In 2010, Congress and President Obama carried into law the Hiring Incentives to Restore Employment Act (“HIRE Act”). The HIRE Act contained a set of provisions named the Foreign Account Tax Compliance Act (“FATCA”), which the U.S. Treasury stated “targets the illicit activities of some wealthy individuals who use offshore accounts to evade millions of dollars in taxes.” Unfortunately, in practice FATCA is much broader than targeting only wealthy individuals evading U.S. taxes through offshore activities – it casts a broad net covering virtually all offshore activities. Moreover, it is important to note that FATCA obligations are in addition to the existing obligations regarding disclosure, reporting and withholding under the Internal Revenue Code.
While the majority of FATCA’s tax provisions have been continuously delayed as the U.S. Treasury and numerous foreign countries have revised rules, regulations and agreements to address issues surrounding FATCA’s broad scope, the current compliance deadline of July 1, 2014, set by the U.S. Treasury is unlikely to be extended any further according to public statements from U.S. Treasury Officials. Given the impending compliance deadline for FATCA, the application of a mandatory thirty (30) percent withholding tax that is not limited to payments of income or even to transactions generating a profit, and inclusion of personal investment structures into the FATCA regime, it is important to take proactive and protective measures now.
A primary thrust of FATCA is to require non-U.S. foreign financial institutions (“FFIs”) to report the income and assets of US persons to the US annually. FFIs that do not comply with this mandate are subject to a mandatory withholding U.S. tax of thirty (30) percent. The withholding tax applies to both income payments (e.g., interest and dividends), and principal payments as well (e.g., gross proceeds received from securities sales and payment of debt principal). Additionally, the thirty (30) percent FATCA tax cannot be reduced by claiming the benefits of an existing income tax treaty, and the thirty (30) percent FATCA tax applies even if the underlying transaction results in a loss for U.S. income tax purposes.
The term FFI is broadly defined. It includes commonly thought of FFIs, such as banks, brokers, and insurance companies. However, it also includes investment companies and trust companies. The inclusion of investment companies and trust companies in the definition of FFI is not limited to entities that hold themselves out and offer their services to the public but also includes investment structures catering and limited to family members. A few personal holding companies and private trusts may be able to avoid FFI status; however, the few that can escape FFI status will not be able to escape FATCA. Instead, most of the escapees will be classified as passive non-financial foreign entities (“NFFEs”). Passive NFFEs will still need to disclose the identity and tax residency of their interest holders to their custodian, brokers, or other financial instructions to avoid the thirty (30) percent FATCA tax.
FATCA requires FFIs to take affirmative steps with both the IRS and with regards to their internal procedures. FFIs will generally need to register with the IRS, obtain a new Global Intermediately Identification Number (“GIIN”), conduct certain due diligence procedures and report certain information to the IRS in order to avoid the thirty (30) percent withholding tax. Alternatively, some FFIs may be eligible to report this information to their local government which will then in turn report this information to the IRS. While FFIs can register for GIIN at any time, FFIs are strongly advised to complete registration with the IRS and receive their GIIN on or before June 3, 2014.
The IRS has stated that FFI registering by this date should be placed on the July 1, 2014 FFI List. The July 1, 2014 FFI list is the final FFI list that will be published prior to the start of FATCA withholding on July 1, 2014. Placement on this list will ensure that custodians, brokers, etc., are able to confirm an IRS-approved FFI registration and thus avoid the thirty (30) percent FATCA tax. Otherwise, the custodians, brokers, etc., are likely to impose the FATCA tax on FATCA payments until the next FFI list is published by the IRS.
Recently, the IRS in Notice 2014-33 announced that calendar years 2014 and 2015 are regarded as transition periods for enforcement and administration of FATCA. This notice grants FFIs and other entities that are obligated to withhold FATCA taxes a limited amount of discretion implementing FATCA’s numerous provisions assuming these FFIs undertake their FATCA obligations in good faith under the existing FATCA Treasury Regulations. This good faith transaction period will provide a limited time frame during which FFIs and others can exercise some reasonable discretion in implementing FATCA’s due diligence, withholding and reporting requirements. However, nothing within Notice 2014-33 delays or suspends the requirement to obtain a GIIN, or for FFIs to withhold FATCA tax for FATCA payments to non GIIN providing taxpayers.
Many U.S. persons conduct their financial affairs through privately-held investment vehicles for both privacy and wealth planning purposes. These privately-held investment vehicles come in a variety of different forms, generally selected after a thoughtful consideration of the relative benefits and burdens, including both nontax and tax aspects of each structure.
Oftentimes these structures are placed in international locations. International locations often have more favorable laws or judicial systems than are available in the U.S. The placement of these structures in an international financial center generally has more to do with favorable underlying laws or access to an international investment market than more nefarious motives such as tax evasion (which is illegal in almost all jurisdictions, including in the U.S.). Unfortunately, FATCA paints all U.S. persons with the same broad brush regardless of the underlying facts, and hence applies a burdensome uniform set of rules and regulations to both the innocent and the mal-intentioned.
Private investors need to recognize that FATCA is not going away and in fact is coming into full force and effect shortly. Registering, establishing the required procedures, and demonstrating the requisite level of due diligence and documentation require time, something that is now in very short supply. Accordingly, action needs to be undertaken immediately, especially by FFIs, to become FATCA compliant. Becoming FATCA compliant now will allow private investment vehicles to avoid becoming subject to the new thirty (30) percent FATCA tax on July 1, 2014. We strongly advise 1.) completing registration with the IRS and receiving a GIIN on or before June 3, 2014 and 2.) a thorough review of your current international structure to analyze what additional steps are necessary to become fully compliant for FATCA purposes.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.