On March 28, 2010, President Obama signed the Foreign Account Tax Compliance Act ("FATCA") into law (sections 1471 through 1474 of the Internal Revenue Code), which became part of the Hiring Incentives to Restore Employment Act. FATCA was enacted to combat tax evasion by U.S. persons holding investments in offshore accounts. The Joint Committee on Taxation estimates that FATCA will prevent the evasion of nearly $9 billion in tax over the next ten years.
FATCA looks to prevent offshore tax abuses by U.S. persons by increasing the IRS' ability to monitor tax evasion by U.S. persons who use foreign financial institution ("FFI")1 or foreign non-financial entities to shield their identities and U.S. tax status from the U.S. government. It imposes significant due diligence, information reporting and control burdens on non-U.S. financial intermediaries and investment entities. FATCA requires a 30% withholding tax on any "withholdable payment"2 made either to a FFI or to a foreign non-financial entity if the FFI or non-financial entity fails to comply with new reporting, disclosure, and related requirements. Subject to some exceptions, FATCA is effective with respect to payments made on or after January 1, 2013.
The 30% withholding tax on any withholdable payment made to a FFI can be avoided if the FFI enters into an agreement with the IRS to: (1) obtain information from each account holder as is necessary to determine which accounts are "U.S. accounts," as defined by FATCA; (2) comply with due diligence procedures with respect to the identification of U.S. accounts; (3) report annually certain information related to any U.S. account maintained by such institution; (4) deduct and withhold 30% on certain passthru payments made to the benefit of an account holder that is unwilling to provide the required information; (5) comply with requests by the Secretary of the Treasury for additional information with respect to any U.S. account maintained by such institution; and (6) attempt to obtain a waiver in any case in which any foreign law would prevent reporting of information under the provision related to any U.S. account maintained by such institution and, if a waiver is not obtained, to close the account. FFIs that do not enter into an agreement with the IRS will be subject to withholding on certain types of payments. A FFI must enter an agreement with the IRS by June 30, 2013 to ensure sufficient time to be identified as a participating FFI prior to January 1, 2014, which is when some withholding is set to begin.
The Timetable
The Treasury Department of the Internal Revenue Service ("Treasury") has issued guidance on phasing in FATCA's significant requirements. The phase-in schedule allows U.S. withholding agents adequate time to build the internal systems needed to fully comply with FATCA's requirements. Withholding on U.S. source dividends and interest paid to non-participating FFIs will begin on January 1, 2014 and withholding on all withholdable payments (including gross proceeds) will be fully phased in on January 1, 2015. Due diligence requirements for identifying new and pre-existing U.S. accounts will begin in 2013. Reporting requirements will begin in 2014.
Reporting Requirements of U.S. Taxpayers with Foreign Investments
FATCA requires reporting requirements of both a FFI as well as U.S. taxpayers with foreign investments. FATCA requires certain U.S. taxpayers holding foreign financial assets with an aggregate value exceeding $50,000 to report certain information about those assets in the taxpayer's annual tax return. Reporting applies for assets held in taxable years ending March 31, 2011 or later. Failure to report foreign financial assets will result in a penalty of $10,000 (and a penalty up to $50,000 for continued failure after IRS notification). Further, underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40%.
Compliance
With the imposition of a 30% withholding tax on withholdable payments, most FFIs will attempt to comply with the provisions and avoid being withheld upon by entering into an agreement with the Treasury to report U.S. persons who are account holders. Rather than engaging in audit procedures, the FFI's chief compliance officer will certify that the FFI has entered into an agreement with the Treasury and has accomplished the required due diligence review. Further, the FFI's chief compliance officer must certify that the FFI personnel did not, in any way, assist, direct or encourage account holders to avoid identification of their accounts as U.S. accounts. Lastly, the chief compliance officer is required to certify that as of the FFI Agreement's effective date, the FFI had written policies and procedures in place that prohibit its employees from advising U.S. account holders on how to avoid having their U.S. accounts identified.
Certain categories of FFIs will be deemed compliant with FATCA's rules. Unless provided otherwise, a deemed-compliant FFI will be required to apply for such status with the IRS, obtain an identification number, and certify every three years that it meets the requirements for such status. However, the safe harbor may be of limited use because of the specific requirements to qualify for same, unless the bank is truly local. The Treasury and the IRS are continuing to consider whether other investment vehicles could be considered deemed complaint. Further guidance is expected on this.
What's Next
By all accounts, the implementation of FATCA is a major undertaking for financial institutions. Financial intuitions are encouraged to begin assessing needs and associated costs of compliance so that they are prepared to comply with FATCA's new withholding and reporting regime as the effective dates draw near.
The IRS has periodically released further guidance regarding the implementation of FATCA in response to comments from bar associations, trade associations, and other financial institution interest groups. The IRS anticipates publishing proposed regulations by December 31, 2011, and final regulations in the summer of 2012. In addition, draft FATCA reporting forms will be published in conjunction with the proposed guidance and final forms are expected to be published for use in the summer of 2012.
If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact any of the members of the Practice Area.
1FFIs include any foreign entity that (1) accepts deposits in the ordinary course of a banking or similar business; (2) holds financial assets for the account of others; or (3) invests or trades securities, interest in partnerships, commodities or any interest in such securities, partnership interest or commodities. Under this broad definition, entities which are ordinarily not considered financial institutions are included in the definition (e.g., hedge funds, private equity funds and certain insurance products).
2"Withholdable payment" is defined as a payment of U.S. source interest (including original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments, and other fixed, determinable, annual or periodical type income.