Morrison & Foerster: Tax bill if enacted may have ripple effects in global capital markets

By Emma Trincal

New York, Jan. 25 - The Foreign Account Tax Compliance Act of 2009, which was introduced at the end of October in the House of Representatives and Senate, could have significant ripple effects in the global capital markets if passed into law, said Thomas Humphreys, partner at Morrison & Foerster, during a "Structured Notes Boot Camp" organized by his firm last week in New York. Investors in structured notes would also be impacted.

On Dec. 7, U.S. House Ways and Means Committee chairman Charles B. Rangel, D-N.Y., introduced H.R. 4213, the Tax Extenders Act of 2009. The bill includes the provisions of the act, which introduce a new 30% withholding tax on withholdable payments made to foreign financial institutions that fail to comply with specified reporting requirements.

30% withholding tax

"People are trying to figure out how it would work," Humphreys said. "The tax would apply to any investor who owns U.S. securities in a foreign financial institution. If the law was enacted, investors whether in bonds or stocks would be subject to a 30% withholding tax. The U.S. entity that makes the payment (the issuer for a debt instrument) would have to withhold 30% of its payment of interest or dividends for tax purposes," he said.

The new proposal gives investors a way to eliminate the new tax burden. But it's precisely this option that has been subject to controversy as it is viewed as coercive.

Reporting names

"That 30% withholding tax could be avoided. But in order to do so, the foreign institution would have to sign an agreement with the IRS promising to report the names of their U.S. account holders. The 30% withholding tax is really a coercive measure intended to force foreign financial institutions to disclose information about the accounts of U.S. taxpayers. This information would include the name of the U.S. account holder and some description of the annual account activity," Humphreys said.

Some time to adjust

The law has not passed yet. It has just been approved by the House, noted Humphreys.

"Will the Senate follow suit? You never know. But if it's enacted, people will have a fairly long time to comply," Humphreys said.

A combination of two factors will give the market time to adjust: first, the law would need to be clarified and second, a grandfather provision was adopted.

"It's a complicated area, which means that the market would have to receive some guidance on how to apply the law. The first step would be for the government to issue regulations and presumably, they would issue regulations well before 2013," said Humphreys.

"In addition, a grandfather provision would exempt the tax withholding for debt outstanding on the date which is two years after enactment of the bill," he added.

For instance, assuming that the law is enacted March 1, a bond that is outstanding on March 1, 2012 would be grandfathered, explained Humphreys. But a bond issued after March 1, 2012 would be subject to the withholding tax beginning in 2013.

London calling

"Last fall, we received calls from brokerage firms and financial institution in London trying to figure out what to do. The proposed legislation caused quite an uproar until the effective date was clarified. But the good news is that the current proposal would give the industry a lot of time to prepare for the tax, if it is enacted," said Humphreys.

"The bill if enacted might have significant ripple effects in the global capital markets. For example, I don't know whether foreign governments will require similar compliance agreements by U.S. financial institutions in the future," he added.

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