The Beginning of an Offshore End?

On October 27, 2009, a bill to amend the Internal Revenue Code was introduced to both chambers of Congress entitled: Foreign Account Tax Compliance Act of 2009.  The act could stir up some serious trouble for investors who have been using legal and accounting gymnastics to spread wealth to offshore bank accounts where reporting, accountability and taxation is at a much lower standard.

As the text of the bill currently stands, the following serious cooperative and punitive measures would be in store for foreign financial institutions and individual investors:

• 30% withholding tax on payments to foreign financial institutions and other entities unless they acknowledge the existence of offshore accounts to the IRS and disclose relevant information including account ownership, balances and amounts moving in and out of the accounts;
• Reporting of offshore accounts with values of USD50,000 or more  by individuals and entities on their tax returns;
• Increasing the statute of limitations from 3 to 6 years specifically when offshore accounts are unreported or misreported;
• Requiring advisors who help set up offshore accounts to disclose their activities or suffer a monetary penalty;
• Requiring electronic filing of information reports about withholding on transfers to foreign accounts; these reports will be matched with IRS tax returns;
• Strengthening rules and penalties with regard to foreign trusts, including rules to expose payouts from foreign trusts to US beneficiaries as well as US transfers to foreign trusts; and
• Clarifying the definition of outgoing US dividend payments so they cannot be disguised as payouts to avoid US taxes.

The problem for the practical businessman may not be so much in continuing the use of offshore bank accounts, since oftentimes the companies who own these bank accounts are registered offshore companies themselves.  The trick is in tracing where exactly money from those bank accounts goes.  Although the details are still unclear, this piece of legislation is surely seeking to clamp down on US beneficiaries funneling their incomes through offshore bank accounts in order to evade taxes.  This bill is due to bring up the age-old question of where the line of legality falls with respect to shell companies incorporated offshore.

But to what extent can the US legally require foreign banks to adhere to these new measures?  That’s a question which is still up for debate. Representative Charles Rangel, who introduced the bill to the House, suggests that “this bill offers foreign banks a simple choice — if you wish to access our capital markets you have to report on US account holders.” But how much of a duty does that put on financial institutions to inquire as to the background of their personal and corporate clients?

From an enforceability perspective, it seems unlikely that foreign courts will be bandwagoning to levy fines on their own financial institutions for lack of cooperation with the potential new US rules.  So what does this mean for the IRS and the US government?  Could we be headed back down the route of economic sanctions as a coercion measure?  While it’s certainly too early to tell, it’s clear that Congress has a lot of thinking to do before they open this international bag of taxation worms.

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