FATCA: a new world of terminology and compliance.

AuthorPasmanik, Philip
PositionForeign Account Tax Compliance Act - Cover story

PREVIEW

* This article provides an overview of the complex documentation and reporting rules introduced by the Foreign Account Tax Compliance Act (FATCA).

* Foreign entities subject to FATCA that fail to comply with its reporting and registration requirements will have 30% withheld from withholdable payments. Payers that are withholding agents are secondarily liable for amounts that are required to be withheld and may also be subject to penalties for not properly reporting withholdable payments.

* The types of payments that are withholdable payments, the types of payees that are subject to withholding and those that are exempt, information that must be reported by foreign financial institutions, and the reporting and registration procedures are discussed in the article.

The Foreign Account Tax Compliance Act (FATCA) introduced a new reporting and tax withholding regime, effective July 1, 2014, that is directed at both foreign financial institutions (FFIs) and nonfinancial foreign entities (NFFEs) to prevent tax evasion by U.S. citizens and residents through use of offshore accounts. The FATCA provisions were part of the HIRE Act, which was signed into law on March 18, 2010. (1)

Withholding Regimes

Withholding taxes for nonemployees and information reporting have become more critical to the IRS. They are also a significant consideration with mergers, acquisitions, and debt and equity transactions, not to mention many transactions arising in the normal course of everyday business.

The Internal Revenue Code imposes significant withholding tax liabilities on payments to nonemployees who fail to provide adequate tax documentation. Payments to non-U. S. recipients (entities and individuals) are governed by a complex set of rules, and the U.S. payer is often liable for 30% of the gross payment unless certain strict documentation rules are followed.

Chapter 61 and Sec. 3406

Chapter 61 of the Code encompasses backup withholding and related reporting obligations in the domestic context. U.S. persons are subject to U.S. income tax at graduated rates on their worldwide income, irrespective of the income's source and their place of residence. (2) Generally, under Chapter 61, a U.S. payer should report to the IRS certain payments to or transactions with U.S. persons who are not exempt recipients. Reporting obligations under Chapter 61 include payments to U.S. nonexempt recipients, generally U.S. individuals, partnerships, estates, and trusts, using, for example, Form W-2, Wage and Tax Statement, for employee wages or the appropriate form in the 1099 series for nonemployee compensation. (3)

Chapter 3

Generally, foreign persons are subject to tax at a 30% rate of the gross amount of certain payments of U.S.-source fixed or determinable annual or periodical (FDAP) income. Such income includes interest, dividends, and similar types of investment income unless the beneficial owner of the payment is entitled to a reduced rate of, or exemption from, withholding tax under domestic law or pursuant to an income tax treaty. (4)

Chapter 4

On March 18,2010, the HIRE Act added to the Code Chapter 4, composed of Secs. 1471 through 1474 (referred to as FATCA). Chapter 4 generally requires withholding agents to withhold 30% on withholdable payments (defined later) made to certain FFIs and NFFEs (defined later). The Chapter 4 withholding regime is in addition to the Chapter 3 withholding regime, and Chapter 4 withholding may not be reduced by tax treaty at the source. It is important to note that if a withholdable payment is subject to Chapter 4 withholding, it is not subject to additional withholding under Chapter 3.

Chapter 61 Backup Withholding Tax

A payer should withhold amounts described below on certain withholdable payments if:

* The payee has failed to furnish his or her taxpayer identification number (TIN) to the payer in the required manner;

* The IRS has notified the payer that the TIN furnished by the payee is incorrect;

* There has been a notified payee underreporting; or

* There has been a payee certification failure. (5)

The withholding described above equals the reportable payment multiplied by the fourth lowest tax rate applicable under Sec. 1(c) (i.e., the fourth-lowest individual income tax rate, currently 28%, for single filers). (6)

A reportable payment under the backup withholding rules includes:

* Interest payments that must be shown on an information return pursuant to Sec. 6049(a); (7)

* Dividend payments that must be shown on an information return pursuant to Sec. 6042(a); (8)

* Patronage dividend payments that must be shown on an information return pursuant to Sec. 6044; (9)

* Payments that must be shown on an information return pursuant to Sec. 6041 relating to information at source; (10)

* Payments that must be shown on an information return under the rules of Sec. 6041A(a) relating to payments of remuneration for services; (11)

* Payments that must be shown on an information return pursuant to Sec. 6045 relating to returns of brokers; (12)

* Payments that must be shown on an information return pursuant to Sec. 6050A relating to reporting requirements of certain fishing boat operators; (13)

* Royalty payments required to be shown on an information return pursuant to Sec. 6050N; (14) and

* Payments that must be shown on an information return pursuant to Sec. 6050W relating to settlement of payment card transactions. (15)

Chapter 3 Withholding

Generally, withholding agents are required to withhold U.S. tax at the source on certain payments made to nonresident aliens and foreign corporations. This withholding rate is usually a flat 30% on gross income from U.S. sources that are not effectively connected with a U.S. trade or business. (16) However, the withholding rate is 14% for certain amounts paid to a nonresident alien present in the United States as a non-immigrant under certain provisions of the Immigration and Nationality Act. (17)

A withholding agent for purposes of Chapter 3 means any person required to deduct and withhold any tax under Sec. 1441, 1442, 1443, or 1461. (18) It is important to note that withholding agents are liable for amounts they are required to deduct and withhold. (19) This means that the withholding agent is required to pay the tax when a withholdable payment is made and the withholding agent fails to withhold the tax.

Domestic partnerships and LLCs are required to withhold under two separate withholding requirements on a foreign partner's allocable share of partnership income and distributions. Under the first withholding requirement, a partnership or LLC must withhold at a flat 30% on the partner's distributive share of U.S.-source income (not effectively connected with a U.S. trade or business). (20) Under the second withholding requirement, a partnership or LLC must withhold at the highest applicable U.S. tax rate (39.6% for individuals and 35% for corporations for 2014) on a partner's share of income effectively connected with a U.S. trade or business. (21) These withholding requirements are imposed on amounts allocable to such a foreign partner or member rather than on any amount actually distributed.

A 10% withholding requirement also applies to sales of U.S. real property interests by foreign investors. (22) The withholding rules for direct and indirect sales of U.S. real property are complex, and a detailed discussion of these rules under the Foreign Investment in Real Property Tax Act (FIRPTA) (23) is outside the scope of this article.

Under the rules of Chapter 3, a flat rate of 30% is imposed on payments that constitute gross income from U.S. sources made to nonresident alien individuals and foreign corporations. This withholding rate may be reduced or eliminated under a tax treaty between the United States and the country in which the payee is eligible for benefits.

The income items referred to above include interest (other than original issue discount (OID) as defined in Sec. 1273); dividends; rent; salaries; wages; premiums; annuities; compensations; remunerations; emoluments; or other FDAP gains, profits, and income. They also include gains described in Sec. 631(b) or (c), amounts subject to tax under Sec. 871(a)(1)(C), gains subject to tax under Sec. 871(a)(1)(D), and gains on transfers described in Sec. 1235 made on or before Oct. 4,1966. (24)

Exceptions to Chapter 3 Withholding

Although the fist of payments subject to Chapter 3 is lengthy, certain payments are specifically exempted. They include:

* Amounts exempt or subject to a reduced rate under an income tax treaty; (25)

* Any item of income (other than compensation for personal services) that is effectively connected with the conduct of a trade or business within the United States and that is included in the gross income of the recipient under Sec. 871(b)(2) for the tax year; (26)

* Per diem for subsistence paid by the U.S. government (directly or by contract) to any nonresident alien individual who is engaged in any program of training in the United States under the Mutual Security Act of 1954, as amended; (27)

* An amount received as an annuity that is exempt under Sec. 871(f) from the tax imposed by Sec. 871(a); (28)

* Interest income from portfolio investments; (29)

* Interest income from bank accounts...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT