Know your FFIs from your GIINs and form W-9s? Follow Michael McMaster through the fine details of FATCA compliance.
FATCA (the Foreign Account Tax Compliance Act, initially part of the HIRE [Hiring Incentives to Restore Employment] Act, signed into US law on March 18, 2010) was enacted to ensure a more accurate reporting of US taxpayer account information for assets held offshore. Proposed FATCA regulations were issued on February 15, 2012 followed by final regulations on January 17, 2013. It is estimated that FATCA will generate approximately $10 billion of additional US tax revenue over a 10-year period beginning in 2014.
Unlike other US withholding tax laws, FATCA withholding requirements are not viewed as a direct tax on US-sourced income, but rather as a penalty tax imposed on certain foreign entities and their account holders who fail to comply with the new FATCA reporting requirements. However, FATCA does not rely on US individuals and entities voluntarily reporting offshore account information to the Internal Revenue Service (IRS). Instead, it requires the actual foreign entities to report US investor account information to the IRS relating to accounts held by US individuals or entities.
To help ensure that offshore entities comply with this reporting, FATCA further requires that withholding agents for US registered corporations and investment entities withhold at a 30 percent rate for certain income distributions made to any underlying investors classified as offshore entities which fail to comply with the FATCA disclosure requirements.
Classifications
The FATCA regulations were implemented to require certain Foreign Financial Institutions (FFIs), that are generally actively managed offshore investment entities, to register and enter into a participating agreement with the IRS. These FFIs then receive a Global Intermediary Identification Number (GIIN) from the IRS and are referred to as Participating FFIs (PFFIs.) In addition to receiving a GIIN, PFFIs are required to file a Form 8966 annually with the IRS beginning on March 31, 2015, that discloses certain account information relating to US investors.
FFIs that are required to register with the IRS but fail to do so are classified as Non-Participating FFIs (NFFIs), or non-compliant. Under FATCA, the IRS requires US-registered entities (ie, US corporations or US investment entities) and their withholding agents to withhold at a 30 percent rate on certain income distributions made by such US entities to a NFFI.
FATCA also requires US entities to withhold at a 30 percent rate for all account holders, both US or foreign, which fail to properly certify, through filing the appropriate W-8 or W-9 forms, that they are neither NFFIs nor any other type of entity that would be subject to FATCA withholding. These investor accounts would be subject to FATCA withholding and are referred to as recalcitrant accounts.
Additional foreign entities that may be classified as non-compliant for FATCA reporting purposes, and potentially subject to FATCA withholding, are classified as Non-Foreign Financial Entities (NFFEs). NFFEs that derive less than 50 percent of their annual gross income from an active trade or business are not subject to FATCA reporting requirements.
The final FATCA regulations include special designations for FFIs that are allowed certain exemptions from full FATCA reporting and disclosure requirements generally required for a FFI. There are three types of deemed compliant FFIs that are neither required to enter into an FFI agreement, nor subject to the rigorous reporting requirements of FATCA:
• Registered deemed compliant FFIs Entities that regulate businesses in their home country or have entered into an Intergovernmental Agreement (IGA) with the IRS where US account holder information is reported to the home country government, which then provides this information to the IRS. The UK, Denmark, Mexico, and Ireland have already entered into IGAs with the IRS, and it is estimated that 60 other countries are in IGA negotiations. Registered deemed compliant FFIs are required to register with the IRS, receive a GIIN, and renew their registration every three years with the exception of some IGAs, but they are not required to disclose US account information to the IRS.
• Certified deemed compliant FFIs Entities such as certain foreign, local, licensed banks and securities holding companies that do nosolicit accounts outside their home country. These entities do not need to register with the IRS to be considered FATCA compliant, and may certify their status on an appropriate W-8 withholding certificate directly to a withholding agent.
• Owner documented deemed compliant FFIs Entities that maintain their status as a US financial institution or a PFFI directly to a withholding agent, or an entity that has entered into an IGA. All registrations for these entity types are made directly to the withholding agent instead of the IRS.
Additional FFI designations include:
• Sponsored FFIs Entities that are Controlled Foreign Corporations (CFCs) and wholly-owned by Regulated Investment Companies (RICs) or blocker corporations as a component of an affiliated group. These are often Cayman Island-registered entities and can rely on the affiliated parent entity and its GIIN—requiring no additional FATCA filings or registrations. Sponsored FFIs are a subgroup of the Registered deemed compliant classification.
• Excepted FFIs Entities not classified as FFIs and are NFFEs that are not subject to FATCA withholding or filings including publicly traded entities and their affiliates, holding companies, start-up companies, and non-profit organisations.
During the investor on-boarding process, FATCA requires US entities and their withholding agents to properly classify all account holders, both foreign and domestic, with the appropriate FATCA classifications of each investor and determine whether there are any recalcitrant or non-compliant accounts that may require FATCA withholding on income distributions made by a US entity on or after January 1, 2014 (see timelines below for specific withholding requirements).
US entities and their withholding agents will generally rely on certifications made from both foreign and US investors during the on-boarding process in determining the FATCA status of each investor. These certifications are usually derived by the new W-8 forms used for foreign individual, intermediary and corporate entities and the new W-9 form used for US taxpayers. All of the new W-8 and W-9 draft forms are more complex and detailed to properly classify all entity designations under the new FATCA regime. Due to this change, the client on-boarding process will become more in-depth. Many investment advisers are likely to update their investor subscription documents and other investor agreements to detail their FATCA on-boarding procedures and processes.
FATCA regulations state that US entities are ultimately responsible for the timely withholding under the 30 percent withholding rate on income distributions made to non-compliant entities and any recalcitrant account holders. Therefore, US entities will be liable to the IRS for any FATCA withholding not properly withheld on these account holders. While the final FATCA regulations also state that investment fund administrators can assist with establishing and performing policies and procedures to ensure both US and foreign entities are FATCA-compliant, the investment entity and its underlying adviser are ultimately liable to the IRS for any withholding amounts failed to be collected for non-compliant entities and recalcitrant accounts.
Final regulation timeframes
The timelines below reflect the anticipated timeframes for certain FATCA registrations, filings, and withholding periods according to the final regulations:
• Non-Exempt FFIs are required to register with the IRS, enter into a Participating Agreement and receive a GIIN between July 15 and October 15, 2013. The IRS will publish an IRS FFI list on a monthly basis beginning December 2, 2013 listing all registered FFIs.
• US entities will begin FATCA withholding on Non-Compliant entities and recalcitrant accounts on income distributions made on or after January 1, 2014 for new accounts established on or after January 1, 2014.
• US entities will begin FATCA withholding on pre-existing (established prior to January 1, 2014) Non-Compliant entities and recalcitrant accounts that, per on-boarding investor data previously collected, appear to be FFIs (prima facie FFIs) on income distributions made on or after June 30, 2015.
• US entities will begin FATCA withholding on all other pre-existing (established prior to January 1, 2014) Non-Compliant entities and recalcitrant accounts on income distributions made on or after December 31, 2014.
• US entities will be required to withhold on distributions derived from gross sales proceeds of property that generates US-sourced dividends or interest income beginning January 1, 2017.
• FFIs that are FATCA-registered with the IRS will be required to withhold on any of their investor accounts that are Non-Compliant entities or recalcitrant accounts beginning January 1, 2017.
As a leading service provider, U.S. Bancorp Fund Services has combined knowledgeable servicing experts with leading industry consultants to identify and document FATCA processes and procedures and assist clients as they begin making adjustments to meet FATCA requirements.
Michael McMaster is director of tax at U.S. Bancorp Fund Services. He can be contacted at: michael.mcmaster@usbank.com
Michael McMaster has been with U.S. Bancorp Fund Services for five years and is responsible for the oversight of all fund administration, fund accounting, and alternative investment product tax matters. He oversees the tax support and services provided to fund administration clients on IRS compliance issues, tax filing requirements, and mutual fund and investment partnership tax laws.
