United States: Announcement 2012-42 Provides Transitional FATCA Relief For Foreign Financial Institutions

Last Updated: November 9 2012
Article by Shlomo Boehm, Mark P. Howe, David S. Miller, Daniel J. Mulcahy and Jason D. Schwartz

Most Read Contributor in United States, December 2018

On October 24, the Internal Revenue Service issued Announcement 2012-42, which (i) delays gross proceeds withholding under the "Foreign Account Tax Compliance Act" provisions contained in sections 1471-1474 of the Internal Revenue Code ("FATCA"), (ii) grandfathers (i.e., exempts from FATCA withholding) obligations that give rise only to foreign-source income or will give rise to U.S.-source dividend-equivalent payments under future section 871(m) regulations, and collateral arrangements that relate only to grandfathered swaps and other grandfathered "notional principal contracts," and (iii) extends the deadlines under FATCA for completing due diligence with respect to counterparties and financial account holders.1

Introduction

The purpose of FATCA is to reduce U.S. tax evasion by requiring certain "foreign financial institutions" to enter into an agreement with the U.S. Treasury Department (an "FFI agreement") to report information to the IRS about U.S. holders of their non-publicly traded debt and equity interests and other "financial accounts," and to withhold 30% on certain payments that are attributable to U.S. assets (referred to as "passthru payments") that they make to holders that do not provide the required information or to foreign financial institutions that have not themselves entered into an FFI agreement.2 Under proposed regulations that were issued in July, a foreign financial institution that does not enter into an FFI agreement with the U.S. Treasury Department will be subject to a 30% withholding tax on (i) U.S.-source income beginning in 2014, (ii) gross proceeds from its sale of assets that produce U.S.-source income and from its receipt of principal on those assets beginning in 2015, and (iii) passthru payments from other foreign financial institutions beginning no earlier than 2017.3 The proposed regulations do not define "passthru payment," and so it is unclear whether the calculation of passthru payments will reflect a "tracing" approach that attempts to determine which payments by a foreign financial institution are attributable to U.S. assets, a "percentage" approach that treats a portion of each payment by a foreign financial institution as being attributable to U.S. assets, or a hybrid or other approach. This memorandum summarizes the aspects of the Announcement that are most relevant to foreign hedge funds and their foreign "blockers," foreign private equity funds, foreign "collateralized loan obligation" issuers, and "catastrophe bond" issuers (collectively, "foreign funds").4

Announcement 2012-42

Announcement 2012-42 makes the following changes to the proposed regulations:

  • Two-year delay of gross proceeds withholding. The Announcement extends the effective date for withholding on the gross proceeds of sales of assets that produce U.S.- source income (and on the payment of principal on those assets) from 2015 to 2017. The Announcement does not extend the effective date for withholding on U.S.-source income that does not constitute gross proceeds. Therefore, a foreign fund that does not enter into an FFI agreement will be subject to FATCA withholding on U.S.-source income beginning in 2014, but will not be subject to FATCA withholding on gross proceeds from its sale of assets that produce U.S.-source income or from its receipt of principal on those assets until 2017.
  • Expansion of grandfathering rule. Under the existing proposed FATCA regulations, FATCA withholding will not be required on any debt or derivative5 that has a stated maturity and is issued or entered into before 2013 (and is not significantly modified after 2012). The Announcement adds a new grandfathering rule for three types of instruments:
  • Obligations that give rise only to foreign-source income. As mentioned above, a foreign financial institution that enters into an FFI agreement will be required to withhold 30% on foreign-source "passthru payments" that it makes to holders of its non-publicly traded debt and equity interests and other financial accounts that do not provide sufficient information for the foreign financial institution to determine whether they are U.S. persons, and to foreign financial institutions that have not themselves entered into an FFI agreement with the U.S. Treasury Department. Thus, a foreign fund that does not enter into an FFI agreement will be subject to 30% withholding on any foreign-source passthru payments that it receives from a foreign financial institution that has entered into an FFI agreement. As mentioned above, the proposed regulations do not define the scope of passthru payment withholding, and provide that passthru payment withholding will not be required before 2017.

The Announcement grandfathers obligations that give rise only to foreign-source passthru payments and are outstanding six months after the publication of final regulations that define the scope of passthru payment withholding, even if the obligations mature after 2016. Therefore, a foreign fund that does not enter into an FFI agreement will not be subject to FATCA withholding on debt obligations, swaps, and other derivative contracts that were entered into with foreign counterparties, give rise only to foreign-source income, and are outstanding now or are entered into until six months after the passthru payment regulations are finalized.6

  • Obligations that produce U.S.-source dividend equivalent payments. Under section 871(m), payments on certain equity swaps, securities loans, and securities repurchase transactions are treated as U.S.-source dividends and subject to 30% withholding tax if the payments are "dividend equivalent payments" that is, if the payments are contingent upon, or determined by reference to, U.S.-source dividends. In addition, beginning in 2014, dividend equivalent payments on all equity swaps and other financial instruments will be treated as U.S.-source dividends and subject to the 30% withholding tax unless regulations are issued that exempt the payments from this treatment.7

The Announcement provides that the extended grandfathering date described above for obligations that produce only foreign-source passthru payments also will apply to obligations that produce U.S.-source income solely by reason of section 871(m), so long as the obligations are outstanding now or are issued until six months after the effective date of any regulations that cause the payments to be treated as U.S.-source dividends.

  • Certain collateral arrangements. As mentioned above, FATCA withholding will not be required on payments of U.S.-source income on any debt or derivative that has a stated maturity and is issued or entered into before 2013 (and is not significantly modified after 2012), or on gross proceeds from the disposition of the obligation. Some practitioners have raised concerns that, because collateral arrangements typically do not have stated maturities, a counterparty may be required to withhold under FATCA when it repays collateral or passes an income payment through on any securities posted as collateral (even if the securities were issued before 2013).

The Announcement provides that a collateral arrangement will be grandfathered, and the posting of collateral after 2012 will not itself give rise to withholding under FATCA, so long as the collateral secures only "grandfathered notional principal contracts" that is, swaps or other notional principal contracts8 that were entered into before (i) 2013, in the case of a notional principal contract that provides for U.S.-source payments (other than dividend-equivalent payments that are not currently treated as U.S.-source dividends),9 (ii) six months after final regulations are issued defining the scope of passthru payment withholding, in the case of a notional principal contract that provides for only foreign-source payments, and (iii) six months after the effective date of any regulations that cause payments under the notional principal contract to be treated as U.S.-source dividends, in the case of a notional principal contract that provides for U.S.-source dividend-equivalent payments.

This grandfather provision is extremely narrow and unlikely to be of much practical use unless it is expanded, because it applies only to collateral arrangements that secure only grandfathered notional principal contracts. Thus, if a collateral agreement serves as security for a single instrument that is not a notional principal contract, or for a single notional principal contract that is not a grandfathered notional principal contract, then the collateral agreement will not be grandfathered.

  • Extension of due diligence deadlines. The Announcement extends the time that a foreign financial institution has to determine the FATCA status of a holder that purchased a non-publicly traded debt or equity interest in the foreign financial institution or that otherwise was treated as opening a "financial account" at the foreign financial institution before the foreign financial institution entered into an FFI agreement.10 A foreign fund that enters into an FFI agreement will not be required to report information about these "preexisting" account holders until after the due diligence deadlines, unless the foreign fund completes its due diligence before the deadlines and discovers a noncompliant holder. In this case, immediate reporting is required. These changes generally are intended to conform the timeline to that contained in the model FATCA intergovernmental agreement released in August.11

Very generally, the revised deadlines are:

Entities:

  • For any holder that is a "prima facie FFI," six months after the effective date of the FFI agreement. In general, a "prima facie" FFI is an account holder that the foreign financial institution has documented as an intermediary in its electronically searchable information. For this purpose, the effective date of an FFI agreement that is entered into before 2014 is January 1, 2014. Thus, the earliest date by which a foreign fund must complete its due diligence with respect to prima facie FFIs will be July 1, 2014.
  • For any holder that is not a "prima facie FFI," two years after the effective date of the FFI agreement.

Individuals:

  • For an individual with an aggregate account balance in excess of $1 million, one year after the effective date of the FFI agreement.
  • For an individual with an aggregate account balance not in excess of $1 million, two years after the effective date of the FFI agreement.

Footnotes

1 All references to section numbers are to the Internal Revenue Code of 1986, as amended, or to the temporary or proposed Treasury regulations promulgated thereunder

2 FATCA also imposes information reporting requirements on non-financial foreign entities. This memorandum does not address those rules.

3 We discussed the proposed regulations in a previous Clients & Friends memo, available at http://www.cadwalader.com/assets/client_friend/021712ApplicationProposedFATCARegulations.pdf.

4 Some practitioners take the position that a catastrophe bond issuer that enters into a reinsurance agreement is a reinsurance company that is not treated as a foreign financial institution under FATCA. This position is not taken if the catastrophe bond issuer enters into a "catastrophe swap" or other noninsurance derivative.

5 Financial instruments that constitute equity for tax purposes are not grandfathered.

6 Likewise, a foreign fund that enters into an FFI agreement will not be required to withhold on passthru payments that it makes under debt obligations, swaps, and other derivative contracts issued or entered into earlier than six months after passthru payment regulations are finalized, even if the instruments mature after 2016 and the counterparties fail to provide required FATCA certifications or are foreign financial institutions that have not entered into their own FFI agreement.

7 We discussed section 871(m) and the temporary and proposed regulations thereunder in a previous Clients & Friends Memo, available at http://www.cadwalader.com/assets/client_friend/012512ProposedRegsAddressUSTaxOnCBEquityDerivatives.pdf.

8 Very generally, a notional principal contract is a financial instrument that provides for the payment of amounts by one party to another at specified intervals calculated by multiplying a notional principal amount by (i) a fixed rate (e.g., LIBOR) or (ii) an index that is based on current, objectively determinable financial or economic information that is not within the control of either of the parties to the contract and is not unique to one of the parties' circumstances (such as the party's dividends or profits, or the value of its stock), in exchange for specified consideration or an obligation to pay similar amounts. Notional principal contracts may include interest rate swaps, caps, and floors, and commodity swaps.

9 Payments under a notional principal contract to a non-U.S. counterparty generally are treated as foreign-source payments, so long as the counterparty is not engaged in a trade or business in the United States for U.S. federal income tax purposes. However, a notional principal contract may be treated as giving rise to U.S.-source payments if it provides for upfront or back-end payments (other than for a cap or floor, or a termination payment), or produces foreign currency gain or loss, and certain other conditions are present.

10 Consistent with these extensions, the Announcement also provides that foreign financial institutions will not be required to file their first information report under FATCA until March 31, 2015. The proposed regulations required the first information report to be filed by September 30, 2014.

11 We discussed the model FATCA intergovernmental agreement in a previous Clients & Friends Memo, available at http://www.cadwalader.com/assets/client_friend/081012USTreasuryDeptReleasesFATCAAgreements.pdf . We also discussed the intergovernmental agreement signed by the United States and the United Kingdom in September in a previous Clients & Friends Memo, available at http://www.cadwalader.com/assets/client_friend/092012USandUKSignIntergovernmentalAgreementUnderFATCA.pdf.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions