Canadian entities that could be subject to the U.S. Foreign Account Tax Compliance Act (FATCA), which takes effect July 1, 2014, will be interested in the CRA’s new guidance on Canada’s intergovernmental agreement (IGA) with the United States. This much-anticipated guidance provides needed clarity to help financial institutions and their advisors understand and comply with their due diligence and reporting obligations under the IGA.
The guidance, which consists of 150 pages and 12 chapters, is summarized below, together with KPMG observations regarding key areas where the guidance has provided much needed clarity, as well as those areas where additional guidance is needed. It is apparent from the guidance that the CRA has considered and attempted to address many of KPMG’s comments on the Canadian legislation as well as concerns raised by a number of industry groups. The CRA has indicated it is open to further comments.
Under the IGA, Canadian financial institutions must report to the CRA and not the IRS. In addition, certain pension plans and registered accounts are exempt from FATCA due diligence and reporting, including Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Pension Plans and Tax-Free Savings Accounts. The IGA also provides:
- Relief from most U.S. FATCA withholding
- Due diligence procedures for pre-existing accounts
- Procedures for the on-boarding of new accounts and obtaining self certifications.
Without the IGA, a 30% withholding on certain of Canadian entities’ U.S. source income would have been used as a penalty to compel Canadian businesses to provide information that the IRS requires about U.S. account holders and U.S. owners. For more details on the IGA see KPMG’s TaxNewsFlash-Canada 2014-06, “Canada Signs FATCA Agreement with U.S.”.
When draft legislation to implement the IGA was originally issued, Finance allowed for a consultation period. During this period, KPMG Canada prepared a submission paper that recommended that Finance should:
- Confirm its interpretation of the term “financial institution” for purposes of the proposed legislation with the U.S. in a memorandum of understanding
- Allow a financial institution to assume Canadian residency for purposes of the “Financial Institutions with a Local Client Base” exemption if, after reasonable inquiry, it has no reason to believe an account holder is a non-resident of Canada
- Provide limited relief from FATCA by allowing an entity with a class of shares that is regularly traded to deem all of its shares to be regularly traded for purposes of the IGA.
For details of KPMG's submission, see TaxNewsFlash-Canada 2014-25, "Canada's IGA Legislation Causes FATCA Concern for Some Trusts".
Notwithstanding submissions by KPMG and various industry groups, the Canadian government passed implementing legislation for the IGA on June 19, 2014 without making any substantive changes to the draft legislation. For details, see TaxNewsFlash-Canada 2014-33, “FATCA Now Law - Are You Ready for July 1, 2014?”
Chapter 1 — Introduction
In the introduction to the guidance, the CRA discusses the purpose and scope of the guidance, and confirms that a Canadian financial institution that complies with the IGA and its Canadian implementing legislation will not be subject to any U.S. withholding tax under FATCA on U.S. source income or gross proceeds (either on its own investments or those held for customers). The CRA reiterates that the IGA is consistent with Canada’s support for international commitments to develop a global standard for the automatic exchange of tax information, and that the guidance was developed with this international context in mind.
Chapter 2 — Definitions and glossary
The CRA provides definitions of key terms used in the IGA and the related implementing legislation. The guidance also invites financial institutions to contact the CRA if they feel that a more favourable result would be obtained if definitions under the IGA were fully co-ordinated with the U.S. Regulations under FATCA. In addition, the CRA notes that it will update the guidance if it believes that increased coordination is warranted in the interest of providing transparency and fairness to all financial institutions.
The CRA’s comments on coordinating with the U.S. Regulations appear to be limited because the relevant U.S. Regulations are those in effect on the date the IGA was signed (i.e., February 5, 2014). This is of particular interest as the United States has since issued harmonizing and correcting regulations which do not appear to apply in Canada even though they contain many relieving provisions, including the corrections to the U.S. Regulations issued on June 30, 2014.
By providing a protocol for Canadian financial institutions that wish to use U.S. Regulations, the CRA suggests that Canadian financial institutions cannot choose to apply the U.S. Regulations without consent.
Chapter 3 — The different types of financial institutions and their reporting requirements
The CRA guidance describes the types of entities that are considered financial institutions under the IGA (i.e., depository and custodial institutions, investment entities, and specified insurance companies). The CRA guidance also distinguishes between reporting and non-reporting Canadian financial institutions, and provides examples that highlight these concepts. The guidance clarifies that an entity can be more than one type of financial institution, and notes that an entity must meet two conditions before it is considered a Canadian financial institution under the implementing legislation. Specifically, the entity:
- Must be a Canadian financial institution under the IGA,
- Must be a “listed financial institution” as that term is defined in the implementing legislation.
The guidance also provides additional commentary on certain pensions and exempt organizations, as well as “deemed compliant financial institutions” under the IGA.
The guidance concludes that trusts that are not promoted or represented to the public (e.g., family trusts) are not intended to be included in the term “listed financial institution”. The guidance also confirms that a trust established for family estate planning purposes is not a listed financial institution and that a family trust professionally managed by an investment entity is viewed as a passive Non-Financial Foreign Entity (NFFE) under Canadian law.
The guidance explains when an entity is considered to be “authorized under provincial legislation” to engage in certain securities dealing, portfolio management, investment advising and similar activities for purposes of paragraph (j) of the “listed financial institution” definition. The guidance provides that an entity does not have to be registered in any way for such an authorization to exist. The provincial legislation must simply contemplate these activities and the relevant entity must be able to perform them in the relevant province. While it is not entirely clear what types of entities are intended to be captured under this definition, it is potentially very broad given the language used. For instance, the CRA should further clarify whether this definition might include general partners of private equity funds.
It appears that a special exception that applies to certain entities such as portfolio managers and introducing brokers under the U.S. Regulations will not apply for purposes of the IGA. This is because the exception came into effect after the date the IGA was signed.
A Canadian financial institution may also be a non-reporting financial institution if it qualifies as an “exempt beneficial owner” under the U.S. FATCA Regulations. Although “exempt beneficial owner” is narrowly defined in the IGA, the guidance confirms that exempt beneficial owner status under the U.S. Regulations is independent of being an exempt beneficial owner under the IGA definition. The guidance also provides a list of plans and arrangements that should be treated as exempt beneficial owners.
The CRA also clarifies the 98% test which allows local financial institutions to claim relief as deemed compliant foreign financial institutions if they have a local client base. For purposes of the test, the guidance clarifies that an account can be treated as held by a “resident of Canada” if the residence address associated with the account is in Canada. However, this special status continues to require ongoing monitoring, registration, reporting and account due diligence.
Chapter 4 — Important terminology and classifications
The guidance describes key terms and classifications under the IGA, including the various types of NFFEs, non-participating financial institutions (NPFIs), and “related entities”.
The guidance clarifies that, for purposes of meeting the “regularly traded” requirement as one way to achieve active NFFE status, not all classes of an entity’s shares need to be regularly traded in many cases. However, the guidance notes that the CRA will provide further clarification.
Chapter 5 — Investment funds and introducing and carrying services relationships
The guidance discusses investment funds and their dealers, including the treatment of accounts held in nominee versus client name. The guidance also considers the relationship between carrying brokers and introducing brokers under various services arrangements, and whether an account is considered maintained by the introducing or the carrying broker.
The guidance confirms that the CRA will require dealers to perform FATCA due diligence and funds to perform FATCA reporting in most instances to avoid duplicative efforts. Even so, the guidance allows flexibility for dealers and funds to co-ordinate these efforts to best suit each relationship. The guidance does not appear to require written agreements to be in place between dealers and funds.
The guidance also allows the introducing broker / carrying broker rules to be applied to other analogous arrangements.
Chapter 6 — Financial accounts and account holders
The guidance describes the types of accounts that are and are not considered financial accounts under the IGA. Accounts considered financial accounts include depository and custodial accounts, cash value insurance and annuity contracts, and equity or debt interests in certain entities. In addition, the guidance discusses types of account holders, including, among others, partnerships, estates and joint account holders.
The guidance provides special rules addressing when a portfolio manager is treated as maintaining a financial account, which should help reduce duplicative FATCA reporting on investors of funds involving a portfolio manager.
Chapter 7 — Due diligence and general requirements
The guidance provides a discussion of the general due diligence requirements of reporting Canadian financial institutions under the IGA, including helpful discussions and examples related to self-certification, account aggregation and currency conversion. The CRA also provides guidance regarding necessary record keeping and retention. The guidance clarifies that, although financial institutions may rely on service providers to fulfill their due diligence and reporting obligations under the IGA, those obligations remain the responsibility of the financial institution.
The guidance illustrates how account aggregation rules are to be applied, including examples. The examples demonstrate that, although individuals’ depository accounts may be relevant for determining whether the de minimis reporting threshold has been exceeded, these accounts may still be non-reportable if they do not exceed the relevant threshold. No similar exception is available to other types of financial accounts.
In addition, the guidance confirms that a contractual arrangement between a financial institution and an advisor must exist before a financial institution can rely on a financial advisor to perform the due diligence procedures required under the IGA on its behalf.
The guidance also confirms that it is the account holder’s responsibility to determine whether it is a U.S. person and not the financial institution’s responsibility.
The CRA’s guidance requires financial institutions to maintain a binder of FATCA policies and procedures to document governance and due diligence processes. Presumably, this binder will be reviewed to determine the adequacy of the financial institution’s FATCA compliance.
The guidance allows account holders to provide documentary evidence by fax and email.
The guidance provides the minimum general requirements for the format of self-certifications, and requires a financial institution to perform procedures to confirm the reasonableness of self-certifications received.
Finally, the guidance also requires financial institutions to file separate information returns for each reportable account (as opposed to consolidated filing). As a result, penalties for failure to file may be much higher than originally anticipated.
Chapter 8 — Pre-existing individual accounts
The guidance provides a detailed discussion of the due diligence and reporting requirements for reporting Canadian financial institutions related to pre-existing individual accounts. Included in this chapter are discussions and examples related to, among other things:
- Threshold exemptions
- Lower value accounts
- High value accounts
- Acceptable documentary evidence
- Timing of reviews.
The guidance also discusses the form of self-certification, including optional certification for snowbirds and other temporary visitors to the United States.
The guidance appears to require financial institutions to attempt to cure any U.S. indicia discovered. Curing U.S. indicia is not mandatory pursuant to the IGA.
Chapter 9 — New individual accounts
While similar to the guidance on pre-existing individual accounts, this section also discusses issues specific to new accounts, including the requirements related to new accounts of pre-existing account holders, and differing forms of self-certification depending on the way in which a new account is opened (i.e., in person, online or by phone).
According to the guidance, new accounts opened by pre-existing individual account holders can avoid being treated as new accounts under FATCA as long as certain requirements are met. One requirement is that the due diligence procedures must “have been carried out or are in the process of being carried out” on the pre-existing individual account holder. This suggests that the financial institution should retain documentary evidence of some action to benefit from this rule. A similar rule is provided for new accounts opened by pre-existing entity account holders in Chapter 10.
The guidance provides much anticipated individual self-certification examples, which provide welcome guidance for financial institutions that must implement individual self-certification as part of their on-boarding procedures by July 1, 2014.
The guidance also provides optional procedures to address snowbirds and other temporary U.S. visitors that should relieve a financial institution from having to perform multiple FATCA documentation cures on their accounts where appropriate certifications are received.
Chapter 10 — Entity accounts
This section of the guidance on entity accounts discusses concepts and issues similar to those related to individual accounts, but also contains additional information specific to entity accounts. This includes a discussion related to the definition of the term “controlling person”, how to determine whether an account holder is a non-participating financial institution (NPFI) or a passive NFFE, and using standardized industry codes to determine the status of an entity account holder.
The CRA has adopted FATCA transitional relief, applicable primarily to entity account holders, provided by the IRS in a recent notice. This should be beneficial for Canadian financial institutions as uncertainty remains about the format of self-certification for entities. The guidance provides an example of entity self certification. However, it notes that financial institutions should consider using U.S. Form W-8BEN-E, “Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)”, which generally certifies the status of non-U.S. entities receiving U.S. withholdable payments including, among others, U.S.-source interest, dividends and rents. This suggestion is likely because the entity self-certification rules are complex, with many defined terms, and can pose a significant challenge to a financial institution attempting to incorporate these rules in a user-friendly manner.
Though the threshold for reporting controlling persons of a passive NFFE is generally understood to be at least 25% control of the entity, it appears the CRA may differentiate trusts so that all trustees, known beneficiaries and settlors of trust entities may be treated as controlling persons.
Chapter 11 — Special circumstances
This chapter of the guidance includes discussion related to:
- Cash value insurance contracts and/or annuity contracts
- Employment-based group plans
- Account transfers
- Dormant accounts
- Information technology transition to Part XVIII (i.e., the implementing legislation).
Chapter 12 — Information reporting
The guidance discusses the information related to U.S. reportable accounts that must be provided to the CRA. This chapter includes examples and a timetable for the specific reporting required in 2014, 2015 and 2016, and in 2017 and subsequent years. The guidance also describes the conditions and consequences of a financial institution’s “significant non-compliance” with its obligations under the IGA.
The guidance provides that Canadian financial institutions do not have to file “nil” returns. It is interesting to note that similar relief is not provided by all countries. For example, the United Kingdom currently requires financial institutions to file “nil” returns. The CRA might not require “nil” returns because it requires account-by-account reporting.
The guidance confirms that the “Responsible Officer” required to be identified on the IRS FATCA registration portal is merely a contact person for registration purposes. This should be a relief to officers of Canadian financial institutions as, under the U.S. Regulations, the “Responsible Officer” is generally required to periodically certify the financial institution’s FATCA compliance. Misrepresentation could lead to significant penalties and even jail time.
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Information is current to June 30, 2014. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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