Hunting Tax Dodgers, Hitting Banks

A proposal to deter offshore tax evasion could keep some foreign banks away from U.S. capital markets.
Marie LeoneDecember 18, 2009

The so-called tax extenders bill passed last week by the House of Representatives is largely a gift to business, renewing a raft of tax breaks that otherwise would have expired at the end of the year. But one provision of the bill could ultimately make it harder for some companies to obtain credit.

The provision, dubbed Foreign Account Tax Compliance, would slap a 30% withholding tax on income and gross proceeds that originate in the United States but are received by a foreign financial institution — unless the foreign institution complied with Internal Revenue Service tracking and reporting requirements. The aim is to crack down on U.S. tax evaders that stash cash in overseas accounts. Such offshore tax evasion drains the U.S. Treasury of $100 billion annually, the Senate Committee on Homeland Security and Government Affairs estimated in 2007. If passed, it is estimated the provision will raise $8.5 billion over the next 10 years.

But the extra burden and expense that would be involved in complying with the provision could dampen the appetite of foreign banks for the U.S. capital markets, says Kimberly Tan Majure, an attorney at law firm Miller & Chevalier. That in turn could tighten the screws on an already-tight credit market. “Anytime you begin squeezing the foreign market, you start making it a little harder for U.S. borrowers to get sources of financing,” says Majure.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Basically, under the proposed law, if a foreign financial institution wanted to participate in the U.S. capital markets, it would have to help hunt down its tax-shy U.S. customers and turn them over to the IRS. “It is a very new approach to finding U.S. tax evaders,” says Majure.

Currently, a foreign financial institution can choose to participate in the IRS’s “Qualified Intermediary” or QI program, in which it agrees to share account information about American customers with the government. The problem with the program is that it’s voluntary, as Deputy Assistant Treasury Secretary Stephen Shay pointed out last November in testimony before a House committee. Foreign institutions that do not participate must rely on self-certifications from U.S. customers with respect to the tax rate they pay. But there is no way to check the accuracy of the self-certifications, Shay noted.

The provision in the House bill (H.R. 4213, now in the Senate Finance Committee) would essentially make the QI program mandatory. To avoid the 30% withholding tax, foreign financial institutions would have to agree to report the identity of their U.S. account holders to the IRS, along with information about their account balances, gross receipts, and withdrawals. They would also have to comply with prescribed due-diligence procedures to verify the taxpayer’s identity. The proposed law would create “a powerful incentive for foreign financial institutions” to hand over the identities of U.S. tax evaders, testified Shay.

But while larger foreign banks and financial institutions may have the manpower and money to rework processes and computer systems to comply with the provision, smaller ones could find compliance too burdensome, says Marc Gerson, also an attorney at Miller & Chevalier. As a result, “there may be some foreign financial institutions that scrap playing in the U.S. markets completely,” he says.

The Foreign Account Tax Compliance provision received a great deal of bipartisan support, points out Gerson, so it is likely to survive intact in the final version of the tax extenders bill.