Foreign Income & Taxpayers
On March 18, 2010, the Foreign Account Tax Compliance Act (FATCA), P.L. 111-147, was signed into law. FATCA comprises chapter 4 in the Code, consisting of Secs. 1471–1474. This new chapter is separate and distinct from chapter 3, which deals with withholding on payments of certain periodic U.S.-source income to nonresidents.
In the three years since the law was enacted, the IRS has issued guidance through a series of notices and proposed regulations to allow foreign financial institutions (FFIs) to prepare for FATCA. The long-awaited final regulations were released on Jan. 28, 2013 (T.D. 9610). In July, Notice 2013-43 postponed certain implementation dates for six month to assist U.S. withholding agents and FFIs. While most of the attention has been directed at the impact FATCA may have on FFIs used by certain U.S. persons to hide income offshore, its reach is much broader. In fact, FATCA affects a broad range of individuals and entities.
FATCA is intended to encourage tax compliance and reduce U.S. tax evasion. The approach taken by Treasury and the IRS has been to encourage FFIs to enter into agreements with the United States to provide information on the accounts of U.S. taxpayers. The “encouragement” is in the form of a 30% withholding tax, as provided under Sec. 1471(a), on all payments to the FFI of U.S.-source fixed, determinable or annual, periodic (FDAP) income (and, after Dec. 31, 2016, gross proceeds from the sale or other disposition of property of a type that can produce interest or dividends that are U.S.-source FDAP income) if the FFI does not enter into an agreement to participate and share certain requested data.
In addition, Sec. 1472 makes FATCA applicable to certain non-FFIs considered to be nonfinancial foreign entities (NFFEs). To be exempt from withholding, these entities must certify to the withholding agent that they have no substantial U.S. owners, or provide the name, address, and tax identification number of any substantial U.S. owners. The withholding tax will potentially apply even if a double-tax treaty would otherwise reduce the rate of withholding on the payment to zero.
Any person that makes a payment of U.S.-source FDAP income to a foreign person is a withholding agent. A withholding agent is responsible for determining the FATCA status of the payee and determining whether the 30% withholding applies. Therefore, all withholding agents need to consider how FATCA will affect them, determine what payment streams are included under FATCA, determine whether their current data-collection procedures and systems are adequate, and implement any adjustments to those systems or procedures. Finally, they will need to be able to report information regarding “recalcitrant” payees (those that fail to comply with certain reasonable requests for information or provide a waiver from foreign disclosure laws), as well as payments made that were subject to withholding.
As of July 1, 2014, withholding agents must have processes in place to determine and document the FATCA status of their payees before payment is made. If it is later determined that withholding should have been applied but was not, the withholding agent will be liable for the tax. Many taxpayers are familiar with chapter 3 withholding and have procedures in place to gather the required data to comply with those rules for payments to foreign payees. Those that do will find FATCA implementation less painful, as the rules are similar.
In addition, documentation collected prior to July 1, 2014, such as on Forms W-9, Request for Taxpayer Identification Number and Certification, and W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, will in some instances be sufficient for purposes of FATCA. As an example, a properly completed W-8BEN received from a non-U.S. individual, foreign government, or international organization will be sufficient for FATCA. A W-8BEN from another type of foreign payee may be relied upon only until July 1, 2017, and only if certain additional information is obtained.
As mentioned above, FATCA withholding generally begins on July 1, 2014. As simple as that sounds, several types of payments are considered not to be withholdable payments, as defined in Regs. Sec. 1.1473-1(a). Additionally, certain foreign entities are considered beneficial owners under Regs. Sec. 1.1472-1(c) that are not subject to FATCA. For example, certain obligations in place as of June 30, 2014, are considered “grandfathered obligations” under Regs. Sec. 1.1471-2(b) and are not subject to FATCA withholding. In addition, certain payments made to NFFEs meeting the “ordinary course of business” exception in Regs. Sec. 1.1473-1(a)(4)(iii) also are exempt from withholding. Withholding agents will need to perform their due diligence to determine whether these or other exceptions apply.
Several other key dates starting in 2013 also need to be considered. FFIs that intend to participate in FATCA will need to register with the IRS via an online portal and receive a global intermediary identification number (GIIN). The registration process was expected to begin on Aug. 19, 2013. If FFIs wish to be included in the published list of participating FFIs to be released by June 2, 2014, they need to complete their registration by April 25, 2014. FFIs may participate through intergovernmental agreements (IGAs) by registering and complying with all information reporting and due-diligence requirements or by indicating they are one of the entities that are deemed to comply because the IRS has indicated they are of low risk. Withholding agents will be using the published list to determine whether FATCA withholding is required on payments made to FFIs.
To have comfort in not withholding on an otherwise withholdable payment, a withholding agent will be required to associate the payment to a form in the W-8 series. The IRS is revising all versions of these forms to gather the information and classification required under FATCA. The current W-8BEN will be used only by foreign individuals. A new version, Form W8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding (Entities), when issued in final form, will be used by foreign entities. The draft version has now ballooned to eight pages (the current W-8BEN is a single page). The increase in pages is directly proportional to the increase in difficulty that foreign payees will have when they are asked to complete the form by the withholding agent. Withholding agents may be called upon by vendors or service providers to assist them in properly completing the form. If the form is not completed correctly, the withholding agent could be subject to the 30% tax that was not withheld, plus interest and penalties for not withholding. If, on the other hand, the withholding agent erroneously decides to withhold, it could be in violation of an agreement with the payee or possibly damage a valuable relationship.
Implementation a Team Effort
Although many assume that FATCA is just a tax issue, addressing it properly will go far beyond the walls of the tax department for businesses that are required to act as withholding agents. The implementation team should include legal, finance, information technology, purchasing, and customer relations. The tax department should play a key role in FATCA compliance. It can review the current documentation, determine whether payments are withholdable under FATCA, and monitor IRS-published lists of FFIs participating in FATCA. Finance will need to help identify the various payment streams across the company. The company’s customer relations team will need to contact current payees to obtain missing information, manage any concerns from vendors and other payees upset with requests for what might be considered privileged company data, or obtain a Form W-8BEN-E or W-9 that had not previously been submitted. The company’s legal counsel will need to review and possibly amend customer or investor agreements to address the possibility of withholding should the payee not comply with the FATCA information requests, as well as review required modifications to onboarding procedures for new customers or investors.
The burden—more specifically, the risk of FATCA noncompliance—is clearly placed on the shoulders of the withholding agent. While there are many exceptions, withholding agents must become familiar with the withholding rules for payments they are making. Withholding agents should assemble their teams across business units and determine their ability to comply.
Frank J. O’Connell Jr. is a partner with Crowe Horwath LLP in Oak Brook, Ill.
For additional information about these items, contact Mr. O’Connell at 630-574-1619 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.