I.R.S. to Tighten Tax Oversight of Foreign Banks

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I.R.S. to Tighten Tax Oversight of Foreign Banks

Post by Mr. Mephistopheles » Thu Oct 16, 2008 6:47 pm

I.R.S. to Tighten Tax Oversight of Foreign Banks
By LYNNLEY BROWNING - The New York Times
October 16, 2008
The Internal Revenue Service is tightening up its oversight of foreign banks that sell offshore services to wealthy American clients, a move intended to stem what officials have called rampant tax evasion.

New rules, issued Monday, apply to a little-noticed, multibillion-dollar I.R.S. program that allows participating foreign banks to funnel hundreds of billions of dollars overseas on behalf of American clients without disclosing their names to the I.R.S. In return, the banks promise to know who their clients are, withhold any taxes due on United States securities in their accounts — typically 30 percent — and send that money to the I.R.S.

More than 7,000 foreign banks participate in the program, which was established in 2001 to help attract foreign investors to United States securities.

But the program, known as qualified intermediary, has come under scrutiny as an offshoot of a federal investigation into the Swiss bank UBS, the world’s largest private bank. Prosecutors contend that UBS deliberately abused the program by selling American clients offshore banking services that went undeclared to the I.R.S. and allowed those clients to evade taxes.

Prosecutors suspect UBS of helping its American clients hide as much as $20 billion in assets offshore, thereby evading at least $300 million in taxes. While using offshore accounts is not illegal for United States taxpayers, hiding income in so-called undeclared accounts is.

The I.R.S. has grown concerned in recent months that it has delegated too much control and authority to the banks and that in recent years American investors have been evading taxes by hiding behind offshore shell companies and trusts set up by the banks.

Under its new rules, banks in the program must now actively determine whether United States investors are behind the foreign accounts they set up.

The new rules, which will go into effect in 2010, will also require banks in the program to alert the I.R.S. to any potential fraud that they detect, whether through their own internal controls, complaints from employees or investigations by regulators. Still, the I.R.S. said it would not automatically cancel a bank’s participation in the program should such concerns come to light.

The I.R.S. will also begin auditing small samples of individual bank accounts in the program, without knowing the clients’ names, to determine whether United States investors actually have control over foreign entities set up by the banks.

The program will also place more duties on external auditors, which participating banks must hire to monitor their compliance. The auditors will have to zero in on the bank employees responsible for identifying and preventing abuse of the program. The external auditor will now be required to report any red flags to the I.R.S.

In addition, banks using foreign-based external auditors, including foreign branches of United States auditors, will have to work with an American auditor, which in turn will accept joint responsibility for the audit.

“This is a tightening up, flowing out of the UBS situation,” said H. David Rosenbloom, an international tax lawyer at Caplin & Drysdale in Washington, and a former Treasury official.

In 2003, banks in the program sent more than $35 billion abroad to individual investors, partnerships, trusts and the like, but withheld taxes of only 5 percent on that amount, according to a government study. The entities receiving the income claimed exemptions under foreign tax treaties with the United States, but if United States investors were behind those entities, they were not entitled to the exemptions.

Douglas Shulman, the I.R.S. commissioner, said Wednesday, “This is an important program, and we cannot tolerate anyone abusing or skirting the requirements.”