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The most recent proposed Foreign Account Tax Compliance Act (FATCA) regulations are designed to lighten the due diligence and compliance burden on foreign financial institutions and U.S. withholding agents, especially with respect to high value accounts.
The Foreign Account Tax Compliance Act (FATCA) is very broad sweeping and will mostly impact foreign financial institutions (FFIs) but will also have an impact on US financial institutions (USFIs) in terms of compliance, whether it is a huge multinational firm or a withholding agent. Early in 2012, the IRS proposed new interpretive regulations that are designed to address the competing interests of numerous parties, including the FFIs, the foreign governments, the U.S. Treasury, and the withholding agents. In most cases the proposed regulations attempt to reduce the burden imposed on foreign financial institutions in complying with the provisions of FATCA. The regulations even contemplate establishing an alternative scheme to satisfy reporting requirements by interposing the foreign government as the entity to which the FFI reports, rather than the U.S. Treasury. In this way the Treasury is trying to accommodate local law restrictions against disclosure and hoping to facilitate foreign governments' efforts to collaborate with the Treasury in fighting the battle against offshore tax evasion. For example the FFI will still be required to collect the information required by FATCA and then report the information to its residence country government and the residence country government, in turn, reports the information to the IRS annually pursuant to a tax treaty, or tax information exchange, or similar agreement. The proposed regulations also seek to reduce the burden on FFIs in other ways. One way is by reducing the required due diligence to be applied in determining payee status, effected by increasing the account balance threshold that would trigger an enhanced review. Another way is by allowing the financial institution to rely more heavily on its general account opening procedures when it conducts an AML/KYC review, because in general, the determination of FATCA payee status would require a review of similar, if not the same, documents.
... [O]n February 8, 2012, the Treasury issued proposed regulations, REG-121647-10, IR 2012-15, to implement the provisions of FATCA in stages so as to minimize the burden of compliance on affected financial institutions.
In general, these proposed FATCA provisions require FFIs and NFFEs to report certain information with respect to their U.S. accounts or substantial U.S. owners, respectively. This is so that the Treasury will know who holds investment accounts overseas and should be reporting income from these accounts. Absent an agreement to report U.S. account owners, the FFI or [non-financial foreign entity] NFFE is subject to an obligation to withhold on any foreign source payments made to or on behalf of U.S. owners. Specifically, IRC Section 1471(a) imposes an obligation on a withholding agent, which could very easily be a U.S. bank, to withhold 30 percent of any withholdable payment made to an FFI that does not meet the requirements of IRC Section 1471(b), beginning January 1, 2014. An FFI that meets the requirements of IRC Section 1471(b) is either a participating FFI or a deemed compliant FFI. Thus to be a participating FFI that is not required to withhold against payments made overseas, the financial institution must enter into an FFI agreement, also known as, an IRC Section 1471(b) agreement. A participating FFI is required to agree to identify its U.S. accounts and to meet certain verification and due diligence requirements within proscribed time periods.
The proposed regulations, of course, expand upon the general statutory provisions. IRC Section 1471 requires that the FFI make an effort to identify U.S accounts including those owned by specified U.S. persons and foreign entities with substantial U.S. owners. Substantial U.S. owners are generally those with a greater than 10 percent ownership interest in the entity. The question remains what sort of an effort must the FFI make to identify such persons and qualify for the status as a participating FFI not subject to the 30 percent withholding obligation? The proposed regulations provide this answer outlining the due diligence required to be undertaken by an FFI to identify U.S. accounts. The level of due diligence exercised depends upon whether the account is an individual account or an entity account and whether the account is preexisting or new. A preexisting account is in existence prior to the time that the FFI agreement becomes effective.
A NFFE is a foreign entity that is not a financial institution. If the payee is a passive NFFE, the withholding agent must obtain owner certifications unless the NFFE is a withholding trust (WT) or a withholding partnership (WP). Either the agent must obtain information from the NFFE that there are no substantial U.S. owners or if there are, the name, address and TIN of each substantial owner, typically through a withholding certificate. The regulations make clear that there are certain circumstances in which the withholding agent may not rely on the payee's certifications. For example, a withholding agent is deemed to know or have a reason to know that a withholding certificate provided by a payee or beneficial owner is unreliable or incorrect if it is incomplete with respect to any item that is relevant to the status claimed, the certificate contains information that is inconsistent with the payee's claimed status, the withholding agent has other account information that is inconsistent with the payee's claimed status or the certificate lacks information that is required to establish the payee's status as exempt. The regulations also contain presumptions of U.S. person status or foreign status when the withholding agent cannot reliably associate a payment with a valid withholding certificate or other documentary evidence. The presumptions are rebuttable.
Rules Applicable to Withholding Agents
The proposed regulations impose an obligation to withhold U.S. tax on a withholding agent and that includes U.S. financial institutions who make payments of U.S. source income to overseas accounts that are held by specified U.S. persons in foreign financial institutions or foreign entities with substantial U.S. owners. In many cases a bank will be a withholding agent as defined by the regulations. For FATCA purposes, a withholding agent is any person, acting in whatever capacity, that has control, receipt, custody, disposal or payment of any withholdable payment. Specifically included in the definition of withholding agents are participating FFIs and grantor trusts. A withholding agent could also be a U.S. bank making payments to FFIs and NFFEs...
Prop. Treas. Reg. 1.1471-5 provides a series of definitions that are essential to interpreting the responsibilities of the FFI or withholding agent under Chapter 4. For example, a U.S. account is a financial account maintained by a financial institution that is owned by one or more specified U.S. persons or U.S. owned foreign entities. In general, the account holder is the person listed or identified as the holder of the account with such institution, even if that person is a flow-through entity. Except that accounts held by agents, investment advisors, and the like are treated as held by the person on whose behalf the agent is acting. A financial account is defined as any depository or custodial account maintained at a financial institution, and any equity or debt interest in such financial institution other than those which are regularly traded on an established securities market. [IRC Section 1471(d)(2)]
A specified U.S. person for the FATCA rules is basically any U.S. person unless otherwise excluded as such in the regulations. Excluded from the definition of a U.S. person are publicly traded corporations, tax exempt organizations, individual retirement plans, real estate investment trusts, regulated investment companies, dealers in securities, common trust funds, and brokers, among others. Also excluded are the United States and its agencies and instrumentalities, the states, Washington D.C. and the U.S. territories, and any political subdivision thereof. [Prop. Treas. Reg. 1.1473-1]
Certain foreign financial institutions are not subject to the withholding obligations under I.R.C. Section 1471(a) and I.R.C. Section 1472(a) because they are deemed compliant FFIs. Deemed compliant FFIs are broken down into two categories - registered deemed compliant FFIs and certified deemed compliant FFIs. A registered deemed compliant FFI, as its name suggests, generally must register with the IRS to declare its status as deemed compliant and to attest that it has satisfied certain procedural requirements. [Prop. Treas. Reg. 1.1471-5(f)]... The proposed regulations expand the categories of deemed compliant FFIs beyond those contained in Notice 2011-34 to include local FFIs, nonreporting members of participating FFI groups, qualified investment vehicles (including certain collective investment vehicles), restricted funds (local investment funds) and FFIs that comply with the requirements of I.R.C. § 1471(b) under an agreement between the U.S. and a foreign government, wherein the FFI agree to fulfill reporting requirements by reporting to foreign government...
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