FATCA: What Do We Do? - americanbar.org New US Withholding Tax • FATCA enacted a new 30%...

© 2011 Dechert LLP

FATCA: What Do We Do?

Michael Hirschfeld, Dechert LLP

Tel: (212) 698-3635

E-mail: [email protected]

September 27, 2011

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September 27, 2011

FATCA: What Do We Do?2

The Abuse That Spawned FATCA

• Some US investors hid their identity or created offshore companies to hold US investments:

– Evaded US withholding tax system

– Failed to pay tax on the income

– Failed to comply with US tax reporting/disclosure rules

September 27, 2011


Reaction To Abuse

• IRS

– Foreign Bank Account Reporting (FBAR) crackdown

• Voluntary Disclosure Program

– Civil Penalties

– Criminal Prosecution

• Congress

– Felt they had to act

• FATCA was the result

September 27, 2011


Foreign Account Tax Compliance Act (“FATCA”)

– Signed into law March 18, 2010

– Created New Internal Revenue Code sections 1471-1474

– Guidance: 3 IRS Notices (2010-60, 2011-34, & 2011-53) so far; much more to come

September 27, 2011


FATCA’s Objective

• “Smoke out” U.S. taxpayers who are evading U.S. tax by making investments and receiving payments from U.S. through offshore structures

• Enforces U.S. government’s disclosure goal by imposing a 30% withholding tax on certain payments to certain foreign persons unless foreign person provides information regarding U.S. owners and accountholders

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Effective Date

• Originally applied to payments made after December 31, 2012

• IRS delayed implementation until 2014 (and later) –Notice 2011-53

• BUT before you relax

– Action is needed now, as we will see below, &

– Chance of repeal before it takes effect:

• “Slim to none”

September 27, 2011


Maze Of FATCA Definitions We Will Discuss

FFI = Foreign Financial Institution

PFFI = Participating FFI

NFFE = Non-financial foreign entity

Financial Account

US Account

Specified US Person and US Person

Substantial US Owner

Recalcitrant Account Holder

Withholdable Payment

Passthru Payment

September 27, 2011


Creates New US Withholding Tax

• FATCA enacted a new 30% withholding tax on “withholdable payments” to certain foreign persons, unless:

(1) Exception applies,

(2) “Grandfather” transition rules are met, or

(3) New reporting requirements are satisfied

September 27, 2011


“Withholdable Payments”- Broad Definition

• Any U.S.-source payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensation, and other fixed or determinable annual or periodical gains, profits, and income as well as

• Any gross proceeds from sale or disposition of any property which can produce U.S.-sourced interest or dividends

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Who Must Withhold?

• “Withholding Agent”

– Any person (whether a U.S. person or a foreign person) having control, receipt, custody or payment of any withholdable payment

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FATCA Reporting Regimes

• FATCA imposes two separate reporting regimes on two classes of entities:

– “Foreign Financial Institutions” (“FFIs”)

and

– “Non-Financial Foreign Entities” (“NFFEs”)

• Broad exceptions from NFFE status under Notice 2010-60

September 27, 2011


Who Is An FFI?

• Any foreign entity that:(1) “Accepts deposits in ordinary course of banking or similar business;”

(2) “As a substantial portion of its business, holds financial assets for the account of others,”or

(3) “Is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities…partnership interests, commodities… or any interest (including a futures or forward contract or option) in such securities, partnership interests orcommodities”

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Scope Of FFI

• Covers all types of Investment Funds:

– Private Equity Fund

– Hedge Fund

– Venture Capital Funds

– UCITs

– Exemptions?

• Deemed Compliant FFI

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Deemed Compliant FFI

• Notice 2011-34 created a limited exception (next slide) & said IRS is considering added exceptions, BUT under narrow circumstances that are disappointing to the industry

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Deemed Compliant FFI If:

(1) All direct investors must be participating FFIs or deemed-compliant FFIs holding on behalf of others, or certain excluded entities per § 1471(f) (e.g., foreign governments, central banks);

(2) Fund must explicitly limit ownership to above persons; and

(3) Fund certifies it will calculate and publish any passthru payment percentages (see below).

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#1: Considering Deemed Compliant FFI If:

• All the interests in fund are regularly traded on an established securities market (e.g., exchange-traded funds (ETFs)).

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#2: Considering Deemed Compliant FFI If:

(i) All direct interest holders in fund are participating FFIs, USFIs, deemed-compliant FFIs, entities described in section 1471(f), or non-participating FFIs acting as distributors;

(ii) Distribution or similar agreements prohibit sales of interests to specified U.S. persons, NFFEs other than excepted NFFEs, and non-participating FFIs holding for their own account;

(iii) Each distributor agrees to enforce the sales prohibitions described in (ii) above, and

(iv) The fund satisfies other requirements and meets other criteria relevant to the purposes of chapter 4.

September 27, 2011


Burden On Deemed Compliant FFI

• Required to:

– Apply for deemed compliant status with IRS (not automatic)

– Obtain an FFI identification number (FFI-EIN) from IRS

– Certify to the IRS every three years that it meets requirements

September 27, 2011


Uncertain Impact Of FFI’s Debt

– Treatment of debt is still unclear • Debt is technically a “financial account” unless regularly traded

on “established securities market”

– Thus, if FFI has a foreign creditor, this could constitute foreign “financial account” that prevents the FFI from qualifying for deemed-compliant status

September 27, 2011


Burden Of Being An FFI

• Unless exception applies, FFIs must enter into agreements (“FFI Agreement”) with IRS, under which FFI agrees to comply with FATCA reporting & related requirements

• Otherwise 30% tax must be withheld

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Content Of FFI Agreement

• Exact scope is not yet clear but it will cover:

– New due diligence requirements

– New Repository obligations

– New Withholding burden on payments to recalitrant holders and non-participation, FFI

• Expect application process will start online by 1/1/13

• In Notice 2011-34, IRS set forth two requirements to get the FFI Agreement:

September 27, 2011


Required Certification #1

• Responsible officer will be required to certify that:

– FFI had written policies and procedures in place as of the effective date of the FFI’s FFI Agreement prohibiting its employees from advising U.S. account holders on how to avoid having their U.S. accounts identified.

– BUT there is one more certification---

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Required Certification #2

• Responsible officer must certify that, between publication date of Notice (May 9, 2011) and effective date of FFI Agreement:

– FFI management personnel did not engage in any activity, or haveany formal or informal policies and procedures in place, directing, encouraging, or assisting account holders with respect to strategies for avoiding identification of their accounts as U.S. accounts under the procedures described above.

– Can this certification be given absent adoption of express policy?

September 27, 2011


Apart From FFI, Who Is A NFFE?

• “Any foreign entity which is not a financial institution”(as defined for purposes of the FFI rules)—in other words, everybody else

– But Notice 2010-60 took a relaxed view as to who are NFFEs by excluding many entities from such status

September 27, 2011


NFFE Requirements

• Unless an exception applies, NFFEs must provide the withholding agent with either:

– Certification that the NFFE does not have any “substantial U.S. owners,” or

– The name, address, and TIN of each “substantial U.S. owner” of the NFFE

• Otherwise the 30% tax must be withheld

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Who Are The People That FATCA Wants A Fund To Identify?

• US Accounts, which are accounts owned by:

– Specified “US Persons”

– US owned foreign entity

• Exists if “substantial US owner”

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“US Persons”

• Tax concept may not match what you may think is a US person

– SEC Concept (Rule 902):

• US Person = Any natural person resident in the United States

– Tax Concept:

• US Persons = US citizens (no matter where they reside) & US residents

• Much broader definition than SEC view

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“Substantial U.S. Owner”

• “Specified U.S. person” that:

– Owns, directly or indirectly, more than 10% of the:

• Stock of a corporation (by vote or value) or

• Profits or capital interests in a partnership

– Comment: Lower threshold than what you have used before

September 27, 2011


“Substantial U.S. Owner” (cont’d)

• Is treated as owner of any portion of trust under grantor trust rules;

• Is treated as owning, directly or indirectly, more than 10% of beneficial interests in a trust (to the extent provided in forthcoming Regulations); or

• Owns, directly or indirectly, any portion of a foreign entity that is engaged or holds itself out as being engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, interests or commodities

September 27, 2011


“Specified U.S. person”

• A “specified U.S. person” is any U.S. person other than:

– A publicly traded corporation or member of the affiliated group of a publicly traded corporation,

– A tax exempt organization or IRA,

– The U.S. gov’t or a state gov’t, or any subdivision or wholly-owned agency or instrumentality thereof,

– A bank, REIT, RIC, common trust fund, or exempt charitable trust

September 27, 2011


How Do You Determine The Status Of Your Investors?

• Pre-existing Individual Accounts

– General rule

• Low value ($50,000 or less) account exemption:

– High Value Accounts ($500K or more)

– Private Banking Accounts/Private Banking Relationship

– Multi-Step Process

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Step One

• Low Value ($50K or less) Accounts

– Do not worry about

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Step Two

• Private banking department accounts

– Detailed scrutiny is required that goes beyond searching electronic database

– Search for the recurring and ask more questions if they exist

• Identification of holder as a US citizen or resident

• US place of birth

• US address

• Standing instructions to transfer funds to US account

• Hold mail or c/o address as sole address

• Power of Attorney / signatory authority given to US person

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Step Three

• Electronic database search for “US indicia”

– Identification of holder as a US citizen or resident

– US place of birth

– US address

– Standing instructions to transfer funds to US account

– Hold mail or c/o address as sole address

– Power of Attorney / signatory authority given to US person

• But do not have to search – PDF and scanned documents

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Step Four

• High value account ($500K or more)

– More diligent review that goes beyond electronic database

• Must check account files

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Step Five

• Annual retesting

– Required beginning in the third year following effective date of FFI Agreement

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Relationship Of FATCA To Existing Withholding Tax Regime

• FATCA requirements and withholding is intended to be integrated with the already existing foreign withholding scheme, but not to double the amount of tax:

– For example, the maximum withholding rate is not 60% (30% FATCA + 30% interest/rents/FDAP withholding)

– If 30% FATCA withholding is required, no additional withholding tax is imposed under the previously existing foreign withholding scheme

September 27, 2011


Effective Date

• Generally these rules now apply to withholdable payments made after December 31, 2013 (or later).

• But FATCA generally not applicable to:

– Certain “obligations” outstanding on March 18, 2012, or

– Gross proceeds from the disposition of such obligations

September 27, 2011


Passthru Payments

• Complex new term you will need to understand

• Why?

– Participating FFI must deduct and withhold a tax equal to 30 percent of any “passthru payment” made to a recalcitrant account holder or non-participating FFI.

September 27, 2011


Recalcitrant Holder

• Holder who fails to:

– Comply with reasonable requests for information necessary to determine if account is a US account

– Provide name, address, and TIN of each specified US person and each substantial US owner

– Provide “waiver” of any foreign law that would prevent FFI from reporting required information

September 27, 2011


Passthru Payment-Clarification?

• Passthru payment is defined as any withholdable payment or other payment to the extent attributable to a withholdable payment.

• In Notice 2011-34, IRS gave guidance that highlights the complexity of this new term and burden placed on Funds.

September 27, 2011


Passthru Payment (cont’d)

• Payment is a passthru payment to extent of:

– Withholdable payments plus;

– Portion that is not a withholdable payment multiplied by “passthru payment percentage” (or PP%) of payee FFI (or use PP% for custodial payments)

September 27, 2011


Passthru Payment Percentage

• Based on FFI’s assets

– PP% = US Assets / Total Assets

– Tested quarterly, with four most recent quarters averaged

– Use gross assets on financial statements

– Look thru rule for lower-tier FFI

– Must publish quarterly

• If do not publish, then PP% = 100%

September 27, 2011


Passthru Payment Percentage (cont’d)

Example:

Fund A, a fund of funds, has total assets of $100M, which consists of:

1. $20M: Interest in Fund B, nonparticipating FFI

2. $30M: Interest in Fund C, participating FFI with 50% PP%

3. $10M: Interest in Fund D, participating FFI that did not publishPP%

4. $40M: Interest in Fund E, domestic corp.

September 27, 2011


Passthru Payment Percentage (cont’d)

Example (cont’d):

Fund A’s PP percentage is 65%, calculated as follows:

US Assets = $65M

• Fund B = 0

• Fund C = $15M

• Fund D = $10M

• Fund E = $40M

Total Assets = $100M

September 27, 2011


What Do We Do?

• More guidance is needed BUT Funds need to act now:

– Do we change our business model?

– Do we adopt procedures to halt abuses that FATCA was addressing?

– Do we begin the process to become FATCA compliant?

• Update electronic database

• Check records

– More?

September 27, 2011


• So first, assess your infrastructure

– Can you identify US persons (remember: there are at least three definitions of US persons commonly used by fund managers; do your forms reflect them all correctly?)

– Can you identify US-sourced income?

• Then assess your exposure

– How many US investors? How large are their holdings?

– How much of portfolio investments will result in US-sourced income? Are there acceptable alternatives?

September 27, 2011


• Minimizing the Burden:

– If you have minimal exposure to US investments, complete withdrawal from US markets may make sense. But participating FFIs may be reluctant to do business with you.

– Entities that never have US investors may be able to reach agreement with the IRS. But we don’t know that the IRS will be receptive.

– In some cases, compliance and agreement with the IRS could be relatively straight-forward—especially for entities that are not widely held.

Bottom line: Either stop investing in the US, find an exemption or comply.

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• Start now:

– There is still some uncertainty regarding the exact form that FATCA will take. But there is not enough time to wait for all possible guidance.

– The key to getting the best possible outcome is obtaining the best possible information efficiently and quickly (e.g., if you are updating your KYC process, consider FATCA updates at the same time).

– You’ll also need to review relationships with custodians and data providers.

September 27, 2011


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IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any U.S. federal tax advice contained in this PowerPoint is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the U.S. Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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FATCA: What Do We Do? - americanbar.org New US Withholding Tax • FATCA enacted a new 30%...

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