US Department of the Treasury Releases Proposed Regulations Implementing FATCA

Foreign Financial Institutions Have an Opportunity to Determine and Control Impact on Their Operations in Advance of Implementation Dates

February 10, 2012

On February 8, 2012, the US Department of the Treasury (the “Treasury Department”) issued detailed proposed regulations to implement the withholding and reporting rules commonly referred to as the “Foreign Account Tax Compliance Act” or “FATCA.” The proposed regulations supplement and, in some cases, modify the rules the Treasury Department previously announced in a series of notices. The release of the new rules provide an opportunity, in advance of the implementation dates, for foreign financial institutions (“FFIs”) to, among other things, determine the impact of the reporting and withholding requirements on their operations, including how much due diligence is required, whether the FFI systems must be enhanced, whether FFI records are currently readily retrieveable, whether the current number of customer files require that due diligence commence now, whether the FFI has sufficient staffing levels, whether FFI staff is sufficiently trained to implement FATCA, and whether third party assistance is required.

More issues are likely to arise as the Treasury Department continues its discussions with other countries. Even though the proposed regulations would further postpone deadlines and effective dates in FATCA, a tremendous amount of work must be completed by FFIs, by US financial institutions, and by US withholding agents to become compliant with FATCA and to avoid being put at a competitive disadvantage.

Background on FATCA

FATCA is intended to force foreign entities, especially FFIs, to report information about the income earned by US persons. Its tool for enforcing this reporting is the threat of a 30% withholding tax, even if a statutory or treaty exemption from withholding tax is otherwise applicable. Under section 1471 of the US Internal Revenue Code, a US person making a “withholdable payment” to an FFI generally must withhold 30% of the payment unless the FFI undertakes certain reporting responsibilities. A “withholdable payment” is generally income attributable to US securities or certain other US assets. An FFI that enters into an agreement with the Treasury Department to provide the reporting required under FATCA (an “FFI agreement”) becomes a “participating FFI.” In addition, a participating FFI must withhold on any “passthru payment” it makes to a recalcitrant account holder or a non-participating FFI. A passthru payment is a withholdable payment or a payment indirectly attributable to a withholdable payment.

Similarly, under section 1472 of the US Internal Revenue Code, a US person making a withholdable payment to a non-financial foreign entity generally must withhold 30% of the payment unless the foreign entity discloses certain information about any substantial US owners it has.

Although FATCA provides that the new withholding rules generally are effective for payments made after December 31, 2012, the Treasury Department announced in Notice 2011-53 that it was administratively delaying certain effective dates, including delaying the imposition of withholding tax until January 1, 2014, for US-source interest, dividends, and other so-called “FDAP” income, and until January 1, 2015, for US-source gross proceeds. FATCA also provides that any obligation issued by March 18, 2012, is a “grandfathered obligation” and payments attributable to the grandfathered obligation are not subject to the FATCA withholding rules. The proposed regulations further delay the date the FATCA withholding and reporting rules become applicable and also extend the grandfathering rules.

Proposed Regulations

Generally

The rules in the proposed regulations are generally consistent with the rules the Treasury Department announced earlier in Notices 2010-60, 2011-34, and 2011-53. Accordingly,

• A US financial institution or withholding agent must withhold on certain payments of US-source income to a foreign person unless the foreign person demonstrates to the financial institution or withholding agent that the foreign person or payment is exempt from withholding under FATCA.
• A foreign person that directly or indirectly receives US-source income, or that is part of an affiliated group in which a member directly or indirectly receives US-source income, must determine whether it is an FFI and, if so, whether it will become a participating FFI.
• If an FFI becomes a participating FFI, it must comply with FATCA’s detailed due diligence and reporting rules. Thus, it must determine which of its accounts are “US accounts” (i.e., accounts held by US persons or foreign persons with US owners) and provide the information required by FATCA. Detailed rules apply as to the steps a participating FFI must take to determine whether an account is a US account, with distinctions between “new” and pre-existing accounts, and the level of due diligence required depends on the size of the account.
• Any FFI, whether or not a participating FFI, must learn the rules that apply to passthru payments to determine whether it has withholding obligations (or was properly withheld) on a payment to or from another foreign person.

Changes and New Rules

Although the proposed regulations generally implement the rules earlier announced in Notices 2010-60, 2011-34, and 2011-53, the proposed regulations go into more detail and, in certain cases, make welcome changes to the rules previously proposed in the notices.

• Extension of cut-off date for “grandfathered obligations.” FATCA provides that the new withholding rules do not apply to obligations issued by March 18, 2012. The proposed regulations would extend this statutory grandfather rule through 2012, excluding from the definition of withholdable payment and passthru payment any payment made under an obligation outstanding on January 1, 2013 (and not materially modified after that date), and any gross proceeds from the disposition of such an obligation.
• Delay in application of “affiliated group” rules. The reporting and due diligence requirements of FATCA generally apply not just to a participating FFI but to all FFIs that are members of its affiliated group. In recognition of the fact that some jurisdictions have domestic laws that interfere with an FFI’s ability to comply with the due diligence and reporting rules of FATCA, the proposed regulations provide a two-year transition rule, until January 1, 2016, for the full implementation of this affiliated group rule. During the two-year transition period, the existence of an FFI affiliate in a jurisdiction that prohibits the reporting or withholding required by FATCA will not prevent other FFIs in the affiliated group from being able to enter into an FFI agreement (or be treated as deemed-compliant FFIs), provided that the FFI in the restrictive jurisdiction agrees to perform due diligence to identify its U.S. accounts, maintain certain records, and meet certain other requirements.
• Expansion of the category of “deemed-compliant FFIs.” Deemed compliant FFIs are not subject to the more detailed reporting and withholding rules that participating FFIs must endure. The proposed regulations identify two types of deemed-compliant FFIs: (1) registered deemed-compliant FFIs (i.e., local FFIs, nonreporting members of participating FFI groups, qualified investment vehicles, restricted funds, and FFIs that are covered by an agreement between the US and a foreign government) which must register with the Treasury Department to declare their deemed-compliant status and to attest that they satisfy certain procedural requirements and (2) certified deemed-compliant FFIs (i.e., nonregistering local banks, retirement plans, non-profit organizations, certain owner-documented FFIs, and FFIs with only low-value accounts) which must certify to the withholding agent that they meet certified deemed-compliant FFI requirements.
• Due diligence required for examination of accounts. The proposed regulations relax the previously announced “due diligence” requirements for pre-existing accounts, especially accounts under US$1 million. For new accounts, FFIs may generally rely on existing customer intake procedures.
• Self-certification that a participating FFI has complied with the terms of an FFI agreement. Verification of compliance through third party audits is generally not required.
• Narrowing of definition of “financial account.” The proposed regulations state that FATCA is intended to focus on traditional bank, brokerage, and money market accounts and interests in investment vehicles, rather than on debt and equity issued by banks and brokerage firms, and “refine” the definition of “financial account” accordingly.
• Further one-year delay in reporting requirements. The proposed regulations provide that reporting on income will be phased in beginning in 2016 (with respect to the 2015 calendar year), and reporting on gross proceeds will begin in 2017 (with respect to the 2016 calendar year).
• Delay in application of withholding to passthru payments. The proposed regulations provide that withholding will not apply to foreign passthru payments until January 1, 2017. Until then, participating FFIs must instead report annually to the Treasury Department the aggregate amount of certain payments made to each nonparticipating FFI.
• No due diligence distinction between private banking accounts and other accounts. Notice 2011-34 stated that the Treasury Department would require greater due diligence regarding private banking accounts. The proposed regulations do not single out private banking accounts, instead requiring a participating FFI to undertake enhanced review of “high value” accounts (generally those accounts with ending balances in excess of US$1 million).

Development of Possible Alternative Reporting System

Simultaneously with the release of the proposed regulations, the Treasury Department issued a joint statement with the Governments of France, Germany, Italy, Spain, and the United Kingdom. That joint statement announced that the six countries have agreed to explore a common approach to FATCA implementation through domestic reporting and reciprocal automatic information exchange and based on existing bilateral tax treaties. The joint statement suggests an approach in which an FFI located in a FATCA partner country would perform the due diligence necessary to identify US accounts and report the information required by FATCA to the FATCA partner government; the FATCA partner government would then transmit that information to the United States on an automatic basis pursuant to a tax treaty or tax information exchange agreement. Such an approach would significantly lessen the burden of FATCA on FFIs located in the FATCA partner country.

Next Steps for the Treasury Department

The Treasury Department as requested comments on the proposed regulations by April 30, 2012, and scheduled a public hearing on the proposed regulations on May 15, 2012. The Treasury Department has previously stated that its goal is to issue final (or, perhaps more realistically, temporary) regulations later this summer.

In addition to developing final regulations and an alternative, automatic information exchange regime with certain countries, the Treasury Department plans to release a draft model FFI agreement in early 2012, followed by release of a final model FFI agreement in autumn of 2012. The Treasury Department also intends to release draft forms for reporting the information required by FATCA. The proposed regulations also announced that the Treasury Department expects to introduce an online process for registering FFIs as participating FFIs or deemed-compliant FFIs no later than January 1, 2013. The online process would allow not only registration but also FFIs to enter into an FFI agreement, complete a required certification, or obtain an FFI-EIN. Further, the Treasury Department intends to revise existing forms (such as Form W-8 and Form W-9) to accommodate FATCA and to revise other withholding regulations and forms so that they are coordinated with the new FATCA rules.