April 4, 2014
Canadian trusts that will be treated as “foreign financial institutions” under the U.S. Foreign Account Tax Compliance Act (FATCA) will want to closely follow legislative developments now that the Canadian government has tabled legislation implementing the Intergovernmental Agreement (IGA) in Canada. The legislation, which prescribes the entities that will be subject to FATCA, the due diligence and reporting required in respect of their financial accounts, and the applicable penalties for non-compliance, continues to exclude certain Canadian trusts from the definition of “Canadian financial institutions” even where such trusts are subject to FATCA under the U.S. regulations.
Canadian financial institutions will be happy to hear that they have been granted a 10-day extension to register to May 5, 2014 (instead of April 25, 2014). Registration allows an entity to be included in the IRS foreign financial institution list, the only list that will be published before withholding begins.
FATCA is a U.S. law designed to combat tax evasion by U.S. citizens and residents through the use of offshore accounts and investments. This law focuses on reporting by financial institutions and investment entities in Canada and other countries to the IRS about financial accounts and substantial financial interests held by U.S. taxpayers.
Canada entered into an IGA with the U.S. on February 5, 2014. The IGA is intended to streamline compliance with the information gathering and reporting requirements under FATCA, which generally take effect July 1, 2014.
Without the IGA, a 30% withholding on Canadians’ U.S. source income would have been used as a penalty to compel Canadian businesses to provide the information the IRS requires about U.S. account holders and U.S. owners.
The IGA confirmed that Canadian financial institutions that have a reporting obligation will register through an online portal managed by the IRS to obtain a Global Intermediary Identification Number for reporting purposes. Under the IGA, Canadian FIs will report to CRA and not the IRS. In addition, the IGA exempts certain pension plans and registered accounts including Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), Registered Pension Plans (RPPs) and Tax-Free Savings Accounts (TFSAs) from due diligence and reporting. The IGA also provides guidance on:
- Relief from U.S. FATCA withholding
- Due diligence procedures for pre-existing accounts
- New customer on-boarding and self certification.
For more details on the IGA see KPMG’s TaxNewsFlash-Canada 2014-06, “Canada Signs FATCA Agreement with U.S. [PDF 204Kb]”.
Draft legislation — KPMG recommendations
Canada’s announcement of the IGA was quickly followed by draft legislation to implement the IGA into Canadian law. Finance Canada invited parties to provide input during a consultation period ending March 10, 2014. KPMG Canada welcomed the opportunity to contribute to the public debate on this important matter and prepared a submission paper on certain aspects of the draft legislation and the IGA. Among its other recommendations, KPMG suggested that Finance Canada 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 had 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 are regularly traded to deem all of its shares to be regularly traded for purposes of the IGA’s definition of “Financial Account”.
For more details on KPMG’s recommendations, see KPMG’s submission to Finance Canada [PDF 39Kb].
Canada's final IGA legislation
Finance Canada released legislation to implement the Canada-U.S. IGA in Bill C-31 on March 28, 2014. Since this legislation is identical to the draft legislation in most aspects, it is hoped that KPMG’s comments, including its concern over the legislation’s definition of financial institution, will be addressed in a CRA guidance document. The legislation is tabled but not yet enacted.
Definition of “financial institution” under the IGA
Although the IGA defines a “financial institution” for FATCA purposes, the Canadian legislation narrows the definition to a list of entities that can be considered a “Canadian financial institution” for purposes of the IGA. This list appears to exclude Canadian personal trusts from the definition, which would otherwise be included as financial institutions (and Canadian financial institutions) under the IGA. KPMG notes that the narrowed definition is a welcome development since it reduces the compliance burden for many Canadian entities. However, because the proposed legislation defines the term “Canadian financial institution” more restrictively than the IGA, there is concern that the U.S. tax authorities will object to the Canadian definition and require that it conform to the IGA’s definition. The U.S. has already required another jurisdiction to make similar revisions to its interpretation of the definition of a Financial Institution under its IGA.
If the definition of “financial institution” ultimately enacted were to include trusts, many Canadian entities that had not considered themselves to be Canadian financial institutions could be delinquent in their FATCA reporting obligations. Accordingly, to avoid such a late-date change to the definition, KPMG recommended in its submission to Finance Canada, that Finance Canada confirm its interpretation of “financial institution” with the U.S. in a memorandum of understanding.
The term “financial institution” is the basis on which the IGA and the proposed legislation impose filing obligations and penalties on reporting Canadian financial institutions. The term is therefore central to the operation of the IGA and the proposed legislation.
Financial Institutions with a Local Client Base
The IGA grants certain FATCA reporting relief for Canadian financial institutions with a Canadian client base under the “Financial Institution with a Local Client Base” exemption. To benefit from the exemption, a financial institution must first apply the on-boarding and due diligence procedures prescribed by the IGA (as required of any reporting financial institution), and then further determine whether any identified specified U.S. persons are resident of Canada.
However, the determination of Canadian residence is often difficult and may, in certain circumstances, be as complex as the determination of whether the relevant person is a Specified U.S. Person. Moreover, with the short-time frame in which financial institutions must become FATCA-compliant, the determination of residency will only be feasible if the test is straightforward. Rather than making this determination, many financial institutions may forego the exemption and report their U.S. reportable accounts like any other reporting Canadian financial institution.
If Finance Canada’s intention is to provide relief to a broad range of small, localized financial institutions, KPMG recommended in our submission that the exemption be tailored to require that due diligence procedures need only be carried out on those Financial Accounts having non-Canadian addresses. In this way, a reasonable balance is struck between protecting the integrity of the FATCA reporting system and reducing the compliance burden on financial institutions whose Financial Accounts are inherently low risk.
Alternatively, Finance Canada could include a rule that a financial institution can assume Canadian residency for purposes of the exemption if, after reasonable inquiry, it has no reason to believe the account holder was a non-resident of Canada. Typically, a representation from the account holder should constitute reasonable inquiry in the absence of other indicia that would lead a reasonable person to doubt the accuracy of such representation.
Changes to the IGA legislation
Although the final legislation is substantially similar to the earlier draft legislation, Finance Canada did make certain changes to:
- Add two new entities that will be characterized as a "financial institution":
- An entity that is represented or promoted to the public as a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund or similar investment vehicle that is established to invest or trade in financial assets and that is managed by a specified entity
- An entity that is a clearing house or clearing agency
- Re-organize the “Canadian financial institution” definition in subsection 263(2) to require entities to first be a “financial institution” under the IGA (as before) and then also a “listed financial institution” as newly defined in subsection 263(1), which contains a list of 13 qualifying entities
- Include a definition of "non-financial foreign entity" that specifies that any entity resident in Canada which does not meet the subsection 263(1) definition of "financial institution" contained in the Canadian legislation is a "non-financial foreign entity"
- Clarify the additional due diligence required if there is U.S. indicia found during the search of electronic records
- Clarify that due diligence for FIs only applies to entities that meet the definition of "financial institution"
- Remove the reference to a designated account’s existing status as a reportable U.S. account in subsection 264(1).
More time to register
The Treasury Department and IRS recently announced that Canadian FIs now have until May 5, 2014 (instead of April 25, 2014) to register to be treated as having agreements in effect until the end of 2014. The Treasury Department and IRS said that this 10-day extension would be allowed because an increasing number of jurisdictions have reached agreements in substance.
The IGA will enter into force once Canada has notified the United States that the procedures required by Canadian law for the bringing into force of the IGA have been completed. It is proposed that the IGA have effect as of July 1, 2014.
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KPMG webcast — FATCA Considerations for General Canadian Businesses
On April 8, 2014, KPMG's FATCA team will present a webcast to discuss the impact of the IGA on your non-financial Canadian entity and multinational corporation. This webcast will review the documentation requirements that will be imposed on Canadian entities by Canadian and foreign financial institutions pursuant to FATCA, the IGA and Canadian law. You can register now to attend this webcast.
We can help
KPMG Canada’s experienced, multidisciplinary team of tax and advisory professionals can help your multinational Canadian company meet its FATCA requirements. We provide FATCA advice to a wide range of financial services and general business organizations and can assist you in determining the FATCA categories for entities in your organization. To discuss any aspect of FATCA, please contact your KPMG adviser.
Information is current to April 4, 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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