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FATCA:Disclose, Withhold or Disinvest?

Jay Krause26 October 2010

Program

• Selected highlights and client implications

• Special issues for trustees

• Comments and strategies

• Q&A

• Comments / questions forwarded to Treasury only if specifically

requested

What is FATCA?

• All FFIs subject to 30% gross withholding on US investments

Unless

• Enter into ‘FFI Agreement’ to

• Identify clients; and

• Withhold where relevant

The Road to FATCA

• LGT and UBS scandals

• The trouble with treaties and TIEAs

• OECD standards don’t address the problem

• I don’t know what I don’t know

FFI Obligations

• What must an FFI do?

• Identifying US clients and disclosing account details;

• Withholding on account holders refusing to be identified;

• Withholding on any FFI not entering adopting these procedures;

• Closing the account of anyone protected by banking secrecy laws

who fails to waive the protections of such laws

Financial Institution Defined

• Accepts deposits in ordinary course of banking or similar

business – 1471(d)(5)(A);

• Holds financial assets for the account of others as a substantial

portion of its business – 1471(d)(5)(B); or

• Engaged primarily in the business of investing… – 1471(d)(5)

(C)

‘Financial Institutions’ Generally Affected

• Banks (whether commercial or savings), savings and loans,

thrifts, credit unions, building societies, etc.

• Broker dealers, clearing organizations, custodians, employee

benefit plans, trust companies, etc.

• Hedge and private equity funds, funds of funds, mutual funds,

ETFs and all other collective investment and securitisation

structures

Comments on Selected FFIs

• Funds

• Employee benefit plans

• Limited ‘same country’ exception

• Trust companies and individual trusts

• Life insurance companies

Identifying ‘Account Holders’ - Individuals

• Existing accounts v New accounts• Pre-existing individual accounts

• Search electronic databases for indicia of US status

• Where US, must obtain W-9

• Where US place of birth or mailing/residence address

• If claiming non-US status, W-8 plus non-US passport

• Other indicia only require W-8

• Beware ‘care of’ and ‘PO Box’ addresses generally

• Transition to new account rules• Five years generally

• Two years where account greater $1,000,000

• New accounts• Documentary evidence required

Identifying ‘Account Holders’ - Entities

• Entities

• Classify entity as FFI or NFFE

• Participating, non-participating, deemed compliant, excepted,

recalcitrant or other…

• Identify each individual with an ‘interest’; and

• Obtain documentation applicable to new individual account holders

• New accounts

• must refer to all information collected

• regardless of whether electronically searchable…

Frequent Reactions

• But we don’t have US clients…

• We’ll stop taking on US clients….

• Do you have US investments?

• All that matters!!!

Frequent Reactions

• But we don’t have US clients…

• We’ll stop taking on US clients….

• Do you have US investments?

• All that matters!!!

Client’s Perspective

• Implications for all US taxpayers not fully tax and reporting compliant

• Am I US? • Citizen;

• Green card holder; or

• Resident

• Worldwide tax and reporting• Regardless of residence

• Credits generally available for taxes paid, but must be claimed!

Client’s Perspective - Expatriation

• Expatriation?

• Citizens

• Green card holders

• Exit tax regime from mid 2008

• Deemed sale of assets

• Tax on deemed gains in excess of $600,000

• Additional implications

• Exceptions

• Dual citizens from birth

• Age 18 1/2

Client’s Perspective – Expatriation

• What if not fully tax and reporting compliant?

• Expatriation exit tax regime applies unless

• Can certify full compliance for last five years

• Voluntary disclosure

Client’s Perspective – Voluntary Disclosure

• Special disclosure program expired 15 October 2009, BUT

• Long standing IRS voluntary disclosure policy

• See IRM 9.5.11.9 — Voluntary Disclosure Practice

• No criminal prosecution

• Must come to IRS before they come to you

• Several options for proceeding – ‘Quiet’ v ‘Noisy’

• Most recent UBS client sentence

• 50% account value, plus tax interest and other penalties

• One year jail followed by house arrest

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Implications of the New HIRE Act Rules:

The Trustee View

Jay Rubinstein, Withers LLP, Geneva26 September, 2010jay.rubinstein@withersworldwide.com

Overview

• Recent History of Foreign Trust US Tax Concerns

• Is a Trust an FFI? NFFE?

• Disclosure and Identification Rules as to beneficiaries and

settlors

• Additional Hire Act rules implicating trusts

Recent History of Trustee US Tax Concerns

• Distinctions between “foreign trust” vs “US trust” and “grantor

trust” vs. “non-grantor trust”

• Application of QI rules beginning in early 2000’s

• Proper trustee and beneficiary disclosures on

• Trust distributions

• Holding companies

• Foreign bank accounts

• Now FATCA

Trust As NFFE – US Persons with a ‘Substantial Interest’ (10% Interest?)

• Beneficiaries or settlor?

• Foreign grantor trust – settlor

• 1473(2)(A)(iii)(I)

• Trust revocable or or distributions limited to settlor / spouse during settlor’s

lifetime

• Slightly different rules for certain pre Sept 19, 1995 trusts

• Foreign non-grantor trust – beneficiaries

• 1473(2)(A)(iii)(II)

Trust as NFFE - Beneficiaries of Discretionary Trusts as ‘Account Holders’

• Who is a beneficiary:

• Letter of wishes?

• Will new IRC section 679 provisions apply?

• Potential beneficiary attribution regimes:

• Maximum exercise of discretion

• Pattern of distributions

• Trust terms

• Other?

Identifying Trust ‘Account Holders’

• Where to begin?

• Notice requires

• Identify each individual with an ‘interest’; and

• Obtain documentation applicable to new individual account holders

• New accounts

• Must refer to all information collected

• Regardless of whether electronically searchable

• Notice section III.B.3.b.

But is a Trust / Trust Company An FFI?FATCA - Financial Institution Defined

• Accepts deposits in ordinary course of banking or similar

business – 1471(d)(5)(A);

• Holds financial assets for the account of others as a substantial

portion of its business – 1471(d)(5)(B); or

• Engaged primarily in the business of investing – 1471(d)(5)(C)

‘Financial Institutions’ Generally Affected – AND NOTICE POTENTIALLY AFFECTING TRUSTS

• Banks (whether commercial or savings), savings and loans,

thrifts, credit unions, building societies, etc.

• Broker dealers, clearing organizations, custodians, employee

benefit plans, etc. [ TRUST COMPANIES? (PTC’s??) ]

• Hedge and private equity funds, funds of funds, mutual funds,

ETFs and all other collective investment and securitisation

structures [ INDIVIDUAL TRUSTS ?? ]

Trusts and Trust Companies

• Trust companies

• Treated as entity holding assets for the benefit of others

• Notice 2010-60 section II.A.2.

• Trusts

• ‘Small family trust’ listed as an example of an FFI

• FFI status supposedly arising under Section 1471(d)(5)(C) which

requires that the entity be primarily in the business of investing

• Notice 2010-60 section II.B.3.

Trusts as FFIs?

• Primarily in the business of investing?

• Existing US classification rules indicate otherwise

• Regulation section 301.7701-4

• Ordinary trusts

• arrangement to protect property for beneficiaries

• Business trusts

• Investment trusts

• generally classified as a ‘business entity’ for US purposes

Trusts as FFIs (con’t)

• Trusts as FFIs effectively contradicts other FATCA provisions

• Section 1473(2)(A)(iii)(II) and 1473(2)(B)

• Substantial US account holder exists where > 10% of trust

attributed to US person; but

• Where FFI is primarily in business of investing, substantial US

ownership exists if anything attributed to a US person

• If all trusts are treated as FFIs, then 10% test can never apply to

trusts not withstanding express language that it does apply to

trusts

OTHER HIRE ACT RULES-Reporting of Specified Foreign Financial Assets

• In addition to current FBAR reporting

• Reporting of “specified foreign financial assets” that exceed $50,000

(aggregate)

• Any financial account maintained by a foreign financial institution;

• Any of the following assets not maintained in a foreign financial

account: non-US stock; any interest in a non-US entity; any

financial instrument or contract with a non-US counter-party

Reporting of Specified Foreign Financial Assets

• Applies to US individuals; IRS has authority to extend to US

entities

• May apply without regard to whether that individual owns more

than 50% interest in trust owning such foreign accounts or

assets

• Reporting on US income tax return (IRS Form 1040)

• Failure to report subject to penalty of $10,000; additional

penalties up to $50,000 could apply

Passive Foreign Investment Company Reporting

• Definition of Passive Foreign Investment Company (PFIC)

• 75% of gross income is passive income or 50% average passive

assets

• Old rule (IRS Form 8621)

• Upon distributions; upon disposition; upon making an election

• New rule

• annual reporting obligation regardless of whether any taxable

event has taken place during the year

Uncompensated Use of Trust Property

• Deemed distribution of income or gains

• Only for uncompensated use of trust property

• Only if used by US person beneficiary

• Only for foreign (non-US) trusts

• Amount of distribution equal to the FMV use of property;

• Taxable if trust generates income or gains

• Interest charges if there is accumulated income or gains

• In all events, reporting of distribution

• Information statement from trustee to meet US reporting

obligations

Uncompensated Use of Trust Property

• Impacts any foreign trust that holds property used by a US

person

• Real property, art, jewelry, automobiles, yachts and airplanes.

• Exception where beneficiary pays FMV for use of property

within a “reasonable period of time”

• Rent payment can give rise to passive income subject to 30%

withholding

Uncompensated Use of Trust Property—Planning Options

• Segregate the use property in a separate “dry” foreign trust

• Domesticate the use property to a US trust (watch for carrying

out income)

• Sell property to a grantor trust (watch for gain recognition)

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Responses to the New Hire Act Rules:

Comments and possible strategies

Richard Cassell, Withers LLP London

26 October 2010

IRS Notice 2010 – 60

• These are only proposals and are open for comment

• IRS specifically is looking for comments as to impact on trusts

and practical trust issues

• We are assembling comments from interested parties

• In order to be effective the comments must be specific and

targeted. There is no point in requesting blanket exemptions or

grandfathering

Surprises in the Notice

• Every trust is an FFI – not the trustee, but the trust, but not undefined “small family trusts”

• Does offer opportunity for a trust to elect to participate separately from trustee but of limited practical use

• Multiplicity of reporting, for example, for private trust companies with professional service provider, but confusion about responsibility (custodian? Paying agent? FFI?)

• Concept of US financial institution – treated like a participating FFI but not defined – does it include US partnerships and US trusts?

• As a result of all trusts being FFIs this ignored Section 1472 definitions of US owners and 10% restriction

Comments

• IRS will be deluged with pointless information (like the FBAR reports) as a result

of including every non-US trust in the world as an FFI. Should only trustees be

FFIs not trusts?

• Should the definition of “small family trust” be expanded? How big is small?

What is a family?

• Will the disclosures be limited to the last participating FFI in the chain or will

intermediate participating FFIs be required to maintain parallel disclosure?

What about potential inconsistencies in disclosure?

• Will certification by a participating FFI provide effective disclosure exemptions?

• Should there be any separate category for charities?

• How do you value a US beneficiary’s discretionary trust balance?

Strategies

• Segregate trusts between those with US and non-US investments. Those with only non-US investments can be non-participating FFIs.

• Generally strategy must be to manage the disclosure. We expect clients will generally need a participating FFI – it must be preferable to control the disclosure in the FFI

• A strategy to limit disclosure to third parties may be to use a US partnership to segregate all US investments and to manage the disclosure – a strategy that could exploit the exemption for family offices that we expect under Dodd-Frank regulations

• Eliminate US beneficiaries who are not intended actually to benefit from discretionary trusts

Client reactions

• Anticipate disclosure or divest from US but a strategy to avoid

all US investments seems very restrictive

• If the clients are non-compliant the voluntary disclosure

program is still open for business and this is the opportunity to

become compliant

• We anticipate that some compliant clients may use this as the

opportunity to look at expatriation –covered expatriate limit is

currently $2m