Sutherland Legal Alert: Spring Is in the Air, and So Is FATCA! Notice 2011-34 Offers Another Dose of Much-Anticipated Guidance

By William Pauls, Carol Tello, Michael Miles, Robb Chase, and David Cho

On April 8, 2011, Treasury and the IRS released Notice 2011-34 (the Notice), which revises and supplements Notice 2010-60, the first guidance under the Foreign Account Tax Compliance Act (FATCA). FATCA was enacted in March 2010 and requires foreign financial institutions (FFIs) to report U.S. accounts to the IRS or pay a 30% withholding tax on any withholdable payments made to such FFIs. Our previous commentary concerning FATCA can be accessed using the following links:

The Notice replaces in its entirety the account identification procedures for preexisting individual accounts described in Notice 2010-60. The new procedures primarily are targeted at banks and brokerage firms that maintain individual accounts. How these bank-centric procedures will be applied to other FFIs, such as insurance companies, is not addressed in the Notice. However, the Notice does request comments on the application of the procedures to non-bank FFIs.

In addition to a wholesale revision of the procedures for identifying preexisting individual accounts, the Notice provides guidance concerning so-called "passthru" payments. Essentially, under these rules, payments consisting of U.S.-source investment income that are made by a participating FFI to a nonparticipating FFI or to a recalcitrant account holder will be subject to a 30% U.S. withholding tax to the extent of such U.S.-source investment income.

I. Identification Procedures for Preexisting Individual Accounts

The Notice provides detailed procedures that an FFI must follow in identifying U.S. accounts among preexisting individual accounts. As noted above, these procedures replace in their entirety the procedures set out in Notice 2010-60. In addition to the steps outlined below, the Notice provides a new certification requirement. Namely, the chief compliance officer of the FFI must certify to the IRS (i) when the FFI has completed the identification procedures, (ii) that the FFI did not engage in any activity directing, encouraging, or assisting account holders with respect to strategies on avoiding identification of their accounts as U.S. accounts, and (iii) that the FFI has in place written policies and procedures prohibiting its employees from advising U.S. account holders on how to avoid having their U.S. accounts identified.

a. Step 1: Documented U.S. Accounts

The Notice states that, if an account holder is already documented as a U.S. person for other U.S. tax purposes, he or she will be treated as a U.S. person and his or her financial accounts will be treated as U.S. accounts. However, unless the FFI elects otherwise, an account still will be considered a non-U.S. account if (i) the account is a depository account, (ii) each holder of such account is a natural person, and (iii) the balance or value of such account as of the end of the calendar year preceding the effective date of the FFI Agreement does not exceed $50,000 (or the equivalent in foreign currency).

Observation. The carveout for depository accounts appears to be less burdensome than it was under the prior procedures. Specifically, under Notice 2010-60, for depository accounts, month-end balances were used to determine the amount threshold.

b. Step 2: Accounts of $50,000 or Less

From the accounts not identified as U.S. accounts in Step 1, the FFI may treat an account as a non-U.S. account if the balance or value of the account as of the end of the calendar year preceding the effective date of the FFI Agreement does not exceed $50,000 (or the equivalent in foreign currency).

Observation. The Notice suggests that this procedure was crafted in response to some concerns expressed over whether, as a practical matter, FFIs could apply the exclusion in Step 1 of Section III.B.2.a of Notice 2010-60 for accounts of $50,000 or less because of (i) the limitations of many FFIs' information technologies systems and (ii) legal restrictions on the sharing of account holder information across branches in different jurisdictions. Note that the $50,000 exception in Step 1 applies only to depository accounts.

c. Step 3: Private Banking Accounts

In brief, the Notice requires FFIs to perform detailed steps with respect to private banking accounts, which are any accounts maintained by an FFI's private banking department or maintained as part of a private banking relationship, that are not addressed by Steps 1 or 2.

Observation. Step 3 represents a new procedure for identifying U.S. accounts among preexisting individual accounts. This provision clearly is intended to stop the practice of some banks actively soliciting U.S. clients, knowing that the accounts and any income therefrom are required to be reported to the IRS. Significantly, the reporting obligations are imposed on individual private banking relationship managers.

d. Step 4: Accounts with U.S. Indicia

If an account is not identified as (i) a U.S. account in Step 1, (ii) a non-U.S. account in Step 2, or (iii) as a private banking account under Step 3, the FFI must determine whether any of the information associated with the account includes any U.S. indicia. Specific U.S. indicia include:

  1. Identification of an account holder as a U.S. resident or U.S. citizen;
  2. A U.S. place of birth for an account holder;
  3. A U.S. residence address or a U.S. correspondence address (including a U.S. P.O. box);
  4. Standing instructions to transfer funds to an account maintained in the United States;
  5. An "in care of" address or "hold mail" address that is the sole address shown in the FFI's electronically searchable information; or
  6. A power of attorney or signatory authority granted to a person with a U.S. address.

If any of the above indicia are present, the FFI is required to request certain documentation (such as Forms W-9 or W-8BEN) to establish whether the account is in fact a U.S. account. Notably, an FFI is only required to search electronic databases for this information.

Observation. Step 4 appears to be unchanged from the prior procedures, other than the removal of a "P.O. box" address from the same category as "in care of" or "hold mail" addresses. The Notice suggests that this change may have been the result of comments received voicing concerns over whether treating a non-U.S. P.O. box as an indication of U.S. status is appropriate in light of the fact that, in certain countries, a significant percentage of the population uses P.O. boxes as their sole address.

e. Step 5: Accounts of $500,000 or More

In the case of any account not identified in the prior steps and that had a balance or value of $500,000 or more at the end of the year preceding the effective date of the FFI Agreement, the FFI must perform a "diligent review" of the account files associated with the account. Such a review presumably requires more than a search of electronics databases, unlike the search required in Step 4. To the extent that the account files contain any of the U.S. indicia described in Step 4, the FFI must obtain the appropriate documentation (as indicated in Step 4) within two years of the effective date of the FFI Agreement. Account holders that do not provide appropriate documentation by the required date will be classified as recalcitrant account holders until the date on which appropriate documentation is received from the account holder by the participating FFI.

f. Step 6: Annual Retesting

The Notice provides that, beginning in the third year following the effective date of the FFI Agreement, the FFI will be required to apply Step 5 annually to all preexisting individual accounts that did not previously satisfy the account balance or value threshold amount to be treated as high value accounts.

g. Long-Term Recalcitrant Account Holders

Despite the detailed guidance provided with respect to identifying U.S. accounts, the Notice does not offer any additional guidance with respect to long-term recalcitrant account holders. However, the Notice does provide that FFIs should not view Notice 2010-60, which provided relief for FFIs that otherwise would not be able to collect the information required to comply with their obligations, as a permanent substitute for collecting and reporting information with respect to U.S. accounts.

II. Passthru Payments

The Notice also provides much-needed guidance with respect to "passthru payments," an area that Notice 2010-60 did not address. In particular, the Notice sheds light on how passthru payments will be calculated and how they will be defined.

In general, FATCA requires an FFI to withhold 30% of any passthru payment made to a recalcitrant account holder or non-participating FFI. Before the Notice, a passthru payment was defined as "any withholdable payment or other payment to the extent attributable to a withholdable payment." The IRS opted against adopting comments proposing to narrow the definition of a passthru payment.

Nevertheless, the Notice indicates that Treasury and the IRS intend to issue regulations providing that a payment made by an FFI will be a passthru payment to the extent of (i) the amount of the payment that is a withholdable payment (i.e. the amount payable to an account holder that is directly traceable to a withholdable payment made to the FFI), plus (ii) the amount of the payment that is not a withholdable payment, multiplied by (A) in the case of a custodial payment, the "passthru payment percentage" of the entity that issued the interest or instrument, or (B) in the case of any other payment, the passthru payment percentage of the payor FFI.

Based on the Notice, the calculation of the passthru payment percentage will be determined by dividing (i) the sum of the FFI's U.S. assets held on each of the most recent four quarterly testing dates, by (ii) the sum of the FFI's total assets held on those dates. Alternatively, an FFI may elect to compute its passthru payment percentage to be used for the first quarter of the first year of its FFI Agreement based on the FFI's assets on a single testing date.

Treasury and the IRS have requested comments regarding possible exemptions from the definition of passthru payments that would be consistent with the policy goals of the passthru payment rule and reasonable in light of the potential burden on FFIs.

III. Other Guidance

In addition to the guidance regarding preexisting individual accounts and passthru payments, the Notice offers guidance in the following areas:

  • Deemed Compliance with FATCA. The Notice provides that certain categories of FFIs will be deemed compliant with FATCA, but an FFI that wants deemed-compliant status must apply for that status and re-certify every three years that it meets the requirements for deemed-compliant status. Treasury and the IRS intend to issue regulations that would treat local banks, local FFI members of FFI groups, and certain investment vehicles as deemed-compliant FFIs.
  • Reporting on U.S. Accounts. The Notice provides that Treasury and the IRS intend to issue regulations that would limit FFIs' account balance reporting obligations to year-end account balances or values. In addition, the Notice indicates that Treasury and the IRS intend to issue regulations that would require FFIs to report annually the following: (1) the gross amount of dividends paid or credited to the account; (2) the gross amount of interest paid or credited to the account; (3) other income paid or credited to the account; and (4) gross proceeds from the sale or redemption of property paid or credited to the account with respect to which the FFI acted as custodian, broker, nominee, or agent for the account holder.
  • Qualified Intermediaries. The Notice indicates that Treasury and the IRS intend to issue guidance requiring all FFIs currently acting as Qualified Intermediaries under section 1441 of the Internal Revenue Code to consent to include in their QI agreements the requirement to become participating FFIs unless they qualify as deemed-compliant FFIs.
  • Affiliated Group Rules. According to the Notice, Treasury and the IRS intend to issue regulations requiring that each FFI affiliate in an "FFI Group" be a participating FFI or a deemed-compliant FFI. For this purpose, the IRS intends to require FFI affiliates to apply for deemed-compliant status through a coordinated application process, which would require additional information reporting.
  • Effectiveness of FFI Agreements. Finally, the Notice states that FFI Agreements will become effective on the later of (1) the date they are executed; or (2) the effective date of FATCA. Also, the Notice provides that draft FFI Agreements (and draft information reporting and certification forms) are still to come.

IV. Treatment of Insurance Companies

As noted above, the Notice is focused on banks and similar financial entities and does not address the many unique issues arising under FATCA that are relevant to insurance companies. The provision of the Notice addressing the identification of preexisting individual accounts does solicit comments on whether procedures similar to those applicable to banks should be applied to insurance companies and their policyholders, including holders of "private placement life insurance." If analogous procedures are applied, insurance companies presumably would be required to (i) identify all policyholders with U.S. indicia (which, in the case of policies with significant cash values, could require a "diligent review" of all account information, whether or not electronically searchable), (ii) request Forms W-9 or W-8BEN (as appropriate) from those policyholders, and (iii) treat non-complying policyholders as recalcitrant account holders.

Moreover, in the event that the passthru payment provisions in the Notice would apply to policyholders of insurance companies, those companies likely would not be permitted under either the terms of the policies or local law to withhold 30% of the payments that they make to policyholders. Instead, the insurers could be required to pay over to the IRS out of their earnings or surplus an amount equal to 30% of such payments (perhaps excluding payments that constitute death benefits or a return of the investment in a policy).

V. Conclusion

Although Treasury and the IRS should be commended for providing much-needed additional guidance in the Notice, there are still many points that need further clarification or guidance. In particular, we expect more information to be issued on FATCA's impact on insurers and the insurance industry. We will continue to monitor future FATCA guidance and keep you updated on any significant developments as they occur.

If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed below or the Sutherland attorney with whom you regularly work.

Carol P. Tello 202.383.0769 carol.tello@sutherland.com
Michael R. Miles 202.383.0204 michael.miles@sutherland.com
Robert S. Chase 202.383.0194 robb.chase@sutherland.com
William R. Pauls 202.383.0264 william.pauls@sutherland.com
David C. Cho 202.383.0117 david.cho@sutherland.com

© 2011 Sutherland Asbill & Brennan LLP. All Rights Reserved.
This communication is for general informational purposes only and is not intended to constitute legal advice or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged to consult independent
counsel before making any decisions or taking any action concerning the matters in this communication. This communication does not create an attorney-client relationship between Sutherland and the recipient.

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