FATCA Regs Come Up Short For P&C Insurance Industry

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1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: FATCA Regs Come Up Short For P&C Insurance Industry Law360, New York (March 10, 2014, 6:41 PM ET) -- On Feb. 20, 2014, the U.S. Department of the Treasury and the Internal Revenue Service pre-released new final and temporary regulations under the Foreign Account Tax Compliance Act that supplement and modify the previous set of FATCA regulations issued in January The new FATCA regulations provide positive changes with respect to several issues raised by the property and casualty insurance industry, including revisions with respect to the treatment of: Holding companies that own insurance companies; Direct reporting and sponsored direct reporting nonfinancial foreign entities ("NFFEs"); Payments on certain offshore obligations where an insurance broker is involved; Premiums paid to U.S. insurance brokers acting as intermediaries for foreign insurers or reinsurers; Events of default under foreign financial institution ("FFI") agreements; Grantor trusts; and Exempt beneficial owners ("EBOs") that are members of an FFI s expanded affiliated group ("EAG"). Background In March 2010, Congress enacted the provisions of FATCA as part of the Hiring Incentives to Restore Employment Act (2010), in order to improve information reporting with respect to the foreign assets and income of U.S. persons. Thereafter, in January 2013, the Treasury Department and the IRS issued extensive final regulations that provided detailed rules governing the application of FATCA. Pursuant to these rules, certain U.S. source payments to foreign entities will be subject to FATCA withholding at a 30 percent rate beginning on July 1, 2014, unless the foreign entities receiving the payment agree to comply with the FATCA due diligence and information reporting rules. In response to numerous comments from the P&C insurance industry and other stakeholders, the new FATCA regulations contain more than 50 discrete amendments and clarifications to the prior FATCA regulations. See T.D. 9657, 79 Fed. Reg (Mar. 6, 2014). In conjunction with issuing the new FATCA regulations, the Treasury Department and the IRS issued coordinating regulations designed to harmonize the requirements under FATCA with the requirements contained in the pre-fatca rules under Chapters 3 and 61 of the Internal Revenue Code and IRC See T.D. 9658, 79 Fed. Reg (Mar. 6, 2014).

2 Holding Companies The prior FATCA regulations provided that a holding company otherwise was not an FFI would be treated as an FFI if it was a member of an EAG that included an "insurance company," notwithstanding the fact that the insurance company did not constitute a specified insurance company (i.e., an insurer that issues cash value insurance contracts or annuities). See Treas. Reg (e)(1)(v)(A) (as promulgated in T.D. 9610, supra). The new FATCA regulations adopt P&C insurance industry comments and amend the definition of an FFI so that a holding company will not be treated as an FFI merely because it is a member of an expanded affiliated group that includes an insurance company that is not a specified insurance company. See Temp. Treas. Reg T(e)(1)(v)(A). Direct Reporting and Sponsored Direct Reporting NFFEs In Notice , I.R.B. 503, the IRS announced its intention to amend the prior FATCA regulations to allow reporting by an NFFE or by the sponsor of an NFFE of the NFFE s substantial U.S. owners directly to the IRS rather than to withholding agents. This announcement was of particular interest to nonpublicly traded P&C insurance companies with substantial U.S. owners, as such companies did not relish the thought of providing information regarding their substantial U.S. owners to a multitude of withholding agents or dealing with the privacy concerns associated with the disclosure of that information. As previewed by Notice , supra, the new FATCA regulations provide certain NFFEs with the ability to elect to be treated as direct reporting NFFEs or sponsored direct reporting NFFEs. See Temp. Treas. Reg T(c)(3) through (5). In order to qualify as a direct reporting NFFE, an NFFE will need to satisfy the requirements described in Temp. Treas. Reg T(c)(3), which include: 1. Registering with the IRS on Form 8957 ("FATCA Registration") in order to obtain a global intermediary identification number (GIIN); and 2. Reporting directly to the IRS on Form 8966 ("FATCA Report") the following information for each calendar year: a. The name, address and TIN of each substantial U.S. owner of such NFFE; b. The total of all payments made to each substantial U.S. owner; c. The value of each substantial U.S. owner s equity interest in the NFFE; d. The name, address and GIIN of the NFFE; and e. Any other information as required by Form 8966 and its accompanying instructions. Furthermore, an NFFE will constitute a sponsored direct reporting NFFE if: (1) the NFFE qualifies as a direct reporting NFFE and (2) another entity, other than a nonparticipating FFI, agrees with the NFFE to act as its sponsoring entity, as described in Temp. Treas. Reg T(c)(5)(ii). See Temp. Treas. Reg T(c)(5)(i). As signaled by Notice , supra, the new FATCA regulations treat an NFFE that qualifies as a direct reporting NFFE or sponsored direct reporting NFFE as an excepted NFFE. See Temp. Treas. Reg T(c)(1). Thus, a withholding agent generally will not be required to withhold (under IRC 1472(a)) on a withholdable payment made to such an NFFE.

3 Offshore Obligations Under the prior FATCA regulations, payments made with respect to an offshore obligation prior to Jan. 1, 2017, would not have constituted withholdable payments unless they were paid by an intermediary. See Treas. Reg (a)(4)(vi) (as promulgated in T.D. 9610, supra). This rule seemed to preclude the use of transitional relief for reinsurance premiums paid between foreign insurers and reinsurers on U.S. risks in situations where a broker is involved, which is almost always the case. The new FATCA regulations provide that insurance brokers will not be treated as intermediaries for purposes of this transitional relief. See Temp. Treas. Reg T(a)(4)(vi). Although the new FATCA regulations offer this helpful clarification, they nonetheless may have inadvertently excluded insurance and reinsurance premiums from the definition of offshore obligation that is now provided under Temp. Treas. Reg T(b)(88). The Treasury Department and IRS are aware of this potential oversight, and we hope that they will clarify that the transitional relief does apply to foreign insurance and reinsurance obligations. Definition of Payee The prior FATCA regulations provided that a withholding agent that makes a payment to a U.S. agent or intermediary must obtain information regarding the beneficial owners of the payment. See generally Treas. Reg (b) (as promulgated in T.D. 9610, supra). Thus, under these rules, withholding agents would be subject to increased due diligence and data collection requirements with respect to withholdable payments made through insurance brokers that are not the beneficial owners of such payments. The new FATCA regulations address this issue, at least in part, by allowing a withholding agent to treat a U.S. insurance broker as a payee with respect to a withholdable payment to the extent that such payment is a payment of premiums. See Temp. Treas. Reg T(a)(3)(iii). Notably, however, this new rule does not appear to address withholdable payments made by withholding agents to foreign insurance brokers who likewise are not the beneficial owners of such payments. Therefore, the increased due diligence and data collection requirements still may apply when insurance and reinsurance premiums are paid through a foreign insurance broker. Event of Default The new FATCA regulations revise the rule regarding what constitutes an event of default under an FFI agreement. Specifically, under the new FATCA regulations, an event of default will occur for a participating FFI where the participating FFI fails to significantly reduce the number of account holders or payees that the participating FFI is required to treat as recalcitrant account holders or nonparticipating FFIs. This could be a result of the participating FFI s failure to comply with the required due diligence procedures for the identification and documentation of account holders and payees. See Temp. Treas. Reg T(g)(1)(ii). Thus, for example, an event of default should not be deemed to occur under an FFI agreement merely because of a change in the FATCA status of the participating FFI s account holders. Grantor Trust Rules

4 In order to address certain issues associated with the determination of the substantial U.S. owners of a foreign grantor trust and whether such persons should be considered account holders, the new FATCA regulations treat a grantor trust as an account holder, rather than the trust s owners or beneficiaries. See Temp. Treas. Reg T(a)(3)(i). EBOs The prior FATCA regulations generally required that each FFI within an EAG be either a participating FFI or a registered deemed-compliant FFI. See Treas. Reg (e)(1) (as promulgated in T.D. 9610, supra). However, as a practical matter, some FFIs within an EAG will be EBOs. In view of this reality, the new FATCA regulations allow EBOs to be excluded from the requirement that each FFI within an EAG be either a participating FFI or a registered deemed-compliant FFI, meaning that such EBOs should not have to register with the IRS. See Temp. Treas. Reg T(e)(1). Additional Changes of Note The new FATCA regulations also adopt a number of changes previewed in Notice , I.R.B. 113, and Notice , supra, including: The revised timelines for the implementation of FATCA. The coordination of withholding under Chapter 4 and backup withholding under IRC The treatment of FFIs located in jurisdictions that have signed intergovernmental agreements (IGAs) for the implementation of FATCA but have not yet brought those IGAs into force. The modification of the definition of U.S. person to include a foreign insurance company that has made an election under IRC 953(d) to be treated as a U.S. corporation for federal tax purposes and that either is not a specified insurance company or is a specified insurance company that is licensed to do business in any state. See Temp. Treas. Reg T(b)(141). The clarification of FFI withholding statement requirements. See Temp. Treas. Reg T(c)(3)(iii)(B)(2). The modifications to the transitional reporting requirements for a participating FFI or registered deemed-compliant FFI making a payment of a foreign reportable amount to a nonparticipating FFI. See Temp. Treas. Reg T(d)(2)(ii)(F). The clarification of the term branch with respect to an FFI to include an entity that is disregarded as an entity separate from the FFI for federal tax purposes. See Temp. Treas. Reg T(e)(2)(ii). Conclusion Although the new FATCA regulations address certain concerns of the P&C insurance industry, they fail to respond to the industry s two primary comments. First, insurance companies, like all other businesses, should be excepted from the reporting and withholding rules that apply to NFFEs if they are actively engaged in the insurance business. By carrying forward the previous definition of active into the new FATCA regulations, the Treasury Department and IRS have effectively eliminated any realistic possibility that there will ever be an insurance company that would fall under the exception for active NFFEs. See Temp. Treas. Reg T(c)(1)(iv); cf. Treas. Reg (c)(1)(iv) (as promulgated in T.D. 9610, supra).

5 Second, withholdable payments should not include noncash value insurance premiums paid in the ordinary course of business. Rather, such payments should be treated as they are for purposes of Chapter 3 of the IRC and generally dealt with under the federal excise tax rules of IRC Needless to say, the failure to address these comments could lead to the reporting of thousands of ordinary course payments, with no apparent compliance benefit. Notwithstanding their failure to address these important issues, the new FATCA regulations are a significant improvement over the prior FATCA regulations. However, in view of the significant commercial consequences associated with the questions that remain outstanding, we are confident that we have not heard the final word on the application of FATCA to the P&C insurance industry. By William R. Pauls, Saren R. Goldner and Rich Sun, Sutherland Asbill & Brennan LLP William Pauls is a partner in Sutherland Asbill & Brennan s Washington, D.C., office, where he is a member of the firm's tax practice group and concentrates on insurance company tax matters, including structuring and implementing captive insurance company arrangements, the federal tax consequences of reinsurance transactions, and complex international insurance tax issues. Saren Goldner is of counsel in Sutherland Asbill & Brennan's New York office. Rich Sun is an associate in Sutherland Asbill & Brennan's Washington, D.C., office. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. All Content , Portfolio Media, Inc.