tax notes Volume 144, Number 13 September 29, 2014

Transcription

1 tax notes Volume 144, Number 13 September 29, 2014 FATCA Implementation for Property and Casualty Insurers by Carol Tello, Kristan Rizzolo, and Saren Goldner Reprinted from Tax Notes, September 29, 2014, p. 1583

2 FATCA Implementation for Property and Casualty Insurers By Carol Tello, Kristan Rizzolo, and Saren Goldner Carol Tello and Kristan Rizzolo are partners and Saren Goldner is counsel, in the tax group of Sutherland Asbill & Brennan LLP. The authors thank William Pauls, Christopher Schoen, and Jeffrey Mace, also members of Sutherland s tax group, for their review and comments. In this article, the authors discuss how the Foreign Account Tax Compliance Act affects property and casualty insurers and they offer insights into nuances that have developed concerning the application of FATCA to those companies. The provisions of the Foreign Account Tax Compliance Act are far-reaching and have implications for all non-u.s. companies, including property and casualty (P&C) insurers and their affiliates. While there are still many questions to be answered regarding the application of the FATCA rules, the regulations issued in January 2013 and February 2014 provide important guidance. This article provides a framework for a discussion of how FATCA affects P&C insurers and insight into nuances concerning the application of FATCA to these companies. A. Background In March 2010 Congress enacted the provisions of FATCA as part of the Hiring Incentives to Restore Employment Act 1 to improve the reporting of non- U.S. assets and income of U.S. persons. Under the FATCA rules, some U.S.-source payments to non- U.S. entities will be subject to FATCA withholding unless the non-u.s. entities agree to comply with FATCA due diligence and information reporting rules. On January 17, 2013, Treasury and the IRS issued extensive final regulations on the application of FATCA. Additional final and temporary regulations were promulgated in February The United States has also entered into several intergovernmen- 1 P.L , 124 Stat. 71 (2010). TAX MATTERS tax notes tal agreements with various countries. 2 The FATCA regime generally became effective on July 1, 2014; however, the IRS on May 2, 2014, issued Notice which provided that the term pre-existing obligation as it applies to an entity will include any obligation entered into before January 1, 2015, thus extending the time for foreign financial institutions to perform due diligence on entity account holders. The notice also indicated that 2014 and 2015 are transition years with modified enforcement, if withholding agents make good-faith efforts to secure the appropriate documentation to avoid withholding. The FATCA withholding tax regime is designed to ensure that non-u.s. income of U.S. persons is reported and to verify whether deposits made in non-u.s. accounts are after-tax income. To achieve that goal, all non-u.s. entities are subject to the U.S. reporting or certification procedures established under FATCA. 3 The FATCA provisions are triggered by a withholdable payment to a non-u.s. entity. 4 If the applicable requirements of FATCA are not satisfied, the payer must withhold U.S. tax equal to 30 percent of the payment made to the noncompliant non-u.s. entity. 5 In some cases, the 30 percent tax will be refundable if a U.S. income tax treaty applies. A withholdable payment is defined as any payment of U.S.-source fixed or determinable annual or periodic income, 6 which includes interest, dividends, rents and royalties, and insurance and reinsurance premiums. After December 31, 2016, the term withholdable payment also includes gross proceeds from the sale or disposition of any property of a type that can produce U.S.-source FDAP interest or dividends. The term also includes any premiums for annuity contracts, investment advisory fees, custodial fees, and bank or brokerage fees. 7 2 As of August 14, 2014, more than 100 IGAs have either been signed or agreed to in substance, according to the Treasury website, available at tax-policy/treaties/pages/fatca-archive.aspx. 3 See sections 1471 and See section Id. 6 Reg. section (a)(1)(i) and (ii). 7 Reg. section (a)(4)(iii). TAX NOTES, September 29,

3 COMMENTARY / TAX MATTERS Under the FATCA rules, non-u.s. entities are divided into two classes: FFIs 8 and nonfinancial foreign entities (NFFEs). 9 FFIs include depository and custodial institutions such as retail and investment banks, mutual funds and other investment entities, and some insurance companies that issue cash value insurance policies and annuity contracts. 10 To avoid withholding, every FFI must enter into an agreement with the IRS that obligates the FFI to determine which of its account holders are U.S. persons and provide to the IRS identifying information about the U.S. account holder and the account, unless the FFI is subject to an IGA that provides alternative rules for reporting. 11 An NFFE is any non-u.s. entity that is not an FFI. 12 Although an NFFE must identify its U.S. owners, it generally is not required to enter into an agreement with the IRS to avoid withholding. Instead, the NFFE provides withholding agent payers with a certificate that either affirms that the NFFE does not have substantial U.S. owners or identifies its substantial U.S. owners, unless the NFFE elects a direct reporting regime. 13 Most P&C insurers will not be considered financial institutions and correspondingly, will not be considered FFIs for FATCA purposes. Instead, they will fall under the NFFE rules, which are generally considered less onerous. 14 However, in rare circumstances, a P&C insurer might fall under specific FFI definitions. Also, non-insurance members of a P&C insurer s expanded affiliated group (EAG) may meet one of the FFI definitions. An EAG generally includes a group of affiliated companies that are more than 50 percent owned by both voting power and value. In this regard, reg. section (i)(2) defines an EAG by reference to section 1504(a), with some changes, specifically: (i) the ownership threshold is reduced from at least 80 percent to more than 50 percent; and (ii) non-u.s. companies and life insurance companies, normally excluded from affiliated groups, are includable members of the affiliated group. P&C insurers and their affiliates also 8 See section 1471(d)(5). 9 See section 1472(d). 10 See reg. section (e). 11 See reg. section IGAs are bilateral agreements between the United States and other countries that provide alternative reporting rules for FFIs that are resident in those other countries. Under the Model 1 IGA, local FFIs report to the local tax authority, which in turn transmits the information to the IRS. Under the Model 2 IGA, the tax authority permits local FFIs to report directly to the IRS under an FFI agreement with it. 12 See section 1472(d). 13 See section 1472(b). 14 Reg. section (e)(1)(iv); reg. section (b)(1)(iv). An NFFE is any non-u.s. entity that is not a financial institution as defined in section 1472(d). should consider how the FATCA rules affect some types of companies in the EAG, such as holding companies (non-u.s. companies that make elections under section 953(d) to be treated as U.S. corporations for U.S. federal tax purposes) and cell or series companies. 15 B. Determining FATCA Status To confirm that it is not an FFI under the FATCA rules, a P&C insurer and each member of its EAG should test itself to determine if it could be one of the following types of FFIs: a depository institution FFI; a custodial institution FFI; an investment entity FFI; or a specified insurance company. Any entity that meets one of those definitions will be required to comply with the FATCA rules governing FFIs. 1. FFI status. This section discusses the different tests that determine whether a non-u.s. entity is an FFI, special considerations for P&C insurers, and other issues that affect FFI status. Each member of an EAG including holding companies (which have special rules), investment subsidiaries, and other non-insurance companies should test whether it is an FFI under the FATCA regulations. a. Reserving activities. As a preliminary matter, a P&C insurer should identify its reserving activities because they should not cause that insurance company to be treated as a depository institution, a custodial institution, or an investment entity. 16 The preamble to the January 2013 final regulations explains that the reserving activities concerning an insurance company s insurance and annuity contracts are not taken into consideration when testing an insurance company s status under those three definitions. 17 As a result, only insurance companies with activities in addition to reserving activities that meet one of those definitions could be treated as an FFI. Otherwise, an insurance company that is not a specified insurance company is an NFFE. 18 The definition of insurance contract in the FATCA regulations is broad, 19 and there is no 15 The term cell company generally includes a separate account company, a segregated account company, and a series limited liability company. 16 Reg. section (e)(6) F.R. 5874, 5887 (Jan. 28, 2013). 18 Reg. section (a)(80). 19 Reg. section (b)(61) provides: The term insurance contract means a contract (other than an annuity contract) under which the issuer in exchange for consideration agrees to pay an amount upon the occurrence of a specified contingency involving mortality, morbidity, accident, liability, or property risk TAX NOTES, September 29, 2014

4 guidance regarding how it will be applied. Moreover, the FATCA regulations do not provide a definition of the term reserving activities, nor is the term used elsewhere in the code or Treasury regulations; guidance must be sought elsewhere. Notice , which addresses non-u.s. arrangements designed to defer income, provides a description of insurance company activities that may offer some guidance on which activities are encompassed by the term reserving activities. According to the notice: The business of an insurance company necessarily includes substantial investment activities. Both life and nonlife insurance companies routinely invest their capital and the amounts they receive as premiums. The investment earnings are then used to pay claims, support writing more business or to fund distributions to the company s owners. The presence of investment earnings does not, in itself, suggest that an entity does not qualify as an insurance company. 20 Thus, the IRS recognizes that an insurance company engages in substantial investment activities regarding both capital and premiums. Although reserving activities is not defined, a reasonable interpretation of the term should include investments and income from both capital and premiums. The fact that U.S. state and non-u.s. regulatory agencies prescribe capital requirements should also support the conclusion that reserving activities include investments of an insurance company s capital. However, if the amount of capital held by an insurance company is excessive compared with the amount of risk it covers, the investment of that excess capital likely would not be included in the insurer s reserving activities. 21 Also, the IRS may interpret the term insurance contract narrowly and exclude from reserving activities investments of premium and capital regarding contracts that fail to satisfy the definition of insurance contracts that otherwise applies for U.S. tax purposes. Although, as noted above, the FATCA regulations provide that the reserving activities of an insurance company should not cause a company to be an FFI, the regulations do not contain further guidance on how the non-insurance FFI tests are to be applied (for example, whether a P&C insurer should be characterized as an investment entity) or how to treat reserving activities when applying those tests. If the preamble language stating that 20 Notice , C.B See Cardinal Life Ins. Co. v. United States, 300 F. Supp. 387 (N.D. Tex. 1969). COMMENTARY / TAX MATTERS reserve activities 22 are not taken into consideration were applied literally, the regulatory definition of a financial institution could lead to treatment of an insurance company as an FFI if the insurance company derives only de minimis income from nonreserving activities. 23 However, the language in the regulatory exception for reserving activities provides a more neutral statement. It is unlikely that a literal interpretation should be applied; instead, a reasonable interpretation would test whether a particular non-u.s. P&C insurer has sufficient insurance activities to qualify as a P&C insurance company under commonly applied insurance company tests, rather than as one of the non-insurance FFIs discussed below. 24 b. Types of FFIs and associated rules. i. Depository institution FFI. To be treated as a depository institution FFI, 25 an entity must accept deposits in the ordinary course of a banking or similar business. To be engaged in a banking or similar business, an entity must accept deposits or other similar investments of funds and regularly engage in one or more of the following activities: making personal, mortgage, industrial, or other loans or providing other extensions of credit; purchasing, selling, discounting, or negotiating accounts receivable, installment obligations, notes, drafts, checks, bills of exchange, acceptances, or other evidence of indebtedness; issuing letters of credit and negotiating drafts drawn on those letters; providing trust or fiduciary services; financing foreign exchange transactions; or entering into, purchasing, or disposing of financed leases or leased assets. 26 The depository institution test is not quantitative, although the test requires that the entity accept deposits in the ordinary course of a banking or similar business. This implies that the banking business is the regular and usual business of the entity. If that implication is correct, an entity that qualifies as an insurance company for FATCA purposes and that derives more than 50 percent of its gross income from insurance activities should not 22 The preamble uses the word reserve, while the regulation uses the word reserving. 23 Reg. section (e)(1). 24 During May 20 and 22, 2013, conference calls, an IRS representative said that while he could not say that a cliff test was not implicated by the language, a reasonable test should apply. Moreover, the representative pointed out that the language of reg. section (e)(6) does not literally exclude the reserving activities from being counted in a ratio test whereby insurance income is compared to non-insurance income. 25 Reg. section (e)(1)(i). 26 Reg. section (e)(2). TAX NOTES, September 29,

5 COMMENTARY / TAX MATTERS be a depository institution because the ordinary course of business of such an entity would not be banking. 27 However, if a P&C group had an entity that regularly engaged in any of the above activities, that entity would be an FFI and would be subject to withholding and reporting under the FFI rules. ii. Custodial institution FFI. A custodial institution FFI 28 is an entity that holds a substantial portion of its financial assets for the benefit of one or more other persons. The term financial asset means a security, partnership interest, commodity, notional principal contract, insurance or annuity contract, or any interest in one of those assets. Substantial portion means that an entity s gross income attributable to holding financial assets and performing related financial services equals or exceeds 20 percent of the entity s gross income during a three-year lookback period. 29 Generally, most of a P&C insurer s business is the issuance of insurance contracts, which would not be considered engaging in a custodial activity for the benefit of other persons. Although it is mathematically possible for a P&C insurer to engage 20 percent in custodial institution activities and more than 50 percent in insurance reserving activities, an entity that derives more than 50 percent of its income from insurance reserving activities generally should not be involved in enough custodial institution activities to qualify as a custodial institution. iii. Investment entity FFI. A P&C insurer or a member of its EAG would be an investment entity FFI 30 if it met the requirements of one of the following subcategories 31 : i. An entity that primarily conducts one or more of three types of activities or operations for or on behalf of customers, which include: a. trading in money market instruments or similar investments; b. managing individual or collective portfolios; or 27 Although one could postulate that the issuance of a guaranteed investment contract by an insurance company, for example, may be characterized as accepting deposits, the entity would need to regularly engage in one or more of the enumerated activities as well. Whether the definition of depository institution would be applied to an insurance company that met the 50 percent or more standard discussed above is not clear because the depository institution test is not quantitative. However, it is unlikely that such a case would be common. 28 Reg. section (e)(1)(ii). 29 Reg. section (e)(3)(i). 30 Reg. section (e)(1)(iii). 31 Reg. section (e)(4). c. otherwise investing, administering, or managing funds, money or financial assets on behalf of other persons; ii. A managed entity, the gross income of which is primarily attributable to investing, reinvesting, or trading; or iii. A collective investment vehicle, a mutual fund, a private equity fund, a hedge fund, or a similar investment vehicle that invests, reinvests, or trades in financial assets. [Emphasis added.] Generally, a P&C insurer wouldn t be considered an investment entity FFI under those tests. However, if a P&C group member contains and holds investments for other members of the group, that entity would very likely be an investment entity FFI under at least one of the above tests. In addition, as there is no authority interpreting the very broad definition of insurance contract under the FATCA regulations (discussed above), it is unclear whether the IRS may seek to impose a more narrow standard that would require insurance contracts to meet requirements that otherwise apply only for U.S. tax purposes. Under such an approach, an insurance company that would not expect to be characterized as an investment entity FFI could be so characterized because its insurance contracts would not be respected as insurance contracts for FATCA purposes, and its investment activities associated with those contracts would not be treated as reserving activities. a. Application of primarily tests. The first two investment entity definitions impose a primarily standard and require that an entity either conduct specific activities or receive specific types of gross income. The terms primarily conducts as a business and primarily attributable to incorporate a 50 percent threshold. 32 Thus, an insurance company that derives 50 percent or more of its gross income from insurance contract premiums or investment income regarding its insurance liabilities cannot also be an investment entity FFI under the primarily standard (assuming reserving activities are treated as described above), because the reserving activities of the company should not be characterized as bad investment activity in applying the primarily standard. However, as noted above, if a P&C insurer is overcapitalized, the investment of that excess capital likely would not be treated as a reserving activity when measuring that P&C insurer s activities or income under the FFI rules. As a result, a non-u.s. entity that is a P&C insurer for 32 Reg. section (e)(4)(iii) and (iv) TAX NOTES, September 29, 2014

6 regulatory purposes may be treated as an investment entity for FATCA purposes. b. Definition of managed entity. Under the investment company test, an entity is a managed entity if it is managed by: i. a depository institution, ii. a custodial institution, iii. a specified insurance company, or iv. an entity that primarily conducts as a business one or more of the following activities: a. trading in money market instruments or similar investments; b. managing individual or collective portfolios; or c. otherwise investing, administering, or managing funds, money, or financial assets on behalf of other persons. 33 An entity is considered to be managed by another entity if the managing entity performs, either directly or through another third-party service provider, any of the activities listed in (a) through (c) on behalf of the managed entity. A P&C insurer would not meet this definition. Accordingly, even if a P&C insurer s gross income were primarily attributable to investing, reinvesting, or trading, it likely would not be a managed entity or investment entity FFI under subcategory b. c. Collective investment vehicle. A collective investment vehicle generally commingles and invests funds of its investors. Although the FATCA regulations do not provide a definition of the term collective investment vehicle, the regulations 34 provide that an entity is a collective investment vehicle if it functions or holds itself out as a collective investment vehicle, a mutual fund, an exchange-traded fund, a private equity fund, a hedge fund, a venture capital fund, a leveraged buyout fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets. An insurance company issues insurance contracts and invests the premiums to meet contract liabilities. While an insurance company engages in similar investment activity as a collective investment vehicle, it does so for its own account in order to meet its liabilities from the insurance contracts it has issued. Moreover, an insurance company s reserving activities should not be characterized as bad investment activity when applying this test. 33 Reg. section (e)(4)(i)(B). 34 Reg. section (e)(4)(i)(C). COMMENTARY / TAX MATTERS iv. Specified insurance company FFI. Some insurers are statutorily included as FFIs if they fit the definition of the term specified insurance company. A specified insurance company is an insurance company that is obligated to make payments on cash value insurance or annuity contracts. 35 For cash value insurance contracts, the rule applies only when the contract has an aggregate cash value in excess of $50, For this purpose, cash value is defined as any amount determined without reduction for any charge or policy loan that (i) is payable under the contract to any person upon surrender, termination, cancellation, or withdrawal; or (ii) any person can borrow under or with regard to (for example, by pledging as collateral) the contract. 37 P&C insurers generally do not issue cash value insurance or annuity contracts and, therefore, generally will not meet the definition of a specified insurance company. v. Holding company FFI. Holding companies that are part of a P&C group may be characterized as holding company FFIs. A holding company will be characterized as a holding company FFI if it is a member of an EAG that includes: a depository institution FFI; a custodial institution FFI; an investment entity FFI; or a specified insurance company FFI NFFE status. If a non-u.s. company is not an FFI, it is an NFFE by default. This category will include most non-u.s. P&C insurers and reinsurers because those companies are unlikely to fit into any of the categories of FFI discussed above. Once a P&C insurance company has concluded that it is an NFFE, it must next consider whether one of the exceptions to the NFFE withholding and substantial U.S. owner reporting rules may apply, including the exception for payments made to publicly traded corporations and their affiliates, for payments made to an active NFFE, and for payments made to direct reporting NFFEs. Companies that fit these exceptions are excepted NFFEs. a. Excepted NFFEs. i. Publicly traded NFFEs. As noted above, FATCA provides an exception from the withholding and substantial U.S. owner reporting requirements for any payment made to a non-u.s. corporation 35 Reg. section (e)(iv). 36 Reg. section (b)(3)(vii)(A). 37 Reg. section (b)(3)(vii)(B). 38 Reg. section (e)(1)(v) and reg. section T(e)(1)(v)(A). TAX NOTES, September 29,

7 COMMENTARY / TAX MATTERS that is publicly traded, meaning the stock is regularly traded on an established securities market. 39 Under the FATCA regulations, a stock is regularly traded if: i. one or more classes of stock of the corporation that in the aggregate, represent more than 50 percent of the total combined voting power of all classes of stock of such corporation entitled to vote and of the total value of the stock of such corporation are listed on such market or markets during the prior calendar year; and ii. with respect to each class relied on to meet the more-than-50-percent listing requirement: a. trades in each such class are effected, other than in de minimis quantities, on such market or markets on at least 60 days during the prior calendar year; and b. the aggregate number of shares in each such class that are traded on such market or markets during the prior year is at least 10 percent of the average number of shares outstanding in that class during the prior calendar year. 40 FATCA also allows affiliates of publicly traded companies to benefit from this exception, if they are characterized as part of the publicly traded company s EAG. 41 Thus, if any non-u.s. P&C insurer is publicly traded or is an affiliate of a publicly traded NFFE, the payments it receives would be excepted from FATCA withholding and substantial U.S. owner reporting. ii. Active NFFEs. FATCA also contains an exception from the FATCA withholding and substantial U.S. owner reporting requirements for payments made to active NFFEs. a. Active income/asset test. An NFFE is active if less than 50 percent of its income is passive (the income test) and less than 50 percent of its assets produce passive income (the asset test). Few, if any, P&C insurance companies can satisfy this conjunctive test. Although P&C insurers may satisfy the income test because premiums will often exceed investment income and premiums should be treated as active income, it is unlikely that a P&C insurer will satisfy the asset test. Because reserve assets are all passive under the regulations 42 and the capital assets held by a P&C insurer (primarily marketable securities) are likely to be treated as passive, a P&C insurer will have very few, if any, active assets, which would be far outweighed by its passive assets. Accordingly, P&C insurers should not expect to meet the active NFFE income and asset test. b. Direct reporting and sponsored NFFEs. The regulations issued in February 2014 allow for direct reporting by an NFFE or by the sponsor of an NFFE of the NFFE s substantial U.S. owners to the IRS on Form Those direct reporting NFFEs would then give their withholding agents Forms W-8BEN-E indicating that they are FATCA withholding excepted NFFEs, instead of having to provide information on their substantial U.S. owners to each withholding agent. As part of the direct reporting process, an NFFE must register with the IRS (electronically or on Form 8957) to obtain a global intermediary identification number and will be listed on the IRS FFI list. 44 An NFFE is included on the FFI list purely so that withholding agents can confirm that the direct reporting NFFE is an excepted NFFE; the direct reporting NFFE will not be characterized as an FFI and need not enter into an FFI agreement with the IRS. A direct reporting NFFE must complete Form 8966 annually, providing the required information about its substantial U.S. owners or certifying that it does not have any; retain specific records; and annually certify to the IRS compliance with its direct reporting election. The regulations also indicate that the NFFE must provide the total amount of all payments made to each substantial U.S. owner regarding the owner s equity interest and its value. The NFFE must also obtain a written certification from each person that would be treated as a substantial U.S. owner if it was a specified U.S. person, indicating whether the person is or is not a substantial U.S. owner. Substantial U.S. owners are specified U.S. persons that own, directly or indirectly, more than 10 percent of the vote or value of an NFFE. Some U.S. persons, such as publicly traded corporations or their more-than-50-percent affiliates, are not specified U.S. persons. 45 Any U.S. person that owns vote or value of the NFFE directly or indirectly and whose ownership would exceed 10 percent if it is aggregated with the ownership of the NFFE by related persons will be characterized as a substantial U.S. owner. b. Non-excepted NFFEs. If a non-u.s. P&C insurer is not an excepted NFFE, in order to avoid 39 Section 1472(c)(1). 40 Reg. section (c)(1)(i). 41 Section 1472(c)(1)(B). 42 Reg. section (c)(1)(iv)(A)(11). 43 Reg. section T(c)(3). 44 That registration effectuates the NFFE s election to be direct reporting. The election may not be revoked without the consent of the IRS. 45 Reg. section (c) TAX NOTES, September 29, 2014

8 withholding on the withholdable payments it receives, it must report to its withholding agents the names, addresses, and taxpayer identification numbers of its substantial U.S. owners. 46 If an NFFE does not have substantial U.S. owners, it must certify that to its withholding agents. 3. Special considerations. a. Section 953(d) company issues. A section 953(d) company is a non-u.s. insurance company generally having 25 percent or more U.S. ownership that elects under section 953(d) to be characterized as a U.S. corporation for all purposes of the code. Although the January 2013 FATCA regulations excluded most section 953(d) companies from the definition of U.S. person, the February 2014 final regulations generally rectify this issue, if the section 953(d) company is not a specified insurance company (the company does not issue cash value insurance or annuity contracts) that is not licensed to do business by a U.S. state. 47 Consequently, under the revised regulations, if a section 953(d) company does not directly issue cash value contracts, it should be treated as a U.S. person for FATCA purposes and, therefore, not be subject to the FATCA withholding regime. b. Cell company issues. The FATCA regulations do not provide specific guidance on whether each cell of a cell company (for example, a series limited liability company or segregated cell, segregated account, or segregated account company) should be treated as separate entities or as one entity. The structure and activities of a cell company and whether each non-u.s. cell is treated separately or collectively may affect (i) characterization as an FFI or an NFFE; (ii) who the appropriate reporting entity is; (iii) whether the cell/cell company is part of an EAG; (iv) the persons characterized as substantial U.S. owners (for example, a person who owns 10 percent at the cell level may not be a 10 percent owner at the cell company level); (v) whether there are U.S. account holders of an FFI; and (vi) insurance company characterization for FATCA purposes. The FATCA regulations do, however, provide that the classification of an entity will be determined under U.S. federal income tax law and note that if an arrangement does not have legal personality and is not a juridical person in its country of tax residence (for example, a cell in a cell company), it will be treated as an entity if it is treated as an entity for U.S. federal income tax purposes. 48 For U.S. federal income tax purposes, it is unclear how 46 Section 1473(2); reg. section (b)(1). 47 Reg. section T(b)(141). 48 Reg. section (b)(2). COMMENTARY / TAX MATTERS cell companies should be characterized, although proposed regulations were issued in In general, the proposed cell regulations characterize cells as separate entities but do not provide guidance on non-u.s. cells that are not characterized as insurance companies for U.S. federal tax purposes. 50 However, they contain grandfathering rules that would allow some cell companies to be characterized as single entities. 51 C. Reporting by Non-U.S. P&C Insurers The primary reporting tool for a P&C insurer that is an NFFE is Form W-8BEN-E, unless the P&C insurer elects to be a direct reporting NFFE. If a P&C insurer does not meet any of the exceptions (including the exception for a direct reporting or sponsored NFFE) and is not characterized as an excepted NFFE, it must give its withholding agent a Form W-8BEN-E that either provides the required information on its substantial U.S. owners, or certifies that it does not have substantial U.S. owners. A direct reporting NFFE will report its substantial U.S. owners directly to the IRS on Form Whether or not an NFFE is a direct reporting NFFE, it is required to give a withholding agent a Form W8-BEN-E that reports its FATCA status. If the P&C insurer is an excepted NFFE under one of the exceptions listed above, it needs to submit Form W-8BEN-E to its withholding agent and designate that it is an excepted NFFE. In general, a P&C insurer s withholding agents will include insureds, ceding companies, non-u.s. brokers or agents, banks, and other investment managers and entities. Any direct reporting NFFE would fall within this category and would give its withholding agents Forms W-8BEN-E indicating that it is an excepted NFFE. No withholding is required on payments to an excepted NFFE. But an excepted NFFE still may have FATCA obligations if it is a withholding agent (see the discussion below). As a U.S. person for FATCA purposes, a P&C insurer that is a section 953(d) company should provide a Form W-9 to its withholding agents, as it does now. D. Withholding for Non-U.S. P&C Insurers 1. Withholding agents. a. P&C insurer s status as a withholding agent. Under FATCA, the payer of a withholdable payment or a foreign passthrough payment 52 is a 49 The proposed regulations are not effective until they are promulgated in final form. 50 See prop. reg. section (a)(5). 51 Prop. reg. section (f)(3)(ii). 52 The term foreign passthru payment is discussed in further detail below in section D.2. TAX NOTES, September 29,

9 COMMENTARY / TAX MATTERS withholding agent and will be liable for the 30 percent withholding amount in the event of a failure to properly withhold. Although FATCA does not impose an explicit withholding requirement on an NFFE, the broad definition of withholding agent could be viewed as imposing a withholding obligation. Reg. section (d) provides that the term withholding agent means any person, U.S. or non-u.s., in whatever capacity acting, that has the control, receipt, custody, disposal, or payment of a withholdable payment or foreign passthru payment. Although the definition is very broad in its application to any person, U.S. or foreign, it is limited by the requirement that the person have control over a withholdable payment (including a foreign passthrough payment). Thus, a person that has control over a payment that is not a withholdable payment or a foreign passthrough payment is not a withholding agent for that payment. There are two instances in which a P&C insurer that is an NFFE could conceivably be a withholding agent. First, a P&C insurer may own assets that can produce interest or dividends; but on the sale or disposition of those assets, the P&C insurer will receive the gross payments from the sale or disposition, rather than making payments of those gross proceeds. Consequently, a P&C insurer should never be a withholding agent for gross proceeds unless it is a purchaser of those assets from a non-u.s. entity, which should be a foreign passthrough payment. 53 Second, for an insurance company, section 861(a)(7) provides that amounts received as underwriting income derived from the issuing (or reissuing) of any insurance or annuity contract covering U.S. risks are U.S.-source income. In this case, a P&C insurer that is an NFFE could be a withholding agent for a premium payment for insurance or reinsurance on U.S. risks. However, such a P&C insurer could not be a withholding agent until at least January 1, 2017, because withholding is not required on U.S.-source payments made outside the United States until that date. 54 b. Intermediaries as withholding agents. FATCA also provides that intermediaries, including NFFEs, can serve a withholding agent/information collection role. Brokers, in particular, should consider the application of these rules. An intermediary s FATCA obligations will depend on its status. In general, however, the intermediary will be required to either report the information from the P&C insurer s IRS Form W-8BEN-E directly to the IRS or forward that form to the original payer of the withholdable payment. For investment income paid through an FFI, the FFI s withholding and reporting requirements will depend on the agreements it has made with the IRS under FATCA and the regular withholding requirements under chapter 3 of the code. In general, however, it is likely that those investment advisers will act as direct withholding agents rather than mere flow-through intermediaries. Thus, investment advisers will be required to provide information to the IRS from the P&C insurer s Form W-8BEN-E, or withhold 30 percent of that payment if the form is not provided, and to file withholding tax returns whether or not an amount was withheld. The reporting requirements of a non-u.s. broker or agent that acts as an intermediary for premiums paid to a P&C insurer will depend on any intermediary agreements entered into between the broker or agent and the IRS under chapter 3 of the code. A broker or agent that agrees to be a withholding agent will have the same obligations as an investment adviser that acts as a withholding agent, described above, except that for payments of premium for which no withholding was required, forms 1042 and 1042-S generally need not be filed. 55 This provision added to the February 2014 regulations should reduce some of the concerns for non- U.S. brokers. A broker or agent that agreed to act merely as a flow-through entity would collect Form W-8BEN-E from the P&C insurer, which is the ultimate beneficiary of the U.S.-source premium payment, and would submit to the withholding agent, that is, the U.S. insured, both Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow- Through Entity, or Certain U.S. Branches for United States Withholding, for itself and the Form W-8BEN-E of the P&C insurer. 56 However, payments for offshore obligations that are not made by an intermediary (such as payments of premium from a non-u.s. cedent to a non-u.s. reinsurer) will not be characterized as withholdable payments 53 Presumably, those purchases would be effected through an FFI broker, which would be responsible for any FATCA obligations regarding the gross proceeds from the sale/purchase of those assets. A purchase of assets from a U.S. seller would not be subject to FATCA because FATCA applies only to payments to a non-u.s. entity. 54 Reg. section (a)(4)(vi). 55 Reg. section T(d)(2)(i). 56 Reg. section (c)(2); Form W-8IMY. See reg. section (d)(12) for the necessary forms submitted by an NFFE. For the definition of an intermediary, see reg. section (c)(13). Under reg. section (a)(3), an NFFE can act as an intermediary for another payee. See also reg. section (b)(1) (showing that an NFFE with proper documentation can act as an intermediary) TAX NOTES, September 29, 2014

10 until January 1, 2017, and, thus, are temporarily exempt from these reporting requirements. 57 Insurers have the ultimate responsibility to see that the proper forms and information are provided to the appropriate entities. If the payer of a P&C insurer s premium or investment income is not satisfied that the appropriate reporting has been done, it will withhold 30 percent of the payment, and the P&C insurer will receive a smaller payment than anticipated. Thus, the P&C insurer will want to work with its intermediaries to ensure that the proper reporting is completed. 2. Foreign passthru payments. The term foreign passthru payment is not yet defined under the FATCA regulations, but section 1471(d)(7) defines the term passthru payment as any withholdable payment or other payment to the extent attributable to a withholdable payment. Consequently, to be attributable to a withholdable payment, a passthru payment must have a relationship to a withholdable payment. Under Notice , a foreign passthru payment is determined by the participating FFI s ratio of U.S. assets to worldwide assets multiplied by the payment. Although the final regulations did not adopt this rule, the proposal demonstrates the concept of a non-u.s. to non-u.s. payment, a portion of which is treated as attributable to a U.S.-source withholdable payment and subject to 30 percent withholding. 3. Withholdable payments of NFFEs. a. General rules. The definition of withholdable payment requires that the payment be from U.S. sources as determined under the U.S.-source rules. 58 Generally, payments made by a non-u.s. entity are treated as non-u.s.-source payments under the U.S.-source rules because most payments, such as dividends and interest, are sourced to the residence of the payer. Thus, dividend and interest payments made by an NFFE are non-u.s.-source payments under section 862. Moreover, because an NFFE by definition is not a custodial institution that holds financial assets for the benefit of another person, it generally will not have control, receipt, custody, or disposal of U.S.-source FDAP income. Although in general, U.S. source rules determine source by reference to the residence of the payer, some source rules determine source on different bases. For example, payments for compensation for services performed in the United States are treated 57 Reg. section T(a)(4)(vi). 58 Reg. section (a)(1)(i) and -1(a)(2)(i)(B). Reg. section (a)(2)(i)(B) provides that a payment is derived from U.S. sources if it is income treated as derived from U.S. sources under sections 861 through 865 and other relevant code provisions. COMMENTARY / TAX MATTERS as U.S.-source payments. Further, royalty payments are sourced according to the place of use, so a royalty paid for the use of a patent, a copyright, or other intangible property in the United States would be treated as U.S.-source income. Thus, an NFFE could make U.S.-source payments for items such as compensation for services performed in the United States and for royalties for intangible property used in the United States. Payments for nonfinancial services and for the use of property, however, are excluded nonfinancial payments under reg. section (a)(4)(iii) and, as such, are not withholdable payments. Although the FATCA preamble and regulations do not provide any explanation of the term use of property, it is clear from the source rules that a royalty is a payment for the use of property. Reg. section provides that gross income from sources within the United States includes royalties for the use of, or for the privilege of using, in the United States, patents, copyrights, and other like property. Based on reg. section , the payment of a U.S.-source royalty is for the use of property and, therefore, is an excluded nonfinancial payment that is not a withholdable payment. Fees paid by an NFFE for financial services performed outside the United States are not included in the withholdable payment definition because only U.S.-source payments are withholdable payments. Fees paid by an NFFE for financial services performed within the United States either to a U.S. payee or the U.S. branch of a non-u.s. entity also should not be a withholdable payment because they are paid to a U.S. payee 59 or are effectively connected income, which is explicitly excluded from the definition of withholdable payment, 60 respectively. For non-u.s. P&C insurers, the most relevant types of income will be premiums for U.S. risks. These payments, when made by a non-u.s. P&C insurer, will be an offshore U.S. source payment that will be subject to FATCA withholding beginning on January 1, 2017, if the payee is not FATCA compliant. Government officials have informally suggested that premiums for indemnity reinsurance might be excluded from the definition of withholdable payment and therefore exempt from withholding under FATCA. The final regulations, however, do not contain such an exemption. The only exemption for indemnity reinsurance is from treatment as cash value contracts. b. Exception for ECI payments. Under FATCA, payments that are effectively connected with a 59 FATCA applies only to payments made to non-u.s. entities. 60 Reg. section (a)(4)(ii). TAX NOTES, September 29,

11 COMMENTARY / TAX MATTERS non-u.s. insurer s U.S. trade or business are not withholdable payments. 61 Thus, although U.S. branches of non-u.s. entities generally are treated as non-u.s. entities for purposes of FATCA, it is likely that any U.S.-source payments to a U.S. branch of a non-u.s. insurer will be excluded from FATCA withholding as ECI. As a result, a P&C insurer with such a U.S. branch generally would not be required to report any information to avoid withholding on payments to the branch. A P&C insurance branch receiving ECI payments must provide Form W-8ECI, certifying that its income is ECI, to the payer of its withholdable payments in order to avoid withholding on that income. E. Special Considerations for Captives Although the rules discussed above generally apply to non-u.s. captives as they do to other NFFEs, captives should keep some of the following highlights in mind. A captive may receive premium payments from several types of entities: affiliated insureds, thirdparty insureds, ceding companies, and non-u.s. brokers and agents. If premium payments are made directly by a U.S. affiliate or U.S. third-party insured, the insured will be the withholding agent, and the captive should provide Form W-8BEN-E to the insured to avoid FATCA withholding. On the form, the captive should indicate that it is an excepted NFFE (for example, part of a publicly traded EAG or direct reporting) or that it has no substantial U.S. owners, or it should provide the relevant information regarding its substantial U.S. owners. Similarly, if a U.S. ceding company makes premium payments to a captive, the ceding company is the withholding agent and the recipient of Form W-8BEN-E. If the premium payment is made 61 Reg. section (a)(4) (listing types of income not treated as a withholdable payment); reg. section (a)(4)(ii) (listing ECI as a withholdable payment). through an intermediary (possibly a broker or an agent), the captive will still be required to provide Form W-8BEN-E, but will provide it to the intermediary rather than the insured or the ceding company. Regarding investment income generally, the captive s investment manager, whether U.S. or non- U.S., will be the withholding agent. 62 Similarly, if the captive has loaned funds to a U.S. affiliate, the affiliate will be the withholding agent regarding the interest payments on the loan. The captive will need to provide to its investment manager and affiliate, as the case may be, Form W-8BEN-E, with the information noted above. Some captives may have made elections under section 953(d) and, as discussed above, generally should be treated as a U.S. person for purposes of FATCA (assuming they are not characterized as specified insurance companies ). If a captive has made a section 953(c) election to have its relatedperson insurance income characterized as ECI, the exceptions discussed above under section D.3.b. ( Exceptions for ECI Payments ) should generally apply to that portion of its income. F. Conclusion The FATCA rules will affect all non-u.s. companies, including P&C insurers and their affiliates. While many questions remain regarding the application of the FATCA rules, the final regulations provide important guidance. Additional guidance should be forthcoming on many of the open questions. Ultimately, all non-p&c insurers and P&C groups will need to consider the implications of these rules for all U.S.-source payments that they receive or make in the course of their businesses. 62 It is possible that an investment adviser instead could be an intermediary (as could a broker). The captive s obligation would not change, however, in that case; it would still be required to provide information to the investment adviser. The intermediary s obligation would be slightly different, as discussed above TAX NOTES, September 29, 2014