Experts at Baker & McKenzie go through the fine print of updated US instructions on foreign bank accounts, a key issue as the IRS continues its drive against alleged tax evasion.

Editor's note: This publication is grateful to Baker & McKenzie, the global law firm, for letting it republish its guidance to the latest instructions from the US Internal Revenue Service on the treatment of foreign bank accounts.

On 26 March 2011, the IRS published a new Foreign Bank Account Report form with revised instructions. While no changes have been made to the FBAR form itself, the revised instructions reflect the final FBAR regulations that became effective on 28 March 2011.

Accordingly, persons filing FBARs after 28 March 2011 must use the new form and follow the revised instructions (including for FBARs required to be filed by 30 June 2011 with respect to foreign financial accounts maintained in calendar year 2010).

Persons who filed their FBARs for calendar year 2010 prior to 28 March 2011 are permitted to rely on the old FBAR regulations and guidance or may reference the final regulations when responding to questions regarding foreign financial accounts on their 2010 returns.

Persons who need to file delinquent FBARs or amended FBARs for calendar years prior to 2010 have to use the new FBAR form. It is unclear whether the final regulations or new instructions need to be followed when filing such delinquent or amended FBARs. Arguably, persons filing such returns should not be required to follow the new final regulations or new instructions because they are not applicable retrospectively.

In general, the new instructions follow the final FBAR regulations. However, there are some minor differences which will be noted below. Among other changes, the new instructions:

-- revise the definition of “US person”;

-- clarify what is an account and whether it is “foreign”;

-- address the treatment of custodial accounts;

-- clarify the definition of financial interests;

-- revise the definition of signature or other authority; and

-- specify that officers or employees who have signature authority over the foreign financial accounts of their employer are not expected to personally maintain records of those accounts.

Background

Pursuant to the Bank Secrecy Act, each US person that has a financial interest in or signature or other authority over any foreign financial accounts in a foreign country, must report these accounts on US Treasury Form TD.F 90-22.1 (Report of Foreign Bank and Financial Accounts), commonly referred to as an “FBAR,” if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year. The FBAR must be filed with the US Treasury Department for a calendar year no later than June 30 of the following year. In addition, persons required to file an FBAR must retain records of the accounts for a period of five years.

For purposes of this requirement, a US person includes a citizen or resident of the US, a US domestic partnership, a US domestic corporation, or a US domestic estate or trust. US citizens and residents must also disclose an interest in a foreign financial account on Schedule B of their annual US tax return in addition to filing an FBAR.

Definition of US Person

The new instructions amend the definition of “US person” for purposes of the obligation to file an FBAR. A US person is defined as a US citizen, a US resident, or an entity formed under the laws of the US, any state, the District of Columbia, a US territory or possession, or an Indian (i.e. Native American) Tribe. This definition differs from the definition of a US person for US federal income tax purposes, particularly in defining who is a US resident and when a trust is considered a US person.

A person qualifies as a US resident if they meet any of the residency tests listed in Internal Revenue Code section 7701(b), which include: (i) the lawful permanent residence test (green card test); (ii) the substantial presence test; and (iii) the first year election. When applying these residency tests for the purpose of the FBAR, the definition of US is expanded to include any State, the District of Columbia, a US territory or possession, or Indian land as defined in the Indian Gaming Regulatory Act.

The instructions specifically note that the US federal tax treatment of an entity does not determine whether the entity has an FBAR filing requirement. Therefore, entities that are disregarded for US federal tax purposes must file an FBAR if otherwise required to do so. Similarly, a trust for which the trust income, deductions, or credits are taken into account by another person (e.g. a grantor trust) for US federal tax purposes must file an FBAR if otherwise required to do so.

Normally, for US tax purposes, a trust qualifies as a domestic trust if it satisfies the “court test” and the “control test” listed in the Internal Revenue Code section 7701(a)(30)(E). These tests focus on the administration of the trust and not necessarily where the trust was formed. The instructions to the FBAR do not use these tests. For FBAR purposes, a trust is now defined as a US person when it was created, organised, or formed under the laws of the US regardless of whether it satisfies the court test or control test.

Definition of foreign accounts

The FBAR reporting obligation applies to foreign financial accounts. The new instructions clarify further what constitutes a financial account. Added to the items listed in the prior instructions are insurance policies with cash value, such as a whole life policy. However, unlike the final regulations, the new instructions do not mention that the reporting obligation is the responsibility of the policyholder and not the beneficiary.

The new instructions explicitly impose an FBAR filing obligation on the holders of shares of foreign mutual funds or similarly pooled funds that are available to the general public and that have a regular net asset value determination and regular redemptions.

The new instructions clarify when an account is considered “foreign” for the purpose of filing an FBAR. An account is a foreign account if it is maintained with a financial institution located outside of the US. The examples given in the instructions focus specifically on the physical location of the branch that maintains the account regardless of whether it is a branch of a US or non-US bank.

Financial interest

The new instructions expand and clarify the definition of a financial interest in a foreign financial account. In the case of a trust with a foreign financial account, the instructions impose a reporting obligation on the grantor of any trust that, for US income tax purposes, is considered a grantor trust.

The instructions provide a filing exception for trust beneficiaries who have a present beneficial interest in the assets or income of the trust for the calendar year. If the trust, the trustee of the trust, or agent of the trust is a US person and files an FBAR disclosing the trust’s foreign financial accounts, then the beneficiary is not required to file an FBAR with respect to those accounts.

The instructions add a new category where a US person has a financial interest in a foreign financial account. In situations where the owner of record or holder of legal title is an entity in which a US person owns directly or indirectly more than 50 per cent of the vote, value, or interests in profits, the US person has an FBAR reporting obligation.

This appears to be a catch all for US persons who meet the ownership requirements of entities that do not fall under the previously listed classifications of corporation, partnership, or trust, such as foundation (Stiftung), establishment (Anstalt), etc.

Interestingly, however, the new instructions do not mention the anti-avoidance provision included in the final regulations. The provision states that if a US person causes an entity (including, but not limited to, a corporation, partnership, or trust) to be created for the purpose of evading the FBAR reporting requirement, such person will have a financial interest in any foreign financial account for which the entity is the owner of record or holder of legal title.

The final regulations clarify that the term “evading” is not intended to apply to persons who make a good faith effort to comply with the final rule.

Signature authority

The new instructions clarify when a person has “signature authority” over an account. Signature authority is defined as the authority of an individual (alone or in onjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account. This definition of signature authority only applies to individuals. An individual has signature authority over an account, therefore, if a foreign financial institution will act on a direct communication from the person regarding the disposition of the assets in the account.

Previously, an FBAR was required if the foreign financial institution would act on either direct written communication or indirect oral or written communication. As currently written, the FBAR instructions exclude indirect oral or written communication because having “other authority” is no longer a trigger to an FBAR filing requirement. The previous instructions separately defined “other

authority” so a US person had to report a foreign account on their FBAR if he/she could exercise comparable power over the account directly or through an agent, nominee, attorney, or in some other capacity on behalf of a US person, orally or otherwise. In contrast, the new FBAR instructions do not make any reference to other authority over an account.

The new instructions also list multiple situations where an individual who has only signatory authority over a foreign financial account will be relieved of his/her reporting obligation. The majority of the exceptions deal with officers and employees of entities that are examined by Federal bank supervisory agencies, registered with the Securities and Exchange Commission, or are traded on a US national securities exchange.

Recordkeeping and truncated filing related to signature authority

A person required to file an FBAR is also subject to certain recordkeeping obligations. Generally, a US person is required to keep records regarding their foreign financial accounts for a period of five years; however, the instructions clarify that officers or employees with only signature authority over the foreign financial accounts of their employer are not required to personally maintain the records of those foreign financial accounts.

An exception is given to US persons employed in a foreign country. A modified form of reporting is available to US persons who are employed in a foreign country and who have signature authority over foreign financial accounts owned or maintained by their employer. Only the filer’s identifying information and the account owner’s identifying information needs to be reported. This excludes any information regarding the value, type, or location of the account.

In an attempt to simplify the reporting for US persons with FBAR filing obligations on 25 or more foreign financial accounts, the instructions provide that those persons need only provide the number of financial accounts and certain other basic information (name, TIN, address, etc.) on the report.

These persons will remain responsible for providing detailed information concerning each account if requested. The instructions state that “other basic information” differs between those with a financial interest in the accounts and those with only signatory authority over the accounts. Those having a financial interest in the accounts must report the number of accounts and identifying information about themselves. Those having signature authority over the accounts must report the number of accounts and identifying information about themselves as well as those who have a financial interest in the accounts.

Previously, FinCEN has clarified that the additional information is required by those with only signatory authority to ensure that law enforcement receives meaningful information about these accounts.

Miscellaneous provisions

The new instructions contain a number of other additions that are also worthy of mentioning:

-- An amendment to a previously filed FBAR should not be made until at least 90 calendar days after the original FBAR is filed.

-- The maximum value of an account is determined first in the currency of the account. That amount is then converted into US dollars using the Treasury’s Financial Management Service rate from the last day of the calendar year. There is no specific reference to quarterly statements like the previous instructions; however, there is a reference to “periodic statements” that “fairly reflect” the maximum amount value.

-- The instructions allow for the possibility to enter “value unknown” for “each of [the] accounts” if it is not clear that the accounts in the aggregate are more than $10,000. This exception will not apply in instances where the maximum values are not known at the time of filing the FBAR but it is clear that the aggregate value of the accounts is greater than $10,000 (e.g. if one account is $15,000 but the value of another two accounts is unknown, “value unknown” can not be entered or the filing would be considered incomplete.)

-- The instructions state that a form can be provided to a local IRS office, US embassy, or consulate to forward to the Treasury; however, the form will not be considered filed until it is sctually received by the Treasury. The instructions also include a physical address for courier delivery.

-- Applicability date

The new FBAR form and instructions are effective immediately with respect to foreign financial accounts maintained in calendar year 2010 and all subsequent calendar years.