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Financial Services Insights - June 2011 - Further Guidance Is Provided on FATCA in Notice 2011-34

The Foreign Account Tax Compliance Act (FATCA) provisions were included in the Hiring Incentives to Restore Employment (HIRE) Act, which was enacted on March 18, 2010. FATCA represents a complex new reporting regime for foreign financial institutions (FFIs) intended to identify the financial accounts of U.S. persons held in such institutions. On August 27, 2010, the Internal Revenue Service published Notice 2010-60 to provide preliminary guidance regarding issues raised by the FATCA provisions. The IRS has now provided additional guidance in Notice 2011-34, which was issued April 8, 2011 (the “New Notice”).

FATCA imposes a 30% withholding tax on payments to an FFI to the extent attributable to U.S. assets (excluding payments with respect to U.S. assets grandfathered under the provisions of FATCA), unless the FFI enters into an agreement with the IRS under which the FFI will adopt procedures to identify and report on any U.S.-owned accounts and the FFI will withhold 30% on payments that are attributable to U.S. assets and that are made to accounts with respect to which it cannot obtain the requisite information (so-called recalcitrant holders). To accomplish the foregoing goals, the FATCA provisions use broad language to determine what constitutes a “financial account,” potential ownership by U.S. persons, and an FFI. A “financial account” includes not only a depository account and a custodial account, but also any equity or debt interest in the FFI (other than such interests regularly traded on established securities markets). A U.S. account includes accounts held not only by U.S. persons, but also by non-U.S. persons that have direct or indirect U.S. ownership. An FFI includes not only entities that engage in a traditional banking business and act as custodians or trustees of assets for others, but also investment entities. For these purposes an investment entity is an entity that is primarily engaged in the business of investing or trading in securities, partnership interests, commodities, or interests — including futures, forward contracts or options — in securities, partnership interests or commodities. The provisions of FATCA will apply to certain payments beginning January 1, 2013, a date that is approaching all too quickly.

THE NEW NOTICE

The guidance provided by the New Notice relates to: (i) identification procedures for pre-existing accounts that have been revised from the identification procedures provided by Notice 2010-60; (ii) the manner to calculate the amount of a payment that is a “passthru” payment subject to withholding; (iii) deemed-compliant status for certain limited classes of FFIs; and (iv) reporting requirements for U.S. accounts, affiliated FFIs and qualified intermediaries.

REVISED IDENTIFICATION PROCEDURES

The revised identification procedures in the New Notice vary from those provided in Notice 2010-60 with respect to pre-existing accounts largely insofar as greater diligence is required for a new sub-category of accounts — “private banking accounts” — to determine whether they have indicia of U.S. ownership.

Previously, the IRS allowed FFIs to limit their searches to electronically searchable information maintained by the FFI. For private banking accounts under the New Notice, however, the FFI must perform a diligent review of paper and electronic files and other records for each client determined based on the best of the knowledge of the private banking relationship manager for each client. A “private banking account” is an account the FFI treats as a private banking account or for which the FFI provides personalized services such as investment advisory, trust and fiduciary, estate planning, philanthropic, or other services not generally provided to account holders. The New Notice also provides some additional administrative rules relating to pre-existing accounts with a balance of $500,000 or more, as well as the need for written policies being certified by the chief compliance officer.

IDENTIFICATION PROCEDURES FOR PREEXISTING INDIVIDUAL ACCOUNTS

The Notice provides detailed procedures that an FFI must follow in identifying U.S. accounts among preexisting individual accounts. As noted above, these procedures replace in their entirety the procedures set out in Notice 2010-60. In addition to the steps outlined below, the Notice provides a new certification requirement. Namely, the chief compliance officer of the FFI must certify to the IRS (i) when the FFI has completed the identification procedures; (ii) that the FFI did not engage in any activity directing, encouraging, or assisting account holders with respect to strategies on avoiding identification of their accounts as U.S. accounts; and (iii) that the FFI has in place written policies and procedures prohibiting its employees from advising U.S. account holders on how to avoid having their U.S. accounts identified.

Step 1: Documented U.S. Accounts 

The Notice states that, if an account holder is already documented as a U.S. person for other U.S. tax purposes, he or she will be treated as a U.S. person and his or her financial accounts will be treated as U.S. accounts. However, unless the FFI elects otherwise, an account still will be considered a non-U.S. account if (i) the account is a depository account, (ii) each holder of such account is a natural person, and (iii) the balance or value of such account as of the end of the calendar year preceding the effective date of the FFI Agreement does not exceed $50,000 (or the equivalent in foreign currency).

Observation. The carveout for depository accounts appears to be less burdensome than it was under the prior procedures. Specifically, under Notice 2010-60, for depository accounts, month-end balances were used to determine the amount threshold. 

Step 2: Accounts of $50,000 or Less 

From the accounts not identified as U.S. accounts in Step 1, the FFI may treat an account as a non-U.S. account if the balance or value of the account as of the end of the calendar year preceding the effective date of the FFI Agreement does not exceed $50,000 (or the equivalent in foreign currency).

Observation. The Notice suggests that this procedure was crafted in response to some concerns expressed over whether, as a practical matter, FFIs could apply the exclusion in Step 1 of Section III.B.2.a of Notice 2010-60 for accounts of $50,000 or less because of (i) the limitations of many FFIs’ information technologies systems and (ii) legal restrictions on the sharing of account holder information across branches in different jurisdictions. Note that the $50,000 exception in Step 1 applies only to depository accounts. 

Step 3: Private Banking Accounts
In brief, the Notice requires FFIs to perform detailed steps with respect to private banking accounts, which are any accounts maintained by an FFI’s private banking department or maintained as part of a private banking relationship that are not addressed by Steps 1 or 2.

Observation. Step 3 represents a new procedure for identifying U.S. accounts among preexisting individual accounts. This provision clearly is intended to stop the practice of some banks actively soliciting U.S. clients, knowing that the accounts and any income therefrom are required to be reported to the IRS. Significantly, the reporting obligations are imposed on individual private banking relationship managers. 

Step 4: Accounts with U.S. Indicia
If an account is not identified as (i) a U.S. account in Step 1, (ii) a non-U.S. account in Step 2, or (iii) as a private banking account under Step 3, the FFI must determine whether any of the information associated with the account includes any U.S. indicia. Specific U.S. indicia include:

  1. Identification of an account holder as a U.S. resident or U.S. citizen;
  2. A U.S. place of birth for an account holder;
  3. A U.S. residence address or a U.S. correspondence address (including a U.S. P.O. box);
  4. Standing instructions to transfer funds to an account maintained in the United States;
  5. An “in care of” address or “hold mail” address that is the sole address shown in the FFI’s electronically searchable information; or
  6. A power of attorney or signatory authority granted to a person with a U.S. address.

If any of the above indicia are present, the FFI is required to request certain documentation (such as Forms W-9 or W-8BEN) to establish whether the account is in fact a U.S. account. Notably, an FFI is only required to search electronic databases for this information.

Observation. Step 4 appears to be unchanged from the prior procedures, other than the removal of a “P.O. box” address from the same category as “in care of” or “hold mail” addresses. The Notice suggests that this change may have been the result of comments received voicing concerns over whether treating a non-U.S. P.O. box as an indication of U.S. status is appropriate in light of the fact that, in certain countries, a significant percentage of the population uses P.O. boxes as their sole address. 

Step 5: Accounts of $500,000 or More 

In the case of any account that is not identified in the prior steps and had a balance or value of $500,000 or more at the end of the year preceding the effective date of the FFI Agreement, the FFI must perform a “diligent review” of the account files associated with the account. Such a review presumably requires more than a search of electronics databases, unlike the search required in Step 4. To the extent that the account files contain any of the U.S. indicia described in Step 4, the FFI must obtain the appropriate documentation (as indicated in Step 4) within two years of the effective date of the FFI Agreement. Account holders that do not provide appropriate documentation by the required date will be classified as recalcitrant account holders until the date on which appropriate documentation is received from the account holder by the participating FFI.

Step 6: Annual Retesting 

The Notice provides that, beginning in the third year following the effective date of the FFI Agreement, the FFI will be required to apply Step 5 annually to all preexisting individual accounts that did not previously satisfy the account balance or value threshold amount to be treated as high value accounts.

CALCULATION OF PASSTHRU PAYMENT PERCENTAGE

Under FATCA, an FFI is required to withhold on any passthru payment it makes to a recalcitrant account holder (as defined above). A passthru payment is a payment that relates to a U.S. asset. Rather than limiting passthru payments to payments directly related to U.S. assets, an FFI must treat all payments it is making as coming proportionately from all of its assets unless it is a payment for which the FFI acts as a custodian, broker or nominee or otherwise as an agent for another person. The New Notice provides that the proportionate determination is made using the gross values of the FFI’s assets (i.e., not reduced by liabilities or other associated obligations). The FFI generally uses the value shown on its balance sheet or provided to holders in their account statements. The New Notice also makes clear that grandfathered obligations (generally obligations originated before March 18, 2012) are not treated as U.S. assets for this purpose.

To prevent non-participating FFIs (and recalcitrant account holders) to indirectly invest into U.S. assets (e.g., through an investment into an participating FFI that is heavily exposed to the U.S.A). the Notice introduces the concept of the “Passthru Payment Percentage” (“PPP”). Thereby, the PPP represents the percentage of U.S. assets an FFI is invested in compared to its total assets. If a non-participating FFI is now investing into a participating FFI, the payments out of this investment are also subject to the withholding tax as part of the income that resulted in the payment (e.g., dividend) is sourced from U.S. assets. As the entire income is not derived from U.S. assets, only the part that resulted from U.S. assets, which is in fact the PPP, is subject to the withholding tax. Following is an example to better illustrate this methodology:

Assume that a non-participating FFI invests in a participating FFI. The participating FFI is heavily invested in U.S. assets (as defined in the Notice) and the calculation of the PPP shows 60% (meaning 60% of total assets are invested in U.S. assets). If the participating FFI now would distribute a dividend to the non-participating FFI in the amount of 100 Euro 60 Euro (60% of 100 Euro) would be subject to the 30% deduction.

The PPP needs to be calculated by all FFIs (participating or recalcitrant) on a quarterly basis and published in a way that the information can be publicly accessed (e.g. on the FFI’s web page). In case that the PPP is not calculated by a participating FFI or not published, a PPP of 100% is assumed.

DEEMED COMPLIANT ENTITIES

The New Notice provides that certain entities can be deemed to be compliant if such entity (i) applies for deemed compliant status with the IRS; (ii) obtains an FFI number from the IRS; and (iii) certifies every three years to the IRS that it meets the requirements for such treatment. Essentially these procedures, contrary to what the name may suggest, create a streamlined agreement procedure for FFIs the IRS considers unlikely to have U.S. accounts. The entities listed in the New Notice that can qualify for this streamlined procedure are (i) local banks that, among other requirements, have procedures in place to not open or maintain accounts for non-residents or non-participating FFIs (i.e., FFIs without an agreement with the IRS); ii) local FFI members of participating FFI groups (those FFI groups that have an agreement with the IRS); and (iii) investment funds that are open only to participating FFIs and deemed-compliant FFIs. All in all, it is a pretty select group of entities.

DEEMED COMPLIANT FFIs

Notice 2011-34 provides further guidance on entities that may treated as deemed-compliant FFIs:

Banks 

A bank with operations confined to a particular country and that meets certain requirements designed to ensure that accounts are not held by U.S. persons, non-participating FFIs or non-financial foreign entities will be treated as a deemed-compliant FFI.

Investment Funds 

An investment fund will be treated a deemed-compliant FFI if (1) all holders of record of interests in the fund are participating FFIs, deemed-compliant FFIs or certain exempt entities; (2) the fund prohibits the acquisition of its interests by any person that is not described in clause (1) above; and (3) the fund certifies that it will calculate and publish its passthru payment percentage in accordance with the procedures in Notice 2011-34. The IRS may also treat an investment fund as a deemed-compliant FFI in certain other situations, such as where all of the interests in the fund are regularly traded on an established securities market or where certain procedures are in place to restrict ownership of interests to entities described in clause (1) of the previous sentence or U.S. financial institutions.

Notice 2011-34 also indicates that the IRS is considering permitting an investment manager to execute a single FFI agreement on behalf of each member of a group of funds that contracts with the manager to perform the functions required under the FFI agreement with respect to each such member.

REPORTING REQUIREMENTS

The New Notice also modifies certain U.S. account reporting procedures from those outlined in Notice 2010-60 so as to simplify some of requirements relating to the frequency of reporting and the amounts to be reported, to confirm that tax basis reporting will not be required, and to allow branch reporting. In addition, the New Notice requires qualified intermediaries to also have a reporting agreement for purposes of FATCA information and procedures relating to agreements required of FFI affiliates. 

Flow Chart of Steps

Insights PDF Graph 

 

Financial Services Insights - June 2011 

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