Foreign 'Blocker' Corporations with No FATCA Documentation: What Happens Now?

By Thomas S. Bissell, CPA

Celebration, FL

It is extremely common for foreign individuals to invest in U.S.
stocks, bonds, and other U.S.-situs assets (such as U.S. real
estate) through a wholly owned, foreign corporation in order to
avoid potential U.S. federal estate tax (FET) upon death. 
This structure is typically used by non-U.S. citizens who are
domiciled outside the United States - and thus not "resident" in
the United States under §2001(a) for FET purposes - and who also
are not protected from FET under a U.S. estate tax treaty.1 Such a foreign
corporation, often called a "blocker," is usually incorporated in a
no-tax jurisdiction that has no income tax treaty with the United
States. This commentary discusses the FATCA rules that apply where
a "blocker" owns only stock in U.S. corporations and debt
obligations of U.S. persons. The stock or the debt obligations
owned by the blocker might or might not be publicly traded.

For U.S. federal income tax (FIT) purposes, a blocker in a
non-treaty country is typically subject to 30% tax on U.S.-source
dividends under §881(a)(1). Because most debt obligations (except
obligations of certain related U.S. corporations) qualify for the
"portfolio interest" exemption in §881(c), however, U.S.-source
interest is usually exempt from FIT. In addition, gains from the
sale or exchange of stock in U.S. corporations (other than U.S.
real property holding corporations) and debt obligations of U.S.
persons are typically exempt from FIT because the gains are usually
not effectively connected income under §882. In order to avoid
backup withholding under §3406 on interest and on the gross
proceeds from the sale of U.S. stocks and bonds, however,
historically the blocker has been required to furnish the
applicable U.S. withholding agent with IRS Form W-8BEN in order to
certify its foreign status.  In accordance with Form W-8BEN,
the U.S. withholding agent then withholds 30% on U.S.-source
dividends under §1442 (in Chapter 3 of the Code), but it does not
withhold on portfolio interest or on the gross proceeds from the
sale of U.S. stocks and debt obligations.2

The FATCA rules in §1471-§1474 (in Chapter 4 of the Code)
require that a set of withholding rules which are roughly parallel
to §1442 be applied where a "withholdable payment" (as specially
defined) is paid to any foreign "entity" that has not provided the
U.S. withholding agent with documentation that satisfies the FATCA
requirements. Significantly, the term "withholdable payment"
includes U.S.-source interest even if it otherwise qualifies for
the portfolio interest exemption in §881(c) - unless the debt
obligation is a pre-7/1/14 "grandfathered obligation"3 - and starting on
January 1, 2017, the term also includes gross proceeds from the
sale or exchange of U.S. stocks and debt obligations. In a manner
similar to the backup withholding rules of §3406, FATCA withholding
is imposed at the rate of 30% on gross income and, after December
31, 2016, on gross proceeds.4 Although in many cases
the foreign entity may claim a refund of the FATCA-withheld tax if
the amount withheld exceeds the amount that would have been
withheld under §1442, as a general rule if the entity is a
"nonparticipating foreign financial institution" (as defined in
Reg. §1.1471-1(b)(82)), it may not be able to claim a refund unless
it is resident in a tax treaty country.

The first phase of the FATCA rules finally took effect on July
1, 2014. Except for gross proceeds from the sale of designated
U.S.-situs assets, 30% withholding started on July 1, 2014, under
§§1471 and §1472 with respect to "withholdable payments" for which
the foreign entity realizing the income had not provided the U.S.
withholding agent with documentation that complied with the FATCA

The Form W-8BEN that a blocker corporation has historically
completed required only that the entity certify that it was a
"foreign person" that was classified as a "corporation." Because of
the extreme complexity of the FATCA rules, however, effective July
1, 2014, a foreign corporation that wishes to comply with FATCA
must determine its status either as a "foreign financial
institution" (FFI) or as a "non-financial foreign entity" (NFFE)
under §1471 and §1472, and also which one of the many FFI or NFFE
categories it falls within. Depending on how the foreign
corporation is classified, in many cases it must file additional
documentation directly with the IRS and/or provide additional
information about itself and about certain other persons
(especially U.S. persons) who are related to it in some manner.
Once a foreign corporation has completed a proper Form W-8BEN-E,
that form will be effective for purposes of both §1442 (Chapter 3)
and FATCA (Chapter 4), and if the corporation has previously filed
a pre-FATCA Form W-8BEN with the particular withholding agent, the
new Form W-8BEN-E will replace it.5

It is clear under the law that where a foreign blocker has never
provided proof of its foreign status to a withholding agent prior
to July 1, 2014, but wishes to do so on or after that date, the new
Form W-8BEN-E must be used for §1442 purposes as well as for FATCA
purposes.6 In addition, if the
blocker owns its U.S. securities through an account that is
maintained with an FFI, in most cases the FFI will have been
attempting to obtain the FATCA-required documentation from the
blocker prior to July 1, 2014. But what happens if the blocker owns
its U.S. securities directly in its own name or through an account
with a U.S. financial institution, and has not provided the
relevant U.S. withholding agents with Form W-8BEN-E in order to
inform them of its status for FATCA purposes? The instructions to
the pre-FATCA Form W-8BEN indicated that it was valid for three
years, but that in many cases it was valid indefinitely if the
foreign person provided a TIN. Did pre-existing Forms W-8BEN issued
by foreign corporations (and other foreign "entities") become
invalid on July 1, 2014, and, if so, did those foreign corporations
become "undocumented" on July 1, 2014, and thus subject to backup
withholding under §3406 not only on U.S.-source dividends and
interest but also on gross proceeds from the sale or exchange of
U.S. stocks and bonds?

The final FATCA regulations appear to deal with this issue
indirectly, although they do not specifically state that a
pre-existing Form W-8BEN that has not expired will continue to be
valid for Chapter 3 (§1442) purposes. Reg. §1.1471-3(d)(1) provides
that a pre-existing Form W-8BEN that has not expired may be relied
upon for FATCA purposes if the withholding agent has certain
additional documentation that is reliable concerning the foreign
payee's probable FATCA status. The regulations do not say what
happens for §1442 purposes if the withholding agent has no
supplemental information at all from the foreign payee, but the
strong implication is that the existing Form W-8BEN is still
effective for §1442 purposes, even though in this situation it is
clearly not effective for FATCA purposes. In addition, Reg.
§1.1471-3(f)(4) establishes a presumption that if a withholding
agent cannot determine on the basis of a "valid withholding
certificate" (or other "valid documentary evidence") what status a
foreign "entity" has for FATCA purposes, the entity is presumed to
be a nonparticipating FFI - and not a completely undocumented
entity that would thus be subject to backup withholding under
§3406. Because the FATCA rules are so extraordinarily complex,
however, undoubtedly there are many U.S. withholding agents who
will be skittish about this issue and who may wish to apply the
backup withholding rules of §3406 if they do not have a new Form
W-8BEN-E from those foreign payees who indicated on their original
Form W-8BEN that they were a "corporation." Unfortunately, the 2014
edition of IRS Publication 515, Withholding of Tax on
Nonresident Aliens and Foreign Entities
, has not yet been
published as of this writing, and the 2013 edition contains only a
brief mention of FATCA and a link to the FATCA portion of the IRS
website. Not surprisingly, however, the FATCA portion of the IRS
website contains numerous IRS documents, and in addition those
documents do not appear to focus on this specific issue.

If it is assumed, however, that a withholding agent is properly
advised and continues to respect a foreign blocker's unexpired Form
W-8BEN for §1442 purposes but not for FATCA purposes, what is the
practical effect for a blocker whose only U.S. investments are in
stocks and bonds?

U.S.-source dividends - 30% withholding will be
imposed under FATCA, the same as the 30% rate that is imposed under
§1442 (because the blocker is resident in a country without a U.S.
income tax treaty). Because duplicate withholding cannot be imposed
under both §1442 and under FATCA, there will be no additional U.S.
tax on the blocker as the result of its undocumented FATCA

U.S.-source interest - Although FATCA can be
imposed on U.S.-source "portfolio interest" that is exempt from
§1442 withholding, if the debt obligation qualifies as a pre-7/1/14
"grandfathered obligation," no FATCA withholding will be imposed.
However, if the blocker purchases newly issued debt obligations on
or after July 1, 2014, or if a pre-7/1/14 debt obligation is
"materially modified" on or after July 1, 2014, 30% FATCA
withholding will be imposed on interest that is paid on that debt,
even if it is portfolio interest for §881(c) purposes. If FATCA
withholding is imposed on portfolio interest, the blocker will then
want to consider filing a refund claim with the IRS, provided that,
before doing so, it furnishes all its missing FATCA documentation
to the IRS (and to any withholding agents who will continue to be
making "withholdable payments" to the blocker). Based on the
detailed refund procedures set forth in Reg. §1.1474-5, the only
situation in which the blocker would be prevented from claiming a
refund would be if it were a "nonparticipating FFI" that is not
resident in a country having an income tax treaty with the United

Gross proceeds from the sale or exchange of U.S. stocks and
- Because FATCA withholding on gross proceeds from the
sale or exchange of U.S. stocks and bonds will not begin until
January 1, 2017, the blocker's existing Form W-8BEN can be relied
upon to avoid both FATCA withholding and backup withholding under
§3406. Note that the exemption from FATCA withholding will apply
until January 1, 2017, even if the debt obligation is newly issued
after June 30, 2014 (or is pre-7/1/14 debt that is "materially
modified" after June 30, 2014), and thus is not a "grandfathered
obligation," whether or not it also happens to be "portfolio

In light of the massive publicity that has accompanied the
introduction of FATCA, one might ask how there could be any foreign
blockers that have not yet replaced their pre-FATCA Form W-8BEN
with a new Form W-8BEN-E. As suggested by the examples immediately
above, many foreign blockers may be fully informed about FATCA but
may simply have delayed updating their documentation - especially
since the examples just given suggest that for many blockers there
may be little or no practical effect until at least January 1, 2017
(or until their existing Form W-8BEN expires, if sooner). But many
blockers may simply not be aware of the new rules, including
blockers that are managed by one or more foreign family members
rather than by an institutional trust company. The U.S. payor may
also be unaware of the FATCA rules, especially if the payor is a
privately held U.S. company and/or a U.S. borrower that does not
have a tax advisor that is familiar with international

Although a discussion of when a blocker might be classified as
an FFI or as an NFFE (and into which category of FFI or NFFE the
blocker fits) is beyond the scope of this commentary, it should be
noted that the FATCA regulations appear to expand the scope of the
statute for many blockers that are owned solely by one or more
members of a foreign family. Thus, while it might be assumed from
the language of §1471 and §1472 that a closely held blocker that is
owned and managed solely for the benefit of a single foreign family
would be classified as a passive NFFE, if the blocker is "managed"
by an entity that itself is an FFI - such as an institutional trust
company - the regulations classify the blocker itself as also being
an FFI. A blocker will also be classified in most cases as an FFI
if it is owned by a foreign trust that has an FFI as its trustee.8 As discussed above,
for the time being the FFI/NFFE distinction may not matter except
for interest paid on "portfolio debt" that is newly issued (or
materially modified) on or after July 1, 2014. However, the
distinction will clearly become much more important on and after
January 1, 2017, when gross withholding starts under FATCA, because
a nonparticipating FFI with no tax treaty protection will not be
able to recover the 30% withholding tax on gross proceeds that
applies then.

In the meantime, however, it would certainly be helpful if the
IRS could expedite the publication of its 2014 edition of
Publication 515, and in addition make absolutely clear (perhaps in
a special IRS Notice) that a pre-7/1/14 Form W-8BEN will continue
to be effective according to its terms for §1442 purposes, even
though it clearly will not be effective for FATCA purposes.

This commentary also will appear in the August 2014 issue of
 Tax Management International Journal.  For
more information, in the Tax Management Portfolios, see Nauheim,
Cousin, Ewell, Limerick, Lakritz, and Lee, 6565 T.M.
Information Reporting and Withholding Under Chapter 4,
 and in Tax Practice Series, see ¶7170, U.S. International
Withholding and Reporting Requirements and FATCA.


  1 For a detailed discussion of these rules,
see Bissell, 903 T.M. (Bloomberg BNA Tax &
Accounting), Tax Planning for Portfolio Investment into the
United States by Foreign Individuals
. If the owner of the
foreign corporation becomes a "resident alien" for U.S. federal
income tax purposes under §7701(b), he or she may be subject to
U.S. federal income tax on the corporation's income under the
Subpart F and/or the passive foreign investment company (PFIC)
rules of the Code, but if the owner remains domiciled outside the
United States, the underlying U.S.-situs assets will still be
protected upon the owner's death from FET. See 903

  2 In addition, U.S.-source interest that does not
qualify for the portfolio interest exemption in §881(c) is also
subject to 30% withholding under §1442.

  3 The principal category of "grandfathered
obligations" are those obligations that are outstanding on July 1,
2014, and have not been subject to a "material modification" on or
after that date. See Reg. §1.1471-2(b)(2)(i)(A) and
Reg. §1.1471-2(b)(2)(iv). Although there are two other categories
that are included in the definition of "grandfathered obligations"
- obligations that give rise to a dividend equivalent under §871(m)
and certain security agreements relating to an otherwise
grandfathered obligation - this commentary discusses only
obligations that are outstanding on July 1, 2014.

  4 It should be noted, however, that the backup
withholding tax rate for 2014 is 28%, not 30%.

  5 It should be stressed that Form W-8BEN continues
to be required from foreign individuals, who are not
affected by FATCA to the extent that they own U.S.-situs assets
either directly in their individual name, or through an account
with a U.S. financial institution.

  6 See the recently released
Instructions for Form W-8BEN-E (June 2014). This situation would
usually arise either where the foreign blocker is newly created on
or after July 1, 2014, or where it was in existence prior to July
1, 2014, but had never made an investment in the United States for
which the completion of Form W-8BEN was necessary.

  7 See Reg. §1.1474-5(a)(2).

  8 For a discussion of this issue,
see Harris and Sanna, "FATCA and Non-U.S. Trusts: An
Overview," Trusts and Estates 27 (May 2013), and
Williams, "A FATCA Primer for Trusts, Trustees, and Companies,"
Tax Notes. (Jan. 13, 2014).