US foreign compliance rules and other developments
Since the credit crunch there has been an increase in
legislative activity around the world, with governments seeking to
counter tax evasions and avoidance. In particular across the
Atlantic, there is one significant piece of legislative action and
one significant piece of legislative inaction, which will affect a
broad range of taxpayers.
It now seems very likely that foreign compliance provisions, which
go back some years to the Stop Tax Haven Abuse Act and which more
recently were included in the Foreign Account Tax Compliance Act,
have now been included in the Hiring Incentives to Restore
Employment ("HIRE") Act which has been passed in
different versions by both the House and the Senate. In addition,
somewhat surprisingly, US federal estate tax has been repealed in
the US for one year.
Another Withholding Tax
For non-US investors in US securities and other US investments
this legislation represents a major overhaul of the withholding tax
rules. The US currently boasts at least two main systems of
withholding tax but soon there could be a third. This new system,
which incorporates the usual 30% withholding tax on dividends and
interest, would apply a 30% withholding tax on the gross proceeds
of sale of securities and other investments.
Note that this is a withholding tax and not a mainstream tax, and
therefore there is no change in the US underlying position that
most non-resident alien investors are not taxed on capital gains.
However under the new system non-resident alien investors would
suffer a withholding tax on the proceeds of sale that could be
reclaimed only by filing a US income tax return. This is a move
away from the exemption system of withholding tax to a refund
system, which is a change in US tax policy in this area.
The 30% withholding tax would not apply to securities held through
financial institutions (defined broadly) which enter into an IRS
information agreement. The agreement would require financial
institutions to maintain full records of their customers, and to
provide directly to the IRS information about all US beneficial
owners. Essentially this is enhanced W-8BEN reporting. We envisage
that most foreign financial institutions would wish to enter into
information agreements but note that these agreements must apply to
all branches of that institution. It is unclear how these new
provisions would mesh with the US treaty obligations. We predict
that this may change the way many investors invest in the United
States and may make direct investment less attractive. As always,
the devil is in the detail and we will need to await the final
version of the legislation which will emerge from conference as
well as IRS interpretation.
US Beneficiaries of Foreign Trusts
US beneficiaries of foreign trusts should note that the legislation also includes a provision which has long been on the Treasury Departments wish list. Since 1995 the Treasury has wanted to tax US beneficiaries of foreign trusts on the benefit of occupying real estate or enjoying chattels owned by foreign trusts. If enacted, US beneficiaries will be taxable on the uncompensated use of such property. Trustees will need to take urgent action, in the short run probably to charge rent, and in the medium term to restructure foreign trusts owning houses and chattels, either into US domestic trusts or into trusts which have no taxable income.
US Estate Tax Repeal
While Congress has been busy with US healthcare and foreign
compliance legislation, one area where much heralded change has not
been forthcoming is US federal estate tax. Those with long memories
will recall that in 2001 Congress abolished estate tax for 2010
only. Most observers expected Congress to repeal the repeal, as
both the administration and the leadership of the House and the
Senate announced they would act to reinstate estate tax before the
repeal took effect at the beginning of this year. However as a
result of the legislative log jam in Congress nothing happened in
2009 with the result that federal estate tax is no longer in
effect. Congress has indicated that it wishes to reverse this, but
it is unclear whether that can be done retrospectively. If Congress
continues its policy of inaction, then the federal estate will
remain abolished throughout 2010 and will be reintroduced in 2011
at 2001 rates. That is, the federal estate tax exemption will be $1
million instead of $3.5 million and the top rate will be 55%
instead of 45%.
Although the abolition of federal estate tax is seen by most as an
unexpected benefit, it carries an equally unexpected price tag for
those US testators leaving gifts of assets or trust interests to
non-US beneficiaries. Along with the abolition of estate tax comes
the removal of the basis step-up for appreciated assets. Therefore
for American beneficiaries the price of not paying estate tax on
your legacy is that you take a carry over basis in appreciated
assets. For non-US beneficiaries the legislation has more immediate
consequences because Congress imposes an immediate tax on any
capital gains on legacies passing on to non-US beneficiaries. As
can be imagined this has a complicated effect on estate planning,
but many clients' enthusiasm for redoing their estate plans is
somewhat tempered by the knowledge that any planning could be
entirely academic after the end of this calendar year at the
latest.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.