Foreign Account Tax Compliance Act (FATCA) What Is It & Why - - PDF document

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Foreign Account Tax Compliance Act (FATCA)

What Is It & Why Should I Care? Presented by: Cynthia J. Hoffman, CPA, J.D. Director of International Tax Advisory Services Schneider Downs & Co., Inc. April 29, 2014

What is FATCA?

Foreign Account Tax Compliance Act (“FATCA”)

 Part of HIRE Act enacted March 18, 2010  Adds new Chapter 4 to Internal Revenue Code  Effective July 1, 2014

• Purpose to gather information on U.S. tax evaders with offshore assets earning

income not reported

• Increase transparency for the IRS with respect to U.S. persons that are investing and

earning income through non‐US institutions

• Requires foreign payees to disclose significant U.S. investors & accountholders
• Foreign payees who fail to comply suffer penalty of 30% U.S. tax withholding on

payments made to them from “U.S. persons”

• Final regulations package issued February 20, 2014

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Why Should I Care About FATCA?

• U.S. and Foreign withholding agents are required to administer the new rules
• This creates an additional set of withholding and reporting rules for U.S. persons who

make payments to foreign persons

• July 1, 2014 for NEW vendors and new obligations
• Transitional rules on preexisting obligations
• New information reporting by U.S. persons of specified foreign financial accounts
• Form 8938 (beginning with 2011 tax year)

 This casts a WIDE NET, since it applies to any U.S. person

• Penalties

– Withholding agent secondary liable – Failure to report on Form 1042 – Failure to file Form 8938 (if applicable)

• Up to $10,000, plus criminal prosecution

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Not‐for‐Profit Entities – Common Transactions

• Common items of concern for NFP’s:
• Payments for funding of off‐shore investments (hedge funds, private equity, foreign

partnerships, etc.)

• Management fees to off‐shore investment managers
• Payments for services to foreign persons (where services are performed in the U.S.)
• Payments to foreign pensioners
• Royalty, interest and other FDAP payments
• What about distributions from foreign sources?

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How Does FATCA Work?

• Foreign Financial Institutions (“FFI’s”)
• Required to register and enter an agreement with the U.S. Department of

Treasury

• Register on‐line & obtain a global intermediary identification number (“GIIN”)
• Deadline now May 5, 2014
• IRS will begin publishing monthly FFI List beginning June 2, 2014
• Determine which accounts are “U.S. accounts”, comply with verification and

due diligence procedures, annually report the U.S. accounts to the U.S. Treasury, withhold 30% on recalcitrant account holder and “nonparticipating FFI’s”

• Certain Non‐Financial Foreign Entities (“NFFE’s”)
• Provide information regarding U.S. owners, or
• Certify eligibility for exempted “low‐risk” status

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What is a “Foreign Financial Institution”?

• What is a “Foreign Financial Institution”?

‐ Any foreign entity that:

• Accepts deposits in the ordinary course of banking or similar

business;

• Holds financial assets for the account of others as a substantial

portion of its business; OR

• Is engaged in primarily in the business of investing, reinvesting, or

trading in securities, partnership interests, or commodities  This may include investment vehicles such as hedge funds and private equity funds

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Types of FFIs

Not all FFIs classifications are the same

• Classification depends on a variety of factors including:
• Local government’s participation and compliance
• Reporting restrictions in local country
• Type of IGA signed by local government
• Individual actions taken by FFI
• Four primary types
• Model 1 or Model 2 participating FFI – treated as complying under an IGA in

force

• Non‐IGA FFI – not covered under an existing IGA but independently complies

with IRS regulations

• Limited – entities unable to comply with FATCA due to local law restrictions
• Registered Deemed‐Compliant FFI – certain other limited classes of FFIs
• Non‐participating – FFI that does not enter into an agreement with the IRS

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What is a “Non‐Financial Foreign Entity”?

• What is a Non‐Financial Foreign Entities?

‐ Any foreign entity that is not a financial institution ‐ Exempted Status:

• Publicly traded corporations and members of an expanded affiliated group

that includes a publicly traded corporation

• Certain nonfinancial holding companies and captive finance companies
• Entity organized under the laws of a US possession and wholly owned by bona

fide resident(s) of the possession

• Foreign government or any political subdivision thereof
• International organization
• Active NFFE’s
• Derives less than 50% of gross income from passive sources, and less

than 50% of its assets are passive assets

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Types of NFFEs

Three primary types

• Direct‐reporting – an NFFE that elects to directly report information on

substantial U.S. owners on Form 8966 instead of reporting to the W/H agent

• Sponsored Direct – NFFE sponsored by another entity, which will report

directly to the IRS information about each NFFE’s direct or indirect substantial U.S. owners

• Excepted – NFFEs receiving exempt status under the Code and regulations

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Intergovernmental Agreements (IGAs)

What is an IGA?

• Agreements signed between the U.S. and foreign partner governments to

cooperate in the identification and reporting of U.S. account holders

• Two basic types:
• Model 1 – standard agreement for FFIs to report directly to local country

government

• FFI register separately with the IRS
• Local country gov’t exchange information with the U.S.
• Model 2 – modified agreement to address local country legal conflicts
• FFI reports directly to the IRS about information on U.S. account holders

 Currently the U.S. has Model 1 IGAs in effect with 46 countries (24 pending) and Model 2 IGAs in effect with 5 countries (1 pending) http://www.treasury.gov/resource‐center/tax‐policy/treaties/Pages/FATCA.aspx)

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Existing Withholding Rules – Chapter 3

 IRC §1441 under Chapter 3

• U.S. Withholding Tax on payment of:
• U.S. sourced;
• Fixed, determinable, periodic income
• Does not apply to Effectively Connected Income (“ECI”)
• Does not apply to Portfolio Interest
• Rate is currently 30%, unless reduced by income tax treaty
• Reduction (or exemption) on withholding must be requested by receiving:
• Form W‐8BEN, Form W‐8BEN‐E, Form W‐8ECI, Form W‐8IMY, Form 8233 (compensation)

 Note there are some New & Revised Forms as of April 2014 – what happens with existing forms?

• Form 1042 & Form 1042‐S Reporting
• Report Gross Income of US Sourced Payment & Tax Withholding (if applicable)
• Annually report to foreign recipient

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Existing Withholding Rules ‐ Examples

• USCo makes a monthly management fee payment to its foreign parent, ForCo .

The services provided by ForCo are performed in Japan. Are these services subject to withholding tax under Section 1441? Are the services subject to reporting on Form 1042?

• USCo makes a quarterly payment of interest to a bank located in the Cayman
• Islands. There is no income tax treaty with the Cayman Islands. Is this interest

subject to withholding tax under Section 1441? Is the interest subject to reporting

• n Form 1042?
• USCo makes a dividend payment to its foreign parent located in Germany. The

U.S.‐German income tax treaty exempts dividends from tax. Is the dividend subject to withholding tax under Section 1441? Subject to reporting on Form 1042?

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FATCA Withholding Rules – Chapter 4

 IRC §§1471–1474 of Chapter 4 Starts with Section 1441 (existing rules), adds gross proceeds (from sale of U.S. securities), then subtracts non‐financial payments and grandfathered payment. Note that all payments are reportable, just not withholdable.

• U.S. Withholding Tax on payment of:
• U.S. sourced;
• Fixed, determinable, periodic income AND
• Gross proceeds from sale of U.S. securities
• Rate is currently 30%; CANNOT be reduced by income tax treaty
• “Grandfathered” debt:
• Payments under obligations outstanding on July 1, 2014
• No material modification of underlying obligation

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FATCA Withholding Rules – Chapter 4 (cont.)

• Revised Form W‐8BEN (Individuals)
• New Form W‐8BEN‐E
• Now 6 pages long including over 20 entity classification types
• List of registered FFI’s and GIIN published by June 2, 2014
• Form W‐8BEN‐IMY (pass‐through payments)
• Certificate of Foreign Intermediary, Foreign Flow‐through Entity, or Certain U.S. Branches for

US tax Withholding

• Intermediary /agent payments have expanded to include “financial institutions” under the

Chapter 4 definition, thereby including investment entities and specified insurance companies

• Form 1042 & Form 1042‐S Reporting – REVISED FORMS

– Reporting may include additional information your systems are not currently capturing

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FATCA (Chapter 4) Withholding Timelines

• July 1, 2014
• Withholding starts on all U.S. source FDAP payments to new vendors and on new
• bligations
• January 1, 2015
• Withholding starts on U.S. source FDAP payments under preexisting obligations to non‐

participating FFI’s

• March 15, 2015
• Forms 1042 and 1042‐S due for 2014 reportable payments on or after July 1, 2014
• July 1, 2016
• Withholding and reporting starts on U.S. source FDAP payments under preexisting
• bligations to remaining FFI’s

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FATCA Implementation Timeline

16 July 1 1) IRS begins monthly publishing of FFI List 2) 30% w/h applies to payments of certain U.S. source income made to non‐U.S. FFIs and other entities

• Jan. 1

Ability to register as an FFI opens Annual reporting begins for certain FFIs in non‐IGA and Model 2 jurisdictions

• Mar. 31
• Mar. 15

Withholding agents required to file Form 1042 and 1042‐S

• Sept. 30

Reporting begins for certain FFIs in Model 1 jurisdictions May 2 Initial FATCA Registration application due to the IRS

2014 2015 2016

• Mar. 31

Certain FFIs in non‐IGA and Model 2 jurisdictions required to begin reporting income paid (except gross proceeds from sale of property)

• Sept. 30

Certain FFIs in Model 1 jurisdictions required to begin reporting income paid (except gross proceeds from sale of property)

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Documentation – Forms W‐8BEN, et. al.

New Form W‐8BEN‐E – Released on March 29, 2014

• To be used by entities to certify beneficial owner status of income
• Should be collected by payor prior to making payment

 Individuals will continue to use Form W‐8BEN (finalized as of March 4, 2014)

Validity of existing forms

• General rule – Form W‐8BEN will remain valid for a period starting from date it

is signed and ending on last day of 3rd succeeding calendar year

• Prior W‐8 Forms that were valid until December 31, 2013 will now be treated

as valid until December 31, 2014 (extended from June 30, 2014) 3‐year validity rule & exceptions – Chapter 3 changed to agree with Chapter 4  Advise clients to begin collecting new forms from foreign payees ASAP

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New Withholding Rules under FATCA ‐ Examples

USCo makes a monthly management fee payment to its foreign parent, ForCo . The services provided by ForCo are performed in Japan. Are these services subject to withholding tax under: – FATCA (Chapter 4)? – Section 1441 of Chapter 3? – Subject to reporting on Form 1042? USCo makes a quarterly payment of interest to a bank located in the Cayman Islands. There is no income tax treaty with the Cayman Islands. Is this interest subject to withholding tax under: – FATCA (Chapter 4)? – Section 1441 of Chapter 3? – Subject to reporting on Form 1042? USCo makes a dividend payment to its foreign parent located in Germany. The U.S.‐German income tax treaty exempts dividends from tax. Is the dividend subject to withholding tax under: – FATCA (Chapter 4)? – Section 1441 of Chapter 3? – Subject to reporting on Form 1042?

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Action Steps

• Identify who is going to take responsibility for FATCA compliance
• Undertake an assessment to identify the relative impact of FATCA on the
• rganization and budget needed to address steps necessary to comply
• Due diligence procedures need to be in place to assess whether payments to

foreign persons have been properly classified and documented

– Determine if a withholdable payment exists – Determine a course of action regarding FORMS to be obtained – Determine if any exceptions for relief apply to either the type of payment or the type of entity receiving the payment – Procedures for withholding, paying withheld tax and reporting

 Written policies and procedures – IRS will ask for this upon audit  Be prepared for questions from foreign payees about forms W‐8BEN

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FATCA Help ‐ Websites

• IRS Tax Map for FATCA materials (Complete list IRS resources currently available

through website) – http://taxmap.ntis.gov/taxmap/ts0/foreignaccounttaxc_o_62bff6a0.htm

• IRS FAQ List – http://www.irs.gov/Businesses/Corporations/Frequently‐Asked‐

Questions‐FAQs‐FATCA‐‐Compliance‐Legal#Financial

• Model Intergovernmental Agreements – http://www.treasury.gov/resource‐

center/tax‐policy/treaties/Pages/FATCA.aspx#ModelAgreements

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Q&A

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