United States: IRS Notice 2015-66 Extends Certain FATCA Transitional Rules And Expands Definition Of Grandfathered Obligation

The Department of the Treasury and the Internal Revenue Service ("IRS") intend to amend the Foreign Account Tax Compliance Act ("FATCA") regulations issued under chapter 4 of the Internal Revenue Code of 1986, as amended (the "Code"), to extend the period of time that certain transitional rules will apply and to modify the rules for grandfathered obligations with respect to collateral.  

Background. Sections 1471-1474 of the Code, commonly referred to as the "FATCA" provisions, generally require U.S. withholding agents to withhold tax (at 30 percent) on certain payments to foreign financial institutions that do not agree to report certain information to the IRS regarding their U.S. accounts, and on certain payments to nonfinancial foreign entities that do not provide information on their substantial U.S. owners to withholding agents.

A "withholdable payment" for purposes of FATCA generally means any payment of U.S. source fixed or determinable annual or periodical ("FDAP") income, and withholding on such U.S. source FDAP generally started July 1, 2014. The term "withholdable payment" also includes any gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends that are U.S. source FDAP income, but only for sales or other dispositions occurring after December 31, 2016.

Withholding on FATCA applies to U.S. withholding agents making U.S. source payments to foreign payees, and also to foreign financial institution payors that make certain "passthru payments" to certain non-FATCA compliant payees. A "passthru payment" is defined in the regulations to mean a withholdable payment and any foreign passthru payment. The FATCA regulations currently reserve on the definition of the term "foreign passthru payment." A transitional rule provides that a foreign financial institution is not required to withhold tax on a foreign passthru payment made to such non-FATCA compliant payees before the later of January 1, 2017, or the date of publication in the Federal Register of final regulations defining "foreign passthru payment."

A withholdable payment does not include a payment made under a "grandfathered obligation." A grandfathered obligation includes any obligation outstanding on July 1, 2014. It also includes an agreement requiring a secured party to make a payment with respect to collateral posted to secure a grandfathered obligation. If collateral secures both grandfathered and non-grandfathered obligations, the collateral posted to secure the grandfathered obligations must be determined by allocating, pro rata by value, the collateral to all outstanding obligations secured by the collateral. Certain payments made on or before December 31, 2016, by a secured party, or to certain secured parties, with respect to collateral securing one or more transactions under a collateral arrangement is not treated as a withholdable payment.

For more background on FATCA and its implementation, see " FATCA's July 1 Effective Date Has Arrived; Last-Minute Guidance Has Been Issued."

Notice 2015-66 Extends Transitional Rules and Expands the Scope of Grandfathered Obligations. In Notice 2015-66, the Department of the Treasury and the IRS provided that they intend to amend the FATCA regulations to:

  1. Extend the start date of gross proceeds withholding by providing that the definition of the term "withholdable payment" means any payment of U.S. source FDAP income, and for sales or other dispositions occurring after December 31, 2018, any gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends that are U.S. source FDAP income.
  2. Extend the start date of withholding on foreign passthru payments to the later of January 1, 2019, or the date of publication in the Federal Register of final regulations defining the term "foreign passthru payment."

    With respect to items (1) and (2) above, the Notice acknowledges that many U.S. and foreign financial institutions, foreign governments, the Department of the Treasury, the IRS, and other stakeholders have devoted resources to implementing FATCA withholding on withholdable payments, as well as for the first U.S. account reporting under FATCA, which was due for certain foreign financial institutions starting in March 2015. The extended deadlines are viewed as necessary to continue to facilitate an orderly phase-in of FATCA withholding.
  3. Provide that the "pro rata" rule with respect to pooled collateral is not mandatory.

    In order to ease administrative burdens when collateral secures both grandfathered obligations and obligations that are not grandfathered, the secured party should be permitted either to withhold on all collateral or to apply the pro rata approach with respect to such collateral.
  4. Treat a substitute payment made with respect to a grandfathered obligation that has been posted as collateral as a grandfathered obligation.

    Commenters had noted that without a rule to cover these substitute payments, it would be difficult to determine the proper treatment of collateral that is itself a grandfathered obligation, as collateral is frequently rehypothecated and the secured party cannot readily determine which collateral was rehypothecated (giving rise to substitute payments to the payee) and which collateral has been retained.

Other changes. Notice 2015-66 also provides that the amendments will extend the use of limited branches and limited foreign financial institutions, and the deadline for a sponsoring entity to register its sponsored entities and redocument such entities with withholding agents.   

Reliance. Prior to the issuance of the amendments described above, taxpayers may rely on the provisions of the Notice.

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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