United States Tax: New U.S. withholding and reporting requirements of FATCA

As a result of recently enacted legislation, virtually all Foreign Financial Institutions (FFI) that own or hold any U.S. investments must implement new, enterprise-wide systems to identify and report U.S. account information to the Internal Revenue Service (IRS) by 1 January 2013. Non-compliance by these foreign financial intermediaries will result in the imposition of a 30% withholding tax on the U.S.-source income and gross sales proceeds of both the enterprise and its account holders. These new rules apply in addition to existing U.S. withholding tax rules, including those applying to Qualified Intermediaries, and will significantly affect withholding agents, as well as foreign financial intermediaries. Separately, somewhat similar rules also apply to non-financial foreign entities.

The U.S. Treasury (Treasury) has been given broad authority to implement these rules, and significant additional guidance is expected over the next 18 months.


Background

On 18 March 2010, President Obama signed the Hiring Incentives to Restore Employment (HIRE) Act, which included provisions of the Foreign Account Tax Compliance Act (FATCA). The FATCA provisions, added as Chapter 4 of the U.S. Internal Revenue Code, require a wide-range of foreign financial intermediaries (such as banks, brokers, investment vehicles such as hedge funds and private equity funds, and collateralized loan and debt obligations) that own U.S. investments to obtain and report information pertaining to U.S. accounts to the IRS. Foreign Financial Institutions that do not have any U.S. clients, but hold U.S. investments, also must comply with the new reporting provisions.

The provisions of new Chapter 4 of the Internal Revenue Code financially compel, through the use of withholding taxes, FIIs to identify and report specified U.S. account holders to Treasury. The withholding tax applies not only to the U.S. investments of U.S. clients of the foreign financial intermediary, but to all U.S. investments held by the financial institution and its affiliates, including its own portfolio.

The details of Chapter 4 are extensive and complex; however, the underlying premise is to financially impact FIIs that do not agree to provide U.S. account information to Treasury. To avoid a 30% withholding tax, these intermediaries must enter into information reporting agreements with Treasury, conduct their operations in compliance with the terms of these agreements between the Foreign Financial Institutions and Treasury and, on an annual basis, provide information in a detailed account statement to the IRS for specified U.S. accounts.

The obligations imposed by Chapter 4 include more than an agreement and annual reporting to Treasury. They also require that the institution obtain information on all accounts owned by U.S. persons or by U.S.-owned foreign entities, and that it comply with any verification and due diligence requirements prescribed by Treasury. The institution must also comply with any Treasury requests for additional information, and agree to obtain a waiver of any foreign privacy law, if necessary. The due diligence that will be required to verify whether an account is U.S., or non-U.S., is unknown at this point.

Importantly, institutions must verify both those accounts held directly and those held indirectly through collective investment vehicles and other specified entities. In such cases, information must be obtained to determine the indirect U.S. ownership of accounts held through these entities.

An institution must also agree to withhold on an account holder that refuses to provide sufficient information for verification purposes or that does not provide a privacy waiver in regards to any foreign laws. Withholding would also apply to an account held by an unrelated FII that has not entered into an agreement with Treasury. Thus, a system of withholding on non-compliant customers must also be implemented.

It should be noted that Chapter 4 applies on an enterprise-wide approach using affiliated group rules. Under these rules, all affiliates must comply with an agreement entered into by another member. Thus, a non-contracting member is not excused from reporting and may cause a compliance failure for the affiliated group.


Suggested action

Foreign Financial Institutions holding any U.S. investments and withholding agents should immediately begin to assess their circumstances and capabilities against the known and expected requirements of new Chapter 4. Significant guidance, including regulations, from Treasury is expected over the course of the next 18 months. Foreign Financial Institutions and withholding agents should prepare to analyze proposed guidance in view of their own capabilities, react quickly and be ready to implement systems and processes in response to Treasury regulations and other guidance.