H.R. 2847, the Hiring Incentives to Restore Employment Act
(HIRE), was signed into law on March 18. This law contains provisions
previously included in proposed legislation in the Foreign Account Tax
Compliance Act of 2009 (H.R. 3933, S. 1934), known as FATCA.
FATCA is intended to create transparency in the
international investment community, so that U.S. persons may not escape the tax
man by hiding behind foreign entities. To reach that goal, the new law focuses
on disclosure and reporting by all "foreign financial institutions"
(FFIs) and imposes a 30 percent withholding on most U.S. source payments made
to an FFI that is not in compliance with FATCA. The term FFI is defined very
broadly and includes not only foreign banks, foreign custodians, and foreign
depositories, but also foreign entities primarily engaged in the business of
investing, reinvesting or trading in securities, partnership interests, or
commodities or any interest in such items. Accordingly, an FFI will generally
include hedge funds and private equity funds formed outside the United States.
The FATCA rules will not become effective until December 31, 2012, and the IRS
is actively working to promulgate guidance with respect to the mechanics for
compliance. Fund managers, however, should be aware of the broad reach of these
new rules and should stay on top of the forthcoming guidance on this topic.1
Generally, the potential for FATCA's 30 percent withholding
applies to any U.S.-source payment of fixed, determinable annual or periodic
(FDAP) income, including interest (including portfolio interest and OID),
dividends, rents, salaries, wages, premiums, compensations and remunerations,
or any gross proceeds from the sale or disposition of property that can produce
interest or dividends from U.S. sources (a Withholdable Payment). Effectively
connected income is not a Withholdable Payment. In determining whether a
payment is a Withholdable Payment, it does not matter whether the payment is
for the benefit of a U.S.
person. Payments made on obligations outstanding on March 18, 2012 should not
be subject to these rules.
Existing law, which has been in place for a long time,
imposes a withholding requirement on payments to foreign persons of FDAP,
subject to reduction or elimination by treaty. The FATCA withholding greatly
expands existing law by creating a withholding obligation on, among other
things, gross proceeds from the sale of stock or a debt instrument which is
generally not taxable to foreign persons and is not subject to withholding
under current law.
FATCA's 30 percent withholding will apply to a Withholdable
Payment made to all FFIs unless:
In determining if an FFI that is a hedge or private equity
fund has substantial U.S.
account holders, there is no de minimis
threshold of ownership. There are, however, certain types of entities that are
excluded from the definition. These include, among others, REITs, mutual funds,
publicly traded companies, tax-exempt organizations, individual retirement
plans, and charitable trusts. Thus, a foreign feeder entity to a private equity
or hedge fund (whether treated as a corporation or a partnership for U.S. purposes) may not have any substantial U.S. account
holders because only tax-exempts, retirement plans and foreign persons invest
through the feeder. Such a foreign feeder would therefore not be required to withhold
on Withholdable Payments. A fund that accepts a variety of investors, however,
will likely be subject to the withholding regime.
If an FFI with U.S. accounts or investors does not elect to
be 1099 compliant, it must agree to report to the IRS the name, address,
identification number, account balance or value, and gross receipts and
withdrawal activity of the substantial U.S. owner or a U.S.-owned foreign
entity as well as to comply with verification and due diligence procedures.
Moreover, the FFI must provide additional information with respect to a
owner upon request. Under existing law only information reporting the identity
of a payee is required (an appropriate Form W-8) and generally only a
pass-through payee must report information with respect to its owners. FATCA
adds transparency by requiring a foreign corporation to also identify its
owner(s) and adds a significant amount of additional financial information to
If an FFI is unable to obtain the necessary information
either because an owner does not provide, or is prohibited under foreign law
from providing, such information (a recalcitrant holder), the FFI must withhold
30 percent on each Withholdable Payment to the recalcitrant holder, or elect to
receive its Withholdable Payments subject to 30 percent withholding, or close
the account of the recalcitrant holder. It is likely that foreign funds and
foreign feeder corporations will require their account holders to certify
whether they are U.S. persons or U.S.-owned foreign entities and provide the
pertinent information if they are. Accordingly, the disclosure and reporting
requirements will affect foreign entities that hold equity or debt, either
directly or indirectly, in any foreign entity that has entered into an
agreement with the IRS or makes an election to be treated as a U.S. FFI.
Implications: Consider an offshore fund of hedge funds that
owns interests in hedge funds treated as foreign corporations for U.S. tax
purposes. The fund of funds will not be required to enter into an agreement
with the IRS because it will not receive Withholdable Payments. If one of the
underlying hedge funds receives a Withholdable Payment and the underlying hedge
fund enters into an agreement with IRS, it will be required to withhold on
payments to the fund of funds unless the fund of funds provides the requisite
information, which will include information on any U.S. person that owns an interest
in it. The fund of funds will need to obtain certifications from all of its
holders and if any of such holders are investing or trading vehicles, the
information requirements continue up the chain.
Disclosure of Foreign
The HIRE Act also includes an additional reporting
requirement for U.S.
individuals. The U.S.
individual will be required to report their interests in foreign financial
assets with an aggregate value in excess of $50,000. There is an asset value
presumption of greater than $50,000 and an individual must demonstrate that the
foreign financial assets have a value of $50,000 or less to rebut the
presumption. The term foreign financial assets includes non-publicly traded
debt and equity of a foreign financial institution, and therefore includes
equity in a foreign private equity fund, foreign hedge fund and foreign
investment vehicle. This reporting requirement becomes effective beginning in
2011. This reporting requirement is in addition to reporting requirements under
the Foreign Bank and Financial Account Reports (FBARs).
The penalty for failing to comply with the HIRE Act's new
reporting requirements in any tax year is $10,000. If the failure to disclose
continues for more than 90 days after notice by the IRS, an additional $10,000
penalty will be imposed for each 30-day period after such 90 day period, with a
maximum penalty of $50,000.
The HIRE Act has added a requirement that each U.S.
shareholder of a passive foreign investment company (PFIC) file an annual
report containing any information required by the IRS. The HIRE Act does not
provide the information that shareholders are required to report. Pursuant to
Notice 2010-34, issued on April 6, 2010, no incremental PFIC annual reporting
is required for tax years beginning before March 18, 2010. Thus, this will
generally not be effective before 2011 and taxpayers should continue to report
on Form 8621, as required pre-HIRE Act. Prior to the HIRE Act, PFIC
shareholders were only required to report distributions from, dispositions of
an interest in, or certain elections with respect to, a PFIC.
1 Similar rules apply to non-financial foreign entities with
certain exceptions included in the HIRE Act and the authority for Treasury to
provide additional exceptions.
The material in this
publication is based on laws, court decisions, administrative rulings, and
congressional materials, and should not be construed as legal advice or legal
opinions on specific facts. The information in this publication is not intended
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lawyer-client relationship. Internal Revenue Service rules require that we
advise you that the tax advice, if any, contained in this publication was not
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purposes of (i) avoiding penalties under the Internal Revenue Code or (ii)
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