What is FATCA?
1. What is FATCA and when will it be introduced?
FATCA, or to give its full title, the Foreign Account Tax Compliance Act is legislation enacted in March this year by the US Government. The purpose of the rules is relatively straightforward - to stop US investors from evading US tax by using foreign subsidiaries or foreign financial institutions to invest back into the US. At that level, the rules sound relatively benign. The issue is, however, in the method adopted to achieve that aim. FATCA requires that a 30% withholding tax is applied to certain US sourced payments made to non US persons unless those persons agree to enter into agreements with the US Internal Revenue Service (“IRS”). Under those agreements, the party will be required to meet a series of obligations which includes identifying US persons of interest to the IRS, reporting information on those persons to the IRS and withholding a 30% tax on any US sourced payments (“pass through payments”) it on pays to non compliant persons or recalcitrant account holders.
While FATCA applies from 1 January 2013 we believe it is important for businesses to start assessing its impact as soon as possible. In this article we endeavor to bring to your attention the key points on FATCA in the form of Questions and Answers. Given the breadth of the new rules we did not attempt to provide a comprehensive summary and would like to encourage you to speak to a Tax expert and Wealth Manager at Tower of London Worldwide in relation to specific issues.
2. Don’t these rules really only apply to Banks?
No. The rules apply to differing degrees to “foreign financial institutions” (“FFIs”) and “non-financial foreign entities” (“NFFEs”). The most significant impacts, are, however, for FFIs. Please refer to our comments in question 6 in relation to NFFEs.
3. Who is an FFI?
An FFI includes any non US entity that:
- Accepts deposits in the ordinary course of its business; or
- Holds financial assets for the account of others as a substantial part of its business; or
- Is engaged primarily in the business of investing, reinvesting or trading in securities, commodities, partnerships or any interest in such.
- The breadth of this definition is obviously wider than Banks, and would in the first instance include the likes of brokers, custodians, insurance companies, investment funds and superannuation schemes. In relation to insurance companies, US Treasury and the IRS plan to issue regulations treating entities whose business consists solely of issuing insurance or reinsurance contracts without cash value as non-FFIs. These would include, for example, most property and casualty insurance or reinsurance contracts or term life insurance contracts. No comparable exemption is provided for issuers of life insurance or annuity contracts with an investment component, although comments on the treatment and definition of such contracts are requested.
Exemptions are also expected to apply in relation to foreign employer sponsored retirement plans (who would otherwise be an FFI) that have no US participants or beneficiaries other than those employed by the foreign employer in the country in which the retirement plan was established. It is unclear whether this exemption is intended to apply to multi-employer schemes.
Further exemptions are proposed from the definition of an FFI for:
- Holding companies for subsidiaries primarily engaged in a trade or business other than providing financial services.
- Hedging and financial centers of a non-financial group
- Start-up companies who intend to operate a non-financial institution business.
- Non-financial entities in liquidation or emerging from reorganisation or bankruptcy.
The need for these later exemptions from the definition of an FFI demonstrates the breadth of the FFI definition.
4. What does an FFI have to do?
In order to avoid the 30% withholding tax, the FFI will be required to enter into an agreement with the IRS under which it agrees to:
- Obtain information to determine whether it has US account holders;
- Comply with verification and due diligence procedures on such accounts as required by the IRS;
- Report information on US account holders to the IRS, including the account balance, contributions into and withdrawals from the account;
- Deduct 30% withholding tax on payments to recalcitrant account holders (essentially those who will not provide the information required to meet the IRS’s verification standards), non compliant NFFEs, and non compliant FFIs (as well as FFIs who elect for the tax to be deducted);
- Comply with requests from the IRS for any additional information;
- Where foreign law would prevent reporting obtain a waiver from the customer. If this is unable to be done, then the account should be closed.
- The rules will no doubt create numerous levels of reporting by FFIs holding accounts with other FFIs. It is expected that only the FFI that has the more direct relationship with the investor or customer will be required to report the information to the IRS.
5. Who is a US account holder?
A US account holder can be one or more specified US persons or US owned entities. The twist is, however, that the FFI has to be able to prove that an account holder is not a US person or a US owned entity (although an FFI can generally rely on documentation provided to it by a customer, provided they do not have reason to know it is unreliable or incorrect).
There are broadly two types of US persons that must be identified:
- US persons or entities in their own right;
- Entities which have one or more substantial US owners.
A substantial US owner includes:
- with respect to a company, a person who directly or indirectly owns more than 10% of the corporation;
- with respect to a partnership, a person who directly or indirectly owns more than 10% of the profits or capital of the partnership;
- with respect to a Trust any person who holds directly or indirectly more than 10% of the beneficial interest of the trust.
6. How do the rules apply to NFFEs?
NFFEs, will be required to provide information about their “substantial US owner” to avoid the withholding tax impost. NFFEs that have no substantial US owners (10% or less) will need to certify this to withholding agents. In relation to substantial US owners, the NFFE will need to provide to the agent their names, addresses and US tax numbers.
There are exemptions for NFFEs from these rules. Notably, a company whose shares are regularly traded on an established securities market, foreign Governments (including a wholly owned agency or instrument of Government), foreign central banks and any other class of persons exempted by the US Secretary of the Treasury are exempted from the rules (but presumably at a practical level they will need to be able to prove this exemption to the payee to avoid the withholding tax impost).
7. What does the withholding tax apply to?
The ambit of the withholding tax is significantly wider than traditional withholding taxes, which typically only apply to interest, dividend and royalties etc. Payments subject to withholding include payments sourced from the US which are interest, dividends, rents, salaries, wages, premiums, annuities. It also applies to any gross proceeds from the disposal of any property which could produce interest or dividends from sources within the US.
8. Isn’t the withholding tax limited by the Double Tax Agreement (“DTA”)?
No. The legislation applies notwithstanding any DTA. If the DTA limits the taxing right, then persons who have suffered a withholding on income subject to DTA relief will need to claim a refund from the IRS.
9. What if I don’t have US sourced receipts?
Firstly check your assumption that you do not have any US sourced receipts. While you may not have a direct exposure to the US, your investment into say, another FFI, may then be into the US. For example, take the case of an investment in a global bond fund. The FFI in which you have invested (the bond fund) will be an FFI investing into the US. It will need to comply with the FATCA rules or risk losing 30% of its principal and interest. When it comes to pass that US sourced income, for example, onto another FFI it will be obliged to withhold 30% unless that FFI has also signed up to be a participating FFI.
Finally, even if an FFI does not benefit from US payments it may be pulled into the regime because other FFIs may not want to deal with a non-compliant entity.
10. Where to from here?
FFIs investing in the US will need to prepare themselves before the new rules start to apply. It is expected that financial institutions would need to make an assessment of whether it is worth becoming a participating FFI against the costs of not becoming one. Those becoming one will need to start building capabilities and systems behind the compliance that comes with the status. They would need to be able to identify the residency of the customers based on the required documentation, classify them into the FATCA categories, and be able to report their financial information to the IRS. They will be required to withhold US tax on non-compliant accounts. Legal ramifications such as information disclosure waivers and changes to documentation will also need to be considered.
NFFEs that have US sourced income will need to be prepared to advise the US withholding agent whether they have any US owners and their status, i.e. under or above 10%, listed or non-listed and provide information in relation to the non-listed substantial owners.
Finally, the rules are far from being fully developed regarding FATCA and we recommend that you consult with one of our global experts and also refer to the above 'FATCA timeline' to ensure you our fully compliant and aware of the progress of FATCA.