IRS Eases FATCA Compliance Rules
January 25, 2019
By Trevor Dulichand and Gerry O’Beirne
On December 18, 2018, the IRS released proposed regulations that are intended to clarify, reduce and/or eliminate certain FATCA reporting requirements. Given the number of International Tax Agreements (“IGAs”) entered into between the U.S. and other taxing jurisdictions which have enhanced FATCA compliance, this is not entirely unexpected. The proposed regulations address a number of items, with the more salient items described below.
Withholding on Gross Proceeds
The proposed regulations eliminate withholding on payments of gross proceeds from the sale or disposition of any property that can generate U.S. source interest or dividends. Previously, such payments could be subject to a U.S. 30% withholding tax. With the elimination of withholding on gross proceeds, only payments of U.S.-source fixed, determinable, annual or periodic (“FDAP”) income would be subject to FATCA withholding. The preamble to the proposed regulations state the reason for this change is the complexity of a framework needed to implement the withholding on gross proceeds and the current level of compliance with FATCA.
Withholding on Pass-Through Payments
The proposed regulations defer withholdings on pass-through payments. A pass-through payment is any payment made by a foreign financial institution (“FFI”) that is attributable to a withholdable payment it receives or is allocated. A participating FFI will not be required to withhold tax on a foreign pass-through payment made to an unresponsive account holder or nonparticipating FFI before the date that is two years after the date of the final regulations. As with the withholding tax on gross proceeds, the preamble cites the complexity of implementing a system to effectively administer withholding on pass-through payments and the fact that there is significant compliance with FATCA.
However, in deferring as opposed to eliminating the implementation of pass-through withholding, the IRS makes it clear that withholding on foreign pass-through payments is important as it prevents nonparticipating FFIs from avoiding FATCA by investing in the U.S. through a participating FFI "blocker." The preamble goes on to say that the IRS will continue to consider the feasibility of withholding on foreign pass-through payments.
Elimination of Withholding Tax on Non-Cash Value Insurance Premiums
The proposed regulations also eliminate withholding tax on premiums for insurance contracts that do not have a cash value as they are considered excluded non-financial payments.
Clarification of an Investment Entity
The proposed regulations clarify the definition of an investment entity and what are considered "managed by" entities. An investment entity will be categorized as such (and therefore as a financial institution) if the entity's gross income is primarily attributable to investing, reinvesting, or trading in financial assets and the entity is managed by another entity that is a depository or custodial institution, insurance company, or an investment entity.
The “managed by” category of investment entities includes entities that receive investment advice from another financial institution that has discretionary management of the first entity’s assets. The proposed regulations have narrowed the definition of discretionary authority for purposes of treating an entity as an investment entity. According to the preamble, the clarification in these proposed regulations is similar to the guidance published by the OECD defining an investment entity under the Common Reporting Standard.