Significant Proposed Legislation Would Increase Compliance Costs For U.S. Payors And Impact Worldwide Recipients Of U.S. Source Income

Originally published November 10, 2009

On October 27, 2009, the Foreign Account Tax Compliance Act of 2009 (FATCA or FATCAT as referenced by some Hill officials) was introduced simultaneously in both houses of the U.S. Congress and endorsed by the Secretary of the Treasury, reflecting the joint drafting of the bill by the Congress and the Treasury Department.

Aimed at requiring the disclosure of income of U.S. persons investing through foreign entities, the legislation is far-reaching in its potential impact on both U.S. payors and foreign recipients. The legislation aims to prevent U.S. persons from hiding their identity behind a foreign corporation, trust, foundation or other type of foreign entity.

The proposed legislation likely will be enacted in late 2009 and would override the existing withholding rules effective for payments made on or after January 1, 2011. Thus, it is important to consider the potential impact now and provide any comments as soon as possible. It is difficult to see that the necessary administrative efforts by all involved parties—the government, U.S. payors and affected foreign entities—could be completed by the proposed effective date.

The key provisions are as follows.

A withholding tax of 30% will be imposed on payments to foreign financial institutions (FFIs) that do not enter into agreements with the IRS. "Foreign financial institutions," a broadly defined term, will be required to enter into an agreement with the IRS under which the foreign entity will identify and report on the accounts maintained by U.S. persons (directly or through U.S.-owned foreign entities); otherwise, U.S. payments made to the FFI generally will be subject to 30% withholding tax. For an FFI that already is a Qualified Intermediary (QI), this new agreement will be in addition to the QI Agreement. Included within the broad definition of "foreign financial institution" are hedge funds, private equity funds and securitization vehicles as well as retail and investment banks and insurance companies that sponsor investment funds. Due diligence and verification procedures will be required to identify U.S. account holders. Certifications from account holders may be relied upon unless the FFI has knowledge or reason to know that the information provided in the certificate is incorrect. If an FFI does not enter an agreement with the IRS, the withholding tax will apply to the entire payment to the FFI even if it has no U.S. account holders...