Gunboat Diplomacy? Treasury Releases Model FATCA Intergovernmental Agreement

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Micah W. Bloomfield, Esq., and Neal D. Richards, Esq.  

Stroock & Stroock & Lavan LLP, New York, NY

It's getting hard to ignore the dreadnought on the horizon- The Foreign Account Tax Compliance Act (FATCA)1 - as the first phases of the regime begin in 2013. The successive deadline extensions appear to have finally run out,2 leaving governments, practitioners, and taxpayers with the formidable task of implementing and complying with FATCA's provisions. The newly-released model intergovernmental agreement (the "model agreement")3 provides an important touchstone for understanding the obligations of foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) under the new regime.

FATCA carries a big stick: FFIs that do not comply with FATCA's reporting and withholding regime are severely limited in their ability to receive U.S.-source payments, as any such payment to non-FATCA compliant FFIs will be subject to an onerous 30% withholding tax.4 Recognizing the infeasibility of entering into agreements with every FFI in the world (and the low likelihood that every FFI will comply), the Treasury has wisely decided that the path of least resistance lies in cajoling (with big stick in hand) foreign governments to take responsibility for implementing FATCA in their respective countries.

By putting the onus on foreign governments to implement reporting, this approach also begins to address the potential conflict between certain FATCA provisions and foreign bank secrecy laws. The United Kingdom, France, Spain, Italy, and Germany all collaborated in drafting the model agreement, and will presumably enter into intergovernmental agreements based on the model agreement in the near future.

The Model Intergovernmental Agreement  

There are three broad potential approaches to FATCA reporting:

  •  Direct agreements between FFIs and the IRS (the default under the statute).
  •  A hybrid approach involving direct reporting by FFIs to the United States with a truncated registration process, supplemented by information provided by the foreign governments.
  •  An intergovernmental agreement providing for reporting to the foreign government, which will then report to the United States.

The model agreement takes the third approach.  However, the United States has already agreed to enter into intergovernmental agreements with Japan and Switzerland based on the second approach (the hybrid approach).

The hybrid approach permits flexible implementation, and is likely to be utilized in various forms with countries that are unable or unwilling to meet the obligations of the model agreement, but nonetheless desire some agreement with the United States with respect to FATCA. A model agreement based on the Swiss and Japanese agreements is expected to be released in the near future.

The currently-published model agreement comes in two flavors: reciprocal and non-reciprocal. In the reciprocal version, the United States provides a quid-pro-quo: the United States will collect information regarding specified U.S. accounts associated with the FATCA partner countries, assisting such countries in implementing their own foreign anti-tax avoidance regimes. In the non-reciprocal version, no assistance is rendered to the FATCA partner country.  Other than this difference, the agreements are essentially identical.

Under the model agreement, FFIs will report specified information to their respective home countries, including the name, address, account balance, account number, and U.S. taxpayer identification number of each account controlled by one or more U.S. persons or business entities. Additionally, depending on the type of account, the FFI will report interest, dividends, and other income with respect to the account.

Reporting FFIs are exempt under the model agreement from withholding on, and closing the accounts of, recalcitrant account holders if they collect and report identifying information on the account.5 However, FFIs that are qualified intermediaries will still be required to withhold on U.S.-source withholdable payments.

Although the model agreement provides for an effective date of 2013, reporting will not begin until September 30, 2015, with respect to information pertaining to 2013 and 2014. The reporting for 2013 and 2014 tax years will only include basic identifying information for U.S. accounts and the balance of each account at the end of the calendar year. For 2015, FFIs must also report total amounts paid or credited to the account, excluding gross proceeds from the sale or redemption of property. Full reporting, including reporting of gross proceeds from sales, is required from 2016 onwards.6 

The model agreement contains a list of due diligence requirements for determining which accounts are subject to reporting.7 Importantly, both existing and new individual accounts with a value of less than $50,000 (or foreign currency equivalent) are exempt from reporting. Existing individual accounts with a value of between $50,000 and $1,000,000 are subject to a basic electronic records search of a database to be maintained by the partner government.  FFIs are required to undergo a thorough records search for existing individual accounts worth in excess of $1,000,000 where an electronic search does not clearly indicate U.S. status. For new individual accounts with values in excess of $50,000, FFIs must obtain a Form W-9 or other agreed upon form from U.S. accountholders. These tiers generally parallel those in the proposed regulations.

Higher dollar thresholds for diligence are provided for business entities. Existing entity accounts with account balances of less than $250,000 on December 31, 2013, are exempt from diligence until their balance exceeds $1,000,000. Entity accounts in excess of that amount must be reviewed for FATCA status based on information maintained for regulatory or customer relationship purposes. For new entity accounts worth in excess of $250,000, absent a self-certification by the entity of U.S. status,8 the FFI must identify the status of the entity using established anti-money laundering (AML) and "know your customer" (KYC) procedures, where available.9

The chart below illustrates important changes for FFIs under the model agreement:

Proposed Regulations  

Model Agreement  

FFIs must register directly with the IRS

No IRS registration required; deemed compliance through satisfaction of reporting obligations to partner country

FFIs must withhold on and close recalcitrant accounts

Reporting obligation only for recalcitrant accounts

Each FFI in an affiliated group must separately register

Affiliate in non-partner country that has not registered with IRS will not cause FFI in partner country to be deemed non-compliant if affiliate satisfies reporting requirements and does not solicit U.S. accounts

Passthru payment withholding begins January 1, 2017

Governments will agree to "work together" on passthru payment withholding

FFI must maintain an electronic database for determining account status

Database maintained by partner country

Reporting begins on September 30, 2014, with respect to 2013 calendar year

Reporting begins no later than September 30, 2015, with respect to 2013 calendar year

FFI agreement specifies condition of default (and loss of participating FFI status); generally requires "substantial compliance" to avoid default

U.S. will request partner country competent authority to investigate non-compliance; participating FFI status lost with "significant non-compliance"

FFI must report on accounts held by any "Substantial U.S. Owner" (generally defined as 10% ownership)

FFI must report on accounts held by any "Controlling Person" that is a specified U.S. person

Some Loose Ends  

The model agreement relies primarily on foreign governments to enforce reporting, although the U.S. competent authority may request that the foreign competent authority take enforcement actions with respect to an FFI it deems non-compliant. A persistent unresolved failure to properly report will result in a loss of deemed compliance, which in turn will result in withholding on payments to the non-compliant FFI. It is not clear how an FFI may return to compliant status once it has lost that status, and whether it may re-establish reporting with the partner country or whether it must register directly with the IRS. There is also no specified redress if the partner to the model agreement fails to meet its obligations.

In many cases, the model agreement relies on the foreign government to pass appropriate legislation to implement the agreement. It is likely that at least a few parties to intergovernmental agreements will fail to pass appropriate legislation prior to the effective date of the agreement or the first reporting date. In such case, the Treasury will face a delicate situation in which it must determine whether to terminate the agreement, provide additional time to comply, or attempt to work with the agreement despite the lack of proper enabling legislation.

The universe of entities deemed to be "investment entities" (a concept similar to that of "financial institution" in the regulations), which are a category of FFI under the model agreement, appears to be broader than the regulatory definition of "financial institution." The definition of "investment entity" under the model agreement includes brokers and other entities that administer funds on behalf of other persons (whether as a primary or secondary activity), whereas the regulatory definition includes only entities that regularly accept deposits or have a substantial portion of their business as holding assets for others.10 Therefore, although the model agreement generally reduces the compliance burden of entities defined as FFIs under the Code, certain entities may be surprised to learn that they are FFIs under the model agreement and subject to the FATCA reporting procedures. This change may indicate that the final FATCA regulations will expand the "financial institution" definition in conformity with the model agreement.

The model agreement provides that the contracting governments will "agree to work together" on reporting of foreign "passthru" payments. The contours of the collaboration remain yet to be determined. Given that passthru payment withholding is not scheduled to begin until 2017,11 it is likely that the model agreement will be amended to deal with passthru payments.

Reciprocal agreements should be closely watched by U.S. financial institutions. Although it is likely that the U.S. will enter into reciprocal agreements with only a select group of countries, the reciprocal version of the model agreement includes policy commitments to implement additional legislation and regulations to provide adequate reporting to the partner country.12 Depending on the implementation, foreign reporting obligations could significantly increase the regulatory burden on U.S. accounts, especially high-value accounts likely to be subject to more stringent diligence standards.

Going Forward  

The model agreement approach likely provides significant relief to FFIs reluctant to enter into an agreement directly with the IRS. The streamlined electronic databases maintained by the FATCA partner countries and local-level enforcement should prove a much easier path to compliance than the individual agreement approach. The relative ease of FATCA compliance for FFIs in countries that have implemented intergovernmental agreements based on the model agreement will result in FFIs in those countries having a competitive advantage over those located in countries that have implemented a Japanese/Swiss-style hybrid agreement or none at all.

The nascent success of intergovernmental agreements, provided they are generally respected by the governments that enter into them, means that the gunboat diplomacy approach of FATCA is working: a wholesale revolt against FATCA compliance seems unlikely in countries that have signed intergovernmental agreements. With major trading partners and their FFIs roped in, the next challenge lies in learning to live with the new regime.

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. © 2012 Stroock & Stroock & Lavan LLP. Reprinted with permission from Stroock & Stroock & Lavan LLP, Stroock Special Bulletin, (8/7/12).

 1 Originally proposed as a stand-alone bill, FATCA was passed as part of the 2010 HIRE Act, P.L. 111-47, and added §§1471-1474 of the Internal Revenue Code (the "Code"). 

 2 Statement of Michael Plowgian, attorney-adviser Treasury Office of International Tax Counsel, Practising Law Institute International Tax Seminar (7/24/12). 

 4 For a more detailed description of FATCA's provisions, see "The Thirty Percent Solution? FATCA Provisions of the HIRE Act," Stroock Special Bulletin (4/21/10).

 5 Model Agreement Art 4.2. "Recalcitrant Account Holder" is defined by §1471(d)(6). 

 6 Model Agreement Art 3.3. All citations herein are to the reciprocal agreement.

 7 Model Agreement Annex I. 

 8 Entity accounts held by NFFEs are divided up into "active" and "passive" varieties. If an entity is not an active NFFE, the FFI must obtain a self-certification from the account holder to establish its status. Annex I, IV.4. 

 9 These procedures are defined in the proposed FATCA regulations. See Prop. Regs. 1.1471-1(b). The FFI may identify FATCA partner financial institutions based on publicly available information, without AML/KYC procedures. 

 10 Compare Prop. Regs. 1.1471-5(e)(1) with Model Agreement Art. 1(g). There is little indication as to why Treasury did not simply incorporate the definition of "financial institution" in the proposed regulations. 

 11 Prop. Regs. 1.1471-3(d). 

 12 Model Agreement Art 6.1.

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