By Edward Tanenbaum
Alston & Bird LLP, New York, NY
Well, the Foreign
Account Tax Compliance Act, affectionately
known as FATCA, is finally upon us. Effective July 1, 2014 (and
subject to some relief for new accounts opened for entities after
July 1, 2014, and before January 1, 2015, contained in Notice
2014-33, 2014-21 I.R.B. 1033), Chapter 4 of the U.S. Internal
Revenue Code imposes a 30% withholding tax on "withholdable
payments" made to foreign financial institutions (FFIs) and
non-financial foreign entities (NFFEs) that are not compliant with
Under FATCA, the foreign entity world is divided into two
segments: (1) FFIs, which generally refer to banks, custodial
institutions, investment entities (e.g., mutual funds, hedge funds,
private equity funds, CDOs, etc.), specified insurance companies,
and certain holding companies and treasury centers; and (2) NFFEs,
which generally refer to all foreign entities other than FFIs.
If an entity is
caught within the FFI definition, the FFI must
enter into an agreement with the IRS (absent a Model 1
Intergovernmental Agreement), and it must comply with significant
due diligence, reporting, and withholding requirements regarding
"financial accounts" held by U.S. persons or U.S.-owned
On the other hand, if a foreign entity is an NFFE, then the
must "simply" provide a certification to the withholding agent as
to whether and to what extent it has "substantial United States
owners" and, if so, the name, address, and TIN of each such
substantial U.S. owner. Under the statute and regulations, a
substantial U.S. owner is generally a U.S. person that owns more
than 10% (directly or indirectly) of the entity (although, if the
foreign entity is an investment company, the threshold percentage
drops to 0%, i.e., any percentage is sufficient).
Intergovernmental Agreements (IGAs) entered into between the
United States and many foreign countries favorably vary a number of
the requirements set forth in the statute and regulations.
As we have heard
said many times before, FATCA is not intended
as a revenue-raiser but, rather, as a mechanism to force reporting
of offshore accounts held by U.S. persons via the threat of 30%
withholding. Suffice it to say that, at least for the initial
years, FATCA will most assuredly act as a revenue-raiser (subject
to refunds) as U.S. withholding agents, FFIs, and NFFEs try to
figure out how to handle the task of becoming FATCA-compliant.
of which, while much has been written on the duties,
obligations, and requirements for compliance with FATCA from the
vantage point of the FFI and NFFE, much less has been written about
the tasks of the U.S. withholding agent in terms of what it must be
doing to comply with FATCA. So what issues should a U.S.
withholding agent be thinking about when it makes payments from the
United States to foreign entities?
primary issue, of course, is whether the payment is a
"withholdable payment." A "withholdable payment" is a payment of:
(1) U.S.-source fixed or determinable annual or periodical income
(FDAP), similar to the concept found in Chapter 3 with respect to
withholding on nonresident aliens and foreign corporations; as well
as (2) gross proceeds from the sale, exchange, disposition, or
redemption of assets giving rise to U.S.-source interest or
dividends (but only after December 31, 2016). Interestingly, some
payments can include both categories, e.g., a corporate
distribution can involve the payment of both FDAP and gross
proceeds. Under §301(c)(1) a corporate distribution is treated as a
dividend to the extent of corporate earnings and profits and under
§301(c)(2) and §301(c)(3) the excess is treated as a return of
basis and as proceeds from a sale or exchange. If such a
distribution is made before January 1, 2017, the FDAP portion (the
dividend) could be subject to withholding while the gross proceeds
portion would not be subject to withholding given the effective
date for gross proceeds withholding of January 1, 2017.
Whether a payment is "U.S.-source" will generally be tested
under the regular §861-§865 rules, with some exceptions. For
example, interest paid by foreign branches of U.S. corporations and
partnerships is treated, for FATCA purposes, as U.S.-source FDAP
(even though normally foreign-source).
While the definition of U.S.-source FDAP for Chapter 4
purposes generally follows the definition for Chapter 3 purposes,
various Chapter 3 exceptions are not available for
Chapter 4 withholding, e.g., bank deposit interest and portfolio
any event, a withholdable payment does not include interest
or OID on short-term obligations; effectively connected income; and
various "non-financial" payments for services, use of property,
office equipment leases, software licenses, awards, prizes, and
interest on accounts payable from the acquisition of
goods/services. Gross proceeds from the sale of property
producing such excludible U.S.-source FDAP is also exclude.
On the other hand, withholdable payments
do include payments in connection with a lending
transaction, a forward, futures, options, or notional principal
contract, and similar investments, and include investment advisory
fees, custodial fees, and bank or brokerage fees.
Assuming that a payment is a withholdable payment, another issue
to consider is whether the withholdable payment is with respect to
an obligation grandfathered under FATCA. Generally, all obligations
outstanding on July 1, 2014, are grandfathered for FATCA purposes.
However, grandfathered obligations do not include equity
instruments or instruments lacking a stated expiration or term.
In the case of non-debt
obligations, the date that a legally
binding agreement is executed will be decisive for the
grandfathering rule. For example, a line of credit or a revolving
credit facility for a fixed term qualifies under the grandfathered
rule as of the issue date, provided that all material terms are
fixed (including the maturity date).
A life insurance contract
payable no later than upon death is
grandfathered. Premium payments on insurance or annuity contracts
that, themselves, are grandfathered are also grandfathered.
Payments made by a secured party with respect to collateral that
secures a grandfathered obligation are also grandfathered even if
the collateral itself is not a grandfathered obligation. For
purposes of the grandfathering rule, all obligations that would
give rise to withholdable payments under §871(m), i.e., dividend
equivalent payments, or foreign passthru payments, will be
considered outstanding (and, thus, grandfathered) prior to six
months after relevant regulations are issued.
In the event of a "material" modification (similar to the
of "significant" modification in regulations issued under §1001) of
an otherwise grandfathered obligation, the obligation will lose its
status as a grandfathered obligation. A withholding agent must
treat a modification of an obligation as material only if the agent
has actual knowledge, e.g., if it receives a disclosure statement
from an issuer of the obligation.
Assuming a withholding agent successfully determines
payments to be withholdable payments that are not grandfathered,
the real fun begins. It is at this point that the withholding agent
must determine the person or entity to whom the payment is being
made as this will govern the extent to which Chapter 4 FATCA
withholding needs to take place.
Thus, the withholding agent must determine who the "payee" is,
i.e., is the payment being made to a participating FFI? A
non-participating FFI? A registered or certified deemed-compliant
FFI? An excepted FFI or NFFE (and, in the case of an NFFE, an
excepted, active, or passive NFFE)? An exempt beneficial owner? Is
the recipient of the payment acting as an intermediary?
The answers to these questions, in turn, will
govern the type of
documentation that the U.S. withholding agent must seek from the
payment recipient. Essentially, this will involve soliciting the
correct certification from the payment recipient, e.g., Form W-9,
W-8BEN, W-8BEN-E, W-8IMY, W-8ECI, or W-8EXP, and determining
whether the form may be properly relied upon (which is done on a
Suffice it to say that there is a lot of homework and due
diligence that U.S. withholding agents must perform in order to
properly fulfill their FATCA withholding responsibilities. Ideally,
by this time U.S. withholding agents have mastered the numerous
FATCA rules and the needed systems are up and running and in
Although the IRS, in
Notice 2014-33, indicated that 2014 and
2015 will be transition years for purposes of FATCA enforcement,
this is not a blanket rule. It comes with the admonition that
withholding agents must be able to demonstrate good faith efforts
to comply with FATCA's requirements before relying on this
This commentary also will appear in the August
2014 issue of
the Tax Management International Journal. For
more information, in the Tax Management Portfolios, see Nauheim,
Cousin, Ewell, Limerick, Lakritz, and Lee, 6565 T.M., FATCA -
Information Reporting and Withholding Under Chapter 4,
and in Tax Practice Series, see ¶7170, U.S. International
Withholding and Reporting Requirements and FATCA.
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