On February 8, 2012, the Treasury Department issued detailed proposed regulations under the Foreign Account Tax Compliance Act (FATCA), which targets reporting noncompliance by U.S. taxpayers holding certain financial accounts in foreign countries. The proposed regulations are voluminous and extremely complex, but they generally incorporate the prior guidance released in IRS Notices 2011-53, 2011-34 and 2010-60, with some revisions. The proposed regulations provide extensive provisions detailing the procedures under which foreign financial institutions ("FFIs") may enter into and satisfy the requirements of an FFI agreement or otherwise be deemed to be compliant with the "Chapter 4" requirements, and much has been written about this aspect of the proposed regulations. In addition, in the case of various persons (other than FFIs) that will be affected by Chapter 4, the proposed regulations delay the effective date of such rules as applicable to debt obligations, preview the types of documentation that will be required by withholding agents, and provide additional guidance on the types of non-financial foreign entities that are likely to come within the ambit of the rules applicable to FFIs.
Grandfathered Obligations. One of the most significant aspects of the proposed regulations is the delay of the date under which "obligations" will be grandfathered. In particular, the proposed regulations delay the grandfather date to exempt obligations outstanding on January 1, 2013 (an extension from the prior date of March 18, 2012). An obligation is outstanding on January 1, 2013 if it has an issue date before January 1, 2013 or is created pursuant to a binding agreement executed before that date. Under this rule, binding obligations created pursuant to credit agreements and lines of credit that have a fixed term and that are entered into prior to January 1, 2013 will have grandfathered status, even if some or all of the amounts are drawn down after December 31, 2012. The regulations make clear that any "material modification" of an obligation on or after January 1, 2013 will result in the loss of grandfathered status.
- Because of the delayed grandfathering date, consideration should be given to entering into financing arrangements (even if drawings will occur later) or amendments to existing agreements (if those amendments may require an analysis of whether a material modification has occurred) prior to the end of 2012.
- A material modification in the context of bonds trading in the market is rare. However, as to other types of financings, it will be important to monitor changes (such as changes to interest rates, terms, security and obligors) to avoid the inadvertent loss of grandfathered status.
- The regulations are in proposed form only, meaning that the extension of the grandfather date cannot be relied upon until the regulations are final. Although the view generally appears to be that January 1, 2013 will be the new effective date, a number of disclosure documents with respect to bonds issued after March 18, 2012 generally describe a level of uncertainty about the application of FATCA and may do so until the proposed regulations become final or additional binding guidance to that effect is issued.
Withholdable Payments, Documentation and Procedures. The proposed regulations further define withholdable payments and provide a framework for obtaining documentation and withholding that is reminiscent of the complete revision of the withholding at source regime contained in the regulations under Code section 1441 (Chapter 3 withholding). The proposed regulations provide that, in the absence of proper documentation, withholding is required on payments to foreign financial institutions ("FFIs") under Chapter 4 of the Code without regard to whether the FFI payee is the beneficial owner or is acting solely as an intermediary.
- Withholdable payments include U.S. source FDAP income (such as interest and dividends) and gross proceeds from the sale or other disposition of property that produces dividends or interest. For purposes of chapter 4, the term sale or other disposition includes distributions from a corporation that represent a return of capital or a capital gain to the beneficial owner of the payment. The status as a dividend as a return of capital may not be determinable until after year end and thus the payment is more likely to be subject to chapter 4 withholding as a presumed dividend.
- The proposed regulations indicate that there may be multiple
layers of withholding agents with respect to certain payments and
provide an example of the payment of a dividend from a domestic
corporation (DC) to a custodial account with a Bank that is a
"participating FFI" (an FFI that has entered into an FFI
agreement). The example notes that the DC and the Bank are both
withholding agents making a payment for which they have custody,
control and knowledge. The proposed regulations also indicate that
where multiple brokers are involved in effecting a sale, each
broker must determine if it is required to withhold under Chapter 4
with respect to the sale proceeds.
- Note that although the proposed regulations attribute a level of knowledge to the payor of the dividend, in the context of publicly traded stock, procedures will need to take into account the complex system of intermediaries and custodial accounts through which such stock is held.
- The proposed regulations indicate that the IRS and Treasury
intend to revise existing Forms W-8 and W-9 to permit a payee to
establish its status for both Chapter 3 and Chapter 4 withholding
(and note that withholding under section 1445 ("FIRPTA")
and 1446 ("effectively connected income" of a
partnership) generally is not subject to Chapter 4 withholding).
The standards of knowledge under which a withholding agent may rely
on information and certifications contained in withholding
certificates or documentation for purposes of Chapter 4 withholding
are generally the same as in Chapter 3 withholding
(i.e., reliance is permitted without additional
investigation unless the agent "knows or has reason to
know" that the information or certifications are untrue).
- A withholding agent also may be liable for failure to withhold if the agent knows or has reason to know that a financing arrangement is a conduit financing arrangement (i.e., the same standard that is applied in Chapter 3 withholding).
Rules Relating to Non-Financial Foreign Entities - FATCA is intended to broadly encompass foreign entities that receive U.S. source withholdable payments. Such entities are subject to different rules depending on whether they are FFIs or non-financial foreign entities ("NFFEs") and whether such entities meet certain exceptions to the application of Chapter 4. The proposed regulations provide helpful guidance in making these distinctions and also provide exemptions from Chapter 4 withholding for certain NFFEs.
- A foreign entity will be classified as an FFI (even if it is not a traditional financial institution) if 50% or more of its gross income for the shorter of the preceding 3 years or the period of its existence is attributable to investing, reinvesting or trading. Under this rule, foreign entities that are not traditional financial institutions and wish to avoid classification as an FFI, will need to evaluate and monitor the sources of their income on a yearly basis in much the same manner as is required under the "passive foreign investment company" or "PFIC" rules.
- Certain entities are excluded from the definition of FFI and also are exempt from Chapter 4 withholding as "excepted NFFEs" provided that the NFFE is the beneficial owner of the relevant payment. These include certain nonfinancial holding companies and start-up companies (but excluding in these cases any entity that functions, or holds itself out, as a private equity fund, venture capital fund, leveraged buyout fund or similar investment vehicle) and section 501(c) exempt organizations.
- Certain other entities also are exempt from Chapter 4
withholding as "excepted NFFEs," including:
- A corporation whose stock is regularly traded on an established securities market or an affiliate of such a corporation (the provisions closely mirror the tests for determining if a "U.S. real property holding corporation" qualifies for the publicly traded "FIRPTA" exception);
- An "active NFFE," which is defined as an NFFE if less than 50% of its gross income for the preceding calendar year is passive or less than 50% of the assets held during that year produce or are held for the production of passive income.
- The proposed regulations indicate that withholding certificates will be revised to include a variety of new representation including that the payee's stock is regularly traded on an established securities market or that the payee is an "active NFFE" within the meaning of the proposed regulations.
The proposed FATCA regulations provide a framework and some guidance on many issues such as the responsibilities of withholding agents and types of documentation and certifications that will be required to avoid withholding. In addition, the proposed regulations define and clarify the requirements to qualify for certain exceptions, such as the exclusion of active NFFEs and the manner of determining whether stock of an entity is regularly traded for purposes of certain exceptions. The foregoing points are some to keep in mind throughout 2012; however, final regulations will undoubtedly differ in many respects from these proposed regulations and will reflect additional comments from financial institutions and other affected parties.
Treasury Department Circular 230 Notice. Any statement regarding U.S. federal tax issues contained herein was not written or intended to be used, and it cannot be used, by any person (i) as a basis for avoiding U.S. federal tax penalties that may be imposed on that person, or (ii) to promote, market or recommend to another party any transaction or matter addressed herein.
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.