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By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
Much has already been written about the Foreign Account Tax Compliance Act (FATCA) provisions of the Hiring Incentives to Restore Employment Act but so much more has yet to be written, this notwithstanding the issuance by the IRS on August 27, 2010, of Notice 2010-60, 2010-37 I.R.B. 329 (the "Notice").
As we know by now, the FATCA provisions are designed to detect U.S. persons who may be evading U.S. tax by holding income-producing assets through accounts at foreign financial institutions (FFIs) or through other foreign entities (non-financial foreign entities, or NFFEs). The law requires withholding on certain payments to an FFI and to an NFFE with respect to those accounts unless the FFI enters into an agreement ("FFI Agreement") with the IRS to identify and report on its "U.S. accounts" and unless the NFFE provides information about its "substantial U.S. owners." The FATCA provisions are generally effective for payments made after December 31, 2012.
Overview of FATCA provisions
Section 1471 provides for a 30% withholding tax on "withholdable payments" made to FFIs that do not enter into FFI agreements with the IRS involving significant due diligence and reporting requirements. Section 1472 provides for a 30% withholding tax on withholdable payments to NFFEs that do not comply with certain reporting requirements. A withholdable payment generally incorporates non-effectively connected: (1) U.S.-source fixed or determinable annual or periodical (FDAP) income; (2) gross proceeds from sales of property that produce U.S.-source FDAP, e.g., interest and dividend income; and (3) interest on deposits with foreign branches of domestic commercial banks (which is otherwise non-U.S.-source income).
The Notice provides guidance on a number of priority issues.
The definition of a FFI under §1471(d)(5). There are three types of FFIs defined in the FATCA provisions, including entities that:
(1) accept deposits in the ordinary course of a banking or similar business;
(2) hold financial assets for the account of others as a substantial portion of their business; or
(3) engage primarily in the business of investing, reinvesting, or trading in financial assets, including securities, partnership interests, and commodities, or any interest in such items.
Thus, the definition of an FFI includes investment vehicles such as hedge funds and private equity funds.
Fortunately, however, the Notice also identifies the types of financial institutions and foreign entities that are deemed to be compliant FFIs, as well as those that are not treated as FFIs or NFFEs and, thus, are exempt from withholding under both §§1471 and 1472. These are welcomed (albeit too limited) carve-outs. For example, certain holding companies, start-up companies, non-financial entities liquidating or emerging from reorganization or bankruptcy, and hedging financing centers of a non-financial group are exempt under the FATCA withholding regime. The Notice also discusses the treatment of certain classes of entities, including entities with certain identified owners, U.S. territory-organized FFIs, certain foreign retirement plans, and certain insurance companies (future regulations will treat entities solely in the business of issuing insurance or reinsurance contracts without cash value, including most property and casualty insurance or reinsurance contracts or term life insurance contracts, as non-financial institutions).
In other areas, unfortunately, the Notice is not that generous. For example, an FFI with a U.S. branch will be required to execute an FFI Agreement to avoid being subject to withholding, unless the U.S. branch receives the payment as an intermediary, in which case the documentation standards required of U.S. financial institutions are imposed (although there would be no withholding on effectively connected income of the branch). In addition, CFCs that meet the definition of an FFI will not be treated as deemed-compliant FFIs under §1471(b)(2) and will be required to execute an FFI agreement since the IRS believes that there is potential for tax avoidance in this case, notwithstanding the existing reporting requirements for owners of CFCs.
The scope of requirements for collection of information and identification of persons under §§1471 and 1472.In order to avoid withholding under §1471, a FFI that agrees to obtain, verify, and report certain information about its account holders under its agreement with the IRS is treated as a participating FFI. Withholding agents and participating FFIs that make withholdable payments will have to determine the type of person to whom they are making a payment and comply with applicable statutory rules.
For accounts held by individuals, withholding agents and participating FFIs must determine whether the accounts are to be treated as:
For accounts held by entities, withholding agents and participating FFIs must determine whether the accounts are to be treated as:
The Notice prescribes very detailed due diligence procedures to:
(1) determine whether an account maintained by an FFI is a U.S. or non-U.S. account;
(2) obtain information about the account that must be reported to the IRS, including the highest account balance of each U.S. account; and
(3) make certain redeterminations regarding certain accounts determined to be non-U.S. accounts or considered to be held by recalcitrant account holders.
For instance, withholding agents and participating FFIs will be allowed to rely on Forms W-9 and W-8BEN to establish the U.S. or foreign status of individual account holders. On the other hand, in order to identify accounts of participating FFIs, the IRS will issue special employer identification numbers (EINs) to participating FFIs in the future. Prior to the issuance of the special EINs, withholding agents and participating FFIs will be permitted to rely on certifications provided by FFIs as to their status as participating FFIs.
Besides making the account determinations described above, the Notice also sets forth separate and distinct due diligence procedures with respect to pre-existing financial accounts held by individuals or other entities (in which case, certain presumptions are provided and the identification of such accounts is based on electronically searchable information in the FFIs' files) and new financial accounts held by individuals or other entities (in which case, the determination generally must be based upon all information collected by the FFI). This distinction is also a very welcomed approach that was initially suggested early on by many of the foreign banks.
The guidance contains somewhat parallel requirements for U.S. financial institutions and separate rules for accounts held with NFFEs. Future guidance will address situations in which a participating FFI maintains an account of another participating FFI. (The FFI with the more direct relationship with the investor or customer must report the required information about the U.S. account.)
All in all, the Notice provides some welcome relief in the form of exemptions and carve-outs from the definition of FFIs as well as detailed guidance regarding the nature of the required due diligence and documentation requirements that favorably distinguish between existing and new accounts.
The scope of obligations exempt from FATCA withholding.FATCA will not apply to payments made under an obligation, or to proceeds from the disposition of an obligation, outstanding on March 18, 2012, subject to an exception for obligations that have been materially modified after March 18, 2012. For this purpose, an obligation is defined as any "legal agreement that produces or could produce withholdable payments," but does not include any instrument treated as equity under U.S. tax law or any legal agreement that lacks a definitive expiration or term. Informal comments from Treasury suggest that no form of equity would ever qualify for grandfathering and that it remains unclear how revolver loans would or should be treated for purposes of determining whether and to what extent loan drawdowns after the effective date of FATCA would be grandfathered.
Proposed Regulations Planned
The IRS plans to issue proposed regulations incorporating the guidance in the Notice and it will publish a draft FFI agreement and draft information reporting and certification forms. More comprehensive guidance is also anticipated before the effective date of the FATCA provisions. In the meantime, the IRS has requested comments on a number of other issues:
While the IRS and Treasury have taken a nice stab at providing initial guidance under the FATCA provisions, a lot more guidance is required as soon as possible. Withholding agents, FFIs, and even NFFEs have a great deal of work ahead of them to design and implement systems that will facilitate compliance with FATCA. This is no easy or small task as those involved in the Qualified Intermediary system will easily attest to.
It will certainly take significant further collaboration with the private bar and industry in order to get this right. It is hoped that all parties will approach the process with the goal of achieving a fair and balanced set of rules that is designed to curb tax abuse without disrupting the free flow of investment into the United States.
This commentary also will appear in the November 2010, issue of BNA'sTax Management International Journal. For more information, in BNA's 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.
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