HIRE and tax consequences

[Niseag]

text derived from different sources, legal opinions, legal resources etc.

On March 18 the $17.5 billion Hiring Incentives to Restore Employment Act (H.R. 2487), abbreviate as HIRE, was passed. Nobody seems to have cared about it enough to actually read it. See the more important provisions on page 27, known as Offset Provisions - Subtitle A—Foreign Account Tax Compliance. The Provision requires that foreign banks not only withhold 30% of all outgoing capital flows (remitting the collection to the US Treasury) but also disclose the full details of non-exempt account-holders to the US and the IRS. Should this provision be deemed illegal by a given foreign nation's domestic laws (for example Switzerland or other high privacy minded jurisdictions), the foreign financial institution is required to close the account.

If you thought you could move your capital to a non-US financial institutions, sorry you lose. Even if they come under name HIRE these Capital Controls are now fully enforced by the law.


Here is the default new state of capital outflows:

(a) IN GENERAL.—The Internal Revenue Code of 1986 is amended by inserting after chapter 3 the following new chapter:

‘‘CHAPTER 4—TAXES TO ENFORCE REPORTING ON CERTAIN FOREIGN ACCOUNTS
‘‘Sec. 1471. Withholdable payments to foreign financial institutions.
‘‘Sec. 1472. Withholdable payments to other foreign entities.
‘‘Sec. 1473. Definitions.
‘‘Sec. 1474. Special rules.
‘‘SEC. 1471. WITHHOLDABLE PAYMENTS TO FOREIGN FINANCIAL INSTITUTIONS.

‘‘(a) IN GENERAL.—In the case of any withholdable payment to a foreign financial institution which does not meet the requirements of subsection (b), the withholding agent with respect to such payment shall deduct and withhold from such payment a tax equal to 30 percent of the amount of such payment.

Clarifying who this law applies to:

‘‘(C) in the case of any United States account maintained by such institution, to report on an annual basis the information described in subsection (c) with respect to such account,
‘‘(D) to deduct and withhold a tax equal to 30 percent of—

‘‘(i) any passthru payment which is made by such institution to a recalcitrant account holder or another foreign financial institution which does not meet the requirements of this subsection, and

‘‘(ii) in the case of any passthru payment which is made by such institution to a foreign financial institution which has in effect an election under paragraph (3) with respect to such payment, so much of such payment as is allocable to accounts held by recalcitrant account holders or foreign financial institutions which do not meet the requirements of this subsection.

What happens if this law impinges and/or is in blatant contradiction with existing foreign laws?


‘‘(F) in any case in which any foreign law would (but for a waiver described in clause (i)) prevent the reporting of any information referred to in this subsection or subsection (c) with respect to any United States account maintained by such institution—

‘‘(i) to attempt to obtain a valid and effective waiver of such law from each holder of such account, and
‘‘(ii) if a waiver described in clause (i) is not obtained from each such holder within a reasonable period of time, to close such account.

Not only are capital flows now to be overseen and controlled by the government and the IRS, but holders of foreign accounts loose any semblance of privacy:

‘‘(c) INFORMATION REQUIRED TO BE REPORTED ON UNITED STATES ACCOUNTS.—
‘‘(1) IN GENERAL.—The agreement described in subsection (b) shall require the foreign financial institution to report the following with respect to each United States account maintained by such institution:
‘‘(A) The name, address, and TIN of each account holder which is a specified United States person and, in the case of any account holder which is a United States owned foreign entity, the name, address, and TIN of each substantial United States owner of such entity.
‘‘(B) The account number.
‘‘(C) The account balance or value (determined at such time and in such manner as the Secretary may provide).
‘‘(D) Except to the extent provided by the Secretary, the gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner as the Secretary may provide).

The only exemption: $50,000 or less in foreign accounts.

‘‘(B) EXCEPTION FOR CERTAIN ACCOUNTS HELD BY INDIVIDUALS.—Unless the foreign financial institution elects to not have this subparagraph apply, such term shall not include any depository account maintained by such financial institution if—
‘‘(i) each holder of such account is a natural person,and
‘‘(ii) with respect to each holder of such account, the aggregate value of all depository accounts held (in whole or in part) by such holder and maintained by the same financial institution which maintains such account does not exceed $50,000.

A "financial account" is as:

‘‘(2) FINANCIAL ACCOUNT.—Except as otherwise provided by the Secretary, the term ‘financial account’ means, with respect to any financial institution—
‘‘(A) any depository account maintained by such financial institution,
‘‘(B) any custodial account maintained by such financial institution, and
‘‘(C) any equity or debt interest in such financial institution (other than interests which are regularly traded on an established securities market). Any equity or debt interest which constitutes a financial account under subparagraph (C) with respect to any financial institution shall be treated for purposes of this section as maintained by such financial institution.

Keep in mind what happens when you are deemed a "Recalcitrant Account Holder."

‘‘(6) RECALCITRANT ACCOUNT HOLDER.—The term ‘recalcitrant account holder’ means any account holder which—
‘‘(A) fails to comply with reasonable requests for the information referred to in subsection (b)(1)(A) or (c)(1)(A),
or ‘‘(B) fails to provide a waiver described in subsection (b)(1)(F) upon request.

However if it is determined that you are "a low risk for tax evasion" :

‘‘(f) EXCEPTION FOR CERTAIN PAYMENTS.—Subsection (a) shall not apply to any payment to the extent that the beneficial owner
of such payment is—
‘‘(1) any foreign government, any political subdivision of a foreign government, or any wholly owned agency or instrumentality of any one or more of the foregoing,
‘‘(2) any international organization or any wholly owned agency or instrumentality thereof,
‘‘(3) any foreign central bank of issue, or
‘‘(4) any other class of persons identified by the Secretary for purposes of this subsection as posing a low risk of tax evasion.

It is not clear but it seems the law incorporates the flow of non-cash assets, such as commodities including gold. If an account transfers, via physical or paper delivery, gold from a domestic account to a foreign one, the language seems to deem this a 30% taxable transaction.

HIRE also changes current U.S. law to require withholding tax on “dividend equivalent” payments made under equity swap contracts, much like what is currently provided for securities loans and repo agreements by regulation (which now will be codified). For certain “specified” equity swap contracts, as well as security lending and repo agreements, this change is effective for payments made on or after September 14, 2010 (180 days after HIRE’s enactment). For all other swap contracts, this change is effective for payments made on or after March 18, 2012 (2 years after HIRE’s enactment).

HIRE’s withholding tax provisions may materially alter payment amounts and withholding obligations under existing longer-term swap contracts, and may trigger change-in-law provisions under such contracts. Thus, a foreign party to an affected swap might receive a payment reduced by the new withholding tax. Alternatively, a U.S. party to an affected swap might be required to “gross-up” for the withheld tax, depending on the terms of the swap contract.

Withholding Tax on Swap Payments before HIRE

Payments of interest, dividends, and other types of fixed or determinable periodic income made from a U.S. source to foreign persons are generally subject to U.S. withholding tax at a 30% rate, unless an exemption from withholding or a reduced withholding rate applies (for instance, under a tax treaty). Dividends paid by U.S. corporations generally qualify as U.S.-source payments. Tax treaties may sometimes reduce withholding on dividends, but are only available to eligible parties in certain jurisdictions, and generally do not eliminate withholding completely.

In contrast, payments under a swap contract typically have qualified as payments under a “notional principal contract” for withholding tax purposes, and have been sourced at the residence of the payee. As a result, payments to a foreign person under a notional principal contract that references a U.S. corporation’s stock have traditionally been treated as foreign-source for U.S. withholding tax purposes and have been exempt entirely from U.S. withholding tax.

“Dividend Equivalent” Swap Payments under HIRE

Adopting provisions from the Foreign Account Tax Compliance Act of 2009 (H.R. 3933, S. 1934) introduced in late 2009 (which was never enacted), HIRE treats “dividend equivalent” payments under certain notional principal contracts as dividends from U.S. sources and therefore subject to the U.S. withholding tax rules.

Under HIRE, a “dividend equivalent” payment is a payment made pursuant to a specified notional principal contract that is contingent upon, or determined by reference to, the payment of a dividend from sources within the United States. For the first two years following HIRE’s enactment, a notional principal contract is a specified notional principal contract only if it possesses one or more of the following characteristics:

i. any long party to the contract transfers the underlying security to any short party to the contract in connection with entering the contract;
ii. any short party to the contract transfers the underlying security to any long party to the contract at the termination of the contract;
iii. the underlying security is not readily trade-able on an established securities market;
iv. any short party to the contract posts the underlying security as collateral with any long party to the contract; or
v. the contract is identified by the Secretary as a specified notional principal contract.

Beginning two years after the date of the enactment of HIRE, “dividend equivalent” payments made pursuant to all other notional principal contracts will be treated as specified notional principal contract payments and will therefore become subject to the new withholding tax rules. Payments made with reference to an index or basket of U.S. source securities will be equally subject to the provisions applicable for “dividend equivalents” relating to a single security. In addition, when a payment is subject to the new rules, withholding tax will apply to the gross payment amount the parties use to calculate any net payment actually made.

HIRE grants the U.S. Treasury authority to exempt from the new withholding tax rules any contracts that do not have the potential for tax avoidance, but also to expand the definition of “dividend equivalent” to include any payment substantially similar to the payments identified in the statute. HIRE’s legislative history refers specifically to payments under total return swaps as an example of the payments to which the provision “generally applies.”

“Substitute Dividends” under HIRE

HIRE also codifies the treatment of “dividend equivalent” payments as “substitute dividends” when made pursuant to a securities lending or a sale-repurchase agreement that is contingent upon, or determined by reference to, the payment of a dividend from sources within the United States. Previous IRS guidance had indicated that the withholding tax on such payments may be reduced when the payer would itself be subject to withholding tax on the relevant dividend; however, HIRE appears to eliminate such withholding tax reduction for substitute dividends made on or after September 14, 2010, at least until the IRS issues further guidance.

Consequences of HIRE under Standard ISDA Swap Terms

For certain “specified” swaps, the new withholding tax rules will apply for dividend equivalent payments made on or after September 14, 2010. For all other equity swap contracts described above, the new rules apply to payments made on or after March 18, 2012. As a result, HIRE’s changes in the withholding tax law could affect long-term swap contracts that are in place currently or will be entered into after March 18, 2010.

Due to the expanded withholding tax obligation on the payer, a party to an affected swap may receive a reduced net amount. In some cases, a swap contract may require the payer to “gross-up” a payment so that the net amount would be the same it would have been if no withholding had applied. However, swap contract terms often provide relief from the gross-up if there has been a change in tax law since the trade date of the contract. HIRE will presumably constitute an applicable change in tax law under any such existing agreement. For swaps entered after March 18, 2010, the new withholding tax rules are unlikely to constitute a “change in tax law” as defined by the swap contract, because HIRE was adopted prior to the trade date for any such transaction.

In order for the change in tax law provisions of a standard swap contract to apply, the party whose obligations or rights are affected generally must provide notice to the counter-party of the change in tax law, and must use reasonable efforts to transfer the relevant transactions to another office or affiliate so as to avoid the new tax liability. The affected party typically may terminate the transaction upon further notice if the contract cannot be transferred.