IRS Releases Preliminary Guidance on the FATCA Provisions of the HIRE Act

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1 IRS Releases Preliminary Guidance on the FATCA Provisions of the HIRE Act SUMMARY On August 27, 2010, the IRS and Treasury Department issued Notice (the Notice ) providing initial guidance on many of the foreign account tax compliance provisions of the Hiring Incentives to Restore Employment Act (the Act ). The IRS and Treasury Department intend to issue proposed regulations incorporating the content of the Notice. The Notice sets forth the IRS s current expectations for: how the grandfathered obligation rules will be applied; how the term financial institution will be interpreted; what foreign financial institutions ( FFIs ) that enter into withholding and information-reporting agreements with the Treasury Department (such an agreement, an FFI Agreement, and such FFIs, Participating FFIs ) will need to do to identify and classify their account holders; what U.S. financial institutions ( USFIs ) that make withholdable payments will need to do to identify and classify their account-holder payees; how to apply exemptions from withholding (including the proposal of a new exempt category for non-financial foreign entities ( NFFEs ) that are engaged in an active trade or business); providing each Participating FFI with an employer identification number ( EIN ) that the Participating FFI can use to document that it is a Participating FFI; and what information a Participating FFI will be required to report. The IRS and Treasury Department also solicit comments on a variety of topics addressed in the Notice. Such comments should be submitted by November 1, The Notice generally does not cover provisions of the Act governing: (i) bearer bonds; (ii) substitute dividend and dividend equivalent payments; (iii) U.S. taxpayer self-disclosure of foreign assets or (iv) certain trusts. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 BACKGROUND The Act, which was signed on March 18, 2010, includes foreign financial account provisions, mostly taken from the previously introduced Foreign Account Tax Compliance Act ( FATCA ), which require: (i) FFIs to report information on their account holders to the IRS and (ii) other foreign entities to provide information regarding their beneficial owners to withholding agents. In the absence of compliance, there will be a 30% withholding tax on payments of U.S.-source withholdable payments (which generally include U.S.- source investment income and gross proceeds from the sale or disposition of assets that generate U.S.- source investment income). 1 The Act, despite providing detailed rules in certain areas, delegates the development of many aspects of the new withholding regime to the Treasury Department and the IRS. THE NOTICE The Notice provides preliminary guidance on a number of foreign tax compliance provisions of the Act. A. GRANDFATHERED OBLIGATIONS Payments on grandfathered obligations, generally obligations that are outstanding on March 18, 2012, are exempted from the Act s withholding provisions. However, because the term obligation is not defined in the Act or the relevant legislative history, uncertainty exists regarding how this exemption should be applied. In the Notice, the IRS and Treasury Department indicate that forthcoming regulations will define an obligation to be any legal agreement that produces (or could produce) withholdable payments, is not equity for U.S. tax purposes, and has a definitive term or expiration date. Accordingly, most fixed-term instruments that have a U.S. issuer and are classified as debt for U.S. tax purposes will be obligations, while demand deposit arrangements will not. Uncertainty remains, however, as to how the IRS intends to classify a variety of financial products, such as prepaid forward contracts and other structured investments (although the guidance given under the Notice appears to suggest that such instruments will constitute obligations as long as they are not treated as equity for U.S. tax purposes). In addition, the Notice indicates that a material modification of an obligation will terminate the obligation s grandfathered status. A material modification, in the case of a debt instrument, will be defined by reference to the general rules that govern whether a significant modification has occurred to 1 Although these provisions are not addressed by the Notice, the Act also: (i) eliminates certain tax exemptions for foreign-targeted bearer bonds; (ii) imposes withholding tax on substitute dividend and dividend equivalent payments; (iii) requires increased disclosure by U.S. taxpayers with respect to foreign assets; and (iv) establishes new rules regarding the treatment of foreign trusts. Additional background on the Act 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 that instrument for U.S. tax purposes. 2 In the case of other obligations, whether a modification is material will be evaluated based on all relevant facts and circumstances. The Notice gives no guidance on how the term outstanding should be interpreted, an area where additional guidance may be needed. B. FOREIGN FINANCIAL INSTITUTIONS AND NON-FINANCIAL FOREIGN ENTITIES Whether many of the Act s withholding and information-reporting requirements apply to a payment is determined by whether the payee is an FFI. To be an FFI, an entity must first be a financial institution. Under the Act, a financial institution is an entity that: (i) accepts deposits in the ordinary course of a banking or similar business; (ii) as a substantial portion of its business, holds financial assets for the account of others; or (iii) is engaged (or holds itself out as being engaged) in the business of investing, reinvesting or trading in securities, partnership interests or commodities (or interests, including derivatives, in such assets) Definition of a Financial Institution a. Entities that Accept Deposits in the Ordinary Course of a Banking or Similar Business In the Notice, the IRS states that an entity that is a financial institution because it accepts deposits in the ordinary course of a banking or similar business 4 generally includes an entity that would qualify as a bank under Section 585(a)(2), 5 a savings bank, a commercial bank, a savings and loan association, a thrift, a credit union, a building society and a cooperative banking institution. Other entities may also be financial institutions under this rule: the Notice observes that the fact that an entity is subject to the banking and credit laws of the United States or a foreign country, or to bank regulation is relevant to but not necessarily determinative of whether an entity is a financial institution because it accepts deposits in the ordinary course of a banking or similar business See Treas. Reg If a debt instrument has undergone a significant modification under these rules, it is generally treated, for U.S. tax purposes, as if it had been retired and reissued on the day when the significant modification took place. See Section 1471(b)(5). See Section 1471(d)(5)(A). Section 585 permits certain banks to deduct bad debt reserves for U.S. tax purposes, and includes a definition of a bank that includes: (i) a bank, as defined in Section 581; (ii) the banking business of a U.S. branch of a foreign corporation; and (iii) a foreign corporation that would be a bank under Section 581 if it were not a foreign corporation. Under Section 581, a bank is a bank or trust company (including a building and loan association), incorporated under U.S. law, a substantial part of the business of which consists of receiving deposits, making loans and discounts, or of exercising fiduciary powers similar to those that national banks are permitted to exercise, which is supervised by a federal or state bank regulator. -3-

4 b. Entities that, as a Substantial Portion of Their Businesses, Hold Financial Assets for the Account of Others The Notice gives several examples of entities that are financial institutions for the purpose of the Act because as a substantial portion of their businesses, they hold financial assets for the account of others: 6 broker-dealers, clearing organizations, trust companies, custodial banks and entities acting as custodians with respect to the assets of employee benefit plans. Moreover, as with deposit-taking institutions, the Notice provides that whether an entity is subject to the banking laws, credit laws or broker-dealer regulations of the United States or a foreign jurisdiction is relevant to, but not necessarily determinative of whether an entity is a financial institution under this rule. c. Entities that Are Engaged Primarily in the Business of Investing, Reinvesting or Trading in Securities, Partnership Interests or Commodities As with the first two categories of financial institutions, the Notice gives several examples of entities that will be classified as financial institutions under the Act because they are engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests or commodities. 7 Such entities include mutual funds (and their foreign equivalents, presumably including unit trusts, European SICAVs and British IVICs), funds-of-funds (and other similar investments), exchange-traded funds, hedge funds, private equity funds and venture capital funds, other managed funds, commodity pools and other investment vehicles. Although the Act refers to entities engaged in the business of investing, reinvesting or trading, the Notice indicates that an entity may be engaged in such a business for purposes of the Act even if the entity s level of activity would not otherwise constitute a trade or business for other U.S. tax purposes. The IRS and Treasury Department expect that the regulations issued under the Act will provide that whether an entity is engaged in such a business is a determination that will be made on the basis of all the relevant facts and circumstances. 2. Excluded and Exempted Entities Pursuant to the Notice, the IRS intends to exempt certain classes of entities from the definition of a financial institution, and provides special rules for the treatment of insurance companies, entities with certain identified owners and entities organized in a U.S. territory or possession. a. Exempted Entities The IRS and Treasury Department intend to issue regulations exempting certain foreign entities from the definition of a financial institution. Such entities will be, instead, treated as NFFEs. Under the Notice, the following entities will generally be entitled to such an exemption: 6 7 See Section 1471(d)(5)(B). See Section 1471(d)(5)(C). -4-

5 holding companies for a subsidiary or a group of subsidiaries that primarily engage in a trade or business other than that of a financial institution (such as a traditional holding company that owns a group of manufacturing subsidiaries); start-up companies (other than financial institutions), which will be exempted for the first 24 months after their formation; non-financial entities that are in the process of liquidating or emerging from a reorganization or bankruptcy; and hedging or financing centers of a non-financial group that do not provide financial services to non-affiliates. However, the Notice generally provides that investment funds, private equity funds, venture capital funds, leveraged buyout funds, and vehicles whose purpose is to acquire or fund start-up companies and hold those companies for investment for a limited period of time will not be exempted entities. In the Notice, the IRS requests comments as to how the classes of entities discussed above can be better defined. b. Special Rules for Insurance Companies The Act s definition of a financial institution is broad enough to include certain insurance companies within the definition of a financial institution. 8 The Notice provides that the IRS intends to issue regulations that exempt insurance contracts that do not have cash value (such as property and casualty insurance policies, and term life insurance contracts) from the definition of a financial account, and further to exempt insurance companies that are primarily in the business of issuing such contracts from the Act s definition of a financial institution (instead, such entities would be treated as NFFEs). However, the IRS, according to the Notice, believes that cash-value insurance contracts and annuity contracts may present the risk of U.S. tax evasion that the Act is intended to prevent. Accordingly, the Notice requests comments regarding the appropriate treatment of such contracts. c. Special Rules for Entities with Identified Owners The Notice also observes that investment funds such as small family trusts that only have a small number of individual owners or NFFE owners that are not subject to the Act s withholding requirements ( excepted NFFEs ) may also constitute FFIs. The IRS notes, however, that the administrative burdens associated with such entities entering FFI Agreements may significantly outweigh the benefits to such entities of making investments that give rise to withholdable payments. Accordingly, the IRS intends to issue guidance under which certain entities that are FFIs because they are engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests or commodities (but not 8 The legislative history of the Act specifically observes that [i]t is anticipated that the Secretary may prescribe special rules addressing the circumstances in which certain categories of companies, such as certain insurance companies, are financial institutions, or the circumstances in which certain contracts or policies, for example annuity contracts or cash-value life insurance contracts, are financial accounts or United States accounts for these purposes. Joint Committee on Taxation, Technical Explanation of the Revenue Provisions Contained in Senate Amendment 3310, the Hiring Incentives to Restore Employment Act, Under Consideration by the Senate (Feb. 23, 2010), at

6 entities that are FFIs because they accept deposits in the ordinary course of a banking or similar business or, as a substantial portion of their businesses, hold financial assets for the account of others) would be treated as deemed compliant FFIs so long as: (i) the withholding agent identifies each individual, specified U.S. person 9 or excepted NFFE 10 that has an interest in such entity; (ii) the withholding agent obtains from each such person the information that the withholding agent would be required to obtain (as described below) from that person if such person were a new account holder or direct payer of the withholding agent; and (iii) the withholding agent reports to the IRS (in a manner that will be detailed in future guidance) any specified U.S. persons that are identified as direct or indirect interest holders in the entity. The Notice is not clear as to how an FFI would be treated if it has, among its owners, one or more privately held NFFEs, or how any U.S. owner of such NFFEs would be treated. The Notice also requests comments regarding whether certain small FFIs (presumably meaning the class described above) should be treated as NFFEs, in addition to being required to follow the procedures described above. 3. Classes of Persons Posing a Low Risk of Tax Evasion The withholding and information-reporting provisions of the Act do not apply to payments to the extent that the beneficial owner of the payment is a member of a class of persons identified by the Treasury Department as posing a low risk of tax evasion. 11 Various commentators suggested that this class may include, among other groups, foreign retirement plans (which may otherwise constitute FFIs). 12 The Notice indicates that the IRS intends to issue guidance exempting payments made to certain foreign retirement plans from the Act s withholding provisions. The requirements to qualify for this exemption may be quite stringent. At present, the IRS expects 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 Under the Act, a specified U.S. person is a U.S. person or entity that is not exempted from Section 1471 reporting rules (including an individual). As noted above, an excepted NFFE is an NFFE owner that is not subject to the Act s withholding requirements. Examples of excepted NFFEs include a publicly traded corporation, a corporation in the same expanded affiliated group of a publicly traded corporation and a foreign government. Section 1471(f). See, e.g., American Bar Ass n, Comments on Foreign Account Tax Compliance Offset Provisions of the HIRE Act (Aug. 16, 2010). Other classes of persons that have been suggested as posing a low risk of tax evasion include widely held investment vehicles and certain other collective investment funds. See id. The legislative history of the Act also indicates that certain widely held collective investment vehicles could be termed deemed compliant with the Act under Section 1471(b)(2). See Joint Committee on Taxation, Technical Explanation of the Revenue Provisions Contained in Senate Amendment 3310, the Hiring Incentives to Restore Employment Act, Under Consideration by the Senate (Feb. 23, 2010), at

7 employees who worked for the sponsor during the time when the relevant benefits accrued, to participate. These rules would not, in their present form, apply to non-retirement benefit plans (such as other deferred compensation plans); however, the Notice requests comments on whether such plans should be permitted to claim similar treatment. In addition, the Notice requests comments on how retirement plan should be defined, and how retirement plans may be able to identify themselves to withholding agents for the purpose of claiming this exemption. 4. Special Rules for U.S. Branches of FFIs Under the Act, a U.S. branch of an FFI is not exempted from the definition of an FFI. Although income that is treated as effectively connected with an FFI s U.S. trade or business (i.e., ECI ) is not a withholdable payment, this exemption does not, for example, operate to cover payments made to an FFI s U.S. branch on behalf of a customer. The IRS and Treasury Department indicate, in the Notice, that they do not intend to exempt FFIs that receive withholdable payments solely through their U.S. branches from the requirement to enter into an agreement with the Treasury Department to avoid withholding under the Act. However, the IRS is considering permitting U.S branches of FFIs to document their account holders under the rules applicable to U.S. financial institutions. In addition, although the current nonresident alien withholding rules provide a presumption that a payment to a U.S. branch of a foreign bank or insurance company is, in the absence of a statement on a withholding certificate to the contrary, presumed to be effectively connected with that entity s U.S. trade or business (and therefore generally exempt from withholding), 13 the IRS indicates in the Notice that it does not anticipate providing a similar exemption with respect to the Act s withholding provisions. 5. Treatment of CFCs The IRS and Treasury observe that the existing reporting requirements for controlled foreign corporations of U.S. shareholders ( CFCs ) are generally less stringent than those prescribed by the Act and that, accordingly, it is not appropriate to treat financial institutions that are CFCs as deemed compliant for the purposes of the Act. 14 In particular, the IRS notes that: (i) under the existing CFC reporting requirements, CFCs are not required to report certain payments to domestic corporations, whereas FFIs are required to report information on account holders that are specified U.S. persons (including certain domestic corporations); (ii) the existing CFC reporting requirements do not require CFCs to report with respect to the U.S. owners of foreign entities for which they maintain accounts; and (iii) the Act requires FFIs to obtain waivers from account holders when a reporting obligation under the Act would otherwise be See Treas. Reg (a)(2)(ii). See Section 1471(b)(2). -7-

8 prohibited under foreign law (or, in the absence of such a waiver, to close such holders accounts), and no comparable requirement would apply to FFIs that are CFCs if they were exempted from FFI status. 6. Financial Institutions Organized in U.S. Territories In general, entities organized in a U.S. territory are considered foreign for most U.S. tax purposes. However, under the Act, a financial institution organized under the laws of a U.S. territory is not an FFI, except to the extent otherwise provided by the IRS and Treasury Department. Territory-organized financial institutions are, however, withholding agents under the Act. 15 The Notice indicates that the IRS generally does not intend to treat territory-organized financial institutions as FFIs. However, as noted above, territory-organized financial institutions are required to withhold under the Act s withholding provisions. The Act does not specify how withholding should apply in cases where a territory-organized financial institution is acting as an intermediary between a U.S. withholding agent and an FFI or an NFFE. Under the Internal Revenue Code s regular (nonresident alien) withholding regime, territory-organized financial institutions are permitted to assume the withholding and reporting responsibilities that apply to U.S. persons. The IRS intends to issue guidance that would permit a territory-organized financial institution that receives a withholdable payment as an intermediary to be exempted from the Act s withholding provisions if it represents (in writing) to the relevant withholding agent that it is assuming the withholding responsibilities imposed on U.S. withholding agents under the Act. a. Territory-Organized Investment Companies The Notice also provides that the IRS and Treasury Department are considering treating territoryorganized financial institutions that are financial institutions solely because they are engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests or commodities as NFFEs. If such an exemption is permitted, it is anticipated that a territory-organized entity may be exempt from NFFE withholding if it: (i) is organized under the laws of a U.S. territory and (ii) is wholly owned by one or more bona fide residents of the same U.S. territory. b. Information Exchange In addition, the Notice indicates that the IRS and Treasury Department expect to engage in discussions with the governments of U.S. territories with the intent of exploring how the current territorial informationreporting systems may supplement the obligations of territory-organized financial institutions. It is possible, after such discussions, that the IRS and the relevant territorial jurisdictions may enter into information-exchange agreements that could focus on providing information to the IRS regarding specified U.S. persons who hold accounts at territory-organized financial institutions. 15 See Section 1473(4). -8-

9 7. Additional Request for Comment The Notice requests comments on the classes of foreign entities that should be: excluded from the definition of an FFI; deemed compliant under Section 1471(b)(2); or identified as posing a low risk of tax evasion under Section 1471(f). C. COLLECTION OF INFORMATION AND IDENTIFICATION OF PERSONS BY FINANCIAL INSTITUTIONS 1. Summary Section III of the Notice: (i) sets forth a framework of rules and procedures for USFIs and Participating FFIs to identify and classify their account holders (or, in the case of USFIs, account holder payees) for the purpose of applying the Act s withholding rules; 16 (ii) proposes a new exempt category for NFFEs that are engaged in an active trade or business; and (iii) provides that Participating FFIs will be issued an EIN that the Participating FFI can provide to a payor (or FFI at which it holds an account) to establish its status as a Participating FFI. The procedures set forth in Section III of the Notice distinguish between new and existing accounts and, with respect to both types of accounts, between those held by individuals and those held by entities. During an introductory five-year period (two years in the case of accounts with an average monthly balance or value exceeding $1,000,000 during the year before the year the FFI Agreement became effective), the methodology applicable to existing accounts differs from the methodology applicable to new accounts. With respect to existing accounts, the methodology focuses on electronically searchable information already available to the financial institution and allows the financial institution to rely on existing forms and information already in its files. If the electronically available information contains some indicia of potential U.S. status, the rules require the financial institution to request additional information. The type of additional information required will depend on the strength of the indicia of potential U.S. status. For example, if a Participating FFI has a U.S. place of birth on file for an individual account holder, that account holder will need to provide a non-u.s. passport or similar evidence plus a Form W- 8BEN to establish his or her non-u.s. status. In contrast, in instances where the only element of potential U.S. status is a power of attorney granted to a person with a U.S. address, other documentary evidence will generally be sufficient. 16 See Sections 1471 and It is important to note that the rules set forth in the Notice are applicable to obligations of USFIs under Section 1472 only insofar as they are making payments to NFFEs that are account holders of the USFIs. The Notice does not provide guidance on how USFIs should apply the rules of Section 1472 (withholding on NFFEs) to withholdable payments made to beneficial owner payees that are not account holders (e.g., NFFEs that are suppliers to USFIs but not accountholders). -9-

10 Generally, an FFI will have one year from the date it becomes a Participating FFI to initially classify its existing account holders and request any necessary information. Account holders will have an additional year to provide that information before they are treated as recalcitrant account holders. USFIs have until December 31, 2013 to request information from those account holders they tentatively classify as FFIs or NFFEs. A foreign entity must provide the requested information by December 31, 2014 or be treated as a nonparticipating FFI or a non-exempted NFFE that is subject to withholding. In addition to the rules and procedures related to identifying and classifying account holders, Section III of the Notice provides that NFFEs that are engaged in an active trade or business will be treated as excepted NFFEs (presumably pursuant to the authority granted to the Treasury under Section 1472(c)(2)). As such, the account of an NFFE engaged in a trade or business will not be treated as a U.S. account for purposes of the Act regardless of whether it has substantial U.S. owners. Section III of the Notice also includes a statement indicating that the Treasury and IRS contemplate issuing EINs (referred to as FFI EINs ) to Participating FFIs. Participating FFI s will use these to identify themselves to withholding agents. 2. Background and Categories a. Participating FFIs To comply with the requirements of the Act (i.e., to be a Participating FFI ), an FFI must enter into an FFI Agreement pursuant to which it agrees to identify and report information on its account holders that are specified U.S. persons or U.S.-owned NFFEs. To do this, it must determine the proper status of all of its account holders. If the account holder is an individual, the FFI must determine whether that account holder is a U.S. person (and therefore a specified U.S. person subject to the Act s reporting rules) or a foreign person. If the account holder is an entity, the determination process is more complicated. The FFI must first establish whether the account holder is a U.S. or non-u.s. entity. If the account holder is a U.S. entity, the FFI must determine whether it is a specified U.S. person. If the FFI concludes that the account holder is a non-u.s. entity, it must then determine whether the non-u.s. entity is: (i) an FFI; (ii) an entity exempted from the Act s withholding and information-reporting rules, such as a foreign government, an international organization or an entity that presents a low risk of tax evasion 17 (an Exempted Entity ); or (iii) an NFFE. If the Participating FFI concludes that the account holder is an FFI, it must ascertain whether it is (i) a Participating FFI, (ii) a deemed compliant FFI or (iii) a nonparticipating FFI. 17 See Section 1471(f). -10-

11 If the Participating FFI concludes that the account holder is an NFFE, it must then determine if it is an excepted NFFE (such as a foreign government or a publicly traded corporation). If the NFFE is not an excepted NFFE, the Participating FFI must evaluate whether the NFFE has substantial U.S. owners. b. U.S. Financial Institutions A U.S. financial institution ( USFI ) (and any other withholding agent) 18 making a withholdable payment to an entity must identify the recipient of the withholdable payment to comply with its obligations to withhold on FFIs, 19 and must identify the beneficial owner(s) of the payment to comply with its obligations to withhold on NFFEs. 20 In order to make this identification, the USFI will generally first need to determine whether the entity recipient is a U.S. or non-u.s. entity. If the relevant entity is a non-u.s. entity, it must evaluate whether it is: (i) an FFI; (ii) an Exempted Entity; or (iii) an NFFE. If the USFI determines that the account holder is an FFI, the USFI must then determine whether the account holder is: (i) a Participating FFI; (ii) a deemed compliant FFI; or (iii) a nonparticipating FFI. If the USFI determines that the entity is an NFFE, the USFI must then ascertain if the account holder is an excepted NFFE. If the entity is not an excepted NFFE, the USFI must determine whether the NFFE has substantial U.S. owners. 3. Information and Procedures a. Existing Documentation and FFI EINs As discussed above, under the rules established by the Act, both Participating FFIs and USFIs will be required to identify certain of their account holders. i. Reliance on Previously Collected Forms and Documentation For the purpose of identifying U.S. account holders, the Notice will permit Participating FFIs and USFIs to rely on any IRS Forms W-9 they have previously collected for other U.S. tax purposes. Any account holder that is an individual and that has provided a Form W-9 will be treated as a U.S. person for purposes of compliance with the requirements of FATCA. FFIs will also be permitted to rely on other previously collected documentation. For example, a Participating FFI will be deemed to have satisfied the requirement to maintain documentation (other than a Form W-8 or W-9) if it retains a record of the documentary evidence collected, and reviews and records certain identifying information about the evidence. ii. EINs for Participating FFIs The Notice states that the Treasury Department and IRS contemplate issuing EINs, referred to as FFI EINs, to Participating FFIs. Participating FFIs will use these to identify themselves to withholding agents The Notice only addresses certain withholding obligations of U.S. Financial Institutions although Section 1471 applies to any payor of a withholdable payment. See Section 1471(a). See Section

12 Treasury is considering requiring Participating FFIs to report the identity of any entity that provides documentation indicating that it is a Participating FFI, but fails to provide a valid FFI EIN. b. Rules and Procedures applicable to Participating FFIs Under its FFI Agreement, a Participating FFI will be required to identify and report information on its account holders that are specified U.S. persons or U.S.-owned NFFEs. The Notice divides these rules into four categories: (i) rules for pre-existing accounts of individuals; (ii) rules for new accounts opened by individuals; (iii) rules for pre-existing accounts held by entities; and (iv) rules for new accounts opened by entities. Pre-existing accounts are financial accounts that are held as of the date the Participating FFI s FFI Agreement becomes effective. i. Pre-Existing Accounts Held by Individuals Section III of the Notice sets forth a series of steps that the Participating FFI must follow to ascertain whether an individual account holder is a U.S. or non-u.s. person: Step 1. If the average month-end balance of all depositary accounts held by the account holder at the FFI during the calendar year preceding the date the Participating FFI s FFI Agreement becomes effective was less than $50,000, the FFI may (but is not required to) temporarily treat the account as a non-u.s. account. As currently drafted, it does not appear that the IRS will require aggregating accounts from all members of the Participating FFI s expanded affiliated group. Step 2. All account holders not addressed in Step 1 that are already documented as U.S. persons for other U.S. tax purposes will be treated as specified U.S. persons. Step 3. Account holders not addressed in Steps 1 and 2 will be treated as non-u.s. persons if the FFI s electronically searchable information does not contain any of the following enumerated indicia of potential U.S. status: (i) the account holder is identified as a U.S. citizen or resident; (ii) a U.S. address is associated with an individual account holder; (iii) a U.S. place of birth is on record for the account holder; (iv) the sole address provided is an in care of, hold mail or P.O. box (presumably, this includes a sole address outside the United States); (v) a power of attorney or signatory authority was granted to a person with an address in the U.S.; and (vi) there are standing instructions to transfer funds to accounts maintained in the U.S. Step 4. 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. If the account holder is identified as a U.S. citizen or 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 -12-

13 an account, the account holder must provide a Form W-9, or both a Form W-8BEN and documentary evidence that the holder is not a U.S. person, such as a non-u.s. passport. Finally, holders of accounts that contain indicia described in clauses (iv)-(vi) must provide either a Form W-9 or a Form W-8BEN, or documentary evidence establishing the individual s non-u.s. status. This documentation may be relied on unless the FFI knows or has reason to know it is incorrect. An FFI will have one year after the effective date of its FFI agreement to request such information, and an account holder will have one year after the date of the request to provide the relevant information. Step 5. Within five years of the effective date of the institution s FFI Agreement (and within two years for accounts with an average monthly balance or value exceeding $1,000,000 during the year before the year the FFI Agreement became effective), all pre-existing individual accounts treated as non-u.s. accounts will generally be subject to the procedures for new accounts described below. ii. New Individual Accounts A new individual account, under these rules, is an account opened after the effective date of the Participating FFI s FFI Agreement. It also includes new account relationships established by an individual holding pre-existing accounts with the FFI. As with the rules for pre-existing individual accounts, a Participating FFI must proceed through a series of steps to determine the proper status of the individual account holder: Step 1. An account for which the opening account balance, and the average monthly account balance of all accounts of the account holder with the FFI, is less than $50,000 may be treated as a non-u.s. account. Step 2. All account holders not addressed in Step 1 that are already documented as U.S. persons for other U.S. tax purposes will be treated as specified U.S. persons. Step 3. If an account is not addressed in Steps 1 and 2, the FFI will be required to obtain documentary evidence establishing U.S. or non-u.s. status of the individual that is the beneficial owner of the account (either a Form W-9 from a U.S. individual or documentary evidence establishing the individual s status as a non-u.s. person). Step 4. If an account is not addressed in Steps 1 and 2 and is not documented as a U.S. account pursuant to Step 3, the FFI must examine all the documents it has collected in connection with the new account (e.g., as part of its account opening procedures and for purposes of maintaining the account, corresponding with the account holder, or complying with regulatory requirements) for the indicia of U.S. status (using the indicia listed above in Step 3 for pre-existing accounts). Step 5. Accounts with any of the enumerated indicia of U.S. status will be treated as potential U.S. accounts. As with the rules for pre-existing individual accounts, the strength of indicia present will determine the amount of other evidence needed to rebut this presumption of potential U.S. status. -13-

14 Step 6. An FFI will be required to repeat Steps 4 and 5 each time it knows, or has reason to know, that circumstances that could affect the account holder s classification have changed. According to the Notice, future guidance will set forth the appropriate time periods for completing the Steps listed above, the default treatment of account holders during that period and the circumstances that may trigger a re-evaluation of the non-u.s. status of an account with a balance of less than $50,000. iii. Pre-Existing Entity Accounts As it does for pre-existing and new individual accounts, Section III of the Notice sets forth a series of steps the Participating FFI must apply to determine: (i) whether an existing entity account holder is a U.S. or non-u.s. person, and if it is a U.S. person, whether it is a specified U.S. person or a non-specified U.S. person and (ii) whether it is (a) a Participating FFI, a deemed compliant FFI or a non-participating FFI; (b) an NFFE or an excepted NFFE; or (c) an Exempted Entity. A Participating FFI also must evaluate whether the account holder must be treated as a recalcitrant account holder. 21 Step 1. Account holders already identified as U.S. persons for other U.S. tax purposes will be treated as U.S. account holders. Such account holders will have one year following the date the Participating FFI s FFI Agreement has become effective to provide documentation establishing that they are not specified U.S. persons. After that point, the account holder will be treated as a specified U.S. person until documentation establishing otherwise is provided to the FFI. Step 2. With respect to all account holders not addressed in Step 1, if the Participating FFI has information in its electronically searchable database indicating that the account holder is a U.S. person, it must be presumed to be a U.S. person. The Participating FFI must request documentation establishing that the account holder is either not a U.S. person or not a specified U.S. person within one year from the effective date of its FFI Agreement. The account holder must provide the information within one year of the request, or it will be treated as a specified U.S. person and a recalcitrant account holder. Step 3. Entities not classified under Step 1 or 2 will be presumed to be non-u.s. entities. A Participating FFI must then complete the following procedures to classify a non-u.s. entity: (i) If the entity s name (or other information readily available in the FFI s electronically searchable files) clearly indicates that the account holder is an FFI, it must tentatively be treated as such. (ii) The Participating FFI must request, within one year of the effective date of its FFI Agreement, that an account holder tentatively treated as an FFI pursuant to (i) above provide either its FFI EIN and certification of Participating FFI status or other 21 A recalcitrant account holder, under the Act, is an account holder that fails to comply with reasonable requests for the information required by the Act, or refuses to provide a waiver of a provision of foreign law prohibiting the reporting of the information that must be reported under the Act. -14-

15 documentation indicating that the FFI is a deemed compliant FFI, a nonparticipating FFI, an Exempted Entity, or an NFFE. (iii) Once the FFI receives an account holder s FFI EIN and certification, it may begin to treat the account holder as a Participating FFI, subject to confirmation by the IRS that the FFI EIN provided is valid. (iv) If information is not received within one year of the request, the account holder will be treated as a nonparticipating FFI. Prior to that time, it will be treated as an excepted NFFE, unless the entity is otherwise identified by the IRS on a published list. Step 4. With respect to entities not classified under Steps 1-3 above, the Participating FFI must examine the account holder s file for evidence that the entity is engaged in an active trade or business (other than as a financial institution). Such evidence may include statements of business activities, evidence of physical assets used in business, evidence of persons employed in business activities, and receivables and payables related to business activities. In addition, the IRS and Treasury Department are considering permitting Participating FFIs to rely, in part, on information extracted from third-party credit reports for the purpose of completing this step. An entity identified as engaged in an active trade or business will be treated as an excepted NFFE. Curiously, there does not appear to be a way for an account holder to certify that it is engaged in an active trade or business, but presumably, it will be permitted to volunteer sufficient information for a Participating FFI to draw that conclusion. The IRS and Treasury Department have requested comments on what level of evidence should be sufficient to establish that an entity is engaged in an active trade or business and ways that this step may be structured to avoid potential abuses. Step 5. An entity not classified under Steps 1-4 above may present documentation identifying itself as a Participating FFI, a deemed compliant FFI, a nonparticipating FFI, an Exempted Entity or an NFFE. The Participating FFI may generally rely on documentation it has in its account files or, in the absence of such documentation, must request, within one year from the effective date of its FFI Agreement, documentation required to show or certify the status of the account holder. The account holder must provide that documentation within one year of its request to avoid being treated as a nonparticipating FFI. Step 6. If the documentation provided in Step 5 indicates that the account holder is an NFFE, the Participating FFI must either: (i) obtain documentary evidence (or rely on existing evidence it has in its files) that the NFFE is an excepted NFFE or (ii) gather information on the NFFE s specified U.S. person owners. In particular, the FFI must identify each specified U.S. person that owns an interest in the NFFE directly or indirectly (other than ownership through a Participating FFI, deemed compliant FFI, excepted NFFE or Exempted Entity). While the Notice refers to all specified U.S. owners, Section 1471 on its terms seems only to require reporting on substantial U.S. owners. If the requested documentation is not obtained, the account holder will be treated as a recalcitrant account holder from the date that is two years after the effective date of the Participating FFI s FFI Agreement. -15-

16 iv. New Entity Accounts A new entity account, under the Notice, is an account opened after the effective date of the Participating FFI s FFI Agreement. In classifying a new entity account, an FFI must follow the methods and procedures established for pre-existing accounts, but using all the information collected by the FFI as part of its account opening procedures (including information collected because of regulatory requirements) regardless of whether such information is in electronically searchable files. v. Anti-Duplication Rules A Participating FFI that makes a withholdable payment to an account holder that is an NFFE will also be a withholding agent for purposes of Section 1472 (withholding on payments to an NFFE). To avoid duplicative documentation, the Notice states that a Participating FFI must use the documentation rules described above rather than the certification procedures in Section 1472(b). c. Rules and Procedures for Identifying Entity Accounts with USFIs Pursuant to its obligations under the Act, a USFI must determine whether to treat an entity to which it makes a withholdable payment as a U.S. entity or a non-u.s. entity. If the USFI identifies a payee as a non-u.s. entity, it must determine whether that payee is a Participating FFI, a deemed compliant FFI, a nonparticipating FFI, an Exempted Entity, an exempted NFFE or an NFFE that is not exempted. Part III of the Notice sets forth procedures to be applied when a USFI is making withholdable payments to an account holder that is an entity. The rules set forth in the Notice are divided between rules and procedures applicable to pre-existing accounts and those applicable to new accounts. Pre-existing accounts, in this context, are accounts that were opened prior to January 1, These procedures are similar, but not identical, to the procedures that Participating FFIs will be required to use under the Notice to identify account holders. i. Pre-Existing Entity Accounts The Notice provides that USFIs will be required to apply a series of steps to identify pre-existing entity account holders: Step 1. The USFI must treat all accounts identified as U.S. accounts for certain other U.S. tax purposes as U.S. accounts. Step 2. For foreign accounts, the USFI must complete the following procedures to classify the non-u.s. entity. (i) If the entity s name or other electronically searchable information readily available to the USFI indicates that the account holder is an FFI, the account holder must be tentatively treated as such. -16-

17 (ii) For each entity tentatively treated as an FFI, the USFI must request certification of the FFI s Participating FFI status and an FFI EIN. Upon receipt of the FFI EIN and certification of Participating FFI status, the USFI may treat the foreign entity as a Participating FFI, subject to confirmation by the IRS that the FFI EIN provided is valid. (iii) If a valid FFI EIN is not provided by December 31, 2013, the USFI must request documentation indicating whether the foreign account holder is a Participating FFI, a deemed compliant FFI, a nonparticipating FFI, an Exempted Entity or an NFFE. If that information is not provided by December 31, 2014, the USFI must treat the account holder as a nonparticipating FFI until it receives appropriate documentation establishing the non-u.s. account holder s status. (iv) Between the date that the information is requested and December 31, 2014, the non-u.s. entity will be treated as an excepted NFFE unless it is otherwise identified by the IRS on a published list of nonparticipating FFIs. Step 3. If an entity is not treated as a U.S. account holder or an FFI, the USFI must examine the entity s account file for evidence that it is engaged in an active trade or business (other than as a financial institution). An entity identified as engaged in an active trade or business will be treated as an excepted NFFE. Step 4. An entity not classified under Steps 1-3 above may present documentation identifying itself as a Participating FFI, a deemed compliant FFI, a nonparticipating FFI, an Exempted Entity or an NFFE. The USFI may rely on documentation it has in its account files, or must request documentation to show or certify the status of the account holder. The account holder must provide such documentation by December 31, 2014 to avoid being treated as a nonparticipating FFI. Step 5. If the documentation provided in Step 4 indicates that the account holder is an NFFE, the USFI must either obtain documentary evidence (or rely on existing evidence it has in its files) that the NFFE is an excepted NFFE or gather information on the NFFE s specified U.S. person owners. In particular, the USFI must identify each specified U.S. person that owns an interest in the NFFE directly or indirectly (other than ownership through a Participating FFI, deemed compliant FFI, excepted NFFE or Exempted Entity). If the USFI is unable to identify such persons or obtain the required information by December 31, 2014, the USFI must withhold on payments made to that account until the requested documentation is supplied. While the Notice refers to all specified U.S. person owners, it is noteworthy that Section 1471, on its terms, only requires reporting on substantial U.S. owners. ii. New Entity Accounts Accounts opened with a USFI on or after January 1, 2013 are new entity accounts. In opening a new entity account, a USFI will be required to follow the method and procedures established for pre-existing accounts, but using all the information collected by the USFI as part of its account opening procedures (including information gathered for purposes of opening and maintaining the account, for correspondence with the account holder and for complying with regulatory requirements) regardless of whether such information is in electronically searchable files. The USFI will also be treated as knowing this information -17-