On July 12, 2013, the Internal Revenue Service (“IRS”) issued Notice 2103-43 (the “Notice”) providing for the delay in the implementation of withholding and other requirements under the Foreign Account Tax Compliance Act (“FATCA”). Although FATCA as passed by Congress formally went into effect on January 1, 2013, the IRS has previously deferred various effective dates (see IRS Announcement 2012-42 discussed in the October 30, 2012 Financial Services Alert). More recently, on January 17, 2013, the Treasury Department and the IRS issued final regulations (the “Regulations”) providing for the phased implementation of the FATCA requirements commencing on January 1, 2014 and continuing through January 1, 2017. The Notice further delays these effective dates. Amendments also will be made to the Regulations to adopt these changes, but in the interim the guidance in the Notice may be relied on.
FATCA imposes a 30% withholding tax on “withholdable payments” made to “foreign financial institutions” (referred to in the Regulations as “FFIs”) and to “non-financial foreign entities” (referred to in the Regulations as “NFFEs”), unless certain certification, information reporting and other specified requirements are satisfied. The term “withholdable payment” means (i) any payment of U.S. source interest, dividends, rents and other types of fixed or determinable annual or periodical income (to the extent treated as a withholdable payment in the Regulations, “U.S. FDAP”), and (ii) gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends payments that would be U.S. source FDAP income (“Gross Proceeds”). Under the current Regulations, certain obligations that are outstanding on January 1, 2014 are “grandfathered,” and payments (including Gross Proceeds) made on such obligations are exempt from withholding.
Under FATCA, an FFI is broadly defined to include not only banks and similar financial institutions, but also investment entities, such as hedge funds, private equity funds, venture capital funds and other investment funds. In considering the FATCA regime, it is helpful to keep in mind that the principal purpose of FATCA is to ensure compliance with federal income tax laws by “specified U.S. persons” (generally, any U.S. individual or entity other than a publicly traded corporation or its affiliates, governmental entities and tax-exempt organizations and retirement plans, and certain categories of entities such as banks, real estate investment trusts and mutual funds). Thus, FACTA withholding applies to any withholdable payment to (i) an FFI, unless (A) the FFI undertakes certain diligence, reporting and withholding obligations with respect to its U.S. accounts - that is, the FFI agrees to become a “participating FFI,” (B) the FFI qualifies as a deemed-compliant FFI, or (C) the withholdable payment can be reliably associated with an exempt beneficial owner, all as defined under the Regulations, and (ii) an NFFE if the beneficial owner of the payment is such entity or another NFFE, unless the beneficial owner either certifies it does not have any substantial U.S. owners or furnishes identifying information regarding each substantial U.S. owner or the NFEE qualifies as an “excepted NFFE.”
As noted above, under the FATCA regime, certain FFIs are exempt from withholding. Exemptions are generally available, for example, for (i) an FFI that registers and enters into an agreement with the IRS pursuant to which it undertakes certain diligence, reporting and withholding obligations (a “Participating FFI”), or (ii) an FFI that registers with the IRS and is treated as a “registered deemed-compliant” FFI under applicable Regulations (a “Registered Deemed-Compliant FFI”). In the case of these FFIs, a critical aspect of the FATCA regime is the web-based FATCA registration portal (the “Portal”) through which they will register with the IRS and agree to act in accordance with their applicable FATCA obligations. An FFI that has registered through the Portal will be assigned a Global Intermediary Identification Number (a “GIIN”), and the IRS will electronically post the list of FFIs registered through the Portal and their GIINs. To establish its exempt status with a withholding agent, a Participating FFI or a Registered Deemed-Compliant FFI will be required to provide its GIIN, and the withholding agent will be required to verify it. In general, verification entails checking the FFI’s GIIN against the IRS’ published list of registered FFIs. Under the Regulations, the Portal was to be accessible for registration by July 15, 2013, and GIINs were to be assigned beginning no later than October 15, 2013. The IRS was to publish the first list of Participating FFIs, Registered Deemed-Compliant FFIs and Reporting Model 1 FFIs (discussed below) by December 2, 2013 and an FFI was required to be registered by October 25, 2013 in order to be ensured inclusion on this first list.
In addition, as part of its implementation of FATCA, the IRS has entered into intergovernmental agreements (“IGAs”) with several countries and is actively negotiating IGAs with many more countries. There are two types of IGAs – Model 1 (both reciprocal and nonreciprocal) and Model 2. Under the Model 1 IGA, an FFI resident in, or a branch of an FFI located in, the partner jurisdiction will be required to provide specified information on its U.S. accounts pursuant to requirements established by the partner jurisdiction, which, in turn, will provide such information to the IRS (a “Reporting Model 1 FFI”). The Model 1 IGAs also will contain a list of FFIs that are exempt from such reporting requirements (a “Nonreporting Model 1 FFI”). In addition, under the reciprocal version of the Model 1 IGA, the U.S. would obtain and provide similar information to the partner jurisdiction on accounts held by certain residents of the partner jurisdiction in certain U.S. financial institutions. Although a Reporting Model 1 FFI will not be required to enter into an agreement and provide information on its U.S. accounts directly to the IRS, the Regulations provide that, subject to certain transition rules, a Reporting Model 1 FFI will be required to register with the IRS and obtain a GIIN.
Under a Model 2 IGA, an FFI resident in, or a branch of an FFI located in, the partner jurisdiction will be required to provide specified information on its U.S. accounts directly to the IRS in a manner consistent with the Regulations, as supplemented by government-to-government exchange of information on request.
It is expected that the IGAs will become a dominant part of the implementation of the FATCA regime. The model IGAs outline timeframes for FFIs in a partner jurisdiction to complete due diligence on their U.S. accounts, and these timelines along with other provisions in the IGAs interact with the Regulations in various ways. In general, the IGAs permit an FFI to use a definition in the Regulations and rely on due diligence procedures in the Regulations, in lieu of relying on corresponding provisions of an applicable IGA, and also contain provisions that coordinate the time for obtaining and exchanging information with the time by which Participating FFIs must report similar information to the IRS under the Regulations. In addition, the model IGAs and all of the IGAs that have been entered into contain a “most favored nation” (“MFN”) clause which entitles an FFI in a partner jurisdiction to the benefit of more favorable terms, including the due diligence rules, agreed to under any other comparable IGA.
In light of numerous comments and practical concerns regarding the phased implementation of FATCA and uncertainties about whether a particular IGA will be in effect so as to enable an FFI in a partner jurisdiction to carry out its due diligence and other obligations, as discussed below, the Notice provides for a 6-month extension of various timelines for implementation of FATCA and conforming changes to related provisions in the Regulations. As noted above, it is also expected that amendments will be made to the Regulations to formally adopt these changes.
Changes Made by the Notice
Withholding and Grandfathered Obligations
The Notice provides that withholding will generally be required to commence on withholdable payments made after June 30, 2014 (instead of December 31, 2013). Similarly, the definition of grandfathered obligations is expanded to cover obligations that are outstanding on July 1, 2014 (instead of January 1, 2014). None of the other dates on which withholding is required to commence (such as withholding on Gross Proceeds, which is scheduled to commence on January 1, 2017), however, is affected by the Notice.
New Account Opening Procedures
The Regulations generally provide less stringent documentation rules with respect to preexisting obligations as opposed to new accounts. Preexisting obligations are generally defined under the Regulations as accounts outstanding on December 31, 2013. The Notice provides that the Regulations will be modified to extend for 6 months the treatment of an obligation as a preexisting obligation (and hence provide a 6-month delay in the timelines for implementing new account opening procedures), with particular definitional rules applicable to different categories of FFIs.
Completion of Due Diligence Procedures on Pre-Existing Obligations
Preexisting Obligations of Prima Facie FFIs
The Notice provides that withholding on withholdable payments made to a prima facie FFI with respect to preexisting obligations will apply to payments made after December 31, 2014, instead of June 30, 2014. Similarly, with respect to a preexisting obligation, a participating FFI generally will be required to determine whether a prima facie FFI is a Participating FFI, deemed-compliant FFI or a nonparticipating FFI within six months of the effective date of its FFI Agreement (that is, by December 31, 2014 for any Participating FFI that enters into an FFI Agreement on or before June 30, 2014). A prima facie FFI is generally an entity which is shown on a withholding agent’s database to be a “qualified intermediary” or a “nonqualified intermediary” (as those terms are defined for purposes of Chapter 3 withholding under Code sections 1441and 1442), or to be a foreign entity that is associated with certain industry codes that are deemed to be associated with financial institution status.
Other Preexisting Entity Obligations
Withholding agents, other than Participating FFIs, will be required to document payees, other than prima facie FFIs, by June 30, 2016, instead of December 31, 2015 as currently provided under the Regulations. Accordingly, beginning on July 1, 2016 (instead of January 1, 2016) any undocumented entity that is treated as a foreign entity and is not a prima facie FFI must be treated as a nonparticipating FFI until the withholding agent obtains sufficient documentation to establish a different status for FATCA purposes of the payee. Similarly, a Participating FFI generally will be required to perform the requisite identification procedures to determine whether an entity (other than a prima facie FFI) is itself a Participating FFI by the later of June 30, 2016 or the date that is two years after the effective date of its FFI Agreement, and will not be required to apply certain presumption rules as to the accounts of such payees until such time.
Preexisting Individual Accounts of Participating FFIs
In general, the Notice extends the dates in the Regulations for obtaining information about preexisting individual accounts, or otherwise treating such accounts as held by “recalcitrant” account holders. The date by which Participating FFIs must perform the requisite identification procedures and obtain the appropriate documentation for “high value” accounts was extended by 6-months to June 30, 2015, and to June 30, 2016 if the account is other than a “high value” account. The determination of whether an account is a high value account (i.e., the account had a balance or value exceeding $1,000,000 as of a specified date) is now to be measured initially as of June 30, 2014, and if that value is less than $1,000,000, the account will not be subject to enhanced review unless the balance or value exceeds $1,000,000 at the end of 2015 or any subsequent calendar year. Thus, in effect, the obligation to determine whether enhanced review is required is deferred by one year.
Timeline for Registration and Implementation of the Portal
The Notice states that the Portal is expected to be accessible by August 19, 2013 (instead of July 15, 2013, the date in the current Regulations). No information provided on the website will be considered final, however, until January 1, 2014, so as to allow FFIs to familiarize themselves with the use of the Portal and the registration process. Consistent with this 6-month extension, the IRS will not issue any GIINs in 2013. Instead, it will publish its first list of FFIs by June 2, 2014, and FFIs will be required to register by April 25, 2014 in order to be included on this first list. As under the current Regulations, however, verification of a GIIN will not be required with respect to payments made prior to January 1, 2015 to a Reporting Model 1 FFI – such an FFI may be treated as exempt with respect to such payments if it provides other documentation required to establish its status as a Reporting Model 1 FFI regardless of whether it provides a GIIN.
Effect of IGAs
In many cases where an IGA has been signed, it is anticipated that implementing legislation by the partner jurisdiction will not have been enacted by the date on which FATCA withholding and other obligations will take effect (even taking into account the delayed effective dates in the Notice). As a result, the Notice provides that a jurisdiction with which Treasury has signed an IGA nevertheless will be treated as having an IGA in effect if it is listed on the Treasury website: http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx. An FFI resident (or a branch of an FFI) in a jurisdiction that is treated as having an IGA in effect will be permitted to register on the Portal as a Registered Deemed-Compliant FFI (if it is a Reporting Model 1 FFI) or a Participating FFI (if it is a Reporting Model 2 FFI). A jurisdiction may be removed from the list, however, if it fails to take the steps necessary to bring the IGA into force within a reasonable period of time, in which case an FFI in that jurisdiction would no longer be entitled to the treatment afforded by that IGA.
Other (Due Date for First Report by a Participant FFI, Withholding Certificates, Foreign Targeted Obligations)
The Notice states that Treasury and the IRS intend to modify the Regulations to provide that a Participating FFI will be required to file information reports regarding its U.S. account holders no later than March 31, 2015 for the 2014 year only (and not 2013 and 2014 as currently required). For FFIs in partner jurisdictions, this change also will apply through operation of the provision that allows the FFI to rely on provisions in the Regulations or through the MFN clause.
Withholding certificates and documentary evidence provided by a foreign person for Chapter 3 withholding purposes generally expire at the end of the third calendar year following the year in which they were provided. In light of the delay in the effective dates (and hence the time when new withholding certificates and/or documentary evidence may need to be obtained for FATCA purposes), the Notice provides that withholding certificates and documentary evidence, as well as qualified intermediary, withholding partnership and withholding trust agreements, that otherwise would expire on December 31, 2013, will expire instead on June 30, 2014. In addition, the Notice extends from January 1, 2014 until July 1, 2014, the transition rule in Notice 2012-20 that permits a withholding agent to rely on certain prior rules regarding documentation of the foreign status of a payee for purposes of the portfolio interest exemption.