Treasury and IRS issue proposed FATCA regulations - EY · PDF fileTreasury and IRS issue...

International Tax Alert

14 February 2012

Treasury and IRS issue proposed FATCA regulationsTreasury releases joint statement on intergovernmental agreement on FATCA implementation

Executive summary

On 8 February 2012, Treasury and the IRS issued long-awaited proposed regulations under the Foreign Account Tax Compliance Act (FATCA) provisions of Sections 1471 – 1474 (also referred to as the “chapter 4” provisions). The proposed regulations address many, but not all, of the major items requiring further clarification following the three prior notices issued on FATCA. They also reflect the government’s considerable attention to comments it has received from affected financial institutions, foreign governments and other stakeholders on the magnitude of the burdens associated with the various elements of FATCA, incorporating approaches aimed at reducing the compliance burden while maintaining the policy objective of improved information reporting on US taxpayers with assets invested in non-US jurisdictions.

At the same time the proposed regulations were released, Treasury also released a joint statement from the United States, France, Germany, Italy, Spain and the United Kingdom announcing an agreement to explore an intergovernmental approach to FATCA implementation that would allow foreign financial institutions (FFIs) in each country to provide the information required under FATCA to that country’s tax authorities rather than to the IRS.

http://www.ofr.gov/OFRUpload/OFRData/2012-02979_PI.pdf

http://www.ofr.gov/OFRUpload/OFRData/2012-02979_PI.pdf

http://www.treasury.gov/press-center/press-releases/Documents/020712%20Treasury%20IRS%20FATCA%20Joint%20Statement.pdf

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The proposed regulations reflect significant modifications or elaborations in several key areas that are critical to FFI and to US financial institutions, which are no longer referred to as “USFIs,” but rather are referred to as part of the larger population of “withholding agents.”

The account identification requirements set forth in the proposed regulations incorporate substantial changes that are consistent with the extensive comments received. For pre-existing accounts, the proposed regulations include enhanced de minimis exceptions, eliminate the controversial “private banking” rules proposed in Notice 2011-34, and generally allow an FFI to rely on an electronic review of its records for pre-existing accounts with a balance or value of $1 million or less. For new accounts, the proposed regulations reflect a greater reliance on documentation gathered for other purposes. These rules reflect an intention to minimize the circumstances in which FFIs would need to go back to account holders for additional documentation or modify account opening procedures on a going-forward basis.

The proposed regulations extend qualification as a grandfathered obligation (which is not subject to FATCA withholding) to obligations outstanding on 1 January 2013. The proposed regulations also expand the categories of FFIs that will be deemed compliant with FATCA’s requirements. In addition, the proposed regulations provide greater

flexibility in the treatment of FFIs in an affiliated group so that barriers to compliance by one affiliate will not taint the whole FFI group.

The proposed regulations reflect a phase-in of dates for FATCA reporting requirements applicable to FFIs as follows:

• The identity of US account holders must be reported starting in 2014 (for the 2013 calendar year);

• Information about income on US accounts must be reported starting in 2016 (for the 2015 calendar year); and

• Full information on US accounts, including information about gross proceeds, must be reported starting in 2017 (for the 2016 calendar year).

In addition, the FATCA withholding rules for FFIs will not apply to certain payments made before 1 January 2015, except for payments made to payees with certain indicia that they might in fact be FFIs (prima facie FFIs).

However, NFFEs remain subject to potential FATCA withholding on US-source fixed or determinable income paid by USFIs beginning 1 January 2014, and on gross proceeds beginning 1 January 2015. Furthermore, US financial institutions must still begin to look at new, nonresident alien entity accounts differently, starting 1 January 2013.

The proposed regulations reserve on the definition of foreign “passthru” payments and provide that

withholding will not be required on such payments before 1 January 2017.

In general, for US withholding agents that are not FFIs, the proposed regulations contain a demarcation line of 1 January 2013, for purposes of distinguishing between “new” and “pre-existing” accounts. Withholding agents must generally consider all documentation obtained for know-your-customer/anti-money laundering (KYC/AML) purposes from an account holder for new accounts when determining the account holder’s status for FATCA purposes. US withholding agents will be required to withhold on payments of US-source FDAP income paid to new accounts held by nonparticipating and presumed FFIs (i.e., entity account holders for which appropriate FATCA certifications have not been received) and pre-existing prima facie FFI accounts starting January 1, 2014, and on gross proceeds paid to nonparticipating and presumed FFIs starting 1 January 2015. While participating FFIs have a phase-in period for reporting under FATCA, US withholding agents that are not FFIs will apparently be required to begin reporting information about substantial US owners of nonfinancial foreign entities (NFFEs) as early as 15 March 2014, for the calendar year 2013, on a form yet to be published.

In addition, the preamble to the proposed regulations indicates that the existing chapter 3 (i.e., nonresident alien withholding and

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reporting) and chapter 61 (i.e., Form 1099 reporting) regulations will be amended effective 1 January 2014, to conform to the FATCA provisions. As a result, in addition to the existing “reasons to know,” withholding agents will be deemed to have reason to know a withholding certificate (e.g., Form W-8BEN) is unreliable if the withholding agent has a US telephone number on file for the account holder, or information indicating that an account holder was born in the United States. In such a case, the withholding agent would be required to obtain additional documentary evidence in order to rely on the Form W-8BEN. Conformity also means that, under the proposed regulations, withholding agents can only rely on a Form W-8 received more than one year after a payment is made if they also obtain documentary evidence as to the nonresident alien’s status. Finally, when the IRS conforms the existing regulations under chapters 3 and 61to the FATCA provisions after 31 December 2013, a withholding agent will be able to rely on a faxed withholding certificate if the withholding agent confirms that the person furnishing the form is the person named on it. Currently, this is not permitted.

A public hearing on the proposed regulations is scheduled for 15 May 2012. Written comments on the proposed regulations must be submitted 30 April if the commenter wishes to speak at the hearing.

For more background on FATCA and previous related guidance, see Tax Alerts: Notice 2010-60 provides

first round of Treasury and IRS guidance under new information reporting and withholding regime contained in the FATCA provisions, dated 2 September 2010, IRS Notice 2011-34 provides second round of Treasury and IRS guidance under FATCA information reporting and withholding regime, dated 20 April 2011, and Notice 2011-53 provides revised timelines for implementation of FATCA information reporting and withholding regime, dated 15 July 2011.

Detailed discussion

This Alert discusses the key sections of the proposed regulations in detail, highlights issues on which Treasury and the IRS have requested specific comments, and describes the Joint Statement on FATCA.

Prop. Treas. Reg. Section 1.1471-2 – Requirement to deduct and withhold tax on withholdable payments to FFIsWhen does withholding on payments to FFIs begin?Prop. Treas. Reg. Section 1.1471-2(a) generally provides that withholding agents must withhold at 30% on payments to certain FFIs, beginning with withholdable payments made after 31 December 2013, subject to the transitional exception discussed below. However, withholding is not required when a withholding agent can reliably associate the payment with documentation from a payee that it may treat as exempt from withholding, or when the payment is made with respect to a grandfathered obligation (see

definition below). Payments that are exempt from withholding based upon valid documentation from the payee include (1) payments to exempt beneficial owners; (2) payments to deemed-compliant FFIs; (3) payments to a “territory financial institution” (a financial institution organized in a US territory); and (4) depending on certain rules, payments to participating FFIs. The proposed regulations make clear that these rules apply to a withholdable payment consisting of gross proceeds and address withholding agent responsibility when there are multiple brokers involved.

Transitional exception to withholdingUnder the transitional exception, a withholding agent will not be required to withhold on a withholdable payment made before 1 January 2015, with respect to a pre-existing obligation of an undocumented FFI unless the payee is a “prima facie” FFI. A pre-existing obligation is an account, instrument or contract maintained or executed by the withholding agent as of 1 January 2013 (for a withholding agent that is a participating FFI, however, the relevant date is the date that the FFI agreement becomes effective). A prima facie FFI is (1) a payee that the withholding agent can identify as a qualified intermediary or a nonqualified intermediary via electronically searchable information, or (2) for accounts maintained in the United States, a payee that is presumed to be or is documented as a non-US entity for purposes of chapters 3 and 61, and for which the withholding agent has


recorded as part of its electronically searchable information certain North American Industry Classification Systems codes or Standard Industry Classification codes indicating that the payee is a financial institution.

Grandfathered obligationsProp. Treas. Reg. Section 1.1471-2(b) addresses grandfathered obligations. In a major change from prior guidance, this term is defined as an obligation (and any gross proceeds from the disposition thereof) outstanding on 1 January 2013, instead of outstanding on 18 March 2012. The definition of the term “obligation” remains generally the same as in prior guidance, meaning any legal agreement that produces or could produce a passthru payment. Passthru payment is defined under the proposed regulations as any withholdable payment and any “foreign passthru payment”; the definition of foreign passthru payment is reserved. An “obligation” does not include equity instruments (as defined for US tax purposes), relationships without a stated expiration or term, such as a savings deposit or demand deposit, or brokerage/custodial accounts that exist to hold other financial assets. A “master agreement” that does not set forth the specific terms of any particular contract is not an “obligation” for this purpose. However, a life insurance contract payable upon the earlier of the insured attaining a stated age or death is an “obligation.” The proposed regulations provided that

a material modification will cause an outstanding obligation to be treated as newly issued as of the date of the modification. The proposed regulations also explain how the grandfathered obligation rule applies to payments to flow-through entities (including trusts) and to amounts allocable to their respective partners, grantors or beneficiaries.

Who are “exempt beneficial owners”?Prop. Treas. Reg. Section 1.1471-3(d)(8) provides that exempt beneficial owners include non-US governments and governments of US possessions, international organizations, non-US central banks of issue, certain retirement funds, and certain entities wholly owned by exempt beneficial owners. In all instances, the withholding agent can rely on a valid withholding certificate that identifies the beneficial owner as an exempt payee. In addition, special documentation rules can be applied to all exempt beneficial owners.

For foreign governments and governments of US possessions and foreign central banks of issue, instead of a withholding certificate, a withholding agent may rely on a written statement from the payee specifying that it is an exempt beneficial owner if the payment being made is with respect to an offshore obligation. A payment made on an offshore obligation is a payment made outside the United States, as defined in Prop. Treas. Reg. Section 1.6049-5(e), with respect to an account, instrument

or contract maintained or executed at an office of the withholding agent located outside the United States or in any US possession. For pre-existing offshore obligations, the withholding agent may rely on an “eyeball test” to determine if the payee is a foreign government or government of a US possession or a foreign central bank of issue. A pre-existing offshore obligation is an offshore obligation that is also a pre-existing obligation.

Consistent with current rules, an international organization may be treated as an exempt beneficial owner without providing a withholding certificate if the payee has been designated an international organization under an executive order.

In lieu of a withholding certificate, certain retirement funds can qualify as an exempt payee with respect to offshore obligations if they provide a written statement, signed under penalty of perjury, that they meet the requirements of Prop. Treas. Reg. Section 1.1471-6(f) (discussed below), along with their organizational documents. Further, for pre-existing offshore obligations, the withholding agent may treat the retirement fund as an exempt beneficial owner if the withholding agent has documentary evidence establishing that the payee qualifies as a retirement fund in the country in which it is organized and if the payee is generally known to be a retirement fund in the country in which the withholding agent is located.


For entities that are wholly owned by exempt beneficial owners, in addition to a withholding certificate, the withholding agent must receive an owner reporting statement, and documentation from every owner of the payee establishing that such owner qualifies as an exempt beneficial owner without regard to the fact that the owner is not receiving the payment. An owner reporting statement contains the name, address and TIN (if any), the entity tax classification and chapter 4 status, and a description of the type of documentation provided for every equity owner. The statement must also indicate the percentage ownership of each owner. Like a withholding statement, the owner reporting statement is subject to the penalty-of-perjury statement provided on the withholding certificate.

Deemed-compliant FFIA withholding agent is not required to withhold on a withholdable payment made to a deemed-compliant FFI, as defined in Prop. Treas. Reg. Section 1.1471-3(d)(5) to (7) (discussed below).

Payments to territory financial institutionsA withholding agent is not required to withhold on withholdable payments made to a territory financial institution that has provided a valid beneficial owner withholding certificate. Alternatively, with respect to a pre-existing offshore account, no withholding certificate is required if the withholding agent has no reason to know that the

territory financial institution is not the beneficial owner and the withholding agent has the payee’s formation documents establishing that the entity was formed under the laws of a US possession and has unambiguously designated the entity as a bank, broker or other financial institution that is not primarily engaged in the business of investing, reinvesting, or trading. Absent the formation documents and the unambiguous designation, the withholding agent can rely on a third-party credit report indicating that the entity is bank, broker or other financial institution that is not engaged primarily in the business of investing, reinvesting, etc, and that the payee is formed under the laws of a US possession.

In addition, a withholding agent is not required to withhold on withholdable payments made to a territory financial institution that has provided a valid intermediary or flow-through entity withholding certificate when the territory financial institution has agreed to be treated as a US person for purposes of chapter 3 (Sections 1441 and 1461) and chapter 4.

Payments to certain FFIsThere are special rules for payments of US-source interest, dividends, royalties, and other fixed or determinable annual or periodical income (FDAP) to a participating FFI that is a non-qualified intermediary or a non-withholding partnership or trust for purposes of the current chapter 3 rules. These entities are treated on a look-through

basis for purposes of chapter 4, as they currently are for purposes of chapter 3. For payments of US-source FDAP income made to these entities after 31 December 2013 (subject to the transition exception discussed above), a withholding agent is required to withhold 30% on the entire payment unless the withholding agent receives a valid intermediary or flow-through withholding certificate and an FFI withholding statement. If the withholding agent receives a valid withholding certificate and an FFI withholding statement, then the withholding agent is not required to withhold on any portion of the payment that is allocated to a class of payees that are not subject to chapter 4 withholding. An FFI withholding statement can provide pooled information that breaks down the payment between recalcitrant account holders, non-participating FFIs and each class of payee that is not subject to withholding under chapter 4. Alternatively, the FFI withholding statement can allocate the payment to each payee and include all the information necessary for the withholding agent to properly report the payment. A withholding agent can rely on a withholding statement provided for purposes of chapter 3 if it specifies the portion of the payment that must be withheld under chapters 3 and 4.

Many FFIs will have elected to be qualified intermediaries (QIs) for chapter 3 withholding purposes. They might elect to either (1) assume primary withholding


responsibility themselves, and receive payments on a gross basis, or (2) direct their payors to withhold on payments to them, on a pooled basis. The proposed regulations attempt to follow this paradigm for chapter 3 purposes, based on the Section 1471(b)(3) rule that an FFI can elect to be withheld upon rather than perform withholding itself. The rules basically provide that a QI can either assume responsibility for both chapter 3 and chapter 4 withholding or neither, but cannot assume responsibility for one but not the other. If a participating FFI that is a QI (PFFI-QI) makes such an election to be withheld upon, then the withholding agent must withhold 30% on US-source FDAP income as directed by the PFFI-QI. A PFFI-QI that makes a Section 1471(b)(3) election cannot assume primary withholding responsibility under chapter 3. A PFFI-QI that does not make a Section 1471(b)(3) election must assume primary withholding responsibility under chapter 3. Similar procedures allow a QI that is not a FFI (e.g., a non-US branch of a US financial institution) to make a Section 1471(b)(3) election.

Prop. Treas. Reg. Section 1.1471-3: Identification of payee This section provides the rules that withholding agents must apply for purposes of FATCA to determine: (1) who is the payee, (2) what documentation the payee should provide, and (3) the presumptions that apply if the withholding agent does not obtain payee documentation.

Who is the payee?For purposes of FATCA, generally, the payee is the person to whom a payment is made, regardless of whether the person receiving the payment is its beneficial owner. However, when an NFFE or participating FFI (other than a QI that assumed withholding responsibility) receives US-source FDAP income as an agent or intermediary, the payee is the person for whose benefit the payment is collected by the NFFE or participating FFI. The proposed regulations set forth specific flow-through entities to be treated as the payees for FATCA:

• An FFI (other than a participating FFI receiving US-source FDAP income) ;

• An active NFFE;

• An excepted FFI;

• A withholding foreign partnership or a withholding foreign trust, when not acting as intermediary with respect to a payment; and

• An entity receiving or deemed to receive effectively connected income or receiving gross proceeds from the sale of property that can produce income not treated as a withholdable payment under FATCA.

Except as noted above, in all other instances, the partners, beneficiaries or owners of a flow-through entity are the payees. Similar to the withholding rules under Section 1441, under FATCA, the single owner of a disregarded entity is the

payee. However, for a payment to a limited branch (e.g., a non-US branch with FATCA compliance restrictions), the branch is the payee and will be treated as a nonparticipating FFI. When a payment is made to a non-US branch of a US person, the payee is a US person; however, when the non-US branch is a qualified intermediary, then the payee is treated as the non-US branch.

What documentation is needed to determine a payee’s FATCA classification?A withholding agent must base a payee’s FATCA status on documentation that the withholding agent can reliably associate with the payment. Similar to the chapter 3 withholding rules, the withholding agent may rely on the classifications contained on a valid Form W-8 or W-9 or a valid intermediary withholding certificate if the withholding agent has no reason to know that the form is unreliable or incorrect. Generally, the proposed regulations prescribe FATCA documentation rules for the following scenarios: (1) payments made after FATCA is effective; (2) payments prior to 1 January 2017 (the effective date for withholding on foreign passthru payments) on pre-existing obligations; (3) payments made for offshore obligations (e.g., accounts opened outside of the United States when payments on such obligations are made outside of the United States); and (4) payments made for pre-existing offshore obligations (e.g., accounts opened outside of the United States before


FATCA’s effective date and payments on such obligation are made outside of the United States).

The proposed regulations set forth the rules on how to identify (e.g., document) 11 FATCA payee classifications:

In addition to obtaining valid withholding certificates or documentary evidence from payees, there are circumstances when a withholding agent is required to obtain additional documentation to classify payees for purposes of FATCA, as well as circumstances when documentary evidence may be obtained in lieu of a Form W-8 or Form W-9. Generally, valid withholding certificates (Forms W-8 and W-9) alone or, in certain instances, in conjunction with other documentation or documentary evidence (e.g., organizational documents, financial statements) are required to document payees for purposes of FATCA.

In response to concerns on how difficult it would be to obtain documentation from certain payees, the proposed regulations adopt rules similar to the rules for offshore payments in Section 6049, and also allow withholding agents to collect documentary evidence from certain non-US payees in lieu of Forms W-8 for offshore payments.

Standards of knowledgeAs with the existing chapter 3 withholding regime, a withholding agent may rely on the information on a withholding certificate or in documentary evidence, absent having actual knowledge or reason to know the information is unreliable or incorrect. As many of the standards of knowledge and reasons to know rules

set forth in the proposed regulations are similar to the provisions in the regulations for chapter 3 withholding, only key points are highlighted below.

The proposed regulations set forth various indicia for when a withholding agent will be deemed to have reason to know that a payee’s claim of non-US status is unreliable or incorrect including when the payee has a telephone number in the United States, or has a US place of birth. The preamble to the proposed regulations provides that the Section 1441 withholding rules will be modified to include the same indicia. For accounts opened on or after 1 January 2013, “reason to know” includes any information that is collected for AML due diligence purposes and that conflicts with a payee’s claimed FATCA status.

As with the chapter 3 withholding regime, a withholding agent that fails to withhold for FATCA purposes, despite knowing or having reason to know that a claim of non-US status is unreliable or incorrect, will be liable for the tax that should have been withheld, plus interest and penalties. A withholding agent will have “reason to know” that a payee’s claimed status is unreliable or incorrect when the IRS has notified the withholding agent that a payee’s status as a US person, participating FFI, deemed compliant FFI or other entity entitled to a reduced rate of FATCA withholding is incorrect. In this instance, a withholding agent is deemed to have knowledge starting no later than 30 calendar days after the notice is received.

In addition, it is envisaged that the IRS will publish a list of participating FFIs and registered deemed compliant FFIs, and the special EINs (FFI-EINs) that they will be assigned. A claim of participating or registered deemed compliant FFI status cannot be accepted if the payee’s name and FFI-EIN do not appear within 90 calendar days from the claim date on the most recently published version of the IRS’s FFI-EIN list. A payor can accept a claim of participating or deemed compliant FFI status for 90 days if the payee indicates that its FFI-EIN has been “applied for.” The FFI-EIN must be provided to the withholding agent within 90 calendar days from the status claim date and the withholding agent has 90

US persons Non-US individuals

Participating FFIs Nonparticipating FFIs

Registered deemed compliant FFIs

Certified deemed compliant FFIs

Exempt beneficial owners Owner-documented FFIs

Excepted FFIs Territory financial institutions

NFFEs


calendar days to verify that the FFI-EIN appears on the IRS’s published FFI-EIN list. A withholding agent is deemed to have reason to know a participating FFI’s or deemed compliant FFI’s name and FFI-EIN was removed from the IRS’ FFI-EIN list on the earlier of (1) discovery date that the name and FFI-EIN was removed or (2) one year from the date the IRS actually removed the name and FFI-EIN from the list.

EY Observes: In other words, withholding agents will need to verify all FFI-EINs on file at least once a year.

Presumption applicable when a withholding agent does not have proper payee documentationWhen a withholding agent cannot, prior to payment, reliably associate a valid withholding certificate or the documentary evidence obtained is ambiguous, the withholding agent must apply certain presumption rules to determine the payee’s status as an individual or entity; whether the payee is US or non-US; and the payee’s FATCA classification.

In the first step, a payee will be presumed an individual if such determination can be made based on the payee’s name or other indications. Otherwise, the payee shall be presumed an entity.

Next, a payee will default to be treated as a US person unless one of the following applies:

• Payee treated as a non-US entity: A payee that is presumed to an entity will classified as non-US if the

(1) withholding agent has actual knowledge the payee’s TIN begins with “98”; (2) withholding agent’s communications to the payee are mailed to an address in a non-US country; (3) withholding agent has a telephone number for the payee outside of the United States; and (4) the name of the payee indicates the payee is on the per se corporation list of Treas. Reg. Section 301.7701-2(b)(8).

• Payee treated as a non-US entity that is an exempt recipient: A payee will be presumed a non-US entity, if the payment is made to a entity that is one of the following exempt recipients under Treas. Reg. Section 1.6049-4(c)(1)(ii)(A)(1): an “eyeballed” corporation, foreign government, international organization, foreign central bank of issue, securities or commodities dealer, financial institution, broker or swap dealer.

Payments made outside the United States with respect to an offshore obligation to an individual or an entity, are presumed made to a non-US payee for chapter 4 purposes. For chapter 3 purposes, however, all individuals are presumed to be US.

Payments made to a non-US entity (presumed or otherwise) that has not provided a valid withholding certificate or documentary evidence to demonstrate the payee’s FATCA classification are deemed to be made to a nonparticipating FFI.

If the name of the payee or the facts and circumstances of the transaction indicate the payee is an intermediary, the withholding agent must treat the payment as made to an intermediary, assuming the withholding agent has no knowledge the payee is receiving the payment for its own account. Any portion of the payment the withholding agent may treat as made to a non-US intermediary is presumed made to a nonparticipating FFI.

When a payment is made to joint payees, and all payees appear to be individuals, the payment is presumed made to an unidentified US person. However, if any joint payee does not appear to be an individual then the entire payment is to be treated as made to a nonparticipating FFI. If one joint payee is documented with a valid Form W-9, the entire payment is treated as made to that US payee. There is an exception for offshore obligations, when all joint payees appear to be individuals and the payment is made outside the United States, then the payment is presumed made to an unknown non-US individual, unless the withholding agent has reason to know otherwise (e.g., there are US indicia associated with any of the payees). If the withholding agent has reason to know that any payee is a US person, then the presumption is that the payment is made to an unidentified US person.

As with chapter 3, a withholding agent that follows the presumption rules, does not have knowledge or reason to know that the payee ought


to be subject to FATCA withholding at a higher rate and withholds according to the presumptions will not be liable for any under-withholding. This is the case even if it is later established that the payee actually has a FATCA status that would call for greater withholding.

Highlights of changes affecting the chapter 3 withholding regimeThe preamble to the proposed regulations indicates that the IRS intends to amend the Treasury regulations to chapter 3 to conform the 1441 withholding regime to FATCA, effective 1 January 2014. These changes include the following:

• Forms W-8 and W-9 will be changed to permit a payee to establish its status for both chapters 3 and 4 on one form.

• Anyone “authorized to sign a declaration under penalties of perjury on behalf of the person whose name is on the certificate” can sign a Form W-8.

• Documentary evidence will be “valid until the end of the expiration period, regardless of whether that expiration date occurs before or after the last day of the third calendar year following the year in which the documentary evidence is provided to the withholding agent.”

• A fax will be acceptable if the withholding agent confirms the person furnishing the withholding certificate is the person named on the form.

EY observes: Withholding agents must continue to rely on original ink-to-paper Forms W-8 as required under current Treasury regulations, until those regulations are updated to conform to these new regulations (which are expected by 1 January 2014).

• When the IRS issues a new version of Form W-8 or W-9, use of the old version must be discontinued no more than 6 months after the IRS revision date for the new form.

EY observes: Once the new Forms W-8 and W-9 are released (expected by January 2014), use of the current Forms W-8 and W-9 must be discontinued, and substitute forms must be updated to reflect any applicable changes (which would be by 1 July 2014).

• Affidavits may be used, with enhanced documentary evidence requirements for documentation collected more than 15 days after a payment was made.

FFI Agreements – Prop. Treas. Reg. Section 1.1471-4The proposed regulations indicate that the Treasury Department and the IRS intend to publish a draft model FFI agreement, followed by a final model FFI agreement by Fall 2012. The IRS’s verification process for determining compliance with an FFI agreement will require that a participating FFI:

• Adopt written policies and procedures governing the participating FFI’s compliance with its responsibilities under the FFI agreement;

• Conduct periodic internal reviews of its compliance (rather than periodic external audits); and

• Periodically provide the IRS with a certification and certain other information that will allow the IRS to determine whether the participating FFI has met its obligations under the FFI agreement.

Comments are requested regarding the scope and content of such reviews and the factual information and representations FFIs should be required to include as part of such certifications. Repetitive or systematic failures of the participating FFI’s processes relating to its compliance may result in enhanced compliance verification requirements (such as an external audit) of one or more issues identified by the IRS. The FFI agreement will also describe the circumstances that will cause a participating FFI to be in default with respect to its FFI agreement.

The FFI agreement will specify how the withholding rules apply to members of the participating FFI’s expanded affiliated group (EAG). The FFI agreement also will provide that if certain conditions are met, the IRS may enter into a transitional FFI agreement with an EAG even if certain members of the FFI’s EAG are prohibited under local law from satisfying the requirements of an FFI agreement.

The FFI agreement will also specify that the participating FFI must obtain a valid and effective waiver of any non-US law that would prohibit


the required reporting, and in the absence of such waiver, to close the account.

The proposed regulations contain additional withholding, due diligence, annual account reporting, and certain other requirements under the FFI agreement, as described below.

Withholding requirements under the FFI agreementA participating FFI is required to withhold on any passthru payment that is a withholdable payment made to a recalcitrant account holder or a nonparticipating FFI (or a participating FFI that has made an election to be withheld upon) after 31 December 2013. However, the requirements for withholding on foreign passthru payments are reserved. Withholding will not be required for foreign passthru payments before 1 January 2017. The proposed regulations also contain a carve-out for withholding on payments made to a recalcitrant account holder if so provided under an agreement between the IRS and a non-US government. A participating FFI that complies with the withholding requirements set out in the proposed regulations and its FFI agreement will be deemed to satisfy its withholding obligations with respect to withholdable payments under Sections 1471(a) and 1472(a).

Tax withheld from a “dormant” account (i.e., an account treated as a dormant or inactive account under applicable laws or the FFI’s normal operating procedures) may be held in escrow, rather than deposited with

the IRS, until the account ceases to be a dormant account. At that time, the participating FFI has 90 days to obtain appropriate documentation from the account holder. In addition, a special withholding rule for US branches of participating FFIs treats a US branch similar to a US financial institution with respect to the withholding requirements under chapter 4, and is intended to eliminate duplicate withholding with respect to account holders at a US branch that are US non-exempt recipients to which “backup withholding” under Section 3406 would apply. This rule is coordinated with special reporting requirements applicable to US branches of participating FFIs set forth in Prop. Treas. Reg. Section 1.1471-4(d) (described below).

Identification of account holders under the FFI agreement The account identification and documentation rules for participating FFIs incorporate the principles of Prop. Treas. Reg. Section 1.1471-3 (described above and applied as though the participating FFI were a withholding agent) and generally follow the procedures described in Notice 2011-34, with certain modifications. Generally, with respect to the due diligence procedures set forth in the proposed regulations, FFIs:

• May rely on documentation collected and maintained with respect to an account, unless they know or had reason to know such documentation is unreliable or incorrect.

• Must obtain appropriate documentation within a prescribed time for accounts that have met documentation exceptions described below, but no longer meet such exceptions in a subsequent year, or treat such accounts as held by a recalcitrant account holder or non-participating FFI.

• Must retain the original or certified photocopies of documentation collected to establish the chapter 4 status of their account holders. For pre-existing accounts, such documentation must be retained for six years, and the retention period may be required to be extended where a request is made by the IRS.

• May report the account balance or value in dollars (translated into dollars, if necessary, in a prescribed way) or in the currency in which the account is denominated. This ability to perform reporting in local currency is new, and did not appear in prior guidance.

For identification of accounts established for entity account holders, the proposed regulations incorporate the identification and documentation rules for determining a payee and establishing payee status set forth in Prop. Treas. Reg. Section 1.1471-3 (described above). An FFI generally must perform the identification procedures and obtain appropriate documentation within one year of the effective date of its FFI agreement for accountholders that are prima facie FFIs, and within two years of the effective date


for all other entity accounts. The proposed regulations provide an exception from these procedures for pre-existing accounts held by entities that are offshore obligations with an account balance or value of $250,000 or less, subject to further due diligence if the account balance or value subsequently exceeds $1 million, if no holder of the account has been previously documented as a US person or as a specified US person. An account that meets this exception is not treated as a US account, and the account holder is not treated as a nonparticipating FFI for withholding and reporting purposes with respect to the account.

Individual AccountsFor accounts established for individual account holders, a participating FFI must review all information collected under its existing account opening procedures to determine whether the account holder has specified US indicia, defined as:

• Identification of an account holder as a US person;

• A US place of birth;

• A US address;

• A US telephone number;

• Standing instructions to transfer funds to an account maintained in the United States;

• A power of attorney or signatory authority granted to a person with a US address; or

• A US “in-care-of” or “hold mail” address that is the sole address the FFI has identified for the account holder.

Except as otherwise provided, when an account has US indicia, a participating FFI is required to obtain specified documentation in order to establish whether the account is a US account. For accounts that are required to be treated as US accounts, the participating FFI is generally required to collect a Form W-9 from each individual account holder. The exceptions and other rules provided in the proposed regulations are intended to minimize the circumstances in which participating FFIs would need to modify account opening and documentation collection procedures in order to comply with these identification requirements.

A participating FFI may treat as other than a US account a pre-existing account (other than cash-value insurance or annuity contracts) with a balance or value of $50,000 or less (after applying aggregation rules as described below) that is held by one or more individuals, and a documentation exception is provided for such accounts. In addition, there is a documentation exception for pre-existing cash value insurance or annuity contracts of individual account holders if such account has an account balance or value of $250,000 or less on the last day of the calendar year preceding the effective date of the FFI’s FFI agreement.

Accounts that meet one of these two exceptions will be subject to further due diligence procedures if the account balance or value subsequently exceeds $1 million. An account that meets a documentation exception is not treated as a US account and the account holder of such account is not treated as a recalcitrant account holder for withholding and reporting purposes.

EY observes: Accordingly, if an FFI wishes to use this special rule for small-value accounts, it will have to keep track of them and periodically review them to see if any have passed the $1 million threshold.

An alternative to the general identification and documentation procedures for pre-existing offshore accounts of individual account holders requires that the participating FFI conduct an electronic search for US indicia and obtain the appropriate documentation to establish the account holder’s status if US indicia are found. A participating FFI that follows this alternative procedure with respect to an account will not be attributed knowledge with respect to information contained in any account files that the participating FFI did not review and that it was not required to review under this alternative procedure. Additionally, under this alternative procedure, a participating FFI will be treated as having obtained the required documentary evidence if the participating FFI’s file contains a notation stating that documentary evidence has been


examined and listing the type of document examined and the name of the employee that reviewed the document. The proposed regulations note that this alternative procedure is intended to limit those cases in which a participating FFI would need to contact its pre-existing account holders to obtain additional documentation of their chapter 4 status.

An account (other than a high-value account, see below) that was previously documented as a non-US individual account by the participating FFI in order to meet the FFI’s obligations under a QI, withholding foreign partnership or withholding foreign trust agreement (or to fulfill certain reporting obligations as a US payor) is excepted from the electronic search.

Aggregation rulesFor purposes of applying the exceptions described above, an FFI is required to aggregate all accounts maintained by the FFI (or members of the EAG), but only to the extent the FFI’s computerized systems link the accounts by reference to a data element (e.g., a taxpayer identification number) and allow account balances to be aggregated. For purposes of determining the aggregate value of “high value accounts” (as described below), however, relationship managers are also required to aggregate all accounts that the relationship manager knows or has reason to know are directly or indirectly owned, controlled or established (other than in a fiduciary capacity) by

the same person. Similar rules apply to the aggregation of cash value insurance and annuity contracts, whereby aggregation is required across such accounts when the FFI’s computerized systems link the accounts or when relationship managers have the ability to aggregate.

High-value accountsThe proposed regulations do not require an enhanced review of private banking accounts, as had been proposed in Notice 2011-34, but instead incorporate a modified concept of a “high-value account,” subject to additional enhanced review procedures. A high-value account is any account with a balance or value that exceeds $1 million at the end of the calendar year preceding the effective date of the participating FFI’s FFI agreement, or at the end of any subsequent calendar year. As part of the enhanced review, the participating FFI must identify all high-value accounts for which a relationship manager has actual knowledge that the account holder is a US person. For these accounts, the participating FFI is required to obtain from the account holder a Form W-9, and a valid and effective waiver, if necessary.

For other high-value accounts, an enhanced review of paper and electronic files is required. The paper review is limited to the current customer master file and certain documents obtained by the participating FFI in the five years prior to the effective date of its FFI agreement, and the paper review

is required only to the extent sufficient information about the account holder is not available in the participating FFI’s electronically searchable information. Documents required to be reviewed under this procedure are:

• The most recent documentary evidence that contains sufficient information to support a claim of status under chapter 4 (as listed in Prop. Treas. Reg. Section 1.1471-3(c)(5) and as described above);

• The most recent account opening contract or documentation;

• The most recent documentation obtained by the participating FFI for purposes of AML due diligence or for other regulatory purposes;

• Any power of attorney or signature authority forms currently in effect; and

• Any standing instructions to transfer funds currently in effect.

There is an exception from the enhanced review requirement for any high-value account for which the participating FFI has obtained a Form W-8BEN and documentary evidence to establish the non-US status of the account holder or the holder of which was previously documented as a non-US individual by the participating FFI in order to meet the FFI’s obligations under a QI, WP, or WT agreement (or to fulfill certain reporting obligations as a US payor), but in each case the participating FFI is still required to perform the relationship manager inquiry.


CertificationsWith respect to its pre-existing individual accounts that are high-value accounts, a responsible officer of a participating FFI must certify that, within one year of the effective date of the FFI agreement, the participating FFI has completed the required review and, to the best of the responsible officer’s knowledge, after conducting a reasonable inquiry, the participating FFI did not have any formal or informal practices or procedures in place at any time from 6 August 2011, through the date of such certification to assist account holders in the avoidance of chapter 4. The Treasury Department and the IRS request comments regarding alternative due diligence or other procedures that should be required of FFIs that are unable to certify that no such practices or procedures were in place after such date in order to maintain participating FFI status.

With respect to all of its pre-existing accounts, a responsible officer must also confirm that, within two years of the effective date of its FFI agreement, the participating FFI has completed the account identification procedures and documentation requirements (or, if it has not obtained the documentation required to be obtained with respect to an account, the participating FFI treats the account holder of such an account as a recalcitrant account holder or nonparticipating FFI).

Reporting requirements of participating FFIsProp. Treas. Reg. Section 1.1471-4(d) describes the reporting requirements of participating

FFIs with respect to both US and recalcitrant accounts and includes a phased-in timeline for reporting. In general, a participating FFI is required to report on accounts that it maintains; however, it is not required to report with respect to any account it maintains for another participating FFI, even if that other participating FFI holds the account as an intermediary on behalf of an account holder of the participating FFI. A participating FFI is permitted to elect to perform reporting for each branch separately, rather than perform reporting on a consolidated basis. This “branch-by-branch basis” election is intended to address legal information-sharing restrictions across branches in different jurisdictions, as well as limits on IT systems. A special reporting rule applies to participating FFIs that are US payors (but not US branches) and requires such entities to add their chapter 4 reporting of US accounts to their chapter 61 reporting of US non-exempt recipients. Another special reporting rule requires a US branch of a participating FFI to satisfy its reporting requirements in the same manner as a USFI.

For accounts held by one or more specified US persons, a participating FFI must report the following information with respect to the accountholder:

1. Name, residence address (or if not available, mailing address) and TIN;

2. Account number;

3. The balance or value (not reduced by any obligations, fees, or etc.) of the account as of the end of the calendar year or, for an account that is an interest in an entity as described in Prop. Treas. Reg. Section 1.1471-5(e)(1)(iii) ( generally speaking, investment funds, including funds that invest in insurance contracts), as determined for the purpose that requires the most frequent determination of value (in either US dollars or the currency in which the account is denominated for purposes of reporting to the account holder);

4. The aggregate gross amount of income (including depository account interest; interest, dividends, gross proceeds and all other income payments on custodial accounts and redemption payments on both equity/debt interests that are not regularly traded on an established securities market and cash value insurance/annuity contracts) paid or credited to the account during the calendar year; and

5. Other information that may be required, such as account statements provided to account holders.

For accounts held by US-owned NFFEs, a participating FFI must report the information in (1), (2), (3) and (4) above, as related to the NFFE itself, in addition to the name, address and TIN of each substantial US owner of the NFFE. A participating FFI that maintains an account held by an owner-


documented FFI (defined in Prop. Treas. Reg. Section 1.1471-3(d)(7)) is required to report with respect to each owner that is a specified US person, regardless of ownership percentage.

If an account has been closed or transferred during the year, a participating FFI must report it as such, and in addition to the payment information required above, the participating FFI must report the amount or value withdrawn or transferred.

Such reporting need not be done based on US tax principles. A participating FFI may use the same principles to determine the amount and character of payments that it uses to report to its local tax administration (if it does so) or those it uses to report to the account holder. If it does neither, the participating FFI may determine payment amounts using either US federal tax principles or any reasonable method that is consistent with its own accounting principles. The participating FFI must use the same method consistently for all account holders and for all subsequent years, unless it is changing to US tax principles or has consent from the IRS.

The IRS will provide a form for the above reporting, which must be filed electronically with the IRS on or before 31 March of the year following the calendar year that is being reported. Procedures for extensions will be provided.

Alternatively, a participating FFI may elect to report under Sections 6041, 6042, 6045 and 6049, i.e., perform 1099-DIV, 1099-OID, 1099-INT, 1099-B and 1099-MISC reporting, to the same extent as is required of a US payor. If this method is elected, a participating FFI must also include the name, address, TIN and account number of each specified US person, US owned NFFE and substantial US owners of such NFFEs. Note that this election does not apply to cash value insurance or annuity contracts.

Under both reporting methods, unless a separate reporting election is made for its branch(es), a participating FFI is required to report the jurisdiction of the branch that maintains the US account being reported.

Reporting rules will be fully phased in for the 2016 calendar year. Under the first reporting method described above, for 2013 and 2014, only name, address, TIN, account number and account balance/value information is required. For 2015, all information as detailed above is required, except gross proceeds from the sale/redemption of property with respect to which the FFI acted as a custodian, broker, nominee or agent for the account holder.

Under the alternative reporting method for 2013 and 2014, only name, address, TIN, and account number is required. For 2015, all information as detailed above is required except amounts reportable under Section 6045.

Recalcitrant accountsA participating FFI must report, in separate groupings, the aggregate number and aggregate value of recalcitrant accounts at the end of the calendar year that (1) have US indicia, (2) do not have US indicia, and (3) are dormant accounts as defined in Prop. Treas. Reg. Section 1.1471-4(d)(6)(ii). This information is required to be filed electronically with the IRS (on a form to be published) on or before 31 March of the year following the calendar year that is being reported.

A special reporting rule for the 2013 calendar year applies, under which a participating FFI is required to report all US and recalcitrant accounts held as of 30 June 2014, to the IRS on or before 30 September 2014. US payors and branches may, however, report with respect to the 2013 calendar year in accordance with the dates otherwise applicable to reporting under chapter 61.

The proposed regulations include paragraphs that were reserved for the reporting requirements for participating FFIs that are QIs and for WPs and WTs. Treasury and the IRS seek comments with respect to the reporting requirements for these entities.

Expanded affiliated group requirements In general, under Prop. Treas. Reg. Section 1.1471-4(e), each member of an EAG must obtain the status of either a participating FFI or a registered deemed compliant FFI.


There are exceptions to this general rule for limited branches, limited FFI affiliates and QIs.

The proposed regulations contain temporary relief for FFIs with branches/affiliates that cannot become an FFI under local law. If an FFI satisfies all requirements to become a participating FFI, except that one or more of its branches (limited branches) or affiliates (limited FFIs) cannot satisfy all of the requirements of an FFI agreement, the FFI may become a participating FFI on an interim basis, if the limited branch / FFI satisfies the conditions laid out in Prop. Treas. Reg. Sections 1.1471-4(e)(2)(iv) and 1.1471-4(e)(3)(iii) respectively. In general, such limited branch or limited FFI account holders must be identified under the due diligence requirements for participating FFIs, and account holder documentation for these accounts must be maintained for six years. Its US accounts must be reported to the IRS if permitted by law and it must not open new US accounts or accounts held by nonparticipating FFIs. In addition, such limited branches and limited FFIs must identify themselves as nonparticipating FFIs.

A participating FFI is required to withhold on certain withholdable payments that it is considered to receive on behalf of a limited branch. All affiliates in the EAG of a limited FFI must treat it as a nonparticipating FFI (except that no withholding is required on foreign passthru payments to it).

The IRS must be notified when a branch or FFI ceases to be a limited branch or limited FFI. Participating

FFIs and deemed compliant FFIs within an EAG will retain their status only if limited branches and limited FFIs within the group comply by the earlier of 31 December 2015, or the beginning of the third calendar quarter after the date on which they are able to become compliant.

QIs are required to become participating FFIs and will be treated as limited FFIs until they become participating FFIs and up until 31 December 2015.

Identification of entity accounts by withholding agents and FFIsFor identification of entity accounts, the proposed regulations incorporate the identification and documentation rules for determining a payee and establishing payee status set forth in Prop. Treas. Reg. Section 1.1471-3. An FFI generally must perform the identification procedures and obtain appropriate documentation within one year of the effective date of its FFI agreement for accountholders that are prima facie FFIs, and within two years of the effective date for all other entity accounts. A USFI must perform the identification procedures and obtain appropriate documentation for existing accounts by 1 January 2014, to avoid potential FATCA withholding. The proposed regulations provide an exception from these procedures for pre-existing accounts held by entities that are offshore obligations with an account balance or value of $250,000 or less, subject to further diligence if the account balance or value subsequently exceeds $1 million, if no holder of the account

has been previously documented as a US person or as a specified US person. An account that meets this exception is not treated as a US account, and the account holder is not treated as a non-participating FFI for withholding and reporting purposes with respect to the account.

Prop. Treas. Reg. Section 1.1471-5(a) - DefinitionsUS accountThe proposed regulations provide guidance on a number of terms that were not specifically defined under prior guidance. Prop. Treas. Reg. Section 1.1471-5(a) provides rules on what is a “US account.” As a general matter, a “US account” is defined as any financial account maintained at a financial institution that is held by one or more specified US persons or US-owned foreign entities. An account is generally treated as held by the person identified as the account holder by the financial institution, including holders that are flow-through entities such as partnerships. For joint accounts, each joint holder is treated as owning the account.

Special ownership rules apply in certain situations. If the grantor of a trust is treated as the owner of trust assets under the grantor trust rules, the grantor, and not the trust, will be treated as owner of a financial account maintained by the trust. Accounts held by agents (such as investment advisors) acting on behalf of another person will not be treated as owned by the agents, unless the agent is a financial


institution. Rather, the person on whose behalf the agent is acting will be treated as the owner. Finally, for insurance and annuity contracts, the account holder is the person who can access the cash value of the contract (through a loan, surrender or withdrawal) or change the beneficiary. If no person can access cash value or change the beneficiary, the beneficiary is treated as the account holder.

FFIs have the option of not treating as US accounts new and pre-existing depository accounts of one or more individuals with a value of not more than $50,000. This $50,000 threshold is using the aggregation rules discussed above. For purposes of determining the threshold for non-US currency accounts, the spot rate on the last day of the year is used to translate the value into US dollars.

Financial accountProp. Treas. Reg. Section 1.1471-5(b) provides rules on the definition of “financial account.” The statute defines the term “financial account” as including depositary accounts, custodial accounts and equity or debt interests in a financial institution (other than interests that are regularly traded on an established securities market). In addition to these three categories, the proposed regulations also include cash value insurance contracts (defined below) and annuity contracts issued by financial institutions.

Depository accounts are defined to include commercial, checking, savings, time, or thrift accounts, certificates of deposit and any

amount held with an insurance company under an agreement to pay interest. Custodial accounts are accounts that hold for the benefit of another person any financial instrument or contract held for investment, such as stock, bonds, notes, swaps and notional principal contracts.

The proposed regulations also provide guidance on the treatment of debt or equity interests as a financial account. Interests in a financial institution that is primarily in the business of investing, reinvesting or trading in securities and other similar property are considered a financial account. Interests in other financial institutions are considered financial accounts only if the value of the interest is determined primarily by reference to assets that give rise to withholdable payments. An equity interest includes a capital or profits interest in a partnership and any ownership or beneficial interest in a trust that is a financial institution.

The definition of financial account also includes insurance contracts with an investment component — namely, cash value insurance contracts and annuity contracts. An insurance contract will have cash value if the policyholder is entitled to any amount on the surrender or termination of the contract (without reduction for surrender charges or policy loans), or is able to take a loan under the contract. Cash value does not include benefits such as personal injury or sickness payments. Pure protection policies, such as term life, disability, health, and property and

casualty insurance contracts with no cash value, are not considered cash value insurance contracts.

The proposed regulations exclude from the definition of a financial account certain savings accounts (both retirement and pension accounts and nonretirement savings accounts) that meet certain requirements. Generally, such exempt savings accounts must either be held by certain retirement plans, or be accounts that are subject to certain regulatory, tax and other requirements, such as a limitation on the source or amounts of contributions and that provide for penalties for early withdrawals. Accounts held by exempt beneficial owners (such as US or foreign governments, international organizations or certain retirement plans) directly or through nonparticipating FFIs as intermediaries are also excluded from the definition of financial account.

US-owned foreign entityProp. Treas. Reg. Section 1.1471-5(c) defines the term “US-owned foreign entity” as any non-US entity that has one or more “substantial US owners”. A substantial US owner is defined in Prop. Treas. Reg. Section 1.1473-1(b) as a person who directly or indirectly owns more than 10% of a non-US entity (more than 0% of certain investment vehicles and insurance companies). Special rules apply for purposes of determining indirect ownership. Additionally, “an owner-documented FFI” that has one or more direct or indirect US owners


that are specified US persons will be treated as a US-owned foreign entity, whether or not it has a substantial US owner.

Financial institution and FFI Prop. Treas. Reg. Section 1.1471-5(d) defines an FFI as a financial institution that is a non-US entity. Financial institutions organized in a US territory are not considered FFIs, but rather are “territory financial institutions.”

A “financial institution” is defined as any entity that:

• Accepts deposits in the ordinary course of a banking or similar business;

• Holds, as a substantial portion of its business, financial assets for the account of others;

• Is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities, notional principal contracts, insurance and annuity contracts or any interest (including a futures or forward contract or option) in such property; or

• Is an insurance company or holding company of an insurance company that makes payments with respect to financial accounts. (This last category of “financial institution” is new.)

Banks include, but are not limited to, entities that qualify as banks under other provisions of the Internal Revenue Code. The determination of whether an entity conducts a banking business is based on the

character of the business conducted, and the fact that the entity is subject to local banking regulation is relevant, but not necessarily determinative. The proposed regulations provide a list of the types of activities that constitute a banking or similar business if engaged in the ordinary course. These activities include the acceptance of deposits and making of personal, mortgage or other loans, and also include activities such as the provision of trust or fiduciary services, the financing of foreign exchange transactions, the issuance of letters of credit and the provision of credit card services.

The determination of whether an entity holds financial assets for the account of others as a “substantial” portion its business is determined by reference to a bright-line test based on gross income. The business is substantial if the income attributable to holding financial assets and providing related financial services equals or exceeds 20% of the entity’s gross income during the three-year period ending on December 31 for the year in which the determination is being made (or the period of the entity’s existence, if shorter). As in the case of deposit-taking institutions, the fact that an entity is subject to financial regulation is relevant but not necessarily determinative.

The proposed regulations also provide guidance on whether an entity is engaged “primarily” in the business of investing, reinvesting, or trading securities and other relevant

assets. This is also a bright-line test based on gross income. An entity is engaged primarily in the business of investing, reinvesting or trading if its gross income from those activities is at least 50 percent of the entity’s total gross income during the three-year period ending on 31 December for the year in which the determination is being made (or the period of the entity’s existence, if shorter).

Finally, the proposed regulations describe entities that are excluded from the definition of a financial institution. Such entities are treated as excepted NFFEs. These entities are certain nonfinancial holding companies, certain start-up companies (for 24 months after initial organization), nonfinancial entities that are liquidating or emerging from reorganization or bankruptcy, hedging/financing centers of a nonfinancial group, and entities described in Section 501(c). The exception for nonfinancial holding companies and start-up companies does not include entities that function or hold themselves out as investment funds (including private equity funds, venture capital funds, leveraged buyout funds) or any investment vehicle whose purpose is to acquire or fund companies for investment purposes.

Deemed compliant FFIsThe proposed regulations add additional categories of deemed compliant FFIs and refine those categories that were introduced in Notice 2011-34. An FFI meeting the criteria to be a deemed compliant


FFI and complying with the prescribed process requirements will be treated as a participating FFI without entering into an FFI agreement or complying with all the FFI requirements. These deemed compliant categories are subject to differing qualification and documentation requirements depending on whether they are (1) registered deemed compliant FFIs, (2) certified deemed compliant FFIs, or (3) owner documented FFIs. In addition, additional categories of deemed compliant FFIs may be added in future guidance.

Registered deemed compliant FFIsIn addition to meeting the criteria for qualification (most of which are aimed at assuring that the FFI does not have any US accounts or accounts of non-participating FFIs), to be a registered deemed compliant FFI, an FFI will be required to register with the IRS, provide a certification from its chief compliance officer or similar executive that all the requirements for its chosen deemed compliant FFI category have been met, obtain a confirmation of its registration and an FFI-EIN, meet requirements for publication of its passthru payment percentage (if it chooses to calculate one), and renew its certification every three years. In addition to the categories provided in the proposed regulations, an FFI that is deemed to comply with FATCA pursuant to an intergovernmental information exchange agreement will be considered a registered deemed compliant FFI.

The following are the registered deemed compliant FFI categories (with certain key requirements):

• Local FFIs: These FFIs must be licensed or regulated in a Financial Action Task Force (FATF) compliant country, have a purely local business and file information returns or withhold tax locally. Ninety-eight percent of accounts must be held by local residents (which in the EU includes residents of any EU country). Policies and procedures assuring no US accounts must be adopted.

• Non-reporting members of participating FFI group: These FFIs must divest themselves of any US accounts or accounts of non-participating FFIs prior to registering and adopt policies and procedures preventing the maintenance of these accounts.

• Qualified Collective Investment Vehicles: Only FFIs that are FFIs because they are primarily engaged in the business of investing qualify for this category. Generally, interests in these vehicles may be held only by participating FFIs, other registered deemed compliant FFIs, and US persons excluded from the definition of specified US persons (such as governments, banks and regulated investment companies).

• Restricted Funds: These FFIs must be regulated investment funds under the law of their country, which must be an FATF-compliant country. The distribution of

these funds, their distributors and distribution agreements are subject to restrictions ensuring that fund interests cannot be held by US persons, non-participating FFIs or US-owned passive NFFEs. Fund interests may be sold only by participating FFIs, registered deemed compliant FFIs, non-registering local banks or “restricted distributors” (described below). If the fund was not subject to sufficient restrictions prior to registration, it must identify accounts held by US persons and non participating FFIs and redeem these accounts or withhold and report.

Certified deemed compliant FFIsCertified deemed compliant FFIs are not required to register with the IRS, but rather are required to certify their status and provide certain documentation to withholding agents from which they receive payments.

EY observes: Certified deemed compliant FFIs are generally FFIs that, by their nature, have no US accounts or accounts of non-participating FFIs, and are thus are deemed to be lower risk than registered deemed compliant FFIs.

The proposed regulations provide the following categories of certified deemed compliant FFIs:

• Non-registering local bank: These FFIs are licensed as banks, have purely local operations, and do not solicit outside their country. They have less than $175 million in assets on their balance sheets.


They must be required by local law to either information report or withhold tax, or to have accounts, all of which are $50,000 or less (with any required aggregation).

• Retirement fund: These FFIs are organized under local law to provide retirement or pension benefits and must meet one of two sets of criteria- one for larger retirement funds and the other for funds with fewer than 20 participants. These criteria require contributions to be made by employers or governments or limited by reference to earned income. Other requirements regarding the taxation of contributions, deferral of tax on income and restricting the interests of participants in pension assets also apply.

• Non Profit Organizations: These FFIs must be organized for charitable and other permitted purposes. No FFI income or assets can inure to the benefit of a private person or non-charitable FFI.

• FFIs with Only Low Value Accounts: These FFIs must be FFIs solely because they either take deposits or hold assets in custody for others. All their accounts must be $50,000 or less (with aggregation) and their balance sheets may contain no more than $50 million in assets.

Owner-documented FFIs These are investment-type entities that, subject to terms and conditions, are permitted to self-certify their

US owners. Their status is only valid for payments that they receive from withholding agents (designated withholding agents) that have agreed to treat them as owner-documented FFIs and to whom they have provided required documentation.

Restricted distributorsA restricted distributor must be organized and operating in a FATF-compliant country and meet local AML due diligence requirements. It must have a purely local business and have at least 30 unrelated customers that make up at least 50% of its customer base. Its gross revenue and assets under management are subject to size restrictions.

EY observes: “Restricted distributor” status seems to be aimed at local brokers and financial advisors.

Recalcitrant account holdersAn accountholder, in addition to being considered recalcitrant because of a failure to provide required documentation or a waiver of local law restrictions on reporting, will be considered recalcitrant for a failure to provide a correct name and TIN combination following the FFI’s receipt of a notice from the IRS stating that an incorrect name and TIN was provided.

With respect to a pre-existing account, an accountholder that fails to provide required documentation will be considered recalcitrant on the date that is two years after the FFI’s FFI agreement became effective. If the account is a high-value account, the accountholder will become

recalcitrant after one year. For a new account, an accountholder that has provided an incorrect name and TIN combination, or whose personal circumstances have changed, will be considered recalcitrant 90 days after the account is opened or after the required information is requested. Accountholders will no longer be considered recalcitrant after the required information is provided.

Passthru paymentsPassthru payments are now defined as any withholdable payments and any “foreign passthru payment”. As discussed above, the definition of “foreign passthru payment” has been reserved for future guidance and withholding will not be required with respect to such payments before 1 January 2017.

Prop. Treas. Reg. Section 1.1471-6 – Exempt Beneficial OwnersFATCA withholding does not apply to withholdable payments (or portions of withholdable payments) made directly, or through intermediaries, to “exempt beneficial owners” based on valid documentation. The proposed regulations provide specific guidance on the categories of beneficial owners that will be exempt beneficial owners because they are considered to pose a low risk of tax evasion. Some of these categories are identified in statutory language; others were described in a limited way in prior guidance and are further elaborated on in the proposed regulations.


The entity categories that can be exempt beneficial owners are the following:

• Foreign governments, political subdivisions of a foreign government, and wholly owned instrumentalities and agencies of a foreign government;

• International organizations and wholly owned agencies of an international organization;

• Foreign central banks of issue;

• Governments of US possessions;

• Certain non-US retirement plans;

• Certain FFIs, i.e., entities primarily engaged in the business of investing, reinvesting, or trading in securities, etc., and wholly owned by one or more of the entities described above.

EY observes: It is unclear why exempt beneficial owners do not appear to include investment entities that are wholly owned either by one or more of the entities described above or by an excepted NFFE, such as a non-US entity that is tax-exempt under Section 501(c).

The proposed regulations define the scope of each of the above categories as follows:

• Foreign government, political subdivision of a foreign government, and wholly owned instrumentalities and agencies of a foreign government: This category includes “integral parts” of a foreign government and

certain “controlled entities,” both as defined. Note that this exception will not apply to a controlled entity that is a deposit-taking banking or similar institution or an entity that holds assets for the account of others as a substantial portion of its business.

• An international organization and a wholly owned agency of an international organization: A person that is an international organization, or any wholly owned agency or instrumentality of an international organization, as defined in the Internal Revenue Code.

• A foreign central bank of issue: This includes the Bank for International Settlements. For purposes of determining whether a foreign central bank is an exempt beneficial owner, a foreign central bank is a beneficial owner of income earned on collateral it held in the normal course of its operations.

• A government of a US possession: This category is determined by applying principles analogous to those described to foreign governments above.

• A retirement fund that meets the treaty test or the foreign law test: Under the treaty test, the retirement fund must meet all of the following three requirements: (1) be established in a country with which the United States has an income tax treaty in force and be generally exempt from income

taxation in that country; (2) be operated principally to administer or provide pension or retirement benefits; and (3) be entitled to benefits under the treaty on income that the fund derives from US sources as a resident of the other country that satisfies any applicable limitation-on-benefits requirement.

EY observes: Under certain US income tax treaties, certain non-US retirement accounts that are similar to US IRAs are entitled to treaty benefits, subject to conditions, including meeting limitation-on-benefits requirements.

Under the foreign law test, the retirement fund must meet all of the following four requirements: (1) be formed for the provision of retirement or pension benefits under the law of the country in which it is established; (2) receive all of its contributions (other than transfers of assets from certain other retirement funds) from government, employer or employee contributions that are limited by reference to earned income; (3) not have a single beneficiary with a right to more than 5% of the entity’s assets; and (4) be exempt from tax on investment income under the laws of the country in which it is established or in which it operates due to its status, or receives 50% or more of its total contributions (other than transfers of assets from certain other retirement funds) from the government and the employer.


Prop. Treas. Reg. Section 1.1472-1 – Payments Made to Non-Financial Foreign Entities (NFFEs)An NFFE is defined as a non-US entity that is not a financial institution. This generally includes entities that are incorporated or organized under the laws of a US possession (including certain liquidating or reorganizing entities). In general, a withholding agent is required to withhold 30% of any withholdable payment made to an NFFE, unless each of the following applies:

• The beneficial owner of the payments is the NFFE or another NFFE;

• The withholding agent can treat the beneficial owner as an NFFE that does not have any substantial US owners or as an NFFE that has identified its substantial US owners; and

• The withholding agent reports required information regarding any substantial US owners to the IRS.

Under Prop. Treas. Reg. Section 1.1473-1(b)(1), “substantial US owners” include:

• Specified US persons that directly or indirectly own more than 10% of the stock (by vote or value) of a non-US corporation;

• Specified US persons that directly or indirectly own more than 10% of a profits or capital interest in a partnership;

• Specified US persons that are treated as the owner of a grantor trust; and

• Specified US persons that directly or indirectly hold more than 10% of the beneficial interests in a trust.

The 30% withholding is not required, however, if the withholding agent may treat the payment as beneficially owned by an excepted NFFE. Excepted NFFEs include:

• Corporations, the stock of which is regularly traded on one or more established securities markets;

• Corporations that are members of the expanded affiliated group of a regularly traded corporation;

• Entities that are organized or incorporated under the laws of a US possession and are, directly or indirectly, wholly owned by one or more bona fide residents of the same US possession;

• Foreign governments, international organizations, foreign central banks, governments of US possessions, certain retirement funds, and entities wholly owned by exempt beneficial owners (as discussed above);

• NFFEs, if less than 50% of the their gross income for the preceding calendar year is passive income, or less than 50% of the assets held at any time during the preceding calendar year are assets that produce or are held for the production of passive income (active NFFEs), and

• Excepted FFIs, as described above.

For purposes of determining whether an NFFE is an active NFFE, passive income generally includes dividends,

interest, rents and royalties (other than rents and royalties derived in the active conduct of a trade or business conducted by employees of the NFFE), annuities, death benefits from life insurance contracts (under US or applicable law), amounts received from or with respect to a pool of insurance contracts (provided the amounts received are determined by reference to the performance of the pool), gains realized from the sale or exchange of property that gives rise to the income described above, gains realized from certain commodities transactions, certain foreign currency gains and net income from notional principal contracts.

Payments to withholding foreign partnerships and withholding foreign trustsWithholdable payments made to withholding foreign partnerships and withholding foreign trusts are exempt from withholding because such entities generally assume primary withholding responsibility with respect to certain payments under the 1441 reporting rules. According to the preamble of the proposed regulations, withholding partnership and withholding trust agreements are expected to be modified to take into account withholding obligations under FATCA.

Reliably associating paymentsFor purposes of determining the beneficial owner of a withholdable payment, a withholding agent will generally apply the rules of Prop. Treas. Reg. Section 1.1471-3, as


described above. For withholdable payments made to a partner or beneficiary of a non-withholding foreign partnership or non-withholding foreign trust, the withholding agent will be permitted to treat the partner or beneficiary as the payee if it can reliably associate the payment with a valid IRS Form W-8 or written notification that the NFFE is a flow-through entity. The withholding agent may also be required to obtain additional documentation sufficient to determine the payee’s status under FATCA.

If a withholding agent is unable to reliably associate a withholdable payment, it will be required to apply the presumption rules of Prop. Treas. Reg. Section 1.1471-3, described above.

Reporting requirementsA withholding agent that makes a withholdable payment under Prop. Treas. Reg. Section 1.1472-1 will be required to provide information about the payee on an IRS Form 1042-S and file a withholding income tax return on IRS Form 1042, as discussed below.

Additionally, a withholding agent that receives information about substantial US owners of an NFFE (not including excepted NFFEs) will be required to report the following information to the IRS on or before March 15th of the calendar year following the year in which the withholdable payment is made:

• The name of the NFFE;

• The names of the US substantial owners;

• Each US substantial owner’s taxpayer identification number;

• The mailing addresses of each US substantial owner; and

• Any other information as required.

EY observes: The 15 March reporting deadline for this reporting is in addition to the Form 1042-S reporting deadline reporting under Prop. Treas. Reg. Section 1.1474-1 discussed below.

In general, a participating FFI that complies with the requirements under an FFI agreement will be deemed to have satisfied its obligations regarding withholdable payments made to NFFEs.

Prop. Treas. Reg. Sections 1.1474-1 through -7 – Depositing and Reporting under Chapter 4The procedural rules contained in the proposed regulations generally parallel the existing procedural rules for chapter 3 withholding and reporting.

Depositing Withheld TaxesTaxes withheld under chapter 4 must be deposited with the IRS promptly, using either wire transfer or the IRS’s FIRE online system. The schedule for depositing is the same as for the existing nonresident alien withholding rules. In some cases, taxes may need to be deposited within three banking days after they are withheld.

Reporting of amounts paid to FFIs and other specified recipientsWithholding agents will be required to perform reporting with respect to the following “chapter 4 reportable amounts” paid to an FFI or other specified recipients after 2013:

• US-source FDAP income, including US-source passthru payments, regardless of whether chapter 4 withholding was performed;

• Gross proceeds from the sale after 2013 of securities that produce/could produce US-source dividends (e.g., US stocks and bonds) and certain equity swap termination payments, but only if chapter 4 withholding was performed;

• Foreign-source passthru payments, but only if chapter 4 withholding was performed.

Such withholding agents will be required to file an annual return on a modified version of the existing Form 1042, Annual Withholding Tax Return for US Source Income of Foreign Persons. In addition, they will be required to perform recipient-by-recipient reporting on a modified version of Form 1042S, Foreign Person’s US Source Income Subject to Withholding.

Recipients that are subject to reporting include participating FFIs and deemed compliant FFIs (regardless of whether they are the beneficial owner of payments received), nonparticipating FFIs that are the beneficial owner of the payment, limited branches, exempt beneficial owners and NFFEs (unless the NFFE is a flow-through entity and provides enough information to allow the payor to report on a look-through basis). For payments to an owner-documented FFI, separate reporting will be required for each owner of the FFI. If a participating FFI elects to be withheld on rather than perform


withholding, it must pass along sufficient information to enable the payor to report with respect to its owners/customers.

A separate Form 1042S must be filed for each category of income (e.g., interest and gross proceeds). A transitional rule allows participating FFIs to aggregate all foreign-source passthru payments made to a nonparticipating FFI for 2015 and 2016.

The procedures and deadlines for filing Forms 1042/1042S would be the same under current law, except as noted below for electronic filing requirements.

Reporting for payments made by FFIsSee discussion of Prop. Treas. Reg. Section 1.1471-4(d), above.

RefundsWithholding agents have the power (although not the duty) to grant refunds of tax withheld under chapter 4 and reimburse themselves under procedures similar to the “set-off” and “reimbursement” procedures under the chapter 3 rules. Such refunds for a year must be made before the 1042-S for the year is issued or 15 March of the following year, whichever is earlier. Otherwise, the beneficial owner of the payment may request a refund from the IRS. Any refund is limited to the excess of chapter 4 tax actually withheld over any nonresident alien withholding otherwise due. Nonparticipating FFIs may only claim refunds of tax withheld from payments that they beneficially own, to the extent required under an income tax treaty.

Coordination of withholding rulesAmounts withheld under chapter 4 are credited against amounts required to be withheld under the NRA withholding rules, although the treatment of equity derivative payments subject to nonresident alien withholding under Section 871(m) is still open. Amounts subject to FIRPTA withholding under Section 1445 or ECI withholding under Section 1446 are not also subject to chapter 4 withholding.

Electronic filing of Form 1042-SFor any “financial institution” as defined above, US or non-US, electronic filing of Form 1042S for years after 2013 (i.e., beginning with filing done in 2015 for the 2014 year) will be required, no matter how few forms the financial institution is filing. Other entities will remain under current law, which only requires electronic filing if the withholding agent is filing more than 250 Forms 1042S.

Comments requested

Treasury and the IRS continue to seek input from taxpayers on issues that require further clarification. In addition to the requests for comments noted above, the preamble also requests input from taxpayers on issues that include the following:

• Approaches to reduce the burdens related to foreign passthru payment withholding (e.g., a simplified computation or a safe harbor);

• Additional categories of deemed compliant FFIs, especially regarding issuers of insurance and annuity products;

• Allocation of gross proceeds among partners in a flow-through entity; and

• Grandfathering of equity interests in certain securitisation vehicles that invest solely in debt and similar instruments, if such vehicles will liquidate within a specified time frame.

Joint Statement on Intergovernmental Approach to FATCA

At the same time the proposed regulations were issued, Treasury issued an announcement labelled “Joint Statement from the United States, France, Germany, Italy, Spain and the United Kingdom Regarding an Intergovernmental Approach to Improving International Tax Compliance and Implementing FATCA.” The statement reiterates the policy behind the FATCA provisions, which is to obtain appropriate reporting of US taxpayers’ financial information, and acknowledges that, in certain countries, compliance with FATCA’s reporting, withholding and account closure requirements may be hindered by local legal restrictions. In light of this, the statement provides that the United States is “open to adopting an intergovernmental approach to implement FATCA and improve international tax compliance” and is willing to collect and exchange information automatically and reciprocally on accounts held in US financial institutions by residents of the five EU countries named in the statement, and that all the countries recognize the importance of keeping


the compliance costs of these efforts as low as possible for financial institutions and other stakeholders.

With this as background, the statement sets out a potential framework for an intergovernmental approach to FATCA compliance, whereby the United States and a partner country would agree to allow FFIs in the partner country to carry out their FATCA obligations by reporting information to the authorities of that country, rather than directly to the IRS. This would eliminate the requirement of each FFI in that country to enter into a separate FFI agreement with the IRS (but might require FFIs to register with the IRS). It would also eliminate FATCA withholding on payments to FFIs in that country, by identifying them to other withholding agents as participating or deemed compliant FFIs, and would identify categories of FFIs in that country that would be treated as deemed compliant or presenting a low risk of tax evasion. The United States would, in turn, commit to reciprocity regarding automatic collection and reporting of information on US accounts of residents of the partner country. FFIs in the partner country would not be required to terminate accounts of recalcitrant account holders, impose withholding on passthru payments to those account holders, or impose passthru payment withholding on payments to other FFIs in the partner country, or in other jurisdictions with which the United States has a similar FATCA implementation agreement.

The statement further provides that the United States and the partner country would also agree to pursue the legislative changes needed to implement such an approach.

Implications

Treasury and the IRS have committed considerable resources to crafting these proposed regulations, and to working with stakeholders to develop rules that operate in tandem with existing systems and procedures to a greater extent than the previously proposed rules. On the whole, the proposed regulations are generally a positive development, not only because they provide more certainty with respect to the government’s overall approach and with respect to key baseline definitional issues, but also because they provide a more practical and risk-based approach than was indicated in prior guidance regarding timelines, income thresholds, and due diligence requirements. The revised procedures for identification of pre-existing and new accounts, the expanded definitions of grandfathered obligations and deemed compliant FFIs, the extended deadlines for information reporting and the rules for allowing EAGs to accommodate certain entities that are not able to comply with FATCA without tainting the other members of the group all are welcome changes from prior guidance.

The Joint Statement on FATCA has provoked considerable discussion. While all the details of the envisioned intergovernmental approach have yet to be worked out, it appears that FFIs would still be required to fulfill the due diligence and reporting requirements of FATCA, but would provide this information to their local tax authority for delivery to the IRS, rather than providing it directly to the IRS. Treasury and IRS officials have indicated that the agreement is not intended to be exclusive in terms of the other participating countries; rather, the five EU countries in the agreement represent a starting point for an approach to FATCA that involves government-to-government information exchange. Other governments have also expressed interest in participating in such efforts.

As the preamble to the proposed regulations acknowledges, many issues remain to be clarified. Treasury and the IRS continue to actively seek comments on specific topics as they work toward finalizing the FATCA regulations. Affected financial institutions and other stakeholders should consider whether it would be beneficial to participate in the comment process, keeping in mind that the comment period is brief (written comments are due to Treasury and the IRS by 30 April 2012, if they are to be presented at the 15 May hearing).

Ernst & Young

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© 2012 Ernst & Young LLP. All Rights Reserved.

SCORE no. CM2717

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services, Washington, DC• Barbara Angus +1 202 327 5824 [email protected]• Lilo Hester +1 202 327 5764 [email protected]• Julia Tonkovich +1 202 327 8801 [email protected]

Ernst & Young LLP, International Tax Services, Chicago• Faye Polayes +1 312 879 3012 [email protected]

Ernst & Young LLP (United Kingdom), International Tax Services, London• Katherine Eldred +44 20 7951 2069 [email protected] • Anthony Calabrese +44 207 951 5802 [email protected]• Erica Duncan +44 20 795 15442 [email protected]

Ernst & Young LLP, Capital Markets Tax Practice, Washington, DC• Deborah Pflieger +1 202 327 5791 [email protected]• Maria Murphy +1 202 327 6059 [email protected]• Roger Brown +1 202 327 7534 [email protected]

Ernst & Young LLP, Capital Markets Tax Practice, New York• Justin O’Brien +1 212 773 4767 [email protected]• Doug Sawyer +1 212 773 8707 [email protected]

Ernst & Young LLP, Capital Markets Tax Practice, Boston• Dawn McGuire +1 617 375 3737 [email protected]• Ann Fisher +1 617 585 0396 [email protected]

Ernst & Young LLP, Financial Services Tax Services, Boston• Matthew S. Blum +1 617 585 0340 [email protected]

Ernst & Young (Ireland), Financial Services Tax Services, Dublin• Amanda Stone +353 1221 1160 [email protected]

International Tax Services

• Global ITS, Jim Tobin, New York• ITS Director, Americas, Jeffrey Michalak, Detroit• National Director of ITS Technical Services, Margie Rollinson, Washington• ITS Director of National Washington, DC, Sal Vaudo, Washington

• NortheastCraig Hillier, Boston

• East CentralJohnny Lindroos, McLean, VA

• FSOPhil Green, New York

• MidwestSimon Moore, Chicago

• SoutheastScott Shell, Charlotte, NC

• SouthwestPaul Palmer, Houston

• WestJulie Wooldridge, Irvine, CA

• Canada - Ernst & Young LLP (Canada) George Guedikian, Toronto

• Israel - Kost Forer Gabbay & Kasierer Sharon Shulman, Tel Aviv

• Mexico and Central America - Mancera, S.C. Koen Van ‘t Hek, Mexico City

• South America Alberto Lopez, New York

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