Foreign Tax Credit Claims Escalate In US

by Mike Godfrey, Tax-News.com, Washington

05 June 2009

The volume of foreign tax credits claimed on tax returns by US businesses and individuals has increased substantially in recent years according to Internal Revenue Service Commissioner, Doug Shulman.

From 2000 to 2007, the amount of foreign tax credits claimed by US firms and individuals rose by 71% and an “eye-popping” 133% respectively, Shulman said in an address to the Organization of Economic Cooperation and Development (OECD) on June 2. This trend, he argued, was just one of the reasons why the United States, and other governments, should focus tax compliance efforts on policing the increasingly complex world of international taxation.

“More businesses and individuals are using the global capital markets as a vehicle for investment, illustrating the opportunities presented by the development of capital markets, but also some of the challenges. Regulatory bodies and governments worldwide are wrestling with complex challenges without easy answers,” he noted.

Whilst admitting that there was no “silver bullet” to solve this set of complex issues, Shulman said that the IRS was in for the long-haul and has devised a multi-year strategy to increase the agency’s capability to deal with sophisticated corporate and individual taxpayers who operate on a global basis. Nonetheless, he claimed that “the tide is turning” to the national tax collectors’ advantage.

“All the right pieces are falling into place. And with the continued cooperation and commitment among nations and organizations, such as the OECD and JITSIC, we will create the right climate – an inhospitable climate for tax evasion and offshore secrecy,” he said.

Shulman’s speech was timed to coincide with the announcement of an agreement by tax authorities from around the world of a new cooperation plan to encourage tax compliance and counter tax evasion and abusive tax avoidance, with special focus on banks, wealthy individuals and offshore activities.

In the United States, the Obama administration has already proposed a number of far-reaching changes to international tax and information reporting rules primarily aimed at restricting the use of offshore and low-tax financial centres by US multinationals and individuals. Examples include changes to the “check-the-box” rules that can make foreign subsidiaries “disappear” for US tax purposes, restrictions on the ability to use foreign tax credits and new rules to prevent corporations from taking deductions on foreign investments until income is repatriated and can be taxed in the US.

Multinationals have warned, however, that these measures would only serve to decrease US competitiveness at the worst possible time in the economic cycle. “The United States is the only major industrialized country which double taxes the overseas earnings of our companies,” US Chamber of Commerce Chief Economist Dr. Marty Regalia has said. “A huge tax hike on US employers is not the way to stimulate our economy. Congress should reject this approach.”

Shulman also outlined proposed changes to the international tax regime for individuals, which is focused on strengthening the Qualified Intermediary (QI) regime.

“The Administration proposes to impose significant withholding tax on transactions involving non-Qualifying Intermediaries,” he said. “Specifically, it would require US financial institutions and QIs to withhold 20 percent to 30 percent of US payments to individuals or businesses who use non-QIs. To get a refund for the amount withheld, investors must disclose their identities and demonstrate that they’re obeying the law.”

The plan also creates a legal presumption against users of non-QI institutions, something Shulman described as “a real game changer.” This means that US citizens who send money to foreign persons not participating in the QI scheme would have to provide “convincing evidence” to prove they’re not breaking US tax laws. These legal presumptions would also make it easier for the IRS to demand information and pursue cases against international tax evaders, Shulman said.

In addition, QIs would be required to report worldwide information on their US customers to the same extent that US financial intermediaries do. In addition, US persons, US financial institutions, and QIs will be required to report cross-border transfers to Non-QIs. Shulman also spoke of agreeing some form of multilateral QI regime with other nations.

These proposals have set alarm bells ringing with foreign banks, some of which have warned that they will not be prepared to service US clients if the new requirements become law in the US. For example, the Association of Private Client Investment Managers and Stockbrokers in the UK has said that the QI regime is already an "administratively burdensome and costly regime" and the new proposals could breach UK laws on data protection.

To pursue this aggressive international tax compliance agenda, the President’s 2010 budget provides the IRS with unprecedented new resources including 800 new staff dedicated to international enforcement.

"At the IRS, we are very committed to adapting and evolving as circumstances evolve,” Shulman said. “We are committed to get it right, and it will remain a top agenda item for us.”

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