Canada: More On FATCA … And More To Come: The Internal Revenue Service And Treasury Department Release Proposed Regulations


In 2010, the United States amended the Internal Revenue Code of 1986 to add provisions relating to foreign account tax compliance (FATCA). Intended to combat international tax evasion by U.S. persons, these amendments were a mere 10 pages long, but they contemplated a comprehensive worldwide system of information gathering, reporting and withholding (see New, Far-Reaching US Tax Requirements Under FATCA Canadian Pension Plans may Even Be Caught , Tax Update dated December 17, 2010).

Since then, the Internal Revenue Service (IRS) and the Treasury Department (Treasury) have issued several releases intended to provide guidance with respect to the manner in which the system is to operate. They have also engaged in extensive consultations with affected persons. This process culminated with the release, on February 8, 2012, of approximately 400 pages of proposed regulations and explanatory material. Comments on the proposed regulations may be submitted until April 30, 2012.

The proposed regulations do not provide any further delay of the phase-in of FATCA withholding and reporting requirements from the scheduled start date of January 1, 2014. The deadline for a "foreign financial institution" (FFI) to enter into an agreement with the IRS to avoid withholding tax remains June 30, 2013.

At the same time as the release of the proposed regulations, Treasury and the governments of five European countries (France, Germany, Italy, Spain and the United Kingdom) released a Joint Statement indicating that the United States and each of their governments had agreed to explore a common approach to FATCA implementation through domestic reporting and reciprocal automatic exchange, based on existing bilateral tax treaties. It is understood that an acceptable approach, if one can be determined, would serve as a template for arrangements with other countries. Such an approach would address concerns raised in the consultation process that requirements imposed on financial institutions to report account holder information to the IRS would contravene applicable privacy laws.

Canada was not a party to the Joint Statement, but it is understood that there are ongoing discussions between Canada and the United States relating to the application of FATCA, having regard to:

  • the relatively large number of U.S. individuals who reside in Canada;
  • the fact that Canada is not a low-tax jurisdiction; and
  • the fact that the Canada Revenue Agency (CRA) already automatically exchanges information with the IRS with respect to certain payments made to persons with U.S. addresses. Publicly available documents indicate that the CRA automatically exchanges details of payments made to U.S. addresses and reported on Canadian NR4 forms such as dividends, interest and trust distributions. However, as U.S. taxpayer ID numbers are not collected in Canada, the information provided is not associated with U.S. taxpayer ID numbers that would facilitate matching. It is also understood that there is no exchange of information relating to proceeds from the sale or other disposition of property. In addition, payments to entities in third countries that may be owned by U.S. persons are not reported.

This update provides a high-level overview of the FATCA regime, followed by a discussion of some of the proposed exceptions to "full" FATCA compliance that might be available to certain Canadian entities.

As FATCA is U.S. law, readers requiring legal advice should consult with U.S. counsel.

Broad Scope of FATCA

FATCA is intended to address tax evasion by "U.S. persons," including U.S. citizens, who maintain accounts in an FFI or who own substantial interests in other foreign entities, i.e., "non-financial foreign entities" (NFFEs). The objective is for the IRS to be provided with information about these U.S. persons. The sanction is an obligation on the part of a person making a "withholdable payment" to a non-compliant FFI or NFFE to deduct 30% withholding tax on that payment.

An FFI is defined to include a non-U.S. entity which:

  • is a bank;
  • holds, as a substantial portion of its business, financial assets for the account(s) of others (e.g., a custodian or a broker); or
  • is engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities or any interest (including a futures or forward contract or option) in such securities, partnership interests or commodities (an Investment Undertaking).

A Canadian investment fund, pension plan or profit-sharing plan may be considered to be engaged in an Investment Undertaking.

FATCA requires an FFI to enter into an agreement with the IRS (FI Agreement). Under the FI Agreement, the FFI is required to:

  • obtain information from each account holder to determine whether the account holder is a U.S. person;
  • comply with verification and due diligence procedures required by the IRS for the identification of "U.S. accounts";
  • make annual reports to the IRS with respect to each U.S. 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);
  • deduct a 30% withholding tax on certain payments to "recalcitrant" account holders (i.e., account holders where the FFI cannot determine if they are, or are not, U.S. persons); and
  • comply with requests for information from the IRS.

Although a draft form of FI Agreement has yet to be released, the proposed regulations outline in considerable detail what it will contain.

Absent an exemption, a Canadian investment fund, pension plan or project-sharing plan that is an FFI would have to comply with procedures to identify security holders or beneficiaries that are U.S. persons.

If an FFI does not enter into an FI Agreement, then beginning January 1, 2014, a person making a withholdable payment must withhold 30% of the payment. Broadly defined, a withholdable payment includes U.S. source dividends, interest and other fixed or determinable annual or periodic income (FDAP income) as well as gross proceeds from the sale or other disposition of property that produce interest or dividends that are U.S.-source FDAP income. Withholding on gross proceeds is required, beginning January 1, 2015.

An FFI that enters into an FI Agreement is required to withhold a tax equal to 30% of any "passthru payment" made to a recalcitrant accountholder or another FFI that has not entered into an FI Agreement. A passthru payment is:

  • any withholdable payment; or
  • any other payment to the extent attributable to a withholdable payment. This is particularly problematic. For example, how would an investment fund receiving income from U.S. and foreign sources determine the percentage of a distribution attributable to withholdable payments and made to a recalcitrant account holder? Similarly, how would it determine what amount of redemption proceeds paid to the recalcitrant accountholder is attributable to a withholdable payment? Although one could say that recalcitrant account holders are the authors of their own misfortunes, the proposed regulations will defer withholding on passthru payments that are not withholdable payments until at least January 1, 2017. Treasury and the IRS specifically request comments on approaches to reduce the administrative burden associated with determining passthru payment percentages.

FATCA also contains provisions applicable to an NFFE. In general terms, a person making a withholdable payment to an NFFE must withhold 30%, unless the NFFE certifies that it does not have any "substantial U.S. owners" or provides the person with the name, address and taxpayer identification number of each substantial U.S. owner. A substantial U.S. owner of an NFFE is, subject to certain exceptions, generally:

  • if the NFFE is a corporation: a U.S. person who owns, directly or indirectly, more than 10% of the stock (by votes or value) of the NFFE;
  • if the NFFE is a partnership: a U.S. person who owns, directly or indirectly, more than 10% of the profits or capital interests; and
  • if the NFFE is a trust: a U.S. person who owns, directly or indirectly, more than 10% of the beneficial interests.

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 (Secretary) 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.

Some Potential Carve-Outs — Canadian Investment Funds, Pension Plans and Retirement Accounts

The proposed regulations contemplate that "registered deemed compliant FFIs" and "certified deemed compliant FFIs" do not have to enter into an FFI Agreement in order to avoid FATCA withholding. As the name suggests, a registered deemed compliant FFI must register with the IRS and will be provided with an identification number. A certified deemed compliant FFI need not register with the IRS, but does need to certify its status to a person making a witholdable payment to it.

Registered Deemed Compliant FFIs

In the investment fund context, there are two potentially relevant categories of registered deemed compliant FFIs — "qualified collective investment vehicles" and "restricted funds."

A qualified collective investment vehicle must meet the following requirements:

  • It must be an FFI solely because it is engaged in an Investment Undertaking.
  • Each holder of record of units or shares (units) must be a participating FFI, a registered deemed compliant FFI or certain enumerated U.S. persons, including:
    • a corporation which has stock regularly traded on one or more established securities markets;
    • a real estate investment trust;
    • a regulated investment company; or
    • any entity registered with the Securities Exchange Commission under the Investment Company Act of 1940.
  • If it is part of an expanded affiliated group, all other FFIs in the group must be participating FFIs or registered deemed compliant FFIs.

A restricted fund must meet the following requirements:

  • It must be an FFI solely because it is engaged in an Investment Undertaking.
  • It must be regulated as an investment fund under the laws of its country of incorporation or organization; this country must be Financial Action Task Force "compliant."
  • Units may only be sold through certain permitted distributors (i.e., a participating FFI, a registered deemed compliant FFI, a "non-registering local bank" or a restricted distributor) or redeemed by the fund.
  • Each distribution agreement with a permitted distributor must prohibit the sale of units to U.S. persons, non-participating FFIs or passive NFFEs with one or more substantial U.S. owners (other than units which are both distributed by and held through a participating FFI). The fund's prospectus and all marketing materials must indicate that sales of units to the foregoing are prohibited.
  • Each distribution agreement with a permitted distributor must require the distributor to notify the fund if it ceases to be a permitted distributor. The FFI must certify to the IRS that it will terminate the distribution agreement within 90 days notice of the change in status and redeem or acquire within six months all units distributed through that distributor.
  • With respect to any pre-existing direct accounts (i.e., accounts held directly by the ultimate investors), the fund must generally review them in accordance with prescribed procedures to identify any U.S. account or account held by a non-participating FFI.
  • The fund must implement prescribed policies and procedures with respect to direct account holders to ensure that it either:
    • does not open or maintain an account for a U.S. person (with certain exceptions), a non-participating FFI or a passive NFFE with one or more substantial U.S. owners; or
    • closes any such account within 90 days after it is opened or the FFI had reason to know the account holder was such a person, or withholds and reports on such account as if it were a participating FFI.
  • If it is part of an expanded affiliated group, all other FFIs in this group must be participating FFIs or registered deemed compliant FFIs.

A qualified collective investment vehicle and a restricted fund may apply to become a registered deemed compliant FFI. In order to do so, its chief compliance officer or equivalent person must certify to the IRS that the relevant requirements are satisfied. The IRS will confirm registration and issue a federal tax identification number (FFI-EIN). Certification must be renewed every three years.

In broad terms, it appears that the definition of qualified collective investment vehicle is intended to exclude from the definition of FFI a fund where the necessary information will be provided by other entities closer to investors. In the case of a restricted fund, the goal appears to be to exclude from FATCA a fund that, through its distribution arrangements, excludes U.S. persons as investors. The requirement that a restricted fund must be regulated as an investment fund under the laws of its country of incorporation or organization is not clear. Presumably, a Canadian mutual fund offered by prospectus and compliant with National Instrument 81-102 of the Canadian securities regulators (which imposes investment diversification and other requirements) would meet this requirement. On the other hand, would a pooled fund offered to accredited investors pursuant to exemptions from prospectus requirements and not subject to government-mandated investment restrictions qualify?

Certified Deemed Compliant FFIs

A certified deemed compliant FFI is not required to register with the IRS. It must provide, to a withholding agent that is making a payment to it, certain prescribed information applicable to the relevant deemed compliant category.

A retirement fund may qualify for certified deemed compliant status if it meets the following requirements:

  • It is organized for the provision of retirement or pension benefits under the laws of the country in which it is established or operates.
  • All contributions to the fund (other than certain transfers from other plans) are employer, government or employee contributions limited by reference to earned income.
  • No single beneficiary has a right to more than 5% of the fund's assets.
  • Under the laws of the jurisdiction in which the fund is established or operates:
    • contributions to the fund are deductible or excluded from gross income of the beneficiary;
    • the taxation of investment income to the beneficiary is deferred; or
    • 50% or more of total contributions to the fund (other than transfers from certain plans) are from the government and the employer.

An initial review of these requirements suggests that most Canadian registered pension plans would satisfy them.

A retirement fund may also qualify for certified deemed compliant status if it meets the following conditions:

  • It is organized for the provision of retirement or pension benefits under the laws of the country in which it is established or operates.
  • It has fewer than 20 participants.
  • It is sponsored by an employer that is not an FFI engaged in an Investment Undertaking or a passive NFFE.
  • Contributions to the fund (other than certain permitted transfers) are limited by reference to earned income.
  • Participants that are not residents of the country in which the fund is organized are not entitled to more than 20% of the fund's assets.
  • No participant that is not resident in the country in which the fund is organized is entitled to more than $250,000 of the fund's assets.

A withholding agent will be entitled to treat a retirement fund as having deemed compliant status if it has a valid withholding certificate from the payee, in which the payee certifies that it meets the requirements and that its organizational documents "generally support" the payee's claim. An organizational document will generally support the payee's claim if it indicates that the payee qualifies as a retirement plan under the laws of the jurisdiction in which it is organized. The organizational document does not have to specify that the payee meets all of the requirements, but it cannot contain information that contradicts the payee's claim to qualify.

Exclusions From the Definition of Financial Account

A financial account is generally a depository or custodial account maintained by a financial institution or an interest in a financial institution engaged in an Investment Undertaking. A "U.S. account" is a financial account held by one or more specified U.S. persons or U.S.-owned foreign entities. Under an FI Agreement, the FFI must comply with verification and due diligence procedures required by the IRS for the identification of United States accounts. The FFI's compliance burden may be reduced, to the extent that categories of account are excluded from the definition of financial account. A retirement fund that meets the requirements to qualify for certified deemed compliant status will also be excluded from the definition of financial account.

Given the significant amount of savings held by Canadian investors in "registered" accounts such as registered retirement savings plans (RRSPs), it would ease Canadian financial institutions' compliance burdens if such registered accounts were also excluded.

A personal retirement account will be excluded from the definition of financial account if it is subject to regulation as a personal retirement account or is registered or regulated as an account for the provision of retirement or pension benefits under the laws of the country in which the FFI that maintains the account is established or in which it operates and meets the following conditions:

  1. The account is "tax-favoured" in the jurisdiction within which it is maintained.
  2. All contributions to the plan are employer, government or employee contributions that are limited by reference to earned income under the law of the jurisdiction in which the account is maintained.
  3. Annual contributions (other than certain transfers) are limited to $50,000 or less, and limits or penalties apply, according to the law of the jurisdiction in which the account is maintained, to withdrawals made before reaching a specified retirement age and to annual contributions not exceeding $50,000 (other than certain permitted transfers).

An account that is "tax-favoured" in the jurisdiction in which it is maintained and subject to government regulation as a savings vehicle for purposes other than retirement will be exempt from the definition of financial account if it meets the following conditions:

  1. Contributions are limited by reference to earned income.
  2. Annual contributions are limited to $50,000 or less.
  3. Limits or penalties apply on withdrawals made before specific criteria are met under the law of the jurisdiction in which the account is maintained.
  4. Limits or penalties apply to excess contributions.

It is not apparent that all Canadian registered accounts would qualify for exclusion:

  • With respect to an RRSP, unless the funds in the RRSP are "locked-in" because they are locked-in pension funds that have been transferred to the RRSP, the annuitant of the RRSP is entitled to withdraw amounts from the RRSP subject to terms of the plan. In most cases, the amount withdrawn must be included in income. Is such an income inclusion a "penalty" for a withdrawal made prior to maturity?
  • With respect to a registered retirement income fund (RRIF), property is generally transferred to the RRIF from an RRSP. Presumably, one would argue that as RRSP contributions are limited by reference to earned income, contributions to an RRIF from an RRSP are similarly limited, particularly as transfers are contemplated by (c) of the personal retirement account exclusion above.
  • A tax-free savings account would not qualify, since contributions are limited to $5,000 per year regardless of earned income.
  • A deferred profit sharing plan might qualify under the personal retirement account exclusion above, depending on how one interprets the penalty for the early withdrawal requirement.

As noted, the proposed regulations are not country-specific. Given the large number of registered accounts in Canada, it would be helpful for the IRS to issue additional guidance confirming which Canadian registered accounts qualify.


This update provides a brief overview of FATCA and a close examination of a few issues regarding its application to Canadian investment funds, pension plans and registered accounts.

The complexity of the law in this narrow area alone is an example of the enormous complexity of the FATCA regime. One hopes that the governments of Canada and the United States are able to simplify the application of FATCA to Canadian residents.

We reiterate that affected persons should engage U.S. counsel and consider making additional submissions as part of the comment process applicable to the proposed regulations.

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.

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