Effective April 19, 2012, the Treasury and IRS published final regulations (T.D. 9584) on the information reporting by financial institutions of interest paid to nonresident alien individuals on deposits held on U.S. offices of certain financial institutions. Proposed regulations had been issued on the subject in January, 2011. The 2011 proposed regulations withdrew proposed regulations that had been issued approximately 10 years before, i.e., August 2, 2002). The earlier set of proposed regulations would have imposed reporting of interest payments to nonresident alien individuals who are residents of certain listed countries. The 2011 proposed regulations provide that payments of interest aggregating $10 or more on a deposit maintained at a U.S. office of a financial institution and paid to any nonresident alien individual are subject to information reporting. The final regulations are applicable with respect to interest payments made after 2012. These regulations will affect commercial banks, savings institutions, credit unions, securities brokerages, and insurance companies that pay interest on deposits.
Prior Comments From The Financial Services Industry and Tax Practitioners on Bank Deposit Information Reporting and Potential for Improper Use of Information
Comments received by the Treasury on the 2011 proposed regulations raised concerns that the information required to be reported might be misused, e.g., that deposit interest information may be shared with a country that does not have laws in place to protect the confidentiality of the information exchanged or that would use the information for purposes other than the enforcement of its tax laws. Such concerns could affect where nonresident alien individuals seek to place their deposits. In response, the government stated that such concerns are addressed by existing legal limitations and administrative safeguards governing tax information exchange. Bank deposit information reported pursuant to these regulations will be exchanged only with foreign governments with which the U.S. has an agreement providing for the exchange and when certain additional requirements are satisfied. Even when such an agreement exists, the IRS is not compelled to exchange information, including information collected pursuant to these regulations, if there is concern regarding the use of the information or other factors exist that would make exchange inappropriate.
More particularly, information reported pursuant to these regulations is return information under §6103 which contains strict confidentiality rules with respect to all return information. Moreover, §6103(k)(4) limits information exchange with a foreign government by the IRS under the requirements of a TIEA to which such foreign government is a party or under a bilateral tax treaty under its exchange of information and mutual cooperation articles. Absent such an agreement, the IRS is statutorily barred from sharing return information with another country, and these regulations cannot and do not change that rule.
Second, consistent with established international standards, all of the information exchange agreements to which the United States is a party require that the information exchanged under the agreement be treated and protected as secret by the foreign government. In addition, information exchange agreements generally prohibit foreign governments from using any information exchanged under such an agreement for any purpose other than the purpose of administering, collecting, and enforcing the taxes covered by the agreement. Accordingly, under these agreements, neither country is permitted to release the information shared under the agreement or use it for any other law enforcement purposes.
Third, consistent with the international standard for information exchange and United States law, the United States will not enter into an information exchange agreement unless the Treasury Department and the IRS are satisfied that the foreign government has strict confidentiality protections. Specifically, prior to entering into an information exchange agreement with another jurisdiction, the Treasury Department and the IRS closely review the foreign jurisdiction’s legal framework for maintaining the confidentiality of taxpayer information. In order to conclude an information exchange agreement with another country, the Treasury Department and the IRS must be satisfied that the foreign jurisdiction has the necessary legal safeguards in place to protect exchanged information and that adequate penalties apply to any breach of that confidentiality.
Finally, even if an information exchange agreement is in effect, the IRS will not exchange information on deposit interest or otherwise with a country if the IRS determines that the country is not complying with its obligations under the agreement to protect the confidentiality of information and to use the information solely for collecting and enforcing taxes covered by the agreement. The IRS also will not exchange any return information with a country that does not impose tax on the income being reported because the information could not be used for the enforcement of tax laws within that country.
In addition, the IRS has options regarding the appropriate form of exchange. For example, the IRS might exchange information with another jurisdiction only upon specific request. In the case of specific exchange requests, the IRS evaluates the requesting country’s current practices with respect to information confidentiality. The IRS also requires the requesting country to explain the intended permitted use of the information and justify the relevance of that information to the permitted use. Alternatively, in appropriate circumstances, the IRS might exchange certain information on an automatic basis. The IRS currently exchanges deposit interest information on an automatic basis with only one jurisdiction (Canada). The IRS will not enter into a new automatic exchange relationship with a jurisdiction unless it has reviewed the country’s policies and practices and has determined that such an exchange relationship is appropriate. Further, the IRS generally will not enter into an automatic exchange relationship with respect to the information collected under these regulations unless the other jurisdiction is willing and able to reciprocate effectively.
The Treasury Department and the IRS announced that the legal and administrative safeguards described in the preceding paragraphs regarding the use of information collected under these regulations should adequately address the concerns identified by the comments and, therefore, these regulations should not significantly impact the investment and savings decisions of the vast majority of nonresidents who are aware of and understand these safeguards and existing law and practice. Nevertheless, to enhance awareness and further address concerns, these final regulations revise the 2011 proposed regulations to require reporting only in the case of interest paid to a nonresident alien individual resident in a country with which the United States has in effect an information exchange agreement pursuant to which the United States agrees to provide, as well as receive, information and under which the competent authority is the Secretary of the Treasury or his delegate.
Operative Effect of New Regulations: Payor Obligated to File Annual Form 1042-S
Sections 1.6049-4(b)(5) and 1.6049-8 of the Income Tax Regulations, as revised
by TD 9584, require the reporting of certain deposit interest paid to nonresident alien
individuals, as defined in §7701(b)(1)(B), on or after January 1, 2013. The regulations provide that in the case of reportable interest aggregating $10 or more paid to a nonresident alien individual, the payor must make an information return on Form 1042-S for the calendar year in which the interest is paid. Reportable interest is interest described in §871(i)(2)(A) that relates to a deposit maintained at an office within the U.S. and paid to a nonresident alien individual who is a resident of a country identified, in an applicable revenue procedure (see Proc. Reg. §601.601(d)(2) of this chapter) as of December 31 prior to the calendar year in which the interest is paid, as a country with which the United States has in effect an income tax or other convention or bilateral agreement relating to the exchange of information per §6103(k)(4) whereby the U.S. agrees to provide, as well as receive, information and under which the competent authority is the Secretary of the Treasury or his delegate.
In Rev. Proc. 2012-24, §3, the Service set forth a list of countries to which the information reporting pertains:
Antigua & Barbuda
British Virgin Islands
Isle of Man
Netherlands island territories: Bonaire, Curacao, Saba, St. Eustatius and
St. Maarten (Dutch part)
Trinidad and Tobago
The Service is not required to exchange information, including information
collected pursuant to the regulations, if there is concern regarding the use of the
information or other factors exist that would make exchange inappropriate. This
revenue procedure will be updated as appropriate.
Prevening Evasion of U.S. Tax
While on the surface the publication of this set of regulations may appear non-controversial, the subject relates directly to the effective tax administration of U.S. tax laws, and in particular, the ability of Service to prevent and detect offshore tax evasion. One purpose of the information reporting required by these regulations is to impede efforts by some U.S. taxpayers with U.S. deposits to falsely claim to be nonresidents in order to avoid U.S. taxation on their deposit interest income.
As previously discussed, the identification of a country as having an information exchange agreement with the United States does not necessarily mean that the information collected under these regulations will be reported to such foreign jurisdiction. As an additional measure to further increase awareness among concerned nonresidents regarding the IRS’ use of information collected under these regulations, the Revenue Procedure also will include a second list identifying the countries with which the Treasury Department and the IRS have determined that it is appropriate to have an automatic exchange relationship with respect to the information collected under these regulations. This determination will be made only after further assessment of a country’s confidentiality laws and practices and the extent to which the country is willing and able to reciprocate.
In further response to comments, the final regulations eliminate the requirement in the 2011 proposed regulations for financial institutions to include in the information a statement provided to nonresident alien individuals informing the individual that the information may be furnished to the government of the country where the recipient resides. In addition, these final regulations clarify that a payor or middleman may rely on the permanent residence address provided on a valid Form W-8BEN, "Beneficial Owners Certificate of Foreign Status for U.S. Tax Withholding", for purposes of determining the country of residence of a nonresident alien to whom reportable interest is paid unless the payor or middleman knows or has reason to know that such documentation of the country of residence is unreliable or incorrect.
The final regulations also modify Prop. Reg. § 31.3406(g)-1 to clarify that, consistent with the backup withholding rules generally, a payment of interest described in § 1.6049-8(a) is not subject to withholding under §3406 if the payor may treat the payee as a foreign person, without regard to whether the payor reported such interest (although a payor may be subject to penalties if it fails to report as required). As under the prior regulations requiring the reporting of interest paid to Canadian non-resident alien individuals, the final regulations define interest subject to reporting to mean interest paid on deposits as defined under §871(i)(2)(A) (including deposits with persons carrying on a banking business, deposits with certain savings institutions, and certain amounts held by insurance companies under agreements to pay interest thereon).
Information Sharing Between the U.S. And Treaty Partners and Tax Information Exchange Parties
As described in the preamble to the final regulations, the U.S. has built a network of international agreements either in the form of tax treaties or information exchange agreements, to facilitate the exchange of information (TIEA) concerning tax enforcement. The underlying rationale for such agreements is to promote cooperation as well as reciprocity of information exchange among sovereign nations. The new U.S. bank deposit regulations, which require reporting of deposit interest to the IRS, are intended to allow the IRS to exchange such information with a treaty partner or TIEA counterpart where designated as appropriate under applicable revenue procedure..
The reporting requirements contained in the final regulations will further allow the Service to exchange information in certain instances with other countries to combat international tax evasion and help implement aspects of the Foreign Account Tax Compliance Act or “FATCA”, which was enacted into law as part of the Hiring Incentives to Restore Employment Act (HIRE) (§§1471-1474). P.L. 111-147 (3/18/2010). FATCA was enacted to combat tax evasion and central among the various reforms in the recent legislation, which is generally effective next year, is the mandatory 30% withholding required on all payments to “foreign financial institutions” and certain “non-financial foreign entities.
FATCA further requires international cooperation between the U.S. and foreign countries. More specifically, FATCA requires overseas financial institutions to identify U.S. accounts and report information (including interest payments) concerning such accounts to the Service. The regulations on bank deposits are designed to aid in the exchange of tax information with foreign governments for tax administration purposes.
International Standard for Transparency and Information Exchange: Seeking Global Transparency
The Organisation for Economic Cooperation and Development (OECD) is an international economic organization of 34 countries founded in 1961 for the purpose of facilitating world trade and economic development based on principles of market economies and democratic government. It publishes standards to identify good business and economic practices. Under the international standard for transparency and exchange of information, which is reflected in the Organisation for Economic Cooperation and Development (OECD) Model Agreement on Exchange of Information on Tax Matters, the OECD Model Tax Convention, and the United Nations Model Double Tax Convention between Developed and Developing Countries, exchange of tax information cannot be limited by domestic bank secrecy laws or the absence of a specific domestic tax interest in the information to be exchanged. The OECD’s global standard on transparency provides that a country cannot refuse to share tax information based on domestic laws that do not require banks to share the information. Moreover, a country cannot opt out of information exchange based on the fact that the country does not itself need the information to enforce its own tax rules. It is noted that countries that do not have a domestic income tax have still agreed to participate in TIEAs to provide information about the accounts of nonresidents.
Treasury Announcement of Intergovernmental Framework for FATCA Implementation
On February 8, 2012, The Treasury issued a Joint Statement from the United States, France, Germany, Italy, Spain and the United Kingdom on an intergovernmental framework for improving international tax compliance as well as implementing FATCA. In the Joint Statement the parties, while announcing their support for the underlying goals of FATCA, acknowledged that foreign financial institutions established their respective countries may not be able to comply with the reporting, withholding and account closure requirements because of legal restrictions. In this regard the United States announced its willingness to reciprocate in collecting and exchanging on an automatic basis information on accounts held in US financial institutions by residents of France, Germany, Italy, Spain and the United Kingdom. The approach under discussion, therefore, would enhance compliance and facilitate enforcement to the benefit of all parties. More guidelines were set forth in the Joint Statement. The details of the Joint Statement are indeed of great importance and worthy of separate discussion and analysis.