On February 8, 2012, Treasury and the IRS issued the first set of Proposed Regulations regarding the Foreign Account Tax Compliance Act ("FATCA") which was included in the Hiring Incentives to Restore Employment Act of 2010 ("HIRE Act"). The HIRE Act identifies three separate groups that are the subject of its reporting requirements as follows:
- U.S. financial institutions and other U.S. payors;
- Foreign financial institutions ("FFIs") with U.S. investments; and
- Other foreign investors ("NFFEs") with U.S. investments.
All U.S. financial institutions and other U.S. payors of U.S. source income are the subject of the HIRE Act and FATCA obligations. The principal obligation of U.S. financial institutions and other U.S. payors under these rules is to withhold U.S. tax at the rate of 30% on U.S. source income paid to FFIs and NFFEs.
The term "FFI" is defined broadly and includes any foreign entity which (1) accepts deposits in the ordinary course of banking or similar business; (2) as a substantial portion of its business holds financial assets for the accounts of others; or (3) is engaged primarily in the business of investing, reinvesting or trading securities, partnership interests, commodities or any interest (including futures and forward contracts) in the preceding assets. This definition includes foreign private equity funds and foreign hedge funds, as well as banks, deposit-taking institutions and mutual funds. An “NFFE” is any foreign entity which is not an FFI, and includes foreign corporations, limited liability companies, partnerships and trusts.
Payments to Foreign Financial Institutions
Withholding of Tax
New Internal Revenue Code ("Code") Section 1471 requires withholding agents to withhold U.S. tax at the rate of 30% on U.S. source income paid to an FFI unless the FFI has filed an "FFI agreement" and certain information reporting requirements are met with respect to that payment. The Proposed Regulations provide that the IRS will maintain a publicly available list of participating FFIs which U.S. payors can rely upon to determine whether withholding is required. Withholding of tax on U.S. source FDAP income will commence for payments made on or after January 1, 2014, while withholding on U.S. source FDAP and gains will commence for payments made on or after January 1, 2015.
In order to avoid the withholding tax, the FFI must have an agreement in place (the FFI agreement), with the IRS in which it agrees to implement procedures to identify U.S. account holders of the FFI and to provide "substantial information" regarding such U.S. account holders. The FFI must agree to the following:
- Obtain information from each account holder to determine whether the account is a "U.S. account;"
- Comply with such verification and due diligence requirements as the Secretary may require with respect to the identification of U.S. accounts;
- Report certain information to the IRS on an annual basis;
- Deduct and withhold a payment of 30% on any pass-through payments made to a U.S. account holder or another FFI which does not also meet these requirements;
- Comply with requests from the Secretary for additional information with respect to any U.S. account; and
- Obtain a waiver from the account holder if any foreign privacy or other law would otherwise prevent the disclosure of the above information, and to close the account if the waiver is not provided.
The Proposed Regulations state that the IRS will issue a model FFI agreement in early 2012.
One of the main concerns raised by many FFIs was whether their existing "know your client" rules would be sufficient to satisfy these requirements, or whether additional information will be required. Under the Proposed Regulations, an FFI's existing AML/KYC rules coupled with a search for indicia of U.S. status will be sufficient. However, additional procedures, including a review of written documents and inquiry of the relationship officer, are required for certain high-balance accounts. For new accounts, existing AML/KYC procedures will generally be acceptable unless indicia of U.S. status is found, in which case additional diligence is required.
The Proposed Regulations provide that a responsible officer of each participating FFI will certify that the FFI has the requisite procedures in place to identify U.S. accounts and that the FFI is complying with the FFI agreement. In what will be good news for FFIs, they will not be held strictly liable for failures to identify U.S. accounts.
Under the Proposed Regulations, if an FFI is part of an affiliated group of FFIs, all members of that group would register separately with the IRS, with limited exceptions that expire as of January 1, 2016.
Payments to Non-financial Foreign Entities
Similar withholding tax provisions apply under Code Section 1472 to withholdable payments made to an NFFE. Withholding can be avoided if:
- The beneficial owner of the payment provides the withholding agent with either (i) a certification that the NFFE has no substantial U.S. owners or (ii) the name, address and TIN of each substantial U.S. owner;
- The withholding agent does not know or have reason to know that any information under (1) is incorrect; and
- The withholding agent reports such information to the IRS in such manner as the Secretary prescribes.
There are exceptions if the beneficial owner is one of the following:
- A corporation whose stock is regularly traded on an established securities market;
- A member of an expanded affiliated group whose parent qualifies under (1);
- Certain corporations organized in a U.S. possession;
- Any foreign government or agency;
- Any international organization or agency;
- A foreign central bank; or
- Any class of person identified by the Secretary.
The Proposed Regulations contain special rules for payments to foreign partnerships and foreign trusts, and in some cases require them to obtain and report information as to their U.S. partners or beneficiaries.
Withholdable Payments and Withholding Agents
The term "withholdable payment" is broadly defined and includes payments of interest (including OID), dividends, rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments and other fixed or determinable annual or periodic gains, profits and income from sources within the U.S. It also includes gain from the sale of any property which can produce U.S. source interest or dividends.
The Proposed Regulations expand the scope of grandfathered obligations to include obligations outstanding on January 31, 2013 (although the HIRE Act provides for a January 31, 2012 date); no withholding is required on payments with respect to such grandfathered obligations. Note that under the Proposed Regulations, a material modification of such obligation after January 1, 2013 will cause it to lose its grandfathered status.
Lastly, under the Proposed Regulations, withholding will not be required of FFIs with respect to pass-through payments before January 1, 2014, although the aggregate amount of such payments will need to be reported by each FFI for the 2015 and 2016 calendar years.
For these purposes, the term "U.S. account" includes financial accounts held (1) by one or more specified U.S. persons or (2) by U.S.-owned foreign entities. Unless the FFI elects otherwise, the term does not include accounts held by a natural person where the aggregate of all accounts held by such person with the institution does not exceed $50,000. A "specified U.S. person" is any U.S. person other than (1) a corporation whose stock is regularly traded on an established securities exchange, and any member of its expanded affiliated group, (2) an entity exempt from tax under Section 501(a), (3) the United States itself, (4) any State or the District of Columbia, (5) any bank, (6) any real estate investment trust, or (7) certain other trusts.
A "financial account" includes deposit and custodial accounts maintained by a financial institution and any debt or equity interests in a financial institution. Thus, a partnership or other equity interest in a foreign hedge fund would constitute a "financial account" for these purposes, as would any debt or equity issued by an FFI.
FATCA and the Proposed Regulations contain a very expansive definition of U.S.-owned foreign entities. This will increase the amount of information an FFI will have to request from a new account holder in order to determine whether the account to be opened constitutes a U.S. account. For these purposes, a U.S.-owned foreign entity is any foreign entity which has one or more substantial U.S. owners. A substantial U.S. owner is one who owns more than 10% of the stock of a foreign corporation, more than 10% of the profits interests or capital interests of a foreign partnership, or more than a 10% beneficial interest in foreign trusts. However, in the case of an entity which qualifies as an FFI by virtue of being engaged in the business of investing, reinvesting or trading securities, partnership interests or commodities, the threshold is 0% rather than 10%. This means that any foreign private equity fund or hedge fund with one or more U.S. investors, regardless of how little they own of the fund, will constitute a U.S.-owned foreign entity for these purposes.
If an FFI has one or more U.S. accounts, and has entered into an agreement with the Secretary, then the institution must provide certain information annually to the IRS. The required information includes the name, address and TIN for each account holder who is a specified U.S. person or of each substantial U.S. owner of a U.S.-owned foreign entity, the account number, the account balance or value and, except as provided for by the Secretary, the gross receipts and gross withdrawals and payments from the account. The requirement to provide information as to the gross receipts and gross withdrawals and payments is likely to require many institutions to develop computer programs specifically to comply with these new U.S. reporting requirements.
The Proposed Regulations phase in the following reporting requirements:
- In 2014 and 2015, an FFI needs to only report the name, address, TIN, account number and account balance for U.S. accounts;
- Income earned by the account will be reported by FFIs starting in 2016 for the 2015 calendar year; and
- Beginning in 2017, full reporting (including reporting of information on gross proceeds from broker transactions) is required.
Alternatively, the FFI can elect to instead provide the information that a U.S. financial institution would be required to provide the IRS if the account holder were a natural U.S. person. This effectively substitutes the Form 1099 filing requirements for those discussed above.
The Proposed Regulations contemplate that the IRS will modify Forms W-8 and W-9 to permit a payee to establish its status for FATCA purposes. In addition, Form 1042-S will be modified to incorporate the new reporting requirements under FACTA; such forms will have to be filed electronically.
The Proposed Regulations will be effective only after they have been finalized.
If you have any questions regarding these reporting requirements, please contact the authors or a member of Venable’s Tax & Wealth Planning Practice Group.