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Title 26 Miscellaneous Offshore Penalty under SDOP

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The Title 26 Miscellaneous Offshore Penalty (“Miscellaneous Offshore Penalty”) is one of the most critical aspects of the Streamlined Domestic Offshore Procedures (“SDOP”). In this article, I want to conduct a general overview of how the Miscellaneous Offshore Penalty is calculated.

As a side note, it is important to keep in mind that this is an educational article which aims to provide a general overview of the calculation of the Miscellaneous Offshore Penalty in common situations. In providing this general overview of the SDOP Miscellaneous Offshore Penalty, the article necessarily glosses over some complex issues that may change the determination of Miscellaneous Offshore Penalty in a particular case.  In order to calculate your Miscellaneous Offshore Penalty properly, the readers should contact an experienced international tax attorney for a legal advice based on their specific facts and circumstances.

What is Miscellaneous Offshore Penalty?

A taxpayer who enters SDOP is required to pay a 5% Miscellaneous Offshore Penalty as part of the SDOP requirements. The Miscellaneous Offshore Penalty is paid in lieu of the penalties associated with the delinquent filings of FBARs, Forms 8938 and other information returns.

The calculation of SDOP Miscellaneous Offshore Penalty is very different from 2014 OVDP calculation in terms of the relevant time period and the penalty base. (Note: OVDP is now closed). Let’s explore each of these factors.

Miscellaneous Offshore Penalty: Time Period

Miscellaneous Offshore Penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. Generally, this means that the Miscellaneous Offshore Penalty is imposed on the past six years covered by the FBAR statute of limitations.

However, there is an exception where the three-year tax covered tax return period does not completely overlap with the six-year covered FBAR period. For example, the SDOP disclosure for tax returns covers years 2012 and 2014 because the due date for the 2014 tax return is passed, but the FBAR period is 2008-2013 because the due date for the 2014 FBAR has not passed. In such cases, the Miscellaneous Offshore Penalty is imposed on the highest aggregate value of the foreign financial assets for the past seven years.

In most cases, six years will be the standard time period for the calculation of the Miscellaneous Offshore Penalty, which is a lot better than the 2014 OVDP eight-year disclosure period.

Miscellaneous Offshore Penalty: Penalty Base

SDOP introduced a new way to calculate Miscellaneous Offshore Penalty which mixed the old FBAR-focused penalty orientation of the 2014 OVDP with the new FATCA-focused Form 8938.

In general, the Miscellaneous Offshore Penalty is imposed on any foreign financial asset in a given year within the covered SDOP time period if one of the following is true:

1. The asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year;

2. The asset should have been, but was not, reported on a Form 8938 for that year; or

3. If the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year.

Two important features of this calculation of the penalty base under SDOP must be emphasized. First, the Miscellaneous Offshore Penalty should be calculated not only on the foreign bank and financial accounts listed on the FBAR, but also on “other specified assets” required to be listed on Form 8938. This means that many more assets outside of a foreign financial account can now be subject to the Miscellaneous Offshore Penalty . Examples of such assets include but not limited to: foreign stocks not held in a financial account, a capital or profits interest in a foreign partnership, certain forms of indebtedness issued by a foreign person (such as a note, bond, debenture, an interest in a foreign trust, foreign swaps, foreign options, foreign derivatives and other assets. It should be remembered, though, that this is a generalization and, in certain circumstances, an international tax attorney may except certain such assets from Miscellaneous Offshore Penalty base.

The second critical difference between SDOP Miscellaneous Offshore Penalty and 2014 OVDP Offshore Penalty is the inclusion in the calculation of the penalty base the assets for which no additional income needs to be reported. There are a lot of nuances with respect to the exclusion and inclusion of assets under the 2014 OVDP which are beyond the scope of this article. For the purposes of the present discussion, I will ignore them and concentrate on the general rule only (again, this is an area that should be explored with an international tax attorney based on the specific facts of a client’s case) that if an asset should have been reported on Forms 8938 and FinCEN Form 114 and it was not, then, it should be included in the penalty base.

Miscellaneous Offshore Penalty: Calculation of Highest Aggregate Value of Assets

As it was mentioned above, the Miscellaneous Offshore Penalty is calculated based on the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. The issue is how this “highest aggregate balance/value of assets” is calculated.

For the purposes of SDOP Miscellaneous Offshore Penalty, the highest aggregate balance/value is determined by a two-step process. First, you need to aggregate the year-end account balances and year-end asset values of all the foreign financial assets subject to the miscellaneous offshore penalty for each of the years in the covered tax return period and the covered FBAR period. Then, you select the highest aggregate balance/value from among those years and calculate the 5% value of this balance.

It is the first step that is radically different from the 2014 OVDP Offshore Penalty determination process, and it can produce very interesting results especially in the case of bank accounts. The most surprising result is that an account that was closed in one of the covered years is likely to produce a zero end-of-year balance irrespective of how much money was on it prior to December 31.

This factor can be a very important consideration when one decides to participate in SDOP. For this reason, I highly encourage the readers to consult an experienced international tax lawyer in these matters.

Contact Sherayzen Law Office for Professional Help with Your Undisclosed Foreign Assets

If you have undisclosed foreign accounts and any other assets, contact Sherayzen Law Office for professional legal and tax help. Our team of experienced tax professionals will thoroughly analyze your case, estimate your current penalty exposure, identify the offshore voluntary disclosure options available to you, prepare all legal documents and tax forms (including amended tax returns) needed in your case, rigorously defend your interests in front of the IRS, and guide you through the entire voluntary disclosure process.

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Treatment of Business Profits under the Canada-US Tax Treaty

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In this article we will briefly examine the treatment of the business profits of a resident of a contracting State under the Canada-US Income Tax Convention, and the important definition of a “permanent establishment” for purposes of determining the potential taxability of income of such profits.

This article is intended to provide informative material for US taxpayers involved with US-Canada cross-border businesses, and is not intended to constitute tax or legal advice. Please contact the experienced international tax law firm of Sherayzen Law Office, Ltd. for issues involving the Canada-US Tax Treaty.

Business Profits under the Canada-US  Tax Treaty

Under the US-Canada Tax Treaty, the business profits of a resident of a Contracting State, “[S]hall be taxable only in that State unless the resident carries on business in the other Contracting State through a permanent establishment situated therein.” (See the definition of “permanent establishment” in next section). Hence, if the resident of a Contracting State carries on, or has carried on, such business, then the business profits of the resident may be taxed in the other State but only to the extent attributable to the permanent establishment.

In determining the business profits of a permanent establishment, certain deductions incurred for the purposes of the permanent establishment, such as executive and general administrative expenses (whether in the State in which the permanent establishment is situated, or elsewhere) may be allowed. However, under the Canada-US Tax Treaty, a Contracting State is not required to allow the deduction of an expenditure which is not generally deductible under the taxation laws of such State.

Additionally, the Canada-US Tax Treaty states that “no business profits shall be attributed to a permanent establishment of a resident of a Contracting State by reason of the use thereof for either the mere purchase of goods or merchandise or the mere provision of executive, managerial or administrative facilities or services for such resident.”

Definition of Permanent Establishment under the Canada-US Tax Treaty

Article V of the Canada-US Tax Treaty provided the original definition of the term “permanent establishment”. As stated in the Canada-US Tax Treaty, the term is defined to mean “[a] fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on.” Under the Canada-US Tax Treaty, permanent establishment includes: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. Furthermore, a building site or construction or installation project constitutes a permanent establishment provided that it lasts more than 12 months. In addition, “A person acting in a Contracting State on behalf of a resident of the other Contracting State other than an agent of an independent status to whom paragraph 7 applies shall be deemed to be a permanent establishment in the first-mentioned State if such person has, and habitually exercises in that State, an authority to conclude contracts in the name of the resident.” (Please see Article V of the Canada-US Tax Treaty for more specific examples of a “permanent establishment”).

The Fifth Protocol (the “Protocol”) to the Canada-US Tax Treaty, signed in September of 2007 and entered into force on December 15, 2008, further modified the definition of permanent establishment. Under the Protocol (Article 3, Paragraph 2), an “enterprise of a Contracting State” that provides services in the other Contracting State may be deemed to have a permanent establishment if it meets at least one of the following conditions:

“(a) Those services are performed in that other State by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual; or (b) The services are provided in that other State for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a permanent establishment in that other State and the services are provided in respect of that permanent establishment.”

Further, the diplomatic notes of Annex B to the Protocol added that, “[t]he principles of the OECD Transfer Pricing Guidelines shall apply for purposes of determining the profits attributable to a permanent establishment”.

Elimination of Article XIV of the Canada-US Tax Treaty

The Protocal had further important impact with respect to services defined as “Independent Personal Services” – Article 9 of the Protocol eliminated Article XIV of the Canada-US Tax Treaty (“Independent Personal Services”). Under previous Article XIV a resident of a Contracting State performing independent personal services in the other Contracting State could be taxed if such “individual has or had a fixed base regularly available to him in that other State but only to the extent that the income is attributable to the fixed base.” The business profits rules explained above and the various definitions of permanent establishment now determine the taxability of such cases.

Contact Sherayzen Law Office for legal help with respect to Canada-US Tax Treaty

Treaty interpretation, international tax resolution and international tax planning may involve very complex issues, and it is advisable to seek the assistance of an international tax attorney in this area. This is why it is advised that you contact Sherayzen Law Office to secure professional legal help involving issues related to Canada-US Tax Treaty.

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