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US rules regarding offshore accounts

March 2011 - Corporate tax. Legal Developments by Jones Day.

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The Hiring Incentives to Restore Employment Act 2010, enacted on 18 March 2010, imposes a new US withholding tax and reporting regime, known as the Foreign Account Tax Compliance Act (FATCA). The FATCA regime applies generally to payments made after 31 December 2012, except on obligations (to be defined in future guidance) outstanding on 18 March 2012. Substantial effort is required by foreign entities to bring their worldwide operations and policies into compliance with the FATCA rules as of the effective date.‚Ä©

Background‚Ä©

Prior to the passage of FATCA, the US Internal Revenue Service (IRS) attempted to identify US taxpayers with undisclosed foreign financial accounts through civil or criminal litigation, a voluntary compliance program and the US Treasury Department disclosure of foreign account (or Report of Foreign Bank and Financial Accounts (FBAR)) rules. FATCA was passed in response to the perceived inadequacy of these approaches to combat offshore tax evasion. The FATCA rules target foreign financial institutions (FFIs), broadly defined as financial institutions that are not US persons, who hold and manage financial accounts on behalf of specified US persons, as well as any other foreign entity (called a ‚Äėnon-financial foreign entity‚Äô (NFFE)) that may have US ownership. ‚Ä©

The new FATCA withholding and reporting requirements are broadly drafted, and exceptions to it are narrowly tailored to specific situations. Consequently, the FATCA rules may apply unexpectedly to a non-US entity making or receiving payments of US-sourced income in the absence of IRS guidance exempting such an entity. ‚Ä©

scope and application of fatca‚Ä©

A payer of certain types of US-sourced income to an FFI, which has not entered into an agreement with the IRS under the FATCA rules (a FATCA agreement), is required to withhold a 30% US tax from that payment, even if the FFI is not the beneficial owner of the payment and the payment would have been exempt under US law. The payer, whether US or foreign, is liable for its failure to withhold the tax. The ultimate beneficial owner of the payment can file a US income tax return and claim a refund, but the FFI cannot claim a refund of FATCA withholding tax on payments beneficially owned by it unless it qualifies for an exemption under an income tax treaty. A payer of US-sourced income to an NFFE is required to withhold 30% of such payments unless the NFFE either: ‚Ä©

  1. certifies that it has no direct or indirect US owners, or reports certain information regarding its substantial US owners; ‚Ä©
  2. is, or is a 50% affiliate of, a publicly traded corporation or another exception applies; or‚Ä©
  3. another exception applies.‚Ä©

A financial institution is defined as any entity that: ‚Ä©

  1. accepts deposits in the ordinary course of a bank or similar business;‚Ä©
  2. holds financial assets for the account of others as a substantial portion of its business; or ‚Ä©
  3. is engaged primarily in the business of investing or trading in securities, partnership interests, commodities, or any interest (including futures or forward contracts or options) in such securities. ‚Ä©

The term ‚Äėfinancial institution‚Äô includes banks, custodians, mutual funds, private equity or hedge funds, and any other investment vehicle. ‚Ä©

To avoid the 30% withholding tax on payments made to it, the FFI must enter into a FATCA agreement promising to: ‚Ä©

  1. obtain information to determine which accounts maintained by it are US accounts;‚Ä©
  2. comply with IRS due diligence procedures for identifying US accounts;‚Ä©
  3. report information to the IRS with respect to the US accounts maintained by it (including the name, address and taxpayer identification number of the US account holder, the account number, account balance, and if required, the transactions in the account); and ‚Ä©
  4. withhold on US-source payments made by it to ‚Äď‚Ä©
  5. any of its account holders who refuse to provide information or a waiver of applicable secrecy laws, or ‚Ä©
  6. other FFIs who do not have a FATCA agreement. ‚Ä©

A US account is any financial account (or a non-publicly traded equity or debt interest in the FFI) held by US persons (other than an individual’s bank deposit account worth $50,000 or less) or foreign entities with substantial US ownership (generally a 10% shareholder, partner or beneficiary who is a US person, but in the case of an investment fund, any US ownership). 


IRS Guidance on FATCA‚Ä©

In August 2010 the IRS issued Notice 2010-60, 2010-37 IRB 329 (9/13/2010), as temporary guidance until more complete HM Treasury regulations are proposed. Under Notice 2010-60, the IRS stated its intention to exempt certain types of entities from the FATCA rules including:‚Ä©

  1. a foreign holding company with subsidiaries that engage in a non-financial institution business (as defined in FATCA), except if such holding company is a private equity, venture capital, leveraged buyout or other investment fund;‚Ä©
  2. a non-financial start-up company investing capital during the first 24 months after organisation;‚Ä©
  3. a non-financial entity that is liquidating or emerging from a reorganisation or bankruptcy;‚Ä©
  4. a foreign entity that primarily engages in financing and hedging transactions with or for its affiliates (who are not FFIs and are engaged in a non-financial business); and ‚Ä©
  5. an insurance company that issues solely property, casualty or long-term life insurance contracts without cash value. ‚Ä©

Future plans‚Ä©

The IRS also intends to exempt certain non-US retirement plans from FATCA if it: ‚Ä©

  1. qualifies as a retirement plan under the laws of the country in which it is established; ‚Ä©
  2. is sponsored by a non-US employer; and ‚Ä©
  3. generally does not allow US participants or beneficiaries, with limited exceptions. ‚Ä©

An FFI may be deemed to satisfy FATCA if it either proves to the IRS that it has adequate procedures in place to ensure that it has no US accounts and meets IRS requirements relating to other FFIs that have accounts with it, or is a type of FFI that the IRS determines should not be subject to the FATCA requirements. ‚Ä©

Finally‚Ä©

Because of the broad extraterritorial application and uncertain scope of FATCA, foreign entities should be reviewing their policies and procedures and the terms of financial arrangements now to ensure that they will be able to comply with FATCA when it comes into effect.‚Ä©

By Patricia Iandoli, partner, international tax group, Watson, Farley & Williams (New York) LLP. ‚Ä©

E-mail: piandoli@wfw.com.