During the late fall of 2009, congressional Democrats introduced the Foreign Account Tax Compliance Act (FATCA). FATCA, which perhaps not unintentionally has a moniker that is strikingly close to “Fat Cat,” has gained considerable attention in the financial sector. FATCA would, in addition to other provisions, impose tax-withholding obligations on certain payments made to offshore accounts and non-U.S. entities as well as robust disclosure obligations. The public policy driving FATCA lies with concerns over rampant abusive practices involving the use of offshore accounts and business activities intended to evade U.S. taxation. The notion of combating suspicious financial and money laundering activities is familiar within the gaming industry.
Gaming industry businesses participate both directly and indirectly in the global marketplace. It is now commonplace for casino operators to own properties not only in multiple states, but also in foreign jurisdictions. Recent investment news illustrates this, detailing the offshore projects and joint ventures major casino operators have undertaken in Macau, Singapore and elsewhere. Gaming equipment suppliers similarly participate in the global economy. Gaming equipment manufactures routinely sell products in nearly all corners of the globe. The global economy—and the impact U.S. tax policy has on offshore operations—is not purely a concern of a select few major casino operators and gaming equipment suppliers. Even a single-property casino operator or tribal gaming entity can be impacted by U.S. international tax policy. For example, the purely domestic casino property may bump into U.S. international tax laws when purchasing gaming equipment manufactured by a non-U.S. supplier. Or a tribal gaming authority may indirectly participate in offshore activities, for example, by investing in an offshore hedge fund. Therefore, if enacted, FATCA will impact the gaming industry.
Background
2009 was a watershed year for tax policy. In the spring of 2009, the Obama administration made public a strong anti-business proposal to overhaul the U.S. system of taxing international activities. The proposal contained some less controversial measures that would modify withholding rules and increase information reporting. Then, throughout 2009, the ongoing dispute between the IRS and Swiss banking giant UBS concerning the disclosure of the identities of thousands of U.S. taxpayers who hold offshore accounts consistently made international news headlines. U.S. law mandates that U.S. taxpayers annually disclose any “foreign financial” that has a value exceeding $10,000 by filing a Report of Foreign Bank and Financial Account (FBAR). Failure to file an FBAR is not only subject to draconian civil penalties, but also criminal sanctions.
The IRS-UBS controversy spurred the IRS to introduce a voluntary disclosure initiative allowing taxpayers with undisclosed offshore accounts to come forward, disclosing their accounts in exchange for avoiding criminal prosecution and reduced civil monetary penalties. In early June 2009, the investment community began to hyperventilate when, during a continuing legal education teleconference, three IRS personnel made the observation that equity interests in offshore hedge and private equity funds—that is, in no uncertain terms, equity interests in business entities—may constitute an interest in a foreign financial account. For the cautious, the IRS position with respect to what can qualify as a foreign financial account could present concerns as to whether current ownership structures implemented to conduct foreign activities, which, for example, may entail the use of foreign holding companies, must be disclosed by filing an FBAR.
The gaming industry is familiar with the underlying policy goal of the withholding and disclosure rules contained in FATCA. Specifically, the provisions are designed to prevent efforts to evade U.S. taxation. Baked within the concept of mitigating tax evasion are anti-money laundering and suspicious activity disclosure principles. The gaming industry, through existing IRS-imposed obligations to report suspicious activities and certain monetary transactions, is well versed in the policy goal to reduce incidences of money laundering and suspicious activities.
Key Provisions
The provisions of FATCA can be categorized into a handful of subject matters, including (1) the imposition of new reporting and withholding obligations on certain payments; (2) expanding the requirement to disclose certain foreign assets; (3) introducing refund and crediting rules; and (4) providing new rules for dividend-equivalent payments.
Reporting Requirements and Withholding
FATCA would establish rules mandating that a person who does not meet certain exceptions and who makes a payment to a “foreign financial institution” must withhold an amount equal to a 30 percent tax from the payment. The withholding tax under FATCA applies to U.S. accounts maintained at a foreign financial institution. Hence, the definition of the terms “withholdable payment,” “foreign financial institution” and “financial account” are important to determining whether the FATCA withholding obligations would be triggered.
Under FATCA, a person would not be required to withhold a 30 percent tax if the foreign financial institution enters into an agreement with the IRS that obligates the financial institution to, among other matters, obtain required information concerning the account holder; adhere with know-your-customer due diligence-type procedures; annually disclose certain information to the IRS; comply with information requests from the IRS; and attempt to obtain waivers of foreign privacy laws.
Absent entering into an agreement with the IRS, foreign financial institutions would be required to withhold a 30 percent tax on all “withholdable payments.” FATCA broadly defines withholdable payments to include payments of interest, dividends, rents, salaries, wages, premiums, annuities, gains, profits and any other income from U.S. sources.
The act further provides for an expansive definition of the term “foreign financial institution,” which would likely reach private equity and hedge funds. The Joint Committee of Taxation’s (JCT) technical explanation of FATCA observes that “the term financial institution may include, among other entities, investment vehicles such as hedge funds and private equity funds.” The JCT explanation generally states that a financial institution includes “any entity engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, interest in partnerships, commodities or any interest (including futures or forward contract or option) in such securities, partnership interest, or commodities.”
The term “financial account” would include depository or custodial accounts. While not necessarily intuitive, “any equity or debt interests in a foreign financial institution” would also be considered to be a financial account.
The definitions of the key terms relative to the FATCA withholding rules are expansive and leave considerable latitude for the IRS to broadly apply the withholding rules.
The reporting and withholding rules would further be extended to payments to “other foreign entities.” In addition to requiring a person making a payment to a foreign financial institution to withhold a 30 percent tax absent entering into an agreement with the IRS, FATCA also imposes a withholding tax at the rate of 30 percent on withholdable payments made to any non-financial foreign entity when the beneficial owner does not meet certain prescribed requirements. FATCA defines “non-financial foreign entity” in the negative by providing that a non-financial foreign entity is any entity other than a foreign financial entity. Thus, the withholding obligation could apply to a wide array of entities.
Reporting and Disclosure
The new reporting and disclosure requirements that FATCA would impose buttress the current obligation of U.S. taxpayers to file a FBAR with respect to certain foreign financial accounts. A “specified foreign financial asset” with an aggregate value exceeding $50,000 would be subject to enhanced information reporting rules. FATCA embraces a wide scope of the types of assets that may fall within the definition of a “specified foreign financial asset.” The class of assets would include not only depository and custodial accounts, but also stocks or securities issued by a foreign person, financial instruments or contracts held for investment, and any interest in a foreign entity. Failure to file the requisite information return would be subject to a minimum $10,000 penalty and a maximum $50,000 penalty.
Refunding and Crediting
An interesting dynamic in FATCA is the interplay between new withholding requirements and existing U.S. tax treaties that may reduce or altogether eliminate withholding obligations. Treaty exemptions would remain effective, but an additional—and, perhaps, convoluted—layer would be added with regard to how the exemption is gained. While a U.S. tax treaty with a foreign country may eliminate withholding on, for example, interest payments, FATCA would operate by still requiring withholding. In order to regain the treaty benefits, FATCA provides for procedures to refund and provide credits against tax for amounts withheld from otherwise U.S. tax-exempt income. One aspect worth highlighting is that interest would only begin to accrue on refunds after 180 days. Thus, when significant amounts are withheld, there can be correspondingly significant earnings lost.
Dividend-Equivalent Payments
FATCA would also introduce new rules concerning the treatment of payments under certain swap transactions. Businesses will often enter into equity swaps using notional principal contracts to gain favorable tax treatment for payments that may be a proxy to a dividend payment. Under FATCA, dividend equivalents are treated as a payment of a dividend from U.S. sources. The FATCA rules would reach certain swap transactions that are based on stock dividends. Thus, withholding rules can be implicated with regard to foreign individuals.
Implications for Gaming
FATCA will have implications for the gaming industry. As with any other industry involved in foreign business activities, FATCA will impose new compliance obligations. These obligations will undoubtedly involve more resources and may require undertaking greater due diligence with respect to the recipients of payments that businesses make. Additionally, gaming businesses with offshore activities will also have to decipher the extent to which interests in offshore entities may be subject to FATCA.
While FATCA does impose new withholding and reporting obligations, which can be viewed as onerous in some respects, these provisions are not necessarily the highly controversial aspects of the Obama administration’s international tax overhaul proposal. The proposals are largely the product of input from the U.S. Department of the Treasury and Congress and are aimed at reducing the incidence of tax evasion, money laundering and other suspicious activities. As of the time of this writing, Congress has not enacted FATCA. Nonetheless, the prospects are relatively high that FATCA will be enacted in some form. Thus, gaming businesses may want to start becoming familiar with FATCA and assessing how it will impact current business practices.
Peter J. Kulick is a tax and gaming attorney with Dickinson Wright PLLC, which has an international gaming law practice with offices in Michigan, Nashville, Washington, D.C., Toronto and Phoenix. He received his LL.M in tax law from New York University. Kulick may be reached at pkulick[at]dickinsonwright.com.
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