Treasury Releases Final FATCA Regulations Richard J. Horne, Brian A. - PDF document

Treasury Releases Final FATCA Regulations Richard J. Horne, Brian A. Silikovitz and Christina M. Iafe of Lowenstein Sandler LLP On January 17, 2013, the U.S. Treasury Department released final regulations implementing sections 1471 through 1474 of the Internal Revenue Code (the "Code"), commonly known as the Foreign Account Tax Compliance Act or "FATCA." The final regulations retain the basic withholding and reporting requirements that were adopted under the proposed regulations. However, the final regulations contain some important changes from the proposed regulations and previous administrative guidance. [1] Highlights of the final regulations and a revised implementation timeline are provided below. An Effort to Fight Tax Evasion FATCA, enacted as part of an effort to combat tax evasion, generally imposes new U.S. information and reporting requirements on "foreign financial institutions" ("FFIs") that maintain U.S. accounts. FATCA also imposes increased disclosure obligations on certain "nonfinancial foreign entities" ("NFFEs"). FATCA generally requires FFIs (but not NFFEs) to enter into an agreement with the IRS (an "FFI Agreement") (i) to comply with verification, due diligence, and information reporting with respect to its U.S. accounts and (ii) to withhold 30% on certain payments (referred to as "passthru payments") attributable to U.S. assets that are made to holders who do not provide the required information to the FFI or to FFIs that have not themselves entered into an FFI Agreement. FFIs that enter into an FFI Agreement will be considered "participating FFIs" ("PFFIs"). Non-PFFIs will be subject to a 30% withholding tax on certain U.S.-source income and gains, as well as on passthru payments. NFFEs that fail to comply with their reporting obligations will be subject to a 30% withholding tax on certain U.S.-source income and gains. Significant Changes from Proposed Regulations Extension of Withholding Dates Payments subject to withholding under FATCA ("withholdable payments") include (i) U.S.- source interest, dividends, and other fixed or determinable, annual or periodical ("FDAP") payments; (ii) gross proceeds from the disposition of property of a type that can produce U.S.-source FDAP income; and (iii) "foreign passthru payments," which the final regulations reserve defining. Consistent with IRS Announcement 2012-42 ("Ann. 2012-42"), the final regulations extend the date for withholding on gross proceeds by two years to January 1, 2017. Withholding on foreign passthru payments will begin on the later of January 1, 2017, or six months following publication of regulations defining foreign passthru payments.

Expansion of Grandfathering Rules "Grandfathered obligations" are generally outside the scope of FATCA. The final regulations extend by one year the date on which certain obligations will be considered grandfathered. Therefore, under the final regulations, withholding will not be required on any obligation that has a stated maturity and is issued or entered into before 2014 (and is not significantly modified after 2013). The final regulations also implement and expand Ann. 2012-42 by including the following as "grandfathered obligations":  Any obligation that produces or could produce a foreign passthru payment and that cannot produce a withholdable payment, provided that the obligation is outstanding as of the date that is six months after the date on which the final regulations defining the term "foreign passthru payment" are finalized (thus, non-PFFIs, such as foreign funds that do not enter into an FFI Agreement, will not be subject to withholding under FATCA on debt obligations, swaps and other derivative contracts that produce foreign-source income and that are entered into with foreign counterparties prior to six months after the regulations on foreign passthru payments are finalized);  Any instrument that gives rise to a withholdable payment solely because the instrument is treated as giving rise to a U.S.-source "dividend equivalent" under Code section 871(m) and the regulations thereunder (such as payments on certain equity swaps where payment is contingent upon, or determined by reference to, U.S.-source dividends), provided that the instrument is outstanding on the date that is six months after the date on which instruments of its type first become subject to such treatment;  Any obligation to make a payment with respect to, or to repay, collateral posted to secure a grandfathered obligation. This is broader than Ann. 2012-42, which provided that only collateral posted to secure a notional principal contract would be considered a grandfathered obligation. The final regulations also clarify that if collateral secures both grandfathered and non-grandfathered obligations, the collateral must be allocated among all of the obligations according to their value; and  Debt issued in a "qualified reopening" if the issue date of the original debt is within the grandfathering period. Modification of "Financial Institution" Definition The final regulations modify the definition of "financial institution" by clarifying when depository institutions and investment entities will be within the scope of the term. An entity is a depository institution only if it both accepts deposits and engages in one or more enumerated banking activities. Entities merely accepting deposits as collateral pursuant to a lease, loan, or similar financing arrangement, or that perform money transfers, will not be considered depository institutions. Under the final regulations, an investment entity includes any entity primarily conducting certain investment activities on behalf of customers, including: (i) trading in certain financial instruments; (ii) professional portfolio management; and (iii) managing or investing money or other financial assets. This new definition ensures that entities functioning as fund managers will be considered financial institutions. Passive entities that are not professionally

managed, including certain "home offices" and family trusts, may not be considered FFIs (and will instead be considered passive NFFEs). New Deemed-Compliant FFI Categories The final regulations create an additional deemed-compliant FFI category for certain pre- FATCA CLOs that qualify as "limited life debt investment entities." A "limited life debt investment entity" will not be subject to FATCA withholding until 2017 if:  It is not a depository or custodial institution or insurance company;  It was formed pre-2012 to purchase and hold limited types of debt and will liquidate on or before a set date (under its organizational documents);  Payments to investors are made through a trustee or cleared through a clearing organization that is a PFFI or U.S. person; and  Its organizational documents cannot be amended without unanimous investor agreement, and such documents do not permit the trustee to be FATCA compliant. Although this category was designed to provide relief to pre-FATCA CLOs, it is not likely to be of much value since these requirements will be difficult to meet. Most CLO indentures do not require unanimous consent for certain amendments. Additionally, even if a pre-FATCA CLO were to qualify for the exception, the exception would only last until 2017. The final regulations also introduce new categories of deemed-compliant FFIs for certain credit card issuers and sponsored FFIs. Registration process for FFIs The preamble to the final regulations outlines the procedure for FFIs to comply with their FATCA obligations. The IRS intends to provide a secure online portal for FFIs to register as PFFIs or deemed-compliant FFIs and enter into FFI Agreements. Each registered FFI will also be assigned a "Global Intermediary Identification Number" ("GIIN") by the IRS. The online portal will be available no later than July 15, 2013, and assignment of GIINs is intended to start no later than October 15, 2013. The IRS plans to publish a monthly list of PFFIs and registered-deemed compliant FFIs, which withholding agents can use to verify an FFI's FATCA status, starting on December 2, 2013. Intergovernmental Agreements The final regulations endeavor to coordinate their obligations with the "intergovernmental agreements" ("IGAs") that some governments are negotiating with the U.S. as an alternative to FATCA compliance. The U.S. has provided two types of IGAs that partner jurisdictions may enter into: Model 1 Agreements and Model 2 Agreements. Under a Model 1 Agreement, FFIs will report information directly to their home governments, which will then automatically transmit the information to the IRS. This will require the foreign government to enact legislation under which resident FFIs will report information to the foreign government instead of directly to the IRS. The final regulations confirm that FFIs in these jurisdictions will not need to enter into FFI Agreements to be FATCA compliant. Under a reciprocal version of a Model 1 Agreement, the U.S. will also agree to report information to the partner jurisdiction. Under a