US Bankers Attack IRS Deposit Interest Reporting Requirement

Tax-News.com, New York

03 December 2002

With yesterday the last day for public submissions to the IRS on its proposal to compel US banks to report interest payments on deposits made by non-resident aliens, a last-minute influx of negative comments was reaching the agency, adding to the substantial mail-bag which has seen numerous organisations and many members of Congress objecting to the measure, which is widely seen as disastrous for US banks.

The banks themselves are in no doubt about it. The American Bankers Association wrote to the IRS for a second time on November 14th, commenting on the proposed regulation. More than 20 months ago, on February 27, 2001, the ABA stated that the "ABA disagrees with placing these new reporting burdens on the banking industry, and we strongly recommend that the Service withdraw the Proposed Regulations."

The new letter sent in November stated, "The ABA previously submitted comments opposing proposed regulations that were issued on January 17, 2001 and subsequently withdrawn. . . Although the new Proposed Regulations are more limited in scope, they impose similar reporting requirements to nonresident alien individuals from 16 specified countries. We have outlined our tax policy concerns with respect to the more expansive former proposed regulations [in our February 27, 2001 letter]." The recently released letter goes into more detail on its objection to "two specific reporting burdens."

In its new letter, the ABA points out that its members already have experience of implementing a reporting requirement for Candian citizens, and this allows them to be sure that the bureaucracy attached to the requirement (applying initially to 15 additional countries) would be very costly, particularly in relation to joint accounts, where the allocation of interest payments between two or more account holders with differential rights and accompanying identification problems would be problematic.

The ABA's February 27, 2001 letter is below:

Ms. Kate Y. Hwa
Office of Associate Chief Counsel (International)
Internal Revenue Service
Room 5226
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: Comments on Reporting of Bank Deposit Interest Paid to Nonresident Aliens

Dear Ms. Hwa:

The American Bankers Association ("ABA"), on behalf of its members, is pleased to have this opportunity to submit comments on the Notice of Proposed Rulemaking ("Proposed Regulations") relating to the reporting of bank deposit interest paid to nonresident aliens, as published in the Federal Register on January 17, 200l. The proposed regulations provide guidance on the reporting requirements for interest on deposits maintained at the U.S. office of certain financial institutions and paid to nonresident alien individuals. The ABA brings together all categories of banking institutions to best represent the interests of a rapidly changing industry.
Its membership - which includes community, regional, and money center banks and holding companies, as well as savings associations, trust companies and savings banks - makes ABA the largest banking trade association in the country.

The Proposed Regulations require information reporting for interest payments aggregating $10 or more on deposits from U.S. bank accounts to nonresident alien individuals. A Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, must be furnished either in person or to the last known address of the recipient. Currently, such deposit interest reporting is required under Treas. Reg. section 1.6049-8(a) for individuals who are residents of Canada. Special rules have been provided in the Proposed Regulations concerning joint account holders who are foreign persons. In this case, banking institutions are required to report the payment to the nonresident alien individual that is the primary account holder and a resident of a country with an income tax treaty or tax information exchange
agreement ("TIEA") with the U.S.The Proposed Regulations appear to apply to payments made after December 31 of the year in which they are published as final regulations in the Federal Register.

The ABA disagrees with placing these new reporting burdens on the banking industry, and we strongly recommend that the Service withdraw the Proposed Regulations. We are concerned about the potential impact the proposed regulations will have on global competitiveness within the financial services market. While the ABA recognizes and supports the reasonable compliance objectives of the Service, competition in the international market for financial services may be adversely affected m a result of these new reporting requirements. Several of our members are concerned that the unilateral imposition of these information requirements on U.S. banks will drive low cost bank deposit funding to foreign banks with no corresponding increase in voluntary compliance in the depositor's country of residence.
Additionally, the costs and administrative burdens created by the Proposed Regulations for the banking industry, and, ultimately, bank customers, significantly outweigh any benefits likely to be realized by the Service.

The Service has not identified sufficient tangible benefits resulting from the implementation of the Proposed Regulations other than a future goal of increasing voluntary compliance. Moreover, the ABA questions whether the Service's goal of voluntary compliance can be achieved by placing this reporting mandate upon the entire U.S. banking industry. For these reasons, and in keeping with longstanding international tax policies, the ABA strongly recommends that the Service withdraw the Proposed Regulations.

Nonresident alien bank deposit interest reporting would adversely impact global competitivenessU.S. banking institutions operate in a highly competitive global marketplace for financial services. Customers are offered many investment choices, including a wide variety of financial products and services that are available in the United States and abroad. Since the financial services market is fluid and sensitive to the manner in which business is conducted, certain governmental actions may adversely impact foreign investment choices. The mandated reporting of bank deposit interest to nonresident aliens as contained in the Proposed Regulations could have a deleterious effect on foreign investment in the U.S. In addition to the administrative burdens created by the reporting mandate, serious economic harm and a major decline in U.S. bank deposits could result if the Proposed Regulations were to be adopted. The reporting mandate ignores sound international tax policy
and would seriously impact foreign investment in the U.S. Numerous banking institutions would suffer, including many community banks. Therefore, the ABA strongly believes that the Service should withdraw the Proposed Regulations. The Service has stepped into an area that must first be reviewed and considered by Congress.

The Proposed Regulations are inconsistent with longstanding policies concerning bank deposit interest paid to nonresident aliens. The legislative history and current tax exemptions governing bank deposit interest reflect a clear congressional desire to encourage nonresident alien investment in the U.S. The Proposed Regulations impose obligations that are contrary to the intent of relevant tax code provisions governing the treatment of bank deposit interest paid to nonresident aliens. Bank deposits established in the U.S. by foreign persons were historically considered non-U. S, source. Under current law, U.S. bank deposit interest is exempt from U.S. income and withholding tax. 1.1LC. section 871(i)(2)(A).

The origins of the tax treatment of bank deposit interest can be found in the 1921 Revenue Act. The House Ways & Means Committee stated that "the exemption of such interest from taxation would be in keeping with the action of other countries and would encourage nonresident alien individuals and foreign corporations to transact financial business through institutions located in the United States."

During the time bank deposit interest was treated as foreign source, Congress also considered the economic consequences of a change designating bank deposit interest as U.S. source. In the Senate Report and Conference Report relating to Internal Revenue Code amendments made in 1966, the Senate stated that that "an immediate alteration of the present source rule might have a substantial adverse effect on our balance of payments." This prompted Congress at the time to defer any changes concerning the sourcing of batik deposit interest for a five-year period.

In 1976, Congress made the withholding tax exemption on bank deposit interest paid to nonresident aliens permanent. In the Tax Reform Act of 1986, Congress treated bank deposits established in the U.S. by. foreign persons as U.S. source income, but exempt from U.S. withholding tax. Only bank deposit interest that is considered effectively connected with a trade or business is subject to tax. This present law has its origins in and is presently built upon a policy designed to encourage investment in the U.S. and strengthen U.S. international competitiveness. The Proposed Regulations, if adopted, would threaten this longstanding policy and risk serious financial harm to many U.S. banking institutions. In addition, the proposed reporting requirements would not produce U.S. tax revenue or further direct compliance goals. Therefore, the ABA believes that, in this case, preservation of sound international tax policies designed to strengthen U.S. global competitiveness and protect the U.S. economy outweigh the Service's compliance objectives. The Service has stepped into an area that must first be reviewed by Congress.

The Proposed Regulations would impose significant costs and administrative burdens on U.S. banking institutions.In addition to the requirement of reporting bank deposit interest paid to all nonresident aliens, the Proposed Regulations provide guidance on the manner in which a Form I042-S is furnished when there are joint account holders, especially if all joint account holders are foreign persons. In such a case, the payor or middleman must report the payment to the nonresident align individual that is the primary account holder and a resident of a country with which the U.S. has an income tax treaty or a tax information exchange agreement ("TIEA").

The costs and administrative burdens associated with compliance with the new rules are horrendous. From a practical standpoint, costly software issues, along with the problems associated with identifying nonresident alien individuals, imposes significant burdens. Even capturing Form W-8 address information in the case of foreign customer with a U.S. address for statements and other correspondence would be a very labor-intensive effort for many banking institutions. Though banking institutions are currently required to report on a Form 1042-S to Canadian individuals, the process of identifying nonresident alien persons and upgrading systems to report for all nonresident alien customers who receive bank deposit interest represents a significant and unnecessary increase in burden for banking institutions.

The requirement in the Proposed Regulations dealing with reporting for foreign joint account holders represents the most significant burden. Payors must identify and report to the person residing in a country that has an income tax treaty or TIEA with the U.S. The difficulties in administering this requirement is based, in part, on the need to review all Forms W-SBEN and identify U.S. income tax treaty or TIEA countries. Such a requirement is overly complicated, administratively unrealistic, and increases the likelihood of reporting errors. The Service should recognize that most information reporting systems maintained by banking institutions, including very large money center financial institutions, are not equipped to handle the reporting requirements outlined in the Proposed Regulations.

The Proposed Regulations offer conflicting effective dates. As the Proposed Regulations are currently written, there is a discrepancy between the Background and Explanation of Provisions (Preamble) and the actual Proposed Regulations. The Preamble and Proposed Regulations section 1.6049-4(b)(5)(ii) indicates an effective date for payments made after December 31 of the year in which the Proposed Regulations are published as final regulations in the Federal Register. However, Proposed Regulation section 1.6049-6(5) applies to payee statements due after December 31. As stated above, the ABA strongly opposes issuance of the proposed Regulations for a variety of sound policy and administrative reasons. However, the effective date for any Proposed Regulation should be the same for all
provisions, and, in the case of a discrepancy, should be resolved in a manner that imposes the least amount of burden on the affected taxpayers.

Conclusion

The ABA appreciates this opportunity to submit comments on the Proposed Regulations. The banking industry files the bulk of information returns on behalf of the Service and remains the most compliant service provider. We believe that the Service is seeking to impose these additional information reporting burdens upon the banking industry in order to fulfill questionable and perhaps unattainable compliance objectives. At this time, we are unable to justify this latest compliance burden. The Proposed Regulations, if implemented, may disproportionately benefit our income tax treaty or TIEA partners, and perhaps countries that do not share such agreements with the U.S. The serious economic and administrative impact the reporting requirements could have on the banking industry are not justified by the
mere possibility of ensuring voluntary compliance by U.S. persons attempting to avoid the payment of taxes.

We look forward to working with the Service in an effort to resolve concerns with respect to the Proposed Regulations. If you need further information or assistance, contact me at (202) 663-5317 or email mbaran@aba.com.

Sincerely,

Mark R. Baran

cc: Pare Olsen
Deputy Assistant Secretary for Tax Policy
U.S. Department of Treasury

Pat Brown
Attorney Advisor
U.S. Department of Treasury

John M. Staples
Assistant Chief Counsel (International)
Internal Revenue Service

Carl Cooper
Attorney Advisor
U.S. Department of Treasury

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