Earlier this year, the United States enacted the Hiring Incentives to Restore Employment Act of 2010, which amended the Internal Revenue Code of 1986 to add provisions relating to foreign account tax compliance (FATCA).1
Broadly speaking, FATCA is intended to address tax evasion by "US persons," including US citizens, who maintain accounts in foreign financial institutions. The simplest example would be a US citizen who maintains a bank deposit or brokerage account with a bank outside the United States and does not declare the relevant income. FATCA is intended to require the bank to enter into an agreement with the Internal Revenue Service (IRS) to disclose information about its US clients, otherwise a person paying interest, dividends and certain other amounts from US sources to the bank must withhold a 30 per cent tax.
FATCA will require a foreign financial institution (FFI) to enter into an agreement with the IRS under which the FFI will be required to (i) obtain information from each accountholder to determine whether the accountholder is a US person; (ii) comply with verification and due diligence procedures required by the IRS for the identification of "US accounts"; (iii) make annual reports to the IRS with respect to each US account (including the name, address and taxpayer identification number of the holder, the account number and its balance or value and gross receipts and gross withdrawals or payments from the account); (iv) deduct a 30 per cent withholding tax on certain payments to "recalcitrant" accountholders (i.e., if the FFI cannot determine whether the holder is a US person); and (v) comply with requests for information from the IRS. If an FFI does not enter into an agreement with the IRS, then beginning January 1, 2013, a person making a "withholdable payment" (defined broadly to include US source interest and dividends as well as gross proceeds from the sale or other disposition of property that produce interest or dividends from US sources) to the FFI must withhold 30 per cent of the payment.
FATCA also contains provisions applicable to a foreign entity that is not an FFI (referred to as nonfinancial foreign entity or NFFE). In general terms, a person making a withholdable payment to an NFFE must withhold 30 per cent unless the NFFE certifies that it does not have any "substantial US owners" or provides the person with the name, address and taxpayer identification number of each substantial US owner. A substantial US owner of an NFFE is, subject to certain exceptions, generally a US person who owns, directly or indirectly, more than 10 per cent of the stock (by votes or value) of the NFFE if the NFFE is a corporation, more than 10 per cent of the profits or capital interests if it is a partnership, and more than 10 per cent of the beneficial interests if it is a trust.
Given the broad definition of FFI, which includes an entity that is engaged in the business of investing, reinvesting or trading in securities, it appears that a Canadian pension plan or profit- sharing plan that is funded would be an FFI. However, the regime applicable to FFIs will not apply to the extent that the beneficial owner of the relevant payment is of a class of persons identified by the Secretary of the Treasury as posing a low risk of tax evasion. In addition, the Secretary may identify classes of persons that are not subject to the rules applicable to NFFEs.
The FATCA provisions in the Internal Revenue Code are the "bare bones" of the new regime; the detailed rules will be set out in the regulations to the Code. In the meantime, the Department of the Treasury and the IRS intend to issue guidance to allow affected persons to prepare. In September, the IRS issued preliminary guidance in Notice 2010-60.
With respect to pension plans, the Notice identified certain retirement plans as posing a low risk of tax evasion and indicated that they would be excluded from the FFI regime. To be within the class of excluded retirement plans, all of the following requirements would have to be satisfied:
- it must qualify as a retirement plan under the law of the country in which it is established;
- it must be sponsored by a foreign employer; and
- it must not allow US participants or beneficiaries, other than employees who worked for the foreign employer in the country in which such retirement plan is established during the period in which benefits accrued.
The Notice requested comments on the definition of a retirement plan for this purpose, and on how such a plan could appropriately identify or document itself to person making payments potentially subject to withholding to verify its compliance with any such definitional requirements.
The Notice raises a number of issues with respect to whether Canadian pension plans and other arrangements will qualify as a retirement plan. If they do not, a Canadian pension plan would have to enter into an agreement with the IRS as described above and, among other things, determine which of its members are US citizens or other US persons. Otherwise, it will be exposed to a 30 per cent withholding tax on interest, dividends and certain other income from US sources. It is unclear how the inconsistency with reduced withholding rates under the Canada/US tax treaty would be resolved.
With respect to the first requirement, it is not clear what "law" is relevant. Must the plan qualify as such under the tax legislation of the country in which it is established or under some other law such as pension benefits legislation? Must the plan be exempt from tax in the country in which it is established? If not, could a "retirement compensation arrangement" qualify?
Are profit-sharing plans to be treated as retirement plans? The requirement that the plan be sponsored by "a" foreign "employer" raises questions about multi-employer plans, and income security or long-term savings plans provided by unions or trade associations.
The third requirement in the Notice may also be too narrow because US citizens covered under a Canadian plan may actually be working in another country.
Submissions raising these concerns about the Notice requirements have been made to Treasury and the IRS. Moreover, it is understood that a request has been made that it be made clear that a retirement plan that is not treated as an FFI will also be exempt from the rules applicable to NFFEs. Informal discussions with Treasury officials suggest that Canadian registered pension plans should qualify as a retirement plan.
Sponsors of Canadian pension plans, profit-sharing and similar plans should follow developments in this area closely and consider making submissions to Treasury.
The potential application of FATCA to Canadian pension plans illustrates the significant extra-territorial reach of FATCA. All intermediaries should be considering the application of FATCA to their business.
1. While we are not qualified to advise with respect to US law, we have set out in this note our understanding of certain implications of FATCA. For legal advice, readers must consult with US counsel.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.