FATCA will impose new due diligence, withholding, and reporting requirements on financial institutions. This paper outlines the significant regulatory change FATCA brings to provide the IRS with an increased ability to detect U.S. tax evaders—specifically, those among U.S. “persons” (individuals or entities) who maintain foreign accounts and investments either directly or indirectly, through their ownership in foreign entities.
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FATCA Compliance: Riding a Roller Coaster of Regulatory Change
1. JULY 12, 2013 UPDATES
An executive briefing on how firms can support the
foreign account tax compliance act
FATCA compliance:
Riding a roller coaster
of regulatory change
2. 2
FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE | EXECUTIVE SUMMARY
EXECUTIVE SUMMARY
U.S. financial institutions are riding a roller coaster of regulatory
change. Specifically, the Foreign Account Tax Compliance
Act (FATCA), included in the Hiring Incentives to Restore
Employment Act (HIRE), is intended to provide the Internal
Revenue Service (IRS) with increased ability to detect U.S. tax
evaders who maintain foreign accounts and investments either
directly or indirectly through ownership of foreign entities. The
ability to quickly identify these challenges will dictate whether
the ride reaches a smooth conclusion or causes severe aches and
pains for months or even years to come.
Considerations for being FATCA compliant:
• Resources – Regulatory and business needs are in constant flux. Do you have the required resources
to support due diligence requirements and comply in a timely manner?
• Cost Effectiveness – Can you efficiently implement withholding systems modifications to capture
relevant data?
• Maintenance – Managing continuous change demands agile operations and constant attention
to functionality. Does your plan cover both Day 1 and ongoing support?
• Partnership – Consider whether to partner or build internally. Do you have the proper reporting tools
and know-how required for achieving and sustaining compliance?
3. 3
FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE
Background
FATCA is proving to be one of the more substantial
changes to tax compliance in recent history, with
far-reaching effects on operations personnel,
policies, procedures, and clients.
FATCA1
represents more than just red tape and
increased due diligence: it is a game-changing
regulation affecting how U.S. entities with strong
ties to overseas financial investments may need
to view their strategies, as well as how financial
institutions are interacting with U.S. investors.
Once an organization determines it is a financial
institution pursuant to FATCA’s broad-based
definition, it must establish whether it is either
a U.S. financial institution (USFI), meaning a
financial institution incorporated in the U.S. or
one of its foreign branches, or a foreign financial
institution (FFI).
For FFIs, the next step is to establish whether the
institution intends to be a Participating FFI (PFFI),
complete with the responsibilities entailed by an
FFI Agreement, a non-participating FFI (NPFFI),
or one of myriad types of Certified Deemed
Compliant FFIs, (CDCFFI), and Registered Deemed
Compliant FFIs (RDCFFI).
FATCA imposes substantial new due diligence,
withholding, and reporting requirements on
financial institutions in pursuit of expanded
information reporting regarding U.S. “persons.”
U.S. persons can include U.S. citizens and
permanent residents, individuals who meet the
“substantial presence test” based on the amount
of time spent in the U.S., and entities such as
corporations, partnerships, and LLCs formed under
the laws of a state or the U.S.
To date, most attention has been focused on
FFI requirements because those requirements
are more cumbersome to implement than the
requirements for USFIs. However, USFIs cannot
afford to postpone planning and should anticipate
without delay the significant impact of FATCA
on their operations.
Due Diligence
FATCA due diligence requirements are
premised on whether an account is
preexisting or new.
For purposes of a USFI, “new” is defined as any
account, instrument, or contract maintained or
executed by the withholding agent on or after
July 1, 2014. For FFIs, “new” is defined as an
account opened on or after the effective date of
the FFI Agreement for a PFFI or the registration
date for a RDC FFI. This would be July 1, 2014 at
the earliest. “Preexisting” accounts are defined as
those held prior to these effective dates.
USFIs have no additional due diligence
responsibilities with respect to preexisting
individual account holders; however, there are
requirements with respect to entity account
holders. For preexisting entity accounts, a USFI
is required to determine FATCA status. For those
account holders indicating they are PFFIs, a
USFI is required to obtain the FFI-EIN (Employer
Identification Number) and to verify this against
the IRS database. A similar exercise will need to be
completed for all new account holders.
In addition, FATCA has expanded the definition
of U.S. indicia for which a USFI will need to
screen new account documentation. These
are certain pieces of data that indicate a high
likelihood that a person claiming foreign status
could in fact be a U.S. person for U.S. tax purposes.
Information needed to screen new onshore
account documentation going forward includes:
• U.S. citizenship, residency, or country of
incorporation
• U.S. place of birth
• U.S. residence address or U.S. mailing address
• U.S. telephone number
FATCA
non-compliance will
be both burdensome
and expensive.
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FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE
All of the above information will be indicia of U.S.
status and require specific documentary evidence
to “cure.” U.S. place of birth and U.S. telephone
number will prove the most problematic because
these data elements may not have been included
previously in customer account onboarding
reviews. USFIs will also need to track subtle
changes in the U.S. indicia rules when dealing
with offshore obligations, while FFIs will need
to be compliant with even different U.S. indicia
requirements. Furthermore, USFIs need to make
plans for the storage of these elements, FATCA
status, FFI-EIN, and validation indicators for
use during withholding or reporting. The most
efficient means for a USFI to seamlessly execute
both preexisting and new account due diligence
is through the still-to-be-finalized W-8 series.
A substantial departure from the status quo.
Compliance measures must enable efficient,
effective response to this new reality. Continued
use of the previous manual approach will be
challenging, as the previously one- page Form
W-8BEN has now been separated into a Form
W-BEN for individuals and a Form W-8BEN-E for
entities. The previously one-page certification
for entities is now six pages to accommodate
all required FATCA certifications. Similarly, the
current two-page Form W-8IMY has expanded
to seven pages. The W-9 Forms will receive a
substantial overhaul as well. Finally, expect to
collect significantly more W-9 Forms as FATCA
effectively eliminates the concept of the U.S.
exempt recipient. FATCA generally presumes
undocumented account holders to be NPFFIs and
subject to a punitive 30% withholding.
Being prepared to capture this data by July 1, 2014
means USFIs quickly need to:
• Adopt new account onboarding procedures
• Modify systems to capture additional
data elements
• Revise due diligence checklists
Any of these requirements, much less all of these
requirements, will pose significant challenges
to every organization’s budget and personnel,
especially in the current economy.
Withholding
Firms must consider the increased costs and
risks of tax reporting, their own capabilities,
and client expectations.
At its core, FATCA represents the evolution of a
global tax information reporting regime. To compel
the provision of required information, FATCA
mandates a punitive 30% withholding tax absent
required documentation. Withholding on payments
of U.S. source fixed, determinable, annual, or
periodic (FDAP) income is effective January 1, 2015,
while gross proceeds on the sale of U.S. securities
are subject to withholding effective January 1, 2017.
The IRS has reserved sections related to foreign
passthru payments for future guidance; however,
foreign passthru payment withholding would be
effective January 1, 2017 at the earliest.
FATCA mandates withholding on three specific
classes of accounts:
1. Recalcitrant Individuals: These are individuals
who fail to provide a valid tax certification,
appropriate documented evidence, or a waiver
allowing a financial institution to report the
required data. Recalcitrant individual account
holders are not a concern for USFIs, as payments
to undocumented individuals are already subject
to 28% backup withholding.
2. Non-Compliant Non-Financial Foreign
Entities (NFFEs): Passive NFFEs, not otherwise
excepted from FATCA requirements, will be
required to disclose substantial U.S. owners.
Generally, a substantial U.S. owner is defined
as owning greater than 10% interest in either a
corporation or a partnership.
3. NPFFIs: NPFFIs are foreign financial institutions
not qualifying as compliant and declining to
enter into an FFI Agreement, as well as “limited”
branches and subsidiaries of FATCA compliant
institutions not meeting all PFFI requirements due
to local legal restrictions.2
With the exception of “limiteds,” it is the account
holder’s own actions, or lack of action that trigger
withholding, thus making FATCA significantly
different from current withholding regimes.
FATCA mandates
a punitive 30%
withholding tax
absent required
documentation.
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FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE
“To manage FATCA is to manage change. The
successful project plan leverages internal and
external partners to manage these changes,
especially when devoting internal expertise
would distract from delivering core business
requirements.”
Cyrus Daftary, Partner – Burt, Staples & Maner, LLP and
Executive Director, Compliance Technologies International, LLP
This emphasizes the IRS position that withholding
is a lever to trigger additional reporting,
as opposed to a means to collect additional
tax revenue.
USFIs will need to enhance their payment
processing and withholding systems in order to
initiate FATCA withholding on July 1, 2014. Systems
should already be able to identify payments of U.S.
source FDAP income as withholding on payments
to non-U.S. persons is required under current non-
resident alien (NRA) withholding provisions.
Special grandfathering provision
Grandfathered obligations are debt instruments
and contracts with a fixed termination date that
are in existence on July 1, 2014 that could be
subject to FATCA because they produce
U.S. Source FDAP.
The payments on these instruments are not
subject to FATCA withholding unless they
are changed after July 1, 2014 by a “material
modification”, which is not defined in the
regulation, but relies on Treas. Reg. 1.1001-3(e) as a
starting point to define a “significant modification”
under the Code, and other events are to be
determined using a facts and circumstances test
as defined by contract law principles. However,
the IRS is indicating that the issuer will be the only
one to determine whether a material modification
has occurred and absent written communication
from the issuer, withholding agents may not
determine on their own whether an instrument
has lost its grandfathered status. Because of the
uncertainty, industry groups are working with
the IRS to attempt to establish a uniform
method of communication between issuers and
withholding agents.
In addition, USFIs will ultimately need to
identify payments of gross proceeds on
the sale of property generating U.S. source
dividends or interest by these newly identified
account classes as currently such payments
are subject to withholding only when paid to
an undocumented U.S. person. USFIs will be
required to withhold on payments of U.S. source
FDAP made to both NPFFIs and non-compliant
NFFEs. There is, however, no FATCA withholding
on individual account holders. This difference
versus FFI requirements is because USFIs are
already required to withhold on undocumented
account holders.
In addition to the systems modifications
mentioned previously, USFIs will be required to
integrate their FATCA withholding procedures
with NRA withholding. FATCA operates in
conjunction with current NRA withholding
requirements. If FATCA withholding applies,
there is no additional withholding. However, if
no FATCA withholding applies, a USFI still must
determine if NRA withholding should apply. While
USFIs should already have the basic withholding
mechanics in place given current NRA regulations,
there is still considerable work required to prepare
for the implementation of FATCA withholding
on July 1, 2014.
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FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE
Reporting
Managing withholding is essential to
FATCA compliance.
As mentioned earlier, withholding is merely the
lever the IRS will deploy to obtain the ultimate
and intended goal of FATCA compliance:
additional information reporting on U.S. persons.
USFIs are excluded from the new individual
USFI REPORTING OBLIGATION SUMMARY EXPLANATION
Substantial U.S. owners of certain NFFEs Reporting includes:
• Name of the NFFE that is owned by a substantial U.S. owner
• Each substantial U.S. owner’s name, TIN, and mailing address
• Any other required information
Chapter 4 reportable amounts Reporting includes:
• The name, address, and EIN of the withholding agent
• Description of each category of income or payment and aggregate amount paid
in USD
• Rate and amount of withholding applied or basis for exemption
• The name and address of the recipient and their TIN or EIN (when required)
• The name, address, and TIN of any FFI acting as an intermediary, a flow-through
entity that is an NFFE, or territory financial institution that is not treated as a
U.S. person when the account holder is the beneficial owner of the payment
• The country of the recipient and of any entity the name of which appears on the
form
• Any other required information
Owner-documented FFIs that are
specified U.S. persons
Reporting includes:
• The name of the owner-documented FFI
• The name, TIN or EIN, and address of the specified U.S. person
• Any other required information
reporting requirements imposed by FATCA, as
these institutions are required to annually report
payments to U.S. persons on Forms 1099 and
payments of U.S. source FDAP income to non-U.S.
persons on Forms 1042-S. However, there are
significant new USFI reporting responsibilities
with respect to entities as delineated in the chart
below.
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FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE
Improving International
Tax Compliance
The key to FATCA’s success will be the ability
of the U.S. Department of the Treasury
(Treasury) to remove international conflicts
of law that pose a barrier to expansive FATCA
reporting by PFFIs.
As part of this effort, Treasury issued a joint
statement with the governments of France,
Germany, Italy, Spain, and the United Kingdom
on an intergovernmental approach to improving
international tax compliance and implementing
FATCA along with the release of the proposed
regulations. As part of the statement, Treasury
indicated these governments have agreed to
initiate discussions on an approach to FATCA
implementation that would address legal
barriers to compliance, simplify implementation,
and reduce the costs associated with FATCA
compliance. Governments choosing to engage in
this approach would be termed “FATCA Partners.”
Since that initial joint statement, Treasury has
released both the Model 1 Intergovernmental
Agreement (IGA) and the Model 2 IGA, and the
United Kingdom, Denmark, Mexico, Germany,
Ireland, Norway, Spain, Japan, and Switzerland
have signed IGAs. In addition, Treasury is
in some level of contact ranging from active
discussion or exploratory talks to informational
sessions with many other jurisdictions. However,
Treasury has had to commit to heightened due
diligence requirements and the implementation
of information reporting for these governments
as a quid pro quo for their cooperation on
FATCA compliance. The Model 1 IGA includes
both reciprocal and non-reciprocal versions. The
reciprocal version would require USFIs to report
specific information regarding account holders
who are tax residents of a Partner jurisdiction
to the IRS, which would then exchange the
information with the Partner government.
Together these expanded reporting obligations
represent a significant challenge for USFIs.
While the U.S. would have until September 30 to
provide the information to a Partner jurisdiction,
the IRS would likely require it to be reported
“The key to smoothly
delivering on FATCA
compliance obligations is to
develop implementation plans
immediately for worry-free
withholding tax compliance.”
Glen Bover, Vice President, Broadridge Tax
Services, Broadridge Financial Solutions, Inc.
to the IRS within a similar timeframe as current
reporting is in order to assemble the necessary
information required for the information
exchange. Furthermore, by requiring FATCA
reporting of Chapter 4 reportable amounts on
the Form 1042-S, the Form 1042 reconciliation
process suddenly has become substantially more
complicated. Therefore, it is critical to invest
in robust due diligence, withholding and
reporting systems now, as opposed to learning
a new solution at the same time as learning
new requirements.
Evaluate FATCA
Preparedness
Key considerations:
• Is internal expertise broad enough to support
design and development, know best practices,
and understand what and when to design
in the future?
• What time and development costs are involved
in developing an internal solution versus using
an external solution?
• Are there competing internal development
priorities that could impact funding or staffing?
• What change management capabilities
and resources are required (both financial
and personnel)?
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FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE
1
FATCA statutory provisions can be found in Chapter 4, Sections 1471-1474 of the Internal Revenue Code (IRC) and operate in conjunction
with the current rules for Chapter 3 non-resident reporting and withholding under Section 1441-1443 of the IRC.
2
FATCA Proposed Regulations §1.1471-4(e). “Each FFI that is a member of an expanded affiliated group must obtain the status of either a
participating FFI or registered deemed compliant FFI as a condition for any member of such group to obtain the status” as further expanded
by §1.1471-4(e)(2)(iii) “A limited branch is a branch of an FFI that, under the laws of the jurisdiction as of February 15, 2012 and that apply
with respect to the accounts maintained by the branch, cannot either report such accounts, close such accounts or transfer such accounts.”
Conclusion
The key to smoothly delivering on FATCA
compliance obligations is developing
implementation plans immediately and
responding swiftly to subsequent changes.
Begin your evaluation of a partner now to deliver
seamless solutions and to help you navigate
through the complexities of FATCA compliance.
Leverage a partner that will provide industry
expertise, ongoing maintenance, and offer cost-
effective tools required for compliance. Delaying
implementation plans to wait for key events will
guarantee a bumpy ride.
IMPORTANT DATES
FACTA effective date for USFIs and FFIs July 1, 2014
Commence withholding on payments of U.S. source
FDAP income to certain recipients July 1, 2014
Commence withholding on payments of U.S. source
FDAP income paid to undocumented prima facie FFIs January 1, 2015
Commence withholding on payments of gross proceeds
of U.S. securities paid to certain recipients January 1, 2017
Earliest effective date for foreign pass-through
payment withholding January 1, 2017