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IRS Regulations for US Investments by US Citizens through Foreign Banks
by Warren Furth, ACA Director
September 2007
As of January 1, 2001, IRS regulations came into effect which had a major impact on investments by "US persons" (as defined by the IRS, this term refers to US citizens, including those with dual citizenship, and green card holders) in US assets (e.g., US equities and bonds) held for them in foreign banks.
Unless the foreign bank has obtained the status of "qualified intermediary," it must, under the terms of the regulations, report to the IRS all earnings received from the US with the names of the beneficial owners. Fines may be imposed if the bank does not comply with this obligation. Although it is difficult to see how these regulations can be enforced legally abroad, a major Swiss bank has speculated that the US authorities might move to block assets which are deposited in the USA in the name of a noncomplying foreign bank.
Foreign banks can claim exemption from US withholding tax on US-source dividends and interest for their non-US clients without being required to disclose the names of the beneficial owners by becoming a "qualified intermediary" (QI). In order to gain QI status the foreign bank must enter into a "QI agreement" with the IRS according to which the bank undertakes to comply with a comprehensive series of regulations. It is believed that most foreign banks which invest in US equities, bonds, money market funds or other financial instruments on behalf of their clients have concluded that it is to their advantage to sign such a QI agreement.
While the QI system thus maintains the principle of bank secrecy with respect to non-US persons, it also ensures that no US person can make investments in US assets through foreign banks without duly declaring them. Under this system US persons are permitted to acquire or hold US investments through a QI only if they declare that they are willing to disclose their identity to the IRS. The QI has to obtain written authorization from clients who are US persons and hold US investments either (a) to forward Form W-9 (disclosure of identity), completed by the client, to the US withholding agent, or (b) to sell the US assets. If the US person does not authorize either course of action, the QI has to deduct and send to the IRS a 31% backup withholding tax on all earnings on the US assets. Moreover, when such assets are sold (or redeemed), the proceeds (and not just the capital gains!) are also subject to the deduction of the 31% backup withholding tax.
It should be stressed that none of the above applies to US persons who have only non-US assets in foreign banks or to US persons whose US assets are held in US banks or financial institutions (e.g., brokers) in the USA.
Clients of foreign banks who have investments in the USA normally receive more detailed information from their banks. If such information is not forthcoming, they would be well advised to contact their bank to determine whether the bank has obtained QI status and what course of action, if any, should be taken with regard to their US assets.
ACA, September 2007