Posted from DeBelis Law - As has become obvious, the IRS has stepped up its efforts to curb non-disclosure of offshore assets and under reported income by U.S. taxpayers.  This blog provides guidance on tax compliance for U.S. taxpayers who store gold and currency cash notes abroad in private vaults – a popular investment these days considering the uncertain global economy and the sharp declined in currency values.

A U.S. person must file an FBAR if that person has a financial interest in or signature authority over any financial account(s) outside of the United States and the aggregate maximum value of the account(s) exceeds $ 10,000 at any time during the calendar year.  In addition, if those foreign financial assets are owned by foreign entities such as corporations, U.S. persons who are officers, directors, or shareholders may also be required to file forms and schedules with the IRS (e.g., Form 5471 is used to satisfy the reporting requirements of IRC Sections 6038 and 6046 and the related regulations.

According to Treasury Regulation 31 C.F.R. § 1010.350, a “financial account” includes securities, brokerage, savings, demand, checking, deposit, time-deposit or other accounts maintained with a person engaged in banking.  In 2011, the regulations expanded the term “other financial accounts” to clarify that it includes commodities, futures, or options accounts, insurance policies with cash value, and mutual funds or similar pooled funds that issue shares available to the general public and that have a regular net asset value determination and regular redemptions.

Financial account also includes an account with a person that is in the business of accepting deposits as a financial agency or a person who acts as a broker or dealer for futures or option transactions in any commodity or is subject to the rules of a commodity exchange or association.  A foreign financial account is defined as one located outside the United States.

Courts have not decided whether a private vault located within a foreign financial institution is a financial account for FBAR purposes.  Section 5312(a)(2) lists 26 different types of entities that may qualify as a “financial institution.” Based on the breadth of the definition, the fourth circuit court of appeals held that “the term ‘financial institution’ is to be given a broad definition.” United States v. Dela Espriella, 781 F.2d 1432, 1436 (9th Cir. 1986).

The closest that the IRS has come to weighing in on the issue is in a published list of frequently asked questions.  The question pertains to whether an FBAR is required for an account maintained with a foreign financial institution if the account holds non-cash assets, such as gold.  The IRS responded affirmatively, stating that an account with a foreign financial institution is a financial account for FBAR purposes, regardless of whether the account holds cash or non-monetary assets.

This question, however, is inherently flawed.  Why?  Because it assumes that the asset is being maintained in a financial account with a foreign financial institution.  What is not addressed is the question of whether a private vault located within a foreign financial institution – but separate and distinct therefrom – is a “financial account” in the first place.

The reason why this is relevant is because if a private vault is not a financial account, then any assets stored inside it – i.e., gold or currency cash notes – need not be reported on an FBAR.

A review of the treasury regulations reveals a similar result.  However, they offer some guidance which is helpful to determining the ultimate question.  According to the regulations, a financial account must be maintained by a foreign financial institution.  31 C.F.R. § 1010.350.

This has a subtle but important distinction that is critical to the analysis.  The fact that a private vault may qualify as a financial account does not automatically trigger a reporting requirement.  Not only must the vault qualify as a financial account, but it must also be maintained by a foreign financial institution.  Then and only then is a U.S. taxpayer required to file a FBAR.  This entails an examination of the relationship between the vault itself and the company operating the vault.

Let’s assume for the sake of argument that our hypothetical private vault falls within the definition of “other financial account[s]” under 31 C.F.R. 103.24.  To be sure, no circuit courts of appeal have yet answered the question of what constitutes “other financial account[s]” under 31 C.F.R. 103.24.  However, just because they haven’t doesn’t mean that it is beyond the realm of possibility for a private vault to fall within the definition of “other financial account[s],” especially in light of the fact that at its most primitive level, a vault is a place where valuable items are stored.

Like a banking account, a taxpayer who owns assets held within a vault controls access to those assets, in the sense that he or she can deposit assets into the vault at will and can withdraw assets from the vault at will.

Assuming that the private vault is deemed a financial account, the next issue is whether it is maintained with a financial institution or other person engaged in the business of a financial institution.  Here, there are two sub-issues.  First, let’s assume that the assets just so happen to be stored in a vault located in a foreign financial institution, specifically a Swiss bank.   Is the relationship between the taxpayer, as owner of the offshore assets in the vault, and the Swiss bank so dependent on each other that the account should be considered “maintained by a financial institution?”

Even if the answer to the first sub-issue is “no,” that does not end the analysis.  The government still has one more quiver left to prove that the account is maintained by a “foreign financial institution.”  The second sub-issue has two parts.  First, can the company that operates the vault be considered a financial institution or at least as a person engaged in the business of banking?  If so, is the relationship between the taxpayer who owns the assets within the vault and the company that operates the vault so dependent on each other that the account should be considered “maintained by a financial institution or a person engaged in the business of banking?”

Before delving any deeper into these issues, there is a framework of analysis that must be followed.  While the framework is unique to safe-deposit boxes, the fact that a vault shares many of the same qualities as a safe-deposit box means that the framework applies to vaults just as much as it does to safe-deposit boxes.  This analysis is consistent with the IRS’ position expressed at a teleconference sponsored by the ABA Section of International Law’s Committee on International Taxation: “Foreign Bank Account Reports: Getting it Straight before the June 30 Deadline!”

On the one hand, in order for the vault to be maintained by a foreign financial institution (or a person engaged in the business of banking), the institution (or person engaged in the business of banking) must be able to exercise control over its contents.  In other words, it must have the authority to access and make deposits and/or withdrawals.  In a case where unrestricted access is granted by the owner to the foreign financial institution (or person engaged in the business of banking), it would indicate that the vault is a financial account and an FBAR is required if the currency notes exceed the reporting threshold.

On the other hand, where the owner maintains exclusive control over the vault and does not give the foreign financial institution (or person engaged in the business of banking) access, reporting currency cash notes stored in such a vault is not required regardless of value.  In that case, the vault would not be deemed a financial account maintained with a foreign financial institution (or a person engaged in business of banking).

With respect to the first sub-issue, aside from the fact that the vault is located inside a Swiss bank, a compelling argument can be made that there is no connection whatsoever between it and the bank.  There are five reasons.  First, the vault is leased exclusively to a private company for the benefit of its customers.  As such, the space is fully segregated from the bank’s own assets.  Therefore, the fact that the vault might physically be located inside a bank is meaningless.

Second, absolutely no co-mingling of assets occurs, as is the case with traditional banks.  On the contrary, each client is the direct owner of his or her assets, which are fully identifiable – at all times – as being the exclusive property of the client.  Moreover, it’s doubtful that the taxpayer will have relinquished control over their currency cash notes to the bank.  Instead, he or she will continue to maintain exclusive control over them.

Third, seldom is it necessary to open up a bank account in order to conduct currency transactions with the assets in the vault.

Fourth, the taxpayer may still access the vault even in the event of a financial Armageddon – i.e., the Swiss banking system undergoes a financial crisis and must shut down.  Finally, to the extent that the U.S. government gives deference to Swiss law, a bank’s vault activities are generally not deemed a “banking activity” under Swiss law.

Therefore, the relationship between the vault and the Swiss bank is so attenuated that it is all but impossible for the account to be considered maintained by a financial institution, Swiss or otherwise.
Turning to the second sub-issue, there are two parts.  First, can the company that operates the vault be classified as a financial institution or at least as a person engaged in the business of banking?  As a preliminary matter, such companies are generally not foreign financial institution.

Indeed, through literature that they disseminate to the public, vault-operating companies go out of their way to represent that they are not banks and that they do not provide banking-type services.  The disclaimer usually appears something like this: “providing access to precious metals storage facilities as offered by ISI-related banks via segregated vaults therein or other commercial storage vault facilities that provide high safety options.”

Even though the vault-operating company might not be a financial institution per se, could it be treated as a person engaged in the business of banking?  Admittedly, this is a gray area.  The government is likely to argue that the company is the functional equivalent of a “commercial bank.”  Section 5312(a)(2)(B).  It will rely on two cases: (1) United States v. Clines, 958 F.2d 578, 581 (4th Cir. 1992) and (2) United States v. Hom, 2014 U.S. Dist. LEXIS 77489 (N.D. CA 2014).

In Clines, the fourth circuit court of appeals held that “[b]y holding funds for third parties and disbursing them at their direction, [the organization at issue] functioned as a bank [under Section 5314].”  Clines, 958 F.2d at 582 (emphasis supplied).  And in Hom, the federal court held that online poker accounts function as banks, making a person’s online accounts with them reportable.
The court reasoned that the defendant opened up all three accounts in his name, controlled access to the accounts, deposited money into the accounts, withdrew or transferred money from the accounts to other entities at will, and could carry a balance on the accounts.  So, in a primitive sense, the court seemed to apply the duck test to reject Hom’s argument that online poker accounts were not the functional equivalent of a financial institution: “If it lucks like a duck, swims like a duck, and quacks like a duck, then it’s probably a duck.”

Based on fourth circuit precedent, a court is likely to agree with the government that the company does, in fact, function as a bank.  In a literal sense, it operates a vault – the very place where a customer’s assets are stored.  As such, it holds assets on behalf of their owner – here gold or cash notes.  Not only is it authorized to hold these assets, but it is presumably authorized to disburse them at their direction.

To the extent that the company is deemed a surrogate bank, is the relationship between the owner of the assets and the company so dependent on each other that the account can be considered maintained by a person engaged in the business of banking?  This is another gray area that can go either way.
In support of the argument that the relationship is so attenuated that it is impossible for the account to be considered maintained by a person engaged in the business of banking is the following.  The gold or currency cash notes are more than likely held together in a designated area of the vault.  In addition, they are individually packaged and labeled so that they are readily identifiable as the taxpayer’s property.  The taxpayer can personally view or take physical possession of the gold or cash notes at any time.  Finally, the taxpayer has not relinquished control over his gold or currency cash notes to the vault-operating company.  Instead, he continues to maintain exclusive control over them.
Therefore, a compelling argument can be made that the vault is not a financial account maintained with a financial institution or other person engaged in the business of banking.  In that case, the taxpayer need not file an FBAR.

The final issue is whether the taxpayer must file a Form 8938, Statement of Specified Foreign Financial Assets, with respect to the gold or cash notes held in the vault.  Under Form 8938, U.S. persons holding certain foreign financial assets outside the U.S. – including financial accounts, certain foreign securities and interests in foreign entities – must report those assets to the IRS.  I.R.C. § 6038D.

An individual must file Form 8938 if the following conditions exist:

1. The person is a specified individual. A specified individual is someone whose tax home is in a foreign country, who satisfies one of the presence abroad tests, and to whom no exception applies; and
2. The person has an interest in specified foreign financial assets. Specified foreign financial assets is defined to include any financial account maintained by a foreign financial institution. A taxpayer has an interest in a specified foreign financial asset even if there are no income, gains, losses, deductions, credits, gross proceeds, or distributions from holding or disposing of the asset included on the tax return for the tax year; and
3. The value of those assets is more than the reporting threshold.

A “financial account” defined by IRC Section 1471(d)(2) includes any depository or custodial account maintained by a financial institution.  Thus, the definition of a financial account under FATCA is similar to the Treasury Regulations for FBAR filing requirements.

Does Form 8938 require U.S. taxpayers to report currency cash notes stored in an offshore vault that the owner has exclusive access to?  As with the FBAR filing requirements, a reportable financial account under FATCA is an account maintained with a foreign financial institution.

In the same way that assets stored in a private vault in a foreign financial institution do not satisfy the requirements of a financial account for purposes of triggering the FBAR filing requirement when a financial institution does not exercise control or have access to its contents, the same reasoning applies in the context of FATCA.  Specifically, the offshore assets do not satisfy the requirements of a financial account for purposes of triggering the Form 8938 filing requirement.

Do not forget, however, an important point.  Even if there is no obligation to report gold or currency cash notes on an FBAR or Form 8938, if the assets are owned by a corporation, partnership or trust, other information returns may be required.  Because failing to file information returns related to foreign corporations, partnerships, and trusts carries its own penalties – many of which are equally or more severe than failing to disclose offshore assets on an FBAR or Form 8938 – if you’re not careful it could cost you the shirt off your back.