JCT Describes Compliance Issues Affecting Offshore Accounts

Under present law, nonresidents who receive payments of U.S.-source investment income are generally subject to U.S. withholding tax imposed at a 30 percent rate. This withholding tax serves as the only mechanism for collection of tax in the case of payments made to foreign persons who are not otherwise required to file a U.S. income tax return. There are, however, a number of significant statutory exemptions from the 30-percent withholding tax (including for interest paid on bank deposits, portfolio interest and most capital gains), and income tax treaties typically provide additional withholding tax relief.

Distinguishing U.S. from foreign persons is therefore important in this context. The IRS has a variety of enforcement tools (including information reporting and backup withholding)² to enforce compliance by U.S. taxpayers. The IRS faces significant enforcement challenges, however, in confirming the status of an offshore payee as a bona fide non-U.S. investor. These challenges include resource constraints (and the resulting need to rely on compliance by both U.S. and foreign intermediaries), the difficulties inherent in determining beneficial ownership of income earned through intermediate vehicles (for example, trusts or partnerships), which typically are organized under foreign law and often do not have close analogies in U.S. trust or company law practice, and disclosure limitations imposed by foreign law.

If a U.S. person can arrange to receive investment income through means that permit the U.S. person to appear to be a foreign person, the U.S. investor may be able to evade U.S. income tax entirely. This problem lies at the heart of the ongoing investigation into the role played by UBS AG ("UBS"), based in Switzerland and one of the world's largest financial institutions, in facilitating tax evasion by U.S. clients and avoidance of U.S. reporting requirements.

This section provides an overview of the nonresident withholding tax rules, particularly as those rules apply to payments of portfolio investment income by financial institutions to U.S. and nonresident customers. It then discusses briefly the enforcement challenges arising under those rules, both as a result of their substantive effect and as a matter of administration.

The principal statutory exemptions from the 30-percent nonresident withholding tax apply to interest on bank deposits, portfolio interest and capital gains. Since 1984 the United States has imposed no tax on "portfolio interest" received by a nonresident individual or foreign corporation from sources within the United States.⁴ Portfolio interest includes generally any interest (including original issue discount) other than interest received by a 10-percent shareholder,⁵ certain contingent interest,⁶ interest received by a controlled foreign corporation from a related person,⁷ and interest received by a bank on an extension of credit made pursuant to a loan agreement entered into in the ordinary course of its trade or business.⁸

In the case of interest paid on a debt obligation that is in registered form,⁹ the portfolio interest exemption is available only to the extent that the U.S. person otherwise required to withhold tax (the "withholding agent") has received a statement made by the beneficial owner of the obligation (or a securities clearing organization, bank or other financial institution that holds customers' securities in the ordinary course of its trade or business) that the beneficial owner is not a United States person.¹⁰ This certification of non-U.S. ownership most commonly is made on an IRS Form W-8.

U.S. tax law also contemplates that U.S. issuers (other than the United States itself) may issue debt obligations in bearer form. Historically, in such cases, a holder would present a physical interest coupon for payment free of U.S. withholding tax, without that holder being required to provide any certification of non-U.S. ownership. Now, however, so-called "bearer bonds" are typically held in "dematerialized" (or electronic) form, much like debt obligations that are issued in registered form; their "bearer" status arises solely from the fact that a holder may request a physical certificate with interest coupons from the issuer. As a practical matter, such requests for physical certificates are extremely rare. Nonetheless, the principal U.S. tax enforcement focus for "bearer bonds" rests on the historical premise that these bonds are actually held in physical form and relates to their mode of original distribution. More particularly, (i) the obligation must be offered and sold pursuant to arrangements that are reasonably designed to ensure that the obligation will be sold in connection with its original issuance only to a non-United States person, (ii) interest on the obligation must be payable only outside the United States, and (iii) the obligation must bear a legend to the effect that any United States person who holds the obligation will be subject to limitations under the U.S. income tax laws.¹¹

Interest on deposits with foreign branches of domestic banks and domestic savings and loan associations is not treated as U.S.-source income and is thus exempt from U.S. withholding tax (regardless of whether the recipient is a U.S. or foreign person).¹² In addition, interest on bank deposits, deposits with domestic savings and loan associations, and certain amounts held by insurance companies are not subject to the U.S. withholding tax when paid to a foreign person, unless the interest is effectively connected with a U.S. trade or business of the recipient.¹³ Similarly, interest and OID on certain short-term obligations is also exempt from the U.S. withholding tax when paid to a foreign person.¹⁴ Consequently, there is no information reporting on Form 1042-S with respect to payments of such amounts.¹⁵

Gains derived from the sale of property by a nonresident individual or foreign corporation similarly are exempt from U.S. tax, unless they are effectively connected with the conduct of a U.S. trade or business. Gains derived by a nonresident alien individual are subject to U.S. taxation only if the individual is present in the United States for 183 days or more during the taxable year.¹⁶ Foreign corporations are subject to tax only with respect to certain gains on disposal of timber, coal, or domestic iron ore and certain gains from contingent payments made in connection with sales or exchanges of patents, copyrights, goodwill, trademarks and similar intangible property.¹⁷ Most capital gains realized by foreign investors on the sale of portfolio investment securities thus are exempt from U.S. taxation.

Treasury regulations provide additional rules governing the treatment of notional principal contract payments and substitute dividend or interest payments made to nonresidents. Payments made pursuant to a notional principal contract (i.e., a derivative) are sourced in accordance with the residence of the recipient.¹⁸ Accordingly, when such payments are made by a U.S. party to a nonresident counterparty, the payment is treated as foreign source and, as such, is generally not subject to U.S. taxation. This rule applies even the payment is calculated in whole or part by reference, for example, to U.S.-source dividends paid on an underlying reference security. However, if the nonresident counterparty is engaged in a U.S. trade or business to which the payment is effectively connected, the payment is subject to regular U.S. net income taxation (and not withholding tax) in the same manner as if paid to a U.S. resident.¹⁹

On the other hand, substitute payments made in lieu of interest or dividend payments pursuant to a securities lending arrangement or similar transaction are treated by regulation as having the same source and character as the payments for which they substitute (a so-called "look-through" approach). As a result, substitute interest payments made to a nonresident with respect to interest paid on a debt obligation of a U.S. obligor may qualify for the portfolio interest exemption, to the extent that they meet the conditions otherwise applicable to actual interest payments on the obligation. Substitute dividends paid to a nonresident with respect to stock of a U.S. corporation are similarly treated as U.S.-source dividends and are subject to 30percent nonresident withholding tax.²⁰ Substitute payments are also eligible for treaty benefits (described below) to the same extent and subject to the same conditions as the actual payments for which they substitute.

As the above summary suggests, many forms of income or gain from U.S. investments are simply not subject to U.S. withholding tax when earned by a non-U.S. investor. On the other hand, the Code does impose withholding tax on some important classes of U.S.-source income earned by non-U.S. investors. In particular, dividends paid by U.S. corporations (but, as described above, not dividend-equivalent payments made in respect of equity derivative contracts) to foreign investors are subject to U.S. withholding tax. So, too, are nonportfolio interest payments (e.g., interest paid by a U.S. subsidiary to a foreign parent company), and certain rent and royalty payments made in respect of property used in the United States (if not incurred in connection with the conduct of a trade or business in the United States).

Even in those cases where the Code imposes the general 30-percent withholding tax on the income or gain of a foreign investor, that tentative tax liability may be reduced or eliminated by a tax treaty between the United States and the country in which the investor is domiciled. Thus, most U.S. income tax treaties provide for a zero rate of withholding tax on interest payments (other than contingent interest of the type described in section 871(h)(4)), with the result that virtually all U.S.-source interest paid to residents of a treaty country is typically exempt from U.S. withholding tax. Most U.S. income tax treaties also reduce the rate of withholding on dividends to 15 percent (in the case of portfolio dividends) and to five percent (in the case of "direct investment" dividends paid to a 10 percent-or-greater shareholder). For royalties, the U.S. withholding rate is typically reduced to five percent or to zero in certain cases. In each case, the reduced withholding rate is available only to a beneficial owner who qualifies as a resident of the treaty country within the meaning of the treaty and otherwise satisfies any applicable limitation on benefits provisions of the treaty.

In this allocation of taxing rights, source-based withholding tax arguably is an anomaly. The current practice of the United States not to tax U.S.-source portfolio interest income (even where the interest expense reduces the U.S. tax base) or capital gains derived by nonresidents can be said to be consistent with this norm.

U.S. tax policy with respect to U.S.-source income earned by non-U.S. portfolio investors also may be influenced by larger macroeconomic trends. This observation is particularly relevant to the exception for interest paid on bank deposits and the portfolio interest exception.

First, the financial markets are largely global; investment choices are not generally constrained by currency exchange controls, and information about global investment opportunities is relatively easy to obtain. As a result, non-U.S. investors have available to them a wide range of investment opportunities, many of which can be said to be close substitutes for one another. Thus, for example, a foreign investor who wishes to acquire a U.S. dollar-denominated debt instrument (or bank account) in practice is not required to make that investment in a U.S. issuer.

Second, and as described in detail in an earlier Joint Committee on Taxation staff pamphlet, the United States for many years has been a net importer of financial capital.²² Measured in nominal dollars, the amount of foreign-owned assets in the United States grew at an annual rate of more than 13 percent between 1981 and 2006.²³ In 2006 the portfolio assets of foreign investors invested in the United States exceeded $10 trillion; direct assets of foreign investors in the United States (e.g., ownership by a foreign parent company of a U.S. subsidiary) exceeded $2 trillion.²⁴ Foreign ownership of U.S. investments in 2006 exceeded the converse case (U.S. investments abroad) by $2.5 trillion.²⁵

Third, many other countries also are net capital importers, or wish to reduce domestic interest costs by increasing the supply of lenders. As a result, many other jurisdictions do not today impose withholding tax on interest paid by resident companies to nonresident investors. In light of the ready substitutability in the global markets of debt obligations on which withholding tax is not imposed for those instruments that are subject to withholding tax, some observers have concluded that the imposition of withholding tax on interest paid to foreign portfolio investors is unlikely to raise revenue, but is likely to affect adversely the supply of lendable funds to domestic issuers (including, in the case of the United States, the U.S. Treasury). This reasoning may in part explain the decision of the United States (and other countries) not to impose withholding tax on portfolio interest income earned by nonresident investors.

As described earlier, however, the Code does impose 30-percent withholding tax on U.S.-source dividends, rents, royalties, and other amounts derived by nonresidents. Notwithstanding the broad international tax framework of source-based taxation of business income and residence-based taxation of portfolio income, there are a few possible explanations for the persistence of these withholding taxes under domestic law. Two practical explanations are first, that source-based withholding taxes generate some revenue²⁶ and, second, that the 30-percent statutory withholding rate is a tool that the U.S. Treasury Department can employ in negotiations over bilateral income tax treaties. On this second point, U.S. bilateral income tax treaties generally allow, as was described previously, reduced rates of U.S. withholding tax on dividends, rents, royalties, and non-portfolio interest derived by qualified residents of the other treaty countries in exchange for similar benefits for U.S. residents with investments in those countries. Where investment flows are disproportionate between the United States and a treaty partner, the United States may also be able to obtain other types of concessions from the treaty partner in exchange for offering to reduce the U.S. withholding tax rate.

A third explanation for the persistence of withholding taxes is the difficulty of enforcing residence-based taxation of foreign-source portfolio income.²⁷ This portfolio income may be truly foreign source as, for example, when a Mexican resident owns shares of stock in U.S. companies, either directly or perhaps through an entity organized in a tax haven jurisdiction. Alternatively, the portfolio income may be foreign source in formal terms only as, for example, when a U.S. resident forms a foreign corporation or other entity for investing into the United States. In either case, the residence country (Mexico in the first example and the United States in the second example) may not be able to enforce residence-based taxation under its regular income tax rules. In this circumstance, tax collected at the source may be the only tax imposed on the income. The enforcement challenges presented when U.S. residents derive portfolio income through foreign entities or accounts are the subject of much of the succeeding discussion in this pamphlet.

There are four types of Form W-8,²⁹ three of which are designed to be filed by the beneficial owner of a payment of U.S.-source income: (1) the Form W-8BEN, which is filed by a beneficial owner of U.S.-source non-effectively-connected income, (2) the Form W-8ECI, which is filed by a beneficial owner of U.S.-source effectively-connected income,³⁰ and (3) the Form W-8EXP, which is filed by a beneficial owner of U.S.-source income that is an exempt organization or foreign government.³¹ Each of these forms requires that the beneficial owner provide its name and address and certify that the beneficial owner is not a United States person. The Form W-8BEN also includes a certification of eligibility for treaty benefits (for completion where applicable). All certifications on Forms W-8 are made under penalties of perjury.

The United States imposes tax on the beneficial owner of income, not its formal recipient. For example, if a U.S. citizen owns securities that are held for her in "street" name at a brokerage firm, that U.S. citizen (and not the brokerage firm) is subject to tax on income from those securities. The distinction between nominal and beneficial ownership of course is important in determining liability for tax in the case of cross-border flows as well, but the complexity and opacity of some foreign law arrangements can make compliance more difficult.³²

The fourth type of Form W-8 is the IRS Form W-8IMY, which is filed by a payee that receives a payment of U.S.-source income as an intermediary for the beneficial owner of that income. The intermediary's Form W-8IMY must be accompanied by a Form W-8BEN, W8EXP, or W-8ECI, as applicable,³³ furnished by the beneficial owner, unless the intermediary is a "qualified intermediary," a "withholding foreign partnership" or a "withholding foreign trust." The rules applicable to qualified intermediaries are discussed in Section II below. A withholding foreign partnership or trust is a foreign partnership or trust that has entered into an agreement with the Internal Revenue Service to collect appropriate Forms W-8 from its partners or beneficiaries and act as a U.S. withholding agent with respect to those persons.³⁴

Provision of the Form W-8 also establishes an exemption from the rules that apply to many U.S. persons governing information reporting on Form 1099 and backup withholding.³⁵ A withholding agent that makes payments of U.S.-source amounts to a foreign person is required to report those payments, including any amounts of U.S. tax withheld, to the IRS on Forms 1042 and 1042-S.³⁶

1. Income categorization

As was described previously, the U.S. 30-percent withholding tax is imposed on discrete categories of income -- dividends, rents, royalties, and non-portfolio interest, for example. The withholding tax treatment of a particular item of income derived by a nonresident may vary based on how the income is categorized. Particularly with the growth of financial derivatives, taxpayers have exploited problems of characterization.³⁷

Perhaps the best-known example of structuring to avoid withholding tax is the use of instruments known as swaps to replicate actual ownership of stock while avoiding the withholding tax that would be imposed on dividends paid on the stock. A nonresident seeking exposure to the U.S. equity markets could purchase stock in U.S. companies. Dividends paid on this stock generally would be considered U.S.-source and therefore would be subject to withholding tax at a 30-percent (or reduced treaty) rate.³⁸ Instead of actually owning the stock, however, the non-U.S. investor could create synthetic ownership by holding an equity derivative contract.

For example, under a typical "total return swap," the investor would enter into an agreement with a counterparty under which returns to each party would be based on the returns generated by a notional investment in a specified dollar amount of stock. The investor would agree for a specified period to pay to the counterparty (a) interest calculated at a market rate (such as the London Interbank Offered Rate (LIBOR)) on the notional amount of stock and (b) any depreciation in the value of the stock, and the counterparty would agree for the specified period to pay the investor (c) any dividends paid on the stock and (d) any appreciation in the value of the stock.³⁹ This swap would be economically equivalent to a transaction in which the foreign investor actually purchased the stock from the counterparty, using funds borrowed from the counterparty, and at the end of the period sold the stock back to the counterparty and repaid the borrowing.

Although the equity swap just described has identical economic characteristics to a leveraged purchase of stock (except that the equity swap party has credit exposure to its swap counterparty), the tax treatment of the foreign investor would be different. Because the source of income from an equity swap (in tax terms, a notional principal contract) is (as described previously) determined by reference to the residence of the recipient of the income, amounts representing dividends in this example would be foreign source and therefore would not be subject to U.S. withholding tax.⁴⁰

There may be non-tax reasons why foreign investors enter into equity swaps on U.S. stock rather than holding the underlying stock. For instance, U.S. securities law regulations forbid extending credit above certain levels for the purchase of stock, but these rules do not apply to swap transactions that replicate leveraged purchases.⁴¹ Nonetheless, certain arrangements have been viewed as abusive. For example, a foreign investor might sell stock it owns to a U.S. counterparty shortly before a dividend is paid, simultaneously enter into a total return swap on the stock with the counterparty, and terminate the swap agreement and repurchase the stock from the counterparty shortly after the dividend is paid.⁴² The IRS has sought data from large U.S. financial institutions to determine whether U.S. withholding tax should have been paid on certain swap transactions that those institutions facilitated.⁴³ Notwithstanding possible IRS successes in individual cases, the volume of swap transactions remains large. Financial engineering has made it difficult to collect withholding tax on cross-border dividend payments.

In response, some commentators argue that the U.S. withholding tax on nonresidents' U.S.-source dividend income should be abolished (or that attempts to collect that withholding tax are futile).⁴⁴ Arguments for why the dividend withholding tax should be abolished include the following. First, the dividend withholding tax impedes U.S. corporations' access to global capital. Second, taxpayers seek to avoid the dividend withholding tax, and this avoidance creates its own issues. Because portfolio interest can be paid to nonresidents free of withholding tax, U.S. corporations seeking foreign financing may find their decisions distorted by a tax preference for debt rather than equity financing. Debt financing, in turn, can result in a stripping of the U.S. tax base since interest payments, unlike dividend payments, are (subject to certain limitations) deductible. Moreover, the IRS must expend resources policing the distinction between notional principal contract income, which can be derived by nonresidents free of withholding tax, and dividend income, which cannot. Eliminating the dividend withholding tax would, in this view, free up resources for other enforcement efforts.

On the other hand, some policy makers and commentators have argued that the United States should not give up on dividend withholding tax. One alternative to giving up on the tax is to enact targeted changes to prevent avoidance of the tax. One targeted measure could be to change the rule under which the source of income from a notional principal contract is determined based on the residence of the recipient of the income. A source rule similar to the source rule for dividends would treat the source of notional principal contract income as the residence jurisdiction of the payor of the income. This rule, however, could create withholding on amounts that are not actually paid (because amounts representing dividends in swaps are netted against amounts representing interest and depreciation) and could be avoided by entering into derivative transactions in which amounts representing dividends are categorized as interest and therefore qualify for the portfolio interest exemption.⁴⁵

Another targeted measure, included in bills introduced recently in the U.S. House of Representatives and the U.S. Senate, would impose the 30-percent gross basis withholding tax on dividend-equivalent amounts paid on swap contracts.⁴⁶ This measure may raise similar concerns to those that apply to a change in the source rule for notional principal contract income -- that withholding tax could be imposed on amounts not actually paid and that the provision might be avoided through the use of other forms of derivative contracts (e.g., forward contracts in which anticipated dividend payments are reflected in the forward pricing).

A more thorough approach to the problem of avoiding withholding tax by deriving income in one category rather than another would be to impose a uniform withholding tax on all deductible payments, including portfolio interest. This approach is described in more detail below.

2. Treaty shopping

A second problem with enforcing withholding taxes arises from the availability of reduced rates of withholding tax under U.S. bilateral income tax treaties. Under the U.S. model tax treaty and in many actual U.S. tax treaties, the withholding tax rate on dividends is reduced to five percent when the beneficial owner of the dividends owns at least 10 percent of the voting stock of the company paying the dividends and is reduced to 15 percent in other cases; the withholding tax rate on interest that would not qualify for the U.S. portfolio interest exemption is reduced to zero (or, in the case of certain contingent interest, 15 percent); and the withholding tax on royalties is eliminated.⁴⁷ Several recent U.S. tax treaties go further than the U.S. model treaty and completely eliminate withholding tax when a subsidiary company makes dividend payments to its parent corporation (so-called "direct investment" dividends).⁴⁸

Nonresidents receiving U.S.-source income subject to withholding tax have an incentive to take advantage of U.S. income tax treaties that reduce withholding tax. Treaty benefits, however, generally are allowed only to residents of the treaty countries. A taxpayer that is not a resident of a treaty country may attempt to benefit from a treaty by organizing an entity in a treaty jurisdiction and causing income to be routed through that entity.

For example, a corporation organized in Singapore (a non-treaty jurisdiction) that intends to make loans to a related U.S. corporation might form a corporation in Luxembourg (a treaty jurisdiction), and then arrange for the loans to be made by the Luxembourg corporation with funds ultimately supplied by the Singapore company. If the Luxembourg corporation is viewed under applicable U.S. law as the owner of the interest income paid by the U.S. affiliate, then interest on the loans will qualify for a zero or 15-percent rate of withholding tax under the U.S.-Luxembourg income tax treaty rather than the statutory 30-percent rate. This hypothetical example illustrates a practice referred to as treaty shopping.

There have been various efforts to restrict treaty shopping. The IRS has successfully litigated some cases, including a leading case involving "back-to-back" interest paid (as in the above example) from a U.S. company to a foreign affiliate in a treaty country that acted as a simple conduit for a loan from a non-treaty ultimate owner.⁴⁹ Similarly, the Treasury has negotiated extensive "limitation on benefits" provisions in treaties, and the problem has been addressed by proposed and enacted legislation and regulations.

All recent U.S. income tax treaties include comprehensive limitation on benefits provisions. These provisions are intended to ensure that only genuine residents of treaty countries are eligible for the benefits of a treaty. Limitation on benefits provisions therefore typically include rules denying treaty benefits unless one of several tests for a genuine connection to a treaty country is satisfied. Under a typical version of one of these tests (the ownership and base erosion test), at least 50 percent of the voting power and value of the person for whom eligibility for treaty benefits is at issue must be residents of the relevant treaty country and deductible payments to persons who are not residents of either treaty country must represent less than 50 percent of the person's income.

Limitation on benefits provisions have not prevented treaty shopping in all cases. The limitation on benefits provisions in some treaties more than 10 years old (the treaty with Luxembourg, for instance, under which, as an example, a Luxembourg company may qualify for treaty benefits even if its direct owner is a resident of a zero-tax jurisdiction so long as at least 50 percent of the company's principal share class is ultimately owned by Luxembourg or U.S. residents) are not as restrictive as the provisions in more recent treaties. Treaty shopping using the U.S. income tax treaties with Hungary and Poland, in fact, is limited only by relatively narrow provisions in those treaties defining residency and by considerations of the domestic laws of the treaty countries. Those two treaties have no rules comparable to comprehensive limitation on benefits provisions found in other treaties.

U.S. internal law, a recent legislative proposal, and Treasury regulations have also addressed certain concerns about treaty shopping. A Code provision denies treaty benefits to certain foreign persons for payments received through certain hybrid entities.⁵⁰ A proposal included in a bill sponsored by House Ways and Means Committee Chairman Rangel would deny treaty-based reductions in withholding tax for any payment to a subsidiary of a foreign parent corporation unless the payment would qualify for treaty benefits if paid directly to the parent corporation.⁵¹ Treasury regulations promulgated in 1995 (the anti-conduit rules) recharacterize as transactions made directly between two parties certain multi-party financing transactions entered into principally to reduce withholding tax.⁵²

In light of these treaty-based and domestic law provisions to limit withholding tax reductions to genuine residents of treaty countries, the extent of treaty shopping is unclear, in part because defining treaty shopping is itself subjective.

3. Self-certification nature of withholding tax rules

A third enforcement difficulty originates in the basic framework of the U.S. withholding tax rules. Those rules rely on certifications by recipients of income potentially subject to withholding and by withholding agents. As described previously, recipients of income potentially subject to withholding must certify their status so that the payors of the income can determine to what extent withholding is required. Recipients must, for example, certify whether they are U.S. residents or nonresidents and, if they are nonresidents, whether they are eligible for reduced rates of withholding tax allowed by a tax treaty. Withholding agents must certify that they have withheld the proper amount of tax, often with respect to very large volumes of income flows. Proper withholding, in turn, requires the withholding agent to determine whether a payee has U.S. or foreign status; whether a payee is the beneficial owner⁵³ of the income or is an intermediary receiving a payment on behalf of the owner; whether the payment can be reliably associated with proper documentation; and whether, in the absence of documentation, certain presumptions require full, reduced, or zero withholding or instead require backup withholding.

Problems with withholding can result from errors related to any aspect of this self-certification process. Moreover, the self-certification system can be difficult for the IRS to audit. Applicable Treasury regulations generally do not impose an "audit" or affirmative diligence obligation on the part of domestic withholding agents in determining the validity of a Form W8,⁵⁴ and as a practical matter U.S. withholding agents cannot verify the accuracy of every Form W-8 they receive. As a consequence, U.S. investors may be able to portray themselves successfully as foreign persons, thereby escaping U.S. income taxation.

In a December 2007 report to the Senate Finance Committee, the Government Accountability Office ("GAO") found a number of potential problems with the self-certification process.⁵⁵ Withholding agents may not know the identity of beneficial owners of income when income is paid through foreign intermediaries. In particular, withholding agents may not be able to identify U.S. beneficial owners who ultimately control foreign corporations or trusts.⁵⁶ Consequently, these U.S. persons may incorrectly benefit from treaty-based reductions of withholding tax or exemptions from withholding tax altogether (because, for instance, the income in question is interest on a bank account or a bond). The problem of U.S. beneficial owners hiding behind foreign entities or accounts is central to the UBS case discussed elsewhere in this pamphlet and has been the focus of various efforts to address noncompliance with information reporting and withholding rules.

Relatedly, according to the GAO significant amounts of income have flowed to undisclosed recipients and undisclosed jurisdictions. For reasons that the IRS could not explain, according to the GAO, withholding taxes on these income flows have been imposed, in the aggregate, at rates significantly below 30 percent. Because beneficial ownership and residence information typically is the basis for reduced withholding tax rates, these reduced rates, according to GAO, suggest some amount of noncompliance. This noncompliance can be expected to have included evasion of U.S. tax by U.S. persons who have derived portfolio income through foreign intermediaries.

Potential changes to the information reporting and withholding rules to address problems arising from the self-certification nature of the rules range from modest to sweeping. In its 2007 report the GAO recommended, among other steps, that the IRS improve its enforcement efforts by making better use of data that it already collects. In particular, the GAO suggested that the IRS determine the extent to which (1) income paid by withholding agents flows through foreign intermediaries that may be providing the IRS with unreliable documentation, and (2) reductions in withholding taxes collected from funds flowing to undisclosed jurisdictions and undisclosed recipients were proper.⁵⁷

The IRS's qualified intermediary ("QI") program has been the major initiative undertaken by the IRS to deal with the compliance issues presented by self-certification. Under this program, the IRS contracts with foreign financial institutions to enforce U.S. withholding and reporting rules. The QI program is discussed in detail in Section II.

Professor Reuven Avi-Yonah has advocated a different approach.⁵⁸ Avi-Yonah's proposal is intended to address the principal concern of this pamphlet -- the failure by individuals to report to the taxing authorities of their home countries income from portfolio investments derived through foreign intermediaries. Avi-Yonah argues that the United States should impose a uniform withholding tax on cross-border interest flows, other deductible payments such as royalties, and payments on derivative instruments. He suggests that this withholding tax should be imposed at a rate that would approximate the tax rate that would apply if the portfolio income were taxed on a true residence basis, a rate of 40 percent or higher. The withholding tax would be fully refundable if the beneficial owner of the income subject to withholding provided a certificate to the tax authorities in the country from which the income was derived attesting that the income was reported in the owner's home country.

Avi-Yonah's approach builds on (but goes further than) the European Union ("EU") Savings Taxation Directive.⁵⁹ That directive provides for (1) the automatic exchange of beneficial ownership and other information when a resident of one member state of the EU receives interest payments from an entity or other payor in another member state and (2) during a transitional period, imposition of a 20 percent (35 percent after June 2011) withholding tax on interest payments received by EU residents from payors located in Austria, Belgium, or Luxembourg unless the recipients of the payments agree to the exchange of information related to their accounts.⁶⁰ Avi-Yonah argues that the United States should use the EU Savings Taxation Directive as the basis for leading a coordinated effort at instituting his proposed uniform withholding tax in all member countries of the Organisation for Economic Co-operation and Development ("OECD").

Avi-Yonah's recommendations must be put in the context of the macroeconomic issues identified earlier. In particular, those recommendations might prove difficult for the United States to adopt unilaterally if withholding increases the cost of borrowing to domestic issuers, including the Federal government. Moreover, as applied to the United States those recommendations presumably would require that bearer bonds be prohibited, and arguably should require domestic withholding on interest as well. To date, at least, the United States has moved in the opposite direction, by emphasizing improved information reporting. It is worth noting, however, that repeal of the special rules for bearer bonds (under which the portfolio interest exemption is made available as long as certain foreign-targeting requirements are satisfied in connection with the original issuance) would also be consistent with the current IRS approach; the continued need for those rules is no longer entirely clear, in light of the absence of demand for actual bearer bonds and the global prevalence of electronic clearing systems.

Professor Michael J. Graetz and Itai Grinberg are not as pessimistic as Avi-Yonah about the ability of residence countries to collect tax on foreign portfolio income in the absence of refundable source-country withholding taxes.⁶¹ Graetz have argued that source-based taxation of foreign portfolio income should be abolished and that, to address noncompliance with residence-based taxation of this income, the United States and other countries should instead engage in continued multilateral cooperation in information sharing. Graetz also have argued for unilateral efforts to address cross-border evasion. As an example of unilateral action, they view the United States' QI program as "a major step forward."

The basic strategy adopted by the QI regulations was for the IRS to rely explicitly on certain foreign intermediaries (QIs) to enforce compliance with U.S. tax information reporting requirements. These foreign intermediaries agree to assume responsibility for obtaining documentation from their customers and to substantiate the status of their customers as the beneficial owners of U.S.-source income. In turn, the IRS agrees to permit the QIs to certify on behalf of their foreign customers, without revealing to the IRS or to other U.S. withholding agents the identity of those foreign customers. Moreover, the IRS agrees to rely on third-party private auditors to audit the compliance of the QIs with the QI program; this condition was viewed as a practical necessity if foreign banks were to agree to participate in the QI program, because these foreign institutions feared that their non-U.S. customer base would not agree to allow a foreign taxing authority (the IRS) direct access (through an IRS audit) to customer account information.

At the time the QI program was adopted, the IRS explained its scope and purpose as follows in Announcement 2000-48:

In developing the QI program, Treasury and the IRS gave particular attention to the problems raised under prior practice by payments made through foreign intermediaries. (As previously noted, payments made through an intermediary are treated as payments made directly to the beneficial owner for whom the intermediary is collecting the payments.) Prior Treasury regulations required different documentation depending on the type of payment, whether the intermediary remitted through a U.S. office, or whether the payee had a foreign address. In cases in which withholding certificates were required, the beneficial owner certification was required to be passed up through a chain of intermediaries to the U.S. withholding agent. These procedures were difficult to implement and enforce in many cases, making it difficult to collect tax from the ultimate beneficial owner of the payments.

A QI is defined as a foreign financial institution or a foreign clearing organization, other than a U.S. branch or U.S. office of such institution or organization, which has entered into a withholding and reporting agreement (a "QI agreement") with the IRS.⁶⁸ In exchange for entering into a QI agreement, the QI is able to shield the identities of its customers from the IRS and other intermediaries (for example, other financial institutions in the chain of payment that may be business competitors of the QI) in certain circumstances and is subject to reduced information reporting duties compared to those that would be imposed in the absence of the agreement. This ability to shield customer information is limited, however, with respect to U.S. persons, because the QI is required to furnish Forms 1099 to its U.S. customers if it has assumed primary withholding responsibility for these accounts, or to provide Forms W-9 to the withholding agent in cases in which the QI has not assumed such responsibility.

A foreign financial institution that becomes a QI is not required to forward beneficial ownership information with respect to its customers to a U.S. financial institution or other withholding agent of U.S.-source investment-type income to establish their eligibility for an exemption from, or reduced rate of, U.S. withholding tax.⁶⁹ Instead, the QI is permitted to establish for itself the eligibility of its customers for an exemption or reduced rate, based on information as to residence obtained under the "know-your-customer" rules imposed by the banking laws to which the QI is subject in its home jurisdiction. The QI certifies as to eligibility on behalf of its customers, and provides withholding rate pool information to the U.S. withholding agent as to the portion of each payment that qualifies for an exemption or reduced rate of withholding. As described below, a QI may also assume responsibility for both nonresident withholding and, in the case of U.S. customers, backup withholding.

The IRS has published a model QI agreement (described in more detail below) that financial institutions wishing to become QIs are generally expected to sign.⁷⁰ A prospective QI must submit an application to the IRS providing certain specified information, and any additional information and documentation requested by the IRS. The application must establish to the IRS's satisfaction that the applicant has adequate resources and procedures to comply with the terms of the QI agreement.

Before entering into a QI agreement that provides for the use of documentary evidence obtained under a country's know-your-customer rules, the IRS must receive (1) that country's know-your-customer practices and procedures for opening accounts and (2) responses to 18 related items. If the IRS has already received this information, a particular prospective QI need not submit it again. The IRS web site (www.irs.gov) lists 59 countries for which it has received such information and for which the know-your-customer rules are acceptable.

Although the QI program "gives the IRS an important line of sight into the activities of U.S. taxpayers at foreign banks and financial institutions,"⁷¹ QIs handle only a relatively small percentage of U.S.-source income flowing through foreign intermediaries. The Government Accountability Office (the "GAO") has reported that, in 2003, only 12.5 percent of income reported as paid by withholding agents was reported by QIs; in fairness, however, the QI program at that point was only in its third year.⁷² Of the remaining 87.5 percent, the GAO made no determination as to the amounts flowing through direct versus indirect (i.e., nonqualified intermediary) account holdings; nor did the GAO distinguish between portfolio and direct investment flows.

Withholding and reporting

As a technical matter, all QIs are withholding agents for purposes of the nonresident withholding and reporting rules, and payors (required to withhold and report) for purposes of the backup withholding rules. However, under the QI agreement, a QI is not required to withhold on payments made to nonresident customers, or to report those payments on Form 1042-S, if the QI has not assumed primary responsibility for nonresident withholding and, instead, provides a U.S. withholding agent with a Form W-8IMY that certifies as to the status of its (unnamed) nonresident account holders. Similarly, a QI is not required to backup withhold on payments made to U.S. customers if the QI does not assume primary Form 1099 reporting and backup withholding responsibility and, instead, provides a U.S. payor with the Forms W-9 of its U.S. non-exempt recipient account holders (i.e., account holders that are U.S. persons not generally exempt from Form 1099 reporting and backup withholding). In either case, the QI must also provide the U.S. withholding agent (or U.S. payor) certain additional information about the withholding rates that should be applied to payments made to such account holders. These rates can be supplied with respect to "withholding rate pools" that aggregate payments of a single type of income (e.g., interest or dividends) that is subject to a single rate of withholding.

Alternatively, a QI may elect to assume primary nonresident withholding and reporting responsibility, primary backup withholding and Form 1099 reporting responsibility, or both. A QI that assumes such responsibility is subject to all of the related obligations imposed by the Code on U.S. withholding agents or payors.

In general, a QI is not required to disclose, either to a withholding agent or to the IRS, the identity of an account holder that is a foreign person or a U.S. person that is an exempt recipient (such as a corporation).⁷⁴ To the extent that a QI has not assumed primary Form 1099 reporting and backup withholding responsibility, the QI generally must provide to a withholding agent Forms W-9 obtained from each U.S. non-exempt recipient account holder (for example, an individual). If a U.S. non-exempt recipient has not provided a Form W-9, the QI must disclose the name, address, and taxpayer identification number (if available) to the withholding agent (and the withholding agent must apply backup withholding). However, no such disclosure is necessary if the QI is, under local law, prohibited from making the disclosure and the QI has followed certain procedural requirements (including providing for backup withholding, as described further below).

Documentation of account holders

QIs agree to review and maintain documentation regarding the status of their account holders in accordance with the terms of their QI agreement and, in the case of documentary evidence obtained from direct account holders, in accordance with "know-your-customer" rules applicable under the banking laws and regulations of the jurisdiction in which the QI is located.

A QI may treat an account holder as a foreign beneficial owner of an amount if the account holder provides a valid Form W-8 (other than a Form W-8IMY) or valid documentary evidence that supports the account holder's status as a foreign person. With such documentation, a QI generally may treat an account holder as entitled to a reduced rate of withholding if all the requirements for the reduced rate are met and the documentation supports entitlement to a reduced rate. A QI may not reduce the rate of withholding if the QI knows that the account holder is not the beneficial owner of a reportable amount or payment.

If a foreign account holder is the beneficial owner of a payment, then a QI may shield the account holder's identity from U.S. custodians and the IRS. If a foreign account holder is not the beneficial owner of a payment (for example, because the account holder is a nominee), the account holder must provide the QI with a Form W-8IMY for itself along with specific information about each beneficial owner to which the payment relates. A QI that receives this information may shield the account holder's identity from a U.S. custodian, but not from the IRS.⁷⁵

In general, if an account holder is a U.S. person, the account holder must provide the QI with a Form W-9 or appropriate documentary evidence that supports the account holder's status as a U.S. person. However, in cases in which a QI does not have sufficient documentation to determine whether an account holder is a U.S. or foreign person, the QI must apply certain presumption rules detailed in the QI agreement. These presumption rules may not be used to grant a reduced rate of nonresident withholding; instead they merely determine whether a payment should be subject to full nonresident withholding (at a 30 percent-rate), subject to backup withholding (at a 28 percent-rate), or treated as exempt from backup withholding.

In general, under these presumptions, amounts of U.S.-source investment income that are paid outside the United States to an account maintained outside the United States are presumed made to an undocumented foreign account holder. A QI must treat such an amount as subject to withholding at a 30-percent rate and report the payment to an unknown account holder on Form 1042-S.⁷⁶ However, U.S.-source deposit interest and interest or original issue discount on short term obligations that is paid outside the United States to an offshore account is presumed made to an undocumented U.S. non-exempt recipient account holder and thus is subject to backup withholding at a 28-percent rate.⁷⁷ Importantly, both foreign-source income and broker proceeds are presumed to be paid to a U.S. exempt recipient (and thus are exempt from both nonresident and backup withholding) in cases in which such amounts are paid outside the United States to an account maintained outside the United States.

Foreign law prohibition of disclosure

The QI agreement includes procedures to address situations in which foreign law (including by contract) prohibits the QI from disclosing the identities of U.S. non-exempt recipients (such as individuals). Separate procedures are provided for accounts established with a QI prior to January 1, 2001, and for accounts established on or after January 1, 2001.

If a QI is authorized to disclose the account holder's name, address, taxpayer identification number, and reportable amounts, it must obtain a valid Form W-9 from the account holder, and, to the extent the QI does not have primary Form 1099 and backup withholding responsibility, provide the Form W-9 to the appropriate withholding agent promptly after obtaining the form. If a Form W-9 is not obtained, the QI must provide the account holder's name, address, and taxpayer identification number (if available) to the withholding agents from whom the QI receives reportable amounts on behalf of the account holder, together with the withholding rate applicable to the account holder. If a QI is not authorized to disclose an account holder's name, address, taxpayer identification number (if available), and reportable amounts, but is authorized to exclude from the account holder's account any assets that generate, or could generate, reportable payments, the QI must follow procedures designed to ensure that it will not hold any assets that generate, or could generate, reportable payments in the account holder's account.

Under both of these procedures, a U.S. non-exempt recipient may effectively avoid disclosure and backup withholding simply by investing in assets that generate solely foreign source income (such as bonds issued by a foreign government). Under present law, foreign source income generally is not subject to Form 1099 reporting and backup withholding or to U.S. nonresident withholding tax.⁷⁸ Thus, this feature of the QI agreement is arguably consistent with the present law framework for withholding and information reporting. Moreover, a U.S. investor seeking to avoid disclosure can hold foreign assets through an account with a foreign financial institution that is not a QI and, similarly, escape information reporting and backup withholding. On the other hand, the fact that QI status affords foreign financial institutions a number of significant benefits arguably justifies the imposition of enhanced reporting by those institutions (for example, with respect to foreign-source income) in order to assist the IRS in its enforcement efforts.

External audit procedures

The IRS generally will not audit a QI with respect to withholding and reporting obligations covered by a QI agreement if an approved external auditor conducts an audit of the QI. An external audit must be performed of the second and fifth full calendar years in which the QI agreement is in effect. In general, the IRS must receive the external auditor's report by June 30 of the year following the year being audited.

Certain requirements for the external audit are provided in the QI agreement. In general, however, the QI must permit the external auditor to have access to all relevant records of the QI, including information regarding specific account holders. In addition, the QI must permit the IRS to communicate directly with the external auditor, review the audit procedures followed by the external auditor, and examine the external auditor's work papers and reports.

In addition to the external audit requirements set forth in the QI agreement, the IRS has issued further guidance (the "QI audit guidance") for an external auditor engaged by a QI to verify the QI's compliance with the QI agreement.⁷⁹ An external auditor must conduct its audit in accordance with the procedures described in the QI agreement. However, the QI audit guidance is intended to assist the external auditor in understanding and applying those procedures. The QI audit guidance does not amend, modify, or interpret the QI agreement.

Term of a QI agreement

A QI agreement expires on December 31 of the fifth full calendar year after the year in which the QI agreement first takes effect, although it may be renewed. Either the IRS or the QI may terminate the QI agreement prior to its expiration by delivering a notice of termination to the other party. However, the IRS will not terminate a QI agreement unless there is a significant change in circumstances or an event of default occurs, and the IRS determines that the change in circumstance or event of default warrants termination. In the event that an event of default occurs, a QI is given an opportunity to cure it within a specified time.

Discussion

Since the adoption of the QI regime in 2001, more than 7,000 QI agreements have been signed. As of July 2008, there were 5,660 active QI agreements involving financial institutions in 60 countries.⁸⁰ The QI program provides a significant benefit to foreign financial institutions -- in particular, the ability to obtain a reduced rate or exemption from U.S. withholding tax for their non-U.S. customers without disclosing the identities of those customers to the IRS or competing financial institutions. At the same time, however, the contractual nature of the QI program provides the IRS with an important mechanism to enforce compliance with U.S. reporting and withholding rules. For example, a foreign financial institution that is a QI is contractually required to disclose the identity of its U.S. customers to the IRS, report the payment of certain amounts to those customers and, in some circumstances, apply backup withholding. These contractual requirements extend beyond the scope of the reporting and withholding that would otherwise be required under applicable Treasury regulations. Moreover, the fact that so many of the world's major financial institutions have entered into QI agreements places a non-QI financial institution at a competitive disadvantage and creates a significant incentive for existing QIs to maintain their QI status. The IRS's ability to terminate a QI agreement in the event of noncompliance, thereby placing a financial institution at such a disadvantage, is a powerful tool for enforcing compliance and ensuring cooperation by a QI when instances of noncompliance are discovered.

On the other hand, the ongoing investigation into the failure by UBS to comply with the terms of its QI agreement has demonstrated certain weaknesses in the QI program as presently implemented. The UBS investigation is described briefly below, followed by a description of certain modifications to the QI program presently under consideration by the IRS to address problems identified in the UBS and other enforcement proceedings and the voluntary disclosure procedures recently announced by the IRS for individual taxpayers with unreported offshore accounts and entities.

The UBS Case

UBS, based in Switzerland and one of the world's largest financial institutions, had voluntarily entered into a QI agreement with the IRS, effective January 1, 2001, under which UBS agreed to identify and document any customers who held U.S. investments or received U.S.-source income in accounts maintained with UBS. Alternatively, if a U.S. customer refused to be identified under the QI agreement, UBS was required to apply backup withholding tax at a 28-percent rate on payments made to the customer, and to bar the customer from holding U.S. investments.

According to a report issued by the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs of the U.S. Senate (the "PSI") on July 17, 2007 (prepared in connection with a hearing held that day), entitled Tax Haven Banks and U.S. Tax Compliance (the "2008 PSI Report"), many of UBS's U.S. clients refused to be identified, to have taxes withheld, or to sell their U.S. assets as required under the QI agreement. To retain these customers, UBS bankers assisted the customers in concealing their ownership of the assets held in offshore accounts by helping to create nominee and sham entities. These entities were set up in various jurisdictions, including Switzerland, Liechtenstein, Panama, the British Virgin Islands, and Hong Kong. The UBS bankers and their U.S. customers then claimed that the offshore accounts were owned by these nominee and sham entities and were not subject to the reporting requirements imposed by the QI agreement.

On July 1, 2008, a Federal district court in Florida granted the IRS permission to issue a John Doe summons to UBS seeking the names of as many as 20,000 U.S. citizens who were UBS customers for which reporting or withholding obligations may not have been met.

At the 2008 PSI hearing, Mark Branson, Chief Financial Officer, UBS Global Wealth Management and Business Banking, acknowledged in his testimony that compliance failures may have occurred and stated that UBS would take actions to ensure that the types of activities identified in the 2008 PSI Report would not recur. As part of that effort, UBS will no longer provide offshore banking services to U.S. customers; instead, such customers will be provided services only through companies licensed in the United States. Moreover, UBS will no longer permit advisors based in Switzerland to travel to the United States to meet with U.S. customers. Finally, Mr. Branson indicated that UBS would comply with the John Doe summons as it relates to the UBS accounts held by U.S. residents.

Subsequent to the 2008 PSI hearing, there have been several developments including the United States and UBS entering into a deferred prosecution agreement, the filing of a petition to enforce the John Doe summons, and an expansion of the Justice Department's investigation to certain Swiss individuals that allegedly worked with UBS employees to help U.S. taxpayers set up offshore accounts and entities to avoid paying U.S. taxes. On February 18, 2009, the United States District Court for the Southern District of Florida accepted a deferred prosecution agreement between the United States and UBS.⁸¹ Pursuant to this agreement, UBS waived indictment and consented to the filing of a one-count criminal information charging UBS in a conspiracy to defraud the United States and the IRS in violation of U.S. criminal law. As part of the agreement, UBS agreed to pay $780 million in fines, penalties, interest and restitution. To the extent UBS meets this, and all other, obligations under the deferred prosecution agreement, the government will recommend dismissal of the charge.

On February 19, 2009, following the acceptance of the deferred prosecution agreement, the government filed a petition to enforce the previously issued John Doe summons with the United States District Court for the Southern District of Florida. In this petition, the government requested that the court issue an order requiring UBS to disclose to the IRS the identities of the bank's U.S. customers with undeclared Swiss accounts. The lawsuit alleges that there may be as many as 52,000 undeclared accounts with approximately $14.8 billion in assets as of the mid-2000s.

On March 4, 2009, a subsequent PSI hearing on Tax Haven Banks and U.S. Tax Compliance -- Obtaining the Names of U.S. Clients with Swiss Accounts ("the 2009 PSI hearing") was held. At this hearing, the Acting Assistant Attorney General, Tax Division, U.S. Department of Justice, John DiCicco, discussed the content of the UBS deferred prosecution agreement.⁸² Specifically, Mr. DiCicco stated that UBS acknowledged that, beginning in 2000 and continuing through 2007, it participated in a scheme to defraud the United States and the IRS through its cross-border business. UBS engaged in such activities through its private bankers and managers that actively facilitated the creation of accounts in the names of offshore companies, allowing U.S. taxpayers to conceal their ownership of, or beneficial interest in, the accounts in an effort to evade U.S. tax reporting and payment requirements. Furthermore, UBS admitted that it had failed to implement effective controls to detect and prevent the unlawful activity, that it had failed to initiate an effective investigation into credible allegations of such unlawful activity, and that it had failed to take effective action to stop such activities.

In addition to making the payment to the United States of $780 million, UBS also agreed to the following conditions:

• UBS will provide the United States with voluminous and detailed records concerning accounts held directly or through beneficial arrangements by United States persons. UBS has a continuing obligation to cooperate with the criminal investigation and any resulting prosecutions, and also to search for and turn over any additional records found concerning such accounts.

• UBS will terminate its U.S. cross-border business. As part of this process, the accounts of United States customers covered by the deferred prosecution agreement will be closed with any underlying assets liquidated. All resulting proceeds will be distributed to the U.S. owners in dollar-denominated instruments.

• UBS's challenge to the government's motion to enforce the John Doe summons, including the filing of an appeal from an adverse ruling, will not be considered a breach of the deferred prosecution agreement. Upon completion of that litigation, however, if the Court were to order UBS to produce the documents sought and hold UBS in contempt for failure to do so, UBS's noncompliance may be determined to be a material breach of the deferred prosecution agreement, permitting the government to proceed with the criminal prosecution of UBS.

• UBS's failure to comply with a term of the deferred prosecution agreement may, in the sole discretion of the government, be deemed a material breach, permitting the government to proceed with the criminal prosecution of UBS. If UBS fully complies with the deferred prosecution agreement, the criminal information will be dismissed.

• The deferred prosecution agreement only applies and provides protection for the bank as to the specific conduct set forth within the agreement.

Mr. Branson went on to state his belief that further enforcement of the summons would be in violation of the original QI agreement and the income tax treaty between Switzerland and the United States. With respect to the QI agreement entered into between UBS and the IRS in 2001, it expressly recognized that UBS would open and maintain accounts covered by Swiss financial privacy laws for U.S. clients who chose not to provide a Form W-9, as long as those accounts held no U.S. securities. According to Mr. Branson, as UBS legitimately maintained those accounts consistent with the QI agreement, the summons seeks client information that the IRS itself agreed would be kept confidential. Additionally, the income tax treaty between Switzerland and the United States discusses those circumstances under which client names and account information located in Switzerland may be shared with U.S. authorities. Mr. Branson, therefore, expressed his belief that the John Doe summons is inconsistent with long-standing treaty obligations and this matter should, instead, be resolved through diplomatic measures.

According to an article published in the New York Times on March 18, 2009, the Justice Department has extended its investigation into UBS offshore tax fraud to include independent lawyers and accountants in Switzerland and the United States who worked with UBS.⁸⁵ Three individuals currently under investigation include Beda Singenberger, a Zurich based accountant who runs a boutique finance and trust company called Sinco Trust, as well as Matthias W. Rickenbach and Andreas M. Rickenbach, two brothers that are lawyers at Rickenbach & Partner, a law firm in Zurich and Geneva. A criminal case is being built against these individuals who are suspected of having traveled with Swiss UBS bankers to the U.S. to work with American clients to evade taxes.

2008 PSI Report

The 2008 PSI Report includes several recommendations for strengthening the QI program, based primarily on its investigation of the UBS matter and a similar investigation of the Liechtenstein Global Trust Group (discussed below). First, the report recommends that QIs should be required to file Forms 1099 for all U.S. persons who are clients (whether or not the client has U.S. securities or receives U.S.-source income) and for all accounts beneficially owned by U.S. persons, even if the accounts are held in the name of a foreign corporation, trust, foundation, or other entity.

The report also recommends that the IRS close what the report describes as a gap in the QI program by expressly requiring QIs to apply to their QI reporting obligations all information obtained through their know-your-customer procedures to identify the beneficial owners of accounts. The 2008 PSI Report claims that the rules of the QI program are distinct from the know-your-customer rules that apply for due diligence purposes under the internal laws of the country in which the QI is located, although a QI must apply such know-your-customer rules as a prerequisite for entering into the QI program. As a result, the 2008 PSI Report concludes, some QIs, including UBS, have apparently taken the position that information the QI acquires about a particular customer as a result of satisfying the QI's requirements under applicable know-your-customer rules does not necessarily affect the determination of that customer's status for purposes of the QI program. Thus, for example, the report states that such a QI may take the position that it can rely on a certification of non-U.S. status (technically a Form W-8BEN) proffered by a foreign nominee owner (e.g., a Liechtenstein foundation) to establish that the nominee in fact is the beneficial owner of an account for withholding and reporting purposes under the QI program, even if the QI knows, as a result of satisfying the applicable know-yourcustomer rules, that a U.S. person is the actual beneficial owner of the account.

The better reading of the model QI agreement is that the gap identified by the 2008 PSI Report does not in fact exist, although admittedly the model QI agreement might be revised to make the point more explicitly. Very simply, a QI is a "withholding agent" for all U.S. tax purposes. The QI agreement expands the obligations of withholding agents under the relevant Treasury regulations,⁸⁶ but does not override them. Under the regulations (and, indeed, under the model QI agreement itself⁸⁷ ), a withholding agent may not accept a certification of non-U.S. status (a Form W-8BEN) if the withholding agent has actual knowledge that the beneficial owner of the relevant income (the taxpayer) is a U.S. person. There is no obvious basis for concluding that information obtained through know-your-customer rules is irrelevant for this purpose. Moreover, the relevant Treasury regulations also provide that a withholding agent effectively must compare a Form W-8BEN that it receives with other account information in its possession, and reject the Form W-8BEN if it is inconsistent with that information.⁸⁸

As a result, a straightforward reading of the model QI agreement, in the context of the Treasury regulations under which the QI program exists, is that a foreign QI cannot accept a Form W-8BEN certification of non-U.S. status where it has actual knowledge (whether obtained through know-your-customer rules or otherwise) that the beneficial owner of the income in question is a U.S. person or where the certification is inconsistent with other account information. The gap, to the extent one exists, is with the consistent treatment of foreign corporations, in particular, as entities separate from their owners for both know-your-customer and withholding tax purposes, but this is a different (and larger) issue.

The 2008 PSI Report also recommends that the IRS broaden QI audits to require external auditors to report evidence of fraudulent or illegal activity.⁸⁹ The report also recommends that the Treasury Department penalize banks located in tax haven jurisdictions that impede U.S. tax enforcement or fail to disclose accounts held directly or indirectly by U.S. clients by terminating their QI status. The report further recommends that Congress amend section 311 of the Patriot Act to allow the Treasury Department to bar such banks from doing business with U.S. financial institutions.

Potential modifications under IRS consideration

During 2008, the IRS announced that a series of potential modifications to the QI program to address certain of the issues raised by the PSI report and the UBS investigation. These modifications are described further below. The modifications do not, however, purport to address compliance and enforcement issues relating to bank secrecy laws. Section III of this pamphlet addresses that subject.

The second proposed change relates to additional fact finding during the basic fact finding phase (phase 1) of a QI audit to enable the IRS to evaluate risk. The QI audit guidance will be amended to add an audit procedure testing certain accounts for characteristics that suggest that a U.S. person has authority over the account. Such information will allow the IRS in the follow up fact finding phase (phase 2) of the audit process to evaluate the risk of any failure of controls and, if necessary, to request that the external auditor perform additional audit procedures.

Furthermore, the QI audit guidance will be amended to add additional procedures for fact gathering by the external auditor relating to the IRS's evaluation of the risk of a material failure of internal controls. These procedures will include, for instance, identifying the persons charged with oversight of performance under the QI agreement and the authority given them to prevent, deter, detect, and correct such failures on the part of other operational personnel. The external auditor will be required to report any facts and circumstances observed in the course of its audit that reasonably relate to the evaluation by the IRS of the risk of a material failure of internal controls.

The third proposed change relates to oversight and review of the QI audit. The QI audit guidance will be amended to require a QI's external auditor to associate a U.S. auditor with the audit and to require the U.S. auditor to accept joint responsibility for the performance of the procedures under the QI audit guidance. It is intended that joining a U.S. auditor to the QI audit will assure appropriate application of U.S. withholding rules and enhance accuracy and accountability in the audit process.

In addition to announcing the proposed changes, Announcement 2008-98 solicited public comments regarding the proposed changes. The government asked that such comments be submitted by February 28, 2009. Several comments were received. In general, the commenters objected to the proposed changes on the grounds that the commenters believed the proposed changes would impose additional costs and burdens on QIs with no, or only marginal, benefit to the IRS. Nevertheless, in a few instances, commenters offered specific technical suggestions in the event the IRS decides not to abandon completely the proposed changes. These suggestions generally were intended to make the proposed changes more understandable and consistent with the existing model QI agreement and QI audit guidance.

In particular, in his 2008 PSI testimony, the Commissioner indicated that the IRS was considering changing the regulations to require QIs to look through trusts or certain other offshore entities to determine if U.S. taxpayers are the beneficial owners of the accounts. Additionally the IRS may require external auditors that conduct the audits required under the QI agreements to report to the IRS indications of fraud or other illegal acts. Currently, there is no requirement for external auditors to make such reports to the IRS. The Commissioner indicated that the IRS was engaged in discussions with the major accounting firms that perform QI audits to identify ways to enhance the detection and reporting of violations of the QI agreement.

As recommended by the 2008 PSI Report, the Commissioner testified in July 2008, and again at both March 2009 hearings, that the IRS and Treasury are also considering regulations that would expand the QI program to require information reporting on additional sources of income for accounts held by U.S. persons. This reporting could include foreign as well as U.S.-source income; QIs are currently required to report only certain U.S.-source income received by U.S. customers who are not otherwise exempt from information reporting and backup withholding.

The Commissioner's March testimonies also include two additional measures to enhance and strengthen the QI program that are currently under consideration by the IRS and Treasury. The first is to strengthen the QI documentation rules, and the second is to require withholding for accounts in cases in which documentation is considered insufficient. The Commissioner provided little detail on either of these measures.

Since the Commissioner's July 2008 testimony, IRS and Treasury Department officials have made several public statements indicating that proposed regulations to further improve the QI program may be forthcoming in the near future. Few details, other than the release of Announcement 2008-98, discussed above, about these proposed regulations are available. However, it is possible that these proposed regulations, whenever issued, may include some, or all, of the changes the Commissioner indicated are under consideration.

Voluntary disclosure procedures

On March 26, 2009, the IRS issued a statement, together with internal field guidance, announcing voluntary disclosure procedures that may be applied to individual taxpayers with unreported offshore accounts and entities. In return for engaging in this voluntary disclosure, these taxpayers can avoid criminal prosecution. In general, the guidance provides that taxpayers who make voluntary disclosures will be required to make all delinquent filings (e.g., FBAR and other information returns), pay back-taxes and interest for six years, and an accuracy or delinquency penalty for all six years. Additionally, such taxpayers will be required to pay a penalty equal to 20 percent of the highest asset value in any unreported bank account at any time during the six-year period. The penalty amount may be reduced to only five percent if the taxpayer did not open the account, there was no account activity while the taxpayer controlled the account, and all taxes have been paid on the account. The IRS's offer took effect March 23, 2009, and is available for only six months.⁹¹

In connection with the implementation of the QI program in 2000, the IRS issued Announcement 2000-48 describing the approach that it intended to take in determining whether financial institutions in a particular country would be permitted to become QIs. The Announcement describes the QI program as a "paradigm shift to greater self-regulation," and states that Treasury and IRS believe that it is appropriate to permit the self-regulation envisioned by the QI system only under circumstances in which Treasury and IRS have confidence that such self-regulation may be effective.

In that regard, Announcement 2000-48 indicated that the Treasury Department and the IRS considered restricting the QI program to institutions operating in jurisdictions with which the United States has a bilateral tax treaty or tax information exchange agreement. However, in response to taxpayer requests that the QI program permit financial institutions to act as QIs in all jurisdictions in which they do business, the IRS decided not to limit the program to institutions in treaty jurisdictions.

Instead, Treasury and the IRS determined that the key criterion for qualification of a jurisdiction as eligible for the QI program was the existence of "know-your-customer rules." Announcement 2000-48 described know-your-customer rules as "a vital component of adequate self-regulation" and states that the IRS generally will not extend the QI program to any country that does not have know-your-customer rules or that has unacceptable know-your-customer rules.⁹² Thus, as described earlier, the IRS, in Rev. Proc. 2000-12, required that a financial institution applying to become a QI provide detailed information regarding the know-your-customer rules applicable in each jurisdiction in which the institution wished to act as a QI.

The IRS does not require that an institution applying to become a QI provide information regarding bank secrecy or other laws that could apply in a foreign jurisdiction to restrict disclosure of the institution's customers to the IRS or otherwise affect the IRS's ability to enforce the terms of the QI agreement. Instead, Announcement 2000-48 stated that the IRS expected to apply more rigorous oversight to financial institutions or their branches in jurisdictions that are tax havens or bank secrecy jurisdictions and show an unwillingness to cooperate with the United States to reform their practices relating to transparency and the provision of tax information.. In addition, the Announcement indicated that QIs should not assume that, merely because they have an agreement covering a business in a particular jurisdiction, such jurisdiction would not later be identified as a specified tax haven or secrecy jurisdiction. However, Announcement 2000-48 indicated that any enhanced audit requirements or stricter enforcement standards would be imposed only on agreements entered into or renewed after identification of the jurisdiction as a specified tax haven or secrecy jurisdiction.

Announcement 2000-48 further stated that the IRS expected that it would agree to renew a QI agreement or, in the case of new agreements that become effective on or after January 1, 2004, enter a new agreement for QIs in a particular country only if the IRS receives a certification from the Treasury Department that the country has effective rules and/or procedures for providing tax information to the United States for both civil tax administration and criminal tax enforcement purposes (including, for example, under an income tax treaty or a tax information exchange agreement), or has taken significant steps towards achieving such effective provision of information. As described further below, the actions taken by the Treasury Department and IRS in connection with the execution of a TIEA with Liechtenstein are consistent with this approach.

Liechtenstein

On July 17, 2008, the PSI released a report (prepared in connection with a hearing held that day) examining the business practices of the Liechtenstein Global Trust Group ("LGT") in Liechtenstein and UBS in Switzerland, both of which are alleged to have facilitated tax evasion by U.S. clients of those institutions.⁹³ The report describes practices employed by LGT, a leading Liechtenstein financial institution that is alleged to have assisted U.S. clients in hiding assets offshore during the period from 1998 to 2007. According to the report, those practices included maintaining U.S. client accounts that were not disclosed to U.S. tax authorities; advising U.S. clients to open accounts in the name of Liechtenstein foundations to hide their beneficial ownership of the account assets; advising clients on the use of complex offshore structures to hide ownership of assets outside of Liechtenstein; and establishing "transfer corporations" to disguise asset transfers to and from LGT accounts. According to the report, LGT also advised clients on how to structure their investments to avoid disclosure to the IRS under the QI program.⁹⁴

The LGT inquiry originated with an investigation by German authorities into the role of LGT in facilitating the evasion of German tax.⁹⁵ On February 25, 2008, the German authorities announced that they would share the information they had obtained in regard to LGT with authorities in other countries whose residents had utilized Liechtenstein to engage in tax evasion.⁹⁶ On February 26, 2008, the IRS issued a news release stating that it was initiating enforcement actions involving more than 100 U.S. taxpayers to ensure that they properly reported income, and paid taxes, in connection with accounts in Liechtenstein.⁹⁷ The news release also stated that the tax authorities in Australia, Canada, France, Italy, New Zealand, Sweden, the United Kingdom, and the United States were working together to address the use of Liechtenstein accounts for tax evasion purposes.

Both the PSI report and news accounts of the IRS and other investigations into the conduct of LGT suggest that Liechtenstein's favorable treatment of foundations, together with its bank secrecy laws, was important to LGT's ability to shield client assets from discovery by U.S. and other tax authorities.⁹⁸ In Liechtenstein, according to these accounts, foundations are effectively taxed at a very low rate,⁹⁹ are permitted to benefit their founders and their founders' families,¹⁰⁰ and are permitted to open bank accounts in their own names outside Liechtenstein (which provides foundation owners with ready access to cash outside Liechtenstein). Efforts to trace the owners or activities of nonpublic foundations are typically precluded by Liechtenstein's bank secrecy laws. Although these foundations function effectively as foreign trusts, the U.S. clients of LGT who established these foundations apparently did not file Forms 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Foreign Gifts) or 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner), and LGT did not disclose the existence of bank accounts opened by these foundations (whether at LGT or other financial institutions) to the IRS. The U.S. clients typically did not file the FBAR form to disclose the existence of these accounts to the Treasury Department, apparently taking the position that only the nominal owner of the accounts were required to file.

On December 8, 2008, the U.S. signed a tax information exchange agreement ("TIEA") with Liechtenstein.¹⁰¹ Under the terms of this agreement, the United States may seek information from Liechtenstein on all types of U.S. federal taxes, and in both civil and criminal tax matters, without regard to whether Liechtenstein needs the information for its own tax purposes or whether the conduct being investigated would constitute a crime under its laws. According to the terms of the TIEA, however, Liechtenstein must change its banking secrecy laws that prevent it from complying with the agreement. Specifically, Article 13 of the TIEA states: "Legislation necessary to comply with and give effect to the terms of this Agreement shall be enacted by December 31, 2009, to the extent necessary."¹⁰² As a result of Liechtenstein entering into this TIEA, the U.S. has agreed to extend Liechtenstein's treatment as an eligible QI jurisdiction until December 31, 2009; prior to this agreement, that status was set to expire on December 31, 2008.

The difficulties in piercing the "bank secrecy" of tax haven jurisdictions are related to the centuries-long tradition against one jurisdiction assisting another jurisdiction with collection of its taxes. This doctrine, known as the "Revenue Rule," is rooted in common law and sovereign immunity. It is often referred to as the Lord Mansfield Rule, who stated "For no country ever takes notice of the revenue laws of another."¹⁰⁴ Although its vitality and scope have been questioned, most recently in Pasquatino v. United States,¹⁰⁵ the doctrine remains a cornerstone of all common law jurisdictions, as well as many others, and is abrogated only by state-to-state negotiations, in the form of multilateral or bilateral international agreements or treaties.¹⁰⁶ Tensions arise when the confidentiality of the information sought is in conflict with the other state's interest in obtaining information relevant to law enforcement.

In the United States, rights to financial privacy are generally governed by statute, both in tax matters and other financial information, and protect one from public dissemination of information. The government's need to have access to financial information to assist it in detecting and preventing money-laundering led to enactment of the Bank Secrecy Act of 1970,¹⁰⁷ which requires U.S. financial institutions to maintain records and submit reports on certain cash or cash equivalent transactions. Since 1974, federal statute has established controls over how federal agencies gather, maintain and use personal information, including financial information.¹⁰⁸ The Right to Financial Privacy Act ensures that the government will not have access to information without service of a valid subpoena, consent of an account holder or as provided in the Code.¹⁰⁹ Further prohibitions on the disclosure of tax return information were enacted in 1976.¹¹⁰

Because the United States taxes its citizens and residents on their worldwide income,¹¹¹ it frequently needs foreign-based financial information to verify the accuracy of reporting by U.S. taxpayers. Obtaining that information requires a balancing of the U.S. interest in tax enforcement with the interests of the other state in maintaining confidentiality. In Société Internationale v. Rogers,¹¹² the Supreme Court articulated a basic rule of comity, holding unanimously that a United States district court could not ignore the interests of the foreign state in determining whether it would compel production of foreign based documents. Since then, courts balancing these conflicting U.S. and foreign interests¹¹³ have tended to give greater weight to the United States' interests in cases involving money laundering or drug dealing, than in those involving tax compliance. Thus, in U.S. v. Bank of Nova Scotia, the court enforced a grand jury subpoena served in the United States for records maintained in the Cayman Islands, despite claims that the bank secrecy laws of that jurisdiction would not permit production.¹¹⁴ In that case, the records were sought in connection with prosecution of money laundering and possible drug dealing.

By contrast, in cases in which the only U.S. law enforcement interest was tax compliance, results have been mixed. Although the Ninth Circuit Court of Appeals has enforced a grand jury subpoena for Swiss business records in a tax fraud case,¹¹⁵ the Seventh Circuit Court of Appeals refused to enforce IRS administrative summons for Greek bank records in a tax case.¹¹⁶

In balancing the conflicting interests of the U.S. and foreign interests, courts will examine whether there exists a reasonable alternative to obtaining the requested information.¹¹⁷ Another alternative means of obtaining documents from a foreign jurisdiction is through negotiations between the states, usually in the context of an income tax treaty or a tax information exchange agreements. The information exchange procedures available under treaties are described in Section IV of this document. The remainder of this Section III describes the statutory and other unilateral measures available to the IRS under present law in connection with obtaining offshore information.

1. Section 7456(b)

Any party who initiates proceedings in the United States Tax Court may be subject to an order compelling production of offshore materials that are subject to that party's control. The term control is not limited to legal control. If the party establishes to the Court's satisfaction that it is unable to produce the materials in court, it may be ordered to make the documents available for inspection wherever situated. Although the Tax Court has attempted to rely on this provision to order production of materials, despite local law prohibitions against disclosure, it has met with limited success. The orders requiring production have been used to enforce government requests for documents as well as interrogatories,¹²⁰ and may require that the party appear personally at hearings or proceedings. The sanctions for failure to comply may include entry of a default judgment, striking pleadings, or adverse findings as to the issues to which the documents relate.

2. Section 982 exclusionary rules

In 1984, Congress enacted section 982, which limits the evidentiary value of foreign-based information by barring its admissibility in a civil proceeding if it was not timely produced to the IRS in response to a formal request for foreign based documents. The provision permits a defense of reasonable cause for non-production, but specifically precludes a defense that foreign law prohibits disclosure of such information.¹²¹ The exclusionary rule has been upheld,¹²² and is useful in prompting compliance with requests for information that are otherwise difficult to enforce. Nevertheless, the exclusion is only of value in denying a taxpayer's ability to use the information in defense of its own position. It does not compel a taxpayer to produce information in its possession that would be adverse to its position or that would help the IRS develop and support an issue identified in an examination.

3. John Doe summonses

The IRS has broad statutory authority to require production of information in the course of an examination.¹²³ A request for information in the form of an administrative summons is enforceable if the IRS establishes its good faith, as evidenced by the four factors enunciated by the Supreme Court in United States v. Powell.¹²⁴ The Powell factors require that the information is sought for a legitimate law enforcement purpose, is of a type that will shed light on the subject of the examination, is not already in the possession of the IRS and that the IRS has complied with all applicable statutory requirements such as service of process. Subsequent to United States v. Powell, the legitimacy of using an administrative summons in furtherance of an investigation into criminal violations was validated in United States v. LaSalle National Bank,¹²⁵ in which the Supreme Court determined that the dual civil and criminal purpose was legitimate, so long as there had not yet been a commitment to refer the case for prosecution.

The use of this summons authority to obtain information from third-parties is subject to greater procedural safeguards,¹²⁶ but otherwise the same good faith elements are analyzed to determine whether the summons should be enforced. When the existence of a possibly noncompliant taxpayer is known but not his identity, as in the case of holders of offshore bank accounts, or investors in particular abusive transactions, the IRS is able to issue a summons to learn the identity of the taxpayer, but must first meet significantly greater statutory requirements, to guard against fishing expeditions.

An effort to learn the identity of unnamed "John Does" requires that the United States seek judicial review in an ex parte proceeding prior to issuance of the summons. In its application and supporting documents,¹²⁷ the United States must establish that the information sought pertains to an ascertainable group of persons, that there is a reasonable basis to believe that taxes have been avoided, and that the information is not otherwise available.¹²⁸ The reviewing court does not determine whether the summons will ultimately be enforceable. Once a court has determined that the predicate for issuance of a summons is met, the summons is served, and the summoned party served may challenge enforcement of the summons, based on the Powell factors. It is not entitled to judicial review of the ex parte ruling that permitted issuance of the summons.¹²⁹

If a taxpayer whose liability is the subject of the summons either initiates or intervenes in a proceeding to challenge the enforcement of the summons, the limitations period for the tax year under investigation is suspended during the pendency of the proceeding.¹³⁰ The taxpayer whose identity is at issue in a John Doe summons would not initiate or intervene in a proceeding, and may not know of the proceeding. Nevertheless, enforcement of a John Doe summons is likely to be subject to time-consuming challenges, possibly warranting an extension of the limitations period.

Under current law, the limitations period for the tax year under investigation is suspended beginning six months after the service of a John Does summons, and ends with the final resolution of the response to the summons.¹³¹ The chronology of the UBS investigation (described previously in Section II) illustrates the time-consuming nature of the process. The basis for requiring six months to elapse between service of the summons, after a court has found that there is a likelihood of non-compliance by an ascertainable group of taxpayers, is less apparent.

Offshore Credit Card Program

The Offshore Credit Card Program ("OCCP"), initiated by the IRS in 2000, illustrates the type of situation in which the IRS has sought to use John Doe summonses. The OCCP was designed to identify taxpayers who hide unreported income in offshore bank accounts and access the funds through credits cards issued by those banks. Between 2000 and 2002, the IRS issued a series of "John Doe" summonses to a variety of financial and commercial businesses to obtain information and records relating to U.S. residents who held credit, debit, or other payment cards issued by offshore banks. The IRS used the information and records obtained through those efforts to trace the identities of people using the payment cards.¹³² As of July 31, 2003, the OCCP had resulted in approximately 2,800 tax returns being selected for audit, a number of which had been referred to the Criminal Investigation Division for possible action.¹³³ Subsequently, in January 2003, the IRS announced the Offshore Voluntary Compliance Initiative ("OVCI") to encourage the voluntary disclosure of previously unreported income placed by taxpayers in offshore accounts and accessed through credit card or other financial arrangements similar to those targeted by the OCCP. Under this program, the IRS waived the civil fraud penalty and certain penalties relating to failure to file information and other returns, including the Report of Foreign Bank and Financial Accounts ("FBAR"),¹³⁴ but taxpayers remained liable for back taxes, interest, and certain accuracy-related and delinquency penalties.¹³⁵ The IRS reported that, as of July 31, 2003, it had received OVCI applications from 1,299 taxpayers who paid over $75 million in taxes and identified over 400 offshore promoters of abusive credit card or other financial arrangements.¹³⁶ Then IRS Commissioner Mark Everson discussed the limited success of the OVCI initiative at a PSI hearing on August 1, 2006. Within his testimony, he stated "In reality, we did not have a good idea of the potential universe of individuals covered by this initiative. As a result, the incentive for taxpayers to come forward and take advantage of this initiative was diminished due to the fact that we did not have the ability to identify immediately and begin examinations for all non-participating individuals."¹³⁷

Model double tax conventions adopted by the United States and the Organization for Economic Co-operation and Development (the "OECD") each include exchange of information provisions. While the OECD has adopted a model TIEA, the model presently being used by the United States Treasury Department is not publicly available.

Article 26 of the 2006 United States Model Income Tax Convention (the "U.S. Model") establishes (in paragraph 1) the obligation of each State to obtain and provide information to the other and provides assurances (in paragraph 2) that information exchanged will be treated as secret in accordance with the same disclosure restraints as information obtained under the laws of the requesting State.

Paragraph 3 of Article 26 provides that the obligation to exchange information does not require either State to: (a) carry out administrative measures that are at variance with the laws or administrative practices of either State; (b) supply information not obtainable under the laws or administrative practice of either State; or, (c) disclose trade secrets or other information where the disclosure of such information would be contrary to public policy. Paragraph 4 of Article 26 provides that when information is requested by one State, the requested State is obligated to obtain the requested information as if the tax in question were the tax of the requested State, even if the requested State has no direct tax interest in the case to which the request relates.

Paragraph 5 provides that a requested State may not decline to provide information because that information is held by financial institutions, nominees or persons acting in an agency or fiduciary capacity. This provision effectively prevents a requested State from relying on paragraph 3 to argue that its domestic bank secrecy laws override the obligation to exchange information.

Paragraph 6 of the 2006 U.S. Model provides the form in which information is to be provided in order to ensure that the information exchanged may be introduced in judicial proceedings held in the requesting State.

Paragraph 7 of the 2006 U.S. Model provides for assistance in the collection of taxes to the extent necessary to ensure that only those persons entitled to treaty benefits actually enjoy such treaty benefits.

Paragraph 8 of the 2006 U.S. Model provides that the requested State shall allow representatives of the requesting State to enter the requested State for purposes of interviewing witnesses and examining books and records. However, such access is granted only with the consent of the person subject to examination.

Paragraph 9 of the 2006 U.S. Model provides that the competent authorities of each State may further agree to the details for the exchange of information under Article 26. Although not expressly stated, this paragraph is interpreted as authorizing the exchange of information on a routine basis, upon request with respect to a specific case, or spontaneously. In this context, a routine exchange of information covers income subject to withholding tax. A spontaneous exchange of information occurs when information discovered during a tax examination indicates possible noncompliance with the laws of the other State is delivered to the other State even thought there is no previous request.

2. OECD Model Agreement

The information exchange provisions in the OECD Model Tax Convention on Income and Capital, approved on July 17, 2008 (the "OECD Model") generally correspond to the first five paragraphs of the 2006 U.S. Model.¹⁴⁰ At the time the OECD Model was approved, several member countries expressly reserved with respect to paragraph 5 of Article 26 (prohibiting a requested State from declining to supply information because that information is held by a bank, other financial institution, nominee or person acting in an agency or fiduciary capacity, or because it relates to ownership interests in a person). These members were Austria, Switzerland, Luxembourg and Belgium, all of which have bank secrecy laws. Notably, each of these countries has recently announced its intention to adopt OECD standards for the exchange of tax information and transparency in order to avoid being placed on a potential new G-20 blacklist of uncooperative tax havens.¹⁴¹

3. Recent developments

Shortly after the adoption the 2006 U.S. Model, the United States executed a double tax convention with Belgium in which the exchange of information provision exceeded the scope of the 2006 U.S. Model (the "Belgium Treaty").¹⁴² Historically, Belgium's bank secrecy rules prevented Belgian banks from providing information about their clients to tax authorities. Earlier negotiations between the United States and Belgium were abandoned because Belgium refused to make any concessions with respect to its bank secrecy rules.¹⁴³ The Belgium Treaty, which entered into force on December 28, 2007, included three innovative provisions related to the exchange of information which link continuity of certain treaty benefits to changes in Belgium's laws, including banking secrecy laws:

• The zero rate of withholding applicable to dividends under Article 10, paragraph 12(a)(i) (Dividends) will be discontinued after five years unless the Secretary certifies to the U.S. Senate that Belgium has satisfactorily met its obligations under Article 25 (Exchange of Information and Administrative Assistance);

• The zero rate of withholding applicable to dividends under Article 10, paragraph 12(a)(ii) (Dividends) may be discontinued if the United States gives written notice by June 30 of any year. However, such notice may not be given unless the United States has determined that Belgium's actions with respect to Articles 24 (Mutual Agreement Procedure) and 25 (Exchange of Information and Administrative Assistance) have materially altered the balance of benefits of the double tax treaty; and,

• The inclusion of paragraphs 5 through 8 (which, with the exception of the first sentence in paragraph 5, are not part of the 2006 US Model)¹⁴⁴ establish Belgium's obligations to change its tax legislation, as implied by the zero withholding rate provisions of Article 10, paragraph 12 (Dividends).¹⁴⁵

Enactment of the Caribbean Basin Economic Recovery Act¹⁴⁶ (the "Act") in 1983 provided the initial catalyst for so-called tax haven countries to conclude TIEAs with the United States. Commonly referred to as the Caribbean Basin Initiative ("CBI"), Title II of the Act authorized unilateral preferential trade and tax benefits for eligible Caribbean countries,¹⁴⁷ including duty-free treatment of eligible products, if the country entered into a TIEA with the United States.¹⁴⁸ Subsequently, in 1984¹⁴⁹ and 1986,¹⁵⁰ additional incentives were enacted; the 1984 provisions were designed to encourage non-CBI countries to execute TIEAs with the United States. TIEAs are entered into by Treasury, without the advice and consent of the Senate, upon the determination by the President that the agreement as negotiated is in the national security interest of the United States.¹⁵¹

1. U.S. TIEA Program

Initiated in 1984, the goals of the U.S. tax information exchange program are (a) assuring the accurate assessment and collection of taxes, (b) preventing fiscal fraud and tax evasion, and (c) developing improved information sources for tax matters in general. With respect to the United States, taxes covered are limited to national taxes, such that state and local taxes are not covered. The objectives of the TIEA include the prosecution of tax crimes, as well as the pursuit of civil tax claims. A State must have adequate process for obtaining information; if the State is required to enact measures providing such process, then the entry into force of the TIEA may be delayed until such requirements have been met. The requirements of the TIEA override individual State's laws and practices pertaining to disclosure of information regarding taxes, although this provision may be eliminated from a TIEA if the internal laws of the other State do not allow for bank secrecy or undisclosed (bearer) ownership of securities or shares.

2. OECD Model TIEA

In 2002, the OECD released its Agreement on Exchange of Information on Tax Matters (the "OECD Model TIEA"), together with commentary (the "Commentary"). The OECD Model TIEA was developed by the OECD Global Forum Working Group on Effective Exchange of Information, which consisted of representatives from OECD Member countries as well as delegates from Aruba, Bermuda, Bahrain, Cayman Islands, Cyprus, Isle of Man, Malta, Mauritius, the Netherlands Antilles, the Seychelles and San Marino.¹⁵² It is represents the standard of the effective exchange of information for purposes of the OECD's initiative on harmful tax practices,¹⁵³ while at the same time does not seek to prescribe the precise format for achieving this standard.¹⁵⁴

Article 5 (Exchange of Information Upon Request) of the OECD Model TIEA sets forth the requirements for exchanging information upon request; notably, there are no provisions for automatic and spontaneous exchanges of information. In addition, it provides that information requested with respect to a criminal matter must be exchange without regard to whether the conduct under investigation would constitute a crime under the laws of the requested State.¹⁵⁵ Paragraph 4 of Article 5 is intended to prohibit banks, other financial institutions and any person acting in an agency or fiduciary capacity, including nominees and trustees from claiming the right of privilege as the basis for declining an information request -- unless the provisions of Article 7 (Possibility of Declining a Request) apply. This paragraph also effectively prevents any claim that bank secrecy should be considered protected as a matter of public policy (ordre public) for purposes of Article 7¹⁵⁶ ? which as noted in the Commentary, should only be invoked in extreme cases, such as an information request motivated by political or racial persecution.¹⁵⁷

3. Recent developments

The most recent TIEA completed by the United States is with Liechtenstein (the "Liechtenstein TIEA"). Signed on December 8, 2008, the Liechtenstein TIEA requires each State to provide information that is foreseeably relevant to either a civil or criminal tax matter.¹⁵⁸ Although Liechtenstein has publicly stated that it still retains the right for a Liechtenstein court to decide the legitimacy of the request from the United States,¹⁵⁹ there are no unique terms in the Liechtenstein TIEA that provide for any extraordinary review beyond the "foreseeably relevant" standard.

The Liechtenstein TIEA requires that any changes or additions to domestic laws as may be necessary to give effect to the agreement must be enacted by December 31, 2009.¹⁶⁰ Accordingly, the Liechtenstein TIEA is not effective until each State has notified the other that it has completed the necessary internal procedures (including enacted of legislation) required for entry into force.¹⁶¹ Although there is no publicly-available list of the changes that must be made to the Liechtenstein laws for this purpose, some commentators have noted that bank secrecy laws must be changed in order to give effect to the Liechtenstein TIEA. This conclusion may be consistent with public statements by Treasury, which has said that the Liechtenstein TIEA is significant because it "pierces bank secrecy."¹⁶²

In concluding the Liechtenstein TIEA, the United States took the additional step of agreeing to a one-year extension of Liechtenstein's eligibility as a QI jurisdiction, until December 31, 2009.¹⁶³ The IRS will not enter into a QI agreement if it has not received a specified list of items regarding the know-your-customer practices and procedures in the jurisdiction in which the applicant is seeking QI status.¹⁶⁴ In this regard, the IRS publishes a list of those countries with approved know-your-customer rules; as of the last update on December 8, 2008, Liechtenstein was included on this list.¹⁶⁵ However, ongoing inclusion in this list is not guaranteed, and the IRS has publicly stated that QIs "should not assume that, because they have an agreement covering a business in a particular jurisdiction, such jurisdiction will not later be identified as a specified tax haven or secrecy jurisdiction."¹⁶⁶ For this purpose, a "specified tax haven or secrecy jurisdiction" is a jurisdiction that shows an unwillingness to cooperate with the United States to reform their practices related to transparency and the provision of tax information.¹⁶⁷ Thus, this temporary QI extension raises the question whether Liechtenstein may have been at risk of being identified as a specified tax haven or secrecy jurisdiction and delisted as an approved QI jurisdiction. Similarly, it raises the question whether a direct correlation should be inferred from the fact that the temporary extension ends on the same date by which Liechtenstein is required to make the necessary changes to its in domestic law by December 31, 2009 in accordance with Article 13 (Implementing Legislation).

On March 12, 2009, Liechtenstein announced that it intends comply with the OECD standards on transparency and exchange of information,¹⁶⁸ and to negotiate new bilateral agreements "that may go beyond OECD standards so as to provide particularly for effective exchange of information to address the global issue of tax fraud and tax evasion as well as double taxation."¹⁶⁹ The announcement further states that Liechtenstein is prepared "to develop comprehensive solutions to protect the legitimate tax claims of other jurisdictions according to their fiscal sovereignty and to balance legitimate interests of jurisdictions" albeit while maintaining "solid and modern bank secrecy laws."¹⁷⁰

1. Routine exchange of information

A "routine exchange of information" is one in which the contracting states have agreed that a category of information will be shared with one another on an ongoing basis, without the need for a specific request for same, because it is of a type that is consistently relevant to the tax administration of the receiving jurisdiction. Information that is automatically shared under this authority may include information that is not taxpayer specific, such as news about changes in domestic tax legislation, or it may be comprise voluminous taxpayer filings, such as magnetic disks containing the information from Forms 1042-S, relating to U.S. source fixed or determinable income paid to persons claiming to be residents of the receiving treaty country. The type of information, when it will be provided and how frequently, are typically determined by the respective Competent Authorities after consultation. The information will then be automatically provided. OECD has developed standards for the electronic format of such exchanges, to enhance their utility to tax administration.¹⁷⁵

The international steps taken to standardize the information exchanged and improve its usefulness are a positive development, but there remain numerous shortcomings, both practical and legal, in the routine exchange of information. Chief among them is the failure to include taxpayer identification numbers ("TINs"), despite the strong recommendation of the OECD that member states provide such information.¹⁷⁶ Ideally, the information received by the IRS should either include a TIN or be subject to a process referred to as "TIN perfection" to enable the IRS to correlate account data in the information received with a valid TIN in its taxpayer databases.¹⁷⁷ Such an undertaking is time-consuming and costly. Other practical hurdles that limit its value are the lack of timeliness of its production, the fact that the data may not readily conform to U.S. taxable periods, the need to translate the language of the documents and the currencies, and its voluminous nature.¹⁷⁸

These practical limitations are further exacerbated by the legal barriers to using the information to pursue FBAR penalties. The treaty information may only be used for a purpose consistent with the treaty. The FBAR penalties arise under Title 31 of the United States Code and are not generally within the scope of the taxes covered by the tax treaties. As a result, the treaty secrecy clause prevents sharing the information with those who investigate FBAR penalties. If foreign account information received under the treaty can be associated with a specific taxpayer's income tax accounts, it becomes tax return information, subject to the provisions of section 6103. Under section 6103, the information may be disclosed for "tax administration" purposes, as determined on a case-by-case basis. Even if the penalties are covered by the treaty, domestic legislation could prevent use of the information. Despite the likelihood that the information would readily establish the applicability of the penalties, it cannot be used for that purpose. In the face of competing priorities, it is not surprising that the IRS has made little use of the information. An adequate cost/benefit study of various means of strategically using the information is needed.

2. Spontaneous exchange of information

A "spontaneous exchange of information" occurs when one contracting state is in possession of an item of information that it determines may be of interest to the other contracting state for the tax administration of that other state. In such an instance, the first state will spontaneously provide the information to the treaty partner. In the United States, such information would typically be identified by a revenue agent or other employee, who would forward the information to the U.S. Competent Authority offices to decide whether the information should be forwarded to the foreign jurisdiction. Information spontaneously provided by a treaty partner to the United States is generally reviewed by the Exchange of Information program analyst or Tax Attache who first receives it, who then forwards it to an appropriate field office for further action and follows up to determine the outcome of the exchange.

3. Specific exchange of information

A "specific exchange" is a formal request by one contracting state for information that is relevant to an ongoing investigation of a particular tax matter. These cases are generally taxpayer specific. Those familiar with the case prepare a request that explains the background of the tax case and the need for the information. That request is forwarded to the Competent Authority, who determines whether to issue the request. If he determines that it is an appropriate use of the treaty authority, he forwards it to his counterpart. When a contracting state receives a specific request for information, it is obligated to use its powers to obtain the information to the same extent that it would do so if it were a domestic case, even if the information obtained could not be used in a domestic case.

4. Other exchanges of information

In addition to the traditional exchanges of information described above, the treaty partners may also work together to gain expertise about specific industries and to facilitate sharing of information when there is a common interest in the information. In those instances, they may arrange a meeting of agents or officials familiar with a particular industry or economic sector to share experiences, know-how, investigative techniques, and observations about trends in that industry. These discussions do not generally address the cases of specific taxpayers. The United States has also joined in the multilateral effort to form the Joint International Tax Shelter Information Centre, in 2004. It now operates with offices in Washington, D.C., and London, England. In addition to the United States, the members are Australia, Japan, the United Kingdom and Canada. Each has a bilateral treaty with each other member. If there is sufficient commonality in an issue or a specific taxpayer, there are procedures to conduct a simultaneous examination which will involve significant cooperation between the participating tax administrations. Both the industry wide meetings and the simultaneous examinations occur under the auspices of the exchange of information program; they are not in lieu of formal exchanges. They establish a process by which extensive exchanges of information can occur, with the assistance of an Exchange of Information analyst or Tax Attache.

In addition to exchanging information with its treaty partners, assistance is provided under the mutual assistance article in the tax treaties. The United States has specifically agreed to provide mutual assistance in collection of the taxes of five treaty partners: France, Canada, Sweden, Denmark, and the Netherlands. The United States does so under its "Mutual Assistance Collection Program" (MCAP).¹⁷⁹ It also provides assistance via the Mutual Legal Assistance in Criminal Matters Treaties (MLATs). Unlike the tax treaties, the role of Competent Authority for MLATs is delegated to the Department of Justice.¹⁸⁰

5. Litigation in support of exchange of information program

In addition to the resources devoted to administer its Exchange of Information program, the United States has litigated extensively in support of the program against a variety of challenges to actions it took to honor its treaty obligations. These challenges have included suits seeking to obtain publication of information received under treaty exchanges, objections to enforcement of administrative summonses and finally, an attempt to claim that the disclosure to another tax administrator was negligent.

The IRS successfully defended its efforts to protect the secrecy of certain information in internal memoranda, including the identity of the treaty partner that had communicated with the IRS.¹⁸¹ The need to safeguard the secrecy of the information in order to protect the working relationship of the treaty partners was sufficient reason to sustain the government position that documents from meetings of Competent Authorities are entitled to treaty protection.¹⁸²

In efforts to obtain the domestic information responsive to a treaty partner's request for information, the IRS uses its authority to issue administrative summonses. Specific challenges to IRS efforts to obtain financial information requested by a treaty partner frequently centered on whether the United States v. Powell 'good faith' elements were satisfied, in particular the need to comply with all procedural constraints. The extent to which the United States was required to look behind the statement of its treaty partner that the information was needed in a tax matter in the foreign jurisdiction was hotly contested, with taxpayers arguing that the foreign authorities should be required to meet the standards that would apply if the investigation were conducted in the United States. As previously stated, in a domestic case, if a matter had already been referred to the Department of Justice for criminal prosecution, a third-party record keeper summons would not be enforced.¹⁸³ In United States v. Stuart,¹⁸⁴ the question presented involved a request from Canada for information relevant to an investigation in that jurisdiction. The target of the investigation argued that the Internal Revenue Service lacked good faith, because it did not attempt to ascertain whether the Canadian tax investigation that led to Canada's treaty request had reached a stage analogous to an IRS referral to the Justice Department for criminal prosecution before issuing an administrative summons. The Court held that the summons was enforceable without such inquiry, stating, "We hold that neither the 1942 Convention nor domestic legislation imposes this precondition to issuance of an administrative summons. So long as the summons meets statutory requirements and is issued in good faith, as we defined that term in United States v. Powell, 379 U.S. 48, 57-58 (1964), compliance is required, whether or not the Canadian tax investigation is directed toward criminal prosecution under Canadian law." Since that opinion, numerous treaty summonses have been enforced, with little controversy.

In a suit for damages based on allegedly negligent or false disclosures made by the IRS to the Japanese National Tax Administration ("NTA"), the trial court granted summary judgment for the United States, rejecting a taxpayer claim that the NTA was an unreliable protector of treaty information and that disclosure to that treaty partner constituted negligence.¹⁸⁵ The United States disclosed information pursuant to its treaty with Japan in the course of a simultaneous examination. Following the disclosures to the NTA, Japanese media reported that a joint examination of plaintiffs had been conducted by the IRS and the NTA. That fact was true, but the articles also contained information that was untrue. Although plaintiffs cited to numerous rumors of leaks by the NTA of information from Japanese domestic audits, and NTA's failure to maintain the confidentiality of taxpayer information, they provided no other examples of an alleged NTA leaks of US/Japan tax treaty information. Plaintiff provided expert testimony that tax information was often reported in the press in Japan, in support of its claim that the United States should have known that information provided to NTA would not be safe from further disclosure. The court concluded that the witnesses did not establish that the information made available to the press came from NTA, nor did they prove that the source of the reports was treaty information. In granting summary judgment for the United States, the court stated:

1. OECD Initiatives

OECD's work on its standards of transparency and exchange of information (the "OECD Standards") was initiated in 1996 by its Global Forum on Transparency and Exchange of Information ("the "Global Forum").

The OECD Standards require:

• Exchange of information where it is "foreseeably relevant" to the administration and enforcement of the domestic laws of a requesting State;

• No restrictions on exchange caused by bank secrecy or domestic tax interest requirements;

• Availability of reliable information and powers to obtain it;

• Respect for taxpayer rights; and

• Strict confidentiality of information exchanged.¹⁸⁷

Also initiated in 1996 was the OECD's Harmful Tax Practices Project, which is carried out through the Forum on Harmful Tax Practices ("FHTP"). FHTP focuses on: (a) eliminating harmful tax practices of preferential tax regimes of OECD Member states; (b) identifying tax havens and pursuing their commitments to OECD Standards; and, (c) encouraging other non-OECD counties to associate themselves with FHTP work.¹⁸⁸ As of 2000, FHTP had identified more than 40 tax havens. By 2005, 35 were "committed jurisdictions," i.e., jurisdictions that formally documented their commitment to the OECD Standards. While seven tax havens initially refused to become committed jurisdictions, the current list of uncooperative tax havens is now comprised of just three: Andorra, Monaco, and Liechtenstein. However, each of these countries has recently announced its intention to implement the OECD standards. It is expected that the list of uncooperative tax havens will be discussed at the upcoming G-20 meeting scheduled for April 2.

Some of the jurisdictions that have recently announced their intention to commit to the OECD Standards have bank secrecy rules. It appears from the press releases issued that none will abandon these rules. These jurisdictions include Austria, Belgium, Liechtenstein, Luxembourg and Switzerland. Rather, each has identified the parameters for lifting banking secrecy rules for purposes of exchanging information. For example, Switzerland will permit the exchange of information upon receipt of a specific, justified request; Austria will exchange information upon request if there is a criminal proceeding involving a tax matter. In contrast, Andorra's government has announced that it will repeal its bank secrecy laws by the end of 2009.

It is presently unknown if such measures will satisfy the G-20 at its April meeting and keep such jurisdictions off the list of uncooperative tax havens. It is also unknown what penalties may be imposed on such jurisdictions.

1. European Union Savings Directive

In its foundational documents, the European Union established access to information and transparency as an important principle.¹⁸⁹ Since then, it has attempted to address the perceived tax evasion facilitated by bank secrecy laws of its member states and others. In June 2003, the European Council issued a directive designed to ensure that all interest earned by a citizen of a member state from an account held in any other member state would be subject to a minimal direct tax ("Savings Directive"). A directive is a non-self-executing resolution of the European Council that member states must implement, whether by local legislation or regulatory action.¹⁹⁰ The Savings Directive ensures that interest income earned by a citizen of one jurisdiction from an institution in another jurisdiction is subject to tax by the appropriate member state by requiring both information reporting by the financial institution to the member state and automatic exchange of such information reports among the member states. Member states were required to implement the directive by July 1, 2005.

A special longer transition period was provided for the several member countries whose jurisdictions were the least transparent among the member states. Belgium, Luxembourg and Austria do not permit exchange of information without a specific request for information on a specific taxpayer. Instead of agreeing to automatic exchange of information, they agreed to act as a withholding agent with respect to accounts in their jurisdictions. They collect tax and pay over tax to the home jurisdiction of the account holder without identifying the account holders. They are nevertheless entitled to receive the automatic exchange of information about their own citizens from the other states. ¹⁹¹

 

APPENDIX

 

 

[To view Appendix see Doc 2009-7190 . ]

 

 

FOOTNOTES

 

² U.S. persons may be subject in certain cases to a "backup withholding" tax with respect to payments of investment income. This backup withholding tax serves as a backstop to the regular information reporting and tax return filing requirements, and does not apply where the U.S. payee has provided an Internal Revenue Service Form W-9 to the payor or where the U.S. payee is a so-called "exempt recipient" (including a corporation, tax-exempt organization or governmental entity). See, generally, sections 3406 and 6041 through 6049 and the Treasury Regulations thereunder. Unless otherwise indicated, all section references herein are to sections of the Internal Revenue Code of 1986, as amended (the "Code"). A copy of Form W-9 is included in the Appendix hereto.

³ See Treas. Reg. sec. 1.1441-1(b).

⁴ Secs. 871(h) and 881(c). Congress believed that the imposition of a withholding tax on portfolio interest paid on debt obligations issued by U.S. persons might impair the ability of U.S. corporations to raise capital in the Eurobond market (i.e., the global market for U.S. dollar-denominated debt obligations). Congress also anticipated that repeal of the withholding tax on portfolio interest would allow the U.S. Treasury Department direct access to the Eurobond market. See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, JCS-4184 (December 31, 1984), at 391-392.

⁵ Sec. 871(h)(3). A 10-percent shareholder includes any person who owns 10 percent or more of the total combined voting power of all classes of stock of the corporation (in the case of a corporate obligor), or 10 percent or more of the capital or profits interest of the partnership (in the case of a partnership obligor). The attribution rules of section 318 apply for this purpose, with certain modifications.

⁶ Sec. 871(h)(4). Contingent interest generally includes any interest if the amount of such interest is determined by reference to any receipts, sales or other cash flow of the debtor or a related person; any income or profits of the debtor or a related person; any change in value of any property of the debtor or a related person; or any dividend, partnership distributions, or similar payments made by the debtor or a related person, and any other type of contingent interest identified by Treasury regulation. Certain exceptions also apply.

⁷ Sec. 881(c)(3)(C). A related person includes, among other things, an individual owning more than 50 percent of the stock of the corporation by value, a corporation that is a member of the same controlled group (defined using a 50-percent common ownership test), a partnership if the same persons own more than 50 percent in value of the stock of the corporation and more than 50 percent of the capital interests in the partnership, any United States shareholder (as defined in section 951(b) and generally including any U.S. person who owns 10 percent or more of the voting stock of the corporation), and certain persons related to such a United States shareholder.

⁸ Sec. 881(c)(3)(A).

⁹ An obligation is treated as in registered form if (i) it is registered as to both principal and interest with the issuer (or its agent) and transfer of the obligation may be effected only by surrender of the old instrument and either the reissuance by the issuer of the old instrument to the new holder or the issuance by the issuer of a new instrument to the new holder, (ii) the right to principal and stated interest on the obligation may be transferred only through a book entry system maintained by the issuer or its agent, or (iii) the obligation is registered as to both principal and interest with the issuer or its agent and may be transferred through both of the foregoing methods. Treas. Reg. sec. 5f.103-1(c).

¹⁰ Sec. 871(h)(2)(B) and (5).

¹¹ Secs. 871(h)(2)(A) and 163(f)(2)(A).

¹² Treas. Reg. sec. 1.1441-1(b)(4)(iii).

¹³ Treas. Reg. sec. 1.1441-1(b)(4)(ii).

¹⁴ Secs. 871(g)(1)(B), 881(a)(3); Treas. Reg. sec. 1.1441-1(b)(4)(iv).

¹⁵ Treas. Reg. sec. 1.1461-1(c)(2)(ii)(A), (B). However, Treasury regulations require a bank to report interest on Form 1042-S if the recipient is a resident of Canada and the deposit is maintained at an office in the United States. Treas. Reg. secs. 1.6049-4(b)(5), 1.6094-8. This reporting is required to comply with the obligations of the United States under the U.S.-Canada income tax treaty. T.D. 8664, 1996-1 C.B. 292. In 2001, the IRS and Treasury Department issued proposed regulations that would require annual reporting to the IRS of U.S. bank deposit interest paid to any foreign individual. 66 Fed. Reg. 3925 (Jan. 17, 2001). The 2001 proposed regulations were withdrawn in 2002 and replaced with proposed regulations that would require reporting with respect to payments made only to residents of certain specified countries (Australia, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, and the United Kingdom). 67 Fed. Reg. 50,386 (Aug. 2, 2002). The proposed regulations have not been finalized.

¹⁶ Sec. 871(a)(2). In most cases, however, an individual satisfying this presence test will be treated as a U.S. resident under section 7701(b)(3), and thus will be subject to full residence-based U.S. income taxation.

¹⁷ Secs. 881(a), 631(b), (c).

¹⁸ Treas. Reg. sec. 1.863-7(b)(1).

¹⁹ Treas. Reg. sec. 1.863-7(b)(3).

²⁰ Treas. Reg. sections 1.861-2(a)(7) (substitute interest), 1.861-3(a)(6) (substitute dividends).

²¹ E.g., Reuven S. Avi-Yonah, The Structure of International Taxation: A Proposal for Simplification, 74 Texas Law Review 1301, 1305-08 (1996); Michael J. Graetz and Itai Grinberg, "Taxing International Portfolio Income," 56 Tax Law Review 537, 540-41 (Summer 2003).

²²Economic and U.S. Income Tax Issues Raised by Sovereign Wealth Fund Investment in the United States, JCX-49-08 (June 17, 2008), at 3-20.

²³ Id. at 14.

²⁴ Id. at 17. In addition, foreign governments in 2006 held official reserve assets in the United States of $2.77 trillion, up from $1.25 trillion only four years earlier. Id.

²⁵ Id. at 14.

²⁶ For tax year 2005, foreign payees received $378.4 billion of U.S.-source income, as reported on Form 1042-S, and $333.2 billion (88.0 percent) of this income was exempt from withholding. (Since interest on bank deposits is wholly exempt from withholding, these figures exclude interest income paid by U.S. banking businesses to foreign depositors.) A total of $6.7 billion in withholding tax was collected on the remaining $45.3 billion of U.S.-source income subject to withholding. This amount of withholding tax represented approximately two percent of the total amount of U.S.-source income reported on Form 1042-S. IRS Statistics of Income Bulletin, Winter 2009, Publication 1136, at 100. This amount arguably is significant in absolute terms, but of course is a small fraction of total foreign investment in the United States. For example, using the 2006 figures cited earlier of some $12 trillion in foreign portfolio and direct private investments in the United States, if one were to assume (solely for illustrative purposes) a five percent presumptive return on those investments, those investments would generate some $600 billion in (presumptive) income. $6.7 billion in withholding tax amounts to a little over one percent of that amount.

²⁷ See, e.g., Reuven S. Avi-Yonah, "Memo to Congress: It's Time to Repeal the U.S. Portfolio Interest Exemption," Tax Notes International, Dec. 7, 1998, at 1817; Graetz and Grinberg, note 16, at 578 (arguing against source-based withholding taxes and expressing the view that residence-based taxation of foreign portfolio income is possible through continued unilateral and multilateral enforcement and information exchange efforts). For a general discussion of the difficulties in collecting residence-based taxes given globalization and technological developments such as electronic commerce and money, see Vito Tanzi, "Globalization, Technological Developments, and the Work of Fiscal Termites," 26 Brooklyn Journal of International Law 1261 (2001).

²⁸ In general, the U.S. information reporting and backup withholding system as it applies to both domestic and foreign investors operates on the basis of offering investors an implicit choice: either the investor can furnish the requisite identifying information (e.g., a Form W-9 for domestic individual investors, or a Form W-8 for a foreign investor), or the investor can suffer withholding tax (technically, backup withholding tax in the case of a U.S. investor or, in most cases, an unidentified investor). While it is true that withholding tax protects government revenues (although not to the extent of the highest individual tax rate), it might be argued that noncompliance with these identification requirements can be evidence of more general noncompliance activity by the taxpayer, which in turn would be relevant to the IRS. As a result, it might be argued (for example) that interest should simply not be payable to a foreign account (or from a U.S. bank account) unless the requisite forms are provided. This approach would go far beyond current law, and might in turn be viewed as unduly intrusive into taxpayer privacy (with potentially adverse effects on U.S. borrowers' ability to raise funds). Alternatively, the backup withholding rate could be increased to the highest marginal tax rate applicable to individuals, or an even higher rate, in order to provide a greater incentive for compliance.

²⁹ Copies of the Forms W-8 and their instructions are included in the Appendix hereto.

³⁰ The Form W-8ECI requires that the beneficial owner specify the items of income to which the form is intended to apply and certify that those amounts are effectively connected with the conduct of a trade or business in the United States and includible in the beneficial owner's gross income for the taxable year.

³¹ The Form W-8EXP requires that the beneficial owner certify as to its qualification as a foreign government, an international organization, a foreign central bank of issue or a foreign tax-exempt organization, in each case meeting certain requirements.

³² A corporation (and not its shareholders) ordinarily is treated as the beneficial owner of the corporation's income; as a result, this problem technically is not one of withholding tax noncompliance as much as it is noncompliance with the rules governing U.S. owners of controlled foreign corporations or passive foreign investment companies. Similarly, a foreign complex trust ordinarily is treated as the beneficial owner of income that it receives, and a U.S. beneficiary or grantor is not subject to tax on that income unless and until he receives a distribution. However, as described by the Senate Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, in its 2006 report, Tax Haven Abuses: the Enablers, the Tools and Secrecy, S. Hrg. 109-797, 109^th Cong., 2d Sess. (August 1, 2006), arrangements such as "trust protectors" have been employed by U.S. taxpayers to achieve substantial control over assets held in offshore trusts. The UBS case, described later in this pamphlet, also involved the use of nominee and sham entities to conceal the assets and income of U.S. taxpayers.

³³ In limited cases, the intermediary may furnish other documentary evidence of the status of the beneficial owner, rather than a Form W-8.

³⁴ Rev. Proc. 2003-64, 2003-32 I.R.B. 306 (July 10, 2003), provides procedures for qualification as a withholding foreign partnership or withholding foreign trust and model withholding agreements.

³⁵ See Treas. Reg. sec. 1.1441-1(b)(5).

³⁶ Treas. Reg. sec. 1.1461-1(b), (c). Copies of Form 1042, Form 1042-S and their instructions are included in the Appendix hereto.

³⁷ At the end of June 2008, the notional amount of interest rate derivatives (that is, the value of financial assets underlying the derivatives) outstanding worldwide was $458.3 trillion. Bank for International Settlements, Monetary and Economic Department, "OTC Derivatives Market Activity in the First Half of 2008" (November 2008), at 2.

³⁸ Secs. 861(a)(2)(A), 871(a)(1)(A), 881(a)(1).

³⁹ Amounts owed by each party under a total return swap typically are netted so that only one party makes an actual payment.

⁴⁰ Treas. Reg. section 1.863-7(b)(1). For a fuller discussion of sourcing and other tax issues related to derivatives transactions, see Joint Committee on Taxation, Present Law and Analysis Relating to the Tax Treatment of Derivatives (JCX-21-08), March 4, 2008. For a presentation of various hypothetical equity and interest rate swaps and stock lending transactions and a discussion of whether and when imposition of withholding tax might be appropriate, see David P. Hariton, "Equity Derivatives, Inbound Capital, and Outbound Withholding Tax," 60 Tax Lawyer 313 (Winter 2007). As a policy matter, Hariton argues that the withholding tax on U.S.-source dividends should be eliminated.

⁴¹ See Hariton, note 32, at 324-25.

⁴² For an extensive discussion of swap transactions entered into by U.S. financial institutions, offshore hedge funds, and other taxpayers, see United States Senate, Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, "Dividend Tax Abuse: How Offshore Entities Dodge Taxes on U.S. Stock Dividends," Staff Report, Sept. 11, 2008.

⁴³ Anita Raghavan, "IRS Probes Tax Goal of Derivatives," Wall Street Journal, July 19, 2007, C1; Anita Raghavan, "Happy Returns: How Lehman Sold Plan to Sidestep Tax Man -- Hedge Funds Use Swaps to Avoid Dividend Hit; IRS Seeks Information," Wall Street Journal, Sept. 17, 2007, A1.

⁴⁴ E.g., Hariton, note 32, at 346-50; Gregory May, "Flying on Instruments: Synthetic Investment and the Avoidance of Withholding Tax," Tax Notes, Dec. 9, 1996, at 1225.

⁴⁵ Statement of Reuven S. Avi-Yonah, Irwin I. Cohn Professor of Law, University of Michigan Law School, Testimony Before the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means, March 5, 2008, available at http://waysandmeans.house.gov/hearings.asp?formmode=printfriendly&id=6821 (last accessed March 25, 2009.

⁴⁶ S. 506, 111th Cong., 1st Sess. (2009), section 108; H.R. 1265, 111th Cong., 1st Sess. (2009), section 108.

⁴⁷ U.S. Model Income Tax Convention of November 15, 2006, Articles 10, 11, and 12.

⁴⁸ See, for example, Article 10(3) of the income tax treaty between the United States and the United Kingdom. Other U.S. treaties that include a zero rate of withholding tax on direct dividends are the income tax treaties with Australia, Belgium, Denmark, Finland, Germany, Iceland, Japan, and Sweden.

⁴⁹Aiken Industries, Inc. v. Commissioner, 56 T.C. 925 (1971).

⁵⁰ Section 894(c).

⁵¹ H.R. 3970, 110th Cong., 1st Sess. (2007), section 3204. Rep. Doggett introduced a similar, though more restrictive, bill. H.R. 3160, 110th Cong. 1st Sess. (2007). The provision in H.R. 3970 would allow the treaty reduction in withholding tax if the parent corporation was eligible for the benefits of an income tax treaty with the United States. By contrast, if the rate of withholding tax applicable under the U.S. income tax treaty with the parent corporation's country of residence were higher than the rate under the U.S. income tax treaty with the subsidiary's country of organization, H.R. 3160 would apply the higher rate.

⁵² Treas. Reg. section 1.881-3; T.D. 8611 (Aug. 10, 1995).

⁵³ The beneficial owner of income is, generally, the person who is required under U.S. tax principles to include the income in gross income on a tax return. A person is not a beneficial owner of income, however, to the extent that person is receiving the income as a nominee, agent, or a custodian, or to the extent that the person is a conduit whose participation in a transaction is disregarded. Foreign partnerships, foreign simple trusts, and foreign grantor trusts are not the beneficial owners of income paid to the partnership or trust. The beneficial owner of income paid to a foreign estate is the estate itself. See Treas. Reg. sec. 1.1441-1(c)(6) and the Instructions to Form 1042-S.

⁵⁴ See, e.g., Treas. Reg. section 1.1441-1(b)(2)(vii)(A) (providing that a withholding agent generally can rely on a Form W-8 or similar documentation if, before the payment, the agent holds the documentation, can reliably determine how much of the payment relates to the documentation, and has no actual knowledge or reason to know that any of the information, certifications, or statements in or associated with the documentation are incorrect).

⁵⁵ Government Accountability Office, Report to the Committee on Finance, U.S. Senate, "Tax Compliance: Qualified Intermediary Program Provides Some Assurance that Taxes on Foreign Investors Are Withheld and Reported, but Can Be Improved" (GAO-08-99), December 2007 (hereafter GAO Report).

⁵⁶ As previously noted, a corporation (and not its shareholders) ordinarily is treated as the beneficial owner of the corporation's income. Similarly, a foreign complex trust ordinarily is treated as the beneficial owner of income that it receives, and a U.S. beneficiary or grantor is not subject to tax on that income unless and until he receives a distribution.

⁵⁷ GAO Report at 15-16, 21.

⁵⁸ Statement of Reuven S. Avi-Yonah, Irwin I. Cohn Professor of Law, University of Michigan Law School, Testimony Before the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means, March 5, 2008, available at http://waysandmeans.house.gov/hearings.asp?formmode=printfriendly&id=6821 (last accessed March 25, 2009); Reuven S. Avi-Yonah, "Memo to Congress: It's Time to Repeal the U.S. Portfolio Interest Exemption," Tax Notes International, Dec. 7, 1998, at 1817.

⁵⁹ Council Directive 2003/48/EC of 3 June 2003 on Taxation of Savings Income in the Form of Interest Payments, available at http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2003:157:0038:0048:en:PDF (last accessed March 25, 2009). To address avoidance of the Directive, the European Commission has proposed amendments that would, among other changes, extend the Directive to interest-equivalents and require payors to apply the Directive when payments are made to non-EU intermediaries on behalf of beneficial owners who reside in the EU. See Proposal for a Council Directive amending Directive 2003/48/EC on Taxation of Savings Income in the Form of Interest Payments, November 13, 2008, available at http://ec.europa.eu/taxation_customs/resources/documents/taxation/personal_tax/savings_tax/savings_directive_review/COM(2008)727_en.pdf.

⁶⁰ Rules similar to the rules for Austria, Belgium, and Luxembourg apply under EU savings agreements with Andorra, Liechtenstein, San Marino, Monaco, and Switzerland and under bilateral agreements between individual EU states and the ten dependent and associated territories of the United Kingdom and the Netherlands (Anguilla, Aruba, the British Virgin Islands, the Cayman Islands, Guernsey, the Isle of Man, Jersey, Montserrat, the Netherlands Antilles and the Turks and Caicos Islands).

⁶¹ Michael J. Graetz & Itai Grinberg, "Taxing International Portfolio Income," 56 Tax Law Review 537, 578-86 (Summer 2003). (More broadly, Graetz and Grinberg argue that the United States should pursue a policy of national neutrality in the taxation of foreign portfolio income and therefore should allow a deduction, not a credit, for foreign taxes imposed on that income.)

⁶² 61 Fed. Reg. 17,614 (Apr. 22, 1996).

⁶³ T.D. 8734 (Oct. 6, 1997). The regulations specific to QIs have subsequently been amended. See T.D. 8804 (Dec. 30, 1998) (delaying effective date and providing additional transition rules); T.D. 8856 (Dec. 30, 1999) (delaying effective date); and T.D. 8881 (May 16, 2000) (providing for withholding rate pools for QIs and changing model QI agreement regulations to conform with Rev. Proc. 2000-12, which includes a provision requiring a QI to disinvest in cases in which a non-exempt U.S. customer does not waive local bank secrecy laws).

⁶⁴ Treas. Reg. sec. 1.1441-1(e)(5).

⁶⁵ Announcement 2000-48, 2000-1 C.B. 1243.

⁶⁶ Id. After December 31, 2006, however, branches located in countries without approved know-your-customer rules are no longer permitted to operate as QIs. See Notice 2006-35, 2006-14 I.R.B. 708.

⁶⁷ See Tax Equity and Fiscal Responsibility Act of 1982, sec. 342.

⁶⁸ The definition also includes: a foreign branch or office of a U.S. financial institution or U.S. clearing organization; a foreign corporation for purposes of presenting income tax treaty claims on behalf of its shareholders; and any other person acceptable to the Internal Revenue Service. Treas. Reg. sec. 1.1441-1(e)(5)(ii).

⁶⁹ U.S. withholding agents are allowed to rely on a QI's Form W-8IMY without any underlying beneficial owner documentation. By contrast, non-QIs are required both to provide a Form W-8IMY to a U.S. withholding agent and to forward with that document Form W-8s or W-9s for each beneficial owner.

⁷⁰ Rev. Proc. 2000-12, 2000-1 C.B. 387, supplemented by Announcement 2000-50, 2000-1 C.B. 998, and modified by Rev. Proc. 2003-64, 2003-2 C.B. 306, and Rev. Proc. 2005-77, 2005-2 C.B. 1176. The QI agreement applies only to foreign financial institutions, foreign clearing organizations, and foreign branches or offices of U.S. financial institutions or U.S. clearing organizations. However, the principles of the QI agreement may be used to conclude agreements with other persons defined as QIs. In addition, the IRS may choose to enter into a QI agreement that deviates from the model agreement.

⁷¹ Written Testimony of Douglas H. Shulman, Commissioner, Internal Revenue Service, Hearing on Tax Issues Related to Ponzi Schemes and an Update on Offshore Tax Evasion Legislation Before the S. Comm. on Fin., 111^th Cong., Mar. 17, 2009 [hereinafter Shulman 2009 SFC Testimony].

⁷² Government Accountability Office, Testimony of Michael Brostek Before the Committee on Finance, U.S. Senate: Tax Compliance: Offshore Financial Activity Creates Enforcement Issues for IRS, GAO-09-478T (Mar. 17, 2009), at 10.

⁷³ Additional detail can be found in Joint Committee on Taxation, Selected Issues Relating to Tax Compliance With Respect to Offshore Accounts and Entities (JCX-65-08), July 23, 2008.

⁷⁴ This absence of a requirement to disclose a U.S. exempt recipient is consistent with the fact that exempt recipients are excluded from the scope of the general rules governing backup withholding and information reporting.

⁷⁵ This rule restricts one of the principal benefits of the QI regime, nondisclosure of account holders, to financial institutions that have assumed the documentation and other obligations associated with QI status.

⁷⁶ Form 1042-S is the IRS form on which a withholding agent reports a foreign person's U.S.-source income that is subject to reporting to the foreign person and to the IRS.

⁷⁷ These amounts are statutorily exempt from nonresident withholding when paid to non-U.S. persons.

⁷⁸ Non-U.S. investments can generate amounts subject to information reporting if they are not considered paid outside the U.S. under Treas. Reg. 1.6049-5(e). Payments are not considered paid outside the U.S. if the customer has transmitted instructions to an agent, branch, or office of the institution from inside the U.S. by mail, phone, electronic transmission, or otherwise, unless the transmission from the U.S. has taken place in isolated and infrequent circumstances.

⁷⁹ Rev. Proc. 2002-55, 2002-2 C.B. 435.

⁸⁰ See Written Testimony of Douglas H. Shulman, Commissioner, Internal Revenue Service, Hearing on Tax Haven Banks and U.S. Tax Compliance Before the Permanent Subcomm. on Investigations, S. Comm. on Homeland Sec. and Governmental Affairs, 110th Cong., July 17, 2008 [hereinafter Shulman 2008 Testimony]. The difference between signed agreements and active agreements is due to mergers, acquisitions, and terminations. As of July 2008, the IRS had issued 600 default letters and had terminated 100 QI agreements.

⁸¹ See United States v. UBS AG, 09-60033-CR-COHN (S.D. Fl.).

⁸² Written Testimony of John DiCicco, Acting Assistant Attorney General, Tax Division, U.S. Department of Justice, Hearing on Tax Haven Banks and U.S. Tax Compliance -- Obtaining the Names of U.S Clients with Swiss Accounts Before the Permanent Subcomm. on Investigations, S. Comm. On Homeland Sec. and Governmental Affairs, 111th Cong., Mar. 4, 2009.

⁸³ Written Testimony of Mark Branson, Chief Financial Officer of UBS AG, Hearing on Tax Haven Banks and U.S. Tax Compliance ? Obtaining the Names of U.S Clients with Swiss Accounts Before the Permanent Subcomm. on Investigations, S. Comm. On Homeland Sec. and Governmental Affairs, 111th Cong., March 4, 2009.

⁸⁴ The Swiss banking authority with the permission of the Swiss government had allowed UBS to agree to transfer approximately 250 names of United States resident account holders for which there is a reasonable suspicion of conduct constituting what Swiss law considers fraudulent acts to the Justice Department as part of the deferred prosecution agreement. See Lee Sheppard, Don't Ask, Don't Tell, Part III: UBS's Sweet Deal, 122 Tax Notes 1050 (2009).

⁸⁵ Lynnley Browning, U.S. Extends Its Inquiry of Offshore Tax Fraud, N.Y. Times, Mar. 18, 2009, at B3.

⁸⁶ Principally, Treasury Regulation sections 1.1441-1 and 1.1441-7.

⁸⁷ See Section 5.10 of the model QI agreement, as set forth in Rev. Proc. 2000-12, 2000-1 C.B. 387.

⁸⁸ Treasury Regulation section 1.1441-7(b)(4).

⁸⁹ A similar recommendation was made in a 2007 report prepared by the Government Accountability Office (the "GAO") on the QI program. The report generally found that the QI program provides some assurance that tax on U.S.-source income sent offshore is properly withheld and reported. However, the report offered four recommendations for the IRS to further improve the QI program. In addition to recommending that external auditors report fraud or illegal acts, the report recommended that the IRS: (1) measure U.S. withholding agents' reliance on self-certified documentation and use that data in its compliance efforts; (2) determine why some funds are reported to unknown jurisdictions and to unidentified recipients and take appropriate steps to recover withholding taxes that should have been paid and to better ensure that U.S. taxes are withheld; and (3) require electronic filing of forms in QI agreements whenever possible. Government Accountability Office, Tax Compliance: Qualified Intermediary Program Provides Some Assurance that Taxes on Foreign Investors Are Withheld and Reported, but Can Be Improved, GAO-08-99 (Dec. 19, 2007).

⁹⁰ See Shulman 2008 Testimony, supra; Shulman 2009 SFC Testimony, supra; and Written Testimony of Douglas H. Shulman, Commissioner, Internal Revenue Service, Hearing on Tax Haven Banks and Offshore Compliance -- Obtaining the Names of U.S. Clients with Swiss Accounts Before the Permanent Subcomm. on Investigations, S. Comm. on Homeland Sec. and Governmental Affairs, 111th Cong., Mar. 4, 2009 [hereinafter Shulman 2009 PSI Testimony].

⁹¹ Kristen A. Parillo & Jeremiah Coder, IRS Reduces Penalties on Voluntarily Disclosed Offshore Accounts, 2009 Tax Notes Today 57-2.

⁹² However, the IRS will permit a branch of a financial institution located in such a country to act as a QI if the branch is part of an entity organized in a country that has acceptable know-your-customer rules and the entity agrees to apply its home country know-your-customer rules to the branch.

⁹³ Tax Haven Banks and U.S. Tax Compliance, Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs of the U.S. Senate (July 17, 2008). The UBS matter is described in Section II of this document.

⁹⁴ The QI program is discussed in detail in Section II of this document.

⁹⁵ For additional background on this investigation, see Nicholas Kulish & Carter Dougherty, Deutsche Post Chief Under Tax Inquiry, N.Y. Times, Feb. 15, 2008, at C4; Randall Jackson, The Mouse that Roared: Liechtenstein's Tax Mess, 49 Tax Notes Int'l 707 (2008) [hereafter Jackson, The Mouse that Roared ]; Mark Landler, Liechtenstein Seeks Man Suspected of Selling Information that Led to Tax Scandal, N.Y. Times, Mar. 13, 2008, at C3.

⁹⁶ Jackson, The Mouse that Roared, supra.

⁹⁷ News Release, Internal Revenue Service, IRS and Tax Treaty Partners Target Liechtenstein Accounts, IR-2008-26 (Feb. 26, 2008).

⁹⁸ See 2008 PSI Report at 36-37; Jackson, The Mouse that Roared, supra.

⁹⁹ Foundations are generally exempt from income taxes in Liechtenstein. However, they are subject to an annual capital tax, which is generally equal to the greater of 0.1 percent of the foundation's capital or CHF 1,000 (approximately U.S. $980). Other taxes may apply, including a stamp duty on formation (equal to no more than 1.0 percent of taxable capital) and a tax on the transfer of securities (equal to 0.15 percent for Liechtenstein securities and 0.30 percent for foreign securities).

¹⁰⁰ Liechtenstein does not tax distributions to beneficiaries residing outside Liechtenstein.

¹⁰¹ Agreement Between the Government of the United States of America and the Government of the Principality of Liechtenstein on Tax Cooperation and the Exchange of Information Relating to Taxes.

¹⁰² In this regard, the Liechtenstein government released a statement on March 12, 2009 that it "accepts the OECD standards on transparency and information exchange in tax matters and supports the international measures against noncompliance with tax laws." Andrew Ross Sorkin, Liechtenstein Pledges Tax Openness, N.Y. Times Deal Book, Mar. 12, 2009.

¹⁰³ "Tax Co-operation: Towards a Level Playing Field," 2008 Assessment by the Global Forum on Taxation, OECD, tabulates the numerous permutations by which information that is available to the host jurisdiction may or may not be shared with a requesting state.

¹⁰⁴Holman v. Johnson, 98 Eng. Rep. 1120 (K.B. 1775), cited in AG of Canada v. R.J. Reynolds Tobacco Holdings, Inc., 268 F.3d 103, cert. denied, 537 U.S. 1000 (2002).

¹⁰⁵ 544 U.S. 349; 125 S. Ct. 1766; 161 L. Ed. 2d 619 (2005)

¹⁰⁶ The United States has mutual assistance in collection agreements with five treaty partners, i.e., France, Canada, Sweden, Denmark, and the Netherlands.

¹⁰⁷ 31 U.S.C. Secs. 5311-5314e, 5316-5332e; 12 U.S.C. secs. 1829b and 1951-1959e.

¹⁰⁸ Privacy Act of 1974, 5 U.S.C. sec. 552a.

¹⁰⁹ 12 U.S.C. 3402.

¹¹⁰ I.R.C. sec. 6103;

¹¹¹Cook v. Tait, 265 U.S. 47 (1924)

¹¹² 357 U.S. 197 (1958)

¹¹³ The balancing test is summarized in the Restatement 3rd on Foreign Relations Law as follows: (a) A court or agency in the United States, when authorized by statute or rule of court, may order a person subject to its jurisdiction to produce documents, objects, or other information relevant to an action or investigation, even if the information or the person in possession of the information is outside the United States; (b) failure to comply with an order to produce information may subject the person to whom the order is directed to sanctions, including finding of contempt, dismissal of a claim or defense, or default judgment, or may lead to a determination that the facts to which the order was addressed are as asserted by the opposing party; and (c) in deciding whether to issue an order directing production of information located abroad, and in framing such an order, a court or agency in the United States should take into account the importance to the investigation or litigation of the documents or other information requested; the degree of specificity of the request; whether the information originated in the United States; the availability of alternative means of securing the information; and the extent to which noncompliance with the request would undermine important interests of the United States, or compliance with the request would undermine important interests of the state where the information is located. Restatement 3d, Foreign Relations, sec. 441(1).

¹¹⁴ 691 F2d 1384 (11th Cir.1982), cert. denied 462 U.S. 1119 (1983).

¹¹⁵United States v. Vetco, 691 F.2d 1281 (9th Cir.1981).

¹¹⁶United States v. First National Bank of Chicago, 699 F. 2d 341 (7th Cir. 1983).

¹¹⁷ Restatement 3d, Foreign Relations, sec. 441(1)(c).

¹¹⁸ Sec. 7465(b)

¹¹⁹ Sec. 982

¹²⁰Gerling International Insurance Co. v. Commissioner, 839 F. 2d 131 (3rd Cir. 1988); Hong Kong Shanghai Banking Corporation v. Commissioner, 85 T.C. (1985)

¹²¹ Sec. 982(b)(2).

¹²²Flying Tigers Oil Co. v. Commissioner, 92 T.C. 1261 (1989).

¹²³ Sec. 7602.

¹²⁴United States v. Powell, 379 U.S. 48 (1964).

¹²⁵ 437 U.S. 298 (1978); codified in section 7609(c)

¹²⁶ Sec. 7609.

¹²⁷ Sec. 7609(h)(2) provides that the determination will be made ex parte, solely on the pleadings.

¹²⁸ Sec. 7609(f).

¹²⁹United States v. Samuels, Kramer & Co., and First Western Government Securities, Inc., 712 F.2d 1342 (9th Cir. 1983), which affirmed a lower court determination that the issuance of the John Doe summons was not subject to review, but reversed and remanded to permit a limited evidentiary hearing on whether the Powell standard was met.

¹³⁰ Sec. 7609(e)(1).

¹³¹ Sec. 7609(e)(2).

¹³² News Release, Internal Revenue Service, IR-2003-95 (July 31, 2003); General Accounting Office, Internal Revenue Service: Challenges Remain in Combating Abusive Tax Schemes, GAO-04-50, at 10-11 (Nov. 19, 2003) [hereafter GAO, Challenges Remain ].

¹³³ News Release, Internal Revenue Service, IR-2003-95 (July 31, 2003).

¹³⁴ News Release, Internal Revenue Service, IR-2003-48 (April 10, 2003). Taxpayers wishing to participate in the OVCI program were required to apply before April 15, 2003. The FBAR reporting requirements are discussed in Section II of this document.

¹³⁵ Rev. Proc. 2003-11, 2003-1 C.B. 311; News Release, Internal Revenue Service, IR-2003-5 (Jan. 14, 2003); GAO, Challenges Remain, supra, at 12; General Accounting Office, Testimony of Michael Brostek Before the Committee on Finance, U.S. Senate: Taxpayer Information: Data Sharing and Analysis May Enhance Tax Compliance and Improve Immigration Eligibility Decisions, GAO-04972T (Nov. 19, 2003).

¹³⁶ News Release, Internal Revenue Service, IR-2003-95 (July 31, 2003).

¹³⁷ Written Testimony of Commissioner of Internal Revenue Mark Everson Before Senate Committee on Homeland Security and Governmental Affairs' Permanent Subcommittee on Investigations Hearing on Offshore Abuses: The Enablers, The Tools and Offshore Secrecy, 109th Cong., August 1, 2006.

¹³⁸ The United States' first double tax convention was entered into in 1932 with France; it did not contain an exchange of information provision. Article XV of the U.S.-Sweden Double Tax Convention, signed on March 23, 1939, included the United States' first the exchange of information provision. This was followed shortly by a second double tax convention with France, signed on July 25, 1939, which provided for the exchange of information in Article 26.

¹³⁹ The 1973 income tax treaty between the USSR and the United States does not have an exchange of information provision. It still applies to the countries of Armenia, Azerbaijan, Belarus, Georgia, Kirgizstan, Moldova, Tajikistan, Turkmenistan, and Uzbekistan.

¹⁴⁰ Paragraph 1 of the OECD Model provides, however, for the exchange of information imposed on behalf of each respective State, or "of their political subdivisions or local authorities." In contrast, the U.S. Model is silent with respect to taxes imposed by political subdivisions and local authorities and the technical explanation specifically states that the Article 26 applies with respect to "taxes of every kind applied at the national level." The OECD Model does not incorporate paragraphs 6 through 9 (described above) of the U.S. Model.

¹⁴¹ Randall Jackson, Kristen A. Parillo and David D. Stewart, Tax Havens Agree to OECD Standards, 53 Tax Notes Int'l 1027 (2009) [hereinafter, Tax Havens Agree].

¹⁴² The U.S. Model was adopted on November 15, 2006. The Convention Between the Government of the United States of America and the Government of the Kingdom of Belgium for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income was signed on November 26, 2006.

¹⁴³ Marc Quaghebeur, Belgium Uses Tax Treaties to Attract Investment, 45 Tax Notes Int'l 1055, 1055 (March 19, 2007).

¹⁴⁴ The provisions of paragraph 6 appear to correspond to commentary included in the technical explanation of the 2006 U.S. Model regarding the statute of limitations.

¹⁴⁵ Marc Quaghebeur, Belgian Parliament Ratifies Belgium-US Tax Treaty, 46 Tax Notes Int'l 768, 776 (May 21, 2007).

¹⁴⁶ P.L. No. 98-67.

¹⁴⁷ See sec. 212(a)(1)(A) of the Act for the list of eligible countries. The list is updated by Rev. Rul. 2007-28, 2007-1 C.B. 1039.

¹⁴⁸ Alternatively, eligible CBI countries could qualify based on a double tax convention with the United States that contained an effective exchange of information program. Section 927(e)(3)(B).

¹⁴⁹ Pursuant to the Deficit Reduction Act, P. L. No. 98-369, a foreign sales corporation established under section 927 could be organized in any foreign country (not just CBI eligible countries) provided that the country had concluded either a TIEA or a double tax convention with the United States meeting the requirements of section 274(h)(6)(A). Section 927(e)(3) (repealed for transactions after 9/30/2000 by P.L. 105-519); Treas. Reg. secs. 1.921-2(d) (A-7, part (i)) and 1.922-1(e) (A-5, part (ii)).

¹⁵⁰ The Tax Reform Act of 1986, P.L. 99-514, added another incentive for eligible CBI countries by treating certain income derived from investments in that country as qualified possessions source investment income for purposes of the section 936 credit (allowing possession corporations a tax credit for U.S. taxes imposed on income earned by such corporations), provided that the eligible CBI country had concluded either a TIEA or a double tax convention with the United States meeting the requirements of section 274(h)(6)(A). Section 936(d)(4), flush language (repealed in 1996 by the Small Business Job Protection Act, P.L. 104-188, which provided for the 10-year phase out of the credit in section 936(j)).

¹⁵¹ Section 274(h)(3)(C); See also, Barquero vs. United States, 18 F.3d 1311, 1314-1315 (5th Cir. 1994); and Treaties and Other International Agreements: the Role of the United States Senate, A Study Prepared for the Committee on Foreign Relations, United States Senate, Congressional Research Service, Library of Congress (January, 2001), S. Prt. 106-71.

¹⁵² OECD Model TIEA, Introduction, paragraph 2.

¹⁵³ OECD Model TIEA, Introduction, paragraph 3.

¹⁵⁴ OECD Model TIEA, Introduction, paragraph 6.

¹⁵⁵ Commentary to OECD Model TIEA, Article 5, paragraph 1, at (¶ 39-40).

¹⁵⁶ Commentary to OECD Model TIEA, Article 5, paragraph 4, at (¶ 46).

¹⁵⁷ Commentary to OECD Model TIEA, Article 7, paragraph 4, at (¶ 91).

¹⁵⁸ Agreement Between the Government of the United States of America and the Government of the Principality of Liechtenstein on Tax Cooperation and the Exchange of Information Relating to Taxes, Article 1 [hereinafter, Lichtenstein TIEA].

¹⁵⁹ Press Release, December 8, 2009, http://www.presseportal.ch/de/pm/100000148/100574800/presse_informationsamt_liechtenstein?pre=1

¹⁶⁰ Lichtenstein TIEA, Article 13.

¹⁶¹ Lichtenstein TIEA, Article 15.

¹⁶² Charles Gnaedinger, Liechtenstein, U.S. Sign Tax Information Exchange Agreement, Tax Notes Today, December 9, 2008, citing Jesse Eggert, an attorney-adviser at the Treasury Department.

¹⁶³ Protocol to the Liechtenstein TIEA, set forth in the Appendix, paragraph 10.

¹⁶⁴ Rev. Proc. 2000-12, 2000-1 C.B. 387, at Section 3.02.

¹⁶⁵ See http://www.irs.gov/businesses/international/article/0,,id=96618,00.html .

¹⁶⁶ I RS Announcement 2000-48, 2000-1 C.B. 1243.

¹⁶⁷ Id.

¹⁶⁸ See infra Section IV.E.1.

¹⁶⁹ The Liechtenstein Declaration, March 12, 2009, http://www.oecd.org/dataoecd/27/21/42340216.pdf.

¹⁷⁰ Id.

¹⁷¹ The United States reserved as to several articles in that treaty, including the provisions that would require collection assistance.

¹⁷² In the United States, the requests are initially received by Tax Attaches, or, in the case of France or Canada, the Exchange of Information Team program analysts in Washington. I.R.M. par. 4.60.1.1(6)(b).

¹⁷³ Sec. 6105.

¹⁷⁴ In calendar year 2007, the United States made 1,429,499 disclosures of information to foreign countries under the exchange of information program. See Joint Committee on Taxation, Disclosure Report for Public Inspection Pursuant to Internal Revenue Code Section 6103(p)(3)(C) for Calendar Year 2007(JCX-47-08), June 3, 2008, at 3.

¹⁷⁵ See Module 3 of "Manual On The Implementation of Exchange of Information Provisions for Tax Purposes", OECD Committee on Fiscal Affairs (23 January 2006).

¹⁷⁶OECD Recommendation on the use of Tax Identification Numbers in an International Context [C(97)29/FINAL], recommends at Article 4: "The information referred to in Article 2 of this Memorandum shall, as much as possible, be provided in a magnetic or electronic format following the Recommendation of the Council on the Use of the Revised OECD Standard Magnetic Format for Automatic Exchange of Information [C(97)30/FINAL] or any further updated format recommended by the Council. This information shall include, as much as possible, the Tax Identification Numbers in the residence and source country of the non-resident recipients of income[.]"

¹⁷⁷Letter from Commissioner, IRS to Chairman, Senate Finance Committee (June 12, 2006), 2006 TNT 115-17 .

¹⁷⁸ Id.

¹⁷⁹ See, I.R.M. Pars. 11.3.25.5 and 11.3.25.6

¹⁸⁰ See, I.R.M. Pars. 11.3.28.3.2.

¹⁸¹Tax Analysts v. IRS, 152 F. Supp. 2d 1, 9 (D.D.C. 2001), rev'd in part on other grounds, 1 2002 WL 1300028 (D.C. Cir. 2002)). Congress enacted section 6105, which explicitly provides that information obtained under a treaty and not taxpayer-specific is nevertheless protected information.

¹⁸²Tax Analysts v. Internal Revenue Service, 217 F. Supp. 2d 23 (D. D.C. 2002)

¹⁸³ Sec. 7602(c); United States v. LaSalle National Bank, 437 U.S. 298 (1978).

¹⁸⁴ 489 U.S. 353; 109 S. Ct. 1183; 103 L. Ed. 2d 388 (1989)

¹⁸⁵Aloe Vera of America, Inc. v. United States, 2007-1 U.S. Tax Cases Par 50,325; 99 AFTR 2d 895 (USDC D. AZ 2/2/2007).

¹⁸⁶The Turner Review: A Regulatory Response to the Global Banking Crisis, Financial Services Authority, United Kingdom, March 2009, at 7 and 74.

¹⁸⁷ Overview of the OECD's Work on International Tax Evasion (A note by the OECD Secretariat) 3, (Mar. 23, 2009) [hereinafter 2009 OECD Overview].

¹⁸⁸ 2009 OECD Overview at 3-4.

¹⁸⁹ "Declaration on the right of access to information", Treaty on European Union, entered into force November 1, 1993, O.J. C. 191, 29 July 1992 [hereinafter Maastricht Treaty].

¹⁹⁰ Maastricht Treaty, Art. 249

¹⁹¹ Council Directive 2003/48/EC of 3 June 2003, OJ L 157 (26-6-2003).