On January 17, 2013, the IRS and Treasury Department released final regulations under the Foreign Account Tax Compliance Act (“FATCA”). The FATCA provisions, enacted as part of the Hiring Incentives to Restore Employment Act of 2010 (“HIRE Act”) and contained in Chapter 4 (sections 1471 through 1474) of the Code require withholding on certain foreign financial institutions (“FFIs”) that do not comply with certain requirements intended to ensure that the IRS obtains information relating to U.S. accounts maintained by such FFIs. In addition, FATCA requires withholding on certain nonfinancial foreign entities (“NFFEs”) that are deemed to pose a significant risk of U.S. tax avoidance and that do not meet certain disclosure obligations. On February 15, 2012, the IRS and Treasury Department issued proposed regulations (discussed in our February 21, 2012 Financial Services Alert) that contained complex and detailed rules regarding the procedures that withholding agents and participating FFIs must follow in determining the status of account holders, as well as in identifying and documenting U.S. accounts. The final regulations generally follow the contours of the proposed regulations, but contain several modifications intended to more specifically target the regulations to areas of concern and reduce unnecessary administrative burdens on those subject to FATCA.
Brief Overview of the FATCA Regime
FATCA imposes a 30% withholding tax on “withholdable payments” made to a “foreign financial institution” (“FFI”), unless (i) the FFI enters into an agreement with the IRS (a “participating FFI”) to comply with certain information reporting and documentation requirements regarding its U.S. accounts (i.e., accounts held by one or more specified U.S. persons or U.S. owned foreign entities), and to withhold on pass-thru payments made to recalcitrant account holders and nonparticipating FFIs, (ii) the FFI qualifies for “deemed-compliant” status under Treasury regulations, or (iii) the FFI is treated as an exempt beneficial owner (such as a foreign government or certain foreign pension funds). An FFI is broadly defined to include any foreign entity that (i) accepts deposits in the ordinary course of a banking or similar business, (ii) as a substantial portion of its business holds financial assets for the account of others, or (iii) is engaged or holds itself out as being engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such assets. Accordingly, the term FFI includes foreign investment vehicles such as foreign hedge funds and private equity funds. Under FATCA, “withholdable payments” include U.S. source interest (including, for this purpose, interest paid by foreign branches of domestic banks), dividends, rents, and other types of “fixed and determinable income” (“FDAP income”) and gross proceeds from the sale or other disposition of property that can produce interest or dividends from U.S. sources.
In addition, FATCA imposes a 30% withholding tax on withholdable payments made to a non-financial foreign entity (“NFFE”), unless the NFFE certifies that it does not have any substantial U.S. owners or complies with certain information reporting requirements regarding each substantial U.S. owner. In general, an NFFE is any foreign entity that is not a foreign financial institution.
Summary of Significant Changes in Final Regulations
Following is a brief summary of the significant changes in the final regulations, which will be discussed in more detail in a forthcoming Client Alert.
- Extensions. The final regulations incorporate extensions on withholding, reporting and due diligence obligations that were included in the proposed regulations and in IRS Announcement 2012-42 (discussed in our October 30, 2012 Financial Services Alert). In addition, the final regulations further expand the scope of grandfathered obligations by exempting from Chapter 4 withholding all obligations that are outstanding on January 1, 2014, and any associated collateral. In addition, the final regulations provide that to the extent obligations (and associated collateral) give rise to withholdable payments under future regulations issued under section 871(m) (relating to dividend equivalent payments) or to foreign pass-thru payments under future FATCA regulations, such obligations will be grandfathered if they are outstanding at any point prior to six months after such future regulations are published.
- Scope of Covered Financial Institutions. In response to comments, the final regulations treat passive entities that are not professionally managed as NFFEs rather than FFIs.
- Expansion of definition of “deemed compliant” and other exempt categories of FFIs. The final regulations expand the categories of “deemed compliant” FFIs somewhat by adding certain qualified credit card issuers, limited term debt investment entities and sponsored FFIs to the categories of deemed compliant FFIs. In addition, the final regulations expand the categories of foreign retirement funds that qualify as exempt beneficial owners.
- Interaction with IGAs. In conjunction with the proposed regulations, the Treasury Department released a joint statement with France, Germany, Italy, Spain and the United Kingdom outlining an intergovernmental approach to implementing FATCA and automatic information exchange between partner countries. On July 26, 2012, the Treasury Department issued model agreements for two types of such intergovernmental agreements (“IGAs”) – a Model 1 form of IGA under which the foreign country would agree to collect information required by FATCA and automatically exchange such information with the IRS, and a Model 2 form of IGA which would offer FFIs a choice between direct reporting to the IRS and indirect reporting using local authorities and automatic information exchange. Under the Model 1 IGA, a U.S. withholding agent generally is not be required to withhold on payments to an FFI in the “FATCA partner country” with which the U.S. has entered such an IGA, except in the case of significant non-compliance by an FFI with its reporting obligations, in which case the non-compliant FFI would be designated as a nonparticipating FFI for FATCA purposes. On September 14, 2012, the Treasury Department announced the signing of the first Model 1-type IGA with the United Kingdom, and since that date, IGAs of both types have been entered into or are being negotiated with several other countries. The final regulations address the relationship of the FATCA obligations of FFIs that are covered by an IGA to those under the final regulations.
- Diligence Procedures. The final regulations contain numerous modifications aimed at streamlining the diligence procedures for identifying and documenting the Chapter 4 status of account holders.