FATCA Revamp

Under FATCA, the IRS seeks reporting on the accounts of U.S. persons and U.S.-owned foreign entities. A U.S. person for purposes of FATCA includes U.S. citizens, dual citizens, U.S. resident aliens, privately owned domestic corporations, domestic partnerships, or a domestic trust or estate. A U.S.-owned foreign entity is one that has one or more substantial U.S. owners. A substantial U.S. owner is a U.S. person with more than 10% interest by vote or value in a foreign corporation, trust or partnership, or any percentage of a foreign investment vehicle.

An FFI is a non-U.S. entity that holds itself out as being in the business of investing or trading in securities, commodities, futures, any interest, forward contracts or options; accepts deposits in the ordinary course of business; or holds financial assets for the account of others as a significant portion of its business. An FFI that enters into an agreement with the IRS and registers is considered a Participating FFI. If an FFI is exempt from withholding it falls into two categories:

1. Registered deemed-compliant: An FFI that registers to acknowledge its status. This includes FFIS that comply with FATCA under an agreement between the U.S. and a foreign government.

2. Certified deemed-compliant: An FFI that is not required to register at all and certifies its status by providing an IRS Form W-8. This may include retirement plans, non-profit organizations or FFI's with low-value accounts. The key compliance issues for FFIs are registration and account identification.

A Qualified Intermediary (QI) is an FFI that signs a QI agreement with the IRS, agreeing to maintain its own records of the “U.S. person status” of beneficial owners of payments and accepting responsibility for income reporting and tax withholding. A QI and its designated Responsible Officer can certify the residence status of its clients on their behalf, obtaining a reduced rate of withholding for its direct non-U.S. customers without revealing the customers' identity to the IRS. The QI agreement requires that QI's conduct compliance reviews and periodically provide a certification from the Responsible Officer as to the effectiveness of the QI's internal controls. For QIs that chose either 2015 or 2016 for the periodic review, the first compliance review is due on July 1, 2018. The key compliance issues facing QIs are classification of account holders, documentation and due diligence.

FATCA withholding does not usually apply to withholdable payments made to exempt beneficial owners. Exempt beneficial owners, including Foreign and Territorial governments, central banks and international organizations, are still subject to withholding on payments held in connection with a commercial financial activity.

Expanded Coverage

Beginning in 2019, proceeds from the sale, redemption, repurchase or other disposition of property abroad that produces U.S. source interest or dividends will also become subject to FATCA's 30% withholding requirement. After Jan. 1, 2019, a withholdable payment will include “gross proceeds from the sale of U.S. issued debt or equity by a foreign person or entity.”

Under current guidance, withholding does not apply to foreign passthrough payments until 2019 at the earliest. The definition of foreign passthrough payments is still being developed and is reserved under the current regulations. However, in general, the scope of foreign passthrough payments is exceptionally broad and, as such, includes all withholdable payments, including other payments attributable to withholdable payments. Although the focus on foreign passthrough payments is primarily on U.S.-source income, it is expected that certain non-U.S.-source income may also be included. It is important to note that one of the primary purposes behind the foreign passthrough payment concept under FATCA is to preclude an FFI from serving as a “blocker” for U.S. persons attempting to avoid U.S. tax via indirect investments in U.S. assets.

Exemptions

Foreign governments and instrumentalities of foreign governments, foreign central banks, governments of U.S. Territories, certain retirement funds and international organizations are generally exempt from FATCA registration and withholding if they are exempt beneficial owners under Treas. Reg. § 1.1471-6(d), are controlled entity of a foreign government under Treas. Reg. § 1.1471-6(b)(2) or are an entity treated as either of those things under an Intergovernmental Agreement.

As a withholding agent, they are not required to withhold to the extent that they can associate a payment with documentation, which determines what portion of the payment is apportionable to an exempt beneficial owner. But remember that an exempt beneficial owner could be subject to withholding for payments derived from commercial activity of a type engaged in by an insurance company, custodial institution or depository institution. For example, “a central bank of issue that conducts a commercial financial activity, such as acting as an intermediary on behalf of persons other than in the bank's capacity as a central bank of issue, is not an exempt beneficial owner … with respect to payments received in connection with an account held in connection with such activity.” Treas. Reg. § 1.1471-6(h).

A U.S. Financial Institution does not typically need to register under FATCA, regardless of whether it maintains a foreign branch. However, it must register if it chooses to become a Lead Financial Institution or a Sponsoring Entity. A Lead Financial Institution is a Financial Institution that will carry out FATCA registration for each of its member FFIs. A Sponsoring Entity is an entity that will perform the reporting, withholding and due diligence obligation of one or more FFIs. It also must register if it seeks to maintain qualified intermediary status with respect to any of its foreign branches. If the U.S. Financial Institution's foreign branch is a reporting “Model 1 FFI” it must register and identify each branch. A U.S. Financial Institution is, however, subject to the withholding and reporting requirements applicable to a U.S. withholding agent. The IRS has set forth suggested procedures in Annex I of the Model 2 IGA.

Additionally, U.S. Financial Institutions may be impacted by FATCA if it has employees who are U.S. Citizens living abroad. According to the BBC, Americans abroad are being denied access to banking facilities — with some foreign banks having “No U.S. Persons” rules. U.S. Financial Institutions may want to consider developing relationships with local banks surrounding the areas in which they have employees that are willing to provide access to U.S. Citizens.

Compliance Issues

The biggest compliance problem all institutions face related to FATCA is insufficient or improper documentation. Create holistic outlines of the documents needed from each up and downstream entity, customer, government and employee. Make sure there is a way to register receipt of those documents and the date on which they expire. It would be helpful if the document management system could identify redundancies, in cases where you need to obtain the same documents for different purposes. Ensure that there is a procedure in place for obtaining timely updated documentation before it comes due.

The next biggest challenge is development of procedures. You've read a thousand times that you need a “robust” procedure and there is a reason it is the compliance mantra. A strong procedure will both prevent error and serve as a safety net when error inevitably occurs. Human error happens with task execution, but no institution can afford error, human or otherwise, in its FATCA procedures. The procedures must set forth the way each choice is made at every cross road in the decision tree; eliminating, to the extent possible, a human judgment call. These procedures should be reviewed by multiple leaders in multiple departments to ensure that there is no small error that would trigger a larger one.

After you have the documents and have developed the procedures, it is time to test reporting. Typically, an FFI must be able to identify U.S. accounts, accounts held by recalcitrant account holders and accounts held by non-participating FFIs. After identifying the account types, the FFI must report the amounts paid, close or transfer certain accounts and deduct and withhold certain amounts. This means the account management software must be updated to include all the variables for these different reports. This includes account-type variables, threshold amounts, ownership information for commercial account holders as well as U.S. indicia variables. Indicia of U.S. variables include:

• designation of the account holder as a U.S. citizen or resident;
• U.S. place of birth;
• U.S. residence or mailing address;
• U.S. telephone number;
• Standing instructions to pay amounts in the account to a U.S. account;
• A current power of attorney or signatory authority granted to a person with a U.S. Address; and
• A U.S. “in care of” or hold mail address that is the sole address the FFI has identified for the account holder.

In the case of aggregate balances greater than $1 million, an FFI must do an enhanced review, identifying accounts to which a relationship manager is assigned and where that manager has actual knowledge that the account holder is a U.S. citizen, and an additional review of non-electronic records. IT departments should be working closely with compliance departments to get this in place.

Conclusion

There are resources that can help. There are many private companies and lawyers who assist financial institutions with their FATCA compliance and software programs that are developed with FATCA in mind. The IRS has a comprehensive FATCA resource website that answers a lot of questions for individuals, FFI's, U.S. Financial Institutions, Governments and Compliance Departments. There are numerous guides and compliance management tools that can help corporate and compliance counsel navigate the regulations and test internal compliance models.

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Ashley Elmore Drew and Adam J. Knight practice in the Financial Services Litigation group at Burr & Forman in the firm's Tampa, FL, office. Reach them at [email protected] and [email protected], respectively.