Additional Guidance on the FATCA Reporting and Withholding
Regime
The IRS and Treasury recently released additional guidance
on the reporting and withholding requirements under the
Foreign Account Tax Compliance Act ("FATCA") that has been
much-anticipated by the tax bar. The guidance contained in
Notice 2011-34, 2011-19 IRB 765 (the "Notice"), which
supplements and modifies the initial guidance on FATCA
provided in Notice 2010-60 issued in August 2010, addresses
seven areas of concern for foreign financial institutions
("FFIs"), which will be the de facto administrators of the
FATCA regime. FATCA, which was enacted in the 2010 Hiring
Incentives to Restore Employment Act (the "HIRE Act") and
applies to payments made on or after January 1, 2013, requires
FFIs to report certain U.S. account information to the IRS or
pay a 30% withholding tax on any payments made in respect of
U.S. securities (and other U.S.-source payments)
("withholdable payments") to the institutions or their
affiliates. FFIs must either enter into an "FFI Agreement"
with the IRS, pursuant to which they agree to report to the
IRS detailed information on their U.S. accounts and satisfy
the reporting and withholding requirements imposed therein, or
be treated as a "non-participating FFI." Notice 2010-60,
issued August 27, 2010, provided general guidance on FATCA and
addressed the grandfathering of obligations from the
application of FATCA, as well as documentation of accounts by
FFIs.
The Notice provides guidance regarding (1) the procedures
to be followed by participating FFIs in identifying U.S.
accounts among their preexisting individual accounts; (2) the
definition of the term "passthru payment" for purposes of
FATCA and the obligation of participating FFIs to withhold on
passthru payments; (3) certain categories of FFIs that will be
deemed compliant under Code section 1471(b)(2); (4) the
obligation of participating FFIs to report with respect to
U.S. accounts; (5) the treatment under Code section 1471 of
Qualified Intermediaries ("QIs") (as defined in Treasury
Regulation section 1.1441-1(e)(5)(ii)); and (6) the
application of Code section 1471 to expanded affiliated groups
of FFIs under Code section 1471(e).
Notice topics covered in this alert:
Preexisting Accounts and the
Private Banking Test
In response to comments that the rules in Notice 2010-60
would potentially result in large administrative costs for
FFIs, the IRS and Treasury have simplified the process for
identifying preexisting U.S. accounts in the Notice in certain
respects, detailing a six-step process that participating FFIs
must follow in identifying U.S. accounts among their
preexisting individual accounts. The Notice provides exclusion
for any account with a balance/value of $50,000 or less. The
FFI's chief compliance officer must certify to the IRS when
the FFI has completed the preexisting individual account
identification process. The Notice states that the IRS and
Treasury are still considering what measures should be taken
to address long-term recalcitrant account holders and has
suggested that after a reasonable period of time, an FFI with
too many holdouts may have its FFI agreement
terminated.
In a departure from prior guidance, the Notice includes a
private banking test that imposes on relationship managers at
private banks enhanced due diligence responsibilities for
finding indicia of U.S. accounts. A private banking
relationship exists when one or more officers or other
employees of an FFI are assigned by the FFI to (1) provide
personalized services to individual clients (or their
families), such as banking, investment advisory, trust and
fiduciary, estate planning, philanthropic, or other services
not generally provided to account holders or (2) gather
information about a client's (or the client's family)
personal, professional, and financial histories in addition to
the information ordinarily gathered with respect to the FFI's
retail customers. These private banking provisions are unique.
Under the test, a private banking relationship manager must
identify those accounts that have U.S. indicia or that the
manager knows to be owned by a U.S. person. There is a
specific set of indicia to follow and then actual knowledge
that determines whether an account is a U.S. account. It
appears that the IRS and Treasury decided to include a special
private banking test because there is more likely to be a
personal relationship between a client and his private banking
relationship manager, who will have access to substantially
more information about his client. The idea is to leverage off
that more personal relationship and rely on the greater
knowledge there is about a client and the fact that the
private banking relationship tends to exist primarily in the
case of high-net-worth individuals who could present a risk of
noncompliance and are a particular focus of the FATCA rules.
The IRS and Treasury have stressed that the private banking
test does not require the banks to know everything about their
clients.
The unexpected inclusion of rules requiring relationship
managers at banks to identify any accounts that they know are
owned by U.S. persons raises some difficult questions.
Practitioners have noted that the Notice's definition of a
private banking relationship is very broad and the new
provisions may prove burdensome for relationship managers.
Practitioners have also pointed out that the Notice provides
different rules for documenting account ownership depending on
the definition of the given account, which introduces a level
of complexity for operations and may be less helpful than
having a standard procedure. For example, in a private banking
relationship, the client must provide documentation of its
non-U.S. status by the end of the first year in which the
bank's FFI agreement with the IRS is in effect, but for other
accounts that the FFI searches electronically, there is a
two-year window for the client to provide information. The IRS
has also identified open questions, including how to treat
large accounts that are not private banking accounts and
whether there might be a family attribution rule for
determining whether an account exceeds the $500,000 threshold
in step 5 of the identification process in the Notice (an FFI
is required to conduct a diligent review of the account files
of all pre-existing individual accounts that are not clearly
identified as U.S. accounts, non-U.S. accounts, private
banking accounts, or accounts with U.S. indicia, with a
balance or value of $500,000 or more at the end of the year
preceding the effective date of the FFI agreement). In
general, however, the process is expected to apply on an
account-by-account basis. The IRS and Treasury have also
indicated that it is willing to entertain suggestions
regarding different thresholds for different types of accounts
but that commentators should explain why particular accounts
do not present a risk of abuse.
The Notice requires FFIs to certify their completion of the
review of preexisting accounts; however, the certification
procedures have been described by practitioners as not
burdensome. The responsibility for making the certification
will typically fall to the chief compliance officer. The
responsible corporate officer also must ensure that no FFI
employees encourage or assist account holders in avoiding the
rules. The IRS and Treasury have stated that the general goal
is to ensure that the officer feels personally responsible for
ensuring that the FFI complies with the FATCA regime and that
the FFI employees do not attempt to circumvent the rules.
Recognizing that the chief compliance officer is not
necessarily in a position to control the activities of every
single employee of a large FFI, the IRS and Treasury have
focused on personnel with management responsibilities and
requires that the responsible officer ensures that those
personnel comply with the FATCA rules, with the goal that such
adherence to the rules will filter down to the employees below
management level. The IRS and Treasury have not yet set a
deadline for certification. The General Counsel or other
compliance officer may find it helpful to send a notice to
persons within the organization warning them about this
requirement.
Additionally, several questions relating to insurance also
require more detailed guidance. The IRS and Treasury have
stated that insurance products cannot be entirely excluded
from FATCA reporting obligations because some of them look too
much like investment vehicles, although the government
acknowledges that standard life insurance policies should not
present a problem. The IRS and Treasury are concerned that
taxpayers who want to evade their obligations will seek out
alternatives, and the government does not want to leave open
obvious loopholes in the insurance area. Some concern has been
expressed about the question of determining who would be
considered the account holder in the context of a life
insurance contract, pointing out that without a clear
definition, it is possible to consider the beneficiary the
account holder for FATCA purposes. The withholding tax and
passthru payment provisions are particularly troublesome to
the insurance industry when the insurer is in a jurisdiction
with strict privacy laws and has recalcitrant account holders.
In such cases, the insurer, unlike a bank, will be unable to
close the account or pass the cost of the withholding tax to a
U.S. life insurance policyholder in order to comply with
FATCA. Other open questions include the extent to which
foreign financial institutions that are insurance companies
should fall within the scope of the FATCA reporting
requirements; how to define an "active trade or business"
where the concern is about entities that are shells being used
as investment vehicles to avoid reporting (regulations are
expected to include a rule stating that if a withholding agent
that is not a financial institution is engaged in an active
trade or business, payments from that agent are also exempt
from withholding); how to define and apply cash value and cash
surrender value in the FATCA context; how to apply the FATCA
rules to insurance products outside the United States; and
private placement insurance (the IRS and Treasury are
currently looking for a possible analogue to the private
banking test for insurance products).
Passthru
Payments
The Notice provides guidance on the definition of passthru
payment, which the IRS and Treasury have identified as a
critical component of the FATCA regime, and explains when
participating FFIs must withhold on such payments. The IRS and
Treasury have stated that the passthru payment approach serves
two roles. First, it gives financial institutions a tool to
incentivize recalcitrant account holders to provide the
institutions the information they need to report, and second,
it prevents a ring of "blocker FFIs" from encircling the
United States, whereby nonparticipating FFIs could invest in
the United States through participating FFIs and circumvent
the policy goals of FATCA. The HIRE Act defines passthru
payments as any withholdable payment or other payment to the
extent it is attributable to a withholdable payment.
"Other payments" are payments other than withholdable
payments, including payments of foreign-source income, as well
as payments that may not even constitute income. The scope of
what is included in this category is still undecided. For
example, the IRS and Treasury are said to still be considering
how to address derivatives. The active business test and the
definition of financial account are also under consideration,
but we understand the IRS and Treasury expect that many
royalty payments will not be covered.
The Notice provides that a passthru payment is equal to the
withholdable payment plus the product of the non-withholdable
payment and the "passthru payment percentage." The passthru
payment percentage, which is determined on a quarterly basis,
is the ratio of the FFI's U.S. assets to its total assets. An
FFI's U.S. assets are those assets that give rise to
withholdable payments, equity or debt interests in U.S.
corporations, and interests in other FFIs in an amount equal
to the value of the interest in the lower tier FFI multiplied
by that FFI's passthru percentage. Concern has been voiced
that the passthru payment provisions provided in the Notice
will be difficult to implement and that it will be hard for an
FFI to obtain information on the asset base of a local
organization. This has raised doubts that every FFI will be
able to calculate the passthru payment percentage.
Some practitioners also believe the concept of passthru
payments included under FATCA is too broad, and under the
mechanics of calculating payment amounts, it is possible that
some amounts, including dividends paid by a publicly traded
foreign financial institution or principal payments on loans,
could be included as passthru payments. We understand that the
IRS and Treasury decided on a broad approach in order to give
FFIs the ability to address recalcitrant account holders in a
way that does not force the FFI to choose between being able
to document all their account holders or else dropping out of
the FATCA system entirely, and to ensure that FFIs that invest
only indirectly into the United States have an incentive to
enter into the system. The IRS and Treasury want to prevent a
result in which participating FFIs could be used as blockers
through which nonparticipating FFIs might benefit from
indirect investment in U.S. assets without being subject to
withholding or entering into an FFI agreement. Rather than
applying a regime of direct tracing, the IRS and Treasury took
what it hopes will be a more administrable approach of
focusing on the ratio of U.S. assets to total assets of an
FFI, and using that to determine a passthru payment percentage
that will then apply to the payment that an FFI makes.
The Notice also provides a transition method for computing
the passthru payment percentage in the first year of a bank's
FFI agreement. There also is a new rule requiring that an FFI
post its passthru payment percentage on its website, which
follows a recent trend of the IRS and Treasury mandating
public disclosures on company websites. The IRS and Treasury
have noted that the purpose of having the FFIs publish ratios
is to avoid a situation in which an FFI that was making a
payment would be reliant on information from another FFI that
it actually has to obtain from that FFI directly; the idea of
the publication requirement is to make the information
available to everyone.
Deemed Compliant
Status
The Notice provides for certain categories of FFIs that
will be deemed compliant with the requirements of FATCA. The
Notice provides a new FFI carve out for some local banks in an
expanded affiliated group, provided all the FFIs in the group
meet certain requirements and they apply for deemed-compliant
status, making the procedure more complicated than some had
hoped. The requirements include that all the FFIs in the
expanded affiliated group must be licensed and regulated as
banks, must be located in the same country, and may not have
operations or solicit accounts outside that country. Some
believe these requirements are overbroad and few European
banks will be able to satisfy them. FFIs seeking
deemed-compliant status will have to apply for the status,
obtain an FFI employer identification number, and certify
every three years that it meets the requirements for
deemed-compliant status. The Notice also provides that future
guidance will identify what collective investment vehicles and
other investment funds will be treated as deemed-compliant.
Some FFIs are unsure how they will make use of
deemed-compliant status, because the rules are too
restrictive. It is expected that FFIs will lobby the IRS and
Treasury for a larger carveout based on a low risk of tax
evasion. However, the IRS and Treasury have stated that, in
connection with deemed compliant entities, it is concerned
about people investing indirectly through other entities and
low-risk entities that would normally not attract U.S. tax
evaders but that may start to once participating FFIs begin
reporting on U.S. account holders. The government has admitted
that the category of local banks that are covered by the
deemed-compliant category outlined in the Notice is narrow and
anticipates that it will be revising some of the factors and
will be adding additional deemed-compliant categories,
particularly for FFIs in emerging countries. The IRS and
Treasury have pointed out that the statutory section providing
for deemed compliance focuses not just on whether an entity is
likely to have a U.S. account or has safeguards in place to
ensure that if it has U.S. accounts it will become a
participating FFI, but also on whether there are safeguards to
deal with investments by entities (particularly
nonparticipating FFIs), so its approach at arriving at the few
deemed-compliant categories identified in the Notice was to
focus on types of entities that were unlikely to be used to
avoid FATCA, either by individuals or by investors who are
investing through other entities. Some have suggested that the
IRS and Treasury might focus on the services that banks offer
within the markets that they serve, rather than focus on the
fact that the business of the bank is so localized that it
would not be offering the types of services that someone who
was trying to hide assets would be interested in. However, the
IRS and Treasury have noted that they need criteria that are
both indicative of low risk and also measurable in a way that
will give comfort that the criteria are not susceptible to
abuse.
Additionally, further clarification of the rules for local
members of participating FFI groups is needed, including what
it means to "solicit" account holders outside the local
member's country of organization and how long local members
will have to transfer certain types of accounts to an
affiliate that is a participating FFI.
Reporting
Requirements
The Notice modifies the proposed reporting requirements for
participating FFIs, removing some of the monthly reporting
requirements in Notice 2010-60. Future regulations will
require FFIs to report only year-end account balances or
values and participating FFIs will not have to report tax
basis information on their accounts. Future regulations also
will require annual reporting of the gross amount of
dividends, interest, and other income, as well as gross
proceeds from the sale or redemption of property, which is
paid or credited to the account with respect to which the FFI
acted as custodian, broker, nominee, or agent for the account
holder. These changes have been generally well received by
FFIs, making the FATCA reporting regime more administrable for
FFIs.
Qualified
Intermediaries
Some foreign banks have become qualified intermediaries
("QI") by entering into agreements with the IRS. FFIs that are
QIs will be required to include in their QI agreements the
requirement to become participating FFIs, unless they qualify
as deemed-compliant FFIs under section 1471. FFIs currently
acting as foreign withholding partnerships and foreign
withholding trusts will be required to include similar
requirements in their agreements. The IRS and Treasury have
stated that this requirement is intended to clarify that the
QI and FATCA regimes will be coordinated and that a QI will
not have a choice on becoming a participating FFI.
Expanded Affiliated
Groups
The Notice provides guidance on the application of section
1471 to expanded affiliated groups of FFIs under section
1471(e). The Notice provides that a lead FFI will be
responsible for the FFI agreement for the expanded affiliated
group. However, there is uncertainty as to what would happen
to the lead FFI if another member of the expanded affiliated
group fails to comply. For example, would the lead FFI be
expected to function as a whistleblower for FFIs in its group?
The Notice provides that draft FFI agreements and draft
information reporting and certification forms are forthcoming.
Although the Notice provides a more detailed framework in some
areas, affected institutions will need more guidance in order
to meet the deadline for implementation of the FATCA regime.
The IRS and Treasury have stated that proposed regulations
that will enable stakeholders and their advisers to prepare
for the January 1, 2013, effective date will be the next major
step toward implementing the new reporting and withholding
regime of
FATCA. |
