The Foreign Account Tax Compliance Act of 2009 (“FATCA”) is a bill designed to discourage U.S. taxpayers from evading U.S. income taxation by hiding assets outside the United States and not reporting income earned on such assets.
FATCA was first introduced in the House Ways and Means Committee and the Senate Finance Committee on October 27, 2009, and later included with some modifications in the Tax Extenders Act of 2009, which was approved by the House of Representatives on December 9, 2009. Similar provisions are also included in the Fiscal 2011 budget proposal of the Obama administration and the proposed legislation introduced by Senate Finance Committee leaders on February 11, 2010 and passed by the Senate on February 24, 2010 and approved by the House with amendments on March 4, 2010. (Note: Since the House made some amendments to the new legislation (the Hiring Incentives to Restore Employment (“HIRE”) Act), the Senate will need to consider the amendments and further actions will be needed by both chambers of the Congress before it can be sent to the President.) FATCA would significantly modify the U.S. withholding and information reporting regime and require foreign financial institutions to monitor investment by U.S. taxpayers. This article will discuss major provisions included in the FATCA bill.
One of the main goals of the Obama Administration’s tax reform is to reduce the tax gap, which is the difference between taxes that taxpayers should pay and the amount that the U.S. government actually collects in a timely manner. The tax gap is estimated to be about $345 billion based on the most recent estimated with respect to 2001 tax year, and a significant portion of the tax gap is attributable to offshore tax evasion by U.S. taxpayers. FATCA attempts to accomplish such goal by primarily creating several new information reporting requirements, imposing withholding tax, and financial and other penalties for the failure to comply with the requirements.
Under the current law, a withholding agent (typically U.S. financial institutions or U.S. corporation making payments subject to U.S. withholding tax to foreign payees) generally must withhold U.S. tax at 30 percent from the gross amount of all U.S.-source fixed or determinable annual or periodical gains, profits, or income (“FDAP income”) of a nonresident alien individual or foreign entity. This 30-percent withholding tax may be reduced or eliminated based on certain statutory provisions or income tax treaty. FACTA first divides foreign payees into two groups; one is "foreign financial institutions (“FFI")” and the other is "non-financial foreign entities," and a different set of rules applies to payments made to FFIs and non-financial foreign entities.
FATCA defines FFI broadly to include a foreign entity that accepts deposits in the ordinary course of a banking business, engages in the business of holding financial assets for the accounts of others1, or engages primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities. Thus FFI would include investment vehicles, such as foreign hedge funds and private equity funds, as well as financial institutions in a traditional sense. Under FATCA, any “withholdable payment” made to FFI would be subject to a 30 percent withholding tax unless the FFI enters into a disclosure agreement with the IRS to comply with certain reporting requirements with respect to a “U.S. account.”
For this purpose, “withholdable payment” generally includes U.S. source FDAP income; however, “withholdable payment” also includes any gross proceeds from the sale or other dispositions of any property that can produce U.S. source interest or dividends. U.S. source income that is effectively connected with FFI (e.g., FFI’s income earned by its U.S. branch) is excluded from “withholdable payment,” but interest paid by foreign branches of U.S. financial institutions would be treated as “withholdable payment.”
To avoid the 30 percent withholding tax on “withholdable payment” it receives, FFI must report annually report the following information with respect to the “U.S. account.”
(1) identity (name, address, and Taxpayer Identification Numbers (“TIN”)) of any U.S. person, including the U.S. owner of any account holder that is a U.S.-owned foreign entity with an account at the FFI (or affiliate);
(2) account number;
(3) account balance; and
(4) gross receipts and gross withdrawals or payments from the account, and to comply with certain due diligence and verification requirements with respect to these accounts.
Furthermore, the FFI would also need to agree to withhold at 30 percent on any “passthru payments” it makes to: 1) a recalcitrant account holder (those account holders who refuse to disclose the requisite information to the FFI or do not waive a foreign law provision that prohibits disclosure of the requisite information); 2) an FFI who failed to enter into its own disclosure agreement with the IRS; or 3) an FFI that has elected to be withheld upon with respect to payments allocable to FFIs who failed to enter into their own disclosure agreement with the IRS and recalcitrant account holders2. “Passthru” payments, for this purpose, include withholdable payments or any payment attributable to withholdable payment. Alternatively, the FFI could elect to be treated as a U.S. financial institution and to treat each holder of a “U.S. account” that is a specified U.S. person or U.S. owned foreign entity as a natural person and a U.S. citizen. Under this alternative, the electing FFI would be required disclose substantially similar information as part of Form 1099 reporting and would still be subject to due diligence and verification requirements.
For this purpose, a “U.S. account” means any financial account (depository or custodial account and any non-publicly traded debt or equity interest in the financial institution) held by one or more specified U.S. persons3, who are defined as any U.S. person other than a publicly traded corporation, a corporation that is a member of the same expanded affiliated group4 of a publicly traded corporation, an organization exempt from tax under IRC section 501(a)5, an IRA, the United States or its possessions, any state or political subdivision, a bank, a real estate investment trust, a regulated investment company, a common trust defined in IRS section 584(a) and any trust exempt under IRC section 664(c) or described in IRC section 4947(a)(1), or by U.S. owned foreign entities. A “U.S. owned foreign entity” means any foreign entity that has one or more substantial U.S. owners. A “substantial U.S. owner” means any specified U.S. person (as defined above) owning more than a 10 percent interest in a corporation by vote or value, more than a 10 percent interest in the capital or profit interest in a partnership, or "any" ownership interest in an entity engaged primarily in investing or trading in securities / commodities.
FATCA would also require a withholding agent to withhold at 30 percent on any withholdable payment made to non-financial foreign entities unless certain reporting requirements are satisfied. Specifically, a non-financial foreign entity must provide the withholding agent with 1) a certification that it does not have a substantial U.S. owner, or 2) the name, address, and TIN of its substantial U.S. owners. It should be noted that certain non-financial foreign entities are exempt from the above certification requirements. Such exempt recipients include publicly traded corporations, members of an “expanded affiliated group” that includes a publicly traded corporation, foreign governments (and their instrumentalities), international organizations, foreign central banks, and entities organized in a U.S. possession and that are wholly owned by one or more bona fide residents of such possession. FATCA would also authorize the Department of Treasury (the “Treasury”) to identify classes of payments that present a “low risk of tax evasion” and exempt such payments from these requirements.
It is important to note that the requirements under FATCA would be separate and additional requirements for those financial institutions that have Qualified Intermediary (“QI”) agreement in effect with the IRS. Furthermore, FATCA would authorize the Treasury to issue regulations that describe situations where an FFI will be deemed to have met the requirements of the disclosure agreement. Specifically, an FFI would be treated as being in compliance with the requirements under FATCA if it either 1) complies with procedures to be prescribed in the regulations to ensure the FFI does not maintain U.S. accounts and meets any other applicable requirements, or 2) is a member of a class of institutions which the Treasury has determined is not required to be subject to these rules.
FATCA would also allow refund in the event of overpayment of withholding tax; however, it is important to note that the refund would be limited to the amount of reduction in withholding tax under income tax treaty if the beneficial owner is the FFI. Thus, if the FFI is not entitled to any treaty benefit, then no refund would be available.
FATCA withholding and reporting requirements would be effective for payments made after December 31, 2012. Furthermore, payments under any obligation outstanding on the date which is two years from the date of enactment of the bill would be grandfathered.6
Under the current law, payments of “portfolio interest” are generally exempt from U.S. withholding tax to a nonresident alien or foreign corporation from sources within the United States. Interest on an obligation that is not in registered form may qualify as portfolio interest if the obligation meets the foreign targeting requirements of IRC section 163(f)(2)(B), which requires, among other things, that the obligation state on its face that a U.S. holder is subject to limitations under the U.S. tax laws and provide that interest on such obligation is payable only outside the United States. FATCA would repeal the portfolio interest exemption for foreign-targeted bearer bonds. Thus, any interest paid on a debt obligation not in registered for would be subject to 30 percent withholding absent a benefit under income tax treaty. It should be noted, however, that FATCA would clarify that dematerialized book entry bonds would satisfy the registration requirement. In other words, holders of dematerialized book entry bonds would need to provide a statement to a withholding agent to certify their foreign status in order to be exempt from U.S. withholding tax. However, FATCA would authorize the Treasury to determine a situation where such statement is not required.
The repeal of the foreign targeting exception would be effective with respect to bonds issued two years after date of enactment.
Under the current law, dividend payments from U.S. corporations made to foreign investors are subject to 30 percent U.S. withholding tax unless a reduced withholding tax rate under a treaty applies. However, payments on equity swaps to foreign investors are generally not subject to U.S. withholding tax even if the payments are determined by reference to dividends on U.S. equity securities that would have been subject to U.S. withholding tax in the hands of the foreign swap counterparty. In order to prevent abusive use of equity swaps or similar instruments to avoid U.S. withholding tax, FATCA would require withholding on any dividend equivalent payment made pursuant to a notional principal contract.
FATCA would require any U.S. individual that holds more than $50,000 (in the aggregate) in reportable foreign assets to report information about the accounts and/or assets on the individual’s annual U.S. tax return. Reportable foreign assets would include foreign financial accounts, an interest in a foreign entity, or any financial instrument or contract held for investment and issued by a foreign person. Failure to comply with this requirement would be subject to a penalty of $10,000.
Various withholding and reporting requirements included in FATCA could significantly increase administrative burdens of affected foreign financial institutions and U.S. withholding agents. While specific details of certain procedural aspects of FATCA are yet to be prescribed by the Treasury, given the fact that the impact of FACTA would reach well beyond traditional definition of financial institutions, it is important for potentially affected institutions to be fully aware of the implications of the provisions in the bill.
If you have any questions on this article, please contact a member of your KPMG engagement team.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.
1. In the proposed text of the bill introduced by Senate Majority Leader Harry Reid on February 11, 2010 and passed by the Senate on February 24, 2010 and approved by the House with amendments on March 4, 2010, the language was slightly modified to read “as a substantial portion of its business, holds financial assets for the account of others.”
2. When an FFI makes such election, it would not be required to withhold at 30 percent on “passthru payments,” however, such FFI must notify each withholding agent with respect to each withholdable payment of the election and provide information necessary to determine the appropriate amount of withholding tax to be deducted by each withholding agent and must also waive any benefit it may have had under an income tax treaty.
3. There is a $50,000 de minimus exception for deposit accounts held by individuals. It should be noted that the $50,000 threshold should be determined on an aggregate basis with respect to the FFI and all other institutions that are members of the same expanded affiliate group.
4. The “expanded affiliate group” means, in general, one or more chains of controlled entities where control means more than 50% ownership by value or vote. For this purposes, partnerships and any other non-corporate entities are also included.
5. IRC stands for Internal Revenue Code of 1986.
6. In the proposed text of the bill introduced by Senate Majority Leader Harry Reid on February 11, 2010 and passed by the Senate on February 24, 2010 and approved by the House with amendments on March 4, 2010, the grandfather provision is further clarified to include “the gross proceeds from any disposition of” the grandfathered obligations.