December 16, 2008

TO: Distribution

FROM: John Staples and Dan Burt

RE: New Withholding Tax Audit Developments

On a number of fronts it appears the IRS intends to raise again the stakes on withholding tax compliance. We would like to bring two specific matters to your attention.
 
Tier 1 Designation:

 IRS Commissioner Douglas Shulman announced on December 8th that the IRS is placing cross-border withholding tax compliance on its “Tier 1” list of issues for audit. The IRS’s “Tiered Issue Focus Strategy” concentrates audit resources within the IRS’s Large and Mid-Sized Business division (“LMSB”) on certain designated areas considered to be of “high-risk” from a tax compliance perspective.

The Commissioner’s announcement will place withholding tax compliance high on the agenda for IRS examiners within LMSB. According to the IRS website (www.irs.gov), all Tier 1 issues are of high strategic importance and require oversight and control by a designated issue management team. All LMSB audit teams must address Tier 1 issues in accordance with the management team’s directions. This is the same coordinated approach the IRS has taken with the most serious corporate tax shelter transactions. Cross-border withholding will now join these “Listed Transactions,” and several other high-impact compliance issues, on the Tier 1 list.

Voluntary Compliance Program Follow-Up:

In 2004, the IRS made available a new voluntary compliance program (the “VCP”) to encourage U.S. withholding agents to identify deficiencies in their cross-border withholding processes and to come forward to disclose and resolve those deficiencies with the IRS. The VCP was established as a temporary program (submissions were accepted on or before March 31, 2006) but it was used extensively by withholding agents within the short period it was available. We understand that approximately 400 VCP participants, including many major financial institutions, successfully settled substantial withholding tax liabilities with respect to their cross-border payments.

We now understand from recent informal discussions that the government has plans to follow up with compliance checks and/or audits of many, if not all, VCP participants. We have heard that as many as 75 former participants could soon receive notification that the IRS will check for the completion of remedial commitments promised in their VCP submissions and potentially audit years 2005 and 2006. This information is consistent with public statements the government made about such checks or audits not long after the VCP came to a close, but the information is newsworthy in that there has been little or no mention of such checks/audits of late.

Recommendation:

In light of this current information, we believe each VCP participant should consider whether or not immediate steps are necessary to ensure its preparedness for a follow-up IRS audit or compliance check focused on its cross-border withholding processes and VCP commitments.