M E M O R A N D U M

October 30, 2009

TO: Distribution

FROM: Burt, Staples & Maner LLP

RE: U.S. Withholding Tax Legislation Introduced on October 27, 2009

Key Congressional tax writers introduced the “Foreign Account Tax Compliance Act of 2009” (“Act”) on October 27, 2009, with the U.S. Treasury expressing its support. The provisions in the Act affecting information reporting and withholding on offshore accounts differ substantially from the provisions originally proposed by the Obama Administration to address the same issues. The provisions of the Act are too extensive to summarize in a short letter. Thus, we focus on two areas where the bill, if enacted, would have the most significant impact and raise the greatest concerns. All U.S. payors would be affected by this legislation, including U.S. operating companies, and not just U.S. financial institutions and Qualified Intermediaries (“QIs”).

Payments to Non-U.S. Financial Institutions: The Act would require 30% withholding on all payments of interest, dividends and other “FDAP” income as well as the gross proceeds derived from sale of instruments that would produce this type of income when paid to any foreign financial institution UNLESS the non-U.S. institution enters into an agreement with the IRS to: (1) provide an annual report that includes the name, address, and account number of any U.S. person owning a non-U.S. bank or securities account (and likely the account’s balance, gross receipts, and withdrawals) and (2) undergo a not-yet specified process for verifying that annual report. Alternatively, the non-U.S. institution could agree to perform full Form 1099 reporting on all payments made to any such U.S. persons including those from foreign source bank accounts and securities. The annual report requirements would apply to the worldwide affiliates of the entity entering into the agreement with the IRS. There would be an election to not report on non-U.S. bank accounts with less than $10,000. These provisions would be effective for payments made after December 31, 2010.

Benefits of the New Approach Compared with Administration’s Original Proposals:

• No longer would mandate that QIs build Form 1099 reporting systems for U.S. owned foreign accounts and securities (although this would remain as an elective alternative).
• Foreign entities without QI status (“NQIs”) could continue to claim withholding reductions at source, provided they enter into the agreement with the IRS, whereas under the Obama proposal NQIs would have faced mandatory 30% withholding on all FDAP payments (and 20% withholding on gross proceeds paid to NQIs in non-treaty jurisdictions), with relief from such withholding only available through an IRS refund system.
• Foreign privacy laws would be addressed by requiring foreign institutions to request a waiver of such laws from any U.S. person opening a foreign account and requiring the account be closed if the waiver is not given.

Key Concerns:

• The current payment processing systems of all U.S. financial institutions and brokers must be adapted to effect 30% withholding on gross proceeds paid to non-U.S. institutions (systems should already be capable of withholding on interest, dividends, and other FDAP payments).
• Payment processing systems must also be adapted to distinguish non-U.S. institutions that have entered into an IRS agreement (and thus qualify for relief from withholding on gross proceeds) from those that have not. The bill seems to contemplate that the IRS would publish and update a list of Qualifying Foreign Financial Institutions with effective agreements in place. Payment and processing systems must be further adapted by withholding agents to deal with non-U.S. institutions that have elected to perform full Form 1099 reporting to U.S. persons. Please note that the above three observations on necessary systems changes (along with those discussed later in this letter) may obsolete computer mainframe systems at many financial institutions that currently perform U.S. withholding and reporting in favor of a relational database technology.
• The bill’s definition of a “foreign financial institution” is very broad and would cover all banks and other financial institutions holding financial assets for others as well as any other entity (e.g., foreign partnership, foreign trust, hedge fund, private equity fund, investment vehicle) engaged in the business of investing or trading in securities, partnership interests, or commodities. For the non-U.S. institution, attempting to collect information on U.S. accounts from worldwide affiliates is likely to be both costly and difficult, depending in part upon the requirements finally adopted to identify U.S. persons.
• It is unclear whether the requirement to identify U.S. customers in non-U.S. retail bank accounts or securities accounts can be satisfied by using the coding in existing systems (e.g., citizenship code, residency code, or address field) which appears to be the only feasible way that such a check could ever work. It is unsettling to see the bill’s requirement that a financial institution rely on a “statement” of non-U.S. status from the account holder since it implies a new worldwide process for collecting such “statements” with the necessity to train worldwide retail banking and brokerage personnel in the relevant U.S. tax requirements, even if they have few or no U.S. customers. Moreover, if higher due diligence standards would be required, such as cross-checks against AML records or other documentation, then many foreign financial institutions may opt out of the new system altogether since such procedures could involve millions of accounts which could take literally years to review and present unacceptable levels of risk to the institution if any U.S. persons are not properly identified.
• Due to the overall burden the bill could place on foreign financial institutions, there remains a very real possibility of disinvestment from U.S. assets.
• We believe the effective date of January 1, 2011 is very unrealistic for most financial institutions, both U.S. and foreign. It is worth noting that even U.S. financial institutions continue to encounter significant compliance challenges with the existing rules almost a decade after the implementation of the section 1441 regulations.

Payments to U.S.-Owned Entities: The Act would require 30% withholding on payments of U.S. source interest, dividends, and other FDAP income, as well as gross proceeds on the sale of securities generating this type of income, to any foreign entity that is not a financial institution UNLESS: (1) the foreign entity or its affiliate is publicly traded, (2) the foreign entity provides the withholding agent with a certification that it has no “substantial U.S. owner” (defined as a U.S. person owning 10% or more of the entity), or (3) the foreign entity provides the withholding agent with the name, address, and TIN of any substantial U.S. owner of the entity and the withholding agent then supplies that information to the IRS. Certain foreign payees such as foreign governments, international organizations, and foreign central banks of issue would be excepted from this requirement, as well as other entities identified by Treasury presenting a low risk of U.S. tax evasion. This provision is substantially similar to the one originally proposed by the Obama Administration.

Key Concerns:

• All withholding agents would need to reconfigure their payment processing systems to differentiate among payees of the same type (e.g., corporations) that would be treated differently under the rules. Systems will need to categorize entities as being: (1) publicly traded or not, (2) an excepted payee type (i.e., foreign government, international organization, etc.) or not; and (3) in compliance with the U.S. ownership certification requirement or not. After making these determinations for purposes of determining whether the bill’s 30% withholding tax applies, systems would then need to evaluate further the appropriate rate of withholding under the already complex set of statutory and treaty-based rules now in effect.
• Systems would need to be reconfigured to allow for withholding on gross proceeds paid to non-certifying entities.
• It is unclear the extent to which a withholding agent must verify an entity’s certification of non-U.S. ownership. Presumably, the expectation is for a withholding agent to somehow integrate AML and withholding tax systems to make this assessment. Few if any financial institutions currently integrate these information systems.
• The IRS itself could assist with the burdens brought about by this new requirement by issuing a new Form W-8BEN that applies solely to entities and builds the relevant criteria for withholding tax relief into the certifications of that document (e.g., whether the entity is publicly traded, whether it has substantial U.S. owners, etc.). There is an equally compelling case for the IRS to issue new versions of all the Forms W-8 to relate rationally to the new rules.

The government has indicated that it is looking for industry input on these legislative proposals and we anticipate that these concerns, and many others, will be taken into account as the government works to better define or modify the proposed legislation before its ultimate enactment. We urge all of our clients, whether or not financial institutions, to be fully aware of any changes to the information reporting and withholding rules. The IRS has launched a far-reaching withholding tax audit program, and if rules similar to the ones in the Act become law, then these audits are likely to be even more challenging than at present with the attendant risk of tax deficiencies being assessed.

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