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Tag: Tax

  • Truss’ jittery Tories blame Bank chief over market meltdown

    Truss’ jittery Tories blame Bank chief over market meltdown

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    As Britain’s central bank boss, tasked with managing inflation and setting interest rates, Andrew Bailey likes targets. Now he is one.

    Markets are dumping U.K. assets amid chaotic policymaking from Liz Truss’ new government — but Bailey’s rocky stewardship of the Bank of England is getting a growing share of the blame. His harshest critics include some of Truss’ most senior Conservative Party colleagues.

    At stake are home loans for 2 million households coming due for renewal amid cripplingly high interest rates in the next two years and the viability of pension funds managing more than £1 trillion worth of assets. Failure to quell a “fire sale” of U.K. bonds and currency risks a financial meltdown that could spread far beyond British shores.

    The current bond market pressure began after U.K. Chancellor Kwasi Kwarteng announced a vast package of unfunded tax cuts, stoking investors’ fears about the long-term sustainability of the government’s debt. 

    The dramatic selloff of government bonds sparked a panic at U.K. pension funds, which couldn’t handle the price falls, and has huge knock-on impacts for mortgage rates and borrowing costs.

    The political fallout has so far landed on Truss’ government’s shoulders — prompting U-turns on key policies as opinion polls showed cratering support.

    Yet before the U.K.’s self-inflicted turmoil, Bailey was feeling political pressure over the central bank’s handling of double-digit inflation and the rising cost of living that comes with it. 

    While No. 10 refuses to be drawn on the Bank’s decisions, Business Secretary Jacob Rees-Mogg suggested a failure to raise interest rates quickly was at the root of the turmoil in financial markets.

    He dismissed it as “commentary” to draw a direct link between the government’s mini-budget and concerns over the U.K.’s financial stability that led to emergency intervention from the Bank, adding that pension funds’ “high-risk” activities had played a role.

    “It could just as easily be the fact that the day before, the Bank of England did not raise interest rates by as much as the Federal Reserve did,” he told the BBC’s Today program. 

    In another apparent swipe at the Bank, Rees-Mogg added: “The pound and other currencies have been falling against the dollar because interest rates in the U.S. have been rising faster than they have in other markets.”

    In the immediate aftermath of Kwarteng’s disastrous mini-budget, the Bank seemed to be in command of the situation when it stepped in to calm the pension fund crisis and refused to be pushed into an early interest rate rise by markets. But two further interventions this week and confusion over stark comments from Bailey himself risk undermining that impression.

    The governor on Tuesday issued a rare ultimatum to beleaguered pension funds struggling to meet cash calls in the government bond market. “You’ve got three days left now. You’ve got to get this done,” he warned at an event in Washington.

    The bank has effectively bailed out pension funds since the U.K. government’s mini-budget roiled the markets. The bond-buying intervention is intended to offer temporary relief and give the affected funds time to raise enough cash to handle historic surges in yields.

    Bailey’s message appeared to be aimed at upping the pressure on funds to sell assets in time rather than expecting an extension beyond Friday’s deadline. “We will be out by the end of this week,” he said.

    Yet the remarks seemed to backfire instantly, sparking a sharp fall in the pound, although it has since recovered.

    U.K. government borrowing costs also increased again on Wednesday, with the yield on 30-year gilts moving above 5 percent — the level that first sparked the bank’s intervention — before dropping back after the Bank used its firepower to buy £4.4 billion of gilts.

    Financial market experts think the governor’s comments were a mistake that will force the bank into following the government’s recent U-turns. 

    Mike Howell of CrossBorder Capital described Bailey’s words as the “shortest suicide note in history,” and said the governor will have to change course. 

    “Andrew Bailey’s insistence that emergency support will end on Friday is an unsustainable position that we expect to be reversed quickly,” said Oxford Economics chief economist Innes McFee.

    If the Bank loses credibility, its ability to rescue the economy from market disruption will be severely hampered. Increasingly costly interventions will yield ever more limited results if investors lose faith in the U.K.’s most important financial institution.

    Before Bailey’s comments on Tuesday, one markets strategist said the Bank could “test the water” by stopping the program on Friday and then restarting if necessary — but that would be risky because it’s unclear how much yields would have to rise before triggering the same problems at pension funds.

    “While a very able central banker, he has spent most of his career outside the BoE’s monetary policy and markets areas,” said EFG Bank chief economist Stefan Gerlach, previously a central banker himself.

    “He is not the best fit for the job, given the nature of the problems the Bank is facing now. His communications missteps over the last year were damaging,” he said, pointing to Bailey’s confusing guidance on interest rates. “It’s like the fire brigade saying ‘you have to have your fire before Friday because then we are heading home.’”

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  • Liz Truss panics as markets keep plunging

    Liz Truss panics as markets keep plunging

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    LONDON — Try as she might, Liz Truss just can’t calm the markets.

    Despite reversing her plan to cut tax for the highest earners, bringing forward a more detailed budget statement by almost a month and halting the appointment of a controversial senior civil servant to oversee the Treasury, the Bank of England was again forced to step in to try to stabilize market turbulence. 

    Insiders pointed to the surprise appointment of James Bowler to the Treasury top job, passing over Antonia Romeo, who it was widely briefed had got the role, as a sign of No. 10’s anxiety.

    “The PM is panicking and reaching for almost anything that she can do to calm the situation. She was so burnt by the fallout from mini-budget that anything that seemed bold, she now wants to massively trim back,” said a senior Whitehall official.

    Treasury officials say that Chancellor Kwasi Kwarteng’s tone in the past week has become markedly more conciliatory as he tries to steady the buffs. 

    But in spite of these U-turns, the current market unease may be out of the government’s hands. 

    The so-called mini budget came at a particularly fragile time for the economy, caused by high inflation and the Bank of England’s attempts to end a policy that saw it buy up huge quantities of government debt, originally an attempt to stabilize the economy in the wake of the 2008 financial crisis.

    Kwarteng’s tax cuts, presented without any detail about how they would be funded, spooked the markets, triggering a crisis at U.K. pension funds because the huge spike in yields forced them to bonds — but that then forced prices down further.

    The Bank of England intervened with a £65 billion check book to give pension funds more time to raise cash and stop the so-called doom loop taking hold. Governor Andrew Bailey said Tuesday the Bank’s emergency support will definitely end Friday, prompting fears this may not be enough time.

    The resulting crisis leaves Britain’s new prime minister with an intensifying political problem, as support ebbs away the longer it takes to tame the markets. 

    Jill Rutter, senior fellow at the Institute for Government and former Treasury official, said: “Paradoxically, having said they were the people to take on the Treasury orthodoxy, they are now walking on such thin ice that they are complete prisoners of the most orthodox orthodoxy.”

    Staying alive

    The race is now on for Kwarteng and his Treasury team to come up with a way to restore credibility by the end of October, when he is due to explain how the tax cuts will be paid for. 

    “It’s really difficult to see how you can have a vaguely deliverable plan to bring that back under control,” said the IfG’s Rutter, who pointed out that trying to find money from one-off events such as asset sales would not help the underlying fiscal position. 

    “If you’ve still got a pension fund problem with collateral issues, what [the government] give you on the 31st will probably not be that relevant, because you’ll still be dealing with a bigger problem,” said one markets strategist, speaking of condition of anonymity.

    “If you as a government have somewhat stabilized [pension funds] … the currency is going to react based on how [the market] views the overall fiscal long-term sustainability.”

    But the government’s dented reputation will be hard to rebuild. “If the root cause is fiscal policy, then the issue probably isn’t going to go away until the markets’ concerns over fiscal policy have eased,” said Paul Dales, chief UK economist at Capital Economics.

    “That makes the chancellor’s medium-term fiscal plan on 31 October a very big event for the gilt market, the pound and the Bank of England. Our feeling is that the chancellor will have to work very hard indeed to convince the markets that his fiscal plans are sustainable.”

    Ministers originally said their plan for £43 billion in tax cuts would be funded by borrowing and economic growth, but experts now warn it will require reductions in public spending. 

    The Institute for Fiscal Studies think tank predicted the chancellor would need to spend £60 billion less by 2026-2027, while the International Monetary Fund released a report calculating that high prices will last longer in the U.K. than many other major economies..

    Ahead of the mini-budget, the Resolution Foundation’s Torsten Bell spelled out why this could have a lasting effect. “The big picture in a world where interest rates are rising and inflation is high, is that you don’t want to be seen as the one country that everyone decides is a bad bet.”

    “Showing how serious you are is important,” he added. “If we are really arguing that our growth strategy is to borrow lots more and then that will pay for itself then they [the markets] don’t believe that.”

    One government official speculated that in order to fill the hole in public finances and make the numbers add up Truss and Kwarteng would be forced to U-turn on further aspects of their mini-budget, such as the decision to cancel a planned corporation tax rise. 

    In the meantime, it’s not just the markets that remain unconvinced by Truss’ and Kwarteng’s approach. 

    At the chancellor’s debut session of Treasury questions in the Commons Tuesday, senior Tory MPs queued up to openly cast aspersion on his strategy. 

    Former Cabinet minister Julian Smith asked for reassurance that tax cuts “will not be balanced on the backs of the poorest people in the country” — normally an attack line reserved for opposition MPs. 

    Treasury committee Chairman Mel Stride warned that if Kwarteng did not seek buy-in from fellow MPs on the next fiscal statement it would upset the markets again.

    The PM’s spokesman reiterated Tuesday that Truss is “committed to the growth measures set out by the chancellor” and “the fundamentals of the U.K. economy remain strong.”

    While that statement continues to be tested, so will the position of the prime minister and her chancellor. 

    Annabelle Dickson contributed reporting.

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  • Liz Truss has U-turned. Will it be enough?

    Liz Truss has U-turned. Will it be enough?

    BIRMINGHAM, England — So in the end, Liz Truss was for turning. But the damage to her faltering administration may already have been done.

    On Monday, Truss’ Chancellor Kwasi Kwarteng bowed to pressure from Conservative Party colleagues and dumped his flagship cut to the top rate of tax from 45p to 40p — a central component of last month’s so-called mini-budget.

    “We get it, and we have listened,” Kwarteng said as he announced the dramatic U-turn on Twitter.

    Later it emerged he will also bring forward an announcement on how the tax cuts will be funded, having initially insisted the public — and the markets — must wait until November 23.

    A parliamentary insurrection, which was rapidly gaining pace as MPs met for their annual party conference in Birmingham on Sunday, appears to have been quelled, for now.

    Asked if he would now support the mini-budget in parliament following the abandonment of its most controversial measure, rebel ringleader Michael Gove said: “Yeah I think so, on the basis of everything that I know. There were lots of good things that they announced … The debate over the 45p tax increase obscured that.”

    The market reaction was also mildly positive, with the bond and currency markets rallying somewhat following the announcement.

    But most MPs and delegates in Birmingham believe it will take significantly more than a single U-turn to rebuild the political and fiscal credibility of the fledgling Truss administration, with some MPs fearful a revival is already out of reach.

    “She started very poorly, and in my experience, what you see is what you get. People aren’t mysteriously really shit, and then become really good,” one senior Tory MP said. 

    Pissed-off

    While a Tory rebellion appears to have been averted for now, few MPs believe it will be the last Truss faces in the difficult weeks and months ahead.

    Even before Kwarteng’s now-infamous ‘fiscal event,’ Truss had plenty of detractors on Conservative benches. Only around a third of her own MPs backed her in the leadership contest, and after taking office she almost exclusively chose loyalists for her ministerial ranks. Those who backed her opponent Rishi Sunak were left out in the cold. 

    “Her party management has pissed people off,” the senior Tory MP quoted above said, with many of what they described as talented MPs questioning whether it was even worth backing the government in the long-term. 

    But while the “lightning rod” of the 45p tax rate had now been “neutralized,” according to one minister, backbenchers could soon find another hot topic and “push on that next.”

    Chancellor Kwasi Kwarteng | Ian Forsyth/Getty Images

    Two potential major flashpoints will be the new government’s approach to welfare payments, and funding public services. Ministers are currently undecided over whether to uprate benefits in line with inflation — as pledged by Boris Johnson’s administration — while also dropping heavy hints that cuts to the state are on their way. 

    The opposition Labour Party, now surging ahead in the polls, see political capital too in Truss’ stated plans to lift the cap on bankers’ bonuses and abandon a hike to corporation tax.

    “They’ve still got a totally unfunded £17 billion [corporation] tax giveaway for the wealthiest businesses at a time when people and businesses are struggling with the cost of living.” one Labour official said, in a taste of the messaging Tory MPs will likely be up against at the next election.

    Few Tory MPs are optimistic Truss can turn things around.

    “Politics works as a pendulum. If it swings towards the middle it’s possible to pull it back. But if it swings too far it can become irreversible,” the minister quoted above said.

    Writing for POLITICO, Boris Johnson’s former No. 10 comms chief Lee Cain said it was “unlikely” Truss’ reputation would ever recover.

    “It didn’t need to be this way,” he wrote. “Many of the unforced errors could have been avoided if the PM had understood how to talk to the audience that matters most — the electorate.:

    Benefit of the doubt

    But voters may yet be more forgiving than some of Truss’ critics in the party, according to pollsters and focus group experts keeping a close eye on public opinion.

    “We consistently find voters don’t mind a U-turn on an unpopular policy,” said Luke Tryl, director of the More in Common consultancy, which regularly hosts focus groups across the country.

    “In fact one of the things we found during the leadership contest was that people quite liked the fact that Liz Truss changed her mind, because they felt that’s what normal people do,” he said.

    But he cautioned that while voters don’t mind U-turns as one-offs, “a series of them starts to look chaotic and will worry voters about whether the government knows what it is doing to see the country through the turmoil.”  

    Fiscal credibility

    Crucially, reversing just £2 billion of the proposed £45 billion of unfunded tax cuts seems insufficient, in isolation, to restore trust in the U.K. economy and bring down spiraling interest rates.

    “When market trust has been shattered, as we saw last week, the uphill task of restoring credibility is extremely hard and even harder when strategies shift,” Charles Hepworth, investment director at GAM, said.

    “The market currently has little faith that the prime minister and chancellor can restore credibility in the short term, and this puts further renewed pressure on U.K. risk assets.”

    Neil Birrell, chief investment officer at Premier Miton Investors, agreed the U-turn would not solve the turmoil in financial markets.

    “High inflation and high interest rates are not going away quickly, and economic growth is under severe threat,” he said.

    “Markets still need to hear how the package will be funded,” added Iain Anderson, executive chairman at H/Advisers Cicero, who said the next fiscal statement planned for November 23 must be brought forward as a matter of urgency. 

    The first senior Tory MP quoted above lamented that the market turmoil following the mini-budget meant the Tory party would now “own interest rate rises — a lot of which were going to happen anyway.” 

    “I cannot remember in my life when any politician has recovered from such a savage self-inflicted wound,” Giles Wilkes, a senior fellow at the Institute for Government and partner at Flint Global, said. 

    “Gordon Brown recovered somewhat from the multiple slip-ups of 2007-08 with his commanding response to the global financial crisis, but even that wasn’t enough.”

    Annabelle Dickson, Esther Webber and Emilio Casalicchio

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  • New US Tax identification number requirements create unworkable situations for Qualified Intermediaries – Banking blog

    New US Tax identification number requirements create unworkable situations for Qualified Intermediaries – Banking blog

    The IRS has recently announced a number of changes related to identification requirements impacting Qualified Intermediaries (QIs). This blog is the first of a two-part series and describes how the current design of the Secure Access Account (SAA), and in particular the request to provide a US Tax identification number to validate the QI’s Responsible Officials identity, would impair the QIs’ capabilities to comply with their electronic reporting obligations through FIRE. The second part of this series, covering QI’s new due diligence challenges linked to their non-US account holders’ US Tax identification number requirement for 1446(a) and 1446(f) purposes, will follow in a separate blog.

    On 26 July 2021 the IRS announced (IRS release available here) it is substantially transforming the existing application procedure for Filing Information Returns Electronically (FIRE) transitioning from Form 4419 to the Information Returns (IR) Application system to obtain the Transmitter Control Code (TCC) required to file electronically via FIRE.

    This transformation is particularly relevant for QIs since they have no other option than filing Forms 1042-S (and sometimes Forms 1099) electronically via FIRE. 

    Currently, the planned changes are not fit for most QIs. Specifically, the system preliminary requires QI’s Responsible Officials to validate their identify through a SAA, unfortunately designed for individuals with US tax filing requirements.

    Luckily this transition is happening progressively and thus most QIs are not yet impacted provided that prior to August 2022 they ensure that the identifying information (legal business name, mailing address, and/or contact information) associated with their active TCC received before 26 September 2021 is current and correct to log into the FIRE System.

    We recommend that QIs immediately validate that the information the IRS has on file is current and correct. If changes are needed, QIs should use paper Form 4419 (Rev. 9-2021) to update this information given that as of 2 August 2022, the IRS will discontinue the paper form process to transition to the IR TCC application system to make such changes. As of this date the complex issues of gaining access to the new system will be a reality for QIs with the risk of being shut out of FIRE if their legal business name is incorrect (e.g., spelling, abbreviations, special characters and spacing do not match the IRS records). 

    New FIRE users

    As of 26 September 2021, new FIRE users can no longer make use of paper and fill-in versions of Form 4419 to request an original TCC, the five-digit number required to file electronic returns through FIRE. Instead, they need to use the new online IR Application for TCC. Additionally, in order to access the IR Application for TCC, new FIRE users are firstly required to verify their identity by creating a Secure Access Account (SAA) to improve security features and thus protect from fraudulent access.

    Since at least two Responsible Officials need to be listed on the IR Application for TCC, both persons need to create their own respective SAA.  

    The IR Application for TCC currently foresees that users need to provide the following information amongst other to create an SAA:

    1. The user’s Social Security number (SSN) or Individual Tax Identification Number (ITIN);

    2. The user’s tax filing status and mailing address from the most recently filed tax return;

    3. A financial account number linked to the user from one of these account (last eight digits of Visa, Mastercard or Discover Credit Card, Student loan, Mortgage or home equity loan, Home equity line of credit, or Auto loan); and

    4. A US-based cell phone in the name of the user (for faster registration) or a mailing address where the user can receive an activation code by mail.

    Existing FIRE users

    Existing FIRE users (i.e., those who submitted their TCC Application prior to 26 September 2021) were originally scheduled to transition to the IR Application for TCC in Fall 2022.

    However, on 16 June 2022, the IRS granted existing FIRE users more time to transition to the new system (IRS release available here). Those existing TCCs will remain active until 1 August 2023. After that date, any FIRE TCC that does not have a completed IR Application for TCC will be dropped and will no longer be available for e-filing. Accordingly, existing FIRE users will need to validate their identity via the SAA, log in to IR application for TCC and complete the online application between September 2022 and 1 August 2023.  

    Existing FIRE users, not yet transitioning to the IR Application, are currently allowed to use paper Form 4419 (Rev. 9-2021) to revise identifying information (legal business name, mailing address, and/or contact information) associated with an active TCC received before 26 September 2021.

    However, paper Form 4419 will be discontinued as of 2 August (IRS release available here) to transition to the IR Application for TCC also for purpose of revising existing TCC information. Therefore, prior to August 2022, existing FIRE users will need to ensure that the information on their application (submitted via Form 4419) contains the current contact’s name, current email address and current telephone number and verify that the company’s current legal business name is correct (spelling, abbreviations, special characters and spacing) to match the IRS records. If any information needs to be updated, the changes through Form 4419 need to be received by the IRS by 1 August 2022.  Notably, as certain QIs have already started experiencing, an incorrect legal business name will trigger the inability to file information returns electronically via FIRE.

    QIs may risk being unable to create an SAA and consequently left out of FIRE

    As mentioned above, the setup of an SAA, currently foreseen by the IR Application for TCC, requires either an SSN or an ITIN.

    • At its most basic level, an SSN is used by US citizens and authorized noncitizen residents (i.e., noncitizens authorized to work in the US).

    • An ITIN is a tax processing number issued by the IRS to individuals who are required to have a US taxpayer identification number but who do not have and are not eligible to obtain an SSN from the Social Security Administration. In general individuals must have a filing requirement and file a valid federal income tax return to receive an ITIN unless they meet an exception. However, a specific exception applies for a non-US representative of a foreign corporation who needs to obtain an ITIN for the purpose of meeting e-filing requirements.

    Since employees of QIs generally do not have a connection to the United States, other than working at a bank that holds US securities, they cannot apply for an SSN. However, based on the above-mentioned exception, they can apply for an ITIN.

    Accordingly, some QIs have already asked certain of their non-US employees to apply for an ITIN via Form W-7 to create an SAA to be able to obtain a TCC via the IR Application to continue to use FIRE.

    Unfortunately, this appears to not yet be sufficient to ensure the creation of an SAA. Although the instructions for Form W-7 allow to apply for an ITIN for e-filing purposes absent a US filing requirement, the SAA presumes a US filing requirement and consequently asks for the user’s tax filing status. This misalignment results in an insurmountable obstacle for most QI’s employees unable to create their SAA. As a result, QIs cannot obtain the required new TCC.

    What are the alternatives?

    The IRS, through its Frequently Asked Questions about the IR Application for TCC originally envisaged two options:

    1. Enlist a third party to file on their behalf; or

    2. Purchase a software package to support their electronic filing.

    An IRS representative, speaking at the last Kaplan Financial Education tax conference in June 2022, indicated that the FAQ was revised to no longer refer to option 2 above, leaving as sole alternative option 1.

    Although option 1 is technically possible, QIs face many issues to put in place the necessary infrastructure to enable it to outsource this activity to a 3rd party in light of client confidentiality (e.g., the case of Form 1099 or nominative Form 1042-S reporting).  

    At the same conference, the IRS indicated it is aware of the implementation issues that non-US filers are facing and that “this is actively being worked and considered”. The IRS representative encouraged stakeholders to bring forward alternatives and provide comments to notify the Service of concrete examples of the challenges that non-US filers are facing.

    Deloitte’s view

    Although SAA is today a limited problem for QIs that are existing FIRE users, given they still have more than a year to transition to the new IR TCC application, they immediately need to check that the information associated with their current TCC is correct. If this is not the case, QIs need to make sure that the IRS receives the corrected legal business name via Form 4419 by 1 August 2022 at the latest to avoid being shut out of the FIRE system (after this date, revising the information associated with a TCC will only be possible through the IR TCC application system with the current SAA issues described above).

    QIs that are existing FIRE users having submitted their TCC Application prior to 26 September 2021, will meanwhile also face the aforementioned SAA issues in case they need an additional TCC or to add a new Form Type. This is because in both circumstances the completion of the IR Application for TCC is required.

    Although Deloitte recognizes the need to strengthen validation controls to protect against unauthorized filing and input of fraudulent information returns, it is clear that SAA, as currently designed, does not work for QIs.

    • QI’s Responsible Officials don’t generally have US tax filing requirements, and as such are unable to populate the user’s tax filing status necessary to go through SAA.

    • At the same time, since non-US applicants will generally not have a US-based mobile phone, requesting them to provide, at SAA set-up, an international postal mail to receive a one-time code that is only valid for 30 days appears an inappropriate way of communication; experience shows that IRS mail is sometimes received by QIs after 30-days of issuance.

    • It is unclear whether it is feasible for non-US applicants to provide the required information pertaining to a financial account or whether such account must be one maintained in the US linked to their name. 

    Therefore, we encourage the IRS to make the SAA process accessible to QIs and more broadly to non-US filers. For this purpose, we would suggest keeping the ITIN requirement consistent with the instructions for Form W-7, while eliminating the need to provide the user’s tax filing status. Moreover, we propose to allow non-US applicants to access the SAA without requesting any financial information and giving the option to provide a non-US phone number or a non-US e-mail address to receive the one-time code through the SAA process.

    There are clearly several obstacles to overcome in order for QIs to have the required access to fulfil their reporting obligations as of August 2023. However, it is quite clear that obtaining an ITIN (which usually takes a few months) will be most likely one of the steps of the transition process. Deloitte, as Certifying Acceptance Agent (CAA), can assist and simplify the ITIN application procedure in the following ways:

    • Support with the completion of Form W-7

    • Review and authenticate the applicant’s passport to verify his/her identity and foreign status

    • Submit to the IRS the completed Form W-7 together with a copy of the applicant’s passport; and

    • Directly receive the applicant’s ITIN from IRS

    By: Elena Bonsembiante, Manager and Lisa Timmer, Consultant, Financial Services Tax 

    If you would like to discuss more on this topic, please do reach out to one of the key contacts below:

    Key contacts

     

    Brani

    Brandi Caruso – Partner, Financial Services Tax & Legal

    Brandi heads Deloitte’s Financial Services Tax team in Switzerland and Liechtenstein. She has extensive expertise in advising the Swiss financial services industry on the implementation of US and international transparency regimes (including QI, FATCA, Section 871(m), CRS, MDR and DAC6). Brandi also leads the Financial Services Tax team’s efforts relating to innovative technology solutions. Brandi is a US Certified Public Accountant and has 20 years of experience with Deloitte and has worked in London, San Diego and Zurich.

    Email

    Karim Schubiger_110x110

    Karim Schubiger – Director, Financial Services Tax 

    Karim leads the Tax Transparency team in the Suisse Romande and Ticino markets within the Financial Services Tax practice and is responsible for services relating to QI, FATCA, CRS, 871(m) and DAC6. He is a technical advisor and subject matter expert to financial institutions in the banking, trust, and insurance sectors. Prior to joining Deloitte, Karim worked for eight years in support teams of Swiss banks, in particular in areas relating to operations, project and change management as well as operational taxes.

    Email

    Ch-profiles-elena-bonsembiante

    Elena Bonsembiante – Manager Financial Services Tax

    Elena is a QI, FATCA and CRS specialist and an Italian certified public accountant. She is leading as Manager several QI, FATCA and CRS projects for middle sized banks in the French and Italian speaking areas. Prior to joining Deloitte Switzerland, she worked for Deloitte Italy and other Italian Tax Firms. 

    Email

    Lena Woodward

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  • Biden Administration’s 2023 Tax Policy Includes Many Key Changes For Crypto Traders And Investors

    Biden Administration’s 2023 Tax Policy Includes Many Key Changes For Crypto Traders And Investors

    What Happened

    On March 28th, 2022, the Department of Treasury issued the 2023 Fiscal Year Revenue Proposal (The Green book) outlining a number of proposed tax policies designed to increase revenues, improve tax administration, and make the tax system more equitable and efficient. The proposal had several key policies that will have a direct impact on crypto taxpayers if adapted as proposed.

    Key Concepts

    Tax Policy Changes Targeted Towards High-income Taxpayers

    The proposal has three major tax policy changes focused on high income earner in the US. First, the treasury wants the highest marginal income tax rate to increase from 37% to 39.6% effective December 31, 2022. This increased marginal rate would apply to taxable income over $450,00 for married filers and $400,000 for individual filers. If your total taxable income is above these thresholds, your short-term cryptocurrency gains (coins & NFTs sold after holding them for less than 12 months) and other types of crypto income such as staking, mining & interest would be subject to this higher rate.

    Second, the proposal is planning to subject long-term capital gains (which are generally subject to a lower tax rate than ordinary income tax rate) to a higher tax rate for taxpayers with over 1 million of taxable income. For example, if your overall taxable income is over 1 million, long-term gains in excess of 1 million would be subject to a much higher ordinary income tax rate vs the maximum 20% rate under the current law. Furthermore, the proposal aims to make transfers of appreciated property as gift and at death as taxable events for wealthy individuals.

    Third and arguably the most aggressive tax proposal included in the document is the 20% minimum tax on “Total income” for taxpayer’s worth over 100 million. Total income includes regular taxable income such as wages and investment income and surprisingly unrealized capital gains on assets you own.

    Specific Policy Changes For Digital Assets

    The proposal includes four digital assets specific tax policy changes. Let’s first go through the three policies that have a direct impact on taxpayers.

    The first proposal talks about cryptocurrency lending activity which has expanded rapidly over the past several years. The treasury aims to make cryptocurrency-based loans tax-free similar to loans based on stocks & securities, as a long as certain criteria is met. This is good news for taxpayers who are involved in lending activity.

    Certain specified financial assets (foreign bank accounts, brokerages, etc.) held by US individuals in foreign countries have been subject to IRS reporting for many years. To comply with the rules, US taxpayers with foreign accounts in excess of $50,000 are required to file a Form 8938 (Statement of Specified Foreign Financial Assets) disclosing various information about those assets. Whether digital assets held in overseas exchanges are subject to Form 8938 reporting has been a grey area for several years. The treasury proposal finally adds clarity to this lingering question and want to subject digitals assets to Form 8939 reporting.

    The next digital asset-specific tax policy change involves day traders of cryptocurrency. Section 475(f) tax election has been a taxpayer-friendly election active day traders of stocks have been enjoying for many years. When this election is properly made, day traders can mark-to-market their positions at year end and treat gains and losses as ordinary income. This allows them to deduct unlimited amounts of losses and override the $3,000 annual cap on capital loss deduction other taxpayers are subject to. If we strictly follow the current law, this favorable tax election is only applicable to stocks and commodity traders. The treasury has clearly identified the growth of crypto markets and proposed to extend this favorable election to active digital asset traders. This is another positive policy change.

    The final proposal related to cryptocurrency is aimed at US cryptocurrency exchanges. To effectively combat offshore tax evasion, the US tax regulators heavily rely on information shared by foreign financial institutions and governments on financial accounts owned by US individuals in foreign countries. The success of this system heavily depends on reciprocity. In simple terms, the US must share information about US financial accounts owned by foreign individuals to those respective countries; Foreign countries must report to the US when US individuals hold financial accounts in foreign countries. This continuous information sharing enables regulators to catch bad actors using offshore strategies to evade taxes.

    To strengthen reciprocity when it comes to crypto-related information sharing, the treasury would require US digital asset exchanges to report account balance for all financial accounts maintained at a US office held by a foreign person to the IRS.

    “This would allow the United States to share such information on an automatic basis with appropriate partner jurisdictions, in order to reciprocally receive information on U.S. taxpayers”

    All aforementioned proposals would be effective after December 31, 2022, except the rule that mandates US exchanges to report foreign account holder information, which is planned to be effective after December 31, 2023. According to treasury estimates, these digital assets specific rules will raise approximately 11 billion in tax revenue between 2023 and 2032.

    Next Steps

    Monitor how the proposed rules are processed through the legislative process in the coming months.

    Further Reading

    Quick Guide To Filing Your 2021 Cryptocurrency & NFT Taxes

    How The Infrastructure Bill Is Brewing A Crypto Tax Compliance Nightmare

    IRS May Not Tax Passive Income From Holding Crypto Right Away

    Shehan Chandrasekera, Senior Contributor

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  • SEC Objects To MicroStrategy Accurately Valuing Its Billion-Dollar Bitcoin Stash

    SEC Objects To MicroStrategy Accurately Valuing Its Billion-Dollar Bitcoin Stash

    What Happened

    MicroStrategy has been purchasing bitcoin since 2020 as a part of its capital allocation strategy. The company holds over 120,000 BTC as of the end of December 2021. As a U.S. public company, MicroStrategy is required to report earnings and transactions related to bitcoin under Generally Accepted Accounting Principles (GAAP) standard. However, properly accounting for these transactions in GAAP financial statements is an emerging area. The current GAAP standards that classify digital assets as intangible assets with indefinite lives (similar to goodwill and trademarks of a business), fail to capture the true financial behavior of bitcoin holdings. This treatment requires companies to report a loss when digital assets’ prices fall below the cost; however it prohibits marking up digital assets to it’s true value when prices later recover. This discrepancy can negatively impact a company’s net income, which could incorrectly translate into lower price per share. 

    To address the shortcomings of GAAP earnings due to bitcoin impairment losses, MicroStrategy added a “Non-GAAP Financial measures” section to Form 10-Q (Quarterly financial report public companies file with the SEC) for the quarter ended September 20, 2021. However, the SEC objected to this new treatment

    Key Concepts

    The Financial Accounting Standards Board (FASB) is the IRS of the accounting world. The FASB is responsible for creating Generally Accepted Accounting Principles (GAAP). As of the date of posting, there are still no cryptocurrency specific GAAP rules.

    In the absence of these crypto specific rules set by the FASB, in 2020, a working group formed by the American Institute of CPAs (AICPA) came up with a Digital Asset Practitioner Guide addressing how to classify cryptocurrencies in GAAP financial statements.

    How Cryptocurrencies are Classified on GAAP Financials

    According to the white paper issued by the AICPA, crypto assets cannot be classified as “cash or cash equivalents” on GAAP financial statements because they are not backed by a sovereign government or considered legal tender. They cannot be classified as a financial instrument or a financial asset because they are not cash (see above why) and do not represent any contractual right to receive cash or another financial instrument. Additionally, since cryptocurrencies are intangible, they do not clearly meet the definition of inventory and cannot be labeled as inventory on the balance sheet either.

    After going through the process of elimination, we are left with only one category to classify cryptocurrencies under: intangible assets with indefinite life. This is how MicroStrategy currently classifies bitcoin in their financial statements. 

    (3) Digital Assets: The Company accounts for its digital assets as indefinite-lived intangible assets in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles—Goodwill and Other. The Company’s digital assets are initially recorded at cost. Subsequently, they are measured at cost, net of any impairment losses incurred since acquisition” (10-Q, page 11)

    Practical Mismatches with Intangible Asset Treatment

    There are a few problems with classifying cryptocurrencies as intangible assets with indefinite life. Practically speaking, this accounting treatment does not align with the reality. Cryptocurrencies like bitcoin are liquid and work extremely similar to cash. The purpose of GAAP financial statements is to paint an accurate, unbiased picture of the underlying entity’s financial situation. By treating crypto assets as intangible assets, GAAP financials fails to communicate the high liquidity of crypto assets. 

    Second, once an item is classified as an indefinite life intangible asset, it should be tested for impairment. This means, if the value of the crypto asset has gone down at the end of the reporting period, the business gets to write off that amount as an impairment loss (not to be confused with tax losses) on the income statement. However, if the value goes back up (which is common due to high volatility), the business does NOT get to mark up the value of the asset. This overly conservative approach often results in businesses showing poor operating results under GAAP which negative affects investor sentiment and stock price. 

    For example, MicroStrategy reported $65,165,000 of impairment losses for the three months ending September 30, 2021, because the market value of bitcoins went below their purchase price. Although this 65M impairment loss was not a cash outflow from the business, it was the largest operating expense which contributed to a net loss of $36,136,000.     

    Similarly, during the three months ending September 30, 2021, Tesla reported 51M of impairment loss. Square reported 6M of bitcoin impairment loss in the same period. 

    To clarify the situation and show the true performance of the business to investors, MicroStrategy added a section named, “Non-GAAP Financial Measures” in their 10-Q. This section shows what would their operating income be without taking impairment and few other non-GAAP amounts (not related to digital assets) into consideration. 

    According to this schedule, if impairment loss was not considered (and few other items not relevant to bitcoin), the company would have a net income of $18,566,000. 

    SEC Letter to MicroStrategy

    The SEC objected MicroStrategy’s Reconciliation of non-GAAP net income schedule above. On December 3, 2021, it sent the company a comment letter and advised the company to remove it under the Rule 100 of Regulation G.

    Reg G requires public companies to “disclose or release such non-GAAP financial measures to include, in that disclosure or release, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure”. 

    Although we don’t know the specifics of the situation, it is clear that MicroStrategy’s 10-Q includes GAAP financials & a reconciliation of non-GAAP net income schedule allowing readers to compare numbers easily. The company’s goal is to clearly communicate the true operating performance of the company minus the “paper bitcoin losses” which is required to report under incompatible GAAP rules. Therefore, the specific concern the SEC has with the presentation is unclear. It is also interesting to see that the letter is only talking about the “adjustment for bitcoin impairment charges” among other items included in the Reconciliation of non-GAAP net income schedule such as share-based compensation, interest expense and income tax effects. 

    On a subsequent letter from MicroStrategy dated December 16, 2021, the company accepted SEC’s comments and removed the adjustment for bitcoin impairment on the reconciliation of non-GAAP net income schedule. 

    Finally, the rising inflation and the uncertainly of interest rates have moved the market sentiment from investing in risky companies to value stocks of profitable companies. Microstrategy may find it challenging to show a net profit under GAAP in the coming months if the price of BTC moves sideways in a bearish market or declines further creating more impairment losses. Even when BTC goes up, Microstrategy will not be able to show a profit under GAAP unless they sell it. This situation could unfairly affect the stock price of the company. If a spot BTC ETF gets approved, investors might be better off directly investing in the ETF compared to using Microstrategy as a way to get exposure to BTC.

    Next Steps

    Keep an eye on how SEC approaches Non-GAAP disclosures related to bitcoin for other public companies holding bitcoin. 

    Further Reading

    ·      Quick Guide To Filing Your 2021 Cryptocurrency & NFT Taxes

    ·      How The Infrastructure Bill Is Brewing A Crypto Tax Compliance Nightmare

    ·      How To Avoid Common NFT Tax Pitfalls.

    Shehan Chandrasekera, Senior Contributor

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  • $ENS Airdrop Comes With A Tax Bill – What You Need To Know

    $ENS Airdrop Comes With A Tax Bill – What You Need To Know

    What Happened

    Airdropping is a popular method used by cryptocurrency projects to reward early adopters. For instance, we saw projects like Flare and Uniswap ($UNI token) airdrop $FLR and $UNI tokens to millions of users in 2020. So far, over 133M $UNI tokens worth over 3 billion have been claimed by the users. 

    Similarly, anyone who had an Ethereum Name Service (ENS) domain as of October 31, 2021, is eligible to receive free $ENS tokens. Specifically, 82,047 of the 137,689 addresses have claimed the airdrop as of November 17, 2021. The specific amount available per address depends on their level and duration of involvement with the project. Currently, $ENS is trading at approximately $50 per coin, making it a lucrative opportunity.

    Key Concepts

    What are Airdrops?

    Airdrops are free tokens that you are eligible to receive as a result of being an early adopter of a cryptocurrency project. Some are surprises. For example, Uniswap airdropped 400 $UNI tokens to early users of the Uniswap exchange. Other airdrops are planned in advance to drive up prices and publicity. For example, Flair had been talking about a potential airdrop for $XRP holders for a while before it occurred on December 12, 2020, the snapshot date.  

    The redemption processes can differ as well. Sometimes, you get airdrops automatically in your wallet without any action from your end. In other cases, you have to intentionally claim the free tokens by following the instructions provided by the project. For example, if you had an ENS domain as of October 31, 2021, you can claim your free $ENS by going to https://claim.ens.domains/. 

    Airdrop Taxes

    The IRS has not issued any direct guidance on airdrops sent to early adopters of a project. It is reasonable to think that such airdrops are unsolicited property for tax purposes because the recipient doesn’t have any prior knowledge about the airdrop. Moreover, the Rev. Rul. 2019-24 talks about airdrops that could happen pursuant to a hard fork. Although the background provided here may not be directly applicable to the $ENS airdrop (since there’s no Hard fork), the dominion & control doctrine used here is important when determining the tax consequences.

    According to past unsolicited property tax rulings (Technical Advice Memorandum 8109003 and 8109004) and the details provided in the Rev. Rul. 2019-24, surprised airdrops like the $ENS token is likely taxed at the time the taxpayer gains dominion & control over the asset. In simple terms, this means at the time you claim the token and have the ability to transfer, exchange or sell the coin. The amount of ordinary income to be reported is the fair market value at the time you gain dominion and control. This amount would be subject to ordinary income taxes (10% – 37%) based on your income tax bracket.

    For example, say you claimed (exercised dominion & control) one $ENS token on November 08, 2021. On this day, one ENS token was approximately worth $30 according to CoinMarketCap data.Therefore, you have to report $30 of ordinary income.  

    Say you later sell this $ENS for $50. Then, you would pay capital gains taxes on $20 ($50 – $30).

    Note that some airdrops could automatically appear on your wallet without you taking any action. In these cases, you’d have a taxable event even If you didn’t want the airdrop. This is because the dominion and control is automatically established when the coins appear on your wallet. If the price of the coin later drops and/or you don’t want the coin, you may still be liable for the tax bill based on the price at the time you received them. Here, you can liquidate the coin at a loss to offset the income reported at receipt.  

    How to Plan Taxes Around the $ENS Airdrop

    ENS protocol allows you to claim $ENS until May 4th, 2022. There are couple of actions you can take to reduce and defer taxes on the $ENS airdrop. First, you can wait until the prices go down before claiming the token, if you think that they will. Going with the example above, assume you claim $ENS in December 2021 when the price is $20 per coin. Here, you’d report $20 of ordinary income instead of $30. On the other hand, if the price rises, you would end up reporting more income. 

    Second, you can claim your $ENS between January 1st, 2022, and May 4th, 2022. By doing so, you can defer the taxable event to the 2022 tax year. If you are subject to a lower tax bracket in 2022 compared to 2021, this will reduce your taxes on the airdrop. Further, 2022 taxes are due by April 2023. This gives you ample time to observe the prices and sell when the price is at Its highest. 

    Either way, it is also important to set aside some money to pay the related taxes on the income reported on the airdrop. The amount to be set aside varies depending on your filing status and the tax bracket. If the airdrop is a large amount, it is recommended to talk to a tax adviser and calculate the estimated taxes on the airdrop.  

    Finally, you can entirely eliminate taxes by not claiming the airdrop at all. If you don’t claim the tokens by May 4th, 2022, you will potentially lose access to the airdrop. According to the ENS website, tokens not claimed by this date will be sent back to the ENS DAO treasury. If you don’t claim, you will not have any taxable event because you never gained dominion & control over the asset. 

    Next Steps

    ·      Consider claiming $ENS when the market price is low.

    ·      Consider claiming $ENS between January 1st, 2022, and May 4th, 2022, to defer tax liability to the next tax year. 

    ·      Have enough cash in hand to pay the related tax liability generated from the airdrop. 

    Further Reading

    ·      Time To Take Advantage of This Key Crypto Tax Loophole Is Running Out, Plus Other Year-End Strategies.

    ·      How To Avoid Common NFT Tax Pitfalls.

    Shehan Chandrasekera, Senior Contributor

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  • How To Avoid Common NFT Tax Pitfalls

    How To Avoid Common NFT Tax Pitfalls

    What Happened

    The record-breaking NFT sale by Beeple in 2021 Q1 re-ignited market interest in NFTs after the initial foundation was laid out by the Cryptokitties project back in 2017. This was followed up by NFT projects like CryptoPunks and Board Ape Yacht club that soared in prices in a very short period of time. The sudden spike in market sentiment for NFTs made many investors millionaires overnight. That said, amidst all this excitement, NFT investors can easily fall victim to many tax pitfalls due to ambiguous tax guidance and lack of education on how to manage NFT taxes correctly.

    Key Concepts

    What are NFTs?

    Non-fungible tokens (NFTs) are digital representations of assets — artwork, domain names, music, characters in games — created in limited quantities to maintain scarcity. Each NFT is unique and therefore not interchangeable with another in a similar manner to fungible digital assets such as bitcoin or ether. 

    For example, CryptoPunks is a collection of a thousand unique pixelated avatars with different facial features and characteristics. Since each character is unique, CryptoPunk #4835 is not interchangeable with CryptoPunk #5801.

    You can buy and sell NFTs in dedicated marketplaces such as OpenSea, SuperRare and Nifty Gateway, among others. Additionally crypto exchanges like Binance, Coinbase, or FTX have announced or launched NFT platforms.

    Tax Treatment of NFTs

    How taxes work for NFT investors

    NFT investors are individuals who buy and sell NFTs in marketplaces like OpenSea. They are subject to a similar set of tax rules (with some tweaks) as cryptocurrency investors.

    How the IRS treats NFTs

    Although the IRS has not issued any NFT specific tax guidance, most art-based NFTs such as CryptoPunks are likely classified as collectibles under the IRS § 408(m)(2)(A)). This tax classification is important to note because it subjects NFT gains to a slightly higher tax rate than regular cryptocurrency in some cases. Note that fractionalized NFTs will still preserve the same underlying tax classification.

    When do Investors have to worry about NFT Taxes?

    First, purchasing an NFT using a cryptocurrency like ether (ETH) triggers a taxable event. This is because you are disposing of a property to buy an NFT. For example, Sam spent 1 ETH to purchase a CryptoPunk valued at $5,000. Sam paid $100 to buy this ETH few years ago. Sam will have a $4,900 ($5,000 – $100) long term capital gain at the time he spends the ETH to buy the CryptoPunk. $5,000 will be his cost basis for the NFT. 

    Second, cashing out an NFT or trading one NFT for another also trigger capital gains tax events for investors. If Sam were to sell his CryptoPunk for 2 ETH valued at $12,000, he’d Incur a capital gain of $7,000 ($12,000 – $5,000)

    Third, some NFTs also pay you royalties each time a subsequent sale occurs. In this case, royalties paid in cryptocurrencies are taxed when earned. 

    NFT Tax Pitfalls

    You could owe NFT taxes without ever receiving cash

    There are three situations where you could owe NFT taxes without ever receiving any cash in hand. These include purchasing an NFT using a cryptocurrency, trading one NFT with another and earning royalties in cryptocurrency. Unfortunately, most NFT holders are not aware of these rules. This could result in large and surprising bills come tax day, which you may not have the cash to pay. 

    You could incur penalties for not paying taxes on time

    If you generated large amounts of profits from NFTs, you could have a quarterly tax obligation in 2021 for the first time. You may be unaware of this leading to underpayment penalties. To avoid getting penalized, you should consult with a tax professional to figure out your quarterly tax obligation or see if you qualify for a safe harbor. 

    At high-income levels, NFT gains could be subject to higher tax rates than you anticipated 

    A short-term capital gain occurs when you sell an asset after holding it for less than 12 months. If you are somebody who rode the NFT wave in 2021, most of your gains will be short-term. Short-term gains on NFTs can be subject to the maximum 37% If you are in the highest tax bracket. Also, be prepared to pay an additional 3.8% Net Investment Income tax if you exceed the applicable income thresholds for the year. 

    A long-term capital gain occurs when you sell an asset after holding It for more than 12 months. Generally, tax law favors long-term capital gains by subjecting them to a lower tax rate than short-term capital gains. The maximum long-term capital gains tax rate is 20% for stocks and cryptocurrencies (plus the 3.8% NII tax when applicable). Unfortunately, since NFTs are classified as collectibles, long-term NFT gains are subject to a maximum rate of 28% for high income earners. 

    Calculating NFT gains & losses is difficult  

    Currently, NFT marketplaces do not provide you with any tax documents nor any transaction history reports to figure out your NFT capital gains and losses. So, it is your responsibility to keep detailed records, figure out the correct cost basis & market values and accurately file taxes. 

    In the cryptocurrency world, there is tax software which helps you automatically reconcile capital gains & losses by connecting to your wallets and exchanges. However, when it comes to NFTs, the software support is at its infancy causing you to have to manually calculate taxes in some cases.  

    NFT Valuation concerns

    NFTs are not like cryptocurrencies where you can actively see fair market values on websites like CoinGecko or Coinmarketcap. Therefore, if you trade one NFT with another, you will have to appraise the value of the receiving NFT to compute the accurate taxable gain or loss. Appraisal could become a big issue especially when the transaction amount is significant. Again, it is your responsibility to identify these events and seek professional help to accurately figure out your NFT taxes. 

    Next Steps

    ·      Reconcile your NFT capital gains and losses. 

    ·      Consult with a qualified tax adviser and calculate your projected tax obligation for 2021.

    ·      Determine If you are required to pay taxes quarterly or meet the safe harbor for 2021. 

    ·      If needed, liquidate some NFT’s and/or other cryptocurrencies into cash to cover the upcoming tax bill 

    Further Reading

    ·      Step By Step Guide To Filing Your Cryptocurrency Taxes

    ·      Do You Have To Pay Quarterly Taxes On Cryptocurrency?

    ·      Time To Take Advantage Of This Key Crypto Tax Loophole Is Running Out, Plus Other Year-End Strategies

    Shehan Chandrasekera, Senior Contributor

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