On December 13, 2018, the Internal Revenue Service (the "IRS") and the U.S. Department of the Treasury (the "Treasury") issued proposed regulations (the "Proposed Regulations") addressing various aspects of the withholding and information reporting regime commonly referred to as "FATCA".1 The Proposed Regulations provide significant relief from potential withholding and compliance burdens that U.S. and non-U.S. financial institutions would otherwise be subject to under FATCA. The preamble to the Proposed Regulations announces that taxpayers may generally rely on the Proposed Regulations pending issuance of final regulations.
Read this post for a brief background of FATCA and a discussion of the most important aspects of the Proposed Regulations.
Elimination of Withholding on Payments of Gross Proceeds
FATCA's main tool to achieve the goal of preventing U.S. taxpayers from holding unreported assets and income offshore is a 30% withholding tax imposed on certain U.S.-source payments (referred to as "withholdable payments") made to an FFI that does not agree to provide the U.S. government with, among other things, the identity of the FFI's U.S. account holders. An FFI that agrees to comply with FATCA's disclosure and information reporting requirements generally is excepted entirely from this 30% withholding tax.
Among the withholdable payments FATCA applies to are payments of (i) interest, dividends, rents, and certain other specified items of income from U.S. sources, and (ii) gross proceeds from the sale or other disposition of property of a type which can produce interest or dividends from U.S. sources (such as a sale of stock or a debt instrument of a U.S. issuer). Withholding on payments described in (i) above is currently in effect. Pursuant to prior guidance, withholding on payments described in (ii) above was scheduled to come into effect on January 1, 2019.
The Proposed Regulations eliminate withholding on gross proceeds entirely, under the broad statutory grant of authority for the IRS and Treasury to provide exceptions to the definition of withholdable payment. The preamble to the Proposed Regulations notes that financial institutions faced significant administrative burdens attempting to comply with such withholding and that the tax policy underlying FATCA was not substantially affected by such gross proceeds withholding (noting specifically that there has been substantial intergovernmental cooperation since 2010 in implementing the goals of FATCA).
Financial institutions that were preparing to comply with FATCA's gross proceeds withholding requirements will be relieved of that potential burden. In addition, issuers of debt or equity (including issuers in capital markets transactions, as well as private investment fund sponsors) will no longer need to address this potential withholding requirement in disclosure documents or otherwise.
Further Suspension of Potential "Foreign Passthru Payment" Withholding
FATCA provides that certain payments by an FFI to a non-compliant account holder at such FFI that are "attributable to" withholdable payments would be subject to withholding under FATCA (such payments, "foreign passthru payments"). The concept underlying this withholding requirement was that U.S. persons or other non-compliant account holders could avoid FATCA by investing or holding accounts in FFIs that were FATCA compliant (so that there would be no withholding on the initial payment to the FFI and no withholding by the FFI because the payment by the FFI would not be a payment of U.S. source income subject to withholding).
Since FATCA's enactment, a separate multi-governmental regime has developed to implement FATCA's objectives. The United States has signed (or agreed in principle) over 100 agreements with other countries implementing FATCA's goals on a bilateral basis (generally referred to as intergovernmental agreements, or "IGAs"). An IGA between the U.S. and another jurisdiction generally avoids FFIs in that jurisdiction having to enter into agreements directly with the IRS. As a result of the establishment of a robust IGA network, the preamble announces that the IRS and the Treasury have determined, at least for now, that withholding on foreign passthru payments is not required, pending further guidance and analysis. The Proposed Regulations provide that such withholding will not be effective before the date that is two years after the publication of final regulations defining the term "foreign passthru payment."
As with the elimination of withholding on gross proceeds, the suspension of withholding on foreign passthru payments should provide administrative and record-keeping relief to financial institutions otherwise affected. However, capital markets and other disclosure documents may still need to retain references to foreign passthru payment withholding against the possibility of such withholding being reinstated in the future.
Clarification of the Definition of Investment Entity
Under FATCA and its implementing regulations, an entity is an "investment entity" (and, therefore, a financial institution potentially subject to FATCA) if the entity's gross income is primarily attributable to investing, reinvesting or trading in financial assets and the entity is "managed by" certain specified entities (generally those in the banking or financial asset management business). Under applicable regulations, "managed by" generally meant "discretionary management" over the assets of the investment entity.
The Proposed Regulations clarify that an entity will not be treated as an "investment entity" solely because it invests into a mutual fund or other pooled investment vehicle (i) that is widely held and (ii) where the financial institution offering interests in the vehicle does not have specific discretionary authority over the entity's investment (for example, if the mutual fund offers shares to the public generally without a tailored investment mandate).
This change clarifies a question taxpayers had regarding when a vehicle investing in public funds could become subject to FATCA (solely by reason of those investment activities).
1 The Proposed Regulations are accessible here. The "FATCA" (the Foreign Account Tax Compliance Act) rules are codified at Sections 1471-1474 of the U.S Internal Revenue Code of 1986, as amended (the "Code"), along with voluminous existing Treasury regulations (only some of which are amended by the Proposed Regulations). The FATCA rules generally require "foreign financial institutions" (as defined under FATCA) ("FFIs") and certain other foreign entities to undertake diligence to identify U.S. accounts, and to report certain information to the IRS with respect to such U.S. accounts, or suffer 30% U.S. withholding on certain U.S. source "withholdable payments" and on foreign "passthru" payments that such foreign entities receive.
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.