FBAR Surprise: Reporting Interests in Offshore Investment Funds

As a result of recent announcements made by or on behalf of the Internal Revenue Service ("IRS"), United States persons with a financial interest in, or signature or other authority over, offshore private equity or hedge funds should consider filing information relating thereto with the IRS and the U.S. Department of Treasury (the "Treasury") no later than September 23, 2009. Although the requirement for United States persons to file information concerning foreign "financial accounts" on Treasury Form TD F 90 22.1, Report of Foreign Bank and Financial Accounts ("FBAR"), has been in place for many years, it was not previously understood to include offshore investment funds. Therefore, many U.S. investors and controlling persons in offshore funds may find themselves scrambling to report information for calendar year 2008 (and possibly back to 2003) by this deadline to avoid the possibility of civil and/or criminal penalties.

FBAR Filing Requirements

The FBAR must be filed with the Treasury each calendar year by "each United States person who has a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts, in a foreign country," if the aggregate value of the financial accounts exceeds $10,000 at any time during the calendar year." The FBAR for any calendar year must be received (not postmarked) by June 30 of the following calendar year. No extensions are available for the June 30 filing deadline and substantial penalties may be imposed for even non-willful violations. However, as discussed below, the IRS will not impose penalties for FBARs received (again, not postmarked) by September 23, 2009 if specified conditions are met.

Offshore Funds May Be Foreign Financial Accounts

In October 2008, the IRS revised the FBAR form and instructions. Included among the numerous changes was clarification of the definition of "financial accounts." Previously, this term encompassed any account in which the assets are held in a commingled fund and the account owner holds an equity interest in the fund. The revised definition further specifies that these types of funds would include mutual funds. Last month, IRS representatives took the position, during a teleconference addressing questions concerning the revised FBAR, that an offshore private investment fund would constitute a foreign financial account for FBAR purposes. Although inconsistent with the commonly held assumption of the investment community, this position purportedly represents merely an increased focus by the IRS on international matters rather than a new requirement. As a result, many United States persons with an interest in or signature or other authority over offshore funds are squarely confronted with possible FBAR filing obligations that they previously thought did not exist.

U.S. Investors and Controlling Persons in Offshore Funds with Possible FBAR Filing Obligations

Only "United States persons" are required to file FBARs. Notwithstanding its current definition in the revised FBAR instructions, this term should be interpreted, for purposes of 2008 (and prior) FBAR filings, to mean a citizen or resident of the United States or a domestic partnership, corporation, estate or trust. United States persons must also have either a financial interest in or signature or other authority over a qualifying foreign financial account for the FBAR filing obligation to apply. A United States person is deemed to hold a "financial interest" in any foreign financial account owned or legally held by (i) a person acting as an agent, nominee, attorney or in some other capacity on behalf of such United States person, or (ii) a corporation, partnership or trust in which the United States person owns a greater than 50% beneficial interest. A person has "signature or other authority" over a financial account if the person can control the disposition of money or other property in the account by delivery of a document containing his or her signature (or with that of co-signatories), or can exercise comparable power by any means of communication either directly or indirectly (e.g., by power of attorney) on behalf of the United States person, to the bank or other person with whom the account is maintained.

In light of the foregoing rules and the IRS's position equating foreign financial accounts with offshore funds, the following entities and individuals should consider, with the assistance of appropriate tax advisors and counsel, making FBAR filings (if for nothing more than as a protective matter):

• U.S. feeder funds invested in an offshore master fund (if a U.S. feeder fund owns more than 50% of the offshore master fund the filings would need to include all foreign financial accounts of the offshore master fund)
• U.S. investors who own more than 50% of a U.S. feeder fund invested in an offshore master fund
• U.S. entities (including tax-exempt entities) invested in any offshore fund (whether a stand-alone fund, master fund or feeder fund)
• U.S. investment managers and general partners with an equity interest in any offshore fund (including carried interests) or with signature or other authority over any offshore fund
• U.S. individuals invested in any offshore fund

In addition, the general partners and managers of offshore funds are well advised to notify investors of their potential FBAR filing obligations.

Extended Deadline for Filing Delinquent FBAR Reports Without Penalty

After much confusion in the wake of its shift in emphasis toward offshore interests, the IRS issued guidance stating that it was extending the 2008 FBAR filing deadline until September 23, 2009 for taxpayers who (i) have reported and paid tax on all their 2008 taxable income, (ii) have "only recently learned" of their FBAR filing obligation and (iii) have insufficient time gather the necessary information to complete the FBAR. Such taxpayers are instructed to file the delinquent FBAR report with the Treasury according to the instructions and to attach a statement explaining why the report is filed late. In addition, a copy of the delinquent FBAR report, together with a copy of the 2008 tax return (if the return is due prior to the extended filing deadline), should be sent to the Philadelphia Offshore Identification Unit of the IRS by September 23, 2009. If these conditions are met, the IRS has indicated that it will not impose a penalty for the failure to file the FBAR.

Taxpayers who have reported and paid tax on all their taxable income for prior years but did not file FBARs may avoid penalties for the failure to file these reports if they file the reports in accordance with the 2008 FBAR filing procedures noted above. In other words, delinquent FBAR reports (one for each relevant calendar year) should be filed with the Treasury according to the instructions, attaching a statement explaining why the reports are filed late. In addition, copies of the delinquent FBAR reports, together with a copies of tax returns for all relevant years, should be sent to the IRS's Philadelphia Offshore Identification Unit by September 23, 2009. When filing reports for prior years, taxpayers have been instructed to use the current version (revised in October 2008) of the FBAR report, but are entitled to rely on the instructions for the prior version of the form (revised in July 2000). Because a six-year statute of limitations applies to the assessment of penalties for FBAR violations, taxpayers may be required to make filings for calendar years dating back to 2003.

Penalties

Failure to timely file an FBAR report can lead to serious penalties. For non-willful violations, a civil penalty of up to $10,000 may be imposed by the IRS. If the failure is willful, the maximum civil penalty increases to the greater of (i) $100,000 or (ii) 50% of the amount of the transaction (if the violation involved a transaction) or the balance in the account at the time of the violation. Criminal penalties for willful violations include a maximum fine of $250,000 or 5 years imprisonment, or both, but may be increased if the violation is in connection with other violations of U.S. law. FBAR penalties are determined per account, not per unfiled FBAR report, for each person required to file. In addition, there may be multiple penalty assessments arising from one account where, for example, there is more than one account owner or a person other than the account owner has signature or other authority over the account.

****

1.IRS Announcement 2009-51 (June 5, 2009), available at http://www.irs.gov/pub/newsroom/voluntary_disclosure_faqs.pdf

2.FAQ 43 to Internal Revenue Service, "Frequently Asked Questions" (revised on June 24, 2009) (the "Revised FBAR Guidance"), available at http://www.irs.gov/pub/newsroom/voluntary_disclosure_faqs.pdf

3.The mailing address is as follows: Internal Revenue Service, 11501 Roosevelt Blvd., South Bldg., Room 2002, Philadelphia, PA 19154, Attn: Charlie Judge, Offshore Unit, DP S-611.

4.FAQ 9 to the Revised FBAR Guidance.

5.FAQ 26 to the Revised FBAR Guidance.