FATCA or Fiction?

On 18 March 2010 the Hiring Incentives to Restore Employment Act (HIRE) 2010 was enacted in the United States.  Chapter 4 of the HIRE Act contains the basic requirements of the FATCA, which was originally enacted in 2009 however the detailed requirements of Act are still be being issued by the US Internal Revenue Service (IRS) in the form of guidance notes and Regulation.

The Act provides a withholding and reporting regime that is designed to prevent US persons from evading US tax by holding income producing assets through Foreign Financial Institutions (FFI) and not declaring the income to the US Treasury.  In order to avoid withholding requirements the FFI must enter into an undertaking with the US IRS to disclose information they hold on all US connected clients.   If the FFI does not enter into an undertaking with the US IRS then they will be regarded as a Non-Participating Foreign Financial Institution (NPFFI) and a 30% withholding tax is imposed on all US sourced income and capital payments paid to the NPFFI. Witholdable payments include, for example, interest, wages, salaries, dividends, gains, profits and income.   FATCA does not prevent FFI’s from doing business with US connected persons, however it does determine how FFI’s will be regarded in the US and if or when they need to report or withhold tax.

A US connected client for the purpose of the Act is any US citizen, whether US resident or not, US residents (regardless of nationality), US nationals and US companies.  This definition includes US shareholders in most offshore companies as well as settlors and beneficiaries of offshore trusts.
 
A FFI is known as a Participating Foreign Financial Institution (PFFI) once the US IRS have agreed to their undertaking to adopt certain procedures such as report annually to the US IRS and carry out a diligent review of electronically searchable information to determine if an person is US connected.  Where the information indicates a US connection the PFFI is required to obtain specific information from the US connected person which must confirm whether or not they are a US connected client.  This must be done within two years of the date of its undertaking with the US IRS.  If the accountholder does not provide the required information it would be treated as a ‘recalcitrant accountholder’ which means those that fail to provide the FFI with the information required which determines whether the account is a US account or not.  These accountholders will be subject to a 30% withholding tax on witholdable payments, the Regulations refer to these payments as ‘passthru payments’.

The definition of a FFI is broad.  The terms financial institution means any foreign entity that:

(i)    accepts deposits in the ordinary course of business or similar business;
(ii)    holds financial assets for the account of others as a substantial portion of its business; or
(iii)   is engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities or any interest in such securities, partnership or commodities.

The definition of a FFI includes trust companies, asset managers and custodians, as well as banking and other financial institutions.

The US Treasury can treat certain categories of FFI as deemed compliant FFI’s.  This means that payments to this FFI are exempt from withholding even though no FFI agreement has been entered into with the US IRS.  An example of this is where the FFI has proved to the US IRS that they have no US connected clients.  In order to retain a deemed compliant status, the FFI must certify every three years to the US IRS that it meets the requirements for deemed compliant status.

The IRS issued Notice 2011-53 on 14 July 2011 which provided the transitional rules for implementation of the Act.  Specifically, the Notice phases in the implementation of the Act in the following manner:

• Due diligence requirements for identifying new and pre-existing U.S. accounts must be implemented before 1 July 2013.  Reporting requirements will begin in 2014.
• A FFI must enter an agreement with the IRS by 30 June 2013, to ensure that it will be identified as a participating FFI. 
• In general, no withholding will be required on US sourced payments to NPFFI until 1 January 2014 and will be fully phased in on 1 January 2015.  However the exact date the withholding obligation commences depends on when the payment is made and whether the US sourced payment* is an income payment, capital payment or a passthru payment.

* A US sourced payment means, for example, a US Bank, fund manager or custodian who make payments of income or capital.

US sourced payment	Date the payment is made	Obligation on the PFFI to withold
Fixed or determinable, annual or periodic income	Before the 1 January 2014	No
Fixed or determinable, annual or periodic income	On or after 1 January 2014	Yes
Gross proceeds of a sale of an asset which produces fixed or determinable, annual or periodic income	Before the 1 January 2015	No
Gross proceeds of a sale of an asset which produces fixed or determinable, annual or periodic income	On or after 1 January 2015	Yes
Passthru payments which do not include fixed or determinable, annual or periodic income	Before 1 January 2015	No
Passthru payments which do not include fixed or determinable, annual or periodic income	On or after 1 January 2015	Yes
Passthru payments which include fixed or determinable, annual or periodic income	Before 1 January 2014	No
Passthru payments which include fixed or determinable, annual or periodic income	On or after 1 January 2014	Yes

It appears that the definition of a FFI includes all non-US life assurance companies that issue cash value insurance contracts such as life assurance contracts or annuity contracts that typically combine insurance protection with an investment component or similar type arrangements.  Whilst some financial institutions are able to start planning and managing the impact the Act has on their business, non-US life assurance companies may be finding it difficult to do the same because guidance and Regulation specific to non-US life assurance companies has yet to be issued.
 
Notice 2011-53 confirms that the IRS will be issuing further Regulations by 31 December 2012 with the final Regulations following in the summer of 2013.  Whether the guidance and Regulation will give non-US life assurance companies the clarity it needs, is not yet known, however what is clear is that non-US life assurance companies are waiting for this guidance so that they can fully understand and assess the impact on their business.

the facts	the fiction
FATCA introduces reporting and withholding obligations on FFI’s.	FATCA introduces a new tax on US connected individuals – it doesn’t.
FFI’s can continue doing business with US connected individuals, although some may choose to stop.	The US IRS and Treasury understood the full impact of FATCA on foreign financial institutions when they enacted FATCA – they didn’t.
It appears that US connected individuals who are fully disclosing tax liabilities have no further impact.	The non-US life assurance industry are not affected by FATCA – wait and see, they may be.