M E M O R A N D U M
July 27, 2012
One of the basic problems with FATCA has been that it imposes obligations on foreign financial institutions ("FFIs") that may contravene the laws of other jurisdictions, such as reporting information to the IRS or closing the accounts of uncooperative customers. IGAs are agreements between the U.S. and FATCA "Partner Countries" intended to allow "FATCA Partner Financial Institutions" ("Partner FIs") to comply with both FATCA and local law. Yesterday the U.S. government released two versions of the FATCA "Model 1" IGA ("Model").
Identification of Entity Type: A Partner FI can treat an entity as an Active NFFE or Partner FI (including from another Partner Country) on the basis of publicly available information or other information in the Partner FI's possession. Other entities can establish their status with a self-certification. Key to Partner FI compliance will be the ability to establish standardized processes for collecting, validating, and maintaining this documentation. As with individuals, Forms W-8 and W-9 continue to be a solution.
The Search for U.S. Phone Numbers. The industry had hoped that U.S. phone numbers would be removed from the U.S. indicia list, but they remain a part of the Model. The final regulations are likely to also retain U.S. phone numbers as indicia of U.S. status and FATCA implementation projects should take this into account in designing search queries for electronic databases.
Deadlines Extended. The deadlines for completing preexisting account due diligence are later under the Model. The measuring date for new versus preexisting accounts is December 31, 2013, six months after the first wave of participating FFIs. High value individual accounts must be reviewed by the end of 2014 and other individual accounts must be reviewed by the end of 2015 (a six-month extension in both cases). Preexisting entity accounts must be reviewed by the end of 2015 (a six- or 18-month extension, depending on the type of entity). Partner FIs do not need to identify "prima facie" FFIs within one year of the effective date of its FFI Agreement as required by the proposed regulations. (See chart at the end of this letter.)
Information Exchange. Partner Countries and the U.S. are expected to exchange information for a calendar year within nine months of the year-end, except that the exchange for 2013 is delayed for an additional year to September 2015. There is no explicit deadline for Partner FIs to provide the information to their governments. In addition, the competent authorities of the parties will make further agreements governing the details of information exchange and other collaboration. (See chart at the end of this letter.)
Reporting. The Model reporting largely mirrors the proposed regulations with respect to reporting. Partner FIs must report account balances and amounts paid to account holders, except that they report to the Partner Country instead of the IRS. Like the proposed regulations, these obligations are phased in so that only balance information is required for 2013 and 2014, income payments are added for 2015, and gross proceeds paid to a custodial account are added for 2016 and subsequent years. We note, however, that the reporting for 2015 includes redemption payments made outside of a custodial account, and that these gross proceeds would not be reportable outside of a Partner Country. It is not clear whether this more burdensome result for Partner FIs was intended. In the reciprocity version of the Model, U.S. financial institutions are required to report to the IRS deposit interest and U.S. source payments, which is largely consistent with what they are required to do currently under U.S. law. Oddly, the Model does not state how withholding on U.S. source income amounts paid to NPFFIs should be reported. Presumably, such reporting will follow the proposed regulation rule of using Forms 1042-S.
Conditions for a Partner FI to Escape FATCA Withholding. Partner FIs must satisfy several key conditions to escape FATCA withholding on payments made to them – it is neither automatic by virtue of being located in a Partner Country nor absolute. Partner FIs must report on U.S. accounts annually, report payments to nonparticipating FFIs ("NPFFIs") for 2015 and 2016, comply with registration requirements, and either withhold 30% on U.S. source payments to NPFFIs or provide information to the withholding agent responsible for withholding. Significant noncompliance could cause a Partner FI to be treated as an NPFFI subject to full FATCA withholding and the IRS will apparently publish a list of such FIs. It remains uncertain, however, how the IRS would identify such non-compliance if the Partner Country is charged with overseeing the Partner FI's compliance, unless it is assumed that the Partner Country would proactively share such information with the IRS under its exchange agreement.
Defusing the "Limited" Time Bomb. Partner FIs that do everything required under the agreement are treated as complying with FATCA, even if branches in other countries or other members of their expanded affiliated group are not able to comply with FATCA. In the proposed regulations, the IRS would have temporarily allowed "Limited Branches" and "Limited Affiliates" until the end of 2015, but at that point the existence of even one Limited Branch or Affiliate would have prevented members of the group from maintaining participating FFI status, subjecting all FFIs in the group to 30% withholding under FATCA. The Model defuses the ticking time bomb of limited status. Partner FIs are, however, required to treat Limited Branches and Affiliates as NPFFIs and the branches and affiliates are required to identify and report upon U.S. accounts to the extent possible and to not solicit nonresident U.S. and NPFFI account holders. In addition, the branches and affiliates may not be used to circumvent the IGA or FATCA.
Withholding Limited to U.S. Source Income. A Partner FI's withholding obligation under the Model is limited to U.S. source income. Gross proceeds and foreign passthru payments are excluded from the definition of "U.S. source withholdable payment." In addition, no withholding is required on recalcitrant accounts at Partner FIs, and such accounts would not need to be closed. On the other hand, the parties agree "to work together, along with other partners, to develop a practical and effective alternative approach to achieve the policy objectives of foreign passthru payment and gross proceeds withholding that minimizes burden."
Reporting by USFIs. The U.S. has only committed to exchange information that USFIs are currently reporting to the IRS with regard to U.S. source income payments paid to direct account holders. They do not need to look through and report on the Partner Country owners of entities nor do they have to report on the account balances and other requirements that will be imposed on reporting of U.S. accounts by Partner FIs.
Conclusion. We view the publication of the Model as a positive development given the severe conflict of law problems that have plagued FATCA implementation projects since day one. However, it is clear that Partner FIs continue to have substantial FATCA compliance obligations and significant downsides if they fail to meet them. The IGAs are hardly an "out" from FATCA. Financial institutions should carefully assess the differences between the Model and the proposed regulations to read the tea leaves as to what the final regulations may well contain; U.S. officials have stated publicly that their goal is to have uniform due diligence and reporting requirements under both the IGAs and the regulations. To the extent that they miss their target of uniformity, FATCA implementation plans will need to be modified to take these differences into account.
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