Closed Any International Deals Lately? Better Watch Out for FBAR

Venture capitalists and others who closed deals in 2009 in which escrows are held in accounts domiciled outside the US may need to comply with recently revised and newly proposed FBAR regulations. Most people have never heard of FBAR and don’t know much about these rules, but failure to comply can result in significant penalties. Since many VCs do not track or carefully consider where the escrows related to their deals are held, they may need to quickly audit whether any of them are held abroad before filing 2009 tax returns.

Here’s the backstory: Over the last year, and as recently as a few weeks ago, the US Treasury Department has provided new guidance and proposed new regulations regarding filing requirements for Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). FBAR, established under the Bank Secrecy Act, is part of the US Government’s fight against clandestine funding of international terrorism. It requires reporting if there is a financial interest in, or signature authority over, any account(s) in a foreign country and the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.

Whether an escrow is in a foreign account may not be immediately apparent to shareholders. For example, JPMorgan Chase Bank is a US bank, but if an escrow goes into its Hong Kong branch, that account is a foreign financial account. And, since most VCs have pro rata interests in escrows in excess of $10,000, they will need to look at this issue carefully. They also will need to closely consider any escrow for which they are serving as the shareholder representative, because that representative almost always has signature authority over the account.

The penalties for non-compliance can be quite severe, with the possibility of forfeiture of up to the greater of 50% of the account value at the time of violation or $100,000. Civil penalties can be assessed anytime up to six years after the date of the violation, and can exceed the balance in the foreign financial account. Criminal penalties may also apply, and can range up to $500,000 or 10 years imprisonment or both in some circumstances. Presumably, the harshest penalties are meant for those actually engaging in some form of money laundering or illicit funding rather than investors who simply did not know about FBAR, but there is no reason to take that risk.

The FBAR filing is due by June 30th of the year following the year that the account holder meets the $10,000 threshold, although the most recent IRS commentary has extended reporting for those with only signatory authority. More urgent, perhaps, is the FBAR box that may need to be checked on taxpayers’ individual income tax returns (Form 1040 Schedule B, lines 7a and 7b) due on April 15, and on other business entity filings on their due dates. In addition, Form TD F 90-22.1 must be filed by either June 2010 or June 2011 depending on the taxpayer’s type of relationship with a foreign account. Making the issue even more complex, it should be noted that the reporting requirements have changed dramatically over the last two tax seasons, and can extend to certain beneficial owners of the underlying economic interest, and not just to the holder of record.

In several of SRS’s most recent deals, escrow accounts were established in banks or branches of US banks outside the United States, which has triggered FBAR reporting. When SRS manages a deal where an escrow is held in a non-US financial account, we notify shareholders of the fact, the value of the account and their pro-rata interest in the account, so that they have the facts upon which their advisors can base reporting decisions.

Given the complexity, fickle nature, and draconian penalties of the FBAR regulation, we advise all shareholders to look at all of their escrows for the taxable year, and consult their tax and legal advisors as to whether FBAR applies both for individual 1040 filers and for business entities. It pays to make sure that shareholders and advisors know whether escrows reside in foreign financial accounts, and that their corporate, partnership and individual FBAR reporting is current.