IRS Proposes Detailed Regulations Under the FATCA Provisions of the HIRE Act

February 9, 2012

The Hiring Incentives to Restore Employment Act (the HIRE Act), enacted in 2010, contained provisions (now commonly referred to as FATCA[1]) intended to reduce the evasion of U.S. tax obligations through the establishment of accounts at foreign financial institutions (FFIs) or by holding assets through nonfinancial foreign entities (NFFEs).  FATCA will generally impose a 30% withholding tax on all withholdable payments made to FFIs and NFFEs, unless they comply with the requirements imposed by FATCA.  "Withholdable payments" are defined as 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 provided limited guidance.  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.

On February 8, 2012, Treasury and the IRS proposed the first regulations regarding FATCA (the Proposed Regulations).  The Proposed Regulations (which total 388 pages) largely reiterate guidance provided in the Notices, but they also modify and supplement the previously released guidance.  The memorandum below summarizes briefly certain major provisions of the Proposed Regulations. 

Please contact any Gibson Dunn tax lawyer to discuss the best way to prepare for the forthcoming compliance obligations.

Grandfathered Obligations Extended Until January 2013

The HIRE Act provides that no amounts are required to be deducted or withheld from payments made pursuant to any obligation outstanding on March 18, 2012, or from gross proceeds attributable to the disposition of any such obligations.  Under the Proposed Regulations, grandfathered obligations are extended to include any obligation outstanding on January 1, 2013.  The Proposed Regulations also explicitly provide that revolving credit facilities will be considered outstanding as of that date, provided that an agreement has been signed prior to January 1, 2013, that fixes the material terms pursuant to which the credit will be extended.  A significant modification that results in a deemed exchange for U.S. federal income tax purposes will result in the obligation being treated as newly issued as of the date of the modification.

Transition Period for the Scope of Information Reporting

The Proposed Regulations extend the transition period for information reporting obligations of FFIs.  For reporting in 2014 and 2015, Participating FFIs are only required to report the name, address, TIN, account number and account balance with respect to U.S. accounts.  Reporting on income will be phased in beginning in 2016 (with respect to the 2015 calendar year), and reporting on gross proceeds will begin in 2017 (with respect to the 2016 calendar year).  In addition, FFIs may elect to report information either in the currency in which the account is maintained or in U.S. dollars.

FFI Affiliated Groups

Payments made to Participating FFIs (FFIs that enter into an agreement (an FFI Agreement) with the IRS regarding certain due diligence, withholding, and reporting obligations with respect to the accounts they maintain) or Deemed-Compliant FFIs (FFIs that meet certain reporting requirements or for which compliance is deemed to be unnecessary) are not subject to withholding under FATCA.  Previous guidance stated that each FFI that is a member of an expanded affiliated group must be a Participating FFI or Deemed-Compliant FFI in order for any FFI in the group to be a Participating FFI.  In recognition that some jurisdictions have laws that would prohibit an FFI’s compliance with FATCA, the Proposed Regulations provide that this requirement will not be fully implemented until January 1, 2016.  In the interim, an FFI affiliate in a jurisdiction that prohibits reporting or withholding under FATCA will not prevent the other FFIs in its affiliated group from becoming Participating FFIs, provided that the FFI in the restrictive jurisdiction agrees to certain due diligence, record-keeping, and other requirements with respect to its U.S. accounts.

Deemed Compliant FFIs

FATCA provides that certain FFIs may be deemed to comply with FATCA’s requirements.  Under the Proposed Regulations, Deemed-Compliant FFIs are divided into two categories.

          Registered Deemed-Compliant FFIs

A Registered Deemed-Compliant FFI is required to register with the IRS, satisfy certain procedural requirements, certify that it meets the requirements of its applicable Deemed-Compliant FFI category, and renew its certification every three years.  This category includes (1) local FFIs, (2) members of affiliated groups, including a Participating FFI, that transfer preexisting accounts of certain U.S. persons and nonparticipating FFIs to a Participating FFI, (3) investment funds of which all holders of record are Participating FFIs, Deemed-Compliant FFIs, or exempt beneficial owners (certain entities generally exempt from FATCA, including foreign governments and their controlled entities), and (4) investment funds that are prohibited from marketing interests to certain U.S. persons and nonparticipating FFIs and that are subject to other restrictions.

          Certified Deemed-Compliant FFIs

A Certified Deemed-Compliant FFI is not required to register with the IRS, but will certify to the relevant withholding agent that it meets the requirements of its Certified Deemed-Compliant FFI category on a Form W-8.  This category includes (1) local banks, (2) retirement plans, (3) nonprofit organizations exempt from tax in their country of organization, and (4) FFIs with exclusively low-value accounts (i.e., accounts with balances of $50,000 or less) and that have no more than $50 million in assets on their balance sheets.

Excepted NFFEs

Although FATCA generally provides for withholding on payments to NFFEs, no withholding will apply to payments beneficially owned by any Excepted NFFEs.  Earlier guidance provided that the following entities will constitute Excepted NFFEs: (i) publicly traded corporations and their affiliates, (ii) entities organized in a U.S. territory and wholly owned by residents of that territory, (iii) foreign governments and their wholly-owned agencies, (iv) international organizations, and (v) foreign central banks of issue.  The Proposed Regulations expand this list to include Active NFFEs, which is defined to include any NFFE if less than 50% of its gross income for the preceding calendar year is passive income or less than 50% of the assets held by the NFFE at any time during the preceding calendar year are assets that produce, or are held for the production of, passive income. 

Definition of Financial Account

The previous guidance raised concerns as to whether an investor owned a "financial account" for FATCA purposes simply by owning debt or equity.  The Proposed Regulations include a more detailed, restrictive definition of "financial account" in order to focus on traditional bank, brokerage, and money market accounts, as well as interests in investment vehicles.  The new definition excludes most debt and equity interests issued by banks and brokerage firms.  As under previous guidance, debt or equity that is regularly traded on an established securities market does not constitute a financial account.  A debt or equity interest in a financial institution is a financial account if the financial institution is primarily engaged in the business of investing, reinvesting, or trading securities, such as a private investment fund.  If the financial institution is a bank or insurance company or holds financial assets for the accounts of others, a debt or equity interest is a financial account only if the value of those interests is determined primarily by reference to assets that give rise to withholdable payments.  In addition, certain insurance and annuity contracts are considered financial accounts if they include an investment component.

Due Diligence Procedures for the Identification of Accounts

The Proposed Regulations modify previous guidance regarding the due diligence procedures that Participating FFIs will be required to undertake to identify their U.S. accounts.

  • For preexisting individual accounts that are offshore obligations, manual review of paper records is limited to accounts with a balance or value that exceeds $1,000,000 (and is only required to the extent that electronic searches are not sufficient).
  • Preexisting individual accounts with a balance or value of $50,000 or less, and certain cash value insurance contracts with a value of $250,000 or less, are excluded from the due diligence procedure.
  • For preexisting entity accounts that do not exceed $1,000,000, FFIs may generally rely on information gathered as part of compliance with anti-money laundering/know your customer (AML/KYC) rules.
  • Preexisting entity accounts with a balance or value of $250,000 or less are excluded from the due diligence procedure. 
  • For new accounts, the Proposed Regulations generally do not require an FFI to make significant modifications to its existing customer intake procedures, other than with respect to account holders identified as FFIs, as passive investment entities, or as having U.S. indicia.

Withholding on Passthru Payments

The Proposed Regulations phase in the passthru payment regime in two steps.  Beginning on January 1, 2014, Participating FFIs will be required to withhold on passthru payments that are withholdable payments made to a recalcitrant account holder or a nonparticipating FFI.   Beginning no earlier than January 1, 2017, the scope of passthru payments will be expanded beyond withholdable payments, and FFIs will be required to withhold on such payments in accordance with future guidance.  To reduce incentives for nonparticipating FFIs to use Participating FFIs to avoid the FATCA rules, the Proposed Regulations require that Participating FFIs report annually to the IRS the aggregate amount of certain payments made to each nonparticipating FFI for the 2015 and 2016 calendar years. 

For jurisdictions that enter into agreements to facilitate the implementation of FATCA, Treasury and the IRS will work with their governments to develop practical alternatives to achieve the policy objectives of passthru payment withholding, and where such an agreement provides for the foreign government to report information regarding U.S. accounts and recalcitrant account holders to the IRS, FFIs in such jurisdictions may not be required to withhold on foreign passthru payments to recalcitrant account holders.

Intergovernmental Approach Announced

In connection with the Proposed Regulations, Treasury released a joint statement with France, Germany, Italy, Spain, and the United Kingdom outlining a possible intergovernmental approach to implementing FATCA and automatic information exchange between partner countries.  Under the proposed framework, the United States and a partner country would enter into an agreement in which the partner country would agree to collect information required by FATCA and transfer that information to the IRS.  This would allow FFIs in the partner country to avoid having to enter into an agreement with the IRS and would eliminate U.S. withholding on payments to FFIs established in the partner country.  The agreement would also include a commitment by the United States to reciprocity regarding automatic collecting and reporting on the U.S. accounts of residents of the partner country.

   [1]   "FATCA" refers to the name of a former bill known as the "Foreign Account Tax Compliance Act of 2009" in which these provisions were originally proposed, but not enacted.  

Gibson, Dunn & Crutcher LLP

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these developments.  If you have any questions, please contact the Gibson Dunn lawyer with whom you work or any of the following:

New York
David B. Rosenauer  (212-351-3853, [email protected])
Jeffrey M. Trinklein  (212-351-2344, [email protected])
Romina Weiss  (212-351-3929, [email protected])

Washington D.C.
Art Pasternak  (202-955-8582, [email protected])
Benjamin Rippeon (202-955-8265, [email protected])

Los Angeles  
Hatef Behnia (213-229-7534, [email protected])
Paul S. Issler (213-229-7763, [email protected])
Sean Feller (213-229-7579, [email protected])
Dora Arash (213-229-7134, [email protected])
J. Nicholson Thomas (213-229-7628, [email protected])

Orange County 
Gerard J. Kenny (949-451-3856, [email protected])
Scott Knutson (949-451-3961, [email protected])

David Sinak (214-698-3107, [email protected])

© 2012 Gibson, Dunn & Crutcher LLP

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