Foreign Persons Investing in the United States (Inbound Investments) Practising Law Institute Basics of International Taxation July 22, 2015

Transcription

1 Foreign Persons Investing in the United States (Inbound Investments) Practising Law Institute Basics of International Taxation July 22, 2015

2 Disclaimers Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which a separate legal entity. Ernst & Young LLP is a clientserving member firm of Ernst & Young Global Limited located in the US. This presentation is 2015 Ernst & Young LLP. and Cooley LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying or using any information storage and retrieval system, without written permission from Ernst & Young LLP and Cooley LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP and Cooley LLP expressly disclaim any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP or Cooley LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. 2

3 Introduction Marc Ganz Partner, International Tax Services (New York) Jeremy Naylor Partner Cooley, LLP (New York)

4 Agenda Inbound Taxation Overview Effectively Connected Income (ECI) and the Use of Blockers US Taxation of Capital Gains US Taxation of Interest Earnings Stripping Rules Conduit Rules U.S. Foreign Investment in Real Property Tax Act U.S. Withholding and Reporting and Foreign Account Tax Compliance Act (FATCA) 4

5 Inbound Taxation Overview US taxation of non US persons Taxable activity or presence in the United States Income effectively connected with a US trade or business (ECI) Branch profits tax, branch level interest tax FIRPTA Certain types of passive US source income Fixed or determinable, annual or periodical income (FDAP) 5

6 Inbound Taxation Overview FDAP Interest But not bank deposit interest or portfolio interest Dividends Rents Royalties (not listed in statute) Generally not capital gains 6

7 Taxable Presence Taxation of Non-US persons Taxation differs depending on type of income earned Non-business (passive) income 30 percent tax on gross amount of certain US-source income Collected through withholding at source US trade/business income Net basis tax on ECI (at the graduated rates) Application of US branch taxes Tax return filing requirements Tax treaties may alter treatment of both types of income 7

8 ECI and the Use of Blockers What is a Blocker Corporation? A corporation that is placed between the foreign investors and the source of ECI to prevent pass through of ECI and the associated tax return filing obligation. Blocker corporations change the character of the underlying income or assets, or both. The U.S. tax consequences of holding an investment through a blocker corporation depend on the chosen structure. Advantages to Blockers: Convert ECI into FDAP-type income which does not necessitate a direct US tax or reporting obligation from the foreign investor; Shield foreign entities from US tax exposure; and, Help manage earnings more effectively. Disadvantage: The Blocker will be subject to a 35% US federal tax rate and possible state income tax. 8

9 ECI and the Use of Blockers Interest Foreign Investor USTB Interest Foreign Investor US Corp USTB Foreign Investor: 35% tax on effectively connected income 30% tax on Branch Taxes (subject to treaty reduction) Disposition Wind-up of US business should not be subject to US tax Foreign Investor files US income tax return Foreign Investor: 30% tax on interest, dividends and royalties (subject to treaty reduction) Disposition sale of shares not subject to US tax unless US Corp is a US Real Property Holding Company Generally not necessary to file a US federal income tax return US Corp: 35% tax on net income US Corp files a US income tax return The use of a blocker does not necessarily reduce the amount of US tax levied on ECI, but it does limit the Foreign Investor s liability and US filing obligations. 9

10 ECI and the Use of Blockers US Blocker Corp Loan Foreign Investor US Blocker Corp USTB US Blocker Corp is subject to tax on a net basis at graduated rates on its income from the USTB. To the extent US Blocker Corp distributes dividends or makes interest or royalty payments to Foreign Investor, the payments are subject to a 30% withholding tax (subject to reduction by treaty). Pros Foreign Investor does not have to report ECI or file a US tax return. Foreign Investors can limit the amount of income subject to US tax by allocating limited risks and activities to Blocker Corp. Leverage can reduce the US tax base as allowed by the earnings stripping and thin capitalization rules. Foreign Investor not subject to US tax on disposition of stock provided Blocker Corporation is not a US Real Property Holding Company Cons Blocker Corp is subject to US tax on a net basis at a 35% rate and must meet US compliance obligations. 10

11 ECI and the Use of Blockers Foreign Blocker Corp Foreign Blocker Corp is subject to tax on a net basis at graduated rates on its ECI. Loan Foreign Investor Foreign Blocker Corp USTB Foreign Blocker Corp is subject to branch taxes at a rate of 30% (subject to reduction by treaty) on deemed distributions and deemed interest payments from USTB. Pros Foreign Investor does not have to report ECI or file a US tax return. Foreign Blocker Corp can limit the amount of income subject to US tax by allocating limited risks and activities to the USTB. Leverage can reduce the US tax base as allowed by the earnings stripping and thin capitalization rules. Foreign Investor not subject to US tax on disposition of Foreign Blocker Corp stock. Cons Foreign Blocker Corp is subject to US tax on a net basis at a 35% rate and must meet US compliance obligations. 11

12 ECI and the Use of Blockers - Partnership This structure is often used when FP acquires a US Target with controlled foreign corporations (CFCs). In order to rationalize the structure, FP contributes its US operating companies to New FHC, and US Target (ECI Blocker) contributes its CFCs to New FHC. FP Special allocation to New FHC partners results in ECI from the US Opcos being allocated to US Target (ECI Blocker). Non- ECI from the CFCs is allocated to FP. US Target (ECI Blocker) Non-ECI Income US Target (ECI Blocker) can make its investment in New FHC in exchange for a preferred interest, which will effectively freeze US Target s (ECI Blocker s) interest in any future appreciation of the US and foreign operations. US Target should be eligible for CFCs deemed paid credits provided it constructively owns at least 10% of the CFCs voting stock. ECI Income US Operations New FHC Foreign Operations 12

13 ECI and the Use of Blockers Private Equity Fund Downstream Blocker Private equity fund has US taxable investors and non-us investors and wants to invest into taxtransparent portfolio company (such as an LLC). Non-US investors want to avoid incurring ECI US investors want to maintain flow-through tax treatment. Fund bifurcates investment partially through blocker corporation. ECI converted into dividend income; Special allocations at Fund level Basic structure shown. Additional features include: Structuring General Partner carry pre-tax Requirement to exit via sale of blocker shares maximize returns to non-us investors Internal leverage to reduce tax at blocker level (subject to earnings stripping and thin capitalization rules) Separate blocker for each LLC investment maximize tax efficiency on exit can be complicated to implement depending on fund economics Non-US Investors capital Non-US Investors US (ECI Blocker) Operations PE Fund Portfolio Company (LLC) US Investors (including GP) US Investors capital 13

14 ECI and the Use of Blockers Private Equity AIV Another common structure for private equity alternative investment vehicles (AIVs) Non-ECI generating investments made through main fund ECI investments made through AIV Blocker interposed between Non-US investors and AIV (typically, but not always, onshore) In some respects simpler than traditional downstream blocker structure GP s carried interest already structurally below the blocker No need to deal with special allocations and whether substantiality test is met Some additional risks, however Aggregation risk with main fund More complicated to exit via sale of blocker shares Separate blockers for each deal to avoid dividend withholding tax on exits All Investors (including GP) Main Fund Portfolio Companies (C Corps) Non-US Investors (ECI Blocker) AIV Portfolio Company (LLC) US Investors (including GP) 14

15 ECI and the Use of Blockers Private Equity Parallel Fund Finally, PE fund sponsor could consider a parallel fund for Non-US investors Parallel fund invests in parallel with main fund directly into C Corp investments, but through blockers into LLCs Main fund invests directly in everything Essentially dowstream blocker structure done through separate fund vehicle No 875 tax filing issue for Non-US investors Still need additional structuring for GP to tax carried interest pre-tax for blocked investments US Investors Main Fund Portfolio Companies (C Corps) Non-US Investors Parallel Fund (ECI Blocker) Portfolio Company (LLC) 15

16 Taxation of US- Source Capital Gains US Domestic Law: US-source capital gain that is not effectively connected with a trade or business in the US is exempt from taxation in the US, unless it is related to the disposition of a US real property interest. Capital Gain is subject to US net basis income tax if it is effectively connected with taxpayer s US trade or business (US T/B). Gain is considered effectively connected only if the asset is used in or held for use in the conduct of a US T/B or the activities of a US trade were a material factor in the realization of the gain. US Income Tax Treaties: The 2006 US Model Treaty allocates taxing rights on capital gains to the source state if the gains are attributable to the sale of: (i) real property; (ii) moveable property that is part of a PE; (iii) ships or aircraft used in international traffic; and, (iv) containers unless they are used solely for transport between places in the state of residency. Otherwise, taxing jurisdiction is ceded to the state of residency. 16

17 Taxation of US- Source Capital Gains Example Foreign Parent US Opco Foreign Opco US HoldCo US Real Property USTB Assets US Real Property Sale of: US Opco shares Foreign Opco shares US HoldCo shares US Real Property USTB (or PE) Assets Taxed by: Foreign Parent Jurisdiction Unclear, but not US US US US 17

18 Taxation of US- Source Interest FDAP income is defined broadly and generally includes all US-source income that is not ECI FDAP includes passive investment income interest, dividends, rents, royalties, etc. FDAP does not include capital gain on the sale of real or personal property. FDAP interest excludes portfolio interest and interest on deposits in US banks. Requirements for qualification as portfolio interest registered form; not 10% shareholder; not contingent interest; bank not lender Nonresident individuals and corporations are taxed at a 30% flat (or lower treaty) rate on the gross amount of FDAP income that is NOT effectively connected with USTB. Tax is paid through withholding at source by the payor (Withholding Agent) who remits the withheld tax to the IRS. 881 and

19 Compliance for US - Source Interest Nonresident corporations receiving FDAP income may be required to file the following forms to the extent that they qualify for treaty benefits: Form SS-4 Application for Employer Identification Number Form W-8BEN-E Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) Withholding Agents are required to file the following forms: Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,must be filed by the Withholding Agent by March 15th following the calendar year in which the income subject to reporting was paid, unless an extension of time to file is obtained. Form 1042-S, Foreign Person s U.S. Source Income Subject to Withholding, must be filed by the Withholding Agent for every foreign payee with respect to which it paid FDAP income. On each Form 1042-S, the withholding agent must indicate the amount of each category of income paid to the foreign payee (e.g., dividends, interest, etc.) and the amount of tax withheld. 19

20 Section 163(j) policy Debt capitalization Equity capitalization FP FP Loan Interest $ Dividend US US E&P stripped out of US Sub as deductible interest Interest may not be subject to withholding tax under treaty Overall US tax cost is reduced Dividend is non deductible Dividend taxable to FP under 1441 (but may be reduced or eliminated by treaty) 20

21 Section 163(j) overview Limits the deductibility of disqualified interest which is: Interest paid to a related foreign person; or, Interest paid to an unrelated person on debt guaranteed by a related foreign person. On interest paid by a US corporation, partnership or branch if the interest income is not subject to US tax or is subject to reduced tax. Applies if: Debtor s debt to equity ratio > 1.5:1; and, Debtor s net interest expense > 50% of adjusted taxable income (Excess Interest Expense). The interest expense deduction is deferred by the lesser of the Excess Interest Expense or the disqualified interest. Excess limitation can be carried forward three years. 21

22 1991 Proposed Regulations Contain broad anti avoidance rules. Interest income and expense Determined under 61 and 163 Nonfunctional currency rules of 988 applicable Reserved on Interest equivalents ATI increased by decrease in accounts receivables and increase in accounts payable. Contain fixed stock write off election. Definition of affiliated group. 22

23 To follow or not to follow the proposed regs? Not an affiliated group under 1504(a) Affiliated group under proposed regulations ForCo ForCo Interest Interest Sub1 US Sub 2 US Sub1 US Sub2 US F is not includible corporation under 1504(b)(3) Sub1 is seen as indirectly owning 100% of Sub2, and vice versa, under 318(a) 23

24 Section 163(j) Planning Strategies Substitute interest with other expenses Increase ATI Minimize disqualified interest 24

25 The Conduit Rules: A basic example Loan Foreign parent FinCo USCo Loan Foreign Parent is in a non US treaty jurisdiction. FinCo is in a treaty jurisdiction with 0% WHT rates with the US The result, based on form alone, is 0% WHT on the interest payments from USCo to FinCo Conduit case law recasts the transaction based on Substance over Form and Business Purpose Doctrines Case law looks to see if FinCo has dominion and control over the funds 25

26 The Conduit Regulations Treasury issued the Conduit Regulations under Treas. Reg in There are four requirements for transactions to fall afoul of the conduit rules. 1) Is the transaction a financing arrangement as defined in the regulations? (financing arrangement has a broad definition). 2) If yes to 1, does the participation of an intermediate entity reduce the tax imposed by 881? (30% withholding tax on FDAP). 3) If yes to 2, is the participation of the intermediate entity pursuant to a tax avoidance plan? 4) If yes to 3, District Director may ignore the existence of the intermediate entity (or entities) for purposes of 881, if the intermediate entity is: Related to other parties to the transaction, or Would not have participated in the arrangement on substantially the same terms but for the fact that the financing entity engaged in the transaction with the intermediate entity. If the arrangement fails the tests set forth above, the loan is recast as being between the financed entity and the financing entity. 26

27 FIRPTA Foreign Investment in US Real Property Tax Act 897 Congress enacted the Foreign Investment in Real Property Tax Act of 1980 ( FIRPTA ) to prevent abuse of certain rules on taxation of effectively connected income ( ECI ) of a foreign person. Prior to enactment it was possible for a foreign investor to avoid US tax on both operating income and gains on sale of a US real property interest ( USRPI ), creating a perceived unfair advantage over US investors. Impact of FIRPTA Subjects foreign investors to US tax on disposition of a USRPI The gain is treated as ECI under 897(a). Such ECI gain, net of allowable deductions allocated to such ECI, is taxed at graduated rates of regular income tax ( 871(b) and 882(a)(1)). Enforcement is done in two ways: Withholding regime. Reporting requirements. 27

28 FIRPTA - USRPI The definition of a USRPI is broad. It includes: Real Property - Treasury Regulation (b) Land and unsevered natural products of the land Improvements to land Personal property associated with certain uses of real property Interests other than an interest solely as a creditor (e.g., leasehold interests) - Treasury Regulation (d)(2). US Real Property Holding Companies (USRPHC) - Treasury Regulation A Corporation is a USRPHC if on any determination date during the lesser of the holding period or 5 years ending on the date of disposition the FMV of its USRPI s is greater than or equal to 50% of the FMV of its: (i) USRPI; (ii) foreign real property interests; and, (iii) assets held for use in a trade or business. Determination dates include: (i) the last day of the taxable year; and, (ii) any other date that could trigger USRPHC status. Alternative - Book value testing. Exceptions: Regularly traded interest in a USRPHC 897(c)(3); and, Real Estate Investment Trusts (REIT). 28

29 FIRPTA - Non recognition exchanges Section 897(d) and (e) strictly limit the ability of USRPHCs to engage in nonrecognition transactions. The general intent of these rules and exceptions is to preserve the ability of the US government to impose at least one level of tax on USRPI gains. However, non-recognition treatment is still available if: USRPI for USRPI requirement (suspended for most foreign to foreign exchanges); The USRPI received would be subject to tax on its disposition; and, The foreign transferor complies with the filing requirements of Treas. Reg T(d)(1)(iii) as modified by Notice If the non-recognition provisions apply, the transferee receives a carryover basis in the property. 29

30 FNewCo stock 3 FIRPTA Non-Recognition Transaction Example Steps FP 1 Distributing FNewCo Controlled stock v: $200M Public (USRPHC) Controlled (USRPHC) Distributing stock v: $500M b: $100M 2 Controlled stock Controlled (USRPHC) Both Distributing and Controlled are USRPHCs 1. Distributing distributes Controlled to FP under Section 355(a) 2. FP drops Controlled into foreign Newco ( FNewCo ) and waits 12 months 3. FP then distributes FNewCo to Public Considerations 1. If Controlled is a USRPHC, under the rules of Reg T(a), the nonrecognition provisions of Section 355(a) apply, and FP does not recognize gain on the deemed exchange of Distributing shares for Controlled shares in step 1. FP s basis in Controlled is 40M; FP s basis in Distributing after step 1 is 60M. 2. No gain recognized on the 351 contribution under Reg T(b)(1)(iii); under that rule, FNewCo must not dispose of Controlled within 3 years of date of receipt. However, Notice reduces this holding period to 1 year. FP s basis in FNewCo stock is 40M. 3. No gain recognition under Section 355(a); no FIRPTA implications so long as FNewCo holds Controlled for at least 1 year prior to this spin. Timing IRS ruling on step 1: 4-6 months; step 2 waiting period: 12 months. Total waiting period approximately months 30

31 FIRPTA Non-Recognition Requirements Failed Transaction Public 1. Distributing is a USRPHC; Controlled is not a USRPHC. Distributing distributes Controlled to FP under Section 355(a). Considerations 1 FP Distributing (USRPHC) Distributing stock v: $500M b: $100M Controlled If Controlled is not a USRPHC, under Reg T(a)(4), FP is considered to have exchanged Distributing stock with a FMV of 200M and an adjusted basis of 40M for Controlled stock with a FMV of 200M. FP must recognize gain of 160M under Section 897(a) on the distribution. FP takes a basis of 200M in the Controlled stock. FP's basis in the Distributing stock is reduced to 60M pursuant to Section 358(c). Controlled Controlled stock v: $200M Unless an exception applies, or a withholding certificate is obtained, Distributing is required to withhold 10% of the amount realized by FP - $20M. Strategies to make Controlled a USRPHC: Have Controlled sell non-usrp assets until USRPHC determination fraction is > 50%. Have Distributing contribute additional USRPI assets to Controlled. 31

32 Investment Through Foreign Corporation Foreign investors Foreign corporation US real property 1. Operating income and gain from the sale of real estate is ECI to Foreign Corporation. Foreign corporation must file US corporate income tax return. State taxes may apply. 2. Foreign Corporation may be subject to an additional 30% US branch profits tax (if not reduced by treaty and exceptions do not apply), which may increase the 35% federal rate by about 19.5%, such that the total US federal tax impact may be approximately 54.5%. (BPT might not apply to certain gains on sale.) 3. No US withholding tax on dividends paid to foreign investors. 4. No US estate tax consequences for foreign individual investors. 5. No filing obligations for investors. 6. Gain on sale of foreign corporation shares not subject to US tax (although it may be difficult to locate a purchaser of stock). 7. Any US taxes paid by the foreign corporation may be creditable in own jurisdiction (i) election? 32

33 Funds With Domestic and Foreign Investors Use of REITs Foreign investors Domestic investors Domestic investors Avoid expense associated with REIT. Any losses will flow through to domestic investors. Purchaser of interest can get basis step up in assets. No worries about violating REIT rules. REIT Foreign investors Need to pool investors. Fund must agree to manage business to comply with REIT rules. No US tax return filings for operating income. US fund US real property Investments in REITs Dividend distributions of operating income and non-usrpi sales proceeds are subject to 30% US withholding tax (subject to treaty reduction). Distributions attributable to USRPI gains are subject to FIRPTA. A 35% withholding tax is imposed, and the investor has a filing obligation. If a REIT is a USRPHC, its stock generally is a USRPI. These gains recognized by a foreign corporate investor are subject to branch profits tax. A 5% or less holder of a regularly traded class of stock is not taxable under FIRPTA on a disposition, and the USRPI-gain distributions are not taxable under FIRPTA (re-characterized as an regular dividend). A holder of domestically controlled REIT stock is not taxable under FIRPTA on a disposition of such stock, unless the disposition is part of a liquidation. 33

34 Creating Domestically Controlled REIT? US Blocker Corp 51% Foreign investors REIT US real property 49% Domestically Controlled REITs Gain on sale of stock of a domestically controlled REIT not generally taxable under FIRPTA Notice overturns this rule in the case of liquidating distribution of domestically controlled REIT Domestically controlled = Less than 50% of stock (by value) held directly or indirectly by foreign persons Directly or indirectly not specifically defined for this purpose PLR Effect of using a US corporate blocker to establish domestic control Some doubt that the government would again issue this ruling Facts of ruling different than accompanying chart, but question at issue is the same does indirect ownership of a REIT by non-us persons through a taxable C corporation count toward the 50% test? If ruling is correct, Non-US investors can escape tax on ~ 49% of gain on exit US buyer would agree to buy REIT shares and can obtain a basis step-up upon liquidation of the REIT immediately after acquisition US blocker would be subject to corporate level gain on exit But subsequent liquidating distribution of US blocker could be taxfree under FIRPTA cleansing sale rule 34

35 Funds With Domestic and Foreign Investors Leveraged Blocker Structure Debt + Equity Foreign investors Leveraged Blocker Equity US fund Equity US real property Domestic investors Issue? Underlying assets may not be REIT compliant (e.g., dealer property) REITs may not materially reduce tax and filing exposures Solution? Blocker corporation previously discussed Shareholder debt provided by foreign investors to reduce tax leakage within blocker Issues? Debt/equity classification issues (thin capitalization) 163(j) need diversification among investors Withholding on interest May be reduced under treaty Or structure interest to qualify for portfolio interest exemption 10% voting stock limitation Dividends subject to 30% FDAP withholding (reduced per treaties) Distributions in excess of basis subject to FIRPTA withholding Liquidating distribution of blocker following fully taxable disposition of underlying real estate = tax-free Multiple blockers for multiple investments? 35

36 Foreign Account Tax Compliance Act (FATCA) Foreign Account Reporting FATCA Enacted in 2010 Combat tax evasion by U.S. persons holding offshore accounts New 30% withholding tax on U.S. source payments to Foreign Financial Institutions who fail to disclose U.S. account holders Banks, brokers, dealers, custodians, investment funds, insurance companies, etc. First step toward worldwide intergovernmental assistance to combat tax evasion Many jurisdictions now have their own version of FATCA (without the tax stick ) Individual Reporting and Entity Withholding 36

37 Foreign Account Tax Compliance Act (FATCA) Foreign Account Reporting FATCA Institutional FFI reporting 2 regimes FFI Agreement/Intergovernmental agreement FFI Agreement regime direct reporting to IRS IGA regime Model 1 reporting to local tax authorities bilateral cooperation Model 2 reporting to IRS Nearly 70 signed IGAs currently in force Individual Account reporting IRC 6038D; IRS Form 8938 Compliance Issues Certifications under US FATCA; self-certifications under local law FATCA Not well coordinated 37

38 Foreign Account Tax Compliance Act (FATCA) Foreign Account Reporting FATCA FFI reporting Disclose to IRS or local tax authority information regarding U.S. account holders Name Address TIN Account number Value of Account Redemptions/withdrawals Timeline of reporting different under Final Regulations and IGAs Form 8966; Local law for Model 1 Reporting FFIs 38

39 Foreign Account Tax Compliance Act (FATCA) Foreign Account Reporting FATCA Individual Reporting Foreign Financial Assets IRC 6038D, enacted in conjunction with FATCA Effective starting 2011 Reporting of specified foreign financial assets above $50,000 Form 8938 Limited to individuals Contrast with reporting of entity account holders by FFIs Proposed regulations extend to entities formed or availed of for purposes of holding specified financial assets 39

40 Foreign Account Tax Compliance Act (FATCA) Foreign Account Reporting FATCA Who must report Reporting Thresholds Living in the United States Unmarried - $50,000 at end of year or $75,000 at any time during year (same thresholds for marrieds filing separately) Married filing joint return - $100,000 at end of year or $150,000 at any time during year Living outside United States Unmarried - $200,000/$300,000 Married filing joint return - $400,000/$600,000 Thresholds subject to change Specific tests for determining residency for these purposes 40

41 Foreign Account Tax Compliance Act (FATCA) Foreign Account Reporting FATCA Specified Foreign Financial Assets Cross-references to FATCA definitions Any financial account maintained by an FFI or by financial institution organized under laws of U.S. possession; and Following assets held for investment and not maintained in a financial institution: Stock or securities of a foreign issuer Interests in foreign entities Financial instruments/contracts with foreign issuer/counterparty Temporary regulations contain examples Held for investment vs. held in trade or business 41

42 Foreign Account Tax Compliance Act (FATCA) Withholding FATCA U.S. Withholding agents are required to withhold the 30% FATCA tax on certain payments to certain foreign financial institutions and NFFEs Several questions embedded here FATCA compliance for withholding agents essentially a series of Q&As First question: Who is a U.S. withholding agent under FATCA? U.S. person Having control, receipt or custody over the disposal or payment of A withholdable payment 42

43 Foreign Account Tax Compliance Act (FATCA) Withholding FATCA Second question: What is a withholdable payment? Starting 7/1/2014, U.S. source FDAP income Interest; Dividends; Rents and royalties; Compensation and other fixed or determinable income; and Starting 1/1/2017, Gross proceeds from the sale or other disposition of property of a type which can produce interest or dividends from U.S. sources. Exceptions: Grandfathered obligations Short-term obligations ECI Excluded nonfinancial payments 43

44 Foreign Account Tax Compliance Act (FATCA) Third question: who is the payee? Identification of payee In general, payee is the recipient Look beyond recipient in following situations: Certain payments through agents/intermediaries Payments to many non-u.s. flow-through entities Participating or Deemed-Compliant FFIs (same treatment as under Chapter 3) Payments to foreign branches of U.S. persons and certain U.S. branches of foreign persons 44

45 Foreign Account Tax Compliance Act (FATCA) Fourth question: how do you categorize the payee? Need to determine whether the payee is U.S. or non-u.s. and if non-u.s., whether an FFI, etc. Categorization of payee U.S. or foreign person? Determine whether payments are made to intermediaries Reliance on documentation W-8 and W-9 forms de facto acceptable Permanent validity of W-8 forms provided by participating FFIs ( PFFIs ) and Registered Deemed-Compliant FFIs (but not Certified Deemed-Compliant FFIs) if no change in circumstances 3 year period otherwise obligation to update. Categorization of payee status under FATCA In general withholding agents will need to obtain new W-8BEN-E forms unless recipient is a foreign individual, foreign government or international organization New W-8BEN-E provides specific categories of each type of entity under FATCA Specific standards of knowledge can override forms Indicia of U.S. residence, e.g., - mainly common-sense rules 45

46 Foreign Account Tax Compliance Act (FATCA) Fifth question: must I withhold? Withhold 30% on withholdable payments to: Non-participating FFIs; Participating FFIs that are non-qualified intermediaries if sufficient documentation is not received (i.e., W-8BEN that establishes all of the beneficial owners are exempt under FATCA similar to current Chapter 3 rules for non-u.s. flow-through entities); or FFIs that elect to be withheld upon Timing of payment When amount would be includible in income of beneficial owner under cash method of accounting principles For flow-through entities, when amounts subject to withholding are distributed, or if amounts are not distributed, generally when K-1s are issued (similar to Chapter 3 principles) File 1042 and 1042-S similar to Chapter 3 withholding 46

47 Questions 47

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