On February 20, 2014 the Internal Revenue Service and U.S. Treasury Department issued the final set of regulations with respect to the Foreign Account Tax Compliance Act (“FATCA”). The implementation of FATCA is imminent, with the IRS beginning to accept registration applications as of January 1, 2014. All entities that fall under the definition of “Foreign Financial Institutions” must register using the Portal by May 5, 2014, in order to ensure inclusion in the first published Global Intermediary Identification Number (GIIN) list.
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Understanding FATCA Classifications
Enacted on March 18, 2010, FATCA imposes certain reporting, withholding and due diligence requirements on foreign financial institutions (“FFIs”) and U.S. withholding agents (“USWAs”), pertaining to foreign financial accounts and offshore assets held by U.S. taxpayers and U.S. entities. Under FATCA, FFIs and USWAs are required to: (1) conduct due diligence and collect documentation from account holders and counterparties; (2) submit reports to the IRS regarding the account activity of U.S. customers and non-compliant FFIs; and (3) withhold 30% of withholdable payments1 made to entities and accounts that do not meet FATCA’s requirements and are not subject to an exemption.
b. FFI Classification under FATCA:
The final regulations to FATCA establish that most non-U.S. funds2 and entities are considered FFIs3. Pursuant to Sections 1471(d)(5)-(e)(4) of the Internal Revenue Code (“Code”), an FFI4 consists of depository or custodial institutions, investment entities, certain insurance companies and holding companies or treasury centers5. While the IRS exempts several categories of FFIs from FATCA’s registration requirements6, most non-U.S. funds will not fall under these categories, as they constitute an investment entity under FATCA.
It is important to note that because of FATCA’s broad definition of investment entity, most fund managers, investment advisers and general partners will constitute FFIs7. Non-U.S. investment advisers who have “earned more than 50% of their gross income for the last three years from providing services as an investment adviser”8 are considered to be investment entities under FATCA and therefore required to comply with FATCA’s requirements. Fund managers and general partners will also constitute FFIs based on their role in trading financial products to customers in addition to providing portfolio management services9. Additionally, while limited guidance has been provided by the IRS concerning the obligations of fund administrators, the revised definition of “investment entity” in the final regulations to FATCA is substantially broad enough that it will likely also be taken to include fund administrators regardless of whether those entities offer custodial services or not.10
USWA Classification and Requirements under FATCA:
Pursuant to the Code and final regulations, non-U.S. persons with the “control, receipt or custody over the disposal or payment of a withholdable payment or foreign passthru payments” are classified as USWAs.11 This broad definition includes U.S. registered funds under the Investment Company Act12, domestic partnerships, domestic corporations, any non-foreign estates and any trusts, if a U.S. court is able to exercise primary supervision over the trust’s administration and one or more U.S. persons have authority to control all substantial decisions of the trust.14
The IRS has released revised Forms W-8 and W-9 in order to account for the additional certifications required by FATCA15. While the proposed and final regulations provide additional information regarding payee identification and the documents USWAs must collect, USWAs will be subject to certain rules under the current withholding arrangement16. To the extent withholding should apply, USWAs will be required to implement appropriate withholding systems to meets FATCA’s withholding requirements.
FFI Requirements under FATCA is Dependent on their Status:
All FFIs will be required to comply with certain due diligence, reporting and withholding requirements under FATCA. Such responsibilities vary and will depend on whether an FFI is required to comply with an FFI agreement, an Intergovernmental Agreement (“IGA”) or both. To fulfill their responsibilities under FATCA, all FFIs must to enter into an FFI agreement with the IRS to avoid FATCA withholding, unless they are an “exempt beneficial owner”17, qualify for “deemed-compliant” status18, or are in a jurisdiction where there is an IGA in place.
FFIs and Intergovernmental Agreements:
The Treasury has entered into several IGAs with other jurisdictions in order to facilitate the efficient implementation of FATCA. There are two types of IGAs, each of which posits different responsibilities for FFIs present in that jurisdiction. The two types IGAs are Model 1 IGAs19 and Model 2 IGAs20. FFIs complying with Model 1 IGAs must present U.S. account holder and additional information to their home jurisdiction’s government agency, and will be extended “registered deemed-compliant status” under FATCA. Model 2 IGA FFIs are required to report applicable account holder information directly to the IRS.
FFIs that must enter into FFI Agreements:
FFIs that do not qualify as “exempt beneficial owners” or for “deemed-compliant” status must enter into an FFI agreement with the IRS in order to avoid FATCA withholding. FFIs that enter into FFI agreements with the IRS are termed “participating FFIs”. On January 13, 2014, the IRS released the final language of the FFI agreement, listing the obligations participating FFIs owe to comply with FATCA.21 Participating FFIs will be required to perform due diligence on account holders and counterparties and report applicable information to the IRS in accordance with such agreements.
Steps to Take to Comply with FATCA:
The IRS’ recently issued final regulations and associated guidance have provided clarification as to the requirements and consequences for failing to timely comply with FATCA. In order to comply with FATCA’s requirements, both U.S. and non-U.S. entities are encouraged to develop policies that: (i) identify their investors and counterparties; (ii) collect the appropriate documentation from investors and counterparties based on their status under FATCA; and (iii) withhold on investors or counterparties that are non-participating FFIs or non-compliant NFFEs, starting on July 1, 2014.
As of January 1, 2014, the IRS has opened an online FATCA registration portal (“Portal”) through which FFIs must register in order to submit FATCA registration information and correspond with the IRS on issues pertaining to FATCA. The Portal can be used by: (i) FFIs, including those in expanded affiliated groups, who are required to enter into FFI agreements; (ii) Model 1 IGAs; and (iii) other registered deemed-compliant entities and sponsoring entities. FFIs who register through the Portal will receive a Global Intermediary Identification Number (“GIIN”).22 FFI GIINs will be used by withholding agents to confirm that registered FFIs are in compliance with FATCA, by checking them against a published list of GIINs from all FATCA-compliant foreign entities. This list will first be published by the IRS on June 2, 2014 and updated monthly thereafter. An entity must register using the Portal by May 5, 2014, in order to ensure inclusion in the first published GIIN list.
After registering through the Portal, entities should confirm whether their FATCA obligations will be determined based on an FFI Agreement or specific IGAs, entered into between their home jurisdictions and the U.S. government. In addition, entities should be aware of the cut-off dates for grandfathered obligations,23 as such obligations have been exempted from FATCA withholding.
1 Section 1473(1) of the IRC defines withholdable payments as: “(i) any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income (FDAP income), if such payment is from sources within the United States; and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States.”
2 Non-U.S. funds may also be considered non-financial foreign entities (“NFFEs”) under FATCA and will be subject to different requirements.
3 Most U.S. funds are U.S. stand-alone or feeder funds formed within the U.S. These domestic funds do not constitute FFIs and will not be required to enter into FFI agreements. They will constitute USWAs under FATCA and must conduct enhanced due diligence procedures and obtain documentation from their payees who receive withholdable income. They will also be required to adhere to enhanced reporting and withholding responsibilities.
4 FFIs may also include “expanded affiliated groups,” defined under Section 1504(a) of the IRC as “a group made up of entities under greater than 50% ownership, measured by vote or value, which share a common parent”. Members of an
expanded affiliated group that are FFIs must register with the IRS in order for any FFI in the group to comply with FATCA’s requirements.
5 Holding companies or treasury centers will only be treated as FFIs if they are formed in connection with, or availed of by a collective investment vehicle, as defined under the IRC. Holding companies or treasury centers in a non-financial group will be excluded from the definition of an FFI for the purposes of FATCA.
6 FFIs exempt from FATCA include: (i) most governmental entities, (ii) most non-profit organizations, (iii) select small and local financial institutions, and (iv) select retirement entities.
7 Fund managers, investment advisers and general partners who are non-U.S. entities would most probably need to enter into FFI agreements with the IRS, unless they are extended “deemed-compliant” status under FATCA or are subject to an IGA. In the case of non-U.S. fund managers, this would generally occur if: (i) the fund manager receives “withholdable payments or foreign passthru payments subject to FATCA, including investment advisers fees constituting U.S. source income, or (ii) the fund manager is part of an expanded affiliated group with other FFIs”.
8 See Final Regulations to FATCA, published January 28, 2013, available at: http://www.irs.gov/PUP/businesses/corporations/TD9610.pdf.
9 Foreign financial entities which are not professionally managed
and are passive entities will not be treated as FFIs under FATCA. Examples of passive entities are small family trusts or certain personal investment companies.
10 The Treasury Regulations state that “investment entities” (for FATCA purposes) also includes any entity which in the last three (3) years earned 50 percent or more of its gross income from “investing, administering or managing funds, money or financial assets on behalf of other persons.” Treas. Reg. § 1.1471-5(e)(4)(iv)(A).
11 See Section 1471(d)(7) of the IRC, defining a passthru payment as “any withholdable payment or other payment, to the extent attributable to a withholdable payment.”
12 Guidance suggests that non-U.S. subsidiaries of registered investment companies, which generally would constitute FFIs under FATCA, may qualify for registered-deemed compliant status as a Qualified Collective Investment Vehicle and investment advisers to such subsidiaries may qualify as sponsoring entities.
13 “U.S. persons” include the foreign branches of a U.S. person that is not a qualified intermediary acting as an intermediary with respect to a payment.
14 See Final Regulations, note 7.
15 See id.
16 Guidance indicates that USWAs will still be liable for tax, interest and penalties, to the extent it does not follow FATCA’s rules for calculating the appropriate amounts to withhold.
17 See Treasury Regulation §1.1471-6(a)-(g) of the IRC. “Exempt beneficial owners” include: “(i) non-U.S. pension and other retirement funds (ii) governmental entities, (iii) international organizations, (iv) non-U.S. central banks, and (v) entities wholly owned by the aforementioned entities.” These entities are exempt from entering into an FFI agreement or registering with the IRS in order to avoid the 30% withholding tax on withholdable payments.
18 FFIs may be “deemed-compliant” by qualifying as a: (i) Certified Deemed-Compliant FFI; or (ii) a Registered Deemed-Compliant FFI. Certified Deemed-Compliant FFIs usually consist of certain retirement funds and non-profit organizations. In order to be “deemed-compliant” under this category, qualifying FFIs must certify their status to withholding agents by providing the required documents listed in Section 1471-3(d)(6) of the IRC. Registered Deemed-Compliant FFIs usually consist of funds which fit the definitions of a: (i) Qualified Collective Investment Vehicle (“QCIV”), (ii) Restricted Fund (“RF”), and (iii) Sponsored Investment Entity. In order to be “deemed-compliant” under this category, qualifying FFIs must conduct due diligence on their investors and directly certify to the IRS that they fulfill the requirements for registered “deemed-compliant” status. It is important to note that while QCIV’s do not need to enter into FFI agreements, they are required to additionally certify,
through a “responsible officer,” as to their status every 3 years.
19 Jurisdictions which have entered into Model 1 IGAs with the U.S. government require FFIs located in that jurisdiction to comply with the obligations included in the specific IGA. FFIs under Model 1 IGAs must register with the IRS, but are not required to enter into FFI agreements.
20 Jurisdictions which have entered into Model 2 IGAs with the U.S. government require FFIs located in that jurisdiction to comply with FATCA by registering with the IRS as a Participating FFI and executing an FFI agreement. Model 2 IGA FFI obligations under such FFI agreements will be modified according to the specifications in the respective Model 2 IGAs.
21 The IRS Revenue Procedure 2014-13 containing the final FFI agreement is available at: http://www.irs.gov/irb/2014-3_IRB/ar10.html.
22 The IRS released a comprehensive user guide with instructions on how to use the Portal, available at: http://www.irs.gov/pub/irs-pdf/p5118.pdf.
23 The final regulations to FATCA defined a grandfathered obligation as an outstanding obligation as of July 1, 2014 which has not been significantly altered thereafter. The regulations further defined an obligation as “any legally binding agreement or financial instrument including: (i) a derivatives transaction entered into between counterparties under an ISDA master agreement, which has been confirmed by June 30, 2014; (ii) total return swaps on U.S. equity which give rise to withholdable payments through future regulations under Section 871(m) related to dividend equivalent payments; and (iii) collateral obligations securing a grandfathered derivative or other obligation, even if the collateral is not such an obligation itself”.