Supplemental Notice Provides Additional Guidance on the Information Reporting and Withholding Rules for Foreign Financial Institutions

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1 Supplemental Notice Provides Additional Guidance on the Information Reporting and Withholding Rules for Foreign Financial Institutions SUMMARY On April 8, 2011, Treasury and the IRS published Notice (the Notice ) providing much anticipated guidance on the information reporting provisions of the Hiring Incentives to Restore Employment Act of 2010 (commonly referred to as FATCA, as most of the provisions were originally introduced in the Foreign Account Tax Compliance Act). The Notice is the first official guidance on this subject since Notice , released in August The Notice supplements, and in some cases supersedes, the guidance provided in Notice Although the Notice does not provide guidance on all aspects of FATCA, it does provide new and updated information on a variety of topics, including: The definition of passthru payments (a definition that is significantly broader than many observers had anticipated); Which entities may be treated as deemed compliant foreign financial institutions ( FFIs ) and the requirements that must be satisfied to qualify as a deemed compliant FFI; The treatment of qualified intermediaries, foreign withholding partnerships and foreign withholding trusts; and The application of FATCA s reporting rules to affiliated groups of FFIs. The Notice also revises and modifies the preexisting individual account identification procedures and U.S. account reporting requirements that were announced in Notice In particular, the Notice: No longer requires certain preexisting individual accounts to be re-tested under the procedures for identifying new individual accounts; Introduces the concepts of high value accounts and private banking accounts and sets forth specific procedures an FFI must comply with in order to identify its high value accounts and private banking accounts as U.S. accounts; New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 Limits when a Participating FFI (described below) must aggregate the accounts a single account holder has at the FFI s different branches and affiliates for the purposes of determining the balance or value of an account; Modifies the information an FFI will be asked to provide to the IRS on its U.S. accounts; and Adds a new requirement that the chief compliance officer (or an equivalent-level officer) of a Participating FFI must certify that, between the publication date of the Notice and the effective date of the FFI s FFI Agreement (described below), the FFI s management personnel did not encourage or assist account holders with respect to strategies for avoiding identification of their accounts as U.S. accounts. The Notice also states that Treasury and the IRS intend to (i) issue regulations incorporating the guidance in the Notice and (ii) publish draft FFI Agreements and draft information reporting and certification forms. Although Notice requested comments on applying FATCA to insurance companies, the Notice does not include any guidance on this topic. BACKGROUND FATCA was passed in March 2010, and is intended to reduce U.S. tax avoidance by U.S. citizens and residents holding assets outside the United States. To accomplish this goal, the main compliance provisions of FATCA encourage: (i) FFIs to sign agreements to report information on their account holders to the IRS (such FFIs, Participating FFIs and such agreements, FFI Agreements ) and (ii) other foreign entities to provide information regarding their beneficial owners to U.S. withholding agents. In the absence of compliance, FATCA imposes a 30% withholding tax on payments of U.S.-source withholdable payments. 1 FATCA also requires Participating FFIs to withhold on passthru payments (discussed below) made to recalcitrant account holders and FFIs that do not sign an agreement with the IRS under the Act (such FFIs, Nonparticipating FFIs ). In August 2010, the IRS and Treasury released Notice , the first round of guidance issued under FATCA. Notice provided the IRS s initial views regarding how a number of provisions of FATCA would be applied, including: (i) the FATCA s grandfathering rules; (ii) the definition of a financial institution for FATCA purposes; (iii) what Participating FFIs will need to do to identify and classify their account holders; (iv) what U.S. financial institutions ( USFIs ) that make withholdable payments will need to do to identify and classify their account-holder payees; (v) how exemptions from withholding will be 1 Withholdable payments, under FATCA, include payments of U.S.-source interest, dividends and other fixed or determinable, annual or periodical income, as well as any gross proceeds from the sale or disposition of an obligation of a type that can produce U.S-source interest or dividends. Additional background on FATCA can be found in the Sullivan & Cromwell LLP publication entitled Hiring Incentives to Restore Employment Act Enacted: Legislation Includes Foreign Account Provisions and Employment Incentives (March 24, 2010), which can be obtained by following the instructions at the end of this publication. -2-

3 applied; and (vi) what information a Participating FFI will be required to report. Notice also requested public comment on a variety of subjects that relate to how FATCA will be implemented. 2 THE NOTICE A. PASSTHRU PAYMENTS The Notice provides the first guidance from the IRS and Treasury regarding how FATCA s requirement that Participating FFIs withhold on certain passthru payments will be implemented. The definition of a passthru payment under the Notice is significantly broader than many observers had anticipated, and if read literally, could encompass any payment made by a Participating FFI that is not made in a custodial capacity (along with certain custodial payments). It is unclear whether the IRS and Treasury intended this level of breadth, or if subsequent guidance will narrow the scope of what represents a potential passthru payment. These rules may, if implemented without further refinement, also create significant logistical and other challenges for Participating FFIs. 1. Background A Participating FFI is required to withhold 30% of any passthru payment made to a recalcitrant account holder (i.e., a person who fails to comply with reasonable requests for certain information that Participating FFIs must request under FATCA) or a Nonparticipating FFI. 3 FATCA defines a passthru payment as: (i) any payment that is itself a withholdable payment and (ii) any payment that is not a withholdable payment, to the extent it is attributable to a withholdable payment. The legislative history of FATCA and prior IRS guidance do not further define what facts should cause a payment to be considered attributable to a withholdable payment, although Notice requested comments on how this feature of FATCA should be implemented. Many commentators had, prior to the Notice, recommended that the IRS adopt a tracing approach to defining the extent to which a payment is attributable to a withholdable payment. 4 Under a tracing view, a payment that is directly linked to a withholdable payment such as a dividend paid by a non-u.s. passive investment vehicle whose sole activity consists of investing in U.S. debt securities would be For additional background on Notice , please see the Sullivan & Cromwell LLP Publication entitled FATCA Guidance: IRS Releases Preliminary Guidance on the FATCA Provisions of the HIRE Act (Sept. 13, 2010), which can be obtained by following the instructions at the end of this publication. See Section 1471(b)(1)(D). FATCA also requires withholding on passthru payments that are made to FFIs that have elected to be withheld upon. See, e.g., N.Y. State Bar Ass n, Tax Section, Report on Notice (Nov. 16, 2010); Letter from Rep. William Lacy Clay to Timothy Geithner, Secretary of the Treasury (Sep. 13, 2010); Letter from David Wagner, the Clearing House Association LLC, to Stephen E. Shay, Deputy Assistant Secretary for International Tax Affairs, U.S. Dep t of the Treasury (Nov. 5, 2010). -3-

4 treated as a passthru payment. However, a payment that is more tenuously attributable to U.S.-source income (such as interest paid by an FFI that is a multinational commercial bank with limited U.S. operations) would not be considered a passthru payment. 2. Passthru Payments under the Notice In the Notice, the IRS and Treasury announced that they do not intend to adopt a tracing approach to determine whether a payment is attributable to a withholdable payment. Instead, the IRS and Treasury describe a proposed rule that will, in effect, treat payments as attributable to withholdable payments in proportion to the fraction of the payor s total assets that have U.S. nexus ( U.S. Assets ). Specifically, subject to limited exceptions: (i) any withholdable payment made by an FFI will be treated entirely as a passthru payment and (ii) a portion -- the passthru payment percentage -- of any remaining or other payment made by an FFI will be treated as a passthru payment. For payments made because an FFI is acting as a custodian, the relevant passthru payment percentage will be the passthru payment percentage of the issuer of the instrument or interest in the custodial account. In other cases, the applicable passthru payment percentage will be that of the payor FFI. The passthru payment percentage of any FFI will generally be the fraction of its assets that are U.S. Assets. Under the Notice, U.S. Assets will be any assets to the extent they could give rise to passthru payments. For purposes of this rule, a debt or equity instrument issued by a U.S. corporation will be treated entirely as a U.S. Asset, and a debt or equity instrument issued by a non-financial foreign entity (an NFFE ) will not be treated as a U.S. Asset. A debt obligation or equity interest issued by another FFI will be treated as a U.S. Asset to the extent of the issuer s passthru payment percentage. 5 A Participating FFI or deemed compliant FFI will be required to compute its passthru payment percentage within roughly three months of the end of each fiscal quarter. Specifically, each such FFI will be required to use quarterly testing dates that, for each fiscal quarter, represent either (i) the last redemption date of the fiscal quarter (in the case of FFIs that conduct redemptions at least quarterly) or (ii) the last business day of the fiscal quarter (in the case of all other FFIs). Within three months of a quarterly testing date, each Participating FFI and deemed compliant FFI will be required to calculate and publish its passthru payment percentage. In general, an FFI s passthru payment percentage will be the sum of its U.S. Assets held on the last four quarterly testing dates over the sum of all of its assets held on those dates. 6 However, an entity becoming a Participating FFI for the first time will be entitled to use a special transition 5 6 Participating FFIs will be entitled to rely on the published passthru payment calculations of other FFIs for this purpose. The Notice also indicates that the IRS and Treasury intend to issue anti-avoidance rules that would disregard asset transfers in cases when FFIs engage in a pattern of disposing of assets shortly prior to a quarterly testing date and reacquiring the same or similar assets at a later date. -4-

5 method that permits it to select an initial testing date that determines its initial passthru payment percentage and phases in information from quarterly testing dates as they occur. 7 Assets, other than assets held in custodial accounts (which will be disregarded), will generally be reflected in passthru payment percentage calculations if (and to the extent) they are shown on a Participating FFI s balance sheet (as prepared under its method of accounting for reporting to interest holders). Participating FFIs will also be required to include off-balance sheet transactions to the extent provided in future guidance. An FFI that is not a Participating FFI or a deemed compliant FFI will be deemed, for this purpose, to have a passthru payment percentage of 0%. 8 However, a Participating FFI or deemed compliant FFI that fails to publish its passthru payment percentage will be treated as having a passthru payment percentage of 100%. 9 In the Notice, the IRS and Treasury also announce that grandfathered obligations (i.e., in general, fixedterm legal agreements that generate or could generate withholdable payments that are not treated as equity under U.S. tax principles) will not be treated as U.S. Assets for the purpose of determining an entity s passthru payment percentage. In addition, grandfathered obligations will not give rise to passthru payments under the rules applicable to custodial payments. 3. Request for Comments In the Notice, the IRS and Treasury request comments regarding the proposed approach to passthru payments that is described above. In addition, the IRS and Treasury have requested comments on the following subjects that relate to passthru payments: The use of the passthru payment percentage with respect to domestic and foreign partnerships and other flow-through entities; How a partnership or other flow-through entity may determine whether a payment it makes to an interest holder is a withholdable payment or a passthru payment; Specifically, under this alternative method, a Participating FFI will select any date that is within the six months preceding the effective date of its FFI Agreement as its initial testing date. The percentage of the FFI s assets that are U.S. Assets on the initial testing date will be the new Participating FFI s passthru payment percentage for the first quarter during which its FFI Agreement is effective. For the next three quarters, a Participating FFI that elects this method will calculate its passthru payment percentage as the sum of its U.S. Assets on each quarterly testing date that has elapsed and the initial testing date over the sum of its total assets on each quarterly testing date that has elapsed and the initial testing date. However, prior to doing so, an FFI will be required to confirm that the lower-tier FFI is not a Participating FFI or a deemed compliant FFI. The IRS intends to maintain a database that will permit such confirmation. It is unclear how the IRS intends to resolve the circularity problem of Participating FFIs that hold significant interests (in the form of debt or equity) in each other and therefore need data from each other before they can furnish data to each other. -5-

6 Whether it is appropriate to permit a USFI that is a partnership or other flow-through entity under U.S. tax principles to calculate and make available a passthru payment percentage that may be used by participating FFIs in determining their own passthru payment percentages with respect to non-custodial accounts held with such U.S. institutions; Possible exemptions from the definition of passthru payments that would, to the extent possible, be consistent with the policy goals of the passthru payment rule and reasonable in light of the potential burden on Participating FFIs; The most efficient mechanism for ensuring that accurate passthru payment percentage is readily available to FFIs for purposes of administering their obligations under FATCA; and Anti-avoidance rules that may be necessary to prevent the manipulation of an FFI s passthru payment percentage. 4. Discussion and Further Considerations At first glance, the passthru payment rules proposed in the Notice do not appear to be particularly complex: in contrast to other U.S. international tax anti-avoidance provisions that require specialized U.S. tax accounting, the passthru payment provisions in the Notice require what appear to be straightforward calculations and rely on ordinary financial accounting. However, when multiple levels of FFIs are involved, obtaining the necessary data to perform these computations may be quite complex. The Notice is also unclear on a number of points, including how broad the IRS intends the passthru payment rule to be. The proposal in the Notice applies passthru payment withholding to any payment made by an FFI to a Nonparticipating FFI or recalcitrant account holder. Therefore, as with the withholdable payment rule, passthru payment treatment could be applicable to payments of both interest and principal. However, the definition of a passthru payment, as provided in the Notice, has the potential to be broader than the definition of a withholdable payment. For example, the literal application of this rule would mean that a Participating FFI would be required to treat a portion of any amount paid to a Nonparticipating FFI for services or to acquire property as a passthru payment even though the same amounts, if paid by a USFI, would not be withholdable payments. It is not clear whether the IRS s intent, in developing the Notice, was to craft the broadest possible definition of a passthru payment, with a view toward hindering the ability of Nonparticipating FFIs and recalcitrant account holders to transact with Participating FFIs, or if the breadth of this definition in the Notice was inadvertent. The Notice also does not clarify whether passthru payment withholding will apply to payments made on existing debt instruments issued by Participating FFIs. Although the Notice provides that: (i) grandfathered obligations will not be treated as U.S. Assets in determining a Participating FFI s passthru payment percentage, and (ii) grandfathered obligations will not give rise to passthru payments under the rules applicable to custodial payments, it is not clear how these rules will apply to preexisting debt issued by Participating FFIs. It is unclear whether debt instruments that generate foreign-source interest are obligations for purposes of the grandfathering rules set out in Notice or whether there is any -6-

7 exemption for payments made directly by a Participating FFI on its own preexisting debt instruments to a Nonparticipating FFIs in a noncustodial setting. 10 By providing that the passthru payment percentage applicable to an obligation will generally be determined by reference to its payor, the rules announced in the Notice also have the potential to create new differences among otherwise-equivalent products offered by Participating FFIs and U.S. financial institutions. Although the Notice recognizes in requesting comments on whether USFIs that are partnerships or other flow-through entities should be permitted to calculate a passthru payment percentage that passthru payments can implicate USFIs, the Notice does not include a proposal that would require USFIs to withhold on passthru payments to Nonparticipating FFIs. The absence of such a rule creates a lack of parity between USFIs and Participating FFIs because a USFI will, without such a requirement, be able to pay an amount that is not a withholdable payment (e.g., dividends from a foreign mutual fund or payments on a derivative contract) to a Nonparticipating FFI without deduction, even though a Participating FFI would be required to withhold on an equivalent payment in accordance with its passthru payment percentage. B. CATEGORIES OF FFIs THAT WILL BE DEEMED COMPLIANT Section III of the Notice describes certain categories of FFIs that will be deemed compliant FFIs under future regulations. Under Section 1471(b)(2), certain FFIs may be deemed to meet the requirements of 1471(b) (and therefore will not be required to enter into an FFI Agreement otherwise required for an FFI to avoid withholding under FATCA on certain payments it receives). The Notice states that future regulations will treat certain local banks, investment funds and retirement plans as deemed compliant FFIs and outlines the requirements for qualification under each category. Of particular note are the rules that permit certain local banks to be deemed compliant FFIs. Many FFIs have commented that locally operating banks and bank branches present a low risk of U.S. tax avoidance and therefore, should not have to incur the cost of becoming Participating FFIs. While the Notice adopts such rules, they are limited in several ways. First, the rules require that the local bank not operate or solicit accounts in any jurisdiction outside of its country of origin. This means foreign banks that have a branch or solicit accounts in a neighboring country (not the U.S.) will not qualify for deemed compliant status even though the bank has policies and procedures in place to ensure that it does not open accounts for U.S. persons. Second, the rules apply only to entities and not to branches. As a result, a Participating FFI with a branch that operates solely in a local jurisdiction will, nonetheless, have to include that branch when implementing the reporting and withholding rules. Third, under the rules, a local bank will not be deemed 10 Under Notice , an obligation is, subject to certain exceptions that generally would not apply to debt, any legal agreement that produces or could produce withholdable payments. Foreign-source interest would generally not be considered a withholdable payment, and it is not clear if could produce should be read broadly enough to encompass instruments that theoretically could, but would not ordinarily be expected to, generate withholdable payments. -7-

8 complaint unless it limits the NFFEs that may open accounts at the bank to NFFEs that are organized and operate in the jurisdiction of the bank. The Notice also requests comments regarding other types of FFIs that could appropriately be treated as deemed compliant FFIs. 1. Banks and Certain Other FFIs that Operate Locally a. Affiliated Banks that Are Organized and Operate in a Single Jurisdiction Under the Notice, each member of an affiliated group of FFIs may be treated as a deemed compliant FFI if each FFI in the expanded affiliated group : 11 Is licensed and regulated as a bank or similar organization authorized to accept deposits in its country of organization; Is organized in the same country as the other FFIs in the expanded affiliated group; Does not maintain operations outside the country of organization; Does not solicit account holders outside its country of organization; and Implements policies and procedures to ensure that it does not open or maintain accounts for non-residents, Nonparticipating FFIs or NFFEs (other than excepted NFFEs that are organized and operate in the same jurisdiction in which the members of the expanded affiliated group are organized and operate). 12 b. Members of a Participating FFI Group that Only Operate in Their Home Jurisdiction Pursuant to the Notice, an FFI that is a member of an expanded affiliated group that includes one or more Participating FFIs may be treated as a deemed compliant FFI if: The member does not operate outside its country of organization; The member does not solicit account holders outside its country of operation; The member implements the preexisting account and customer identification procedures applicable for Participating FFIs to identify U.S. accounts, accounts of Nonparticipating FFIs Under FATCA, a financial institution generally would be part of an expanded affiliated group that includes another financial institution if: (i) one financial institution controls the other financial institution directly or through a chain of controlled entities or (ii) they are both under the common control (directly or through a chain of controlled entities) of a single corporation (whether or not such corporation is a financial institution itself). More specifically, FATCA defines an expanded affiliated group as an affiliated group, as defined by Section 1504(a), but by substituting a more-than-50% ownership requirement for the at-least-80% ownership requirement in each place where it appears in Section 1504(a), and disregarding the Section 1504(b)(2) prohibition on including insurance companies in an affiliated group and the Section 1504(b)(3) prohibition on including non-u.s. corporations in an affiliated group. It also includes partnerships and trusts if they are controlled, within the meaning of Section 954(d)(3), by other members of the expanded affiliated group (including other controlled partnerships or trusts). Pursuant to Notice , an excepted NFFE includes an NFFE that is engaged in an active trade or business. -8-

9 and accounts of NFFEs (other than excepted NFFEs that are organized and operate in the same jurisdiction in which the member is organized and operates); and The member agrees that if any of the types of accounts described immediately above are found, it will either (a) enter into an FFI agreement; (b) transfer the account to an affiliate that is a Participating FFI within the time proscribed in future regulations; or (c) close such account. Treasury and the IRS have asked for comments on how an expanded affiliated group operating in a single jurisdiction and an FFI member of an expanded affiliated group in which one or more members is a Participating FFI could demonstrate that it meets the relevant requirements described above. Treasury and IRS have also asked for comments as to whether there are policies and procedures other than those applicable to Participating FFIs that an FFI member of a Participating FFI group could use to identify any U.S. accounts. 2. Certain Investment Funds a. Funds where all Holders Are FFIs or Exempt Entities Pursuant to the Notice, an FFI that is an investment fund may be treated as a deemed compliant FFI if: The holders of the direct units or global certificate in the fund are (a) Participating FFIs or deemed compliant FFIs holding on behalf of other investors, or (b) entities that are exempt under Section 1471(f) (generally foreign governments, international organizations, foreign central banks or other entities identified by the IRS as having a low risk of tax evasion); The fund prohibits entities other than those described above from holding an interest in the fund; and The fund agrees that any passthru payment percentages that it calculates and publishes will be done in accordance with the rules set forth in the Notice. (See discussion in Section A above). Significantly, the category of acceptable holders does not include U.S. financial institutions. b. Funds with Other Specified Owners (Including U.S. Financial Institutions) Based on comments received, Treasury and the IRS are considering, but have not yet determined, whether funds may be treated as deemed compliant where: All direct holders in the funds are Participating FFIs, U.S. financial institutions, deemed compliant FFIs, exempted entities under Section 1471(f) or Nonparticipating FFIs acting as distributors; The fund s distribution or similar agreements prohibit investors that are specified U.S. persons, NFFEs other than excepted NFFEs and non-participating FFIs; Each distributor of the funds agrees to enforce the investment restrictions; and Certain other requirements relevant to FATCA are met. -9-

10 c. Funds Traded on an Established Securities Market Under the Code, an FFI that issues only debt or equity interests that are regularly traded on an established securities market does not have financial accounts. Nevertheless, according to the Notice, such entities are still FFIs that are subject to certain obligations to the extent they receive passthru payments. Such FFIs would be required to enter into FFI Agreements to avoid FATCA withholding on withholdable payments they receive, and must withhold on passthru payments that they make to Nonparticipating FFIs and certify as to their passthru percentage. Treasury and the IRS are considering, but have not yet determined, the circumstances under which such FFIs could be deemed compliant FFIs. 3. Foreign Retirement Plans The Notice states that Treasury and the IRS still intend to issue guidance describing the types of foreign retirement plans that pose a low risk of tax evasion under Section 1471(f). 13 Payments beneficially owned by such retirement plans will be exempt from withholding under FATCA. In addition, Treasury and the IRS intend to provide guidance on those foreign retirement plans and retirement accounts that may be deemed compliant FFIs. 4. Other Entities that Should Be Treated as Deemed Compliant FFIs Treasury and the IRS have requested comments regarding other categories of entities that should be treated as deemed compliant FFIs. 5. Becoming Designated and Complying with Deemed Compliant FFI Rules a. Use of Agent to Meet Due Diligence Requirements In recognition of the fact that many FFIs employ paying agents or transfer agents to act on their behalf, Treasury and the IRS intend to issue guidance clarifying that an FFI may use an agent to perform the due diligence and other required actions to maintain their status as a deemed compliant FFI. The FFI will, however, remain responsible for ensuring that the requirements are being met. Similarly, a Participating FFI may use an agent to perform its obligations under an FFI agreement. 13 Notice stated that the IRS intended to treat a foreign retirement plan as posing a low risk of tax evasion only if the plan: (i) qualifies as a retirement plan under the law of the country where it is established; (ii) is sponsored by a foreign employer; and (iii) does not permit U.S. persons, other than employees who worked for the sponsor during the time when the relevant benefits accrued, to participate. -10-

11 b. Certification as to Deemed Compliant Status In order to qualify as a deemed compliant FFI, an FFI must apply to the IRS for deemed-compliance status, obtain from the IRS an FFI identification number (an FFI-EIN ) that designates it as a deemed compliant FFI, and certify every three years that it meets the requirements for a deemed compliant FFI. C. RULES FOR QUALIFIED INTERMEDIARIES, FOREIGN WITHHOLDING PARTNERSHIPS AND FOREIGN WITHHOLDING TRUSTS Section V of the Notice covers rules for qualified intermediaries, foreign withholding partnerships and foreign withholding trusts. These rules make clear that every qualified intermediary, foreign withholding partnership and foreign withholding trust that is a FFI will be required to become a Participating FFI. 1. Qualified Intermediaries Under Section 1471(c)(3), a qualified intermediary (generally a foreign financial institution or clearing organization or foreign branch of a U.S. bank or clearing organization that has entered into an agreement with the IRS to take on certain information reporting and withholding responsibilities under Chapter 3 and Chapter 61 of the Code for payments of U.S.-source income that it receives as a custodian) (a QI ) is also required to comply with the account identification, reporting and other requirements of FATCA. Pursuant to the Notice, Treasury and the IRS intend to issue guidance that will require all QIs that are FFIs to become Participating FFIs unless they are deemed compliant FFIs under Section 1471 (see discussion of deemed compliant FFIs in Section B above). Entities that are currently QIs will be required to consent to include in their QI agreement the requirements for a Participating FFI. Such consents would be effective as of January 1, The Notice states that Treasury and the IRS intend to issue transition rules under both Chapter 3 and Chapter 4 of the Code to facilitate the change. Entities that wish to apply for QI status after January 1, 2013 will be required to be Participating FFIs (unless they qualify for an exception under Section 1471). 2. Foreign Withholding Partnerships and Foreign Withholding Trusts Treasury and the IRS also intend to require all FFIs that are foreign withholding partnerships or foreign withholding trusts (generally foreign partnerships and trusts that have entered into an agreement with the IRS to take on certain information reporting and withholding responsibilities similar to those taken on by a QI) to agree to become Participating FFIs under similar procedures. According to the Notice, Treasury and the IRS intend to coordinate the reporting obligations of QIs, foreign withholding partnerships and foreign withholding trusts under Chapter 3 and Chapter 4 of the Code and request comments on how the rules under Chapter 3 may be modified for that purpose. D. COMPLIANCE BY AFFILIATED GROUPS The Notice also provides new rules that will be applicable to expanded affiliated groups. These rules will generally require FFI affiliated groups to coordinate the FFI Agreement application process through a -11-

12 single lead FFI and, on a going forward basis, to appoint a contact entity to handle ongoing communications with the IRS. The Notice also requests comments on the possibility of centralized compliance among funds with the same asset manager. Pursuant to Section 1471(e), the reporting requirements imposed on a Participating FFI apply to each U.S. account maintained by the Participating FFI and to the U.S. accounts maintained by every other FFI that is a member of the same expanded affiliated group that includes the Participating FFI (each such FFI an FFI affiliate of an FFI Group ). 1. All Members of FFI Group to Be Participating FFIs or Deemed Compliant FFIs The Notice provides that Treasury and the IRS intend that each FFI affiliate in an FFI Group must either be a Participating FFI or a deemed compliant FFI. Each FFI affiliate will be required to execute its own FFI Agreement (through the coordinated application process described below) that applies to all of its worldwide branches and offices, and will be issued its own FFI-EIN. In addition, each FFI affiliate will be responsible for its own due diligence, withholding and reporting obligations. The Notice states that Treasury and the IRS are still considering whether to allow an FFI Group to include one or more Nonparticipating (and presumably non-deemed compliant) FFI affiliates. 2. Coordinated Compliance a. Application Process As set forth in the Notice, Treasury and IRS intend to require each FFI Group to designate a lead FFI to complete an FFI Agreement with the IRS or a certification of deemed compliant FFI status for itself and on behalf of each of its FFI affiliates. In particular the lead FFI will, among other things, be required to: Provide legally binding authorization from each FFI affiliate for the lead FFI to act on its behalf; Represent that it has identified each FFI in its expanded affiliated group and has completed the application in accordance with the instructions from each FFI affiliate; Represent that it is authorized to act as agent for the group for purposes of an ongoing requirement to identify any new FFI affiliates and any entities that cease to be FFI affiliates; Provide certain information about each FFI affiliate in its FFI Group and other information about the affiliate including whether it is a Participating or deemed compliant FFI, the types of accounts the affiliate maintains, whether the affiliate maintains private banking accounts (discussed below) and whether it is a QI, foreign withholding partnership or foreign withholding trust; Indentify each affiliate that maintains a branch that elects to separately report its U.S. accounts pursuant to Section IV of the Notice (discussed below); Provide the name, address and country of organization of each member of the FFI Group that is not an FFI; and Provide any additional information set forth in future guidance. -12-

13 b. Ongoing Coordination Treasury and the IRS intend to require the lead FFI to continue to act as the central contact person for issues that arise concerning the agreements and certifications of each FFI affiliate as well as matters related to any non-ffi affiliate. In the alternative, the lead FFI may identify one or more other FFI affiliates to act as contact person for particular members of the FFI Group (for example, to represent affiliates in a single jurisdiction or that share a common business line). FFI Groups will also be permitted to appoint one or more FFI affiliates in the FFI Group to oversee the group s compliance (such FFIs are referred to in the Notice as Compliance FFIs ). This centralized compliance approach is intended to create a more efficient process for both the FFI Group and the IRS. Treasury and the IRS seek comments about this approach, including the time a Compliance FFI would need to establish the policies and procedures for assuming these responsibilities and additional suggestions to facilitate a Compliance FFI s role in enforcing its affiliates compliance. c. Compliance by CFCs The Treasury and IRS have asked for comments as to whether U.S. shareholders of controlled foreign corporations ( CFCs ) 14 that are FFIs should be allowed to take on a role similar to that of a lead FFI or a Compliance FFI for the CFC. d. Centralized Compliance for Funds with a Common Asset Manager Treasury and the IRS are also considering whether a group of funds with the same asset manager (or other agent) should be permitted to contract with the asset manager or other agent to perform its functions under an FFI Agreement. The asset manager or other agent would enter into a single FFI Agreement for the funds and would be the point of contact for the IRS. This option would only be permitted where the legal agreements and other arrangements with the fund permit the asset manager or other agent to monitor the fund s compliance. Each fund would remain liable for the performance of its obligations under the FFI Agreement. E. REVISED PROCEDURES FOR IDENTIFYING PREEXISTING INDIVIDUAL ACCOUNTS The Notice also revises the procedures set forth in Notice that a Participating FFI must follow to classify its preexisting individual accounts (i.e., accounts in existence prior to the effective date of such FFI s FFI Agreement) as U.S. or non-u.s. accounts. Treasury and the IRS received several comments that the procedures set forth in Notice for determining whether a preexisting individual account holder is a U.S. or non-u.s. person presented 14 Generally, a CFC is a foreign corporation more than 50% of which (by vote or value) is owned by U.S. shareholders, where a U.S. shareholder is defined as a U.S. person that owns 10% or more of the voting power of the corporation. -13-

14 significant compliance challenges. In response, Section I of the Notice replaces Section III.B.2.a. of Notice in its entirety. Generally, the Notice adopts a modified version of the procedures originally set forth in Notice The procedures in the Notice are more onerous in some respects and less onerous in other respects than those proposed in Notice For example, Notice required an FFI s preexisting individual accounts to be re-tested under the procedures for determining whether new individual accounts are U.S. accounts within five years of the effective date of the FFI s FFI Agreement, unless certain exceptions applied. Under the Notice, there is no provision for re-testing under the procedures for new individual accounts. However, the Notice creates new steps in the identification procedures for high value accounts (accounts with a balance or value of more than $500,000 at the end of the year preceding the effective date of the FFI s FFI Agreement) and for private banking accounts. In general, a private banking account is an account maintained by the FFI s private banking department or serviced as part of a private banking relationship, and includes an account held by an entity, nominee or other person to the extent the account is associated with a private banking relationship with an individual client. The new procedure places certain identification responsibilities on the private banking relationship manager. A private banking relationship manager is an officer or employee of an FFI who is assigned responsibility for specific account holders on an ongoing basis and advises such clients on their private banking needs. The Notice generally allows a Participating FFI to elect to treat all accounts with a balance or value of $50,000 or less as non-u.s. accounts. In Notice , this election applied only to depositary accounts. For the purposes of determining whether an account s value is above or below the $50,000 threshold, Notice required all depository accounts held by an account holder at an FFI to be aggregated. In response to comments that certain local law restraints might prevent information sharing across branches and affiliates of an FFI, the Notice now requires an account holder s accounts to be aggregated for the purposes of determining balance or value only if the accounts are associated with one another under the FFI s existing computerized information management, accounting, tax reporting or other recordkeeping systems. The Notice also adds a requirement for a responsible officer of an FFI to certify compliance with the steps outlined below. Other changes from the procedures set forth in Notice include clarifying the terms electronically searchable information and documentary evidence, and no longer treating a non-u.s. P.O. box as an indication of non-u.s. status. It is unclear how these rules will interact with the procedures for new individual accounts set forth in Notice In particular, under Notice , consistent with the procedure for preexisting -14-

15 individual accounts, an FFI could elect to treat all new individual depository accounts with a balance of $50,000 or less as non-u.s. accounts. The aggregation rules outlined in the Notice (aggregation of accounts only if they are associated with one another on the FFI s computer systems) may not apply to new individual accounts, which would be subject to the aggregation rules outlined in Notice (aggregation of all of an account holder s accounts), notwithstanding the fact that the comments that motivated the change with respect to preexisting accounts apply equally to new accounts. It is not clear whether the IRS plans to issue further guidance modifying the procedures for identifying new accounts as U.S. or non-u.s. accounts. 1. Rules for Preexisting Individual Accounts The revised steps are as follows: Step 1. Subject to Step 2, all account holders that are already documented as U.S. persons for other U.S. tax purposes will be treated as specified U.S. persons. Step 2. The Participating FFI may elect to treat all accounts (including those with account holders documented as U.S. persons for other U.S. tax purposes) with a balance of $50,000 or less at the end of the calendar year preceding the effective date of the Participating FFI s FFI Agreement as non-u.s. accounts. Step 3. If the Participating FFI maintains a private banking account that is not addressed in either Step 1 or Step 2, the FFI must perform the steps below: 15 Each private banking relationship manager must: request that a client provide a Form W-9 if the private banking relationship manager has actual knowledge that such client is a U.S. person; and perform a diligent review of the paper and electronic account files and other records with respect to whom he or she serves as a private banking relationship manager, and identify each client (including associated family members) who, to the best of the knowledge of the private banking relationship manager, has any of the following indicia of potential U.S. status: (i) U.S. citizenship or lawful permanent resident status; (ii) a U.S. birthplace; (iii) a U.S. resident or correspondent address (including a U.S. P.O. box); (iv) standing instructions to transfer funds to accounts maintained in the U.S.; (v) the sole address provided is an in care of or hold mail address; or 15 For the purposes of Step 3, a Participating FFI may not rely on any documentation if the private banking relationship manager knows or has reason to know that the information contained in such documentation is unreliable or incorrect. -15-

16 (vi) a power of attorney or signatory authority was granted to a person with an address in the U.S. If any client is identified as having indicia of potential U.S. status, the private banking relationship manager must: (i) request additional documentation 16 in order to determine whether the client is a U.S. or non-u.s. person; 17 and (ii) request, from each client that provides a Form W-9, a waiver of applicable restrictions, if any, on reporting the client s information to the IRS. Each client that provides a Form W-9 and has agreed to provide a waiver of any information reporting restrictions must be included in the FFI s reporting of its U.S. accounts. In general, if the client is identified as a U.S. person (either because he or she provides a Form W-9 or because he or she is identified as having indicia of U.S status and does not establish non-u.s. status), the Participating FFI must treat all accounts associated with such client as U.S. accounts. 18 Each account for which the account holders either have not provided the documentation requested (or, in the case of U.S. persons, have not provided a waiver of any information reporting restrictions) must be treated as recalcitrant accounts after the end of the first year in which the FFI s FFI Agreement is in effect and must be included in the FFI s reporting with respect to such accounts. The private banking relationship manager must create and retain lists of all existing clients whose accounts are U.S. accounts, non-u.s. accounts or recalcitrant The Notice defines documentary evidence as including (i) documentary evidence sufficient to establish the identify of an individual and the status of that person as a non-u.s. person (including any documentation that includes an individual s name, address and photograph issued by an authorized governmental body within the last three years), (ii) any valid document issued by an authorized governmental body that includes the individual s name and address and is typically used for identification purposes, and (iii) with respect to an account maintained in a jurisdiction with antimoney laundering/know-your-customer rules that have been approved by the IRS in connection with a QI agreement, any of the documents (other than a Form W-8) referenced in the jurisdiction s attachment to its QI agreements for identifying natural persons, as shown on the IRS s webpage. As was the case in Notice , the type of documentation required varies depending on what U.S. indicia the client is identified as having. If the client is identified as a U.S. citizen or lawful permanent resident, the account is presumed to be held by a U.S. person, and such person must provide a Form W-9. If the indicia described in clause (ii) or (iii) are present with respect to an account, the client must provide a Form W-9, or both a Form W-8BEN and a non-u.s. passport or other government issued evidence establishing the client s citizenship in a country other than the U.S. In addition, a client identified as having a birthplace in the U.S. must include a written explanation regarding the client s renunciation of his or her U.S. citizenship, or a reason why the client did not acquire U.S. citizenship at birth. Holders of accounts that contain the indicia described in clause (iv) must provide either a Form W-9, or a Form W-8BEN and documentary evidence establishing the individual s non-u.s. status. Holders of accounts that contain the indicia described in clauses (v) or (vi) must provide either a Form W-9, a Form W-8BEN or documentary evidence establishing the individual s non-u.s. status. However, an account held solely by a client s family member will not be treated as a U.S. account if the family member provides a Form W-8BEN and documentary evidence establishing the non-u.s. status of the family member, unless the private banking relationship manager knows or has reason to know the family member is acting as a nominee or agent for the client. -16-

17 accounts. The FFI must ensure that all of the written requests and responses related to the search are retained by the FFI for ten years. The Participating FFI must complete the procedures above by the end of the first year in which the FFI s FFI Agreement is in effect. A private banking relationship manager that subsequently becomes aware that a preexisting private banking account has any of the U.S. indicia described above must request additional documentation and, if the account holder does not establish non-u.s. status within one year of the date on which the private banking relationship manager discovers the U.S. indicia, must include the account in the FFI s reporting of its U.S. accounts or treat the account as a recalcitrant account. Step 4. For accounts not addressed in Steps 1, 2 or 3, the FFI must determine whether the FFI s electronically searchable information contains any of the indicia of potential U.S. status described in Step 3 above. The Notice defines electronically searchable information as information that an FFI maintains in its tax reporting files, customer master files or similar files, that is stored in the form of an electronic database against which standard queries in programming language may be used. Customer master files include an FFI s primary files for maintaining account holder information. Information, data or files are not electronically searchable merely because they are stored in an image retrieval system (i.e., pdfs or scanned documents). Similar to the process described in Step 3, if any of the above indicia of potential U.S. status exist, the FFI must request and obtain additional documentation to establish whether the account holder is a U.S. person. As in Step 3, the documentation required depends on the particular indicia of U.S. status. 19 Step 5. For all accounts not identified in Steps 1 through 4, and that have a balance of $500,000 or more at the end of the year preceding the effective date of the FFI s FFI Agreement ( high value accounts ), the FFI must perform a diligent review of the account files associated with the account. To the extent any of the accounts contain U.S. indicia, the FFI must obtain the required documentation within two years of the effective date of the FFI Agreement. Account holders that have not provided appropriate documentation within two years of the effective date of the FFI s FFI Agreement will be classified as recalcitrant account holders until such documentation is received. Step 6. Beginning the third year following the effective date of the FFI Agreement, the FFI will be required to apply Step 5 annually to all preexisting individual accounts that were not previously high value accounts, but that would be high value accounts if the account balance or value of the account were tested on the last day of the preceding year. If an account has become a high value account, the FFI will be required to treat such account as a recalcitrant account if it has not received the required documentation by the end of the year. 19 See footnote