Tax Break

John Fisher, international tax consultant

Archive for the tag “IRS”

Bits in pieces

It doesn't get any easier when they get older

It doesn’t get any easier when they get older

“Look mum. No hands!” It is every parent’s nightmare to be forced to watch helplessly as their 7 year-old, with the new-found independence of two wheels, goes careering fearlessly along the uneven pavement in front of the house.  Thanks to a guardian angel, the escapade normally ends with nothing more than a toppling skid or collision with an ancient lamppost that the child’s pride leads him to insist was not there yesterday – painful but, mercifully, not tragic.

Bitcoin, the virtual currency that has taken the  world by storm, is like a bike with no handlebars being ridden by a reckless kid with a pair of cheap tyres thrown in for free.

A friend of mine, a financial adviser by trade, told me the other day that one of his clients was considering investing in some Bitcoins. I expressed genuine delight as someone could now finally explain to me in non-binary language how the Mining process works. Not so fast. His face glazed over as he offered me another whisky. Had he heard of the Mt Gox collapse or the thefts from Flexcoin and Poloniex? Yes – but everybody seemed to agree that these were local  problems, not a systematic issue. “Everybody” would appear to consist of the Lower Manhattan Chapter of 7 year-old bicycle-mounted Hells Angels.

For the uninitiated, Bitcoins had the internet equivalent of an immaculate conception about 5 years ago, appearing on the scene as an orphaned concept, the creator not known until this very day. The idea was to produce an alternative currency to those currently maddening the world that would not be dogged by regulation of Central Banks and Governments. The ostensible genius was in the way – in the absence of all that regulation – the system would regulate itself.

There go another 25 Bitcoins. Time to buy a supercomputer

There go another 25 Bitcoins. Time to buy a supercomputer

In the beginning there was the Algorithm and  a digital Bible that had fallen from the Heavens telling the first punters how to play. In the maturing market participants are required to open accounts, generally through brokers (they are even given virtual wallets to keep their Bitcoins in) and are given two codes – one private and one public. When they undertake  a transaction, they only provide the public code (surprise, surprise). Privately held increasingly powerful computers then race to calculate, by trial and error, the single solution for a block of transactions that is attached to the Block Chain (which includes the entire history of Bitcoin transactions). Every 10 minutes a single computer finds the solution, it is verified by at least 50% of computers (or computer power) extant in the system and the winner is rewarded with 25 newly mined Bitcoins. This process will continue until a predetermined maximum number of bitcoins are mined (I believe around 2030).

This all sounds very clever and infallible but, let’s face it, to err is human, to really screw things up requires a computer. Lo and behold, in the recent Mt Gox, Flexcoin and Poloniex debacles Bitcoins have been disappearing into the ether. But, being the computer dinosaur that I am (I once had to plead with a New York hotel computer help line not to ask me if the computer was plugged-in) my reasoned reservations are entirely analog.

When I studied Monetary History – if my children are to be believed, around the time people were bartering pigs for firewood – I learned what defines money (not as bloody obvious as you think, clever clogs). It must be three things: a “medium of exchange”, which can reliably be swapped for goods and services; a stable store of value, enabling users to hold it for a while  more or less maintaining its purchasing power; and it should function as a unit of account against which value in an economy can be measured. Throwing all three conditions into a basket,  Bitcoin is not looking too respectable. Leaving aside the recent insane fluctuations in value which might sort themselves out eventually, realistically until such time as citizens of the world are paid in Bitcoins and pay for their daily needs in Bitcoins, their value is always going to be measured against other currencies.

Then, even if all the conditions were somehow met ( which they will not), the Bitcoin economy will need to operate according to a very narrow, and largely discredited, “Monetarist” regime. Monetarism, adopted by Thatcher at the end of the Inflationary Roaring 70s and given lip service by Reagan a few years later, claimed control of the money supply as the critical factor in the macro economy. But the money supply had various definitions that went well beyond notes and coins. Only real whackos believed it was about keeping the supply of notes and coins constant – effectively aping the gold standard. Looking at the recent successful use of Quantitive Easing – resort to the printing presses – by the world’s central banks (most recently the ECB) to stimulate the economy it is easy to realize how futile a fixed narrow money supply would be. But that is precisely what Bitcoin is about. The only way for it to work long-term, even if it were adopted as a regular currency, would be for the system to develop an override which would have to be regulated by dreaded humans – a Bitcoin Central Bank. Back to square one.

Having got all that off my chest this is one of the rare moments when I find myself praising the IRS. They issued guidance last week on how Bitcoins should be treated for tax purposes. Instead of giving them the longed-for special status of money (not defined in the Code) they decided that Bitcoins are property. Hence, increases in value will be liable to capital gains tax (or, in some circumstances, income tax on sale of inventory). This treatment also exposes transactions to possible  Sales Tax at the State level.  The IRS approach is in line with several other countries that insist on charging VAT on transactions – a noted exception being the UK.

Real men don't speculate with Bitcoins

Real men don’t speculate with Bitcoins

With complex reporting requirements and huge dollops of VAT, it means that there is – thankfully –  little hope of Bitcoins being more than speculative assets in the foreseeable future. Of course, if circumstances change as the digital economy expands tax treatment could be altered. But a cautionary tale – we are 20 years into the Information Revolution and only now are tax authorities beginning to try to find solutions to the basic problems, while as I noted last month, they are over a hundred years behind with the central tax concept of management and control. It is a “bit” too soon to throw away your dollars.

The Yanks are coming

This post is dedicated to the memory of Orni El-Ad, my mentor and friend, who introduced me to the world of taxation and taught me how to “think tax”. Orni died suddenly this weekend at the premature age of 64. May his memory be blessed.

And then came the Zeppelins

“The Children’s Book” by A S Byatt is, without doubt, one of the most absorbing novels I have ever read. Set in the waning days of the Victorian era and first two decades of the 20th century, it is a saga of interwoven families where the adults gradually shrug off their Victorian correctness while the children gain their voice after a long period of being “seen but not heard”. 

One of the most poignant moments in the book is the attendance by the chief protagonists at the gloriously atmospheric first night of J M Barrie’s Peter Pan. Fooled momentarily into nostalgia for the Darling Family and the adventures of Wendy, Michael and John, the reader quickly regains the sad perspective that this idyllic world is sliding helplessly towards 1914 and the utter carnage of the Great War.

Years ending in 14 to 18 have always given me the creeps and that book got me marching in the direction of 2014 with much trepidation. It was, therefore, with a palpitating heart that I approached the much heralded latest proposed FATCA regulations which are full of 2014, 2015, 2016, 2017 and beyond (the way they are going they might even get to 2039 and  my heart will have a whole new reason to palpitate). In fairness, however, cause of death from FATCA is far more likely to be due to 389 pages of acute boredom than a grenade lobbed across the wire by Jerry.

The Foreign Account Tax Compliance Act (FATCA), which was enacted in 2010 and, according to the latest proposed regulations, is due to commence hostilities on January 1, 2014, is a supreme effort by the US legislature to combat offshore tax evasion by US citizens. At its core it is an ultimatum to nothing less than,the entire world’s financial institutions to act as mercenaries on behalf of the US Treasury by providing information about US account holders and deducting 30% tax at source on payments to identified and suspected US tax evaders – or themselves face 30% withholding on all taxable payments from the US.

You scratch my back James and I'll scratch yours

Due to wholesale opposition from America’s allies who saw this extraterritorial reach as an act of imperialist belligerence, there was, until recently, considerable doubt as to whether it would prove just another example of US saber rattling. However, a Joint Statement on February 8 by the United States, France, Germany, Italy, Spain and the United Kingdom abandoning all those tax evaders seeking a safe haven in exchange for reciprocal spying services by the Americans, means that it is probably time for any American with anything to hide to get his head down in the trench, pull his tin hat firmly over his ears and pray.

Foreign financial institutions (FFI’s) will need to enter into an agreement with the IRS sometime during  the first six months of 2013 in order to be in place for the first winter offensive starting January 1, 2014. In 2014 and 2015  names, addresses, taxpayer identification numbers, account numbers and account balances will need to be reported, while in 2016 any income paid to an account will be required. From 2017 gross proceeds paid to the account will be demanded.

In the meantime, with effect from 2014, participating FFIs, having performed appropriate due diligence to identify their American customers, will need to start withholding 30% tax on such payments as US source dividends, interest and royalties to recalcitrant individuals (basically anybody who is not willing to play) and recalcitrant non-financial foreign entities (NFFEs) aka companies with more than 10% US ownership. Such payments to non-participating FFIs would suffer the same fate. From 2015 proceeds from asset sales will also be subject to withholding.

Right for once

Implementation of the  most Rambo-like proposal has been postponed until  2017 at the earliest and will likely be hit by a stray, but lethal, shell sometime before that. With a view to really thrusting and turning the bayonet, the IRS want to force the participating FFIs to withhold tax on payments that do not even originate in the US using a formula based approach of applying the ratio of US to non-US assets on the FFI’s balance sheet to its payments to recalcitrant individuals and NFFEs. Well boys, you can push your luck and go “over the top” whenever you like but don’t be surprised if  the other side is just waiting to see the whites of your eyes before halting you in your tracks.

Not all entities will need to enter into an agreement with the IRS, an exemption applying to those where the risk of recalcitrant Americans hiding under a tarpaulin in the corner of the trench is not great. Considering the requirements for becoming a deemed FFI, it is not entirely clear what the advantage over entering into an agreement is and it has been suggested that it may just be a decoy.

Ultimately, it is the buy-in by foreign governments that will make this work. Local secrecy laws could have totally derailed the project whereas it is now likely that agreements will be worked out with participating governments for information to be provided to them for sharing with the US authorities. Meanwhile, banks in several jurisdictions are shouting “Yankee, go home” to their  American customers before the regulations come into force.

Looking to the future, the tax evader’s lot is not an enviable one as he is forced to retreat with his  funds into undesirable corners of the world where their risk of loss is greater. As the world goes global places to hide, like Peter Pan’s Neverland, are ever harder to locate. The IRS recently announced yet another Amnesty, offering offenders the chance to wave a white flag and pay their way out of trouble. In the meantime, advanced troops were sent in to lay Switzerland waste. Speculation is now rife as to where the crusading troops will go next .

The attitude of  the US authorities can probably best be summed up by the chorus of the most famous American song of the First World War:

Over there, over there,
Send the word, send the word over there
That the Yanks are coming, the Yanks are coming
The drums rum-tumming everywhere.
So prepare, say a prayer,
Send the word, send the word to beware –
We’ll be over, we’re coming over,
And we won’t come back till it’s over, over there.

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