Issues With FATCA Grandfathered Obligations

Transcription

1 Issues With FATCA Grandfathered Obligations October 7, 2014 Washington DC Stevie D. Conlon, Senior Director & Tax Counsel Wolters Kluwer Financial Services 1

2 Agenda FATCA withholding tax rules went into effect on July 2, 2014 Notice does not delay withholding tax rules or special rules for grandfathered obligations Understanding the FATCA grandfathering rules for debt and the impact of the February 2014 Amendments to the FATCA Regulations Understanding the Rules of Treas. Reg. Sec to determine if debt is materially modified Concerns regarding modifications of non-debt grandfathered obligations 2

3 Reporting Grandfathered Obligations IRS Form 1042 (2014) Annual Withholding Tax Return for U.S. Source Income of Foreign Persons Section 2: FATCA-specific reconciliations 3

4 Treas. Reg (b): FATCA Grandfathering a withholdable payment does not include any payment made under a grandfathered obligation described in paragraph (b)(2)(i)(a) of this section, or any gross proceeds from the disposition of such an obligation. Grandfathered obligation: giving rise to a dividend equivalent pursuant to section 871(m), provided that the obligation is executed on or before the date that is six months after the date on which obligations of its type are first treated as giving rise to dividend equivalents any agreement requiring a secured party to make a payment with respect to, or to repay, collateral posted to secure a grandfathered obligation. Obligation: Debt instrument or agreement to extend credit A derivatives transaction confirmed under an ISDA master Annuity contract payable for set period or for the life of annuitant Life insurance payable no later than death of insured individual(s) 4

5 FATCA Grandfathering Exclusions Does not include agreement or instrument: Equity for US tax purposes Lacks a stated expiration or term (Temp. Reg T(b)) Brokerage agreement, custodial agreement, investment linked insurance contract, investment linked annuity contract, or similar agreement to hold financial assets for the account of others Master agreement that merely sets forth standard terms and conditions that are intended to apply to a series of transactions between parties but that does not set forth all of the specific terms necessary to conclude a particular transaction Date outstanding: Issue date for debt If not debt, if a legally binding agreement establishing the obligation was executed between the parties to the agreement before such date 5

6 Notice : The FATCA May 2014 Relief Notice The Notice includes repeated use of the term obligation. At issue is the extent to which the use of the term obligation in the Notice has significance in the context of a withholding agent s responsibilities relating to grandfathered obligations pursuant to Treas. Reg. Sec (b). The underlying FATCA regulations do not appear to provide determinative guidance. Obligation appears to have an extremely broad meaning for purposes of Section 1471 and the FATCA rules. Obligation has a narrower, prescribed definition for purposes of defining grandfathered obligations that differs from the use of the term obligation in other FATCA contexts. 6

7 The FATCA May 2014 Relief Notice The notice does not include any reference to grandfathered obligations or the related grandfathered obligations FATCA regulation provisions. Without explicit reference, withholding agents face a risk that the Notice could be construed as not providing any relief for a withholding agent s obligations with regard to grandfathered obligations that begin on July 1, This conclusion appears consistent with the Notice s explicit statement that the IRS will not provide transitional relief with respect to its enforcement regarding a withholding agent s determinations of the character and source of payments for withholding and reporting purposes. Alternatively, even if the term obligation as used in the Notice was broadly construed to include grandfathered obligations, it appears that the relief would only relate to the IRS Notice s shorter six month relief period for obtaining and reviewing Forms W-8BEN-E, W-8IMY, etc. from entities. The Notice does not appear to support any relief beyond July 1, 2014 relating to obtaining and reviewing Forms W-8BEN from individuals. 7

8 Summary of Amendments to Grandfathered Obligations Regs amendments removed the reason to know standard of knowledge for material modifications for withholding agents that are not agents of issuer The standard for non-issuer agent withholding agents is now actual knowledge the withholding agent must have actual knowledge that a modification is material in order for a grandfathered obligation to lose grandfathered status Issuer agents are still subject to know/reason to know standard (note: custodians and trustees may be agents of issuers) Actual knowledge is not a defined term in the Code/Regs. Issuer disclosure is one way, but not the only way, that a withholding agent may have actual knowledge (issuer disclosure is provided as an example of actual knowledge, which implies other forms of actual knowledge are possible) 8

9 Amended Rule for Material Modifications: (b)(4)(iv) Determination of material modification. For purposes of paragraph (b)(2)(iv) of this section (defining material modification), a withholding agent, other than the issuer of the obligation (or an agent of the issuer), is required to treat a modification of the obligation as material only if the withholding agent has actual knowledge thereof, such as in the event the withholding agent receives a disclosure indicating that there has been or will be a material modification to such obligation. The issuer of the obligation (or an agent of the issuer) that is a withholding agent is required to treat a modification of the obligation as material if the withholding agent knows or has reason to know that a material modification has occurred with respect to the obligation. 9

10 Treas. Reg (b)(4)(ii) Knowledge Standards Issuer disclosures YES Knows/Has Reason To Know Actual knowledge other than issuer disclosure Withholding Agent Issuer/ Agent of Issuer? Reason to know NO Actual Knowledge Issuer disclosures Actual knowledge other than issuer disclosure 10 10

11 Observations Re: Actual Knowledge Standard Receipt of issuer disclosure is clearly actual knowledge But, what if unclear, or incorrect? What is (and is not) an issuer disclosure? Not defined New regulations do notprovide that an issuer disclosure is the only way to have actual knowledge What if You receive issuer disclosure from client or competitor? Issuer posts tax information on its web site? What if your internal tax counsel knows facts sufficient to determine that a material modification has occurred? Could the actual knowledge standard actually put you at a disadvantage if your level of tax expertise is superior to that of your competitors? What does actual knowledge mean? Broad vs. narrower interpretation 11 11

12 FATCA Grandfathering Overview Focus in this presentation is on rules for debt FATCA regulations require that security must be debt for tax purposes Tax analysis independent of issuer notices may be required Tax calculations as of the date of the change in terms under analysis, of adjusted issue price and amortized bond premium are required in order to apply the change in yield test Legal analysis is also required due to many rules of the regulation, including for determining if a change is a modification or a change in payment terms 12 12

13 FATCA and Grandfathered Obligations U.S. Withholding Agent FATCA Grandfathering Analysis No later than 7/1/2014 Every day after 7/1/2014 Step 1 Determine if obligation is grandfather-eligible Was obligation issued on/before 7/1/2014 Is obligation of requisite kind: debt for tax purposes, insurance or annuity, derivative collateral Step 2 Determine if a material modification occurs that causes obligation to lose grandfather status & become subject to withholding Check for issuer disclosure indicating material modification Determine if you have actual knowledge (or reason to if agent of issuer) that a material modification occurred, based on: Issuer disclosure Other methods 13 13

14 Material Modification Standard Is Existing Law In the case of an obligation that constitutes indebtedness for U.S. tax purposes, a material modification is any significant modification of the debt instrument as defined in (e). This is a tax law determination under existing law and regulations that were originally finalized in 1996 (and updated in 2011 and 2013). Testified on the proposed regulation in Wrote an article on the final regulation in Wrote opinions. IS FATCA material modification standard special or different than the general tax rule for determining if debt is materially modified? NO 14 14

15 Issuer Notices Are Not Enough Regulatory/legal interpretation: Issuer notice is not the exclusive manner by which a withholding agent has a actual knowledge that a material modification has occurred. Issuer notice is ONLY ONE WAY that a withholding agent has actual knowledge The regulations do not say only if issuer notifies agent. Industry asked the IRS to say this in comments on proposed regulations and the final regulations did not do so. [FIF Comment Letter ; Treas. Reg (b)(4)(ii)] RESULT: Withholding Agents have a new regulatory burden that requires consideration of whether they have actual knowledge based on facts that are not provided in an issuer notice 15 15

16 Analyzing the Tests Requires Legal & Tax Analysis A material modification of a debt instrument for FATCA grandfathered status depends on whether modifications result in a significant modification under Reg (e). Reg (b) provides that a change in the terms of a debt instrument must be a modification in order for it to be necessary to assess whether it is a significant modification. Reg (c) sets for the rules for assessing whether changes to the terms of debt instruments constitute a modification. These are legal tests, rather than simply data tests. See, e.g., Reg (c)(1)(ii) regarding alteration by operation of terms. These are also tax law tests. See, e.g., Reg (c)(2)(ii) regarding property that is not debt for tax purposes

17 Material Modification Significant Modification Tests 1. Collective modifications are significant ((e)(1)) 2. Change in annual yield greater than pre-existing yield (as of date of modification) of: (A) 25 basis points per full year of term of debt OR (B) 5% ((e)(2)) 3. Change in payments greater than a material change in payments that is lesser than a change that (A) results in material deferral of scheduled payments OR (B) extends original term more than 5 years or 50% of original term ((e)(3)) 4. Change in obligor (or co-obligor) on recourse debt ((e)(4)) (special rule for tax-exempt debt & certain other transactions) 5. Change in collateral on nonrecourse debt ((e)(4)(iv)) 6. Change in nature (to non-debt) or recourse to non-recourse (except for defeased tax-exempt bonds) ((e)(6)) 17 17

18 Detailed Tax Analysis Can Be Required Yield test (tax law based): adjusted issue price & bond premium Material deferral prong of payment test Change in payment expectations under priority test? Tax Analysis 18 18

19 FATCA Grandfathered Debt - Decision Matrix U.S. Debt Instrument Before Issue Date? After Grandfathered Debt (GFD) Material Modification? No Yes Actual knowledge/reason to know No Withholding No Yes Withhold on Payments to noncompliant FFIs 19 19

20 Material Modifications for Non-Debt Life insurance contracts: a material modification includes any substitution of the insured under the contract. Temp. Reg T(b)(2)(iv). No clear rules for material modification for nondebt/non-life insurance contracts: whether a modification of an obligation is material is determined based on the facts and circumstances. Rev. Rul and the fundamental change standard: key employee life insurance. Preamble to regulations explains that Rev. Rul and existing law applies to non-debt, NOT Extremely narrow scope of Treas. Reg regarding dealer/clearinghouse assignments of derivative contracts

21 Modifications of Non-Debt: Rev. Rul Preamble to debt mod regs( ) says you can t rely on the rules for nondebt (Preamble, T.D (1996)): For equity instruments in particular, the IRS and Treasury believe that the application of certain rules in these regulations would be inappropriate. Similarly, for contracts that are not debt instruments, the final regulations do not limit or otherwise affect the application of the fundamental change concept articulated in Rev. Rul Rev. Rul states: A change in contractual terms effected through an option provided in the original contract is treated as an exchange under section 1001 if there is a sufficiently fundamental or material change that the substance of the original contract is altered. What is a fundamental or material change? X exercised an option to change the insured from A, the original insured under the policy, to B,... This resulted in a change in the fundamental substance of the original contract because the essence of a life insurance contract is the life that is insured under the contract

22 Notional Principal Contracts, Options, Forwards & Short Sales Limited and narrow guidance: regarding dealer assignments of NPCs meeting certain conditions James S. Reilyv. Comm. (extension of option was not a continuation of original option term is an essential aspect) Rev. Rul (extension of option), obsoleted by Rev. Rul Rev. Rul (exchange of warrants on Y stock for warrants on X stock), modified by Rev. Rul GCM (Feb. 22, 1980) (call options with same terms except strike prices: substantially identical for wash sale purposes) Notice (assumption of option obligation), modified by Notice TAM (July 12, 2011) (analysis of 1001 consequences of modification of settlement, strike and term provisions of several different options) 22 22

23 Limitations and Disclaimers WoltersKluwer Financial Services does not provide tax advice. You should consult your own tax advisers and they (and not WoltersKluwer Financial Services, GainsKeeperor Capital Changes) are solely responsible for any tax, tax penalties or interest related to their tax returns GainsKeeper, this prototype and our related corporate action suite products are tools to assist taxpayers but do not cover a variety of specific tax rules or taxpayer circumstances and facts This document and its contents are confidential and proprietary and subject to non-disclosure restrictions that prohibit any redistribution thereof without the express written consent of Wolters Kluwer Financial Services 23 23