The IRS Issues Final FATCA Regulations

Keywords: IRS, FATCA, final regulations

On January 17, 2013, the Internal Revenue Service (IRS) released 544 pages of final regulations implementing the provisions of the Foreign Account Tax Compliance Act (FATCA). The FATCA provisions of the Internal Revenue Code require non-U.S. financial institutions and investment entities to conduct due diligence on their account holders, broadly defined, and report on U.S. persons who hold accounts with such companies to the IRS. The final regulations differ dramatically from the proposed regulations issued in February 2012.

1. A BRIEF BACKGROUND FOR THE NEWLY-INITIATED

   The FATCA rules were added to the Internal Revenue Code of 1986, as amended (the "Code") in March 2010 by the Hiring Incentives to Restore Employment Act of 2010.1 These provisions, contained in Code §§ 1471 through 1474, contain an extraordinary set of penalty tax rules on foreign financial institutions (FFIs) that do not (i) conduct due diligence on their account holders, equity holders and debt holders to ferret out U.S. persons that are holding assets outside of the United States and (ii) disclose the identity of such persons to the IRS.2 Specifically, if the FFI does not comply with the FATCA rules, then "withholdable payments" to it for its own account and on behalf of its customers are subject to U.S. federal income tax withholding.3 Withholdable payments include items of U.S.- source income, such as interest and dividends, as well as gross proceeds "from the disposition of any property of a type which produce interest or dividends from sources within the United States."4 If the payment is made for the account of a non-participating FFI, "no credit or refund shall be allowed or paid with respect to such tax."5 In other words, if an FFI does not comply with the FATCA rules, it will be subjected to gross proceeds withholding on its U.S.-source income and will not be able to recover the withheld amounts.

   Code § 1471(b) contains the six requirements that must be met in order for an FFI to be considered to be in compliance with the FATCA rules:

   The FFI must obtain the information necessary to determine if it has "United States accounts." The FFI must comply with IRS-specified due diligence and verification requirements with respect to U.S. accounts. The FFI must annually report IRS-specified information to the IRS on its U.S. accounts. The FFI must withhold on U.S.-source payments made to recalcitrant account holders6 and non-compliant FFIs and withhold on payments to other FFIs who have elected not to withhold on their own recalcitrant account holders. The FFI must comply with IRS requests for additional information. The FFI must attempt to obtain a waiver of any foreign law that would prevent the transmission of the information sought by the IRS to the IRS on the FFI's accounts and, if such waiver cannot be obtained, to close the affected accounts. Prior to the release of the final FATCA regulations, the IRS has released proposed regulations,7 and four public administrative releases: (i) Notice 2010-60,8 (ii) Notice 2011- 34,9 (iii) Notice 2011-5310 and (iv) Announcement 2012-42.11 Notice 2010-60 delineated when certain foreign entities would be treated as FFIs and prescribed certain due diligence rules that FFIs would be required to complete in order to satisfy their due diligence requirements on account holders. Notice 2011- 34 modified and expanded such due diligence requirements and provided guidance on the passthru payment rules. Notice 2011-53 extended the period of time that FFIs would have before FATCA withholding requirements became effective. Announcement 2012-42 revised the timeline for FATCA compliance and presaged certain changes to such timeline that are now contained in the final FATCA regulations. II. FATCA DEADLINES, EFFECTIVE DATES AND GRANDFATHERING RULES

   The effective dates for FATCA compliance have been a moving target because the IRS revised such timeline on several occasions to reflect comments from affected persons about the scope of the actions required by a particular date. In addition, the timeline for due diligence and reporting for FFIs subject to Intergovernmental Agreements (IGAs) did not appear to be coordinated with the timeline for such responsibilities for FFIs governed by the FATCA provisions contained in the Code.

   1. PFFI Reporting for 2013. FFIs that elect to comply with the FATCA due diligence and withholding regime (referred to as "Participating FFIs" or PFFIs) must enter into an FFI Agreement with the IRS. The final FATCA regulations delay the effective date for all pre-2014 FFI Agreements until December 31, 2013. This change aligns the effective date of, and due diligence periods under, the FFI agreement with the timelines provided under the IGAs.

      A PFFI must report on all accounts that are identified and documented as U.S. accounts or accounts held by owner-documented FFIs as of December 31, 2014, (or as of the date an account is closed if the account is closed prior to December 31, 2014) if such account was outstanding on December 31, 2013. The final regulations incorporate the reporting requirements in Announcement 2012-42 with respect to calendar year 2013. The reporting for U.S. accounts that are maintained by a PFFI during 2013 is made under streamlined reporting rules. The final regulations also move back the reporting 2013 accounts from September 30, 2014 to March 31, 2015.

   2. CIV and Restricted Fund Grandfathering. For FATCA purposes, collective investment vehicles (CIVs) include investment entities that are registered as such or whose managers are regulated as a manager in the country in which the investment fund is registered.12 A Restricted Fund is an investment entity regulated in a country which is compliant with the Financial Action Task Force (FATF) anti-money laundering policies. 13 CIVs and Restricted Funds can qualify as "deemed compliant FFIs." A deemed compliant FFI is automatically considered to meet the 6 requirements specified above to be FATCA compliant.14 The final regulations permit qualified CIVs and Restricted Funds to have outstanding bearer obligations that were issued prior to January 1, 2013, if the qualified CIV or Restricted Fund identifies the status of the holder prior to payment, no shares are issued in bearer form, including reissuances of surrendered shares, after December 31, 2012, and certain other conditions are met. All bearer instruments must be "immobilized" or redeemed prior to January 1, 2017.15

   3. Restricted Fund Distribution Agreements. In order for a Restricted Fund to qualify as a deemed compliant FFI, interests in the Fund must not be sold to specified U.S. persons, non-participating FFIs (NPFFIs) or passive NFFEs with one or more substantial U.S. owners.16 The IRS, in recognition that renegotiation of distribution agreements will take a substantial amount of time, provided investment funds until the later of June 30, 2014, or six months after the date the investment fund registers with the IRS as a registered deemed-compliant FFI to renegotiate its debt and equity interest distribution agreements to comply with this rule. The Treasury Department and the IRS also modified the sales restrictions to restrict sales only to specified U.S. persons, rather than all U.S. persons as was provided in the proposed regulations.

   4. FATCA Withholding Generally. Subject to the exception for preexisting accounts, the final regulations provide that withholding agents can be required to withhold on payments to nonfinancial foreign entities (NFFEs) only with respect to payments made after December 31, 2013.17 Similarly, except as otherwise provided in a Model 2 IGA, a PFFI is required to deduct and withhold a tax equal to 30% of any withholdable payment made to an account held by a recalcitrant account holder or to a NPFFI after December 31, 2013.18 In addition, withholding agents are not required to withhold on payments made before January 1, 2015, with respect to a "preexisting obligation" to a payee that is not a prima facie FFI and for which a withholding agent does not have documentation indicating the payee's status as a passive NFFE with one or more substantial U.S. owners.19 Importantly, the definition of pre-existing account has been amended by the final regulations to include "any account, instrument, contract, debt or equity interest . . . outstanding on December 31, 2013.20

      The final FATCA regulations provide special rules that permit Model 1 IGA FFIs to provide certain information to a withholding agent to confirm their status and avoid FATCA withholding tax.

   5. Prima Facie FFI Withholding. Prima facie FFIs include banks, brokerages, securities and commodities dealers and asset-backed securities.21 If the payee is a prima facie FFI, the withholding agent must treat the payee as a NPFFI beginning on July 1, 2014 and begin withholding on payments, until the date the withholding agent obtains documentation sufficient to establish a different FATCA status of the payee.

   6. Preexisting Accounts. For any withholdable payment made prior to January 1, 2016, with respect to a preexisting obligation held by an FFI for which a withholding agent does not have documentation indicating the payee's status as a NPFFI, the withholding agent is not required to withhold unless the payee is a prima facie FFI.22 A preexisting obligation is a financial instrument that was held in account with the withholding agent on December 31, 2013. In addition, the final regulations allow participating FFIs and withholding agents until December 31, 2015, to document account holders and payees that are not prima facie FFIs.

      In contrast to the rule for FFIs, withholding agents are not required to withhold on payments made before January 1, 2015 to a passive NFFE, with respect to a preexisting obligation and for which a withholding agent does not have documentation indicating the payee's status as a passive NFFE with one or more substantial...