The FATCA Proposed Regulations

The Treasury Department ("Treasury") and the Internal Revenue Service ("IRS") issued proposed regulations on February 8, 2012, moving forward towards the implementation of the Foreign Account Tax Compliance Act ("FATCA"). The proposed regulations spread out the implementation of FATCA further and relax some of the rules (for example the balance account thresholds and the due diligence process), responding to the comments of the financial community. Treasury and the IRS tried to take into account the comments provided on the FATCA notices and tried to leave enough time to FFIs to implement FATCA.

FATCA was enacted on March 18, 2010 by Congress as part of the Hiring Incentives to Restore Employment (HIRE) Act. FATCA requires foreign financial institutions ("FFIs") to report to IRS information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.

The proposed regulations provide a step-by-step process for the identification of U.S. accounts, information reporting, and withholding requirements for FFIs, other foreign entities ("NFFEs"), and U.S. withholding agents. The proposed regulations spread out the obligations under FATCA to alleviate burdens and costs while still achieving the goals of fighting against international tax evasion.

The proposed regulations confirm that in order to avoid a FATCA withholding, a participating FFI will have to enter into an agreement with the IRS and, according to this agreement, will have to " identify U.S. accounts, report certain information to the IRS regarding U.S. accounts, verify its compliance with its obligations pursuant to the agreement, and ensure that a 30-percent tax on certain payments of U.S. source income is withheld when paid to non-participating FFIs and account holders who are unwilling to provide the required information."

Treasury and the IRS also provided that "[r]egistration will take place through an online system which will become available by January 1, 2013. FFIs that do not register and enter into an agreement with the IRS will be subject to withholding on certain types of payments relating to U.S. investments."

The highlights of the proposed regulations consist in phasing-in the reporting and withholding obligations of FATCA over an extended transition period, decreasing the administrative burdens related to detecting U.S. accounts by adjusting due diligence requirements based on the value and risk profile of the account (FFIs may also rely in may situations on AML/KYC information), and expand the categories of deemed compliant FFIs.

The proposed regulations are subject to comments to be submitted by April 30, 2012. These comments will help Treasury and the IRS in drafting final FATCA regulations.
 

The Main Changes

The executive summary provided by Treasury and the IRS highlights the main "modifications and additions" to the Notices: Expanded Scope of "Grandfathered Obligations," transitional Rules for Affiliates with Legal Prohibitions on Compliance, additional Categories of Deemed-Compliant FFIs, modification of Due Diligence Procedures for the Identification of Accounts, (v) Guidance on Procedures Required to Verify Compliance, (vi) refinement of the Definition of Financial Account, (vii) extension of the Transition Period for the Scope of Information Reporting, (viii)Passthru Payments.

Based on Treasury and the IRS comments with respect to these issues, we note that:

1. The proposed regulations exclude from the definition of withholdable payment and passthru payment any payment made under an obligation outstanding on January 1, 2013, as well as any gross proceeds from the disposition of such an obligation.
2. Compliant entities part of an affiliated group of entities would not be penalized by the non-compliance of certain affiliated entities until January 1, 2016.
3. The proposed regulations expand the guidance in Notice 2011-34 and provide additional categories of deemed-compliant institutions.
4. As mentioned by Treasury and IRS, [t]he proposed regulations rely primarily on electronic reviews of preexisting accounts.
   1. "For preexisting individual accounts that are offshore obligations, manual review of paper records is limited to accounts with a balance or value that exceeds $1,000,000 (unless the electronic searches meet certain requirements, in which case manual review is not required)." "Additionally, with respect to preexisting accounts, individual accounts with a balance or value of $50,000 or less, and certain cash value insurance contracts with a value of $250,000 or less, are excluded from the due diligence procedure. With respect to preexisting entity accounts, a number of burden-reducing measures are proposed, including exclusions of accounts of $250,000 or less and extended reliance on information gathered in the context of the due diligence required to comply with anti-money laundering/"know your customer" (AML/KYC) rules, and simplified procedures to identify the chapter 4 status of preexisting entity accounts."
   2. "With respect to new accounts, the proposed due diligence rules rely extensively on an FFI’s existing customer intake procedures. Accordingly, the proposed regulations generally do not require an FFI to make significant modifications to the information collected on customer intake, other than with respect to account holders identified as FFIs, as passive investment entities, or as having U.S. indicia."
5. As provided by Treasury and the IRS, "[r]esponsible FFI officers will be expected to certify that the FFI has complied with the terms of the FFI agreement. Verification of such compliance through third-party audits is not mandated. If an FFI complies with the obligations set forth in an FFI agreement, it will not be held strictly liable for failure to identify a U.S. account."
6. Treasury and the IRS also provided that "[t]he proposed regulations refine the definition of financial accounts to focus on traditional bank, brokerage, money market accounts, and interests in investment vehicles, and to exclude most debt and equity securities issued by banks and brokerage firms, subject to an anti-abuse rule."
7. The proposed regulations provide that reporting on income will be phased in beginning in 2016 (with respect to the 2015 calendar year), and reporting on gross proceeds will begin in 2017 (with respect to the 2016 calendar year). In addition, the proposed regulations provide that FFIs may elect to report information either in the currency in which the account is maintained or in U.S. dollars."
8. Withholding will not be required with respect to foreign passthru payments before January 1, 2017. The proposed regulations also comment on the passthru percentage.

Obligations of FFIs

The executive summary also highlights the obligations of FFIs: due Diligence Required to Identify U.S. Accounts, deemed compliant FFIs, transitional Rule for Affiliated Groups, phase-In of Reporting Obligations, (v) Phase-In of Scope of Passthru Payments, (vi) Refunds.

Based on the comments of Treasury and the IRS with respect to these obligations we note that:

1. FATCA requires FFIs to identify U.S. accounts. The proposed regulations provide guidance on the required due diligence process depending on preexisting/new and individual/entity accounts.
   1. For preexisting individual accounts, the important threshold determining the level of due diligence are $50,000 ($250,000 for cash value insurance and annuity contract) and $1,000,000. The due diligence can vary from an exemption, an electronic search, or a manual search. A balance of less than $50,000 ($250,000 for cash value insurance and annuity contract) would be exempt from review unless elected otherwise by the FFI. The prior $500,000 and private banking tests have been abandoned.
   2. For new individual accounts, the due diligence should start with existing AML/KYC rules. Additional due diligence should only be required in case of U.S. indicia.
   3. The due diligence for preexisting entity accounts also varies depending on certain threshold. Accounts of $250,000 or less are exempted from due diligence until they exceed $1,000,000. For remaining entities, review is either merely based on AML/KYC information or may require identification of all substantial U.S. owners ora certification that the entity does not have substantial U.S. owners
   4. Treasury provided that under the proposed regulations, new entity accounts of another FFI (other than an owner-documented FFI for which the participating FFI has agreed to perform reporting) and new accounts of an entity engaged in an active nonfinancial trade or business or otherwise excepted from documentation requirements will be exempt from documentation of substantial U.S. owners. With respect to the remaining entities (essentially, passive investment entities), FFIs will be required to determine whether the entity has any substantial U.S. owners upon opening a new account, generally by obtaining a certification from the account holder.
2. With respect to deemed compliant FFIs, the proposed regulations implement the exclusions already in the notices and expand the scope of deemed compliant FFIs representing low risk of tax evasion.
3. The proposed regulations provide some transitional rules until January 1st 2016 for compliant (with the due diligence procedure) FFIs affiliated with certain non-compliant FFIs.
4. The proposed regulations phase in the reporting obligations of FFIs starting in 2014 and 2015 with light reporting obligations, increasing the reporting obligations in 2016, and requiring full reporting in 2017.
5. The proposed regulations phase in the passthru payment regime starting on January 2014 with a withholding on passthru payments that are withholdable payments, continuing for the calendar years 2015 and 2016 with some aggregate reporting of payments made to each nonparticipating FFI, and finally, beginning no earlier than January 1, 2017, expanding the scope of withholding beyond withholdable payments based on future guidance.
6. The proposed regulations clarify how either an FFI or an NFFE may request a refund of withholding. Treasury and the IRS intend to issue future guidance regardingthe substantiation requirements necessary for claiming a refund.

The financial community was looking forward to the release of the proposed regulations and was impatient to see to what extent Treasury and the IRS had taken into account the numerous comments made on prior guidance. Although many comments were taken into account, the release of the proposed regulations constitute a step further towards the ineluctable implementation of FATCA, putting additional pressure on U.S. tax residents trying to evade their tax obligations through offshore accounts and pushing these U.S. tax residents to come forward.

By Benjamin Tolub and Dave Wolf

Benjamin can be reached at benjamin@lawfirmwolf.com and Dave can be reached at dave@lawfirmwolf.com

Hacohen Wolf is a law firm specializing in Real Estate, Taxation and Commercial Law with offices in Jerusalem, Beit Shemesh, Tel-Aviv and New York and affiliate offices in Greater China, London and Amsterdam.