Offshore Lenders Targeted By IRS Audit Campaign

• Published date: 26 August 2021
• Subject Matter: Accounting and Audit, Finance and Banking, Tax, Audit, Financial Services, Fund Management/ REITs, Income Tax, Withholding Tax
• Law Firm: Holland & Knight
• Author: Mr Alan Winston Granwell, Katie Erin Gerber, Abbey Benjamin Garber and William Sharp

Highlights

• Offshore lenders have become the latest target of an Internal Revenue Service (IRS) audit campaign because of concern that foreign lenders are not properly reporting or paying U.S. tax on certain types of "inbound" lending transactions.
• The IRS wants to audit more returns in this area because absent an IRS review of the underlying facts and circumstances, the agency is unable to ascertain whether the return has been properly prepared and filed.
• This IRS campaign, announced on June 10, 2021, without much fanfare, is reflective of the agency's interest in activities of "inbound" taxpayers, particularly those engaging in offshore lending to U.S.-based borrowers.
• As a result, U.S. taxpayers and advisors in this area should take heed.

Since 2017, the Internal Revenue Service (IRS) Large Business and International Division (LB&I) has shifted its audit efforts to issue-based examinations, premised on strategically identified and prioritized areas of compliance risks to address taxpayer compliance. LB&I's goal has been to improve return selection, identify issues with significant compliance risks and make the best use of its limited resources.

On June 10, 2021, the IRS announced a new campaign that focuses on the U.S. activities of financial service entities.¹ The campaign addresses the issue of whether foreign investors participating in "inbound" lending transactions were engaged in a U.S. trade or business and generated income effectively connected with a U.S.-situs lending trade or business. The description of the IRS campaign notes that under the U.S. Internal Revenue Code, foreign investors who only trade stocks and securities for their own account are not treated as being engaged in a U.S. trade or business under a safe harbor.² However, that safe harbor is unavailable to dealers in stocks or securities, to entities engaged in a lending business or to foreign investors in partnerships engaged in such activities.

To ascertain whether there has been correct reporting, the IRS must audit the applicable taxpayer and review the underlying facts and circumstances, since a mere review of the face of the return does not provide information sufficient for the IRS to make a determination as to whether a taxpayer is or is not engaged in a U.S. trade or business.

A recent article³ reports that IRS LB&I initiated the campaign focused on foreign investors' lending income because the IRS has reason to believe that there may be noncompliance in this area by...