Proposed FATCA regulations: April 30, 2012.

• Position: Foreign Account Tax Compliance Act

On April 30, 2012, Tax Executives Institute submitted the following comments to the Internal Revenue Service on proposed regulations under the Foreign Account Tax Compliance Act provisions of the 2010 HIRE Act, better known as FATCA. The proposed regulations provide comprehensive details regarding the withholding, reporting, and due diligence requirements for withholding agents, foreign financial institutions, and non-financial foreign entities in respect of certain U.S. source payments. TEI's comments were prepared under the aegis of the Institute's IRS Administrative Affairs Committee, whose chair is Michael Bernard of Microsoft Corporation, in conjunction with TEI's International Tax Committee, whose chair is Jocelyn Krabbenschmidt of Amazon.com. Paul Heller of Royal Bank of Canada and Janice Lucchesi of Akzo Nobel led a working group that developed the Institute's comments. Benjamin R. Shreck, TEI Tax Counsel, serves as liaison to the International Tax Committee and coordinated the preparation of the Institute's comments. TEI previously submitted formal comments to the IRS regarding FATCA on October 19, 2010, and July 7, 2011.

General Comments

Tax Executives Institute, Inc. (TEI) is pleased to submit these comments regarding recently issued proposed regulations under Chapter 4 of the Internal Revenue Code (Code), (1) commonly known as "FATCA." Before providing comments in the general format requested in the preamble to the regulations,2 TEI has the following broader comments.

First, TEI's specific comments and recommendations below focus predominantly on issues of key importance to non-financial institutions. Whereas the focus of Chapter 4 is on financial institutions, we remain concerned regarding the limited focus of the proposed regulations on those aspects most relevant to non-financial institutions. One example is the apparent inconsistency between the preamble and the regulation itself in respect of the definition of an active non-financial foreign entity (NFFE), the preamble stating a conjunctive test and the regulations providing a disjunctive test. (3)

Second, it will be difficult if not impossible for non-financial institutions to establish the necessary procedures to comply with FATCA's extremely detailed requirements before the current effective date. For example, it will be nearly impossible for non-financial withholding agents to begin documentation of new payees on January 1, 2013. Regrettably, we believe this situation flows from a misapprehension of the issues faced by non-financial institutions, which generally do not have the robust reporting and withholding systems and processes typically found in financial institutions. (4)

Third, there is precious little awareness among non-financial institutions or their advisers that FATCA applies to them. This general lack of awareness is likely attributable in large measure by the Treasury and IRS's focusing overwhelmingly on providing guidance to financial institutions. In fact, until the proposed regulations were promulgated, the introductory notes in the Notices generally refer to "Foreign Financial Institutions" (FFI) and "U.S. Financial Institutions," and it is not until well into each Notice (if at all) that it becomes clear that non-financial institutions have certain obligations under FATCA. TEI therefore urges the IRS and Treasury to accelerate their efforts to inform non-financial institutions of their obligations under FATCA in the coming months.

Finally, we regret that the proposed regulations, as applied to non-financial institutions, have seemingly lost sight of FATCA's central goal--combating tax evasion by U.S. persons through the use of unreported offshore accounts and structures.[section] For example, it is unlikely that a U.S. individual might route payments through a hedging or financing affiliate of a non-financial group6 as part of a tax evasion scheme, or concoct such a scheme through arm's-length U.S. source withholdable payments made in exchange for property.7 To be sure, the proposed regulations provide exceptions for such entities and payments, but the exceptions are unnecessarily narrow and in need of much clarification and expansion, as we discuss further below.

TEI Background

TEI is the preeminent association of inhouse tax executives worldwide. Our nearly 7,000 members represent 3,000 of the leading corporations in the United States, Canada, Europe, and Asia. TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner.

Summary of Recommendations

This section provides a summary list of TEI's primary recommendations, as requested in the preamble. (8) The supporting reasoning for each of the recommendations is set forth in the sections that follow.

1. Modify the first general definition of a financial institution in Prop. Reg. [section] 1.1471-[section](e)(1)(i), and the list of activities that constitutes a "banking or similar business" under Prop. Reg. 1.1471-[section](e)(2)(i) as follows:

   1. Clarify whether accepting deposits is a separate requirement under the first general definition from the list of activities that constitute a banking or similar business as it is included in each provision;

   2. Adopt a threshold income requirement before an entity will be considered a financial institution under the first general definition (20 percent of the entity's gross income over a certain period);

   3. Provide that the provision of credit by a member of an expanded affiliated group (EAG) in conjunction with the sale of goods produced by a member of the EAG, or the provision of services by such a member, be excluded from the list of activities that may cause such an entity to be considered a financial institution (as long as the EAG is primarily engaged in a non-financial institution business);

   4. Exclude from the definition of a financial institution entities that require deposits in conjunction with a "true lease" (as defined under U.S. tax principles); and

   5. Provide a definition of what constitutes "accepting deposits," by at a minimum, excluding from such term accepting or holding cash deposits as an ancillary part of a business that provides nonfinancial services, goods, or the use of property to customers.

2. Modify the definition of a "hedging/ financing centers of a nonfinancial group" in Prop. Reg. [section] 1.1471-5(e)(5) (iv), as follows:

   1. Provide a non-exclusive list of activities that constitute "financing and hedging" activities provided to members of the center's EAG; (9)

   2. Adopt a definition of what it means for an EAG to be "primarily engaged" in a business "other than that of a financial institution" by referencing the EAG's gross income over a certain period and, for such purpose, excluding the income of any entity described in Prop. Reg. [section] 1.1471-5(e)(5) (excluding certain entities that would otherwise be financial institutions from the definition of a financial institution);

   3. Allow a hedging/financing center to perform de minimis services for unrelated parties and still qualify for the exception; and

   4. Provide that the determination of whether an entity qualifies as a hedging/financing center is based upon the entity's actual activities, and not the activities that it may be permitted in engage pursuant to its organizing documents or under local law.

3. Modify the definition of "certain non financial holding companies" in Prop. Reg. [section] 1.1471-5(e)(5(i), as follows:

   1. Define a "subsidiary" as a downstream member of the holding company's EAG (or, alternatively, provide guidance on what is not a subsidiary);

   2. Remove the parenthetical "in whole or in part" from the definition or clarify what is meant by that phrase; and

   3. Provide an objective definition of "substantially all of the activities" by referencing the entity's income, while taking into account that many holding companies also act as hedging/financing centers or, alternatively, revert to the "primary purpose" standard of Notice 2010-60.

4. Provide an alternative to IRS forms for entities to certify to withholding agents their exempt FATCA status as a nonfinancial holding company or hedging/ financing center, under Prop. Reg. [section] 1.1471-3(d)(9).

5. Modify the exception for retirement funds in Prop. Reg. [section] 1.1471-[section](f)(2)(ii) to allow funds to qualify for the exception if contributions are "limited by reference to earned income or are subject to a maximum contribution limit under local law."

6. Modify the general definition of a withholdable payment in Prop. Reg. [section] 1.1473-1(a)(1) to:

   1. Exclude gains from the sale of property from the definition of FDAP income under Prop. Reg. [section] 1.1473-1(a)(2)(i)(A), in accordance with the Chapter 3 definition of such income;

   2. Except from the definition of a withholdable payment related party payments reported on Form 5471 or 5472.

   3. Provide a de minimis exception to the definition for any payment of less than $600, potentially subject to an anti-abuse rule.

7. Modify the exception to the definition of a withholdable payment for certain payments made in the ordinary course of a withholding agent's business in Prop. Reg. [section] 1.1473-1(a)(4)(iii), as follows:

   1. Exclude payments for "goods" from the definition of a withholdable payment, whether or not the payment was made in the "ordinary course" of the withholding agent's business (if payments for property are not excluded from the general definition of FDAP income, as recommended above);

   2. Define "goods" for purposes of such an exclusion to include raw...