August 30, 2010

TO: Distribution

FROM: Burt, Staples and Maner, LLP

RE: First Round of FATCA Guidance Published by IRS

On Friday, August 27, the IRS published Notice 2010-60 (“Notice”), the first round of guidance under the Foreign Account Tax Compliance Act (“FATCA”) provisions enacted in March 2010. The Notice likely will disappoint those who expected this initial guidance to dramatically scale back the scope and complexity of the FATCA statute. In addition, the Notice leaves open many questions presented by the statute and instead asks for comments on them and also introduces a number of new questions regarding the guidance contained in the Notice. Still, the Notice is significant because it provides a first glimpse of the compliance architecture that the IRS envisions for FATCA.

We provide below a high-level summary of the key provisions of the 62-page Notice. The summary is no substitute for reading the Notice in its entirety, but we hope that you will find it helpful.

• Documentation of Accounts by Participating Foreign Financial Institutions (“FFIs”). FFIs that enter into an agreement with the IRS (“participating FFIs”) must identify “United States accounts” and provide the IRS information about the owners of those accounts. The IRS expects to set up different rules for pre-existing and post-FFI agreement accounts and the rules for accounts held by individuals are subject to different rules than accounts held by entities. The value of the easier electronic search procedures proposed for pre-existing individual accounts is significantly undercut, however, because those accounts generally must be documented like post-FATCA accounts within 5 years. On the other hand, non-U.S. entities that have active non-financial businesses would be exempt from FATCA, which is welcome news.
  
  • Pre-Existing Accounts. These are accounts in existence on the effective date of the FFI’s agreement with the IRS (“Effective Date”).
    • Individual Accounts. Each account is tested against a series of filters. If the sum of an individual account holder’s average balances (typically as measured at the end of a month or quarter) are less than $50,000 in the calendar year preceding the Effective Date, the accounts can be excluded from FATCA. Otherwise, if the FFI treats the account as a U.S. account for other U.S. tax purposes, the account must be treated as a U.S. account. All other individual account holders are subject to a search of the FFIs electronic records. If that search reveals any indicia of U.S. status (e.g., residence, citizenship, address) then, depending on the type of indicia found, the FFI is required to request within one year of its Effective Date a Form W-9 or other documentation (including, in some cases, non-U.S. passports) to establish the status of the account, and must actually obtain the documentation within one year of the request, or treat the account as subject to FATCA withholding. Moreover, individual accounts not treated as U.S. accounts under the steps described above, and that had an average balance exceeding $1,000,000 in the year before the FFI entered into its agreement with the IRS, must be documented under the procedures for post-Effective Date accounts within two years of the Effective Date, and all other accounts must be so documented within five years.
      
    • Entity Accounts. The participating FFI must determine whether the account is a U.S. account or held by another participating FFI, a “deemed-compliant” FFI, an entity exempt from FATCA, a non-participating FFI, a “recalcitrant” account holder, an excepted non-financial foreign entity (“NFFE”), or another NFFE.
      • U.S. Entities. The FFI must determine whether a U.S. entity account holder is a specified U.S. person that must be disclosed to the IRS. If the FFI treats the account as a U.S. account for other U.S. tax purposes, the account holder will be given an opportunity to show that it is a publicly traded corporation or another type of entity that is not a specified U.S. person; if the entity fails to do so within a year of the Effective Date, it should be treated as a specified U.S. person. An FFI will be required to search its electronic records for entities that have indications of U.S. status, and within a year after the Effective Date, the FFI must request that such entities provide proof that they are not specified U.S. persons. Such entities would be treated as specified U.S. persons if they fail to comply within a year after the request.
      • Non-U.S. Entities.
        • Other FFIs. If the name or electronically searchable information clearly indicates that the account holder is another FFI, the account holder may be tentatively categorized as an FFI but the withholding agent must request its special U.S. tax identification number (“FFI EIN”) and certification of FFI status. If the entity does not provide the FFI EIN and certification within nine months of the Effective Date, the participating FFI must request documentation of the account holder’s status for FATCA purposes within the next three months. For up to a year, until the response is received, the FFI may treat the account holder as exempt from FATCA withholding and disclosure unless the IRS identifies the entity as a non-participating FFI on a published list. After the year is up, the entity would be treated as a non-participating FFI if it fails to provide documentation to the contrary.
        • NFFEs. For entities not categorized as U.S. entities or tentative FFIs, a participating FFI could consult its account records (and, if the IRS so decides, third-party credit databases) to determine if the entity has an active non-financial business. If so, the entity would be treated as exempt from FATCA withholding and disclosure. Other entities will be “permitted” to document their status under FATCA, and the participating FFI may rely on its own records for this purpose. If the participating FFI is unable to establish the account holder’s status, it must request documentation within a year of the Effective Date, and the entity has one year to respond. If it fails to do so, the entity would be treated as a non-participating FFI. If the documentation indicates that the entity is an NFFE, the participating FFI would request information regarding the entity’s direct and indirect owners who are specified U.S. persons. If such information is not forthcoming within two years after the Effective Date, the account holder must be treated as “recalcitrant,” and therefore subject to FATCA withholding.
  • Post-Effective Date Accounts.
    • Individuals Accounts. The first two steps are the same as for existing accounts. If the sum of an individual account holder’s average month-end balances are less than $50,000 in the calendar year preceding the Effective Date, the accounts can be excluded from FATCA. If the FFI treats the account as a U.S. account for other U.S. tax purposes, the account must be treated as a U.S. account. However, if the account is not addressed by these steps, the FFI must obtain “documentary evidence” establishing U.S. or non-U.S. status, and any U.S. account holders must be documented with a Form W-9. The records for any account not already treated as a U.S. account must then be examined for indicia of U.S. status. In the absence of such indicia, the account is considered a non-U.S. account. If such indicia are present, however, then, depending on the type of indicia found, the FFI is required to request a Form W-9 or other tax documentation (including, in some cases, non-U.S. passports) to establish the status of the account. If the participating FFI knows or has reason to know that the status of the circumstances have changed in such a way as to change whether the account is a U.S. account, it must repeat the search for U.S. indicia and, if necessary, request documentation to establish the status of the account.
    • Entity Accounts. The procedures for new accounts are expected to be similar to those for pre-existing accounts, except that the FFI would have to examine all information in its possession, regardless of whether it is electronically searchable, including documentation collected to comply with anti-money laundering, know-your-customer, and other regulatory rules.
• Documentation of Accounts by U.S. Financial Institutions (“USFIs”). A USFI will be required to determine whether entity account holders are U.S. or non-U.S., and if non-U.S., which category they fall into. First, a USFI would filter out any entity it treats as a U.S. person for tax reporting purposes. Then, it would categorize the remaining entities for FATCA purposes under procedures similar to those described above for participating FFIs dealing with non-U.S. entity accounts. Certain deadlines would change. Tentative FFIs would have until December 31, 2013, to provide an FFI EIN and certification, and entity account holders would have until December 31, 2014, to provide other proof of exempt status (e.g., as an NFFE with an active trade or business).
• Definition of Financial Institution. The statute provides for three categories of financial institution – (A) those that accept deposits in the ordinary course of a banking or similar business, (B) those that hold financial assets for the account of others as a substantial portion of its business, and (C) those engaged (or holding themselves out as being engaged) primarily in the business of investing, reinvesting, or trading in securities. The Notice deals with the first two categories in a straightforward way, but notes that being regulated as a bank or broker is a relevant, but not necessarily determinative, factor. Category (C) is likely to be the most controversial. The regulations are anticipated to provide that the determination would be made on a facts-and-circumstances basis, and the Notice states that additional guidance would be forthcoming. The Notice says that the “business” of investing would include firms which may not be considered in the “trade or business” of investing for other purposes of the Internal Revenue Code; for example, isolated transactions that might not give rise to a trade or business may nonetheless cause the entity to be considered a financial institution under FATCA.
• Family Trusts and Other Small Entities. Entities that otherwise would be Category (C) financial institutions, but have only a few account holders or owners all of whom are individuals or excepted NFFEs (“small FFIs”), would be treated as deemed-compliant FFIs. It is unclear exactly which FFIs will be covered by this concept since the Notice does not provide a definition or rule regarding which entities are “small.” However, in concept, small FFIs are given essentially the same treatment as NFFEs. The entity qualifies for deemed-compliant FFI status if the withholding agent (i) specifically identifies each individual, specified U.S. person, or excepted NFFE that has an interest in such entity, either directly or through ownership in one or more other entities, (ii) obtains from each such person the documentation that the withholding agent otherwise would be required to obtain if such person were a new account holder or direct payee of the withholding agent, and (iii) the withholding agent reports to the IRS any specified U.S. person identified as a direct or indirect interest holder in the entity. The IRS requested comments whether small FFIs should simply be treated as NFFEs.
• Collective Investment Vehicles (“CIVs”). There had been great hope that the Notice would exclude some or all CIVs from FATCA on the basis that they present a low risk of U.S. tax evasion potential. Instead, the IRS requested additional comments regarding the laws and practices under which non-U.S. CIVs prohibit ownership by U.S. persons. The Notice implies that the IRS may ultimately determine such vehicles to be deemed-compliant FFIs that do not need a formal FFI agreement with the IRS, at least under some circumstances. The Notice also implies that such deemed-compliant FFIs would need to be subject to some sort of verification procedure to ensure that they indeed exclude U.S. persons as a matter of course.
• Possible Elimination of Withholding on Individual Recalcitrant Account Holders. The IRS and Treasury requested comments regarding whether an FFI should be relieved of its obligation to withhold on individual recalcitrant account holders if it provides sufficient information to permit the IRS to “obtain information about the identities of those recalcitrant account holders through an information exchange request to a foreign jurisdiction.”
• U.S. Branches of FFIs. U.S. branches will be considered FFIs and will be subject to withholding on payments other than income effectively connected with their U.S. trades or businesses (“ECI”) if they do not comply with the FFI rules. However, the IRS is considering allowing U.S. branches to elect to be treated as USFIs with respect to payments for which they act as intermediaries. Also, a payment to a U.S. branch will not be presumed to be ECI, unlike the current withholding rules under chapter 3 for bank and insurance company branches.
• Controlled Foreign Corporation (“CFC”) FFIs. The IRS will not exempt CFCs from the FFI regime because their current information reporting requirements are “less stringent” than those that will be imposed on FFIs. That is, unlike FATCA, the Form 1099 reporting requirements for CFCs do not: (1) apply to payments made to certain U.S. entities; (2) apply to the substantial U.S. owners of non-U.S. entities; and (3) require the CFC to obtain waivers from U.S. account holders in bank secrecy or privacy jurisdictions or disinvest such account holders if they fail to provide the waiver. However, there will be coordination with a CFC’s current Form 1099 obligations to avoid duplicative reporting.
• Carve-outs from FFI Status. The following types of entities will not be considered FFIs. They will be considered NFFEs instead, but the Notice states that these entities also will be exempted from NFFE withholding under IRC § 1472.
  • Holding companies for non-financial enterprises.
  • Start-up companies (other than financial institutions) during their first 24 months of existence.
  • Liquidating non-financial entities.
  • Non-financial entities emerging from a reorganization or bankruptcy.
  • Hedging/financing centers within non-financial corporate groups.
  • Insurance companies that do not issue cash-value insurance or annuities.
• Non-U.S. Retirement Plans. The IRS intends to recognize that certain non-U.S. retirement plans, although technically “financial institutions,” pose a low risk of evasion and therefore should be exempt from FATCA withholding. A retirement plan would be entitled to this treatment if it qualifies as a retirement plan under local law, is sponsored by a non-U.S. employer, and does not allow U.S. participants or beneficiaries other than employees who worked in the country where the plan is established. The IRS requested additional comments on this approach.
• U.S. Territory Organized Financial Institutions. “Territory-organized” financial institutions (which are not treated as FFIs under FATCA) will be able to assume FATCA withholding obligations and receive payments on behalf of customers free of FATCA withholding by making written representations to the withholding agent that they have taken on these obligations. Category (C) financial institutions organized in a territory may be treated as NFFEs for payments they received for their own accounts. Such entities, if wholly owned by bona fide residents of the same territory, would be exempt from NFFE withholding under IRC § 1472. The IRS intends to discuss information exchange issues with territorial governments to help identify account holders that are specified U.S. persons.
• Annual Report. The IRS will create a new form for the annual reporting of information about U.S. account holders required by FATCA and expects to require electronic filing of the form. The account balance/value to be reported would be the highest balance used to report to the customer during the year (e.g., the highest monthly statement balance). The IRS would be entitled to ask for account statements and other records. Where the “account” is actually an interest in an entity, the value would be the highest of the values used for other purposes (e.g., to compensate an investment manager). The values to be reported on the form must be in U.S. dollars and future guidance will provide currency translation rules. The IRS requested comments on how to minimize the burden of reporting of gross receipts and withdrawals.
• Duplicative Reporting. The Notice anticipates that the FFI with the most direct account relationship with a beneficial owner will be required to report the account and other FFIs will be relieved of this obligation. For example, an interest in an investment fund typically would be considered an “account” under FATCA, and that interest might be custodied at a participating FFI who is a broker. The IRS anticipates that only the broker, and not the fund, would be required to report to the IRS, since the broker has the most direct relationship with the customer.
• Grandfathered Obligations. FATCA provides that its withholding provisions do not apply to “obligations” outstanding on March 18, 2012. The Notice states that the regulations will provide that an “obligation” includes any legal agreement that could result in withholdable payments (e.g., interest or royalties), other than equity interests or agreements that do not have a definite expiration date or term. Contrary to some hopeful expectations in the financial industry, deposit accounts and custodial accounts are not treated as “obligations” and are not subject to grandfathering relief. Also, if the obligation is debt that is treated as exchanged for new debt after March 18, 2012, under the “significant modification” rules of section 1001, it will no longer be exempt from FATCA withholding. A facts-and-circumstances test will apply to modifications of other obligations.
• Requests for Comments. The Notice requests comments regarding at least 20 different topics under FATCA, many of which have raised significant concerns in the financial community since the March enactment of FATCA. In addition to those mentioned above, these topics include:
  • Audit and verification procedures for FFIs.
  • How to determine whether a payment is “attributable to” a withholdable payment, and therefore a “pass thru payment” subject to FATCA withholding.
  • The types of accounts an FFI’s election to be withheld upon should cover, and whether the FFI should be allowed to elect different treatment for different types of accounts.
  • How to address long-term recalcitrant account holders.
  • Application of FATCA to US withholding agents that are not USFIs, such as U.S. multinationals and others who may make withholdable payments to non-U.S. persons.

We hope that you find the above summary useful. It is important to stress that the Notice is only the first tranche of guidance that Treasury and the IRS have promised to release over the period leading up to the 2013 effective date of the FATCA statute. Both financial institutions and non-financial U.S. companies should monitor these FATCA developments carefully and consider what steps may be useful to take at this point to stay on track to being compliant on a timely basis.

For more information about FATCA, please visit the FATCA section of our website at http://bsmlegal.com/fatca.asp