January 22, 2013
The Hiring Incentives to Restore Employment Act (the HIRE Act), enacted in 2010, contained provisions commonly referred to as FATCA that are intended to reduce the evasion of U.S. tax obligations by U.S. persons through the use of foreign entities. FATCA will generally impose a 30% withholding tax on all withholdable payments made to foreign financial institutions (FFIs) and nonfinancial foreign entities (NFFEs) unless they comply with the requirements imposed by FATCA. "Withholdable payments" are payments of interest, dividends, rents, salaries, and other fixed or determinable annual or periodical (FDAP) gains, profits, and income from any U.S. source, as well as gross proceeds from the disposition of property that can produce U.S. source interest or dividends.
Since the enactment of the legislation, the Internal Revenue Service (the IRS) has issued three substantive Notices that have provided limited guidance. On February 8, 2012, Treasury and the IRS proposed the first set of regulations under FATCA (the Proposed Regulations).
On January 17, 2013, Treasury and the IRS issued final regulations under FATCA (the Final Regulations). While retaining much of the substance and clarifying some of the details of the Proposed Regulations, the Final Regulations incorporate some important changes in the wake of comments from practitioners and the business community. The memorandum below summarizes certain major changes to prior guidance that were implemented in the Final Regulations, highlighted by the following:
Please contact any Gibson Dunn tax lawyer to discuss the best way to prepare for the forthcoming compliance obligations.
Extension of Dates before Payments Subject to Withholding
Withholding obligations on payments to FFIs and NFFEs will begin January 1, 2014, subject to certain exceptions. Notably, as provided in IRS Announcement 2012-42, withholding on gross proceeds from the disposition of property that can produce U.S. source dividends or interest is delayed until January 1, 2017. In addition, a Participating FFI (an FFI that enters into an agreement (an FFI Agreement) with the IRS regarding certain due diligence, withholding, and reporting obligations with respect to the accounts it maintains) is not required to withhold on foreign passthru payments before the later of January 1, 2017, and the date on which final regulations are published defining the term foreign passthru payment. The Final Regulations also delay until January 1, 2017, withholding on payments of U.S.-source FDAP income made by an offshore withholding agent with regard to an offshore obligation so long as that person is not acting as an intermediary with regard to the payment (this delay is intended to allow for better coordination with intergovernmental agreements that are being negotiated). In addition, the Final Regulations clarify that certain short-term obligations, effectively connected income, and nonfinancial payments listed in the Final Regulations (e.g., payments made in exchange for services) are generally not withholdable payments.
Extra time has also been provided to bring preexisting accounts into compliance. All accounts maintained by an FFI prior to January 1, 2014, are considered preexisting accounts under the Final Regulations, as are new accounts of a preexisting customer if all such customer’s accounts are treated as one obligation for diligence purposes. With respect to preexisting accounts, withholding agents and Participating FFIs have until December 31, 2015, to document account holders and payees (other than certain FFIs). Participating FFIs are required to file their first information reports (with respect to calendar years 2013 and 2014) no later than March 31, 2015.
Grandfathering of Obligations Extended Until January 2014
Under the Proposed Regulations, any obligation outstanding on January 1, 2013, was excluded from FATCA withholding. The Final Regulations extend the applicable date to January 1, 2014. In anticipation of future regulations on dividend equivalent payments, grandfathered obligations also include certain obligations that produce withholdable payments solely because the obligations are treated as giving rise to dividend equivalents, so long as the obligations are issued within six months of the issuance of regulations providing for such treatment. In addition, grandfathered obligations include agreements requiring payments with respect to collateral securing a grandfathered obligation (even if the collateral itself is not a grandfathered obligation). Debt issued in a qualified reopening will be considered outstanding as of the issue date of the original debt for purposes of determining whether such debt is a grandfathered obligation.
The Treasury Department has published two model intergovernmental agreements (IGAs) that facilitate implementation of FATCA in jurisdictions that have legal impediments to compliance. The IGAs contemplate that the partner jurisdiction will require financial institutions (subject to exceptions or exemptions) to identify and report information about their U.S. accounts. The model agreements contemplate certain simplifications and burden reductions associated with the application of FATCA in the relevant jurisdiction. Each IGA will address the extent to which full compliance with the Final Regulations is required. In applicable jurisdictions, the IGA will determine the status of certain entities under FATCA (notably whether an entity is an FFI, NFFE, or Exempt Beneficial Owner).
Enhanced Exclusions and Reduced Diligence
The Final Regulations provide numerous welcome exclusions from FATCA and reduce diligence requirements imposed on financial institutions.
The Final Regulations exempt from review all preexisting accounts held by individuals with a value of $50,000 or less. The threshold is raised to $250,000 for preexisting accounts held by entities and for preexisting accounts that are cash value insurance and annuity contracts. Participating FFIs may determine whether any preexisting accounts with a value of $1,000,000 or less are held by U.S. individuals based solely on a search of electronically searchable data for certain U.S. indicia of ownership set out in the Final Regulations.
Insurance contracts with a value of $50,000 or less are exempt from treatment as financial accounts. The excepted category of retirement and pension accounts is revised to eliminate the requirements that all contributions to the account be government, employer, or employee contributions and that the contributions be limited to earned income, although the Final Regulations add the condition that the relevant tax authorities require information reporting with respect to the account.
Withholding agents may rely on review conducted for anti-money laundering due diligence purposes to identify substantial U.S. owners of passive NFFEs in lieu of obtaining certification from the owners. The Final Regulations expand the scope of evidence on which a withholding agent may rely to determine the status of a payee– e.g., a withholding certificate–and limit the review that must be conducted of certain documentation. Whereas the Proposed Regulations required updated documentation every three years, the Final Regulations permit documentation to remain valid indefinitely in certain circumstances, including for certain low-risk categories of payees (e.g., Deemed-Compliant FFIs), unless a change in circumstances warrants updated documentation. The Final Regulations also establish a six-month grace period during which withholding agents that acquire accounts in a merger may rely on the FATCA statuses assigned by certain predecessor withholding agents.
The IRS has established the FATCA Registration Portal (the Portal), a secure online web portal through which FFIs will be able to register with the IRS. The Portal will be accessible to financial institutions beginning no later than July 15, 2013, and will be used to manage registration information, to make representations required for a specific status under FATCA, and to facilitate communication between the IRS and FFIs. The IRS anticipates that required certifications of compliance by responsible officers of Participating FFIs may eventually be made through the Portal. Each registering FFI will be assigned a Global Intermediary Identification Number that it will use for FATCA reporting purposes.
Compliance and Certification of Participating FFIs
Consolidated Compliance Groups
Participating FFIs may agree to establish and maintain a consolidated compliance program and perform a periodic review on behalf of one or more FFIs in the same expanded affiliated group. The Final Regulations also require a sponsoring entity to act as the compliance FI for all FFIs in such consolidated compliance group. Forthcoming guidance will elaborate the registration and certification procedures applicable to such groups.
Default Under an FFI Agreement
If the IRS determines than a Participating FFI has not substantially complied with the requirements of an FFI Agreement, it will deliver notice of an event of default. The Final Regulations clarify that an event of default does not result in automatic termination of the FFI Agreement. Rather, the Participating FFI will be permitted to develop a plan to remedy the default. However, the IRS may terminate the Participating FFI’s status as such if it fails to respond to the notice of default or comply with an agreed-upon remediation plan.
The Final Regulations also add clarity to various categories of Financial Institutions (FIs).
The Final Regulations provide that accepting deposits is necessary, but not sufficient, to classify an entity as a depository institution. The entity must also engage in one or more banking or financing activities, enumerated in the Final Regulations, on a regular basis.
The Final Regulations–adopting comments that passive, non-commercial investment vehicles should not be considered FIs–define "investment entity" (a type of FI) as an entity that primarily conducts trading, portfolio management, etc., as a business on behalf of customers. Accordingly, foreign passive entities that are not professionally managed will be treated as passive NFFEs rather than as FFIs. However, mutual funds, hedge funds, or similar investment vehicles will be considered FIs.
Holding Companies and Treasury Centers
The Final Regulations provide that a company within an affiliated group that serves as a holding company or provides treasury services for group members will be treated as an FFI in two situations: (1) if it is part of an expanded affiliated group that includes a depository institution, custodial institution, insurance company, or investment entity; or (2) if it is formed in connection with, or availed of by, a private equity fund, hedge fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets.
Exceptions to FFI Status
The Final Regulations provide an exception to FFI status for holding companies, treasury centers, and captive finance companies that are part of a nonfinancial group (unless availed of by private equity funds or similar entities). Such entities are also Excepted NFFEs. Nonfinancial groups may include FFI members to a limited extent when all such members are Participating FFIs or Deemed-Compliant FFIs.
FATCA provides that certain FFIs may be deemed to comply with FATCA’s requirements. The Final Regulations introduce new categories of such Deemed-Compliant FFIs and modify certain existing categories.
Registered Deemed-Compliant FFIs
The Final Regulations expand the types of entities that qualify as local FFIs to include insurance companies, credit unions, and investment entities. The Final Regulations create new categories of Registered Deemed-Compliant FFIs for (1) credit card issuers that limit their customers to deposits of $50,000 or less, and (2) sponsored FFIs for which a sponsoring entity agrees to perform all due diligence, withholding, reporting, and other requirements that the sponsored FFI would have been required to perform if it were a Participating FFI, in addition to certain other requirements.
Certified Deemed-Compliant FFIs
The Final Regulations create a category of Certified Deemed-Compliant FFIs for closely held investment vehicles sponsored by a sponsoring FFI in the same manner as the Registered Deemed-Compliant FFI category and expand the category of nonregistering local banks to include certain credit unions and similar organizations. Certain limited-life debt investment entities that are unable to comply with FATCA without amending their trust agreements will be considered Deemed-Compliant FFIs until January 1, 2017, at which point compliance will be required.
The Final Regulations do not prohibit Owner-Documented FFIs from issuing debt interests in excess of $50,000 to persons other than non-Participating FFIs, provided the issuer reports all individuals and specified U.S. persons that hold such interests to the designated withholding agent.
Exempt Beneficial Owners
The definition of international organization–a category of Exempt Beneficial Owners–is modified under the Final Regulations to eliminate the requirement that the United States participate in the organization as a member. The Final Regulations also expand the classes of pension funds by including several new categories that apply without regard to whether the pension fund is the beneficial owner of the income due to concerns that the pension fund might not be so treated under local law. New categories include: (1) pension or retirement funds entitled to benefits under an income tax treaty, regardless of whether the funds are exempt from taxation in the country of organization, (2) funds formed pursuant to pension plans that would meet the requirements of Section 401(a) of the Internal Revenue Code if they were funded by a trust organized in the United States, and (3) certain pension funds established by another Exempt Beneficial Owner for its employees, their beneficiaries, or other service providers.
Government Investment Funds
Government investments funds, also known as "sovereign wealth funds," are also addressed specifically by the Final Regulations. Sovereign wealth funds qualify as Exempt Beneficial Owners, which are exempt from withholding on payments that they beneficially own, so long as such funds are considered "integral parts" or "controlled entities" of a foreign government. As this language generally traces the requirements for exemption available to foreign governments under Section 892 of the Internal Revenue Code, any sovereign wealth fund entitled to exemption under that section will enjoy status as an Exempt Beneficial Owner under FATCA.
 An FFI is any financial institution that is not a U.S. person. FATCA requires a withholding agent to deduct and withhold 30% of any withholdable payment made to an FFI, unless the FFI enters into an FFI Agreement or otherwise falls within an excepted category. NFFE is defined broadly to include any foreign entity that is not a financial institution, subject to certain exceptions. Withholding agents must also deduct and withhold 30% of any withholdable payment to an NFFE unless the NFFE provides the appropriate certification as to its owners.
 On August 27, 2010, the U.S. Treasury and the IRS published Notice 2010-60, providing initial guidance regarding FATCA. Notice 2010-60 was supplemented on April 8, 2011, by Notice 2011-34, which clarified and replaced some of the earlier guidance. Notice 2011-53, released July 14, 2011, described a timeline for phased implementation of the FATCA provisions. These Notices are explained more fully in our previous client alerts: IRS Issues Guidance on New FATCA Withholding Obligations, distributed on October 7, 2010, and IRS Notices Extend Date for Implementation of FATCA Provisions of the HIRE Act and Provide Additional Guidance, distributed on August 9, 2011.
 Certain major provisions of the Proposed Regulations were summarized in our previous client alert, IRS Proposes Detailed Regulations Under the FATCA Provisions of the HIRE Act, distributed on February 9, 2012.
 The term offshore obligation means any account, instrument, or contract that is maintained and executed at an office or branch of the withholding agent at any location outside of the United States or in any location in a U.S. territory. The term also includes any equity interest in a foreign entity that is purchased by the owner of such interest outside of the United States either directly from the entity or from another person that is located outside of the United States.
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