FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions.

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1 November 2012 FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions. The US Internal Revenue Service released Announcement (the Announcement ) on October 24, 2012 containing a number of changes to the proposed FATCA regulations it issued in February this year. The proposed changes: > push back some of the reporting and due diligence deadlines to match those set out in the model intergovernmental agreements; > push back the deadline for gross proceeds withholding to December 31, 2016; and Contents FATCA... 1 Due diligence deadlines pushed back... 2 Deadline for gross proceeds withholding pushed back... 3 Extension to grandfathering provisions... 3 What this means in practice... 5 > extend the grandfathering provisions for obligations that give rise to foreign passthru payments, instruments that result in withholdable payments solely because they give rise to dividend equivalent payments and collateral posted under grandfathered derivatives. Further information on these changes is set out below. FATCA The foreign account tax compliance provisions (commonly known as FATCA) of the Hiring Incentives to Restore Employment ( HIRE ) Act of 2010 were introduced to combat the use of offshore accounts by US taxpayers to avoid US tax. FATCA imposes a withholding tax of up to 30% on certain payments to foreign financial institutions ( FFIs ) unless the institution enters into a contract directly with the IRS ( FFI Agreement ). A draft form of the FFI Agreement has not yet been made available, but the IRS did issue proposed regulations in February 2012 (the proposed Regulations ) which provide detail about its likely content. FATCA potentially raises a number of conflicts with local laws and existing contractual obligations. To resolve these conflicts, the US developed two model intergovernmental agreements with a number of European jurisdictions ( IGAs ) FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions 1

2 and entered into such an agreement with the UK ( UK IGA ). Under these agreements, the FFI will provide information about US customers to its local tax authority who will then provide the information to the IRS. The IRS has also announced another IGA model whereby countries will agree to modify their local laws to permit direct reporting to the IRS supplemented by information provided by the foreign governments upon request by the United State. Switzerland and Japan have announced that they expect to enter into this type of IGA. On October 24, 2012, the IRS issued the Announcement, which proposed some further amendments to the position set out in the proposed Regulations. Although this provides helpful insight into the likely content of any final regulations, it does not represent a final position. It is still uncertain when the final regulations will be issued (although they are expected very shortly) and when the model FFI Agreement will be released. Due diligence deadlines pushed back One of the changes proposed by the Announcement is to push back certain deadlines so the timelines for due diligence are aligned for FFIs in jurisdictions with IGAs, FFIs that sign up to FFI Agreements and US withholding agents. Accordingly, the IRS has proposed the following changes to the proposed Regulations to align them to the IGAs. These changes should, in due course, be reflected in the final regulations and/or FFI Agreements: > the deadline for putting new FATCA-compliance account opening procedures in place has been pushed back to January 1, 2014; > the deadline for completing due diligence on pre-existing high-value individual accounts is pushed back six months to December 31, 2014; and > the deadline for completing due diligence on pre-existing individual accounts (other than high-value accounts) and entity accounts (other than prima facie FFIs) is also pushed back six months to December 31, These dates all assume that the FFI has entered into an FFI Agreement prior to January 1, If not, some of these dates are pushed back further until six months after the effective date of the FFI Agreement. The Announcement also extends the reporting deadline for calendar years 2013 and 2014 to March 31, This is likely to be similar to the date for reporting under the IGAs. For example, proposals to implement the UK IGA suggest the reporting deadlines for calendar years 2013 and 2014 will be March 31, 2015 and June 30, 2015 respectively. The extension of these deadlines is welcome, as is the IRS desire to try and reduce the administrative burden on global financial institutions by harmonising the due diligence and reporting procedures under the IGA and FFI Agreements. FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions 2

3 However, a number of many of the key deadlines remain unchanged. For example, FFIs in non-iga jurisdictions should still aim to sign up to FFI Agreements by mid-2013 and withholding still begins in January 1, 2014 unless specifically extended. The Announcement clarifies that notwithstanding the due diligence extensions described above, once a particular account has been identified as a US Account or as a nonparticipating FFI, withholding or reporting, as appropriate, must begin with respect to that account even though the time period for completing the identification and documentation of accounts of that type may not have yet expired. It is also unclear how far the process of harmonising the final regulations and IGAs will go. Some differences may remain. For example, under the proposed Regulations a withholding agent (whether or not an FFI) was required to treat prima facie FFIs that it had not yet identified as participating or otherwise exempt from FATCA as nonparticipating FFIs beginning on January 1, 2014, which meant that withholding was potentially required on payments to these entities after that date. According to the Announcement, the deadline for establishing the status of a prima facie FFI is moved to the later of June 30, 2014, or six months after the effective date of the FFI Agreement. However, the model IGA does not specifically reference prima facie FFIs, but instead the model IGA simply states that due diligence on all preexisting entity accounts with an account balance above a certain minimum must be completed by December 31, Deadline for gross proceeds withholding pushed back The 30% withholding tax imposed by FATCA is also imposed on gross proceeds from the sale of assets that produce US source dividends or interest. Recognising that this could have significant implications, the date from which gross proceeds withholding will come into effect has moved back two years to December 31, Extension to grandfathering provisions The proposed Regulations include "grandfathering" provisions for some obligations issued before January 1, Payments on these obligations will not be subject to any withholding on account of FATCA so long as the obligations are not substantially modified after that date. Importantly, the grandfathering provisions do not apply to any obligation that is considered equity for US tax purposes or that does not have a definite term. The Announcement creates extended grandfathering provisions for three types of obligation. First, the withholding obligations under FATCA will eventually apply to payments that may be only indirectly attributable to US assets ( foreign passthru payments ). Although the IRS had issued a notice suggesting that passthru payments by FFIs would be subject to withholding on the basis of the FFI s FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions 3

4 percentage of US assets, these provisions have proved problematic in practice and were omitted from the proposed Regulations. Given the uncertainty surrounding the foreign passthru payment regime, the IRS has proposed to extend grandfathering for obligations that produce only foreign passthru payments until six months after the regulations defining that term are finalised. There can sometimes be difficult questions about whether a particular instrument could possibly produce withholdable payments. For example, a payment by a non-us borrower could be recharacterised under the US conduit rules as a US source payment making it a withholdable payment and not eligible for the extended grandfathering. Moreover, because there is no current definition of the term foreign passthru payment, it is difficult to rely on the extended grandfathering as it is unclear what instruments will fall into this category. However, it is expected that loans, bonds and other instruments of non-us issuers that cannot produce withholdable payments will be included and therefore grandfathering for such arrangements is likely to continue until at least summer 2013 if not longer. Equity instruments and other obligations without a definite term continue to be outside the definition of obligations and the extended grandfathering will not apply to these instruments even if issued by non-us issuers. A new statutory provision (Section 871(m)) (also enacted as part of the HIRE Act), treats certain payments (so-called dividend equivalent payments ) that are determined (directly or indirectly) by reference to US source dividends as US source payments. This has the effect of making such payments subject to FATCA withholding. On January 23, 2012, the IRS published both temporary and proposed regulations under Section 871(m). However, because those regulations have not yet been finalised (and presumably because there may be some changes between the final and proposed regulations), the Announcement provides that for FATCA purposes grandfathering in respect of an obligation that produces dividend equivalent payments will continue until six months after the date on which the relevant instrument is first treated as giving rise to dividend equivalent payments. This will presumably be some date after the publication of final regulations. Section 871(m) already treats payments under certain repos, security lending arrangements and certain notional principal contracts that meet certain requirements as dividend equivalent payments (i.e., no regulations are needed to bring these payments within the scope of Section 871(m)). It therefore appears that these instruments that are already subject to Section 871(m) will not benefit from the extended grandfathering. Finally, grandfathering will now specifically include any obligation to make a payment with respect to, or to repay, collateral posted to secure obligations under a notional principal contract (i.e. derivative) that is a grandfathered obligation. In some cases collateral may secure both grandfathered and non-grandfathered obligations. In those cases it is unclear whether payments on the collateral would benefit from the extended grandfathering provisions. FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions 4

5 Contacts For further information please contact: What this means in practice Announcement helpfully aligns some of the due diligence requirements for FFIs that will enter into FFI Agreement with those that apply to FFIs in jurisdictions with IGAs. In addition, the extension of grandfathering for certain obligations, especially for obligations that produce foreign passthru payments provides some welcome breathing room for FFIs struggling to determine whether and how they will comply with FATCA going forward. However, many unresolved questions remain, such as how the IRS will define foreign passthru payments. Until further guidance is issued, in the form of draft FFI Agreements, final regulations or otherwise, FFIs will continue to struggle to know definitely what their obligations under FATCA will be. Gordon Warnke Partner (+1) Francisco Duque Counsel (+1) Richard Cumbley Partner (+44) Peter Church Solicitor (+44) This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2012 Linklaters in the U.S. provides leading global financial organizations and corporations with legal advice on a wide range of domestic and cross-border deals and cases. Our offices are located at 1345 Avenue of the Americas, New York, New York Linklaters LLP is a multinational limited liability partnership registered in England and Wales with registered number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com Avenue of the Americas New York, NY Telephone (+1) Facsimile (+1) Linklaters.com FATCA IRS Proposes Extending Certain Deadlines and Grandfathering Provisions 5 //