Regulatory fatigue? FATCA inaction may risk noncompliance

Many companies are not prepared to comply with FATCA.
By Denise Hintzke, J.D.

Eight years after Congress passed the Foreign Account Tax Compliance Act (FATCA, which was enacted as part of the Hiring Incentives to Restore Employment Act, P.L. 111-147) to address the potential for tax evasion, lack of planning in response to evolving FATCA guidance may be putting some financial institutions at risk of noncompliance and potentially steep penalties.

FATCA requires all domestic and certain foreign financial institutions (FFIs) to report to the IRS — either directly or indirectly — information about financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest (see the IRS webpage "Summary of FATCA Reporting for U.S. Taxpayer"). FFIs that fail to meet their FATCA reporting obligations are subject to a punitive withholding tax.

Compliance framework

Although many FFIs have established reporting architectures in response to FATCA, that is not enough to drive the preparation needed for compliance. As FATCA continues to evolve, financial institutions need to remain vigilant and periodically update their compliance systems to ensure they remain fully compliant with the law. 

Given the financial costs of FATCA noncompliance, complacency about FATCA's ever-evolving requirements should be avoided. Delaying the collection of information needed for reporting, failing to implement a broad compliance framework, or delaying planning to meet pending FATCA certification requirements could be costly mistakes. 

The certification of preexisting accounts (COPA) requirement applies to participating foreign financial institutions (including FFIs reporting directly to the IRS under a Model 2 intergovernmental agreement (IGA)), sponsoring entities of sponsored FFIs, consolidated compliance groups, registered deemed-compliant FFIs — local FFIs, and registered deemed-compliant FFIs — restricted funds. The periodic certification requirement applies to, among others, participating foreign financial institutions (including reporting Model 2 FFIs), consolidated compliance groups, and various kinds of registered deemed-compliant FFIs including local FFIs, restricted funds, and qualified credit card issuers (see the IRS webpage "Draft FATCA Certifications"). All of these actions (or inactions) could put FFIs at risk of not meeting compliance requirements.

For large financial institutions with well-staffed compliance departments, preparation for FATCA compliance may be fighting for prioritization among many other priorities. For smaller entities and investment funds with minimal tax compliance personnel, the complexity and cross-border impacts of FATCA may prove overwhelming.

Perhaps a key deficiency in the current approach some financial institutions have taken in their FATCA compliance is a tendency to overlook subtle, but important, regulatory changes until shortly before the implementation deadline. Those delays may occur if financial institutions lack the FATCA compliance infrastructure required to identify and address requirements and effectively account for their impact on their organization. Financial institutions should adopt a dynamic FATCA compliance program that allows them to proactively anticipate changes to the FATCA reporting and withholding regime and make revisions to their procedures, processes, and systems in advance of applicable deadlines.

Withholding systems

At the 30th Annual Forum on International Tax Withholding and Information Reporting Conference in June (referred to in the financial services industry as the Loscalzo Conference), the IRS stated that guidance on FATCA gross proceeds withholding would be issued before year end. When this guidance is released, financial institutions may need to make substantive revisions to their existing withholding systems. The impact of careful planning and systemic action — and the potential unpreparedness of U.S. institutions and FFIs — may be highlighted when the IRS releases these new rules in the coming months.  

As background, FATCA requires withholding agents to withhold 30% on any "withholdable payments" made to recalcitrant account holders and to FFIs that have not attained a FATCA compliant status (Secs. 1471(a) and (b)(1)). Under Regs. Sec. 1.1473-1(a), the term "withholdable payment" is defined as any payments of U.S. source fixed or determinable annual or periodical (FDAP) income, and for sales or other dispositions occurring after Dec. 31, 2018, any gross proceeds from the sale or other disposition of property of a type that can produce U.S. source interest or dividends that are FDAP. The sale or other disposition includes (but is not limited to) sales of securities; redemptions of stock; retirements and redemptions of indebtedness; entering into short sales; and closing a transaction under a forward contract, option, or other instrument that is otherwise a sale.

Special rules apply to sales effected by brokers and for gross proceeds from sales settled by a clearing organization (Regs. Secs. 1.1473-1(a)(3)(i)(B) and (C)). FATCA will additionally require FFIs to withhold 30% on any passthrough payments made to undocumented account holders and nonparticipating FFIs, although the timing for this requirement is yet to be determined (Sec. 1471(b)(1)(D)(i)). (FDAP income includes all income included in gross income under Sec. 61 except for those enumerated in Regs. Sec. 1.1441-2(b)(2) and includes U.S. source payments of interest, dividends, rents, and royalties. A noncompliant FFI receiving any of these will be subject to 30% withholding on the payment.)

Under FATCA, FFIs must deduct and withhold a tax equal to 30% of any passthrough payment that is made by that institution to a recalcitrant account holder or any FFI that is not FATCA compliant. Passthrough payment is defined as "any withholdable payment and any foreign passthrough payment" Regs. Sec. 1.1471-5(h)(1). However, the Chapter 4 regulations have not yet defined "foreign passthrough payment" (See Regs. Sec.1.1471-5(h)(2)).

In Notice 2010-60, the IRS first discussed the three prongs of the FATCA withholding regime in detail explaining its intention to implement sweeping FATCA withholding provisions to address FFI compliance. The passthrough payments concept was itself introduced to encourage more FFIs to participate in FATCA by attaching a U.S. withholding tax to certain non-U.S. source income.

Logistical challenges

While gross proceeds and passthrough withholding may be in line with the intent of the original legislation, incorporating them into existing tax compliance systems may represent logistical challenges that are not overcome easily or inexpensively. FFIs were able to implement FATCA withholding on FDAP income payments relatively effectively because preexisting systems developed for Chapter 3 withholding purposes already imposed withholding on those payments. By contrast, gross proceeds paid to non-U.S. persons have never been subject to withholding, and, thus, financial institutions may not be able to rely upon a preexisting withholding and information reporting architecture to meet the requirements.

Moreover, substantial practical questions exist about how financial institutions will ultimately collect gross proceeds and withhold on foreign passthrough payments. Specifically, it is intended that gross proceeds withholding will apply to proceeds arising from the sale or other disposition of property of a type that can produce interest or dividends that are U.S. source. 

At a theoretical level, identifying those payments may not be easy. More practically, this new requirement represents a fundamental change for brokers and other financial institutions. In the typical stock sale scenario, actual funds do not change hands, thereby allowing the purchasing broker to withhold if appropriate documentation is not collected. Instead, financial institutions maintain accounts with a clearing organization.

When transactions take place, as opposed to securities and cash actually being exchanged between the buying and selling brokers, they merely instruct the clearing organization to debit and credit the accounts of the respective custodial institutions. The purchasing brokers generally do not know who the beneficial owner of the payment is, and, even if they did, they would not have the cash against which to withhold. Some parties have asked whether the custodian of the selling party may be in the best position to withhold. As previously mentioned, the current systems at custodial institutions do not have the ability to identify and withhold on these types of payments, and, therefore, substantial lead-time may be needed to design, implement, and test those systems. Failure to provide sufficient time could give rise to withholding in inappropriate situations and potentially substantial reclaims. 

FATCA withholding on passthrough payments presents similar challenges. Because the IRS has yet to define exactly what will constitute a passthrough payment, organizations cannot begin to make changes that would allow them to calculate those payments and withhold if necessary. As this calculation is new and specific to the FATCA regime, it is uncertain how it will reliably be done in practice. 

While financial institutions may be reluctant to incur additional costs from FATCA, substantial changes to the FATCA withholding regime are anticipated to be just beyond the horizon. For many FFIs, gross proceeds and foreign passthrough payments withholding will require substantial revisions to their existing FATCA compliance systems. Financial institutions should proactively analyze the planning considerations embedded in this upcoming compliance challenge to develop a more dynamic, proactive, and responsive program to comply with FATCA.

Denise Hintzke, J.D., is the managing director of the Financial Services Tax practice of Deloitte Tax LLP. To comment about this article or to suggest an idea for another article, please contact Sally Schreiber, senior editor, at

This article contains general information only and Deloitte is not, by means of this article, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this article.

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