fatca revisited: notice 2011- 34 and beyond
TRANSCRIPT
FATCA REVISITED: NOTICE 2011-
34 AND BEYOND
John M. Staples – Burt, Staples & Maner
Erika Nijenhuis – Cleary Gottlieb Steen & Hamilton
Jesse Eggert – United States Treasury
International Tax Institute – June 2011
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FATCA Overview
FATCA stands for the “Foreign Account Tax Compliance Act” which was incorporated into the HIRE Act that became law on March 18, 2010.
The goal of FATCA is to require “foreign financial institutions” (“FFIs”) and “non-financial foreign entities” (“NFFEs”) to provide information to the IRS identifying U.S. persons invested in non-U.S. bank and securities accounts.
FATCA’s lever to achieve this goal is a NEW 30% withholding tax levied on “withholdable payments” made to non-participating “foreign financial institutions”.
“Withholdable payments” include all U.S. source income (“FDAP”) and gross proceeds from the sale or disposition of any property of a type that can produce interest or dividends from U.S. sources.
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FFIs
Broad definition that includes any non-U.S. entity that:
Accepts deposits;
Holds financial assets for the account of others;
Engages primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities.
FFI Examples: banks, securities brokers and dealers, hedge funds, collective and family investment vehicles, private equity funds, trusts and trust companies, etc.
Rules apply to all FFIs in an “affiliated group” – that is, to all more-than-50% owned FFI affiliates and entities of an FFI worldwide regardless of whether they receive U.S. source amounts.
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The FFI Agreement Route
A participating FFI must enter into an agreement with the IRS to do all of the
following:
Identify its “U.S. Accounts” including all its worldwide affiliates;
Comply with due diligence criteria to ensure that it has really identified its U.S.
Accounts;
Provide the IRS with an annual report with details about the U.S. Accounts that it has
found;
Deduct and withhold 30% on withholdable payments made to “recalcitrant account
holders” or bad FFIs;
Provide any follow-up information requested by the IRS with respect to the U.S.
Accounts; and
Request a waiver from any U.S. account holder if disclosure would otherwise be
prohibited on the basis of non-U.S. law (e.g., privacy or bank secrecy laws), and
close the account if the account holder refuses to cooperate.
The IRS can terminate the agreement if any of the above is not done.
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NFFEs
Non-financial Foreign Entities (“NFFEs”) are non-U.S. entities that are not FFIs.
Examples: non-U.S. corporations, partnerships.
The goal of section 1472 is to find “substantial U.S. owners” of these entities.
“Substantial” means >10% U.S. owners of non-U.S. corporations or partnerships and >10% beneficiaries of non-U.S. trusts.
A U.S. person treated as the owner of ANY portion of a foreign trust (i.e.,a grantor trust) is considered a substantial U.S. owner of the trust.
NOTE: non-active NFFEs that solely hold financial assets are treated as FFIs with NO threshold for determining U.S. owners (e.g., a BVI corporation holding a brokerage account is an FFI, not an NFFE).
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“Good” NFFEs
How to be a “good” NFFE not subject to 30% FATCA withholding: Belong to a class of NFFEs that Treasury/IRS designate as
per se “good” and not subject to FATCA withholding (or “good” under the statute, e.g., publicly traded corporations);
Certify to the withholding agent that the NFFE has no substantial U.S. owners; or
Provide the names, addresses, and U.S. taxpayer identification numbers (“TINs”) of substantial U.S. owners to the withholding agent to then be reported to the IRS.
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Key Dates
Sections 1471 and 1472 apply to payments made on or after January 1, 2013.
The exception is for payments made on certain “obligations” which are outstanding on March 18, 2010 (“grandfathered obligations”).
FATCA statute provides substantial discretion to U.S. Treasury and IRS to define operative rules through regulations and other guidance.
These looming deadlines and the lack of definitive guidance present many practical operational challenges and limits on what an institution can currently do to be compliant by these dates.
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Notice 2010-60 -- Issued August 27, 2010. Overall FATCA system architecture. Grandfathering of certain obligations from FATCA withholding. Documentation of accounts by FFIs, including transition “relief.”
Notice 2011-34 – Issued April 8, 2011. Modified rules for documenting preexisting individual accounts.
Passthru payments.
Deemed compliant FFIs.
FFI annual reporting. Expanded affiliated FFI group rules.
QI coordination.
Understanding the nature of a “Notice” under U.S. tax law.
The FATCA Notices
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#1: The Looming Effective Date: Issues for Discussion
Many commentators have told Treasury/IRS that major IT system changes take a minimum of 2 years to implement and final requirements are necessary to begin this sort of major global change project.
There is a general fear that it is already too late to implement FATCA by 2013.
Is some sort of effective date relief being considered?
Is there any intent or interest to work with Congress to extend the statutory date (e.g., by adding such a provision to pending legislation)?
Would penalty relief during a compliance grace period be considered or some other sort of transitional relief?
Other options?
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# 2: “Passthru” Payments -- Description
FATCA withholding applies to both withholdable payments and
“passthru payments.”
Passthru payments are defined as “any withholdable payment or
any other payment to the extent attributable to a withholdable
payment.”
By definition, this means that a certain percentage of some non-U.S.
source payments would be subject to FATCA withholding.
Withholding on passthru payments is intended to prevent evasion of
FATCA’s purpose thorugh “blocker” FFIs – that is non-participating
FFIs with U.S. accounts.
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#2: Passthru Payments – Proportionate Allocation
Approach
Proportionate Allocation Approach: Notice 2011-34
determines that an FFI payment is a passthru payment to the
extent of:
1) The amount of the payment that is U.S. source (withholdable
payment); PLUS
2) The amount of the payment that is not a withholdable payment
multiplied by:
a) Generally, the “passthru payment percentage” of the FFI;
b) If the FFI holds assets as a custodian, the passhthru payment percentage of
the entity that issued the interest or instrument held in custody.
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#2: Passthru Payment Percentages (“PP%”)
The PP% is determined on a quarterly basis by dividing “U.S. Assets” by “Total Assets” “Assets” include any asset on a balance sheet
(treatment of off-balance sheet items await future guidance) but not custodial assets. Assets measured at gross values unreduced by liabilities.
U.S. Assets: (1) Assets that give rise to “withholdable amounts”; (2) equity or debt interest in U.S. corporation; (3)interests in other FFIs that are not custodial accounts in an amount equal to the value of the interest in the lower tier FFI multiplied by that FFI’s passthru percentage.
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Examples of The Passthru Payment Concept
Fund Example: If 15% of Luxembourg Fund’s assets are U.S. assets, 15% of Lux. Fund’s distributions are passthrupayments. Lux. Fund must withhold 4.5% (15% X .30) of distributions to recalcitrant account holders.
Custodial Bank Example: If French Bank holds interests in Lux. Fund for a recalcitrant investor, French Bank must withhold 4.5% of amounts attributable to Lux. Fund’s distributions to that investor.
Bank Example: If 15% of French Bank’s assets are U.S. assets, 15% of French Bank’s French source bank deposit interest are passthru payments, and French Bank must withhold 4.5% of interest paid to a recalcitrant accountholder.
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#2: Passthru Payments – Multiple Areas of Complexity
And Uncertainty
How is lower tier equity to be determined? Intangible assets + tangible – liabilities?
Look-through to underlying assets if consolidated for financial account purposes?
A multinational “active business” FFI group would have to determine the PP% of each FFI in the group and then aggregate those PP% through each tier in the group to come up with the PP% of higher level members and the ultimate parent entity.
Such groups can have hundreds or even thousands of such FFIs and these calculations must be done each quarter.
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#2: Passthru Payment – Potentially Broad Scope of the
Term “Payment” Subject to Withholding
Notice 2011-34 does not limit the scope of what is a “payment” subject to FATCA withholding under the passthru payment concept, particularly for “active business” FFIs.
Does it include interest on cash deposits paid outside the U.S.?
Payments on derivatives?
Payments that are not income (e.g., principal payments on loans)?
The purchase price paid for the acquisition of any asset?
Ordinary course type payments such as for services, royalties, licenses, etc.?
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#2 – Passthru Payments – Policy Concerns
Does the fund approach make sense for banks?
The need to comprehensively overhaul systems worldwide to allow for this withholding for a worldwide group will be both an expensive and time consuming exercise.
Are specific passthru transition rules being considered?
Should the rules be limited to custodial and investment accounts for banks?
Will “successful” systems become obsolete – making the “spend” hard to justify?
USFIs are not subject to passthru payment rules. Are Treasury/IRS intending to address the potential for an unequal playing field?
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#3: What Does “Regularly Traded” Mean in the
FATCA Context?
Equity or debt in an FFI constitutes a financial
account unless it is “regularly traded on an
established securities market.”
FUNDS: A “regularly traded” fund is considered to
have no “accounts” for FATCA purposes.
BANKS: A bank whose debt is considered “regularly
traded’ will be able to avoid having to build new
account diligence mechanisms for debt investors holding
such debt – which typically do not exist today since it
involves institutional investors.
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#3 – “Regularly Traded” Equity For Funds
Fund equity may (a) trade like a stock in the case of exchange traded funds (“ETFs”); (b) be listed on an exchange but trade privately; or (c) trade like mutual fund shares.
Notice 2011-34 proposes to treat “regularly traded” investment vehicles as deemed compliant FFIs if they:
Enter into an FFI agreement;
Withhold on passthru payments to non-participating FFIs; and
Publish their passthru payment percentages.
Why not simply exclude such funds from FFI status?
Are other funds being considered for deemed compliant or excluded status?
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#3: “Regularly Traded” Debt For Banks
In addition to retail deposits, banks rely on an array of financing transactions with institutional investors to fund their assets – e.g., interbank deposits, commercial paper, medium-term notes, repos and securities lending, and subordinated debt.
What does “regularly traded” mean with regard to such transactions? Focus on the “market” or on the level of trading?
What FATCA purpose would be served by treating any of this institutional funding as an “account”?
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#4: Documentation of Existing Individual Accounts
Notice 2011-34 proposes rules for documenting existing individual accounts that replace those suggested in Notice 2010-60.
Key change is the introduction of more rigorous requirements for private banks and less comprehensive search and follow-up standards than those in the first notice for other types of accounts.
“Private banking” is defined broadly for any type of private banking or wealth management service offered for high net worth individuals.
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#4: Documentation of Existing Individual Accounts:
Industry Concerns/Open Issues
Is the government considering a more targeted definition of “private banking” given the breadth of the current definition (e.g., any department providing personalized services to clients or gathering information about their histories)?
Might a threshold approach in the private banking context achieve a result more consistent with identifying accounts of real compliance concern? (For example, accounts with values greater than $500k or $1m)
What does it mean to identify each private banking client “including any associated family member”?
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#4: Documentation of Existing Individual Accounts:
Industry Concerns/Open Issues (Cont’d)
What is meant by the proposed U.S. indicia “directions received from a U.S. address?”
Is this meant to be the same as the standard in Treas. Reg. §1.6049-5(e)(2) (“instructions from inside the United States”)?
Note: The analogous section 6049 rule is largely unadministrable given the difficulty in knowing if telephonic or internet instructions came “from inside the United States.”
Why are “hold mail” instructions inherently indicative of U.S. indicia?
Example: Argentine customer with hold mail instructions at Singapore branch and investments only outside U.S.
Timing to document accounts.
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#4: Documentation Of New Individual Accounts: Open
Issues
Would Treasury/IRS consider an account opening process more akin to the current electronic Form W-8 processes that solicit U.S. indicia type information through a Q&A type approach ?
Under Step 6, when does an FFI “know or have reason to know” that an account treated as non-U.S. during account opening process may have acquired U.S. status?
Will this require a periodic search of all accounts post-FATCA?
Could an FFI be liable if a relationship manager informally learns of U.S. status and does nothing with regard to it?
Are FFI’s on notice regarding complicated terms of trusts or other vehicles that may result in new U.S. beneficiaries/owners at some future date?
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#4: Documentation of Existing Entity Accounts: Open
Issues
What does it mean to collect documentation establishing entity type for FATCA in Step 3C? Standardized certification? Bespoke certification allowed?
Can the active nature of an NFFE be determined through a third-party database if not evident from account records? How about through certification or other communication from an entity customer?
There is a continuing concern with the divergence on what constitutes a “substantial” owner for FATCA purposes (>10%) and for other regulatory regimes like AML/KYC. Do Treasury/IRS intend to address this substantial problem?
There does not appear to be any requirement to examine additional data (e.g., AML/KYC data) over a transitional period as there is for individual accounts to ensure that information collected in initial effort is accurate. Is this intentional?
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#4: Documentation of New Entity Accounts: Open
Issues
Open Issues Likely requires totally new account opening procedures.
Can bespoke certifications be used rather than IRS forms to solicit FATCA entity type and any information on owners?
Can FFI rely on these certifications with the exception of FFIs that do not provide an FFI EIN?
Need to integrate tax systems with other regulatory systems worldwide (e.g. AML/KYC systems)?
Is it intentional that there is no requirement to re-document account if FFI “knows or has reason to know” that the circumstances affecting the correctness of an entity account holder’s classification have changed?
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#5: FFI Carve-Outs: Non-U.S. Retirement Plans
Non-U.S. Retirement Plan Carve-Out: A non-U.S. retirement plan will be treated as presenting a “low risk” of U.S. tax evasion potential and exempt from FATCA withholding if it meets the following criteria:
Qualifies as “retirement plan” under local law (Note: Must it also qualify under U.S. law as a retirement plan? Longstanding and contentious treaty issue),
Sponsored by a non-U.S. employer, and
Does not allow U.S. participants and beneficiaries other than those who worked in the country where the plan was established.
Open Issues
In light of many statements by Treasury/IRS officials acknowledging that the above criteria are too narrow, what is being considered to broaden this exception?
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Deemed Compliant FFIs -- “Small” FFIs
General Description: The Notice states that certain FFIs may be relieved of having to enter into an FFI agreement and from providing an FFI annual report IF either a larger FFI or a U.S. withholding agent agrees to:
Specifically identify each individual, specified U.S. person, or excepted NFFE that has an interest in such entity, either directly or indirectly;
Collect documentation from such persons; and
Report to the IRS any specified U.S. person identified as a direct or indirect interest holder in the entity (no % threshold).
For example, a U.K. bank functioning as an FFI agrees to identify the underlying beneficial owners and owners of its trust customers or smaller, closely held investment entities.
Such “smaller” FFIs would be relieved of their FFI obligations.
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#6: “Small” FFIs (Cont’d)
Open Issues
No ownership threshold to identify U.S. investors (but >10% for NFFE) – seems
odd to treat small trusts as FFIs given specific NFFE ownership tresholds.
What is being considered for guidance on the treatment of trusts? Rules for
“beneficial interests” and grantors of great concern.
Why would an FFI be willing to take on this risk in order to help their
“small” FFI customer base?
Is the option of defining what constitutes a “small” FFI still on the table in
order to either simply carve a number of these entities out of FATCA
completely or in the alternative treat them as NFFEs?
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#6: Deemed Compliant FFIs -- No U.S. Accounts
The FATCA statute deems certain FFIs to meet the FFI requirements if they can comply with procedures to prove that they do not have and will not have “U.S. accounts.”
Industry Concerns/Open Issues
What are the criteria for proving “no U.S. accounts?” Could less stringent requirements be possible than those in the two Notices given the likely population to make use of the exception?
What is being considered for the application procedure for this exception?
Would there be some sort of follow-up certification required with regard to continuing compliance with the requirements?
What are the potential risks if an FFI misses some U.S. accounts (particularly U.S. owned entities) and finds them after an initial due diligence phase? Would an actual knowledge standard be the norm?
What will be the audit/verification requirements?
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#6: Deemed Compliant FFIs -- Same Country Local
Banks
Notice 2011-34 adds new FFI carve out. Each FFI
in an expanded affiliated group will be deemed
compliant if all the FFIs:
Are licensed and regulated as banks;
Are in same country and have no operations outside
that country;
Do not solicit accounts outside that country; and
Implement policies and procedures to prohibit accounts
to non-residents (e.g., no U.S. people); non-
participating FFIs; and NFFEs (unless excepted NFFEs).
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#6: Local Banks -- Issues
Why are there prohibitions on soliciting outside
country of organization? Seems vastly overbroad –
and largely unworkable in markets such as Europe.
Same question as to prohibiting operations outside
country of organization.
Are the “local bank” and the “local FFI member”
provisions meant to carry out the “no U.S. account”
deemed compliant concept? If so, seems
substantially too narrow compared to statute.
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#6: Deemed Compliant FFIs -- Local FFI Members
FFIs that are members of an affiliated participating FFI group can be deemed compliant if FFI member:
Maintains no operations outside country of incorporation;
Does not solicit account holders outside such country;
Conducts search of account holders as required of all FFIs to identify U.S. accounts;
If any U.S. accounts are ever found must (1) become an FFI; (2) transfer them to participating FFI; or (3) close them.
Unclear if this is the extent to which a member of an FFI affiliated group could satisfy the “no U.S. account” exception. If it is, seems unduly restrictive.
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CONTACT DETAILS
John M. Staples
+1 202 783-1500 (U.S.)
Please visit our websites for up-to-date information on FATCA:
www.bsmlegal.com or www.cticompliance.com.
Erika W. Nijenhuis
+1 212 225 2980 (U.S.)