On March 18, 2010, the Hiring Incentives to Restore Employment Act of 2010 added Chapter 4 to Subtitle A of the Internal Revenue Code. Also known as the Foreign Account Tax Compliance Act (“FATCA”), Chapter 4 generally requires withholding agents to withhold at a 30 percent rate on certain payments to a Foreign Financial Institution (FFI) unless the FFI has entered into an agreement with the Internal Revenue Service to obtain status as a participating FFI and to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes on withholding agents certain withholding, documentation, and reporting requirements with respect to certain payments made to certain non-financial foreign entities (NFFEs). The IRS has published several sets of regulations on FATCA, and several Notices as well, but many non-financial companies and their customers haven’t implemented the necessary reporting and withholding obligations under FATCA.
Under FATCA, non-financial companies can be withholding agents with respect to a broad range of cross-border payments. While some non-financial payments, made in the ordinary course of business, are excluded from this withholding obligation, many payments by non-financial companies are subject to FATCA withholding and reporting. Non-financial companies should evaluate their existing information reporting and withholding procedures and expand these to cover the FATCA requirements as needed.
Complying with FATCA
The tax or financial executive with a non-financial company should ask the following FATCA-related questions:
- Is my company a “withholding agent?”
- Is it making a “withholdable payment?”
- Does the “grandfathering” exception apply to any payments?
- If there is a withholdable payment, to whom is it made?
- Does an exception apply from FATCA withholding?
- If no exception is available, what are my company’s FATCA compliance and reporting requirements?
A “withholding agent” is “any person, U.S. or foreign, in whatever capacity acting, that has the control, receipt, custody, disposal, or payment of a withholdable payment or foreign pass-through payment.” This broad definition is likely to consider a person or operating unit a withholding agent in almost every company with outbound payments.
Many companies that make payments to foreign entities – whether related or unrelated – will conclude that these are “withholdable” under FATCA. Withholdable payments include U.S.-source financial types of payments, such as interest, dividends, premiums for insurance contracts or annuity contracts, investment advisory fees, custodial fees, and bank or brokerage fees. A broad range of nonfinancial payments is exempt from FATCA, such as services (including wages and stock option compensation), payments for the use of property, office and equipment leases, software licenses, transportation, freight, gambling winnings, awards, prizes, scholarships, and interest on accounts payable arising from the acquisition of goods or services. But payments in connection with forward, futures, option or notional principal contracts or similar instruments do come within the scope of FATCA. Therefore, non-financial companies should examine their cross-border payments and determine whether they have to withhold tax, or collect documentation from counterparties to substantiate FATCA compliance and exempt them from withholding. Any withholdable payments that are made to non-FATCA compliant parties are subject to tax withholding and reporting. Notably, if the US withholding agent fails to withhold taxes and fulfill the necessary reporting obligations, it can be held liable for the FATCA tax, as well as interest and penalties. Although the 30% withholding tax under FATCA isn’t intended as a revenue collection mechanism, it is high enough to eliminate profits on almost any transaction and becomes the cost of non-compliance.
The FATCA withholding rules do not apply to payments on grandfathered obligations. Grandfathered obligations are generally obligations issued before July 1, 2014 that:
- Produce (or could produce) a foreign pass-through payment,
- Cannot produce a U.S.-source withholdable payment, and
- Are outstanding as of the date that is six months after the date final regulations defining foreign pass-through payments are filed with the Federal Register;
- Any instrument that gives rise to U.S.-source withholdable payments solely because it is treated as making a dividend equivalent payment under section 871(m) (provided the instrument is outstanding on the date that is six months after the date the instrument becomes subject to dividend treatment;)
- Any obligation to make a payment with respect to, or to repay, collateral posted to secure obligations under a notional principal contract that is a grandfathered obligation.
However, if any “significant modifications” are made to a grandfathered obligation, it will lose its grandfathered status and become subject to FATCA withholding.
Who is the Payee
The FATCA regulations classify foreign payees as FFI’s or NFFE’s. FFI’s generally include:
- Depository institutions
- Custodial institutions
- Investment entities
- Insurance companies and affiliated holding companies; and
- Holding companies and treasury centers that are part of an expanded affiliated group that includes a depository institution, custodial institution, insurance company, or investment entity
For a payment to an FFI to be exempt from FATCA withholding, the FFI will need to be a “participating” FFI, a “deemed-compliant” exempt FFI, or an FFI located in a country that has entered into an Inter-Governmental Agreement (IGA) with the USA. Otherwise, the withholding agent will be required to withhold 30%. The FATCA regulations specify how an FFI can be classified as exempt. If the FFI is not exempt, the withholding agent must withhold 30% on withholdable payments.
If an entity is not an FFI, it is an NFFE. The FATCA Regulations do not require withholding on payments to any NFFE that: (1) certifies to the withholding agent that it has no substantial U.S. owners; (2) reports substantial U.S. owners to the withholding agent; or (3) belongs to a class of NFFEs that Treasury and the IRS have designated as excepted NFFEs or exempt beneficial owners. Excepted NFFEs are:
- Publicly traded corporations and their corporate affiliates,
- Any entity organized under the laws of a possession of the United States,
- Any foreign government or any political subdivision or wholly owned agency thereof, any international organization or any wholly owned agency or instrumentality of such,
- Any foreign central bank (unless acting as an intermediary for clients),
- Excepted FFIs (the excepted nonfinancial group entities exception), and
- Active NFFEs
The FATCA regulations specify how an NFFE can be classified as an “active” NFFE, and how an NFFE can be “excepted” for withholding purposes. Unless an NFFE falls into one of the excepted categories, the withholding agent must withhold 30% on withholdable payments.
Compliance and Reporting
The IRS has issued extensive instructions with respect to electronic FATCA registration by FFIs. This registration process provides an FFI with a Global Intermediary Identification Number (GIIN) and allows it to be included in the list of FATCA-compliant entities. In the case of NFFEs, in most cases the withholding agent will be required to obtain IRS Form W-8BEN-E from the NFFE. This new eight-page form provides the withholding agent with the certification of FATCA-compliant status by the NFFE and permits the withholdable payment to be made without the 30% FATCA withholding tax. IRS Forms 1042 and 1042-S have been expanded to encompass the reporting of payments subject to FATCA, in addition to FDAP payments for which these forms have been used to date.
FATCA requires a concerted effort to review the law and regulations and to prepare or obtain documentation so that the withholding agent may make withholdable payments without the 30% FATCA withholding tax. FGMK can assist you in every stage of the FATCA process. If you have any questions about FATCA, please contact Fuad Saba, Managing Director, at (847) 964-5305.