IRS sheds light on when incoming and outgoing FATCA information becomes confidential
IRS sheds light on when incoming and outgoing FATCA information becomes confidential
Legal Advice Issued by Associate Chief Counsel 2015-005
In a redacted Legal Advice Issued by Associate Chief Counsel, IRS has given its opinion on the exact moment when information that it provides to, and information it receives from, foreign tax authorities and other parties pursuant to the Foreign Account Tax Compliance Act (FATCA), becomes protected under the Code’s confidentiality rules.
Background—FATCA and “IDES.” In 2010, Congress passed the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147 (the HIRE Act), which added chapter 4 of Subtitle A to the Code. Chapter 4, commonly known as FATCA, essentially represents an international tax reporting regime, the object of which is to thwart efforts by U.S. persons to hide unreported income and assets offshore. (See Code Sec. 1471 to Code Sec. 1474.)
Chapter 4 generally requires withholding agents to withhold tax on certain payments to a foreign financial institution (FFI), unless it has entered into a FFI agreement with the U.S. to, among other things, report certain information with respect to U.S. accounts. In addition, it also imposes withholding, documentation, and reporting requirements on withholding agents, with respect to certain payments made to certain non-financial foreign entities.
In cases in which foreign law would prevent an FFI from complying with the terms of an FFI agreement, IRS has collaborated with other governments to develop two alternative model intergovernmental agreements (IGAs) that facilitate FATCA implementation.
The International Data Exchange Service (IDES) is a system to report and exchange financial account information to and between tax administrations around the world developed as part of IRS’s implementation of FATCA. It was primarily designed by IRS and developed and implemented by a third-party vendor with whom IRS has a contract. The data transmitted includes: (1) taxpayer data that will be sent to IRS from foreign tax administrations (Host Country Tax Administrations; HCTAs), as well as from third parties such as FFIs (inbound transmissions); and (2) taxpayer data that will be sent by IRS to HCTAs or to third parties (outbound transmissions).
Background—the Code’s confidentiality rules. Code Sec. 6103(a) provides the general rule that returns and return information must be kept confidential and can only be disclosed as authorized under the Code.
The term “return” means any tax or information return, declaration of estimated tax, or claim for refund required by, or provided for or permitted under, the Code filed with IRS by, or on behalf of, any person. (Code Sec. 6103(b)(1))
Return information includes the taxpayer’s identity and any taxpayer-related information that is “received by, recorded by, prepared by, furnished to, or collected by the Secretary.” But return information does not include data in a form that cannot be associated with, or otherwise identify, directly or indirectly a particular taxpayer. (Code Sec. 6103(b)(2))
There are many exceptions to the general rule of Code Sec. 6103(a). Under one such exception, an internal revenue officer or employee is permitted, in connection with his official duties relating to any audit, collection activity, or civil or criminal tax investigation or any other offense under the tax laws, to disclose return information to the extent that the disclosure is necessary in obtaining information with respect to (a) the correct determination of tax, liability for tax, or the amount to be collected or (b) the enforcement of any Code provision. (Code Sec. 6103(k)(6))
Information received from a foreign government pursuant to a tax convention (tax treaty) is subject to the confidentiality rules of Code Sec. 6105. Code Sec. 6105(a) contains the general rule that tax convention information must not be disclosed unless it falls under one of the exceptions listed in Code Sec. 6105(b). The terms “tax convention information” and “tax convention” are defined in Code Sec. 6105(c)(1) and Code Sec. 6105(c)(2), respectively. In general, tax convention information, subject to the protection of Code Sec. 6105(a), includes information exchanged pursuant to a tax treaty or other bilateral agreement (including multilateral conventions) providing for the exchange of information, which is treated as confidential or secret under the relevant convention or agreement.
Each of the tax treaties, as well as the IGAs, to which the U.S. is a party, include confidentiality provisions that require all information exchanged to be kept confidential in accordance with the provisions of such treaty or agreement, as well as provisions generally limiting the use of the information only for purposes of tax administration. For example, Article 26, section 2 of the US Model Treaty provides that any information received under that article must be treated as secret in the same manner as information obtained under the domestic laws of that country.
IRS’s use of IDES doesn’t violate Code Sec. 6103. IRS noted that the Chief Counsel’s office had previously rendered advice that it is permissible for IRS to transmit financial account information to foreign countries under an applicable treaty, tax information exchange agreement (TIEA), or IGA, and that disclosures may be made by appropriate IRS employees in certain circumstances to third parties for purposes of verifying, correcting, or investigating information submitted to IRS by those third parties under Code Sec. 6103(k)(6).
And, it said that, earlier in the development of IDES, oral advice was rendered by the Chief Counsel’s office that IDES was a sufficiently secure means of transmission so that using it did not give rise to an improper disclosure of tax return information.
When does information transmitted or received become confidential under Code Sec. 6103? IRS noted that case law does not directly address when information begins to be protected by Code Sec. 6103.
In the case of outbound transmission, IRS already possesses the data to be transmitted, so it already constitutes tax returns or tax return information under Code Sec. 6103(b)(1) and Code Sec. 6103(b)(2). Consequently, both IRS and the third-party vendor are responsible for taking appropriate steps to protect the data. Under the terms of the treaty, TIEA, IGA, or Competent Authority Agreement (CAA) governing the transmission, the foreign HCTA is, or will be, also obligated to protect the data once it has possession of it. Thus, the outbound transmission of financial data will be protected accordingly throughout its transmission on IDES.
Regarding the inbound transmission of data through IDES, IRS said that there is some uncertainty as to the point at which the data acquires legally-protected status under Code Sec. 6103. It concluded that, based on the current facts and circumstances, the arguments that protection arises on upload outweigh the arguments that protection arises only at download by IRS.
IRS noted that the statutory language of Code Sec. 6103(b)(1) (definition of “return”) and Code Sec. 6103(b)(2) (definition of “return information”) use different verbs to define the scope of their terms. Under the statutory language, a return includes certain items “filed with” IRS. By contrast, “return information” under Code Sec. 6103(b)(2) includes data “received by, recorded by, prepared by, furnished to, or collected by” IRS. Accordingly, the different statutory language (and the absence of controlling precedent) might lead a court to apply different timing rules to a “return” than to “return information.” On the other hand, because the information exchanged over IDES does not precisely fit within either category, a court may be inclined to hold that the same analysis should apply (i.e., as to when Code Sec. 6103 protection arises) regardless of whether the item is a return under Code Sec. 6103(b)(1) or return information under Code Sec. 6103(b)(2).
IRS said that, as a preliminary matter, the financial information transmitted through IDES is most likely characterized as a mix of “returns” and “return information.” Data uploaded by FFIs with regard to particular account holders will be provided on Form 8966 (Foreign Account Tax Compliance Act (FATCA) Report), and would likely constitute an information return that falls within Code Sec. 6103(b)(1)’s definition of “return.” Information provided by foreign HCTAs is the same as or similar to information provided on Form 8966. IRS concluded that it should apply a uniform timing analysis to all information exchanged over IDES.
IRS first noted that there is broad consensus that, to be protected by Code Sec. 6103, information must be possessed in some manner by IRS. Citing Baskin, (CA 5 1998) 81 AFTR 2d 98-91881 AFTR 2d 98-918, it said that, to be return information, any information must first be received by, recorded by, prepared by, furnished to, or collected by IRS. It also cited Stokwitz, (CA 9 1987) 60 AFTR 2d 87-595260 AFTR 2d 87-5952, a case in which U.S. Navy investigators searched a personal office, discovered personal copies of income tax returns filed with IRS, and subsequently disclosed information from those returns, and the Ninth Circuit held that the returns were not protected by Code Sec. 6103.
It said these authorities lend some support to the position that Code Sec. 6103 should not apply until IRS downloads the information from IDES. They emphasize that it is not enough for information to be related to a tax matter or even that it be in copies of returns that had been filed with IRS (as in Stokwitz ) in order for Code Sec. 6103 to arise.
However, IRS felt that a stronger case could be made for concluding that inbound information becomes subject to Code Sec. 6103 when it is uploaded to IDES. Arguments may be made to draw different inferences from the case law. For one, IRS said it was unaware of a case addressing whether Code Sec. 6103 applies when information is on its way to IRS, and therefore it is possible to argue that the existing case law is distinguishable. Further, the case law does not address situations where IRS has entered into a contract to procure or convey the information.
When does information transmitted or received become confidential under Code Sec. 6105 and under treaties, etc.? IRS noted that: a) the legislative history under Code Sec. 6105 does not describe when information becomes tax convention information; b) there is very sparse case law under Code Sec. 6105 and the treaties, and it does not address the timing of when protection arises; and c) Article 26 of the US Model Treaty (and corresponding international models) does not shed light on the exact moment when the duty to protect treaty exchanged information arises.
IRS first concluded that information uploaded directly by FFIs and other non-HCTA entities to IDES is not exchanged between competent authorities and is not therefore exchanged pursuant to a tax convention. Consequently, protection of this information, if any, is limited to the application of Code Sec. 6103, described above.
IRS then said that information exchanged by HCTAs is covered by protections contained in the exchange of information articles of treaties, and, as a result, potentially under Code Sec. 6105. Under the statutory language of Code Sec. 6105(c)(1)(E), information becomes tax convention information when it is “exchanged pursuant to a tax convention which is treated as confidential or secret under the tax convention.” Arguably, the use of the past tense “exchanged” suggests that Code Sec. 6105 protection will not arise for this class of tax convention information until the exchange is completed. Therefore it is also arguable that information uploaded to IDES is not fully exchanged until it is actually downloaded successfully from IDES. Article 26, section 2, of the U.S. Model Tax Treaty contains a similar past tense usage: “Any information received under this Article…” (emphasis added). Consequently, similar inferences might be drawn from the language of the U.S. Model treaty.
However, following a section of the Legal Advice that was redacted, IRS concluded that it seems likely that a court would be persuaded that treaty protection should harmonize with domestic law. Accordingly, because, as noted above, IRS ultimately concluded that a court would be more likely to be persuaded that Code Sec. 6103 protection arises on inbound transmissions when uploaded, it concluded that a court would also be likely to interpret Code Sec. 6105 and tax treaties to use the same timing.
References: For withholdable payments to FFIs and other foreign entities, see FTC 2d/FIN ¶ O-13079 et seq.; United States Tax Reporter ¶ 14,714. For confidentiality of return information, see FTC 2d/FIN ¶ S-6200 et seq.; United States Tax Reporter ¶ 61,034; TG ¶ 1974.