IRS Declares 2014 and 2015 as a Transition Period for FATCA Administration and Enforcement and Provides an Additional Six Months of Relief for Certain Preexisting Obligations

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Pursuant to Notice 2014-33 (the Notice), the IRS announced that it will treat calendar years 2014 and 2015 as a transition period for the administration and enforcement of the due diligence, reporting, and withholding provisions of the Foreign Account Tax Compliance Act (FATCA). During this transition period, the IRS will take into account the extent to which a taxpayer has made “good faith” efforts to comply with the requirements of the FATCA regulations. A taxpayer that has not made “good faith” efforts to comply with the new requirements should not expect any relief from IRS enforcement during the transition period.

The Notice also provides an additional six months for withholding agents, foreign financial institutions (FFIs), and other taxpayers with FATCA responsibilities to perform due diligence and obtain appropriate Forms W-8 from foreign entities prior to the effectiveness of FATCA’s withholding obligations. As described in the Notice, a taxpayer generally will be permitted to treat an obligation held by an entity (but not an individual) that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation that is subject to the due diligence, reporting, and withholding provisions applicable to such an obligation.

“Good Faith” Efforts

The Notice provides some indication of the scope of “good faith” efforts.  In particular, the IRS will assess whether a withholding agent has made “reasonable” efforts during the transition period to modify its account opening practices and procedures to document the FATCA status of payees, to apply the relevant standards of knowledge, and to apply the presumption rules. For a participating FFI, the IRS will assess the FFI’s efforts to identify and facilitate the registration of each member of its expanded affiliated group. Notably, the IRS has employed similar transition-period approaches when it has introduced or significantly revised due diligence, reporting, and withholding rules.  See, e.g., Notice 2001-4, 2001-2 I.R.B. 267; Notice 99-25, 1999-20 I.R.B. 75; Notice 98-16, 1998-15 I.R.B. 12.

Sutherland Observation: A taxpayer’s ability to prove that it has satisfied the good-faith standard seemingly will be an important component of the IRS’s enforcement approach during the transition period. Thus, in an instance where a taxpayer’s efforts to make modifications to its systems and procedures for FATCA implementation are ongoing as of July 1, 2014, it generally will be advisable for the taxpayer to document such ongoing activities and the remaining efforts required to fully implement the modifications. Furthermore, if, after July 1, 2014, a taxpayer identifies a deficiency in its systems and procedures for FATCA implementation, similar efforts to document the deficiency and the corresponding solution are advisable.

Expanded Universe of Preexisting Obligations

As recognized by the Notice, comments received by Treasury and the IRS following the issuance of the temporary FATCA regulations in February 2014 (T.D. 9657) have indicated that the release dates of the final Forms W-8 and accompanying instructions present practical problems for both withholding agents and FFIs attempting to implement new account opening procedures. In an effort to alleviate the strain caused by the late release of the new Form W-8BEN-E (and its accompanying instructions, which remain pending), the Notice announces that Treasury and the IRS will amend the FATCA regulations to allow withholding agents and FFIs to treat any obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of the due diligence and withholding requirements applicable to preexisting obligations under the FATCA regulations. However, as indicated in the Notice, this expanded definition of preexisting obligation will not apply to obligations held by individuals.

Sutherland Observations

1. When applying the expanded definition of preexisting obligation, the distinction between a preexisting obligation, which generally will give rise to payments that are subject to withholding under FATCA on and after July 1, 2016, and a grandfathered obligation, which generally will not give rise to withholdable payments for FATCA purposes, will need to be kept in mind. In brief, a grandfathered obligation is an obligation that is outstanding on July 1, 2014, but only where the obligation is not a legal agreement or instrument that (i) is treated as equity for U.S. federal tax purposes; (ii) lacks a stated expiration or term, e.g., a savings deposit or demand deposit, a deferred annuity contract, or an annuity contract that permits a substitution of a new individual as the annuitant under the contract; (iii) is an agreement to hold financial assets for the account of others and to make and receive payments of income and other amounts with respect to such assets; or (iv) is a master agreement that merely sets forth standard terms and conditions that are intended to apply to a series of transactions between parties but that does not set forth all of the specific terms necessary to conclude a particular transaction. Notably, in the case of a life insurance contract that contains a provision that permits the substitution of a new individual as the insured under the contract, that contract generally will constitute an obligation for purposes of the exception for grandfathered obligations only until a substitution occurs.

2. Foreign property and casualty insurance companies should benefit from the expanded definition of preexisting obligation, as payments of insurance or reinsurance premiums on policies issued by such companies prior to January 1, 2015, generally will not be subject to FATCA withholding or reporting requirements until July 1, 2016.

3. A life insurance company that makes a payment to an individual will not benefit from the expanded definition of preexisting obligation, as the relief offered by the proposed change does not apply to such an obligation. However, payments made by life insurance companies to foreign retirement plans and other foreign entities generally should receive the benefit of the expanded definition.

4. Financial institutions and other persons that enter into derivative contracts also should benefit from the expanded definition of preexisting obligation, assuming that the counterparty to the derivative contract is a foreign entity.

The Notice provides that the proposed amendments to the FATCA regulations otherwise will not affect the July 1, 2014, implementation date provided in those regulations for due diligence, reporting, or withholding. For example, if a withholding agent treats an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation and receives a Form W-8BEN-E from the entity to document its status as a nonparticipating FFI, the withholding agent should begin withholding and reporting under FATCA when otherwise required for a preexisting obligation under the FATCA regulations.

Other Proposed Modifications

In brief, the Notice announces several additional modifications to the FATCA regime, as well as the new temporary regulations coordinating the withholding regulations under IRC §§ 1441 and 1442 (among other provisions) with FATCA. Several of those proposed modifications are summarized below.

  1. Intergovernmental agreements (IGAs):  With respect to FFIs covered by an IGA, the Notice indicates that Treasury intends to update the due diligence procedures described in Annex I of the Model 1 and Model 2 IGAs to incorporate due diligence procedures consistent with the Notice.  Thus, it is expected that Annex I of future Model 1 and Model 2 IGAs will include new due diligence procedures for an entity account opened on or after July 1, 2014, and before January 1, 2015, to allow an FFI covered by a Model 1 IGA or Model 2 IGA to treat such an account as a preexisting entity account, but without applying the $250,000 exception for preexisting entity accounts that are not required to be reviewed, identified, or reported.  Moreover, a partner jurisdiction with an IGA that has been signed or that has reached an agreement in substance generally will be permitted to adopt the revised due diligence procedures described above pursuant to the most-favored nation provision contained within its IGA, once an IGA with the revised procedures has been signed with another partner jurisdiction.
  2. Relief for limited FFIs and limited branches of participating FFIs:  Treasury and the IRS intend to amend the FATCA regulations to permit a limited FFI or limited branch to open U.S. accounts for persons resident in the jurisdiction where the limited branch or limited FFI is located, and accounts for nonparticipating FFIs that are resident in that jurisdiction, provided that the limited FFI or limited branch does not solicit U.S. accounts from persons not resident in, or accounts held by nonparticipating FFIs that are not established in, the jurisdiction where the FFI (or branch) is located and the FFI (or branch) is not used by another FFI in its expanded affiliated group to circumvent the obligations of such other FFI under IRC § 1471.  This modification is meant to be consistent with the treatment of related entities and branches provided in the model IGAs.
  3. Registration of limited FFIs:  Treasury and the IRS intend to amend the FATCA regulations to provide that, if an FFI is prohibited under local law from registering as a limited FFI, the prohibition will not prevent the members of its expanded affiliated group from obtaining statuses as participating FFIs or registered deemed-compliant FFIs if the first-mentioned FFI is identified as a limited FFI on the FATCA registration website by a member of the expanded affiliated group that is a U.S. financial institution or an FFI seeking status as a participating FFI.

Topics:  Due Diligence, Enforcement, Extensions, FATCA, FFI, IRS

Published In: Finance & Banking Updates, International Trade Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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