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FBAR Reporting for Foreign Mutual Funds

2009-09-18

Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (hereinafter referred to as the “FBAR”), generally must be filed by June 30th of each year to report financial interests in, or signature authority over, foreign financial accounts held during the prior calendar year.

In October 2008, the I.R.S. revised the FBAR and its accompanying instructions.  The instructions were modified in several controversial ways.  This blog posting only discusses the changes with respect to U.S. citizens or U.S. residents that own interests in foreign commingled funds, including foreign mutual funds.

Both the old and the new instructions to the FBAR provide that a financial account includes “any bank, securities, securities derivatives, or other financial instruments account.”  The revised FBAR instructions, however, add an embellishment to the definition of financial account.  The revised instructions provide that financial accounts:

generally also encompass any accounts in which the assets are held in a commingled fund and the account owner holds an equity interest in the fund (including mutual funds).

On its face, the instructions would now appear to require every U.S. citizen and U.S. resident with an interest in a foreign mutual fund, or commingled fund, to file the FBAR.  Given the potential civil penalty of $10,000 per year for nonwillful failure to file the FBAR, this is an important change to the instructions.

Unfortunately, the instructions do not provide a definition of an “account.”  Further, there does not appear to be any other authority to provide additional guidance as to what is meant by an account.

If a U.S. person directly acquires stock in a foreign corporation, it is difficult to see how the shares of stock themselves constitute an “account.”  Clearly, if the shares are in a foreign brokerage account, then the foreign brokerage account could trigger the FBAR filing requirement.  However, not all shares in foreign corporations are acquired through foreign brokerage accounts.  The following discussion assumes that a U.S. person’s direct ownership of shares of a typical foreign corporation that has active business operations does not rise to the level of an “account” for purposes of the FBAR.

Many, if not most, foreign mutual funds would be treated as corporations for U.S. tax purposes.  In fact, the passive foreign investment company (“P.F.I.C.”) rules are specifically targeted at foreign mutual funds.  In order to be a passive foreign investment company, the foreign entity must be a corporation under U.S. tax principles.  If the FBAR instructions apply to foreign corporations that are treated as mutual funds, each time a U.S. person acquires shares of stock in a foreign corporation (a mutual fund or otherwise), a determination would need to be made as to whether the foreign corporation was a “commingled fund,” such as a mutual fund.

The instructions to the FBAR do not provide a definition of a commingled fund or of a mutual fund, and it is unclear what these terms are intended to mean.  For instance, if a foreign holding company has one wholly owned subsidiary and no other assets, presumably the holding company would not be a commingled fund.  On the other hand, if the foreign holding company owns a small percentage of many different companies (just like a mutual fund), the holding company may be a commingled fund.  It is unclear where on this spectrum a non-commingled fund becomes a commingled fund (and therefore causes the shares to become an “account”).

After receiving comments from U.S. tax practitioners, the Treasury Department last month (August 2009) issued Notice 2009-62.  This notice provides an extension to file an FBAR until June 30, 2010 for the 2008 year and earlier years with respect to foreign commingled funds.  In the interim, the Treasury Department is expected to provide additional guidance.

Interestingly, if the forthcoming definition of a commingled fund is not simple and clear, it may be easier (read less expensive) to file protective FBARs for all foreign shareholdings.  If U.S. tax return preparers must investigate the activities of each foreign corporation in which their client owns shares (to determine the entity’s status as a commingled fund or not), it may be easier, cheaper, and safer (penalty wise) to complete the FBAR for all foreign shareholdings.

Andrew Mitchel is a U.S. international tax attorney who advises businesses and individuals with cross-border activities.

Tags: 1291 PFICs, Other - FBAR