FATCA's withholding requirements for foreign financial institutions.

• Author: Pasmanik, Philip T.
• Position: Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA), which was enacted as part of the Hiring Incentives to Restore Employment (HIRE) Act and signed into law on March 18, 2010, imposes rigid new account identification, reporting, and tax withholding requirements on foreign financial institutions (FFIs) and other withholding agents.(1) The withholding requirement applies to payments to FFIs and certain nonfinancial foreign entities (NFFEs).

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FATCA also imposes requirements on U.S. financial institutions and applies to payments made with respect to accounts of individuals. In addition, it adds tax return reporting requirements for individual taxpayers (and specified entities once they are defined in regulations) with specified foreign financial assets.(2) This article addresses the withholding rules applicable to FFIs as payers and to accounts of and payments to FFIs and other foreign entities (rather than those of individuals).

FFIs that do not enter into an agreement (discussed below) with the IRS to comply with the FATCA requirements will be subject to a 30% withholding tax on certain types of payments to the FFI. FFIs that enter into such agreements are known as "participating FFIs."

Specifically, FATCA imposes a new 30% withholding tax (which can be reduced or eliminated under a tax treaty (3)) on withholdable payments (defined below) made to FFIs (defined below) unless the FFIs enter into an agreement with the IRS to, among other things, identify and disclose certain financial accounts of specified U.S. persons (defined later) to the IRS, provide information about substantial (generally more than 10%) U.S. owners of foreign entity account holders, and withhold on payments to FFIs and other foreign entities. The withholding requirement also applies to other payments known as "passthrough payments" (discussed later).

The IRS has taken several steps in defining FATCA's many terms and facilitating its implementation by providing guidance in Notices 2010-60, 2011-34, and 2011-53 and, on Feb. 8, 2012, proposed regulations.(4)

FATCA's purpose is not so much to collect the withholding tax as to enable the IRS to obtain information about U.S. persons who directly or indirectly hold accounts or other investments abroad that earn income that has not been reported to the IRS. The withholding tax is designed to be a "stick" for FFIs to encourage U.S. persons to provide the required information and for other FFIs to participate in the FATCA regime.

New Withholding Requirements

Subject to grandfathering provisions, certain withholdable payments made after Dec. 31, 2013 (originally 2012, but delayed by Notice 2011-53), to FFIs or to other foreign entities (NFFEs) (5) will be subject to withholding at 30% if the payee FFI is not itself compliant with FATCA or the payee NFFE is not excepted from FATCA or does not provide the required owner information. In addition, FFIs will be required to report information on certain accounts that are connected to the United States (U.S. accounts) and other interests of U.S. persons.(6) The FATCA rules also may apply to payments made by an FFI's U.S. branches.(7)

For FATCA purposes, a withholdable payment means any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the United States, and any gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends from sources within the United States. (8)

A payment that is effectively connected with a U.S. trade or business of the payee is not a withholdable payment. (9) Accordingly, a withholdable payment received by a U.S. branch of an FFI that is reported as effectively connected income (ECI) would not be subject to withholding under the new withholding regime. Conversely, a withholdable payment that is not reported as ECI and is made to a U.S. branch of an FFI would be subject to withholding.

Grandfathered Obligations

Congress has recognized that implementing the compliance requirements of these complex rules requires substantial preparation. Accordingly, Notice 2010-60 provides that withholding is not required from a payment under an obligation outstanding on March 18, 2012, or from the gross proceeds from any disposition of such an obligation. The recently issued proposed regulations would extend that date to Jan. 1, 2013. (10)

FFI Defined

An FFI is defined for FATCA purposes as any financial institution that is a foreign entity. An FFI does not include a financial institution that is organized under the laws of any possession of the United States. (11)

A financial institution is any entity that:

* Accepts deposits in the ordinary course of a banking or similar business;

*...