FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA) PROVISIONS AND COMPLIANCE WITH REPORT OF FOREIGN BANK AND FINANCIAL ACCOUNTS (FBAR) REQUIREMENTS

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1 FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA) PROVISIONS AND COMPLIANCE WITH REPORT OF FOREIGN BANK AND FINANCIAL ACCOUNTS (FBAR) REQUIREMENTS Institute of International Bankers June 21, 2010 Steven A. Musher Associate Chief Counsel (International), IRS Faye Tannenbaum Partner, Deloitte Tax LLP Yaron Z. Reich Partner, Cleary Gottlieb Steen & Hamilton LLP Mark Naretti Director, KPMG LLP Jonathan Jackel Senior Counsel, Burt, Staples & Maner, LLP Joyce Burns Director, BNP Paribas SA (Moderator)

2 FOREIGN ACCOUNT TAX COMPLIANCE ACT

3 FATCA: Table of Contents Overview Background FATCA provisions: FFIs and NFFEs Scope of FFIs Identifying U.S. accounts Withholdable payments, passthru payments and withholding agents Flow chart and decision trees FFI Agreement Elections under FATCA Refunds and credits Tiered entities considerations Effective date and grandfather clause FATCA planning: what can be done now? 3

4 FATCA Overview The Foreign Account Tax Compliance Act ( FATCA ) provisions are included in the Hiring Incentives to Restore Employment ( HIRE ) Act, signed into law on March 18, 2010 Purpose is to prevent the perceived tax abuse by U.S. persons using off-shore financial facilities Requires non-u.s. financial institutions to provide the Internal Revenue Service ( IRS ) with information on U.S. persons invested in accounts outside of the U.S. and for non-u.s. entities to provide information about U.S. owners to withholding agents for reporting 4

5 FATCA Overview (cont d) The incentive to encourage these entities to provide this information is a new withholding requirement on certain payments unless these provisions are followed The new provisions of Chapter 4 financially compel, through the use of withholding taxes, foreign financial intermediaries to identify and report specified U.S. account holders to the U.S. Treasury FATCA will require the withholding agent to withhold 30% of payments made to foreign financial institutions ( FFIs ) that do not enter into an agreement with the IRS and on payments made to non-financial foreign entities that do not disclose substantial U.S. owners 5

6 FATCA Overview (cont d) The FATCA legislation amalgamates previous proposals including the Stop Tax Haven Abuse Act and the Greenbook proposals It is clear that detailed regulations are crucial to implementation of these rules Represents a major change to the information reporting and withholding tax regime, and imposes extensive new compliance obligations Cost of non-compliance includes both financial liability and reputational damage 6

7 Current Rules FATCA provisions supplement the current rules under Code Section 1441 dealing with withholding on certain U.S. payments to foreign persons 30% withholding on U.S. source FDAP income paid to non-u.s. persons Reduction of the 30% rate by treaty or statutory exemption with appropriate documentation No withholding on gross proceeds No separate classification of foreign entities 7

8 FATCA Provisions 8 Code Sections require withholding of 30% on withholdable payments paid to a non-u.s. entity UNLESS the payee agrees to provide information on its U.S. customers or owners Withholdable payment includes any U.S. source FDAP (interest, dividends, royalties, etc.), as well as gross proceeds from the sale of any property that can produce U.S. source interest or dividends Applies even where treaty or portfolio interest exemption relief would normally apply New rules apply to all payors (withholding agents) Significant tax and penalty exposure possible from failure to comply Statute grants extensive regulatory authority to IRS New FATCA rules effective January 1, 2013

9 FATCA Provisions (cont d) FATCA splits all foreign entities into Foreign Financial Institutions (FFIs) and Non-Financial Foreign Entities (NFFEs) Broadly, the purpose of the legislation is to identify and report all U.S. persons who have an account with an FFI or an interest in an NFFE FATCA creates two regimes: Section 1471 regime for FFIs Simpler Section 1472 regime for NFFEs 9

10 FFIs Definition An FFI includes any non-u.s. entity that: accepts deposits holds financial assets for the account of others or engages primarily in the business of investing or trading securities, commodities, partnerships, or any interests in such positions 10

11 FFI Agreement with the IRS The FFI must agree to: Obtain information to determine which holders are U.S. accounts Comply with verification and due diligence procedures on such accounts as required by the IRS Report annually Deduct and withhold the 30% tax on payments to recalcitrant account holders, electing FFIs and FFIs that did not enter into an FFI agreement with the IRS Recalcitrant account holder is any account holder that does not provide documentation as to its status as U.S. or foreign or fails to provide a waiver if located in a foreign jurisdiction that prevents reporting of any information on the account holder Comply with requests from the IRS for additional information Where foreign law would prevent such reporting, to close the account if a valid waiver of the law cannot be obtained from the account holder 11

12 FFIs Required Annual Reporting An FFI will meet the annual information reporting obligation under an FFI Agreement by providing the following information on each U.S. account: Name, address and TIN of each account holder that is a specified U.S. person; Name, address and TIN of each substantial U.S. owner of any account held by a U.S. owned foreign entity; Account number; Account balance or value; and Unless guidance provides otherwise, gross receipts and gross withdrawals/payments from the account In lieu of annual reporting and withholding, FFI can elect to provide Form 1099 reporting for each specified U.S. person and U.S. owned foreign entity 12

13 Payments to NFFEs Non-financial foreign entity (NFFE) includes any foreign entity that is not an FFI, subject to certain exceptions Withholding agents will be required to withhold 30% on withholdable payments to an NFFE unless the NFFE: Certifies to the withholding agent that it has no substantial U.S. owners Provides the names, addresses and U.S. taxpayer identification numbers of the substantial U.S. owners to the withholding agent to report the information to the IRS, or Is a specifically excepted entity Substantial U.S. owner includes any U.S. person who owns directly or indirectly the following: More than 10% of the stock (either by vote or value) of a corporation More than 10% of the profit or capital interest in a partnership Any U.S. owner of a grantor trust or more than 10% of the beneficial interest in a trust Special rule for investment vehicles the ownership interest for a substantial U.S. Owner is reduced to zero 13

14 NFFEs Excepted Entities The rules do not apply to payments to one of the following specifically excluded entities: Corporations that are publicly traded and their subsidiaries An entity organized under the laws of a U.S. possession and wholly owned by bona fide residents of the U.S. possession Any foreign government Any international organization or wholly owned agency or instrumentality A foreign central bank of issue or Any other class of persons identified by the Secretary as posing a low risk of tax evasion 14

15 Scope of FFI Who Is Subject to Full Section 1471 Regime? The broad definition of an FFI would include all forms of investment entities such as: Hedge funds Private equity funds Mutual funds Family investment vehicles CBO issuers Pension plans Insurance companies 15

16 Scope of FFI Who Is Subject to Full Section 1471 Regime? (cont d) Broad definition encompasses many tens of thousands of entities Massive administrative burden Risk of widespread opt-outs from FATCA Possible solutions: Exclude low-risk entities? For example: pension plans, certain pooled investment vehicles, widely held investment vehicles Exclude foreign investment entities with a small number of investors or only small accounts? Exclude QIs that are eligible for the QI external audit waiver? Exclude U.S. branches of foreign banks? Complete exclusion vs lite or NFFE-type reporting regime? How to identify FFIs, NFFEs, exempt entities and those subject to other regimes? 16

17 Identifying U.S. Accounts: Concepts A U.S. account is defined as a financial account held by a specified U.S. person or a U.S. owned foreign entity A specified U.S. person is any U.S. person other than a publicly traded corporation, bank, REIT, RIC, government entity and certain tax-exempt entities Includes dual citizens, green card holders, and those satisfying the substantial presence test A U.S owned foreign entity is: Corporation, partnership or trust with more than 10% ownership held, directly or indirectly, by a specified U.S. person Grantor trust with any specified U.S. person owner Foreign investment entity with any interest held by a specified U.S. person 17

18 Identifying U.S. Accounts: Concepts (cont d) Financial account includes depositary and custodial accounts maintained by a financial institution and non-publicly traded equity and debt interests in a financial institution Exceptions: Depositary accounts of $50,000 or less (in the aggregate) held by individuals (unless an FFI elects not to to have the exception apply) Accounts of FFIs with sec agreements Accounts of holders subject to other reporting requirements 18

19 Identifying U.S. Accounts: Issues FFIs essentially have to prove that an account is not held by a specified U.S. person or a U.S. owned foreign entity AML/KYC information in most jurisdictions does not yield the level of diligence required by FATCA Standard EU AML data only reaches 25% ownership threshold AML rules have a different concept of beneficial ownership AML s risk assessment approach means little data collection in some cases Some business lines have not historically collected U.S. tax documentation An FFI may have millions of accounts to sift through Also need to identify U.S. accounts maintained by members of FFI s expanded affiliate group (50% common ownership) 19

20 Identifying U.S. Accounts: Possible Solutions Require different levels of due diligence for: Existing vs. new accounts: Institutions can change their account-opening procedures, but for existing accounts, there is no easy way to obtain or sort through information For pre-fatca accounts, a reasonable methodology of database searches for U.S. status indicia (e.g. address, citizenship, residency, any U.S. tax documentation)? Even for post-fatca accounts, it will be difficult to obtain U.S. tax documentation if accounts are not invested in U.S. securities and where the customer base is largely non-u.s. Direct account owners vs. accounts owned by entities with substantial U.S. owners: Direct owners are easier to identify. KYC/AML data often do not reach FATCA s 10% threshold Allow eyeball tests? Increase the ownership threshold to, for example, 25%? Reasonable methodology search? 20

21 Identifying U.S. Accounts: Possible Solutions (cont d) Accounts invested in U.S. securities vs. bank accounts and accounts invested in non-u.s. securities: FFIs have leverage to request information when withholding tax is at stake. The same is not true for accounts invested only in non-u.s. securities or bank accounts. Collect new W-8BENs with FATCA information for those accounts investing in U.S. securities? For those accounts not investing in U.S. securities, distinguish between high- and low-risk entities (e.g., passive vs. operating companies, treaty vs. tax haven jurisdictions)? Issue a new Form W-8BEN requiring details to facilitate FATCA diligence For individuals, certify non-u.s. status or provide U.S. indicia For entities, indicate status as FFI or NFFE or exceptions If FFI, whether participating or not If NFFE, whether it has substantial U.S. owners or not, information regarding substantial U.S. owners 21

22 Identifying U.S. Accounts: Possible Solutions (cont d) Create presumption/eyeball rules Eyeball tests for identifying FFIs, NFFEs, entities subject to the FFI-Lite regime, and those excluded from the definitions Publish lists for withholding agents to be able to rely on Utility of $50,000 threshold? Difficult for FFIs to aggregate accounts, especially if Treasury requires aggregating across the affiliate group Allow automatic deemed election? 22

23 Payors and Payments Covered: Withholdable Payments Withholdable payment is defined as: U.S. source FDAP Gross proceeds of a sale or disposition of property that can produce U.S. source dividends or interest Includes interest paid on deposits by foreign branches of domestic banks Applies even where treaty relief or portfolio interest exemption would normally apply Exception for ECI System changes are required to implement withholding on gross proceeds What types of payments might be appropriately excluded from the definition of withholdable payments? Exclude miscellaneous FDAP not related to securities investments? Exclude payments that are also excluded under Chapter 3 withholding (e.g., shortterm interest, market discount, OID on non-redemption sales)? 23

24 Payors and Payments Covered: Passthru Payments FFIs must withhold on passthru payments, defined as withholdable payments and payments to the extent attributable to a withholdable payment, made to recalcitrant account holders or non-participating FFIs The concept, if applied expansively, could deter U.S. investments How should an FFI determine if a payment is attributable to a withholdable payment? Require a traceable link between account holder and withholdable payment? Examples: Payments by an investment entity to an account holder on account of a portfolio of U.S. securities? U.S. source payments from custodial accounts? Not: payments of interest on deposits and straight debt securities issued by financial institutions? If no tracing required, the concept could result in a ratable portion of, e.g., interest on foreign bank deposits by recalcitrant holders being subject to Chapter 4 withholding where a bank earns U.S. source FDAP income or gross proceeds How does an FFI allocate among different payments and among recalcitrant and compliant holders? Will allocations be audited? 24

25 Payors and Payments Covered: Withholding Agents Withholding agent includes any person (U.S. or foreign) having the control, receipt, custody, disposal, or payment of a withholdable payment Withholding agents must be able to: Classify entities as FFIs, NFFEs, entities subject to a hybrid system as may be provided by regulations, or entities excepted from those categories Determine if an FFI is participating Collect and report information from NFFEs on substantial U.S. owners Limit the definition to financial institutions and those making more than a threshold amount of payments annually? Otherwise individuals and non-financial businesses would need to set up FATCA compliance mechanisms for miscellaneous FDAP payments and U.S. source gross proceeds 25

26 Payors and Payments Covered: Withholding Agents (cont d) Where there are multiple withholding agents, who should have the responsibility to withhold? Examples: Investment manager, custodian and broker in a securities sale; multiple trustees Limit withholding responsibility to the agent actually paying the amount and equipped to perform FATCA withholding? 26

27 FATCA Payment Flow Chart & Decision Trees Sample Payment Flow Chart Payments to Foreign Entities Payments to NFFEs Payments to Direct Recalcitrant Account Holders 27

28 Sample Payment Flow Chart U.S.Withholding Agent U.S. Source FDAP/Gross Proceeds FFI Individual NFFE NQI Bank FFI Bank Fund Foreign Individual Foreign Corp. Substantial U.S. Owner Fund of Funds Private Co. Foreign Individual U.S. Deposit Account Holder NFFE Custodial Account Holder Individual Individual 28

29 Withholding Agent Decision Tree 1- Payments to Foreign Entities Withholding Agent Is it a withholdable payment? No Generally out of scope. Is it paid to a financial account? Yes No Out of scope. Yes Is payee an FFI? No Payee is an NFFE. See Decision Tree 2. Yes Is the beneficial owner exempt? Yes Out of scope. Has FFI concluded an agreement with the IRS? Has FFI instructed you to withhold on passthru payments allocable to any recalcitrant account holder? No penal Chapter 4 withholding required. Ready for Chapter 3 analysis. No Yes No No Yes FFI is subject to 30% withholding. Withhold in accordance with instructions received. 29

30 Withholding Agent Decision Tree 2 - Payments to NFFEs Withholding Agent NFFE Is the beneficial owner exempt? Yes Out of scope. Has NFFE certified there are no substantial U.S. owners? Has NFFE provided details of substantial U.S. owners? No No No Payee is a recalcitrant account holder. See Decision Tree 3 Yes Yes No further action required for Chapter 4 withholding. Ready for Chapter 3 analysis. Withholding Agent reports. Ready for Chapter 3 analysis. 30

31 Withholding Agent Decision Tree 3 - Payments to Direct Recalcitrant Account Holders Withholding Agent Recalcitrant Account Holder Is payment a No Is payment attributable to No Out withholdable payment? a withholdable payment? of scope. Yes Yes 30% withholding 30% withholding applies. applies. 31

32 FFI Agreement Format Model document similar to QI Agreement? Variances? Application and approval process Electronic transmittal? Affiliated groups? Publicly available list of FFIs? 32

33 FFI Agreement (cont d) Verification of compliance Self-certification? Use of internal audit function? External audit? Agreed-upon-procedures (AUP)? Scope and frequency? Combined with QI external audits? Limiting the cost to FFIs Consequences of identified non-compliance? 33

34 FFI Agreement (cont d) Reporting Account balance timing and calculation Gross receipts and withdrawals included? If yes, period and calculation method? Segregation of cash and security values? Electronic filing? Paper acceptable? 34

35 FFI Election to be Withheld Upon 35 How will an FFI s election to push withholding on recalcitrant account holders upstream to another withholding agent be implemented? Revise Form W-8IMY? Other communication between institutions? What if the implementing withholding agent has no relationship to the proceeds of the transaction? Only by by mutual agreement? How would the election apply to gross proceeds? What does it mean that an FFI making this election must waive any right under any treaty of the United States with respect to any amount deducted or withheld? 35

36 Form 1099 Alternative to FFI Annual Report 36 As an alternative to producing an annual FFI report, an FFI can choose to file Forms 1099 to the same extent as a U.S. domestic financial institution, but Generally limited to 1099-B, -DIV, -INT, and -MISC Treat the holder of a U.S. account as a natural person/u.s. citizen Will FFIs be required to do cost basis reporting? Should Forms 1099 be provided to U.S. owned foreign entities, rather than the U.S. owners? 36

37 Refunds and Credits 37 Section 1474 provides that credits or refunds will be given for overwithheld amounts Exception for FFI beneficial owner in which case no credit or refund is allowed if FFI is not a treaty resident If FFI is a treaty resident, the amount of any credit or refund shall not exceed the amount of credit or refund attributable to the treaty reduced rate No interest is allowed with respect to such credit or refund What procedures will apply? 37

38 Refunds and Credits (cont d) 38 Potentially vast increase in need for IRS to process reclaims from (1) good beneficial owners behind bad FFIs; and (2) treatyeligible FFIs Need for procedures Standards of proof, documentation, etc. IRS staff to process the claims. Inadvertent withholding? 38

39 Tiered Entities Considerations 39 Tiered entities present numerous complexities How will duplicative FATCA withholding down the chain be prevented? Will beneficial owners simply have to apply for a refund? How will Chapter 3 withholding be prevented where FATCA withholding has already been imposed? Again, will beneficial owners simply have to apply for a refund? Who has withholding responsibility when an entity down the chain elects to be withheld upon? What responsibilities does each withholding agent in the chain have? Should each payor be responsible only for verifying its immediate payee s status? 39

40 Effective Date 40 FATCA s general effective date is January 1, 2013 IRS has said guidance is to be issued in several tranches Is it realistic to expect institutions to implement systems in time? Options Delay/stagger effective date? Prioritize guidance? 40

41 Grandfather Clause 41 FATCA withholding does not apply to any payment under any obligation outstanding on [March 18, 2012] or from the gross proceeds from any disposition of such an obligation What is an obligation? Hybrid securities When is an obligation outstanding? Revolvers Delay draws 41

42 FATCA Planning: What Can Be Done Now? Internal awareness Senior management education and buy in Identify all group entities impacted Identify all business lines impacted Identify accounts potentially impacted Training for relevant resource Initial workshops for institutional clients 42

43 FOREIGN BANK ACCOUNT REPORTING

44 FBAR: Table of Contents Basic requirements Background Proposed regulations Relief for signature authority filers Continued areas of concern 44

45 Basic Requirements 45 Applies to U.S. persons who have: a financial interest in, or signature or other authority over, A bank, securities, or other financial account in a foreign country Provided the aggregate maximum value of all such accounts during the year exceeds $10,000 File Form TD F , Report of Foreign Bank and Financial Accounts, a.k.a. FBAR Tax practitioners are often involved in the preparation of the FBAR because there is a checkbox regarding FBAR on income tax returns 45

46 Why FBAR? 46 Money laundering Tax evasion Terrorism 46

47 Historical Exceptions 47 Some persons who solely had signature authority did not have to file: Bank officer/employee Public/large company/group officer/employee (if notified) Foreign sub officer/employee (if notified) Some account types are exempt: Nostro/correspondent accounts Military banking facilities Abbreviated filing for 25 or more accounts owned Did not apply to those with only signature authority 47

48 FBAR s Profile Rises 48 Concerns about terrorist financing post 9/11 Use of foreign accounts for U.S. tax evasion attracts attention Large foreign institutions targeted Levin hearings Voluntary compliance initiative Controversy over 2008 revision to form Who is required to file (definition of U.S. person )? Which accounts are covered (hedge funds)? No regulations virtually all of the law is in the instructions to the forms 48

49 What s in the Proposed Regulations? 49 The law is now in the proposed regulations, not the instructions No need for employers to notify employees that an exception applies to the employees Officer/employee exceptions Federally supervised banks & credit unions SEC/CFTC-examined financial institutions SEC-registered authorized service providers to mutual funds & other 1940 Act companies Entities listed on U.S. national exchange (including foreign entities) Plus U.S. subs reported on a consolidated report Not foreign subs U.S. entity with registered section 12(g) securities 49

50 What s in the Proposed Regulations? (cont d) 50 Participants and beneficiaries in qualified retirement plans will not be required to file an FBAR with respect to a foreign financial account held by or on behalf of the plan (the same rules apply to IRAs) Beneficiaries of a trust do not have to file if the trust (or a trustee or agent) is a U.S. person that files for the trust Consolidated reports available for any kind of parent or member entity, not just corporations, so long as parent is U.S. person Abbreviated filing for signature authority over 25 or more accounts Definition of who must file ( United States person ) carved back 50

51 What s in the Proposed Regulations? (cont d) 51 Foreign-located U.S. citizens get modified filing. No foreign sub officer/employee exception Foreign financial accounts are defined to include "mutual fund or similar pooled fund" accounts, but not hedge funds, private equity funds, etc. (for now) Signature authority defined as something an individual, not an entity, may have 51

52 Relief for Signature Authority Filers 52 No need to file this month! Notice says that those with signature or other authority over (but no financial interest in) an account have until June 30, 2011, to file Applies to all open years No need to amend tax returns for 2009 and earlier just because they indicate no reportable accounts Must adhere to FBAR guidance in effect at the time the FBAR is filed (not when it was due) 52

53 Continued Areas of Concern 53 Exceptions not quite broad enough, even where they apply Foreign subs SEC-registered entities that are not financial institutions State-chartered banks Many employees still have to file, maintain records for employer accounts IIB requested modified filing, like for foreign-employed U.S. citizens IIB requested that employees have no obligations to maintain records, even assuming they have to file 53

54 Continued Areas of Concern (cont d) 54 U.S. employees of foreign publicly traded groups may not qualify for an exception unless they work for the parent (e.g., via U.S. a branch) Technical issue because employees of U.S. subs can only be covered by a consolidated report, and only U.S. parents can file one IIB requested that a U.S. sub or branch be allowed to file a consolidated report to excuse U.S. employees Some exceptions appear to apply (unintentionally) even though no one files for an account, e.g. employees of U.S branches of foreign banks IIB requested that employees be exempted but that the branch be able to file 54