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Tax Law

FATCA Imposes Burdens on NFFEs

by Lawrence A. Kogan*

The Foreign Account Tax Compliance Act of 2010 (FATCA) and its regs impose certain information gathering, reporting and withholding requirements on nonfinancial foreign entities (NFEEs) operated by U.S. taxpayers overseas. In part, FATCA is intended to address difficulties that authorities have had with identifying US beneficial owners of US source income paid through foreign entities.

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FATCA... [empowers] the IRS to unilaterally deputize foreign financial institutions ("FFIs") [26 USC 1471(d)(4)] to serve as the IRS' extraterritorial information reporting and withholding agents with respect to accounts held in the names of NFFEs for the benefit of their respective owners. Where a disclosure compliance agreement has been entered into between the IRS and an FFI, the FFI must generally assume the following obligations in order to avoid the imposition of a 30% withholding tax upon certain of its own U.S. source income [See 156 CONG. REC. S1745. See also 26 USC 1471(a), (b)(3)]:

  1. to conduct due diligence necessary and sufficient to secure correct U.S. account and account holder information;

  2. to file related information reports;

  3. to generally withhold a 30% tax from U.S. source "withholdable payments" made directly to an NFFE or indirectly to U.S. account holders through NFFEs; and

  4. to close U.S. accounts with respect to which the FFI has not been provided a waiver granting it a derogation from bank secrecy nondisclosure laws. [See 26 USC 1471(a), (b)(3); 26 USC 1471(d)(6).]

General Rule With Respect to NFFEs:

A participating FFI ("PFFI") or other withholding agent that has entered into an agreement with the IRS must deduct and withhold a 30% tax from any U.S. source "withholdable payment" made to an NFFE that is the beneficial owner of such payment or to some other NFFE, if: 1) such beneficial owner or the payee fails to provide the PFFI with certain prescribed information; 2) the withholding agent knows or has reason to know that any provided information is incorrect; or 3) the withholding agent fails to report such information to the U.S. Treasury Department in the form prescribed...

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FATCA holds PFFIs and other withholding agents ultimately responsible for reporting such information to the IRS and withholding a 30% tax if appropriate; it does not impose direct IRS reporting or withholding obligations on NFFEs except in rare instances...

NFFEs, otherwise, bear the fundamental burden of producing information about itself and their beneficial owners that is sufficient in terms of quality, quantity and form (burden of production and persuasion) to enable responsible PFFIs or other withholding agents to satisfy their FATCA (statutory and regulatory) obligations...

Exceptions to General FFI Obligation to Withhold from NFFE Payments:

Non- "Withholdable Payments"

A PFFI or other withholding agent is not required to withhold a 30% tax on any U.S. source payment made to an NFFE that can be treated as other than a "withholdable payment." An NFFE payment will be considered other than a "withholdable payment" depending on the status of the payor or the nature of the payment, or depending on whether the NFFE payee qualifies as an "excepted NFFE" under one or more FATCA regulatory provisions.

FATCA proposed regulations exclude from the definition of "withholdable payment" any payment made to an NFFE that is attributable to income "effectively connected with a U.S. trade or business." ...

A payment made to an NFFE will also not be treated as a "withholdable payment" to the extent it is attributable to a withholding agent's "ordinary course of business" payment - i.e., an arm's-length payment made by a withholding agent "in the ordinary course of its business for nonfinancial services, goods, and the use of property." ...

Furthermore, FATCA does not treat as a "withholdable payment" any payment of interest or original issue discount on short-term obligations, gross proceeds from the sale or other disposition of any property that can produce U.S. source fixed, determinable, annual or periodic ("FDAP") income falling within the previous three exceptions, or any payment made from sales of fractional shares of such property.

Otherwise Withholdable Payments Made to Certain "Excepted" NFFEs

Otherwise withholdable payments which a withholding agent may treat as beneficially owned by an "excepted NFFE" are exempt from 30% withholding. These include payments beneficially owned by:

  1. a publicly traded corporation;
  2. a corporate affiliate of a publicly traded corporation;
  3. a "territory entity" organized under the laws of a U.S. Possession and owned by one or more bona fide residents thereof; and
  4. certain "exempt beneficial owners" ...

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Documentary Evidence Required to Substantiate Chapter 4 Payee/Intermediary"/"Flow-Through Entity" Status, "Non-Withholdable Payment" Status, and "Excepted NFFE" Status:

Reliable and Valid Evidence

FATCA effectively imposes a tiered withholding and reporting framework on PFFIs and other withholding agents that effectively requires an NFFE to disclose to such parties information about itself, its beneficial owners, and about other NFFEs in which it may hold beneficial interests. A PFFI or other withholding agent must be able to "reliably associate" a withholdable payment or a payee's status with valid documentation, in order to determine for FATCA withholding purposes whether a payment made to an NFFE qualifies as a withholdable payment or whether an NFFE qualifies as an "excepted NFFE." ...

"Payee/Intermediary"/"Flow-Through Entity" Status

The burden of producing documentation sufficient to facilitate these determinations falls primarily upon the NFFE. For example, an NFFE must be able to validate its bonafide status as "payee", "intermediary", or "flow-through entity" with respect to a given payment or course of payments. Where an NFFE presents documentary evidence verifying that it serves in the capacity of an intermediary (nominee, agent or custodian) with respect to a payment, it will not be treated by a PFFI or withholding agent as the payee. Similarly, where a foreign flow-through entity presents documentary evidence verifying that it is an "active NFFE" or "excepted FFI" acting in the capacity of an agent or intermediary with respect to a payment, it will not be treated by a PFFI or withholding agent as the payee. Thereafter, the NFFE must be able to identify via valid documentation each of the legal persons for whom it collects a payment, including other NFFEs, which can be established by presentation of valid beneficial owner withholding certificates (i.e., IRS Forms W-9, W-8BEN or W-8BEN-E)...

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"Non-Withholdable Payment" Status

Furthermore, an NFFE may demonstrate that a payment it received or made to a payee is effectively connected with a U.S. trade or business, and thus a "non-withholdable payment", if the withholding agent is able to reliably associate the payment with a valid Form W-8ECI. IRS Form W-8ECI is generally filed by a foreign recipient of effectively connected income to establish that it is the beneficial owner of the income being reported but not a U.S. person, and also to claim that the reported income is effectively connected with the conduct of a U.S. trade or business and not subject to withholding...

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"Excepted NFFE" Status

Moreover, an NFFE must present to a withholding agent certain prescribed documentation to establish its chapter 4 status for purposes of qualifying under one or more of the "excepted NFFE" 30% withholding exemptions. In general, an NFFE may establish prima facie its status as a publicly traded corporation, a corporate affiliate of a publicly traded corporation, a territory entity, and an active NFFE by delivering to the withholding agent a valid owner withholding certificate or beneficial owner withholding certificate identifying itself or another NFFE payee as having such status...

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Conclusion

While the FATCA regime primarily holds PFFIs and other withholding agents ultimately responsible for reporting information to the IRS about, and where appropriate, withholding a 30% tax from, U.S. source payments made directly and indirectly to NFFEs, NFFEs, which are usually in varying degrees of privity with their beneficial owners, bear the fundamental and often not-insubstantial burden of satisfying that obligation. In other words, FATCA provides no "Get-Out-Of-Jail-Free-Card" for NFFEs.

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* Lawrence A. Kogan, Esq. is Managing Attorney of The Kogan Law Group, P.C., a New York City-based multidisciplinary professional services firm focusing on identifying, assessing and addressing cross-border regulatory and trade risk for multinational business assets and operations.

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.

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