under chapters 3 and 4.

II. BACKGROUND

A. Final and Temporary Regulations under Chapter 4

On March 18, 2010, the Hiring Incentives to Restore Employment Act of 2010, Pub. L. 111-147 (H.R. 2847), added chapter 4 to Subtitle A of the Code. Chapter 4 generally requires withholding agents to withhold at a 30 percent rate on certain payments to an FFI unless the FFI has entered into an agreement (FFI agreement) to obtain status as a participating FFI and to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes on withholding agents certain withholding, documentation, and reporting requirements with respect to certain payments made to certain non-financial foreign entities (NFFEs). 

On January 17, 2013, Treasury and the IRS published final regulations under chapter 4 (TD 9610, 78 Fed. Reg. 5873) (final chapter 4 regulations). Following the publication of the final chapter 4 regulations, Treasury and the IRS issued Notice 2013-43 (2013-31 I.R.B. 113) to preview, among other things, a revised timeline for implementation of the FATCA requirements. On February 20, 2014, Treasury and the IRS released temporary regulations under chapter 4 (T.D. 9657, 79 Fed. Reg. 12,812) (temporary chapter 4 regulations) that clarify and modify certain provisions of the final chapter 4 regulations, including incorporating the revised timeline for the implementation of FATCA set forth in Notice 2013-43. The temporary chapter 4 regulations accordingly require that withholding agents (including participating FFIs, qualified intermediaries, withholding foreign partnerships, and withholding foreign trusts) begin withholding with respect to withholdable payments made on or after July 1, 2014, unless the withholding agent can reliably associate the payment with documentation upon which it is permitted to rely to treat the payment as exempt from withholding under chapter 4. On February 20, 2014, Treasury and the IRS also released temporary regulations under chapters 3 and 61, and section 3406 (T.D. 9658, 79 Fed. Reg. 12,726) (temporary coordination regulations), to coordinate those regulations with the requirements provided in the final and temporary chapter 4 regulations.

To date, the IRS has published updated final versions of all forms in the Forms W-8 series and certain instructions to these forms to incorporate the documentation requirements of chapter 4. The IRS expects to publish all of the remaining instructions in this series in the near future.

B. Intergovernmental Agreements (IGAs)

During 2012, Treasury first released Model 1 and Model 2 intergovernmental agreements (IGAs) to facilitate the implementation of FATCA and to avoid legal impediments under local law that would otherwise limit an FFI's ability to comply with the requirements under chapter 4. On April 2, 2014, Treasury and the IRS published Announcement 2014-17 (2014-18 I.R.B. 1001), providing that the jurisdictions treated as having an IGA in effect would include jurisdictions that, before July 1, 2014, have reached agreements in substance with the United States on the terms of an IGA and that have consented to be included on the Treasury and IRS lists of such jurisdictions, in addition to jurisdictions that have already signed IGAs. An FFI that is resident in, or organized under the laws of, a jurisdiction that is included on the Treasury and IRS lists as having an IGA in effect is permitted to register on the FATCA registration website and is permitted to certify to a withholding agent its status as an FFI covered by an IGA. As of May 1, 2014, Treasury had signed 30 IGAs, and had agreements in substance with 29 jurisdictions. A complete list can be found on Treasury's website, available at http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx.

III. TRANSITION PERIOD FOR ENFORCEMENT AND ADMINISTRATION OF COMPLIANCE

Calendar years 2014 and 2015 will be regarded as a transition period for purposes of IRS enforcement and administration of the due diligence, reporting, and withholding provisions under chapter 4, as well as the provisions under chapters 3 and 61, and section 3406, to the extent those rules were modified by the temporary coordination regulations. With respect to this transition period, the IRS will take into account the extent to which a participating or deemed-compliant FFI, direct reporting NFFE, sponsoring entity, sponsored FFI, sponsored direct reporting NFFE, or withholding agent has made good faith efforts to comply with the requirements of the chapter 4 regulations and the temporary coordination regulations.

For example, the IRS will take into account whether a withholding agent has made reasonable efforts during the transition period to modify its account opening practices and procedures to document the chapter 4 status of payees, apply the standards of knowledge provided in chapter 4, and, in the absence of reliable documentation, apply the presumption rules of § 1.1471-3(f). Additionally, for example, the IRS will consider the good faith efforts of a participating FFI, registered deemed-compliant FFI, or limited FFI to identify and facilitate the registration of each other member of its expanded affiliated group as required for purposes of satisfying the expanded affiliated group requirement under § 1.1471-4(e)(1).

An entity that has not made good faith efforts to comply with the new requirements will not be given any relief from IRS enforcement during the transition period. Further, the IRS will not regard calendar years 2014 and 2015 as a transition period with respect to the requirements of chapters 3 and 61, and section 3406, that were not modified by the temporary coordination regulations. For example, the IRS will not provide transitional relief with respect to its enforcement regarding a withholding agent's determinations of the character and source of payments for withholding and reporting purposes. The transition period for compliance provided in this notice is similar to other transition periods that the IRS has provided when it has introduced or significantly revised due diligence, reporting, and withholding rules. See, e.g., Notice 98-16 (1998-15 I.R.B 12), Notice 99-25 (1999-20 I.R.B 75), and Notice 2001-4 (2001-2 I.R.B. 267).

IV. TREATMENT OF CERTAIN ENTITY OBLIGATIONS ISSUED, OPENED, OR EXECUTED ON OR AFTER JULY 1, 2014

A. Chapter 4 Regulations

Under the chapter 4 regulations, withholding agents (other than participating FFIs and registered deemed-compliant FFIs) are generally required to implement new account opening procedures beginning on July 1, 2014. A participating FFI is required to implement new account opening procedures on the later of July 1, 2014, or the effective date of its FFI agreement, and a registered deemed-compliant FFI is required to implement new account opening procedures on the later of July 1, 2014, or the date on which the FFI registers as a deemed-compliant FFI and receives a global intermediary identification number (GIIN). 

Comments received after the publication of the temporary chapter 4 regulations have indicated that the release dates of the final Forms W-8 and accompanying instructions present practical problems for both withholding agents and FFIs to implement new account opening procedures beginning on July 1, 2014. In consideration of these comments, Treasury and the IRS intend to amend the chapter 4 regulations to allow a withholding agent or FFI to treat an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of implementing the applicable due diligence, withholding, and reporting requirements under chapter 4. The proposed amendments to the chapter 4 regulations described in this section IV will be available only to obligations held by entities. The proposed amendments to the chapter 4 regulations will not be available for obligations held by individuals because the procedures for documenting individual accounts are less complex than those for documenting entities for chapter 4 purposes and the Form W-8BEN (for withholding agents to document individuals) and its accompanying instructions were published in final form on March 3, 2014.

More specifically, the proposed amendments will allow withholding agents and FFIs to treat any obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of the due diligence and withholding requirements applicable to preexisting obligations described in §§ 1.1471-2(a)(4)(ii), 1.1472-1(b)(2), and 1.1471-4(c)(3), except that an FFI may not apply the documentation exception under § 1.1471-4(c)(3)(iii).

As a result, a withholding agent that treats an obligation described in this section IV as a preexisting obligation will have the additional time provided in § 1.1471-2(a)(4)(ii) or § 1.1472-1(b)(2) in order to document an entity that is a payee or account holder of the obligation to determine whether the entity is a payee subject to withholding under chapter 4. For example, a withholding agent may document an entity that is a payee of an obligation issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, by December 31, 2014, if the payee is a prima facie FFI, or by June 30, 2016, in all other cases (as provided in § 1.1471-2(a)(4)(ii)). A withholding agent would otherwise be required to document the entity by the earlier of the date a withholdable payment is made or within 90 days of the date the obligation is issued, opened, or executed.

An FFI that is a participating FFI or registered deemed-compliant FFI may also treat an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation to document the obligation for chapter 4 purposes within the period permitted under § 1.1471-4(c)(3)(ii) as if the effective date of its FFI agreement or the date on which the FFI registers as a deemed-compliant FFI and receives a GIIN is June 30, 2014, and may not exclude such accounts from review under § 1.1471-4(c)(3)(iii).

The proposed amendments to the chapter 4 regulations described in this notice will not otherwise affect the timelines provided in the final and temporary chapter 4 regulations for due diligence, reporting, or withholding and will not modify the starting date for an FFI to implement new account opening procedures with respect to accounts maintained by the FFI that are held by individuals. For example, if a withholding agent treats an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation and receives a Form W-8BEN-E from the entity to document its status as a nonparticipating FFI, the withholding agent must begin withholding and reporting under chapter 4 when otherwise required for a preexisting obligation under the chapter 4 regulations.

B. Intergovernmental Agreements

The Model 1 and Model 2 IGAs contain a provision that allows a partner jurisdiction that has entered into an IGA to receive the benefit of certain more favorable terms that are set forth in a later signed IGA, including revisions to the procedures under Annex I of an applicable IGA, unless the partner jurisdiction declines in writing to adopt the update (the "most-favored nation" provision). With respect to FFIs covered by an IGA, Treasury intends to update the due diligence procedures described in Annex I of the Model 1 and Model 2 IGAs to incorporate due diligence procedures consistent with this notice.

Thus, it is expected that Annex I of future Model 1 and Model 2 IGAs will include a new due diligence procedures for an entity account opened on or after July 1, 2014, and before January 1, 2015, to allow an FFI covered by a Model 1 IGA or Model 2 IGA to treat such an account as a preexisting entity account, but without permitting application to such accounts of the $250,000 exception for preexisting entity accounts that are not required to be reviewed, identified, or reported. A partner jurisdiction with an IGA that has been signed or that has reached an agreement in substance will be permitted to adopt the revised due diligence procedures described above pursuant to the most-favored nation provision contained within its IGA, once an IGA with the revised procedures has been signed with another partner jurisdiction.

Annex I of the Model 1 IGA contains a provision that allows a partner jurisdiction to permit a reporting Model 1 FFI to rely on the procedures described in relevant U.S. Treasury regulations to establish whether an account is a U.S. reportable account or an account held by a nonparticipating financial institution. Annex I of the Model 2 IGA contains a provision that allows a reporting Model 2 FFI to rely on the procedures described in relevant U.S. Treasury regulations to establish whether an account is a U.S. reportable account or an account held by a nonparticipating financial institution. Prior to the publication of the proposed amendments to the chapter 4 regulations, a partner jurisdiction may rely on the provisions of this notice to permit a reporting Model 1 FFI to apply the due diligence procedures for documenting entity accounts described in this section IV. Similarly, prior to the publication of the proposed amendments to the chapter 4 regulations, a reporting Model 2 FFI may rely on the provisions of this notice to apply the due diligence procedures for documenting entity accounts described in this section IV.

V. MODIFICATION OF THE STANDARDS OF KNOWLEDGE RULES UNDER CHAPTER 3

A. Background on Reason to Know

The temporary coordination regulations, among other things, revised the reason to know standard under § 1.1441-7(b) to provide that a withholding agent will have reason to know that documentation establishing the foreign status of a direct account holder is unreliable or incorrect if the withholding agent has a current telephone number for the account holder in the United States and no telephone number for the account holder outside the United States, or has a U.S. place of birth for the account holder. See § 1.1441-7(b)(5) and (8). The addition of rules concerning a U.S. telephone number and a U.S. place of birth as U.S. indicia to the standards of knowledge for withholding agents was made in the temporary coordination regulations to coordinate with the standards of knowledge applicable to a withholding agent's reliance on a payee's claim of foreign status for chapter 4 purposes. The temporary coordination regulations also provide a transitional rule to allow a withholding agent that has previously documented the foreign status of a direct account holder for chapters 3 and 61 purposes prior to July 1, 2014, to continue to rely on such documentation without regard to whether the withholding agent has a U.S. telephone number or U.S. place of birth for the account holder. The withholding agent would, however, have reason to know that the documentation is unreliable or incorrect if the withholding agent is notified of a change in circumstances with respect to the account holder's foreign status or the withholding agent reviews documentation for the account holder that contains a U.S. place of birth. See § 1.1441-7(b)(3)(ii).

B. Modification of the Standards of Knowledge

Commentators have noted that the transitional rule for preexisting obligations described in § 1.1441-7(b)(3)(ii) has limited use for withholding agents because it is tied to a withholding agent's reliance on documentation obtained from an account holder prior to July 1, 2014, and may therefore not include cases in which a withholding agent renews a withholding certificate or documentary evidence on or after July 1, 2014, under the requirements of § 1.1441-1(e)(4)(ii)(A) (referring to the time period for renewal of certain withholding certificates or documentary evidence). Commentators further note that because of the extension until December 31, 2014, provided in the temporary coordination regulations for withholding agents to renew withholding certificates and documentary evidence that would have otherwise expired on December 31, 2013, withholding agents will have a significant number of accounts that were documented prior to July 1, 2014, but that will need to be re-documented by December 31, 2014, at which time they will no longer be able to rely on the transitional rule in § 1.1441-7(b)(3)(ii) even if the renewal documentation does not include any information indicating a change in circumstances. See § 1.1441-1(e)(4)(ii)(A) for the extended renewal allowance for withholding certifications and documentary evidence otherwise expiring on December 31, 2013.

Accordingly, Treasury and the IRS intend to amend the temporary coordination regulations to provide that a direct account holder will be considered documented prior to July 1, 2014, without regard to whether the withholding agent obtains renewal documentation for the account holder on or after July 1, 2014 pursuant to the requirements of § 1.1441-1(e)(4)(ii)(A). Therefore, a withholding agent that has documented a direct account holder prior to July 1, 2014, is not required to apply the new reason to know standards relating to a U.S. telephone number or U.S. place of birth until the withholding agent is notified of a change in circumstances with respect to the account holder's foreign status (other than renewal documentation that is required under § 1.1441-1(e)(4)(ii)(A)) or reviews documentation for the account holder that contains a U.S. place of birth. See § 1.1441-7(b)(3)(ii).

VI. REVISION OF THE DEFINTION OF REASONABLE STATEMENT UNDER CHAPTER 4

A. Background on Reasonable Explanation Supporting a Claim of Foreign Status

The final chapter 4 regulations in § 1.1471-3(e)(4)(viii) and the temporary coordination regulations in § 1.1441-7(b)(12) each provide that a withholding agent may rely on the foreign status of an individual account holder irrespective of certain U.S. indicia if, in certain cases, the account holder provides a reasonable explanation supporting the account holder's claim of foreign status. Section 1.1441-7(b)(12) describes a reasonable explanation supporting a claim of foreign status for chapter 3 purposes as either a written statement prepared by an individual or a checklist provided by a withholding agent stating that the individual meets the requirements described in § 1.1441-7(b)(12)(i) through (iv). Section 1.1471-3(e)(4)(viii) also describes a reasonable explanation supporting a claim of foreign status by an individual account holder for chapter 4 purposes, and it is substantially similar to the description under § 1.1441-7(b)(12), except that it limits the contents of a reasonable statement provided by an individual account holder to the explanations permitted on the checklist. Thus, unlike the description provided in the temporary coordination regulations, the description provided in the final chapter 4 regulations does not permit an individual to provide a written explanation other than an explanation that the individual meets the requirements described in § 1.1471-3(e)(4)(viii)(A) through (D).

B. Revision of Reasonable Explanation Prepared by an Individual

Commentators have noted that the description of a reasonable explanation of foreign status in the final chapter 4 regulations differs from the description provided in the temporary coordination regulations. Treasury and the IRS intend to amend the final chapter 4 regulations to adopt the description of a reasonable explanation of foreign status provided in the temporary coordination regulations, which permit an individual to provide a reasonable explanation that is not limited to an explanation meeting the requirements of § 1.1471-3(e)(4)(viii)(A) through (D). 

VII. LIMITED FFIS AND LIMITED BRANCHES

A. Background

The final and temporary chapter 4 regulations require that for any member of an expanded affiliated group (as defined in § 1.1471-5(i)(2)) to obtain status as a participating FFI or registered deemed-compliant FFI, each FFI member of the expanded affiliated group must have a chapter 4 status of a participating FFI, deemed-compliant FFI, exempt beneficial owner, or limited FFI. The final chapter 4 regulations also provide in § 1.1471-4(e)(2)(iv) and (3)(iii) that an FFI or branch of a participating FFI must be registered with the IRS and agree to certain conditions in order to be treated as a limited FFI or limited branch. The conditions for limited FFI or limited branch status include, among other things, that the FFI or branch not open accounts that it is required to treat as U.S. accounts or accounts held by nonparticipating FFIs, including accounts transferred from any member of its expanded affiliate group.

The IRS's FATCA registration website, available at www.irs.gov/FATCA, serves as the primary way for FFIs to register for status as a participating FFI, registered deemed-compliant FFI, or limited FFI. The FATCA registration website allows FFIs that are members of an expanded affiliated group to designate a lead financial institution (Lead FI) to identify member FFIs that will register as participating FFIs, registered deemed-compliant FFIs, or limited FFIs and to perform certain functions with respect to member FFIs. A Lead FI is not, however, required to act as a Lead FI for all FFIs within an expanded affiliated group.

B. Relief from Limited FFI and Limited Branch Restrictions on Account Opening.

FFIs and other stakeholders continue to express strong support for IGAs as a way to facilitate effective and efficient FATCA implementation while avoiding conflicts with local law. While Treasury stands ready and willing to negotiate IGAs based on the published models, commentators have expressed practical concerns about the status of FFIs and branches of FFIs in jurisdictions that are slow to engage in IGA negotiations and that have legal restrictions impeding their ability to comply with FATCA, including the conditions for limited FFI or limited branch status under the chapter 4 regulations. Specifically, comments have noted that the restrictions imposed by the final chapter 4 regulations on a limited branch or limited FFI on opening any account that it is required to treat as a U.S. account or as held by a nonparticipating FFI hinders the ability of an FFI to agree to the conditions of limited status due, for example, to requirements under local law to provide individual residents with access to banking services or to the business needs of the FFI to secure funding from another FFI in the same jurisdiction with similar impediments to complying with the requirements of FATCA.

In response to these comments, Treasury and the IRS intend to amend the final chapter 4 regulations to permit a limited FFI or limited branch to open U.S. accounts for persons resident in the jurisdiction where the limited branch or limited FFI is located, and accounts for nonparticipating FFIs that are resident in that jurisdiction, provided that the limited FFI or limited branch does not solicit U.S. accounts from persons not resident in, or accounts held by nonparticipating FFIs that are not established in, the jurisdiction where the FFI (or branch) is located and the FFI (or branch) is not used by another FFI in its expanded affiliated group to circumvent the obligations of such other FFI under section 1471. This modification is consistent with the treatment of related entities and branches provided in the model IGAs.

C. Registration of Limited FFIs.

Commentators have also stated that certain jurisdictions are explicitly prohibiting an FFI resident in, or organized under the laws of, the jurisdiction from registering with the IRS and agreeing to any status, including status as a limited FFI, regardless of whether the FFI would otherwise be able to comply with the requirements of limited FFI status. Treasury and the IRS intend to amend the final chapter 4 regulations to provide that, if an FFI is prohibited under local law from registering as a limited FFI, the prohibition will not prevent the members of its expanded affiliated group from obtaining statuses as participating FFIs or registered deemed-compliant FFIs if the first-mentioned FFI is identified as a limited FFI on the FATCA registration website by a member of the expanded affiliated group that is a U.S. financial institution or an FFI seeking status as a participating FFI (including a reporting Model 2 FFI) or reporting Model 1 FFI. In order to identify the limited FFI, the member of the expanded affiliated group will be required to register as a Lead FI with respect to the limited FFI and provide the limited FFI's information in Part II of the FATCA registration website. If the Lead FI is prohibited from identifying the limited FFI by its legal name, it will be sufficient if the Lead FI uses the term "Limited FFI" in place of its name and indicates the FFI's jurisdiction of residence or organization. 

By identifying a limited FFI in the FATCA registration website pursuant to this subsection VII.C, the Lead FI is confirming that: (1) the FFI made a representation to the Lead FI that it will meet the conditions for limited FFI status, (2) the FFI will notify the Lead FI within 30 days of the date that such FFI ceases to be a limited FFI because it either can no longer comply with the requirements for limited status or failed to comply with these requirements, or that the limited FFI can comply with the requirements of a participating FFI or deemed-compliant FFI and will separately register, to the extent required, to obtain its applicable chapter 4 status, and (3) the Lead FI, if it receives such notification or knows that the limited FFI has not complied with the conditions for limited FFI status or that the limited FFI can comply with the requirements of a participating FFI or deemed-compliant FFI, will, within 90 days of such notification or acquiring such knowledge, update the information on the FATCA registration website accordingly and will no longer be required to act as a Lead FI for the FFI. In the case in which the FFI can no longer comply or failed to comply with the requirements of limited FFI status, the Lead FI must delete the FFI from Part II of the FATCA registration website and must maintain a record of the date on which the FFI ceased to be a limited FFI and the circumstances of the limited FFI's non-compliance that will be available to the IRS upon request.

VIII. DRAFTING INFORMATION

The principal author of this notice is Tara N. Ferris of the Office of Associate Chief Counsel (International). For further information regarding this notice, contact Ms. Ferris at (202) 317-6942 (not a toll-free call).

For a couple of instant reactions from the compliance industry: KPMG; Deloitte.
In the media: Accounting Today; Reuters.