Alert April 13, 2010

HIRE Act Becomes Law: Revenue Offsets Aimed at Offshore Tax Evasion Have Extensive Reach

President Obama signed the Hiring Incentives to Restore Employment Act (“HIRE Act”) into law on March 18, 2010.  The HIRE Act, which is intended to facilitate the creation of jobs, provides a number of tax breaks, including a payroll tax holiday.  Under the new legislation, private employers are generally exempted from the employer portion of social security taxes in relation to “qualified employees” for the period starting after March 18, 2010 and running through December 31, 2010.  A qualified employee must start work anytime after February 3, 2010 and before January 1, 2011, and must have been unemployed for at least 60 days before his or her start date.  The HIRE Act additionally provides a business credit for the retention of certain newly hired employees who remain employed for at least 52 consecutive weeks.  Both provisions contain limitations that aim to prevent manipulation by employers.

To help pay for the tax incentives, the HIRE Act enacts a modified version of the previously proposed Foreign Account Tax Compliance Act of 2009 (“FATCA”).  The cornerstone of FATCA is an enhanced reporting and withholding regime.  As compared to the “qualified intermediary” (“QI”) rules, FATCA reaches a wider spectrum of payments and institutions, and, for those institutions that are subject to both regimes, FATCA’s requirements are in addition to the QI requirements.  FATCA applies to “foreign financial institutions” (“FFIs”), which are broadly defined to include not only banks but also investment vehicles such as hedge funds.  FATCA essentially puts an FFI to the choice of either (i) reporting annually to the Internal Revenue Service (“IRS”) information about financial accounts that are held by certain US persons and US-owned foreign entities or (ii) being subject to a 30% withholding tax on “withholdable payments.”  The term “withholdable payment” includes all US-source interest, dividends, rents, salaries, wages, annuities, and other similar items (commonly referred to as “FDAP”), as well as the gross proceeds from the sale or other disposition of property (such as stock and bonds) that can produce US-source interest or dividends (even if there is no gain on the disposition), provided, in each case, that such income is not already subject to US tax on account of its being attributable to the recipient’s conduct of a US trade or business.  The FATCA reporting and withholding requirements apply only to payments made after December 31, 2012, and do not apply to payments made after 2012 on obligations in existence on March 18, 2012, or to the gross proceeds received after 2012 from the disposition of any such grandfathered obligation.

Some of the other significant changes in the in the HIRE Act include:

  • Prospective repeal of the so-called “foreign targeted obligations” exception to the tax sanctions that apply to unregistered bearer bonds; this change, which applies to obligations issued after March 18, 2012, would, among other things, generally disqualify interest paid on foreign targeted bearer bonds from “portfolio interest” (and therefore exemption from withholding).
  • Requiring taxpayers with more than $50,000 in “specified foreign financial assets” (including accounts maintained at foreign financial institutions) to disclose such assets on their US tax returns for taxable years beginning after March 18, 2010, and imposing a penalty of up to $50,000 for failure to report.
  • Expanding the accuracy-related penalties to include underpayments attributable to undisclosed foreign financial assets for taxable years beginning after March 18, 2010, and imposing a penalty equal to 40% of the underpayment.
  • Extending the statute of limitations to six years for understatements of income in which the excluded amount exceeds $5,000 and is attributable to one or more reportable foreign assets; the extension is effective for all returns for which the statute of limitations did not expire as of March 18, 2010.
  • Requiring a shareholder of a passive foreign investment company (“PFIC”) to file an annual report with the IRS; the effective date is March 18, 2010, but Notice 2010-34 indicates that PFIC shareholders who were not already required to file an annual report will not be required to do so for taxable years that begin before March 18, 2010.
Treating “dividend equivalent” payments made on or after September 14, 2010 as dividends from US sources for certain purposes, including withholding taxes on payments made to foreign persons; the scope of notional principal contracts subject to this rule expands on March 18, 2012.