Editor's Note:  In the February 2011 issue of Hemispheres, international business attorney Joel Nagel wrote about provisions in a 2010 jobs bill called the HIRE Act that could affect your ability to move funds abroad outside the U.S.  The provisions require both U.S. and foreign banks to withhold 30 percent of any transfer to foreign financial institutions that don’t meet United States standards for information sharing, and remit that percentage to the Internal Revenue Service (IRS) as a tax payment.  To get the payment refunded when you file your U.S. tax return, you have to show that the funds transferred were already taxed.

Most countries in the world, however, do have tax information sharing agreements with the IRS.  Could you avoid the withholding provisions simply by avoiding transfers to countries that the IRS considers non-compliant tax havens?  Below, Joel answers that question in detail.

Its not really as simple as just avoiding banks in countries that don't share information with the IRS.  The law does distinguish between countries that have tax information exchange treaties (TIEAs) with the US and those that don't, but its not a question of just making a list.  All TIEAs are not the same.

The HIRE act really is intended to force bank cooperation, and direct agreements by individual banks with the IRS to supply any and all information that the bank has about all U.S. clients.

Some TIEAs don't go that far.  They allow for the IRS to ask for information about a specific client or specific transaction.  Switzerland, for example, limits the scope of information and circumstances under which information can be disseminated to particular cases of tax fraud.  I suspect that the final agreement that emerges from Panama (and I understand that the deal still has to be approved by the Panama legislature) will be similar.  TIEAs with limits such as these do not meet the requirements of the HIRE Act.

However, agreements with other developed countries such as Germany or Canada already allow for a free flow of information back and forth, so banks in those countries would not have to negotiate individual agreements with the IRS.

But even that is not the full story. Individual banks in those countries will still have not only the obligation to disclose the identities of all U.S. clients, but also U.S. transactions -- particularly when those transactions go to other (and especially non-compliant) jurisdictions.

So if a German bank wires money to a Hong Kong bank for receipt by a client with a U.S. beneficial connection, then that German bank must disclose the transaction to the U.S. government.  If the German bank fails to disclose the transaction, then it subsequently becomes subject to U.S. bank withholding tax on any incoming transaction from any other bank worldwide.

So again, to stay with the German example, if Deutsche Bank transfers money to a bank in Hong Kong for receipt by a U.S. client, and the Hong Kong bank does not have an agreement with the U,S, and the German bank does not collect the tax funds and remit the information and funds to the IRS, then Deutsche Bank becomes subject to the tax the next moment that  a compliant bank -- for example, a bank in New York or Australia -- wires money to the German bank.

What we have is an overlapping system of public sector agreements (between the U.S. and other governments) and private sector agreements (between individual banks and the IRS).  A public sector agreement allows for the individual institution to supply information to the IRS, and the presumption is that the banks will indeed do that.  But if a bank falls short in its  global enforcement on behalf of the IRS, it can be grouped with  non-compliant institutions and countries.

Conversely, the IRS presumes that banks in non-compliant countries will be non-compliant about supplying information, so the 30 percent withholding tax will be required.  It then becomes incumbent on the individual bank to decide how it wants to operate going forward.  It can choose any of the following actions:

1)  The bank can provide an affidavit to the IRS that it has no U.S. customers -- including U.S. clients with individual assets less than $50,000.  By doing so, it is not subject to the withholding tax.

2)  The bank can refrain from doing transactions in U.S. dollars.   All U.S. dollar transactions must pass a U.S. Federal Reserve Bank, which is the point at which the US Government can exert authority and control.  If a financial transaction is done in, for example, Japanese yen, then it eventually must pass through the Bank of Japan, not a U.S. Federal Reserve Bank -- and so is not subject to IRS withholding.

3)  The bank can choose to protect its clients' privacy and ignore the HIRE Act rules.  In that case, any U.S. client will simply have to plan around the 30 percent withholding tax on any transfer made in U.S. dollars (which is, after all, a credit to be claimed on the U.S. taxpayer's account).

4) The bank can choose to enter into a private agreement with the IRS, and thereby avoid being subject to withholding on transfers in U.S. dollars for U.S. clients -- unless those transfers are to a non-compliant bank.

So again, it is not a simple issue of an entire country -- or even an individual bank -- being on or off a list of IRS-compliant entities.  Like a constantly moving target, countries and banks will be moved on and off the lists of which are compliant and which are not, depending on how well they show their willingness to enforce the new law.

As a result, the estimated enforcement cost of the HIRE Act -- which is being thrust onto banks worldwide -- is many times higher than the anticipated increase in tax revenue collection

The law is actually an unprecedented effort by the U.S. to bring every bank in the world under its domain and control in regard to financial transactions by U.S. persons.  So, you can imagine that unless a foreign bank has a significant number of U.S. clients (and significant income from those clients), they probably will be inclined to simply not accept U.S. clients after the law goes into effect.

Its clear that the web is being woven tighter and tighter, with the U.S. Treasury calling the shots on all types of foreign banks and foreign transactions on behalf of U.S. citizens.