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Obama’s new act will prove costly for City firms

PARTNER, WITHERS LLP

ON 18 March 2010 President Obama signed the Hiring Incentives to Restore Employment (HIRE) Act, creating far-reaching client identification and disclosure requirements for every City bank, financial institution, brokerage house and fund structure. While the act is intended to boost US employment through tax breaks for US businesses, it also contains revenue-raising provisions, which will give the IRS “new tools to find and prosecute US individuals that hide assets overseas”. These latter provisions will impact financial institutions across the globe.

The HIRE Act is a quantum step beyond the Stop Tax Haven Abuse Act previously co-sponsored by then Senator Obama. Whereas the Stop Tax Haven Abuse Act would have created a limited jurisdiction blacklist, the HIRE Act effectively creates a worldwide institutional blacklist for any “foreign financial institutions” (FFI) opting not to adopt the new procedures. The HIRE Act aims to combat tax evasion through imposing extensive reporting requirements about US taxpayers’ assets that are held outside of the US. Its primary targets are FFIs, banks, funds and collective investment structures which either serve US clients or invest in US equities or bonds. In other words, nearly every City firm. Numerous entities such as trusts and family offices – which would not fall under the definition of financial institutions themselves but who invest through FFIs – will also be affected.

Under the new rules, effective from 1 January 2013, unless an FFI enters into an enters into an information-sharing agreement with the IRS, it will be subject to 30 per cent gross withholding on all of its US investments (whether for the account of the FFI itself, its US account holders or its non-US account holders). FFIs may well have to review their client base annually to identify any US account holders and report their names and addresses, as well as the account number, the account balance and any gross payments or withdrawals to the IRS. The FFI will also be required to comply with any due diligence or verification procedures imposed by the US Treasury under regulations to be issued this autumn.

FEW EXEMPTIONS
Despite intense lobbying by a wide variety of banking and fund associations, the IRS has informally indicated that relatively few categories of FFIs will be exempt from these compliance requirements. Almost all FFIs will have to trawl through their entire client bases to establish whether they have any US citizens or green card holders on the books, as well as accounts of trusts, companies and foundations affiliated with US persons under detailed rules to be issued in the autumn. Compliance and reporting costs will soar. This has already prompted suggestions that many would opt to refuse services to US persons completely, rather than handle the added compliance burden. In a straw poll conducted by Withers at a recent seminar, 95 per cent of respondents said they expected to see a growing number of instances where US individuals are refused banking or financial services outside the US as a result of the HIRE Act. Nevertheless, it seems unlikely that FFIs would be in a position to certify that they have no US account holders unless they in fact adopt the HIRE Act procedures for identifying US account holders, thus leading to a chicken and egg scenario certain to vex FFIs over the coming months.

The other (theoretical) option for avoiding application of the HIRE Act is to avoid US investments entirely. However, the importance of US investments to both FFIs themselves and their account holders was highlighted in the Withers survey, 87 per cent of respondents believing financial institutions would comply with the Act to maintain competitive advantages in US investments.

The City cannot escape the HIRE Act’s reach. Management teams within financial institutions and funds, together with trustees and family offices, will need to understand the composition of their customer and beneficiary bases and learn to comply effectively with the new regime if they are to service their clients efficiently and avoid subjecting both their investments and their clients’ investments to huge costs.