US-UK Cross-Border Taxation in the Financial Arena Post-COVID-19By Julio M. Jimenez | October 27, 2020
The global response to the COVID-19 pandemic has not spared the horizon of cross-border taxation; residency issues from travel restrictions and telecommuting, shipping impacts on imports and exports, compliance difficulties and even enforcement initiatives by tax authorities have been impacted. The finance world has been equally affected; volatility in capital markets, financing arrangements that required workouts or adjusting to financing provided by governments to bolster the economy, changes in market standards, distressed debt, REITs impacted by real estate crashes and of course regulatory initiatives have all resulted from the pandemic. If that were not enough, the horizon between the US and the UK already had multiple issues affecting cross-border taxation before the pandemic; BREXIT entails a plethora of issues, the change from LIBOR to SOFR has potential impacts for US-UK financing arrangements, the momentum of cryptocurrency, FATCA, CRS and MDII compliance standards, and changes in Internal Revenue Service (IRS) and Her Majesty’s Revenue and Customs (HMRC) enforcement all were already impacting or had already altered the landscape of US-UK cross-border tax dynamics.
Here are some highlights impacting the US-UK finance horizon worth monitoring as they develop:
THE LIBOR TRANSITION
LIBOR reference rates are global, and the sheer volume of financial products using LIBOR boggles the mind; approximately $200 trillion of financial products referencing USD LIBOR in 2018 – and LIBOR benchmarks are calculated for four other currencies (British sterling, Swiss francs, Japanese yen and euros).
In 2014, the U.S. Federal Reserve Board and the New York Federal Reserve Bank convened the Alternative Reference Rates Committee (ARRC), which identified the Secured Overnight Financing Rate (SOFR) as the successor to the USD LIBOR rate that represents best practice for use in certain new USD derivatives and other financial contracts. Similar working groups were established by the Bank of England, the European Central Bank, the Bank of Japan and the Swiss Central Bank, among others. The UK authorities have stated that as of 2021 banks will no longer need to follow LIBOR. The end of LIBOR is here whether we like it or not.
Although it feels like yesterday, it was over a year ago, on October 9, 2019, that the IRS issued proposed regulations, REG-118784-18, attempting to ameliorate the tax impact of this transition impacting all products, from debt to swaps. Generally, changing the reference rate could result in a taxable exchange unless certain safe harbors for debt were met, and the yield change calculated for a de minimis impact (under 5%). The Proposed Regulations avoid that result if the new rate used is a “qualified rate.” The proposed regulations set out a three-step test for determining what constitutes such a “qualified rate,” and we will expand on this in a further piece. There are some traps for the unwary, and while the regulations are not final yet, we do expect the IRS to finalize before year end, if not any day.
The main issue impacting US-UK taxation from Brexit revolves around the tax treaty accommodating other EU nations in the limitations of benefit tests. Investment funds, mutual funds and other regulated companies in the UK with investors in other EU nations still maintained access to the US-UK treaty. With Brexit, obviously, it raises the question if that reciprocity would be preserved. AS of now, the UK and the US have indicated that course remained the same through 2020, but 2021 was the key concern. While it appears that 2021 will also stay the course, no final answer has been given yet by either side. Earlier this year, Italy indicated how it will view UK pensions pre- and post-Brexit.
In addition to the use of treaties on investment structures for UK funds, the manner in which the UK will follow the OECD guidelines is potentially up for change, although everything indicates that these dynamics should remain relatively unaltered. Compliance with CRS and FATCA appears unaffected for the moment, but worth monitoring.
US WITHHOLDING RULES
US Tax Reform in 2017 brought about a withhold taxing provision for sales of partnership interests. The IRS finalized these regulations under Section 1446 on October 7, 2020. Custodians, intermediaries, banks and investors have all needed to begin amending systems to adapt to the new withholding rules, particularly when they come to publicly traded partnerships. As if that were not enough, the full impact of withholding on US dividend equivalents, under Section 871(m), for instruments with a delta of 0.8 and higher, are set to be effective in 2022, just one year away. Monitoring expected final regulations on this front is key.
The IRS has begun its wave of FATCA audits, and several financial institutions have begun to feel the sting. While earlier the IRS announced general easement of enforcement due to the pandemic, examinations efforts have begun after July 15 of this year and as promised by the IRS, FATCA is at the top of the list.
HMRC has stated in its International Manual that if a financial institution cannot meet the FATCA reporting deadline of May 31, 2020 due to difficulties arising from the coronavirus pandemic, HMRC will accept that the institution has reasonable excuse and will not levy a penalty for the late report, provided it is made without unreasonable delay after the difficulties are resolved. Similarly, the IRS indicated that the March 2020 deadline was extended to July 2020, but with not as much leniency as the HMRC. Hence, the IRS has begun FATCA examinations in its current wave of audits.
Early in January 2020, the IRS had finalized certain FATCA provisions that impact all jurisdictions, even those with an IGA Model 1 like the UK.
While the landscape is still subject to change, US-UK cross-border taxation in the financial arena still has several other issues that requiring monitoring, planning and preparation. Please contact us for any questions you may have.
About Julio M. Jimenez
Julio M. Jimenez, JD, LL.M., is a Principal in the Tax Services Group at Marks Paneth LLP, where he specializes in international tax services for multinational corporations and individuals. Prior to joining the firm, he served in technical leadership roles at two different national public accounting firms, his own international tax advisory practice and the Internal Revenue Service National Office of the Chief Counsel, where he was involved in both IRS examinations and Department of... READ MORE +