Implications of the “Hire” Act of 2010

The Hiring Incentives to Restore Employment Act of 2010 ("the HIRE Act") was signed into law by President Obama, on 18 March 2010. Although the thrust of the Act is to create new jobs through tax incentives, it also contains provisions which were formerly part of the Foreign Account Tax Compliance Act of 2010. These provisions are intended to offset the projected revenue lost from the incentives in the Act by providing the Internal Revenue Service with "new tools to find and prosecute US individuals that hide assets overseas".

The provisions of the Act that deal with Foreign Account Tax Compliance will have dramatic effects on most non-US financial institutions as well as trustees who invest through those institutions.

Summary

Some of the key provisions of the HIRE Act are as follows:

• A new withholding tax of 30% is imposed on payments to Foreign Financial Institutions (FFI) and certain Non-Financial Foreign Entities unless the FFI enters into an agreement with the IRS to report information about its US account holders on an annual basis.
  
  A requirement for FFIs to file certain returns electronically with the IRS.
• New disclosure rules for US persons with respect to Foreign Financial Assets.
   
• New rules applicable to foreign trusts under which (a) a foreign trust will be presumed to have a US beneficiary, (b) the use of trust property by a US beneficiary will be treated as a distribution, (c) minimum reporting requirements are imposed on US owners of foreign trusts, and (d) significant penalties are imposed for failing to comply with reporting requirements with respect to foreign trusts.

The New Withholding Tax

Unless the FFI has entered into an agreement with the IRS to lodge annual reports regarding its US account holders, a US withholding agent must deduct 30% withholding tax from any Withholding Payment made to the FFI.

The definition of a FFI is extremely broad and includes not only banks but hedge funds and private equity funds. It may also include privately owned investment vehicles but probably does not include a non-US trustee which acts as a trustee of a discretionary trust where no US person has a vested interest.

A Withholding Payment includes:

• Interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations or emoluments from sources in the US.
  
• Any fixed or determinable annual or periodical gains, profits and income from sources in the US.
   
• Any gross proceeds from the sale of any property that could produce interest or dividends from sources within the US. The effect of this part of the definition is that, generally speaking, there would be an obligation to withhold 30% of the gross proceeds of sale of US source assets, regardless of cost base.

The new withholding tax will not apply to a FFI which is a Qualified Foreign Financial Institution (QFFI). To become a QFFI, the FFI must agree to:

• Obtain such information on each account holder as is necessary to determine which accounts are US-owned accounts.
   
• Comply with certain due diligence and verification procedures with respect to the identification of US-owned accounts.
   
• Report annually to the IRS the following information:
  - Name, address and TIN of each US account holder
  - Name, address and TIN of each substantial US-owner of any account holder that is a US owned entity (eg. a foreign trustee)
  - Account balance
  - Account number
  - Gross receipts and gross withdrawals
  
• Agree to comply with requests from the US Treasury Secretary to supply additional information in relation to a US-owned account when requested.

Note that the QFFI regime is in addition to the existing Qualified Intermediary regime.

The new withholding tax will also apply to a Non-Financial Foreign Entity (NFFE) unless the NFFE provides the US withholding agent with:

• The name, address and TIN of each substantial US owner of the NFFE; or
   
• A certification that the NFFE does not have a substantial US owner

New Rules Applicable to Foreign Trusts

There is now a presumption that, where a US person establishes a trust, the trust will have a US beneficiary unless the US person establishing the trust can demonstrate to the satisfaction of the US Treasury Secretary that:

• Under the terms of the trust, no part of the income or corpus of the trust may be paid or accumulated during the taxable year for the benefit of a US person.
   
• If the trust were terminated during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of a US person.

Any uncompensated use of trust property by a US person is treated as a distribution of the fair market value of the use of the property to the US person. For example, if a beneficiary is allowed to live in an apartment rent free, the beneficiary will be treated as having received a distribution equal to the market value of the rent which could have been obtained had the property been rented on a arm's length basis. Special problems will arise in respect of the use of trust assets such as art collections or other collectible investments.

There is a requirement for a US person who is treated as an owner of any portion of a foreign trust, to provide such information as may be required in relation to the trust, in addition to ensuring that the trust complies with its reporting obligations.

Effect of Legislation

The effect of this legislation on non-US financial institutions which have US account holders (either directly or through non-US entities which are "owned" by US persons) will be dramatic in terms of compliance costs. It is probable that the number of non-US private banks servicing the US market will diminish having regard to the enormous compliance task that the new reporting requirements will create. Foreign collective investment structures in which US investors hold interests will face similar challenges.