Gaining momentum

  • Author : Lawrence H McNamara Jr
  • Date : June/July 2011
ABOUT THE AUTHOR: Lawrence H McNamara Jr TEP is an Oregon accountant who has an international tax practice

This is a second article I have written for the STEP Journal which describes developments and offers suggestions in a frenzied impetus by global tax administrations to coordinate actions in tax enforcement to achieve stronger tax compliance (thus seeking the rewards of greater tax revenues). The first article, ‘International Scrutiny’ (STEP Journal Vol19 Iss1), described the progress of US tax legislation and the Treasury’s operative plans to solicit cooperation, develop coordinated tax procedures and tax information sharing with other countries. It is important for STEP members to understand the scope of these momentous developments in order to advise their clients with cross-border transactions.

The US Treasury, with effective legislation passed by Congress, has led the trend by achieving better tax administration results, such as the US ‘QI’ (qualified intermediate) agreement1. Although ‘information-exchange agreements’2 have developed into the generally-accepted norm, the US continues to use its capital markets to obtain information (as well as collect tax withholdings) that is more effective than its information-exchange agreement partnership. The Hiring Incentives to Restore Employment (HIRE) Act, passed on 18 March 2010, added the Foreign Account Tax Compliance Act (FATCA), which requires non-US financial institutions to disclose data entity investment accounts outside the US to the Internal Revenue Service (IRS) and information about US account owners to tax withholding agents3. Concerns from abroad have reverberated back to US officials from foreign financial institutions faced with implementing such procedures after 2012. The EU sent a letter to the US Treasury complaining of the severe financial burden that FATCA reporting will impose on European institutions4. The US Treasury issued two notices as guidance for compliance with the new statute sections5. The key grandfathering statute provision of FATCA is that it is not applicable to certain financial obligations outstanding on 18 March 2012, or from gross proceeds from the disposition of such obligations6.

Similar apprehension of compliance with FATCA procedures exists with foreign fiduciaries. The trust provisions stipulated in the HIRE Act appear to apply to all foreign trustees, which would classify them as FFIs (foreign financial institutions). Such definition includes any entity engaged in a business activity of holding financial assets for the account or custody of others (i.e. the prime responsibility of a trustee). The trust is a legal institution which can only be found in the legal systems existing in common-law countries. This distinction causes difficulties in countries whose legal systems are ignorant of trusts.

‘Tax treaty countries are developing coordinated procedures to enforce laws’

Similar in some respects to the FATCA provisions, the EU Savings Directive (the Directive) attempts to ensure that savings income from interest income payments made in one member state to the beneficial owner of that income who is a resident (for tax purposes) of another member state is subject to the tax rules of the member state where the taxpayer has residence7. The Directive’s objectives include requiring all signatory countries to disclose to one another’s tax authority the income earned by a resident of an EU country, thus declaring the taxpayer’s country of residence. Such procedures require the paying agents to identify the beneficial owner8.

As we look at these trends in tax compliance administration procedures being implemented on a global scale, it is noteworthy that an institutional progression in this development is a ‘one coordinated tax return’ to report all of the taxpayer’s cross-border transactions. Such a product could be jointly developed to become workable and efficiently designed for tax authorities and taxpayers, which clearly reports all of an individual’s or entity’s source income by country.

One coordinated tax return

As demonstrated above, tax treaty countries are developing coordinated procedures to enforce their tax laws. Tax administrators from over 40 countries reaffirmed their commitment to offshore tax compliance9. They endorsed the use of ‘joint audits’ and agreed to target HNWIs. Judging from this concerted effort by affirmative tax administrations, it is conceivable that ‘one coordinated tax return’ could be jointly developed to effectively report the taxpayer’s tax liability due to each applicable country’s tax jurisdiction. Foreign currency and language translations could be incorporated in the tax forms and instructions to accommodate all affected parties, for example. The IRS currently offers basic tax filing information in some languages, which could be expanded to accommodate taxpayers and their preparers, as well as foreign tax authorities10.

Such a development could be a realistic goal, considering the recent public comments by IRS Commissioner Douglas Shulman on 9 December 201011. His comments included, ‘Ideally, all countries with developed tax systems would come together to design a united system for information reporting on their residents investing abroad’, and ‘we will press on with our efforts… while keeping in mind that we are perhaps paving the way for broader-based efforts…’. He further stated: ‘I am a believer in moving beyond cooperative government relationships to true coordinated action.’ In another example of the US government’s focus on international tax cooperation efforts, the Government Accountability Office (GAO) recently told the Senate Finance Committee: ‘IRS and foreign tax administrators encounter similar issues even though their tax law provisions may differ.12’ GAO cited examples such as assisting taxpayers with the preparation and filing of returns, describing the way that foreign tax administrators deal with issues similar to those encountered in the US, and suggested the possibility of adopting tax administration practices used in other countries. It further commented: ‘Although differences in laws, culture, or other factors likely would affect the transferability of foreign tax practices to the US, these practices may provide useful insights for policyholders and the IRS.’ Any serious consideration by tax administration officials for such a ‘joint tax return project’ should first explore suggestions and comments by respected professional tax organisations such as the Society of Trust and Estate Practitioners and the American Institute of Certified Public Accountants.

As indicated in my previous article, the AICPA has developed a ‘one coordinated tax return’ for an estate or trust (Form 1041NR with related forms and instructions)13. It is designed and suitable for an estate or trust with non-resident beneficiaries (including some in the US), administered in a foreign country or under a foreign court’s jurisdiction. Such beneficiaries in many cases lack the filing information (accounting data and/or applicable tax forms to file in their country), to properly report their current year distributions from the estate or trust on their corresponding individual income tax returns. I have held informal discussions with a tax return software vendor regarding the development of a ‘commercial product’ for such a tax return14. Their response was positive, with serious consideration to the development project commencing with the US Treasury’s approval of the form’s format and joint project.

Form 1041NR and its related forms incorporates schedules to accommodate tax treaty provisions, as well as the reporting of income that might be taxable in a foreign jurisdiction, but not in the US, for example, regarding a foreign estate or non-grantor trust, for US tax purposes, capital gains income from US sources that are not effectively connected with a US trade or business or from the sale of a US real property interest are not taxable in the US15. It is, however, income included in ‘distributable net income’ and would be taxable in a distribution by the entity to most foreign beneficiaries. Form 1041NR and its related attachments, including inter-related foreign jurisdiction form(s), would enable all beneficiaries to report their respective taxable income from the entity, as well as the fiduciary, in their reporting responsibilities. Foreign jurisdictional tax authorities would have the corresponding tax information to substantiate the proper reporting by its residents.

A positive step forward

I demonstrated the benefits of the Form 1041NR Project after IRS officials asked the AICPA to assist in development of the fiduciary tax return in 200716. The evidence above, including supportive comments, corroborates collective approval by global tax authorities for the project, especially as it is so close to fruition. It supports tax compliance and consistency for taxpayers and tax authorities. The implementation of this tax-return project could gravitate the development of other coordinated tax-return projects, such as for corporations and partnerships.

A withholding agent may rely on the certification of a QI (typically a financial institution operating abroad) as to the tax status of other persons (typically account holders of the QI) and whether they are entitled to a reduced tax withholding rate (IRC s1441 et seq.). The QI enters into a W/H agreement with the IRS. The QI’s compliance with the agreement is ensured by means of a detailed audit of the QI by an IRS-approved auditor.
Article 26 of the OECD model tax convention provides a legal basis for the bilateral ‘information-exchange agreement’. Currently, more than 3,000 bilateral treaties are based upon Article 26 (See www.oecd.org/document/ 34/0,3343,en_2649_33767_33614197_1_1_1_1,00&&en-USS_01DBC.html).
HIRE Act (PL 111-147) Sec. 501; new IRC Sec. 1471 to 1474, effective after 12-31-2012; Spencer, ‘FATCA and Automatic Exchange of Tax Information’, 21 JOIT 62 (WG&L) (September 2010).
See BNA Daily Tax Report, 7 April 2011, TaxCore.
IRS Notice 2010-60, 2010-37 IRB and Notice 2011-34, 2011-19 IRB; both provide some guidance; both request that the public make comments before upcoming proposed regulations are issued.
HIRE Act Sec. 501(d); IRS Notice 2010-60, 2010-37 IRB.
See EU Savings Directive, Art. 1(1); effective on 1 July 2005.
Ibid, Art. 4(1).
See STEP Journal, ‘International Scrutiny’, pg. 46 (Vol19 Iss1).
See the ‘Multilingual Gateway’ at www.irs.gov/languages.
See IRS News Release 2010-122, 12-09-2010; prepared remarks by IRS Commissioner, Mr Shulman, before the 23rd Annual Institute on Current Issues in International Taxation, Washington, DC.
See Report (GAO – 11 – 540T); the 12 April 2011 testimony can be found at http://www.gao.gov/new.items/d11540t.pdf.
See pg. 47, STEP Journal (Vol19 Iss1); footnotes 7 and 9.
Telephone and email communications were exchanged between the author and product development personnel at CCH Incorporated (A Wolters Kluwer business) in March 2011.
Although an NRA is subject to a 30 per cent tax rate on US capital gains, if he/she is present in the US for at least 183 days during the year, this rule no longer applies to foreign trusts. The Taxpayer Relief Act of 1997 (PL 105-34, 8-5-97), amended IRC s641(b) to treat a foreign trust as an NRA who is not present in the US at any time during the year. Thus, IRC s871(a)(2) no longer applies to a foreign non-grantor trust.
See the article, ‘New Foreign Trust Tax Form Project: 1041NR’ in the AICPA’s The Tax Adviser (September 2007) at www.britannica.com/bps/additionalcontent/ 18/26504243.

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