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Tax Law Update

june 24, 2011


Peter J. Connors

Stephen J. Jackson
+33 1 5353 8111

Stephen C. Lessard


For additional information, you can also contact:

Grady M. Bolding

Colman J. Burke

Steven C. Malvey

John Narducci

Greg R. Riddle

George G. Wolf

James M. Larkin

Eric C. Wall

Wolfram S. Pohl

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.