On January 17, 2013, the Treasury Department and the IRS issued comprehensive final regulations implementing Sections 1471 through 1474 of the Internal Revenue Code (commonly known as the Foreign Account Tax Compliance Act, or FATCA). FATCA aims to combat tax avoidance by U.S. taxpayers by imposing sweeping reporting and withholding obligations on a broad range of foreign financial institutions (FFIs) and requiring certain non-financial foreign entities (NFFEs) to report information about their substantial U.S. holders.1 Although some uncertainties remain, the final regulations include welcome modifications and clarifications to the proposed regulations issued in February 2012.
The Treasury and the IRS attempted to minimize the burdens of FATCA compliance by adopting a targeted, risk-based approach to achieving FATCA’s policy goals, such as extended grandfathering and compliance dates, expanded exemptions and less onerous documentation and due diligence requirements. As expected, the final regulations harmonize key aspects of FATCA with the intergovernmental agreements (IGAs) that the United States is putting into place with partner countries in order to overcome legal impediments to FATCA compliance by institutions in those countries.2 Finally, the regulations provide specifics on the administrative process for FFIs registering and entering into an agreement with the IRS.
Certain key points include the following:
As noted above, IGAs with partner countries represent a main focus of the effort to implement FATCA. Partner jurisdictions that enter into a “Model 1 IGA” agree to adopt rules requiring FFIs to identify and report information about U.S. accounts to the partner jurisdiction, which then exchanges this information with the IRS on an automatic basis. The Model 2 IGA, on the other hand, is an agreement whereby a partner jurisdiction agrees to “direct and enable” all FFIs that are located in the jurisdiction to register with and directly report information to the IRS about U.S. accounts in a manner consistent with FATCA. Certain information about recalcitrant account holders is supplemented by government-to-government exchange of information. The final regulations confirm that FFIs covered by a Model 1 IGA do not need to apply the final regulations for purposes of complying with and avoiding withholding under FATCA. FFIs covered by a Model 2 IGA, however, will be required to follow the final regulations except to the extent expressly modified by the agreement. While the final regulations harmonize FATCA’s requirements with the provisions of the existing IGAs in many respects, the extent to which they will be coordinated fully remains to be seen.
In sum, while further developments are needed, the final regulations represent a significant step forward in terms of providing clarity and easing certain of the burdens of FATCA’s far-reaching rules.
1 Very generally, FATCA imposes a 30 percent withholding tax on certain U.S.-source payments (and payments of gross proceeds from the disposition of property that can produce such payments) made to an FFI unless the FFI enters into an agreement with the IRS to report the identities and other information about its U.S. account holders. FATCA also requires FFIs that enter into such agreements (participating FFIs) to withhold 30 percent of “passthru payments” made to other FFIs that do not comply with the FATCA rules. FATCA requires NFFEs to report information about their substantial U.S. holders to paying agents in order to avoid a 30 percent withholding tax.
2 One significant impediment to FATCA’s implementation has been local bank secrecy laws, which may prevent FFIs from disclosing account holder information directly to the IRS. To address this concern, the United States has entered into several IGAs with other countries that either allow financial institutions to report information to their local jurisdiction (which is then shared with the IRS) or enable financial institutions in the foreign jurisdiction to register with and report directly to the IRS. To date, the United States has signed or initialed IGAs with the United Kingdom, Denmark, Mexico, Ireland, Norway, Spain and Switzerland and expects to enter into many more in the coming months.
3 FATCA withholding generally applies to certain U.S.-source payments such as dividends and interest and gross proceeds from the sale of instruments that could produce U.S.-source dividends and interest. FATCA withholding also can apply, however, to certain non-U.S. source “foreign passthru payments” made by foreign financial institutions. While IRS notices initially had defined the scope of foreign passthru payments broadly, the proposed regulations reserved on the concept. The proposed regulations delayed commencement of withholding on such payments, but they did not grandfather instruments that could give rise to such payments beyond the end of 2012. Thus, parties were faced with having to allocate risk for potential withholding in many common types of transactions (for example, financings and derivative transactions), even where the transactions could not give rise to any U.S.-source payments and the transactions involved solely non-U.S. parties.
4 Note, however, that if reopened debt issued after the grandfather date was not treated as part of a qualified reopening under Treas. Reg. Section 1.1275-2(k), the new debt may not be fungible with the original debt issued before the grandfather date because the new debt will be subject to FATCA, even though both may be issued without original issue discount and thus otherwise be fungible for U.S. tax purposes.