Tax bill could hurt U.S. bond, stock demand

NEW YORK (Reuters) - Proposed U.S. legislation to impose new tax disclosures on clients of foreign financial institutions may penalize U.S. companies by making overseas investors adverse to buying their stocks and bonds.

U.S. lawmakers are proposing a new 30 percent withholding tax on payments on U.S. securities held by all clients of foreign institutions. The tax will only be waived if clients make disclosures to show they are not U.S. citizens or residents.

The bill is meant to tighten tax compliance among U.S. citizens living or investing abroad. But analysts and international financial associations warn it would be too costly and complicated to implement, and that investors may be reticent to give information due to privacy concerns.

The bill follows an agreement by UBS UBSN.VX, Switzerland's largest bank, to disclose the names of thousands of U.S. customers in order to settle U.S. litigation.

Uncertainty over the impact of the proposed rule, and the potential costs and complications of its implementation, has already caused some nervousness about investing in U.S. securities, and if enacted is expected to weigh further.

“Given all the uncertainty that’s surrounding this proposed legislation, I think it’s reasonable that non-U.S. people outside the U.S. who invest in U.S. securities are a little bit apprehensive,” said Jonathan Sambur, associate at Mayer Brown in Washington.


The bill was amended in December so that a so-called grandfather clause, which exempts payments for a time, would apply to payments on assets made after December 31, 2012, instead of December 31, 2010. That eased some immediate concerns.

“Particularly before the grandfather was clarified, foreign investors were reticent to buy securities of U.S. issuers because of the tax uncertainty. Most of the concern has been around corporate debt, and to some degree, corporate stock,” said Thomas Humphreys, partner at Morrison & Foerster in New York.

The legislation was passed by the House of Representatives in December and is before the Senate.

The rule would be wide-reaching and would apply to investors that hold investment accounts with banks or funds, including mutual and private equity funds.

“It’s like a legislative thumb screw. Today there is no hammer or wedge or ability on the part of the government to extract this information from a foreign brokerage house on a voluntary basis,” said Ray Simon, partner at White & Case in New York.

“Any U.S. bond or equity would be potentially caught. A foreign corporation that is privately held and is investing surplus cash in U.S. commercial paper would also be caught if they fail to satisfy the reporting requirement,” he said.


International banking associations have warned that the requirements may be too costly and difficult to introduce, and would hurt demand for U.S. assets.

The European Fund and Asset Management Association testified to the House Ways and Means Committee, which introduced the bill, that the move could devastate U.S. investment funds operating overseas.

Obtaining information on individual investors in a fund may also be impossible, as in many cases the investments are made through intermediaries, it said at a November hearing.

The process “would be extremely onerous and costly for what we believe to be a small benefit to the U.S.,” the Australian Bankers Association said in testimony.

“This may in some cases force Australian banks to withdraw from investments in the U.S. (including on behalf of their customers) if such banks are unable to sustain the steep costs of compliance with the new reporting and withholding requirements of the Bill,” they said.

The Investment Industry Association of Canada agreed. “Ultimately, this will likely have a detrimental impact on U.S. capital markets generally by creating disincentives for Canadians and other foreign investors to invest in the U.S.,” it said.

The law as drafted has a provision that will permit the Treasury and Internal Revenue Service to draft and implement rules, however, and they may seek to do so in a manner that is not overly burdensome to non-U.S. institutions.

“In delegating authority to IRS and Treasury to promulgate appropriate rules, I would think they would be motivated to use that authority to draft rules that are practical, and not intrusive with respect to foreign investors so that there isn’t capital flight; whether they succeed, remains to be seen,” said Mayer Brown’s Sambur.