As the United States attempts to punish Russia for its actions in Ukraine, the Treasury Department is deploying an economic weapon that could prove more costly than sanctions: the Internal Revenue Service, the federal tax collecting agency.
This summer, the US plans to start using a new law that will make it more expensive for Russian banks to do business in America.
"It's a huge deal," says Mark E. Matthews, a former IRS deputy commissioner. "It would throw enormous uncertainty into the Russian banking community."
Long before the Ukraine crisis, Congress approved the law in 2010 to curb tax evasion that relies on overseas accounts.
Now, beginning in July, US banks will be required to start withholding a 30 per cent tax on certain payments to financial institutions in other countries unless those foreign banks have agreements in place to share information about US account holders with the IRS. The withholding applies mainly to investment income.
Russia and dozens of other countries have been negotiating information-sharing agreements with the US in an effort to spare their banks from such harsh penalties.
But after Russia annexed Crimea and was seen as stoking separatist movements in eastern Ukraine, the Treasury Department quietly suspended negotiations in March. With the July 1 deadline approaching, Russian banks are now concerned that the price of investing in the United States is about to go up.
The new law means that Russian banks that buy US securities after July 1 will forfeit 30 per cent of the interest and dividend payments. The withholding applies to stocks and bonds, including US Treasuries. Some previously owned securities would be exempt from the withholding, but in general, previously owned stocks would not.
Private investors who use Russian financial institutions to facilitate trades also face the withholding penalty. Those private investors could later apply to the IRS for refunds, but the inconvenience would be enormous.
"It's a big problem for them," said Matthews, who is now a lawyer at Caplin & Drysdale, a tax firm based in Washington. "It decreases their competitiveness and they may have capital flight elsewhere."
The US and Russia are significant trading partners, though not all transactions would be subject to withholding.
Last year, the US imported USD 27 billion in goods from Russia, which ranked 18th among importers to the US, according to the Census Bureau. The US exported USD 11 billion in goods to Russia.
