FATCA: US Tax Authorities Require Foreign Entities to Report

The Foreign Account Tax Compliance Act (FATCA) is a new chapter in the US Internal Revenue Code. Enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, FATCA is intended to combat tax evasion by US persons holding financial assets outside the country. However, the new law imposes significant information reporting burdens and compliance requirements on several foreign entities located in other jurisdictions which are not US tax payers.

Summary of FATCA requirements:

• US taxpayers holding foreign financial assets with an aggregate value exceeding US$50,000 to report certain information about these assets to US Internal Revenue Service (IRS) as part of their annual return.
• Foreign financial institutions (FFIs) to enter into an agreement with IRS agreeing to:
  • Undertake certain identification and due diligence procedures with respect to its account holders.
  • Report annually to the IRS on its account holders who are US persons or foreign entities with substantial US ownership.
  • Withhold and pay over to the IRS 30% of any payment of US source income as well as gross proceeds from the sale of securities that generate US source income made to: non-participating FFIs (i.e. FFIs which have not entered into agreement with IRS); individual account holders failing to provide sufficient information to determine whether or not they are US persons; or foreign entity account holders failing to provide sufficient information about the identity of its substantial US owners.

   

The definition of FFI includes any foreign entity that accepts deposits, holds financial assets for the account of others or engages in the business of investing or trading in securities, commodities, partnerships or any interests in such securities or commodities. This definition is broad and encompasses several different entities such as banks, insurance companies, asset management companies, as well as investment vehicles such as hedge funds, private equity funds and certain insurance products.

FATCA affects non-financial foreign entities (NFFEs) as well. Any entity that is not a FFI is a NFFE unless it is specifically exempted. NFFEs are required to report whether they have substantial US ownership and, if so, provide the required information relating to such US owner. Substantial US owner includes any US person who owns more than 10% of the shareholding in a corporation, or more than 10% of the profit or capital interest in a partnership.

Initial Timelines

FATCA is being implemented in a phased manner. Notice 2011-53, issued by the IRS provides the following timeline for implementation of the various requirements of FATCA:

• FFIs must enter an agreement with the IRS by 30 June 2013.
• Withholding on US source dividends and interest paid to non-participating FFIs will begin on 1 January 2014.
• Due diligence requirements for identifying new and pre-existing US accounts (including certain high-risk accounts) will begin in 2013.
• Reporting requirements will begin in 2014.

Recent Developments

With the deadline for implementation of FATCA fast approaching, the IRS has published draft regulations spanning nearly 400 pages for consultation. The consultation period will expire on 30 April 2012. Under the proposed regulations the deadlines for reporting obligations will now range from 2014 to 2017 depending on the nature of the information sought.

A joint statement released by the US, France, Germany, Italy, Spain and the UK (FATCA partners) states that these countries are exploring an alternative regime for FATCA reporting. This statement provides that the US is “open to adopting an intergovernmental approach to implement FATCA and improve international tax compliance” and accordingly is prepared to collect and exchange information reciprocally on accounts held in US financial institutions by residents of the countries named.

What FATCA Means to Global Business

FATCA will present a number of challenges to the financial institutions, as well as non-financial institutions that have global business operations and/or that have direct or indirect US owners. These challenges may include changes to ownership, processes or operations. It is therefore imperative to carry out any impact analysis early on and initiate appropriate steps for meeting the new challenges. These steps may include:

• Check if your entity or business is covered or otherwise affected by FATCA.
• If you are a financial institution having US customers or entities that have direct or indirect US ownership, to decide whether to enter into an agreement with IRS.
• If you are a NFFE or non-participating FFI to consider changes to ownership, business, operations, or processes to minimise impact to revenue flow due to the potential 30% withholding of payments.

Some of the key challenges relating to FATCA compliance include:

• Monitoring client database: this would including identification of existing US accounts, classification of new accounts in the future and procedures to monitor subsequent changes to the status of their clients.
• How the institution is going to develop and maintain an effective system for meeting reporting obligations and to withhold payments, as and when necessary.
• Existing policies and procedures relating to Know Your Customer (KYC) and anti-money laundering (AML) need to be revised to bring them in line with FATCA requirements.
• Updating existing systems of technology, software and document retention, as well as training employees.