By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
In June 2012, the Treasury Department issued a Joint Statement with Switzerland, as well as one with Japan, regarding a framework for cooperation to facilitate the implementation of the Foreign Account Tax Compliance Act (FATCA). This heralded the Model 2 Intergovernmental Agreement (IGA) as a companion to the Model 1 IGA, discussed in my last commentary.1 The Model 2 IGA calls for direct foreign financial institution (FFI) reporting to the IRS but with aggregate disclosure of "recalcitrant" account holder data, subject to exchange of information requests by the IRS.
The key element in the Joint Statement with Switzerland involved Switzerland's agreeing to direct its financial institutions to conclude FFI Agreements with the IRS (enabling these FFIs to comply with FATCA reporting) and to honor U.S. Competent Authority requests for additional information about accounts identified as recalcitrant and reported by these FFIs on an aggregate basis. In exchange, the United States agreed to identify specific categories of Swiss deemed-compliant or exempt FFIs or schemes and eliminate U.S. FATCA withholding on payments made to FFIs in Switzerland. In addition, these FFIs would not be required to terminate accounts of recalcitrant account holders and would not be required to impose foreign "passthru payment" withholding on payments to: (1) recalcitrant account holders; and (2) FFIs in any country in which a Model 1 or Model 2 IGA was in place (including Switzerland).
The Joint Statement with Japan was similar except that Japan would not direct that its FFIs conclude FFI Agreements with the IRS. Rather, it would direct and enable its FFIs to "register" with the IRS and confirm their intention to comply with official guidance issued by Japan that is consistent with the obligations of FFIs under FATCA.
While the Model 1 and Model 2 IGAs are alternatives to the soon-to-be-released final FATCA regulations, and while each contemplates involvement or cooperation of the foreign government, the Model 1 IGA establishes the involvement of the foreign government to receive FATCA reporting from FFIs as the intermediary or middleman and to automatically exchange information with the IRS. The Model 2 IGA contemplates direct reporting by an FFI to the IRS under its FFI Agreement (or registration process in the case of Japan), with group or aggregate reporting of recalcitrant account holders by the foreign government in response to a subsequent U.S. request for exchange of information. Thus, the Model 2 IGA only involves the foreign government in exchange of information requests. FFIs might like the Model 1 IGA since it does not involve entering into an agreement with the IRS and it eliminates direct reporting by FFIs to the United States. On the other hand, a foreign government might not like it because it places that much more of a cost and administrative burden on the foreign government. This may militate in favor of the Model 2 IGA, depending on the country and its composition of financial institutions.
On November 15, 2012, the Treasury Department released a prototype Model 2 IGA. This prototype combines the essential elements of both the Joint Statement with Switzerland and the Joint Statement with Japan. However, unlike the Joint Statement with Switzerland, the prototype Model 2 IGA does not provide that the foreign government direct its FFIs to conclude FFI Agreements with the IRS. Rather, like the Joint Statement with Japan, it provides that financial institutions will be directed and enabled to "register" with the IRS and comply with the requirements of an FFI Agreement, including with respect to due diligence, reporting, and withholding. On the other hand, unlike the Joint Statement with Japan, the prototype does not restrict compliance to guidance issued by the foreign government that is consistent with obligations of participating FFIs under FATCA.
Under the prototype Model 2 IGA, with respect to Pre-Existing Accounts that are identified as U.S. accounts, the FFI must request the account holders' U.S. TINs and must obtain consent to report the information to the IRS. U.S. account holders must be informed that if consent is not obtained, aggregate information with respect to accounts of recalcitrant account holders (referred to in the prototype as "Non-Consenting U.S. Accounts") will be reported to the IRS and the IRS may subsequently request specific information about the accounts, in which case the FFI would be required to forward specific information to its home country for exchange of such information with the IRS. (A similar procedure is to be followed for accounts of non-participating financial institutions with respect to foreign reportable amounts.)
A key difference between the Model 1 and Model 2 IGAs is that the Model 1 IGA contemplates specific account information being given to the foreign government with no need to obtain account holder consent (for simultaneous exchange of information with the IRS), whereas the Model 2 IGA requires consent to be obtained since the FFI directly reports to the IRS. At the end of the day, specific account holder information becomes known to the IRS and the only question is when.
New accounts identified as U.S. accounts or new accounts of non-participating financial institutions may only be opened on the condition that consent is obtained from the account holder or non-participating financial institution.
As to exchange of information, under a Model 2 IGA the U.S. Competent Authority will be able to make a group request to the foreign country based on the aggregate information reported to it by a financial institution and based upon the standards otherwise set forth in the relevant exchange of information treaty provision. The foreign country then has six months to provide the information in the same format in which it would have been reported if the reporting financial institution had reported it directly to the IRS. If for some reason there is a delay in being able to respond, the financial institution must treat the account as a recalcitrant account and withhold tax as required, commencing on the date that is six months after the date of the receipt of the group request and ending on the date that the information is exchanged.
Assuming registration and compliance, the financial institution will be treated as FATCA-compliant and not subject to withholding. Moreover, assuming compliance by the financial institution and by the foreign Competent Authority, the financial institution will not be required to withhold tax with respect to a recalcitrant account holder or to even close the account.
The prototype Model 2 IGA also deals with retirement plans established in and regulated by or located in the foreign country (and to be identified in Annex II) by treating them as exempt beneficial owners, deemed-compliant FFIs, or exempt products, as the case may be.
As under the prototype Model 1 IGA, if a financial institution has a related entity or branch located in a country that would otherwise prevent it from being a participating FFI or deemed-compliant FFI, the financial institution may nevertheless be treated as a participating FFI or deemed-compliant FFI, provided certain conditions are met. The definition of "related entity" is different (broader) than the definition in the statute and proposed regulations, which is based on the notion of an "expanded affiliated group," although the FATCA partner may treat an entity as not related if the two entities are not members of the same expanded affiliated group.
As under the prototype Model 1 IGA, the parties are committed to working together to determine an alternative approach to achieve the policy objectives of foreign passthru payment and gross proceeds withholding. Moreover, as under the Model 1 U.K. IGA, the FATCA partner is granted "most favored nation" status with respect to other partner jurisdictions. The United States also agrees to reciprocate by collecting and exchanging information on accounts held by residents of the FATCA partner in U.S. financial institutions and to negotiate a Model 1 IGA if the FATCA partner subsequently seeks this alternative.
With some differences, the due diligence obligations of the FFI set forth in Annex I are similar to those contained in Annex I of the prototype Model 1 IGA. Annex II lists the particular country's exempt beneficial owners (e.g., governmental entities, retirement funds) as well as certain exempt products (e.g., retirement accounts and other tax-favored products). Annex II also lists two types of deemed-compliant FFIs, i.e., small financial institutions with a local client base and certain collective investment vehicles (CIVs), and includes some new rules regarding CIV bearer shares and reporting by investment entities that service CIVs.
Both the Model 1 and Model 2 IGA prototypes provide insight into what the final regulations will look like, although there will likely be significant variations on the theme. While Treasury and the IRS have worked hard to provide alternative approaches to the implementation of FATCA, the different approaches will most assuredly create challenges for FFIs operating in different jurisdictions.
This commentary also will appear in the January 2013 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Tello, 915 T.M., Payments Directed Outside the United States - Withholding and Reporting Provisions Under Chapters 3 and 4, and in Tax Practice Series, see ¶7170, U.S. International Withholding and Reporting Requirements.
1 "Here They Come: FATCA Intergovernmental Agreements," 41 Tax Mgmt. Int'l J. 623 (11/9/12).