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USA: New global tax and information reporting regimes create risks and burdens for businesses

Emboldened by the plethora of new legislation and guidance passed by the United States, many countries are considering implementing a standardised global information reporting (GIR) system. The purpose of a GIR system is to increase the transparency of taxpayers’ financial assets and income outside of their home jurisdictions to facilitate home country tax enforcement. Under a variety of international proposals, taxpayers would be required to provide additional financial and other information in virtually every country in which they conduct necessary to propose and sustain meaningful adjustments. In light of the shifting landscape, taxpayers with international operations should take time now to develop a long-term strategy to manage these increased business risks.

GIR regimes have grown substantially

In response to various tax evasion scandals involving undisclosed offshore bank accounts, the US Congress enacted the Foreign Account Tax Compliance Act (FATCA) in 2010, which imposes steep the United States has negotiated Mutual Legal Assistance Treaties (MLATs) with other governments that are specifically designed to facilitate cooperation in the investigation and prosecution of tax evasion or other crimes, including money laundering. MLATs have historically proven useful in tax matters because tax authorities may invoke them to obtain banking and other financial records maintained in the jurisdiction of a treaty partner. However, MLATs and treaties contain some limits on a government’s ability to obtain information located in a business. Thus, these proposals will likely impose significant new burdens on taxpayers’ legal, compliance and financial reporting functions.

While proposals to adopt a common reporting standard may reduce instances of double taxation and provide a more efficient way to report to multiple tax authorities, it is likely that such enhanced information reporting will result in increased audit activity in multiple jurisdictions for taxpayers with international operations, elevating the risks of doing international business. In particular, taxpayers may face substantial penalties for noncompliance because the increased prevalence of GIR regimes makes it more likely that tax authorities will have the information necessary to propose and sustain meaningful adjustments. In light of the shifting landscape, taxpayers with international operations should take time now to develop a long-term strategy to manage these increased business risks.

GIR regimes have grown substantially

In response to various tax evasion scandals involving undisclosed offshore bank accounts, the US Congress enacted the Foreign Account Tax Compliance Act (FATCA) in 2010, which imposes steep penalties on taxpayers who fail to report certain information to the US tax authorities. Moreover, the US Treasury Department has, under the authority of FATCA, negotiated far-reaching agreements (known as Intergovernmental Agreements or IGAs) to exchange information with over 70 governments around the world. 

While FATCA has become the catalyst for a host of new GIR reporting proposals by many tax authorities the concept of sharing information between governments is not new. For example, many US income tax conventions contain provisions that specifically authorise the IRS to share tax information lawfully obtained under domestic rules with other tax authorities.2

In addition, the United States has negotiated Mutual Legal Assistance Treaties (MLATs) with other governments that are specifically designed to facilitate cooperation in the investigation and prosecution of tax evasion or other crimes, including money laundering. MLATs have historically proven useful in tax matters because tax authorities may invoke them to obtain banking and other financial records maintained in the jurisdiction of a treaty partner. However, MLATs and treaties contain some limits on a government’s ability to obtain information located in a foreign jurisdiction.3

As a result, tax authorities have sought additional legal tools to obtain taxpayer information held outside of their jurisdiction. After many failed attempts, the European Union (EU) in 2003 adopted the European Savings Directive4 (ESD), which requires member states to provide information regarding interest paid by residents of one member state to residents of another.5

The ESD requires member states to adopt and integrate the ESD provisions into their national legislation. On 24 March 2014, the EU Council of Ministers adopted a revised version of the ESD that would close existing loopholes and better prevent tax evasion. The 2014 revised ESD fortifies the existing rules relating to the exchange of information on savings income, with the aim of enabling member states to better detect and enforce tax fraud and evasion.6

While income tax conventions, MLATs and other laws such as the ESD have facilitated some information exchange, the enactment of FATCA by the US Congress in 2010 has encouraged governments to pursue tax policies favoring comprehensive information exchange. FATCA has changed the information reporting landscape by imposing significant and, in some cases, substantial new information reporting burdens on taxpayers.7

Under FATCA, certain US taxpayers holding financial assets outside the United States must report those assets to the IRS. In addition, FATCA requires foreign financial institutions (FFIs) to report directly to the IRS certain information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest.8 If non-US payees fail to provide such information, US withholding agents must withhold 30 percent of the gross amount of any US-source payments.9

To avoid this withholding tax, a “participating” FFI (i.e., one that agrees to report information required by FATCA) must register with the IRS using an online registration portal and may have to withhold tax on certain payments to non-US persons starting 1 July. Thus, participating FFIs must identify US and non-US account holders; conduct due diligence and document all account holders; comply with annual information reporting to the IRS; and withhold and pay to the IRS 30 percent of any payments of US-source income, including gross proceeds from the sale of securities that generate US- source income, subject to certain limited FATCA exceptions. The scope of FATCA is quite expansive, and it applies not only to non-US financial institutions, but also to virtually any non-US entity unless that entity provides documentation to show it has no significant US owners. FATCA provides the US Treasury with a formidable weapon in the fight against offshore tax evasion and, significantly, will also provide the US Treasury with data that it can exchange with other governments that are similarly looking to address tax evasion in their jurisdictions.

The GIR movement is rolling forward

The enactment of FATCA has encouraged tax authorities around the world to consider adopting tools that will facilitate global information exchange not only with the United States, but with all trading partners. To this end, the Organisation for Economic Co-operation and Development (OECD) proposed a Common Reporting Standard (CRS) on 13 February 2014, which was finalised on 15 July 2014. The CRS would provide a new global standard for automatic exchange of financial account information between governments in an effort to improve cross-border tax compliance. The CRS borrows heavily from FATCA and is based on the “Model I” FATCA IGA. Under the CRS, financial institutions must identify reportable accounts and report accountholder identifying information to the institutions’ local tax administration, which will then exchange such information with other governments that have also adopted the CRS. As of February 2014, approximately 42 countries have committed to adopting the CRS. The CRS represents another global compliance burden for financial institutions and may increase compliance costs, perhaps substantially, as governments around the world officially adopt the CRS.10

It may seem that financial institutions will bear the brunt of these GIR initiatives, but non- financial businesses may also face new and significant information reporting burdens. For example, on 30 January 2014, the OECD released a discussion draft as part of its work on base erosion and profit (BEPS) that recommends countries adopt a new two-tier approach to transfer pricing documentation. Under this approach, taxpayers would prepare a master file containing standardised information relevant to all members of a multinational group, including a country-by-country (CbC) reporting template. In addition, taxpayers would prepare a local file containing relevant information regarding material local transactions of the taxpayer in the local jurisdiction. While much of the information a taxpayer must report under this proposal tracks information the taxpayer likely collects to support its transfer pricing, the taxpayer must also provide significantly more information than current rules generally require, including information regarding the activities of other members of the group located outside of the reporting jurisdiction. While tax authorities generally require taxpayers to provide specific financial information to support their transfer pricing, this two-tier approach presents a risk of providing too much information. This may lead to lengthier and more contentious audits as tax authorities examine the financial and transactional data of entities located in other countries.

The security and privacy challenge

In the words of one modern philosopher, “with great power comes great responsibility.”11

Given the plethora of information demanded by tax authorities, an important question remains unanswered: Is my information safe? In private conversations, US tax officials have conceded that the security of information collected under FATCA and exchanged with other tax authorities concerns them greatly. In that regard, they have pledged to exchange information with governments that they believe have strong privacy and security safeguards in place. However, as we have seen, many large financial institutions (and large public companies) have suffered security breaches, and sensitive information, including taxpayer identification numbers, credit card data, and the like, has become the ill-gotten booty of hackers around the world.12 As governments compile more information and share it with potentially dozens of foreign authorities, there is a significant risk that wrongdoers will steal such information and use it improperly. However, it is not clear whether governments will feel obligated to make potentially substantial investments to secure the information of non-citizens. Thus, while GIR regimes may enhance tax enforcement, they are likely to increase the risk that sensitive taxpayer data may be disclosed.13

GIR regimes create business risks

The current maze of GIR regimes (along with any proposed rules that become law in the future) presents a variety of business risks other than potential disclosure of confidential data. GIR rules will result in additional compliance costs and greater exposure to tax audits than companies have faced before. Companies with international operations should expect greater scrutiny from tax authorities than wholly domestic businesses. Moreover, because tax authorities will have so much more information available to them, they are likely to ask more questions, with audits taking longer to resolve. Despite these potential burdens, companies can and should manage their risks sooner than later.

What should taxpayers do?

As governments around the world embrace comprehensive tax disclosure regimes, businesses must prepare to adapt in ways that reduce or minimise any significant risks of noncompliance, including monetary penalties, interest, and the damage to reputation that may result if any failures to comply become public.

Therefore, companies should adopt a long-term strategy and fundamental policies that will facilitate and enhance compliance with GIR regimes. While each taxpayer should develop a strategy tailored to their specific situation, any approach should include certain key principles.

First, taxpayers should document all significant transfer pricing practices. The CRS described above reflects a common view that the majority of abusive tax practices result from the use of aggressive (or even negligent) transfer pricing. Thus, taxpayers should expect tax authorities to pursue transfer pricing adjustments and should arm themselves

with thorough analysis and documentation. Second, taxpayers should ensure that they possess the ability to comply with relevant GIR regimes. For example, taxpayers should review their current approach to complying with FATCA and assess whether their tax information reporting systems are robust enough to capture and transmit all requisite information. Third, businesses should develop a system of internal controls to monitor and detect potential noncompliance before it becomes appropriate internal controls will vary widely and may involve approaches ranging from sophisticated technology solutions to simply preparing a written internal policy that tax executives will follow and apply as part of their regular compliance duties. An effective controls policy will draw on industry best practices and take into account the specific circumstances of the taxpayer.

Surprisingly, taxpayers may actually reap benefits by implementing an effective GIR compliance strategy. For example, since failure to comply often involves substantial amounts of tax and penalties (in some cases, US penalties for transfer pricing adjustments may be as high as 40 percent), an effective GIR strategy can help management minimise the risk of significant tax adjustments and associated penalties. In addition, GIR regimes may result in the coordination of activities among multiple tax authorities in a way that minimises the risk of double taxation. In the context of mergers and acquisitions, buyers will demand a discount if there is substantial risk of a material tax cost emerging post-sale. Thus, a robust compliance strategy will not only facilitate tax compliance, but will also minimise uncertain tax liabilities for financial statement purposes, which may come in handy if and when it comes time to sell the business or go public. At a minimum, businesses that implement strategies to comply with GIR regimes can take the opportunity to examine their current practices and evaluate existing exposure. In reality, many taxpayers do not have sufficiently robust internal controls, resources and compliance systems to comply with existing laws, let alone address the tsunami of GIR regimes that is quickly emerging.

Footnotes
1 Adnan Islam, JD, LL.M., MBA, CPA is an international tax director in the Los Angeles office of McGladrey LLP. Ramon Camacho, JD is the International Tax Technical Lead for the Washington National Tax Office of McGladrey LLP.

2 Of course, the IRS routinely shares information with the tax authorities of the 50 states. 

3 For example, although the USSwitzerland income tax convention allows the United States to exchange information in cases involving “tax fraud,” a Swiss court ruled in the recent high-profile UBS tax fraud case that the exchange of information provisions do not apply to cases of “tax evasion.”

4 Directive 2003/48/EC (effective 1 July 2015).

5 The EU has also negotiated similar agreements with certain non-EU countries such as Monaco, Liechtenstein, San Marino, Andorra and Switzerland. 

6 The significant changes within the revised ESD include: (i) a look-through approach to prevent individuals from circumventing the ESD by using an interposed legal person or other indirect ownership structures (e.g., trust) situated in a non-EU country that does not tax the interposed legal person/arrangement; (ii) enhanced rules to determine the real business purpose and objective of using indirect ownership structures in an EU member state; (iii) extending the scope of certain financial products to include instruments that have similar characteristics to debt claims but are not labeled as such in form or legally classified as such; and (iv) the inclusion of all relevant income from both EU and non-EU investment funds in addition to the income obtained through undertakings for collective investment in transferable securities. The revised ESD and the revised savings agreements will both be aligned with the OECD Common Reporting Standard on automatic exchange of information. 

7 The US Treasury has issued over 1,200 pages of regulations to implement FATCA, along with several other pieces of written guidance. 

8 Documentation for US persons related to FATCA includes IRS Form 8938, along with new Forms W-9, W-8 and W-8BEN-E. FATCA has significantly expanded existing compliance obligations for withholding agents. For example, Form W-8BEN has increased in length from 1 page to 8 pages.

9 Withholding generally begins on 1 July 2014, with various exceptions for pre-existing and other obligations.

10 To be clear, OECD pronouncements do not have the force of law in any country in the absence of specific
country legislation. However, many countries routinely enact laws based on OECD proposals and several
countries have already committed to implementing the CRS

11 Ben Parker to Peter Parker in the movie, The Amazing Spiderman (2002).

12 See, e.g., JPMorgan CEO: Target breach is a wake-up call (14 Jan 2014) at http://www.usatoday.com/
story/money/business/2014/01/14/jpmorgan-ceo-dimon-targetbreach/4475665/.

13 The CRS acknowledges the importance of data security and sets forth certain standards that governments should meet in order to secure data received under an exchange of information programme.

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