Firm Seeks Safe Harbor in Guidance on Foreign Trust Reporting

01 June 2020

STRICTLY PRIVATE & CONFIDENTIAL

Internal Revenue Service
Office of Associate Chief Counsel (International)

Attention: Tracy Villecco

Dear Sirs

Comments re Rev. Proc. 2020-17, 2020-12 IRB 539, 03/02/2020, IRC §6048

In the above referenced revenue procedure, an exemption from Internal Revenue Code (IRC) §6048 (Forms 3520 and 3520-A) reporting obligations was announced for certain transactions between a U.S. person and a “tax-favored foreign trust”. Comments were requested about “these and other similar types of foreign trusts that should be considered for an exemption from section 6048 reporting”.

We are writing specifically about the relief provided for “tax-favored foreign retirement trusts” as defined in §5.03 of Rev. Proc. 2020-17. Having previously written to the Internal Revenue Service (in response to a request for comments on Forms 3520 and 3520-A) recommending that certain foreign pension trusts should be excepted from §6048 filing requirements, we welcome the initiative taken in Rev. Proc. 2020-17. As discussed below, we recommend that the approach taken in Rev. Proc. 2020-17 be modified in order to better achieve its objectives, specifically through the addition of a “safe harbor” for pensions established in States having a comprehensive income tax treaty with the U.S.

§6048 imposes filing obligations on U.S. persons who are grantors, owners and/or beneficiaries of a foreign trust. The IRS has developed Forms 3520 and 3520-A to implement these obligations. §6677 imposes penalties for the failure to comply with these obligations of up to 35% of the amount of any transfer to a foreign trust, 5% of the value of any U.S.-owned foreign trust (per year of noncompliance) and 35% of the amount of any distribution received from a foreign trust. The extraordinarily high penalties were a reflection of Congress' concern at the time §§6048 and 6677 were amended to their current form in 1996 that foreign trusts (particularly those established in “tax haven” jurisdictions) could be used to evade taxation.

Since 1996, Congress has become more methodical in its approach to income from foreign assets. §6038D, enacted in 2010, requires disclosure of all foreign financial assets above certain threshold amounts, and foreign pensions are included within its scope. This includes all foreign pensions and not merely those which happen to be organized in common law jurisdictions and take the form of trusts.

Rev. Proc. 2020-17 appears to reflect the IRS' view that §6038D disclosure is adequate for interests in foreign pension trusts, exempting Form 3520 and 3520-A filing obligations in cases where its requirements are met. Those requirements are the following.

While we welcomed the announcement of Rev. Proc. 2020-17, a perusal of the above requirements led us to the conclusion that in neither of the foreign jurisdictions where we have our offices (the United Kingdom and New Zealand) will local pension products meet all the above requirements. Modest contributions are permitted to U.K. personal pensions even where there is no earned income, thus failing the requirement of §5.03(3) (see iii. above). In the case of U.K. employer-sponsored pensions, it may be difficult to establish with certainty whether the nondiscrimination requirement of §5.03(6) (see vi. above) is satisfied. New Zealand plans also allow contributions from those who have no earned income and so do not meet the requirement of §5.03(3).

To address these anomalies, we propose consideration be given to adding a “safe harbor” that would waive the requirements in §5.03(2) to (6) of Rev. Proc. 2020-17 (listed in ii. to vi. above) in the case of pension trusts described in §5.03(1) that are established in a State with which the United States has a comprehensive income tax treaty within the meaning of IRC §457A.

This would be consistent with treaty provisions applicable to pensions in those States. For example, in the current US/UK income tax treaty, the term “pension scheme” is defined as any arrangement established in either State which is:

“(i) generally exempt from taxation in that State; and

(ii) operated principally to administer or provide pension or retirement benefits or to earn income for the benefit of one or more such arrangements.”

Article 3(1)(o). This is virtually identical to the requirement of §5.03(1) of Rev. Proc. 2020-17.

An additional benefit of a blanket exemption under Rev. Proc. 2020-17 for pensions established in treaty States would be the elimination of the potential application of the confiscatory §6677 penalty regime to such pensions, which could otherwise lead to “competent authority” complaints. See, for example, Article 26(3)(h) of the US/UK treaty providing for mutual agreement on the application of domestic law penalty provisions “in a manner consistent with the purposes of this Convention”.

We urge you consider this modification to Rev. Proc. 2020-17 in order that it can provide the meaningful relief from excessive reporting obligations that was undoubtedly intended. If you have any questions please contact the undersigned at +44 20 7520 3885.

Yours faithfully

[signed]

Frank Hirth Plc
London, UK

By Jeffrey L Gould, Director