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March 6, 2012

While many have a difficult time feeling sympathetic toward financial institutions, the reality is that they are being subjected to an extraordinary amount of new regulations and significant changes to their former business models. The days of accountability are here. Financial institutions are responding to Dodd-Frank regulatory matters and mapping out recovery and resolution plans. They have paid back (or are paying back) their Troubled Asset Relief Program (TARP) funds. They are shedding assets and closing or exiting certain businesses. They are focusing on their core banking activities. And, if all of that weren’t enough, the U.S. government is now requiring financial institutions to help find unreported U.S. taxable income. Financial institutions that used to pride themselves on protecting their clients’ secrecy might no longer be able to provide that secrecy from U.S. disclosure. This article addresses some of the more significant tax issues affecting financial institutions today.

FATCA Update

The Foreign Account Tax Compliance Act (FATCA) generally requires U.S. citizens and U.S. resident aliens to attach a statement to their tax returns identifying their investment in “specific foreign financial assets” over a certain threshold. However, FATCA also requires foreign financial institutions (FFIs) to report U.S. account holders to the IRS whose investments in either non-U.S. financial accounts or non-U.S. entities meet specified thresholds. This compels FFIs to perform significant and enhanced due diligence in order to identify which account holders are U.S. persons and whether their investments meet the specified limits.

FATCA has been controversial ever since it was enacted as part of the Hiring Incentives to Restore Employment Act in 2010. As you may have heard in the news, heads of large financial institutions have been publicly frustrated not only with the scale on which these compliance-related activities must be undertaken, but also with the price tag that compliance with FATCA carries. The due diligence that banks will need to perform to identify U.S. accounts, analyze their investments and ensure the proper forms are completed to avoid withholding (or actually withhold and remit the 30 percent tax) is an arduous process that is not only time-consuming but extremely costly. Some have suggested that the revenue FATCA generates by identifying and taxing U.S. persons who hide assets and income overseas could be equivalent to the expenditures banks must assume to comply with it.

However, proposed regulations issued in early February have eased some of the compliance burdens. Initial estimations are that the cost of complying could be less than expected, although the cost is still anticipated by some to outweigh the revenue generated by enforcing the law. It is still important to note that these regulations are not technically effective until they are finalized, and future adjustments to them could still be made.

Generally, to avoid withholding under FATCA, a participating FFI must enter into an agreement with the IRS to identify and report certain U.S. accounts to the IRS as well as withhold 30 percent on certain U.S. connected payments to non-participating FFIs and non-compliant account holders. The good news here is that the proposed regulations reduce the diligence surrounding this process by both increasing the floor by which accounts must be manually reviewed and increasing the ceiling by which accounts are excluded from compliance. Additionally, the proposed regulations set forth a schedule to phase-in an FFI’s reporting obligations and a schedule for withholding obligations to begin on January 1, 2014.

There have been a few question marks surrounding FATCA’s implementation, specifically whether the U.S. has the authority to enforce such compliance in foreign jurisdictions. Recently, the U.S. Treasury issued a joint statement — with France, Germany, Italy, Spain and the United Kingdom — articulating their intent to implement a FATCA framework between them. An exchange of information and data between these countries would help identify both individuals and entities committing tax evasion using foreign accounts. However, the ability of FFIs that may be precluded from complying with such information requests by local regulations remains to be seen.

Internal Revenue Code Section 6050W

For financial institutions that are also payment settlement entities, Internal Revenue Code (IRC) Section 6050W applies for tax years beginning after December 31, 2010. In order to match income and ensure that all income is reported, new IRC Section 6050W requires that payment settlement entities furnish Form 1099-K to the IRS for each merchant whose sales dollar amount and number of transactions meet specific criteria — that is, all payments made in settlement of payment card transactions must be reported, whereas payments made in settlement of third-party network transactions need be reported only if gross payments to a payee exceed $20,000 and the number of such transactions exceeds 200 in such year. Payment settlement entities must also furnish a “payee statement” to merchants detailing the same information filed with the IRS.

Form 1099-K is an aggregate transaction report that details the gross amount of reportable transactions by month, as well as the name, address and tax identification number (TIN) for each payee. Failure to comply with IRC Section 6050W will result in the payment settlement entity being required to perform backup withholding (on IRC Section 6050W payments made after December 31, 2012, per IRS Notice 2011-88), as well potentially incurring applicable penalties.

This new reporting requirement also creates additional compliance costs for payment card transaction providers and third-party network transaction providers, in order to furnish these statements, determine the TIN for each qualifying merchant and track merchants’ transactions. Entities required to file these transaction reports for payment card and third-party network transactions are able to use the TIN Matching Program procedures set forth in Rev. Proc. 2003-9, 2003-1 CB 516, which will help filers sustain a reasonable cause relief from penalties that may be imposed and will also reduce the number of backup withholding notices required.

U.S. Indictment of Swiss Banks

Wegelin & Co., Switzerland’s oldest private bank, has been indicted by the U.S. Department of Justice (DOJ) on charges that it enabled U.S. persons to evade taxes. This appears to be the first time that a foreign bank has been charged with tax evasion in the United States. Three Swiss bankers at Wegelin were also previously indicted but have not (as of the publication of this article) been arrested.

The indictment against Wegelin alleges that while U.S. clients were fleeing UBS, which was under a separate investigation by the DOJ for similar actions, Wegelin was courting these clients by highlighting the fact that it had no U.S. offices and was thus not subject to law enforcement pressure in the U.S. The DOJ concluded that Wegelin aided and abetted U.S. taxpayers who were in flagrant violation of the U.S. tax code and allegedly concealed over $1 billion from the IRS. This comes on the heels of a 2009 agreement between UBS and federal prosecutors whereby the banking giant agreed to pay a $780-million fine and disclosed the identity of thousands of account holders to the U.S. At this time, the DOJ is also pursuing similar investigations against Credit Suisse and a handful of other banks.

In a separate action, the U.S. government seized approximately $16 million in Wegelin’s correspondent bank account at UBS, alleging that the money was used to launder undeclared funds for U.S. clients. Both the aforementioned DOJ actions and the implementation of FATCA demonstrate that the U.S. is serious about taking aggressive action against those that evade taxes.

Alvarez & Marsal Taxand Says:

The U.S. government is serious about finding its taxpayers and getting them to report their assets and income subject to U.S. tax. In addition, the U.S. government is working closely with its trading partners to get those jurisdictions to help enforce these U.S. compliance efforts. For now, these efforts are concentrated not through audit activity or promoting more self-compliance, but rather through changing the rules applicable to financial institutions and their information reporting. It seems that these obligations will continue to increase on financial institutions. And as of now, the U.S. government does not appear to be persuaded about costs of compliance exceeding the benefits. The name of the game is to ferret out the tax evaders.


Layne Albert
Managing Director,
New York
+1 212 763 9655

Lisa Rosen, Director, contributed to this article.

For more information:

Ernesto Perez
Managing Director, Miami
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Managing Director, San Francisco
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Managing Director, New York
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