Foreign Account Tax Compliance: Witholding and Information Reporting Requirements on 'Withholdable Payments' to Foreign Entities

The Hiring Incentives to Restore Employment Act (the "HIRE Act"), signed into law this past March, includes certain foreign account tax compliance provisions designed to combat offshore tax evasion through increased tax withholding and information reporting obligations with respect to "withholdable payments" made to certain foreign entities (the "FATC Provisions"). The FATC Provisions also require certain foreign financial institutions (broadly defined, as discussed below, to include virtually all offshore investment funds) to disclosure significant information to the Internal Revenue Service (the "IRS") regarding their United States ("U.S.") investors. Although the FATC Provisions discussed herein generally apply only to payments made after December 31, 2012, taxpayers and commentators have raised numerous questions regarding the application and potential impact of these provisions. This Tax Alert summarizes these provisions.

General

The FATC Provisions are set forth in new Sections 1471 through 1474 of the Internal Revenue Code of 1986, as amended (the "Code"), and generally impose a 30 percent withholding tax on any "withholdable payment" made to foreign entities unless certain requirements are satisfied. Like other withholding taxes, withholding agents failing to withhold any tax required pursuant to these new rules are liable for the tax.

For purposes of these rules, a "withholdable payment" generally is defined as (i) any payment of interest (including original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments and other fixed or determinable annual or periodical gains, profits and income, if such payment is from U.S. sources, and (ii) the gross proceeds from the sale or disposition of property of a type, which can produce U.S. source interest or dividends (i.e., debt securities and shares of stock of U.S. issuers), but does not include any item of income that is effectively connected to a U.S. trade or business.

The new requirements distinguish between payments made to a "foreign financial institution" (an "FFI") and payments made to a "non-financial foreign entity" (an "FE"). As described further below, 30 percent withholding generally is imposed on a withholdable payment to (i) an FFI unless the FFI enters into an agreement with the IRS to identify and report significant information with respect to the FFI's "United States accounts," and (ii) an FE, unless the FE identifies its substantial U.S. owners or certifies that it does not have substantial U.S. owners.

For purposes of these rules, an FFI is broadly...

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