March 11, 2001

CFP Condemns New U.S. Interest Reporting
Regs for Nonresident Aliens

by Robert Goulder

The Center for Freedom and Prosperity has announced it will vigorously oppose recent IRS proposed regulations that would require domestic financial institutions to report interest income paid to nonresident aliens.

The Washington-based Center for Freedom and Prosperity (CFP) has announced that it intends to oppose recent IRS proposed regulations that would require domestic financial institutions to report interest income paid to nonresident aliens. The regs (REG-126100-00) were issued January 16, during the waning days of the Clinton administration. If implemented, the regs could alter a decades-old U.S. tax policy.

Since the early 1920s, the CFP says, the United States has refrained from taxing interest income earned by nonresident aliens unless it was effectively connected to a U.S. trade or business, a policy described in section 861. Also, U.S. law has not required domestic banks to report the interest paid to nonresident aliens to either the IRS or to foreign governments, other than to Canada -- the only nation with which the United States has truly effective exchange of information (EOI) practices. The policy helps U.S. banks attract large amounts of wealth from foreign sources and is viewed as a contributing factor in the relative strength of U.S. financial markets.

The new regulations would not impose a tax on interest payments to nonresident aliens but would call upon domestic banks to report such interest payments to the IRS. The IRS, in turn, would presumably convey the information to foreign tax officials. Congress last considered changing this policy in the mid-1970s; after some debate, the idea was scrapped. Congress feared that some U.S. financial institutions would not survive the outbound capital flight that might result from the proposed change. In short, the interests of preserving the U.S. financial sector trumped the competing arguments for increased EOI measures.

Increased Capital Mobility

Although these concerns were raised several decades ago, CFP President Andrew Quinlan believes the same rationale still applies today. He argues that the adverse consequences of imposing the proposed EOI requirements would be more severe now because we live in a more globalized and interconnected world. "There is no denying that financial capital is more mobile today than it was 25 years ago, so it would be even easier for nonresident depositors to withdraw funds and move them to foreign financial centers," he said.

Quinlan also criticized the means by which the regulations were offered. He suggested the new regulations were, in effect, making new law rather than enforcing existing statutes approved by the U.S. Congress. "Major changes in U.S. tax policy should be decided by elected officials, not bureaucrats seeking to advance an ideological agenda of worldwide taxation based on information exchange," he added.

CFP co-founder Dan Mitchell recently told Tax Analysts that, if implemented, the new regulations have the potential to turn the IRS into the "global tax police." Mitchell, a senior fellow at the Heritage Foundation in Washington, argued that this development is not in anyone's best interest, adding, "American tax laws should be based on what is best for the United States, not what is best for foreign tax collectors."

Public Hearings

The CFP intends to argue its case before IRS and Treasury Department officials at March 21 public hearings on the proposed regulations. "We will do our utmost to convince the powers that be at the IRS why this is terrible tax policy, which will have devastating economic consequences on U.S. financial markets. We strongly encourage other concerned individuals to register their disapproval to these regulations," he added.

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