IRS regulations The Foreign Account Tax Compliance Act (FATCA) and its impact on the US foreign withholding tax and reporting system

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1 IRS regulations The Foreign Account Tax Compliance Act (FATCA) and its impact on the US foreign withholding tax and reporting system What is FATCA? The Foreign Account Tax Compliance Act (FATCA) is a new US law, which will enter into effect on January 1, 2013 and represents a significant modification of the US foreign withholding tax and reporting system. It adds a new chapter to the Internal Revenue Code (Chapter 4), which is aimed at addressing the perceived tax abuse by US persons who use offshore accounts. FATCA will require foreign financial institutions (FFI s) to enter into an agreement with the IRS, under which the foreign financial institution is obligated to report directly to the IRS, certain information about financial accounts and investments held by: US person 1 or, by foreign entities in which US Person hold an ownership interest. By entering into an FFI agreement, FFI s will commit to applying the strict account verification and due diligence procedures, as prescribed by the FATCA regulations. US based financial institutions and their foreign branches (USFI s) are not required to enter into agreements with IRS. However, they will have similar FATCA obligations enforceable by the IRS. In those cases where a financial institution has a client who is non-compliant with FATCA, the financial institution must apply a withholding tax of 30% on certain US source payments to that client. Who will be impacted? In general, FATCA will impact on all US and foreign financial institutions and their clients. Generally, for the purposes of FATCA, a Financial Institution is amongst others: a bank, broker dealer, hedge fund, private equity fund, trustee company, securitization vehicle and a personal holding company. You will be affected if you are a: US Financial Institutions USFI s are already required under existing US tax law to report or withhold on US individuals 2. However, currently a US withholding agent has no responsibility to identify owners of a non-us entity 3. 1 US taxpayers are often referred to as a US persons, please see the Acronyms and definitions list at the end of this document for a more comprehensive description. 2 USFIs are required to obtain documentation from individuals to establish their U.S. or non-u.s. status, and to file Form 1099 information reporting annually with respect to U.S. investors. Non compliant US person will suffer 28% backup withholding. 3 Note exceptions may apply if it concerns a Foreign Intermediary, Foreign Flow-Through Entity, or if the US withholding agent has reason to doubt the certification provided by the foreign entity. 1 The Citco Group of Companies, October 2011

2 FATCA introduces an additional obligation for a USFI s to identify and report US direct and indirect owners of foreign entities. In respect of payments to non-compliant foreign entity clients, USFI s may have to apply FATCA withholding on qualifying US source payments. Foreign Financial Institutions (FFI s) FFI under FATCA includes any non-us entity that: Accepts deposits in the ordinary course of a banking or similar business, As a substantial portion of its business, holds financial assets for the account of others, or Is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities. FFI s with US investment exposure will have to enter into an FFI agreement with the IRS and comply with reporting and withholding regulations or they may suffer FATCA withholding on qualifying US source payments they receive from USFI s. Non-Financial Foreign entities (NFFE) Foreign entities who are not qualified as FFI s will be considered as NFFE s under FATCA. NFFE s do not have FATCA reporting or withholding obligations towards the IRS. However, a NFFE which is a client of, or investor in a participating FFI or USFI, maybe be asked by their FFI or USFI s to provide FATCA certification on the US or non-us tax status of their ultimate direct or indirect owners. If the required information is not provided within a certain time frame, the account held by the NFFE will deemed to be non-compliant and may suffer FATCA withholding. Compliant accounts held with, or investments in FFI s or USFI s, by NFFE s with direct or indirect owners being US taxable persons, may be reported to the IRS by the FFI. Generally the following category of NFFE s are excluded from FATCA withholding and reporting: Non-financial foreign affiliated groups whose stock is regularly traded on an established securities market; Foreign governments; Central banks and, International organizations. Individuals Individual clients of, or investors in participating FFI s may be asked by their FFI to provide the required certification on their US or non-us tax status. If the required information is not provided within a certain time frame, their accounts may be deemed non-compliant and may suffer FATCA withholding. Accounts held with or in FFI s by US persons maybe reported to the IRS by the FFI. 2 The Citco Group of Companies, October 2011

3 What information will be disclosed to the IRS? With respect to US individuals and US ultimate owners of NFFE s: their identity including the name, address and Tax Identification Number (TIN) the account number ; and the account balance or value. FFI s that are funds may also be required to report the gross amount of distributions, interest, and similar amounts credited during the year; each redemption payment; as well as gross withdrawals with respect to accounts that are closed or transferred. While detailed guidance regarding reporting requirements has not been issued, it is anticipated that the above described reporting will be required for post-2013 years. However, under recently released transition guidance, only the December 31, 2013 account balances would be required to be reported for the 2013 transition year. Which payments will be subject to FATCA withholding? The 30% FATCA withholding tax will be applicable on qualifying US source payments to non-compliant FFI s 4, NFFE s and Individuals. More specifically: USFI s will have to withhold 30% FATCA withholding tax on US source income payments including certain payments of certain 5 gross proceeds to: FFI s that have not entered into an agreement with the IRS ( non-participating FFI s ) NFFE clients 6 who failed to provide the required FATCA compliance information ( recalcitrant account holders ). FFI s will have to withhold a 30% FATCA withholding tax on certain payments of US source income and certain gross proceeds they pass on ( Passthru payments ) to: Non-participating FFI s and, NFFE and Individual recalcitrant account holders. The Passthru payment withholding obligation will be enforced through the participating FFI s agreement with the IRS and is deemed necessary by the IRS in order to prevent participating FFI s from functioning as FATCA blockers for indirect US investments of recalcitrant account holders and non-participating FFI s. The FATCA withholding regime and especially the Passthru payment withholding obligation, differ significantly from the existing non-resident US withholding and reporting regime. Both regimes serve a different purpose 7 and will exist alongside each other. 4 FATCA withholding will not apply to payments made to or received by USFI s. 5 Tax would also be imposed on disposition proceeds of a security that produces interest or dividends subject to FATCA withholding. 6 USFI s will follow the existing backup withholding regime for Individual recalcitrant accountholders. 7 The existing US withholding and reporting regime on Fixed, Determinable, Annual, Periodical (FDAP) US source income aims to ensure taxation on US source income earned by non-us persons. While FATCA is aimed at the information reporting on US persons that invest through FFI and foreign entities. 3 The Citco Group of Companies, October 2011

4 When will FATCA become effective? The preliminary FATCA guidance as provided by the US treasury up to the moment of this publication provides for a phased implementation starting on January 1, The US Treasury has deferred the first reporting deadline to September 30, 2014 and intends to introduce the FATCA withholding regime in the following phases: On January 1, 2014 USFI s are scheduled to start withholding on qualifying US source income payments to non-participating FFI s. On January 1, 2015 USFI s are scheduled to start withholding on qualifying US source income and gross proceeds payments to non-participating FFI s and recalcitrant account holders. No later than January 1, 2015 FFI s are scheduled to start withholding on Passthru payments to non-participating FFI s and recalcitrant account holders. In order to avoid FATCA withholding by USFI s as of January 1, 2014, FFI s will have to enter into an agreement with the IRS before June 30, Although, FATCA has been signed into law, preliminary guidance in the form of notices and/or regulations from the US Treasury will further clarify the reporting and withholding requirements. The proposed regulations are expected by the end of 2011 and final regulations are expected by the summer of Disclaimer: The proposed rules set forth in the IRS Notices discussed herein constitute preliminary guidance only, and may change significantly before they are finalized This note is intended to provide a high level understanding of the subject under consideration. It does not purport to give legal or financial advice that may be acted or relied upon. Specific professional advice should always be taken in respect of any individual matter. 4 The Citco Group of Companies, October 2011

5 Acronyms and definitions: FATCA : Foreign Account Tax Compliance Act FFI : Foreign financial institution (FFI) USFI : US Financial Institution (USFI) NFFI : Non-financial Foreign entity (NFFE). FDAP : Fixed, Determinable, Annual, Periodical US source income. Passthru payments : US source income and gross proceeds passed on by FFI s to clients Non-participating FFI : Foreign financial institution that did not enter into a FATCA agreement with the IRS. Recalcitrant accountholders: Individual or NFFE client who failed to provide the required FATCA compliance information to a FFI or USFI. Non-+compliant client : A recalcitrant accountholder or Non-participating FFI Foreign Entity : The term foreign entity means any entity which is not a US person. US person 8 : This term is widely used in US tax law to describe groups of US taxpayers that are taxed by the US on their worldwide income. US persons can be broadly categorized in the two groups: Individuals, for example: US citizens, Anyone born in the US, Either parent US, Passport irrelevant: US residents, Green card holder; or Anyone meeting the substantial US physical presence test. US Entities, for example: Entities created or organized in the US. 8 This description is intended to provide a high level understanding of the term US person. It should not be relied upon and specific professional advice should always be taken in respect of any individual matter. 5 The Citco Group of Companies, October 2011

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