Analysis of Final FATCA Regulations

Transcription

1 Analysis of Final FATCA Regulations January 2013 kpmg.com

2 For more information about the FATCA regulations, contact a tax professional with KPMG LLP: General information: Laurie Hatten-Boyd [email protected] Carl Cooper [email protected] Banking: Mark Price [email protected] Mark Naretti [email protected] Mindy Schmidt [email protected] Funds: Emma Preston [email protected] David Richardson [email protected] Deanna Flores [email protected] Insurance companies: Craig Pichette [email protected] Fred Campbell-Mohn [email protected] Jean Baxley [email protected] kpmg.com ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. NDPPS

3 On January 17, 2013, the U.S. Department of Treasury (Treasury) and the Internal Revenue Service (IRS) released the final regulations for the Foreign Account Tax Compliance Act (FATCA). Since the enactment of FATCA in March 2010, Treasury and the IRS have issued several rounds of preliminary guidance, including proposed regulations. The recently released final regulations have been much anticipated by taxpayers that expect to be affected by the new FATCA withholding and reporting regime, particularly in light of the looming January 1, effective date. On January 21, 2013, KPMG released a high level analysis of key changes in the final rules. See TaxNewsFlash-United States: FATCA KPMG s initial analysis of final regulations This document contains a more comprehensive analysis of the changes, by section, incorporating salient points from the initial release. Background In an effort to curb perceived tax abuses by U.S. persons with offshore bank accounts and/or investments, Congress passed broad-sweeping legislation intended to combat offshore tax evasion by such persons. Specifically, FATCA, signed into law on March 18, 2010, incorporates a new Code chapter 4 reporting regime that is designed to achieve this stated intent by imposing a severe withholding tax on certain foreign entities that refuse to disclose the identities of these U.S. persons. The statute, while providing very general information with respect to the new withholding and reporting rules, deferred much of the administration and implementation of the new regime to Treasury and the IRS. While uncertainty remains (given the adoption of an intergovernmental alternative approach to FATCA, which many countries are expected to follow, and the lack of final withholding certificates, reporting forms, and the need for the updated regulations under chapters 3 and 61), the final regulations take affected entities one step closer toward the ability to implement their FATCA compliance programs. The Preamble to the final regulations provides that Treasury and the IRS carefully considered stakeholders comments in an effort to develop an 1 December 31, 2013, for Participating Foreign Financial Institutions (PFFI). 1

4 implementation approach that achieves an appropriate balance between fulfilling the important policy objectives of chapter 4 and minimizing the burdens on stakeholders. Significantly, Treasury and the IRS stated they have carefully considered the hundreds of comments received and established three avenues for addressing the principal concerns burdens, legal impediments, and technical implementation. Their methodology for addressing the first avenue was to adopt a risk-based approach to effectively address policy concerns, eliminate unnecessary burdens and, when possible, build on existing practices and obligations. To address the local impediments, Treasury and the IRS collaborated with other governments to develop the alternative intergovernmental approach via intergovernmental agreements (IGAs) that eliminate those conflicts of law while achieving the intent of the statute. Treasury and the IRS addressed the third avenue by stating it will simplify the process for foreign financial institutions (FFIs) registering and executing the FFI Agreement. Detailed analysis As mentioned above, in finalizing the FATCA rules, Treasury and the IRS made efforts to minimize burdens, when possible, and to address the issue of local law conflicts. Below is a comprehensive, section-by-section, analysis detailing certain changes made. Reg. section Withholding requirements on withholdable payments to certain FFIs There were several significant changes associated with the rules set forth in Reg. section Namely, the expansion of the grandfathered obligation rules, clarification relating to the election by a PFFI to be withheld upon, the reservation on a prior rule relating to withholding on proceeds, and the rules relating to withholding agents when they have a lack of knowledge regarding the payment. Grandfathered obligations The most notable change to this section is the expansion of the grandfathered obligation rules. Pursuant to the statute, a withholding agent would not be required to impose FATCA s penal withholding on any payments, including the gross proceeds from any disposition, related to an obligation that was outstanding on March 18, The proposed regulations extended this relief by excluding, from the definition of 2

5 withholdable or passthru payment, any payment made under an obligation outstanding on January 1, The final regulations extend this date further to include any obligation outstanding on January 1, The regulations also incorporate additional relief set forth in Announcement (namely, an extension of this relief for: (1) obligations the payments of which will be captured under section 871(m) that are executed on or before the date that is six months after the date such obligations will be subject to those rules; and (2) any obligation the payment of which will be captured under the foreign passthru payment rules if the obligation is executed on or before the date that is six months after the date the final regulations defining that term are filed with the Federal Register). The final regulations make clear that the withholding relief also applies to any agreement requiring a secured party to make a payment with respect to, or to repay, collateral posted to secure a grandfathered obligation. Other changes to the grandfathered rules include coverage for life insurance contracts that are payable upon the death of the insured. The proposed regulations did not include such contracts within those having the requisite definitive term. In addition, to alleviate concerns voiced by withholding agents, the final rules provide that a withholding agent who is not the issuer of an obligation may, absent actual knowledge or reason to know otherwise, rely on a written statement by the issuer regarding whether the obligation qualifies for the grandfathered treatment. In addition, the withholding agent is only required to treat a modification as disqualifying the obligation from meeting the requirements for withholding relief, if it knows or has reason to know such modification was material. For this purpose, the withholding agent will be treated as having reason to know if it receives a disclosure from the issuer. As a final point, as indicated above, it is important that a withholding agent understand that this exception relates to withholding only. A withholding agent that is a PFFI would still be required to identify the account and report, when required. Election to be withheld upon The final regulations parallel the proposed regulations regarding what withholding agents can make an election to be withheld upon (i.e., a PFFI or RDCFFI that is a: (1) nonqualified intermediary (NQI), nonwithholding foreign partnership (NFP) or nonwithholding foreign trust (NFT); or (2) a QI that has not assumed chapter 3 withholding responsibilities). Specific to this, a withholding foreign partnership (WP) and a withholding foreign trust (WT) or QI that has assumed chapter 3 withholding responsibilities is not permitted to make an election to be withheld upon. 3

6 Interestingly, however, the regulations also prohibit a QI branch of a U.S. financial institution from making such an election. Given Treasury and the IRS s stated intent to follow the chapter 3 rules, this appears to be a drafting error. The final regulations further clarify that, similar to the chapter 3 rules, the electing QI can make this election on an account by account basis. Finally, the regulations have reserved whether this election will also be permissible on the payment of gross proceeds. Brokers (delivery versus payments) For brokers, it is interesting to note that the final regulations removed (and reserved) the withholding provision relating to payments of gross proceeds. Specifically, the rule in the proposed regulations would have required each broker, including those that pay proceeds in a delivery versus payment or cash on delivery transaction, to withhold on the proceeds by reference to the FATCA status of the payee. This was an unusually onerous requirement based on the nature of these transactions (very high volume with no current processes or procedures in place to document the next broker in the chain or to withhold or report on the payment). Because this provision is reserved and not eliminated entirely, it may be premature for potentially affected brokers to find much comfort. Lack of knowledge Many withholding agents raised concerns regarding a lack of knowledge of facts surrounding a payment when they are in the chain of payment but only following payment instructions. For example, the payment instruction may provide that the payment is a dividend payment on a U.S. security but the withholding agent in the chain does not know any other facts relating to the payment (e.g., whether withholding is required and, if so, whether the originating withholding agent has already imposed withholding). To address this issue, the proposed regulations cross-referenced a provision in chapter 3 that eliminates the requirement to withhold when the withholding lacks certain knowledge. While the final regulations do not change this rule, they do eliminate the cross reference and, instead, set forth the precise rule. The problem with the provision is the continued exception for payments with respect to stock or other securities. It is unclear why relief is not available for this type of payment. As indicated in the example, above, it is very possible that the withholding agent does know the payment is made with respect to stock but nevertheless lacks the requisite knowledge of other salient facts related to the payment (Who is the beneficial owner? Is withholding required? Has it already been imposed? etc.) 4

7 Further, it is unknown whether this exception would apply when the payment was with respect to stock but the withholding agent did not know that when the payment was made (for example, when the payment instruction does not contain any information relating to the type of payment). As drafted, it would appear that the exception would still not apply, and thus, the withholding agent that failed to impose withholding would remain liable. Finally, adopting another similar concept from the chapter 3 rules, the final regulations provide that when the withholding agent is unable to determine the source or character at the time of payment, it must treat the payment as a U.S. source withholdable payment. Causing some unnecessary confusion, however, is the example relating to unknown source (the example addresses a circumstance when the withholding agent does not know the source of services income because it does not know whether the services were performed in the United States). The example is confusing because the regulations make clear that payments for services are not subject to chapter 4. See Reg. section below. On a positive note, the regulations do provide that, when this does occur, the withholding agent can place the withholding associated to the undeterminable payments in escrow for a period of one year before it must pay them to the IRS. Given the breadth of the presumption rule in these circumstances, this procedure should help to eliminate unnecessary refund claims (i.e., the withholding agent should be able to resolve many instances of improper withholding within that year). Reg. section Payee identification Treasury and the IRS made many concessions relating to the payee identification rules, including loosening certain account documentation requirements. They also addressed issues with forms that are not completed properly, due diligence and presumption rules, electronic submission of documentation, record retention, and the use of third-party documentation. As indicated below, however, some of the changes are likely to cause problems for withholding agents. Loosening certain account documentation requirements (including validity periods) The final regulations contain much needed account documentation relief in various instances. For certified deemed compliant FFIs (other than the new category of sponsored FFI), retirement funds, nonprofit organizations, and excepted NFFEs, the final regulations provide that a withholding agent must obtain a withholding certificate with the proper certifications. Unlike the proposed regulations, however, the withholding agent is no longer required to also obtain financial statements, letters from counsel, etc., to corroborate the claims made. 5

8 The final regulations also include additional relief for payments made with respect to an offshore obligation (generally a requirement to obtain only written statements when the account holder does not receive payments of U.S. source FDAP and written statements and documentary evidence when it does). 2 Significant to this, the term documentary evidence has been expanded to include certain credit reports and certain information contained in government websites, in addition to the usual government issued documents. For offshore obligations, the final regulations have eliminated the requirement that a written statement include a penalties of perjury statement where there is no payment of U.S. source FDAP. For certain U.S. account holders, the regulations permit a withholding agent to rely on documentary evidence in lieu of a Form W-9. At first glance, this appeared to be a substantial departure from the proposed regulations that had effectively eliminated the so-called eyeball test and required a withholding agent to presume certain exempt recipients (i.e., corporations and financial institutions) to be NPFFIs unless a Form W-9 was on file. Because withholding agents are not required to obtain Forms W-9 from these entities under the current withholding and reporting regime, this would have required very expensive remediation efforts. It is significant to point out, however, that this new provision references a withholding agent s ability to eyeball an exempt recipient and not eyeball a U.S. person other than a specified U.S. person. Specifically, when the withholding agent can determine the payee is a U.S. person through documentary evidence and an exempt recipient through the documentation and/or the so called eyeball test (e.g., the entity has a clear corporate designation in it name) the withholding agent can treat the payee as a U.S. person that is other than a specified U.S. person. Given this, an entity may, in fact, be a privately held U.S. corporation (which under the FATCA rules, is a specified U.S. person) and never reported upon. Consequently, it appears inevitable that Treasury and the IRS will be modifying the definition of an exempt recipient as it relates to a corporation to include only those corporations that are publicly traded when they harmonize the existing withholding and reporting regulations (chapters 3 and 61) to the FATCA regulations. Thus, the relief is not likely to be as broad as withholding agents had hoped. The final regulations do provide some welcomed documentation relief for owner documented FFIs (ODFFIs). First, the reporting statement and documentation requirement have been scaled back to require information relating only to direct or indirect owners that are individuals and specified U.S. persons (looking through all entity owners for such persons). Second, the reporting statement is 2 For this purpose, the definition of payment made with respect to an offshore obligation means a payment made outside the United States, within the meaning of Reg. section (e), with respect to an offshore obligation. This definition is significant because, pursuant to those rules, a payment is not made outside the United States under those rules where the payment is processed and mailed from within the United States notwithstanding the fact that it is physically mailed to a foreign address (or credited to a foreign bank account). 6

9 no longer required to contain allocation information and is no longer required to be updated annually. Third, the final regulations provide additional relief for offshore accounts when the ODFFI s account balance is $1 million or less. For those accounts, the withholding agent may treat the account as held by an ODFFI if it has collected documentation sufficient to identify any owner that is an individual or specified U.S. person, the documentation obtained satisfies its AML due diligence requirements, the withholding agent has sufficient information to report all specified U.S. persons, and the withholding agent does not know or have reason to know the entity has any contingent beneficiaries, unidentified owners, NPFFI owners, or that any NPFFIs or specified U.S. persons own a debt interest in excess of $50,000 in the payee (other than a specified U.S. person that the withholding agent has sufficient information to report). Another area of significant relief is found in the final regulation s provisions relating to documentation validity. Under the proposed regulations, absent a change in circumstances, the validity period for most documentation was the year signed (year presented for documentary evidence) plus three full calendar years. For documentary evidence with an expiration date, the validity period ended on that expiration date, even if the date was before the end of the threeyear period. This rule was very onerous because, under anti-money laundering (AML) and know your customer (KYC) regulations, a withholding agent is rarely required to refresh documentation, even if it has expired. The final regulations provide, as the general rule, the three plus rule outlined above. Of particular interest, however, are the numerous new exceptions. Specifically, absent a change in circumstances, the following documentation (among others) will have an indefinite validity period: Withholding certificate or statement from a PFFI or registered deemed compliant FFI (RDCFFI) that has furnished a Global Intermediary Identification Number (GIIN) that has been verified pursuant to those requirements; A Form W-8BEN provided by an individual claiming non-u.s. status if it is supported by documentary evidence and there are no current U.S. addresses or U.S. telephone number(s) that are the only telephone number(s) on file; A withholding certification from any of the following entities claiming non- U.S. status (if such entity is the payee and the withholding certificate is furnished with documentary evidence establishing the entity s non-u.s. status): o Exempted retirement fund or an entity wholly owned by such fund o Excepted non-financial group entity o 501(c) entity 7

10 o Non-profit organization o Nonreporting IGA FFI o Territory financial institution that agrees to be treated as a U.S. person o NFFE whose stock is regularly traded (and an affiliate thereof) o An active NFFE (that is monitored through AML due diligence) o Sponsored FFI A withholding certification from an intermediary, flow-through entity, or U.S. branch (not including the underlying owner documentation or withholding statement); A withholding certificate, written statement, or documentary evidence furnished by a foreign government, government of a U.S. territory, foreign central bank (including the Bank for International Settlements), international organization, or an entity that is wholly owned by any such entities; and Documentary evidence that is generally not renewed (e.g., articles of incorporation). In addition, the list is expanded for offshore obligations: A Form W-8BEN or documentary evidence provided by an individual claiming non-u.s. status if the withholding agent does not have current U.S. addresses, U.S. telephone number(s) that are the only telephone number(s), or standing instructions to make a payment into the United States on file; A withholding certificate, written statement, or documentary evidence provided any of the following entities (if such entity is the payee): o Exempted retirement fund or an entity wholly owned by such fund o Excepted non-financial group entity o 501(c) entity o Non-profit organization o Nonreporting IGA FFI o Territory financial institution that agrees to be treated as a U.S. person o NFFE whose stock is regularly traded (and an affiliate thereof) o An active NFFE (that is monitored through AML due diligence) o Sponsored FFI A withholding certificate of an ODFFI; 8

11 A reporting statement of an ODFFI with account balance $1 million or less (if no contingent beneficiaries or designated class of unidentified beneficiaries); A withholding certificate of a passive NFFE or excepted territory NFFE if the account balance does not exceed $1 million (and the withholding agent does not know or have reason to know the entity has contingent beneficiaries or designated classes of unidentified beneficiaries). Accommodations for substitute forms The final regulations clarify the requirements for substitute forms and permit the withholding agent to create a substitute form in foreign languages. They also also permit the person completing the form to do so in a language other than English (as long as the withholding agent will translate the content upon IRS request). While the certifications must be the same as IRS forms, the penalties of perjury statement is not required if the withholding agent also has documentary evidence supporting the payee s non-u.s. status. Interestingly, and likely an insight into the certifications on the final IRS forms, the regulations require the certifications on substitute forms to include a certification that the payee will notify the withholding agent within 30 days if there is a change in circumstance that causes the claim on the form to be incorrect. Issues relating to incomplete/incorrect forms Another important provision relating to documentation addresses inconsequential errors. Specifically, the regulations provide that an inconsequential error will not invalidate a tax form if the withholding agent has other account file information that conclusively cures the error. Troubling, however, is an example that describes a country abbreviation on a form provided by an individual. The example concludes that the withholding agent can cure the abbreviated address if it has government-issued identification for the person that reasonably matches the abbreviated country on the form. The example is troubling because, both informally at withholding conferences and on audit, the IRS has generally taken the position that an abbreviated country on a Form W-8 does not invalidate the form as long as the withholding agent can easily discern the country from the abbreviation (e.g., U.K.). In addition, because the form is only being used to establish non-u.s. status, if additional documentary evidence is to be required, government issued identification from any non-u.s. country should suffice. The regulations also make clear that a form or statement is not invalid if completed by a director of an entity. Withholding agents and the IRS have experienced a long-standing disagreement with respect to who should be able to complete a withholding certificate for an entity and, in particular, acceptable titles on the certificate s capacity line. While this provision provides some limited relief, 9

12 the issue may be theoretical in the future, assuming the IRS sticks with the new capacity check box in lieu of the prior capacity line which required the signer to include an actual title on the form. Due diligence The due diligence rules, relating to when a withholding agent has reason to know that documentation is invalid or otherwise incorrect, are modeled very much after the existing chapter 3 rules. Specifically, the general rule provides that a withholding agent has reason to know that a claim made on documentation is invalid when a reasonably prudent person in the position of a withholding agent would question the claim made. As in chapter 3, the rules continue with specific fact patterns when a withholding agent would have such reason to know that a claim of foreign status was incorrect and the requisite curative documentation that it must obtain before it can accept the payee s original claim. These so-called red flags are very similar to those set forth in the chapter 3 rules (e.g., U.S. address, or, for offshore obligations, standing instructions to pay inside the United States). In addition, the chapter 4 rules add two more flags that withholding agents should be looking for when a payee claims foreign status U.S. birthplace and U.S. telephone numbers. In the proposed regulations, there had been one very important distinction between the two sets of rules clear safe harbor language in the chapter 3 rules. Specifically, for withholding agents that are financial institutions, the chapter 3 due diligence rules limit the circumstances of reason to know to those specifically stated in the regulations. The final regulations fix this inconsistency and make clear that a withholding agent has reasons to know that a claim of foreign status is invalid or incorrect only if there is one of more of the listed U.S. indicia associated with the account. 3 It is interesting to note that when the curative documentation requires a written explanation, the final regulations provide that such a written explanation can take the form of a checklist provided from the withholding agent. Historically, the IRS has resisted such checklists as meeting the standards for a written explanation for purposes of chapter 3 audits. One unsettling point relating to a withholding agent s reason to know is a new provision relating to account holders that are PFFIs or DCFFIs. The final regulations provide that a withholding agent has reason to know that such an account holder is a limited branch or limited FFI if it has an address for the account holder outside the country in which the entity claims to be a PFFI or DCFFI or if it makes a payment to an address outside such country. This is 3 It is important to note that this reason to know relates to a claim of foreign status only. Withholding agents continue to have other due diligence responsibilities relating to the chapter 4 status claimed by an entity. Specific to this, the final regulations make clear that a withholding agent continues to be responsible for confirming a particular chapter 4 claim with all account information obtained, including, for example, any credit reports or financial statements that are obtained in the account opening process. 10

13 notwithstanding the fact that the withholding agent has valid documentation and a GIIN that has been verified against the IRS published list. Paramount to this new reason to know, there appears to be no cure available. Consequently, the withholding agent will be required to impose withholding as if the account holder is an NPFFI. Given the nature of the financial industry, payment instructions to accounts in other countries is not unusual. As a result, it is anticipated that this new rule will result in a vast amount of unnecessary withholding. Presumption rules Unlike the QI regime, the final regulations make clear that withholding agents, including PFFIs, can choose to follow the presumption rules in lieu of obtaining documentation. [In the QI Agreement, a QI is in default of its agreement if it has invalid or incorrect documentation for a significant number of direct account holders.] Notwithstanding this general statement, there is a confusing provision relating to when a withholding agent can reject a form (including an IRS form). Specifically, the regulations provide that a withholding agent who rejects a form must provide an acceptable substitute form within five business days of receipt. This requirement does not appear to comport with the general rule that a withholding agent can choose not to accept documentation. The final regulations also include a new presumption for payments to U.S. branches of foreign financial institutions when the withholding agent has the branch s EIN as well as the GIIN of the branch s head office. In such circumstances, the withholding agent may presume that the branch is the payee and that the income is ECI. A final note as it relates to the presumption rules is the treatment for certain Passive NFFEs account holders of PFFIs. While not explicitly stated in the presumption rules, the modification to the definition of recalcitrant account holders changes the application of those rules. Specifically, when a PFFI maintains an account for a Passive NFFE and has documentation for the Passive NFFE but does not have the requisite certification that the entity has no substantial U.S. owners (or the name, address, and TIN of such owner(s)), it must treat the account holder as a recalcitrant account holder and not a NPFFI. Conversely, when the withholding agent is a U.S. withholding agent or a PFFI that does not maintain an account for the Passive NFFE (e.g., a PFFI that has entered into a swap contract with the Passive NFFE), the final rules retain the requirement to treat the entity as an NPFFI. This ensures that withholding will be imposed when the PFFI makes a payment where there is no account (the rules do not require an account for withholding on payments to an NPFFI). This modification was presumably made to align the final regulations with the IGAs, when possible. [The IGAs cross reference Code section 1471(d)(6) for the definition of a recalcitrant account holder, which includes an account holder when the withholding agent is unable to obtain the information necessary to determine 11

14 whether the account is a U.S. account.] The change is baffling, though, because the treatment of a recalcitrant account holder under the IGA is very different from the treatment under the regulations. In addition, it seems to result in unnecessary complexity without a corresponding benefit to the IRS. In fact, had the government retained the rule in the proposed regulations, it would have received withholding and, in certain circumstances, payee specific reporting, regardless of whether the PFFI maintained an account or not. As drafted, it will never know the name of the Passive NFFE when the PFFI does maintain an account because reporting for recalcitrant account holders is never payee specific. Electronically submitted forms The Preamble indicates that a withholding agent will be permitted to obtain documentation electronically (i.e., via facsimile or scanned documents transmitted via ). The final regulations, however, cross reference the section 1441 regulations that permit electronically submitted forms. Currently, those rules would not permit a withholding agent to accept a form via facsimile or one that was otherwise scanned into an electronic system for submission (because those forms do not contain the requisite electronic signature). It is anticipated that the 1441 regulations that are cross-referenced will be updated to permit such transmissions in the near future. This is something that withholding agents have requested since the implementation of the current withholding regime in 2001 and should allow them to simplify documentation processes a great deal. Record retention Similar to the proposed regulations, the final regulations require a withholding agent to retain copies of documentations for as long as it is relevant to the determination of tax liability. There was a slight change in the rules for the retention of documentary evidence. The withholding agent must note the date the document was received and reviewed (the proposed regulations would have also required the withholding agent to note the person by whom the document was received and reviewed). A more significant change relates to the record retention for documentary evidence associated with offshore accounts. The final regulations permit a withholding agent to retain such a document via a file notation (i.e., type of document reviewed, date reviewed, document s identification number (if any), and whether the document contained any U.S. indicia) in lieu of a scanned or paper copy if it is not required to retain a copy pursuant to its AML due diligence requirements. A similar rule is provided for pre-existing accounts, with the elimination of the U.S. indicia notation. 12

15 Multiple accounts, universal accounts, shared accounts, agents, and thirdparty data providers Pursuant to the final regulations, a withholding agent must document accounts on an account-by-account basis. There are, however, numerous exceptions. First, a withholding agent may rely on documentation provided by the account holder relating to another account if both accounts are held at the same branch and both accounts are treated as consolidated obligations (obligations the withholding agent treats as a single obligation for purposes of the preexisting account rules when a preexisting account holder opens a new account and the withholding agent is able to rely on the due diligence performed on the preexisting account or in order to share documentation). Another exception permits withholding agents in the same expanded affiliated group to rely on the documentation obtained by other members if they treat the accounts within the group as consolidated obligations and share a universal account system (unique identifier required). Finally, withholding agents within an expanded affiliated group may rely on documentation obtained by other members if they treat the accounts as consolidated obligations and share an account system, electronic or otherwise. It is important to note that any U.S. indicia that are discovered with respect to an account that is treated as a consolidated obligation is imputed to the other accounts so treated. Because of this, the shared system must, among other requirements, permit a withholding agent that discovers such indicia to relay the information to others within in the shared group. Similar to the proposed rules, the final regulations permit a withholding agent to engage an agent to carry out its FATCA obligations. In those instances, the withholding agent remains liable for the actions of its agent. One notable point is the final regulations reference to a paying agent. When an agent takes on certain responsibilities, its status rises to that of a paying agent. This is significant because a paying agent is a withholding agent in its own right and must report the payments it makes as a paying agent under its own name and EIN. Pursuant to current IRS guidance, an agent becomes a paying agent when it agrees to withhold and report a payment. The regulations, though not entirely clear, appear to depart from this. Instead, the regulations seem to indicate that an agent rises to the level of a paying agent simply by agreeing to make the payment. An example relating to this point is confusing. In the example, a foreign withholding agent hires a U.S. person to act as its paying agent. The example concludes that both are withholding agents and are liable for the paying agent s 13

16 failures, if any. Under the current withholding regime, however, this isn t quite true. Withholding agents in a chain are each liable, but the liability relates to what they do and what they know at the time they control the payment. Thus, as a withholding agent in the chain of a payment, the foreign person making the payment to its U.S. paying agent should be responsible for the documentation of its U.S. paying agent absent actual knowledge or reason to know that paying agent would not fulfill its responsibilities. The paying agent, in turn, has the responsibility for the payment that it then controls. In other words, pursuant to the current rule relating to multiple withholding agents in a chain, the prior withholding agent s responsibility should end when it relinquishes control unless it knows or has reason to know that the next withholding agent in the chain will not fulfill its responsibilities. The FATCA rules cross-reference the withholding agent rules in the 1441 regulations. Until Treasury and the IRS release the harmonizing chapter 3 rules, this issue will remain unclear. As in the proposed regulations, the final regulations permit a withholding agent to rely on a repository of documentation obtained by an agent for use by multiple withholding agents. To meet the requirements of such a shared system, any withholding agent that uses the system must have easy access to the documentation and, more importantly, must be able to easily transmit data to the system when it become aware of facts that may affect the reliability of documentation. In this, every withholding agent accessing the system has reason to know that documentation is invalid or incorrect when one withholding agent obtains conflicting data. Another important, and new, documentation provision relates to third-party data providers. The regulations provide that a withholding agent may rely on documentation obtained by a third-party data provider if: (1) the third-party data provider collects documentation sufficient to determine an entity s chapter 4 status pursuant to the account identification rules set forth in the regulations; (2) the third-party data provider is in the business or providing credit of business reports to unrelated customers and the chapter 4 status claimed by an entity is verified against the other information it has for such entity; (3) the third-party data provider must notify each entity providing chapter 4 data that it is required to notify the third-party data provider within 30 days of a change in circumstance and, pursuant to the contract between the third-party data provider and its subscriber, the third-party data provider must notify the subscriber of such changes; and (4) the subscriber must be able to provide documents obtained by the third-party data provider to the IRS upon request (and will remain liable for any associated underwithholding related to invalid documentation). One significant distinction between the third-party data provider rules and the shared system outlined above is that the subscribers using a third-party data provider are not required to notify the provider of any conflicting data it may have in its files. 14

17 Bulk mergers/transfers Addressing a significant issue when a withholding agent acquires another, the final regulations permit the acquirer to rely on the documentation (or copies of documentation) obtained by transferor, if unrelated, for a maximum period of six months (or earlier if it discovers the documentation is unreliable prior to the end of the transition period). At the end of the six-month period, the acquirer is permitted to rely on the chapter 4 classification assigned by the transferor only if the documentation it has for the account holder, including the documentation provided by the transferor, supports the classification assigned. If it does not, the acquirer must apply the presumption rules. Further, if the acquirer makes future payments to such an account, it must impose withholding (including any withholding that relates to payments made during the six-month transition period). While the relief is an important step, the six-month period may be inadequate where the acquisition is sizable. Reg. section FFI Agreement The final regulations brought myriad additions and modifications to Reg. section , the section specifically relating to the FFI Agreement. Effective date The first modification relates to the effective date of the FFI Agreement. The new effective date for those entities that timely execute the FFI Agreement will be December 31, The requirements for account identification (new onboarding and the commencement of the clock ticking for pre-existing accounts) and the earliest possibility for any withholding remain January 1, Presumably, this one-day shift is attributable to future reporting requirements for certain accounts maintained by the PFFI on December 31, U.S. branches of PFFIs The final regulations confirm the treatment of U.S. branches, a topic much of which had only been relayed informally in the past. Specifically, the regulations make clear that a U.S. branch of a compliant head office (PFFI or RDCFFI) can elect to be treated as a U.S. person. When the U.S. branch does elect such treatment, the final rules provide that it will satisfy its withholding obligations on accounts that are held by U.S. nonexempt recipients by satisfying its backup withholding obligations under section 3406(a). As indicated above, it is anticipated that we will see a modification to those rules (specifically, the definition of a nonexempt recipient) as Treasury and the IRS 15

18 modify the regulations under chapters 3 and 61 in an effort to harmonize them to chapter 4. Given this, the new responsibilities for U.S. branches that will elect to be treated as U.S. persons remain somewhat uncertain. Mergers/bulk acquisitions Similar to other withholding agents, the final regulations provide some account identification relief to PFFIs that acquire accounts in unrelated mergers or bulk acquisitions. Under these new rules, the PFFI may treat the acquired accounts as pre-existing accounts, using the acquisition date instead of the FFI agreement effective date as the benchmark for the time limitations. When the PFFI (including a U.S. branch of such entity) acquires another PFFI, a DCFFI, or a U.S. financial institution that has applied the relevant FATCA due diligence procedures to the acquired accounts, the PFFI acquiring such account may, in certain instances, rely on the chapter 4 status previously assigned to the account and will not be considered to have any of the stated reasons to know unless and until there is a change in circumstances related to the account. To avail itself to this relief: (1) the acquirer must not have actual knowledge that the chapter 4 status assigned to an account is unreliable or incorrect; (2) the acquirer tests a sample of the acquired accounts to determine whether the chapter 4 status assigned is correct (this is necessary for purposes of the required responsible officer certifications, discussed below); (3) for accounts acquired by a PFFI or RDCFFI (other than a U.S. branch treated as a U.S. person), the acquirer PFFI obtains a written representation that the requisite due diligence procedures have been applied; and (4) for entity accounts acquired by a U.S. financial institution (or U.S. branch of a PFFI or RDCFFI treated as a U.S. person), the U.S. financial institution made a withholdable payment to the account prior to the date of transfer and, for acquired individual accounts, the U.S. financial institution made a reportable payment (as defined under section 3406(b)) to the account prior to the transfer. Expansion of preexisting accounts additional account As indicated above, the final regulations provide some narrowly tailored relief relating to account identification when a withholding agent, including a PFFI, maintains a preexisting account for an account holder, the account holder opens a new account and, pursuant to the withholding agent s AML procedures, the withholding agent is not required to obtain additional documentation with respect to the new account. The relief is narrowly tailored because Treasury and the IRS have placed considerable requirements on the applicability of the new provision. Namely, the new account and the preexisting account must be treated as a single account for purposes of not only AML due diligence but, also, for purposes of account aggregation and applying the due diligence reason to know standards. Given this, many withholding agents may not have adequate systems 16

19 in place to meet such requirements and, consequently, will not be in a position to avail themselves to the relief. Bearer shares Prior FATCA guidance did not address the issue of bearer shares. This was of particular concern for many funds because many had issued bearer shares in the past and, thus, would not be in a position to identify accounts within the prescribed time limits. The Model 2 IGA first mentioned the issue of bearer shares by stating that an investment fund, that otherwise qualified, would be treated as deemed compliant notwithstanding the fact that it had bearer shares as long as it: (1) has not issued, and does not issue, any physical shares in bearer form after December 31, 2011; (2) performs the due diligence procedures (and reports, where necessary) with respect to any such share when presented; and (3) has implemented policies and procedures to ensure that such shares are redeemed as soon as possible and, in any event, prior to January 1, Because of the nature of the shares (i.e., bearer), it is unclear how a fund could ensure that all such shares would be redeemed by January 1, The final regulations provide that the account identification procedures for a preexisting obligation in bearer form will be performed at the time the share is presented for payment. Notwithstanding the fact that the obligation is preexisting, however, the PFFI must perform the new account identification procedures at that time. This new provision is vital for any PFFI that has outstanding bearer shares. Without it, it could never attain FATCA compliance as it relates to account identification. In addition, under the final guidance, an otherwise qualifying fund that issued bearer shares in the past can nevertheless qualify as a registered deemed compliant qualified collective investment vehicle or restricted fund if it: (1) ceased issuing interests in bearer form after December 31, 2012; (2) retires all such interests upon surrender, (3) implements policies and procedures to redeem or immobilize all such interests prior to January 1, 2017; and (4) identifies the account prior to payment (under the new account procedures) and agrees to withhold and report as if it were a PFFI. As indicated above, the 2017 cut off date to redeem or immobilize may continue to make this exception unavailable to anyone with prior issued bearer shares. Insurance-related provisions The final regulations also brought numerous changes relating PFFIs and the insurance industry. First, when a PFFI maintains an account that is an employersponsored group cash insurance contract or a group annuity contract, the regulations provide that it may treat the account as a non-u.s. account until an 17

20 amount is payable to an employee/certificate holder or beneficiary if the employer has provided a certificate that no employees/certificate holders are U.S. persons. For this purpose, the contract must be one that is issued to an employer and covers 25 or more employees/certificate holders, the employees/certificate holders are entitled to the cash value of the contract and to name beneficiaries for the benefit payable upon their death, and the aggregate amount payable to any one employee/certificate holder does not exceed $1 million. Additional relief is provided with respect to the requirement to identify beneficiaries of certain cash value life insurance contracts. Here, the PFFI may presume that a beneficiary (that is not the owner) is a non-u.s. person unless it has actual knowledge or reason to know otherwise. Finally, the regulations make clear that an insurance company that has made a section 953(d) election is not treated as a U.S. person for purposes of FATCA if it is not licensed to do business in the United States. The regulations also make clear that an insurance company that is an FFI cannot make an election to report under section 6047(d) in lieu of the reporting requirements set forth in section 1474 and the FFI Agreement. This is because the reporting under those provisions does not apply to contracts that are issued by an insurance company that is not licensed to do business in the United States. A limited accommodation is provided if such insurance company reports the sum of a cash value or annuity contract s account balance or value as well as any distributions under the contact on a Form 1099-R (treating each U.S. account as an individual and citizen of the U.S.). Limited FFIs The limited FFI concept was adopted to help certain FFIs within expanded affiliated groups. Treasury and the IRS have consistently stated that all FFIs within an expanded affiliated group must either be a PFFI, DCFFI, or otherwise exempted from the rules. Understanding that certain FFIs operate in jurisdictions that prohibit disclosures of account holder information, of the closure of recalcitrant accounts, etc., Treasury and the IRS devised a transition rule for limited FFIs. Specifically, the limited FFI rule would apply when an FFI within an expanded affiliate group is legally prohibited from either: For U.S. accounts reporting, closing, or transferring to a U.S. financial institution, PFFI, or reporting Model 1 FFI; or For recalcitrant accounts holders and accounts held by NPFFIs blocking, closing, or transferring to a U.S. financial institution, PFFI, or reporting Model 1 FFI. Pursuant to this concept, if an FFI in such a jurisdiction qualifies as a limited FFI, the IRS will permit the other FFIs within its expanded affiliated group to become 18

21 PFFI and/or DCFFIs. The limited FFI within the group must register with the IRS, agree to the account identification requirements as set forth in the FFI Agreement, and retain such documentation for six years from the effective date of its registration as a limited FFI. It must also agree to report identified U.S. accounts to the extent permitted by law. Further, it must agree to not open any new U.S. or NPFFI accounts. Significantly, the rules provide that the limited FFI must be treated as a NPFFI for purposes of the penal withholding on reportable payments. Under the proposed regulations, the limited FFI relief was transitional and ended on December 31, In the IGAs, however, the limited FFI in the group can continue to act in that capacity, indefinitely, without harming the compliant FATCA status of other group members as long as certain conditions are met. It was anticipated that this same relief would be included in the final regulations. Unfortunately, Treasury and the IRS did not harmonize the two regimes with respect to the limited FFI. The final regulations continue to treat the limited FFI relief as transitional and retain the December 31, 2015 end-date. As discussed above, the limited FFI concept is incorporated into the rules to permit FFIs in an expanded affiliate group to become PFFIs or DCFFIs notwithstanding the fact that one or more of the group members operates in non- IGA jurisdictions which prohibit it from complying with certain terms of the FFI Agreement. The problem, however, is the fact that the relief is transitional. Even with the relaxation of certain FFI requirements, compliance with the FATCA regime will be both onerous and expensive. Under this transition relief, the FFIs in the group that have no legal prohibitions relating to full compliance will expend sizable resources, in terms of both time and money, developing systems and processes to satisfy the requirements of the FFI Agreement and/or an IGA. However, as drafted, the FFIs in the group that are not operating in IGA countries will lose their PFFI or DCFFI status after December 31, 2015, if there is a limited FFI in the group that cannot comply. Adding to this problem is a new anti-abuse rule that provides that when an expanded affiliated group changes the ownership structure in an attempt to avoid withholding or reporting, the IRS will disregard such changes. As a result, the possible options are narrow: (1) a law change in the limited FFI s country of operation that would permit the limited FFI to achieve full compliance: (2) the country in which the limited FFI operates enters into an IGA with Treasury; or (3) the limited FFI ceases operations in that country by December 31, For some, it is likely that none of the possibilities is attainable from either a plausibility or timing perspective. Even if it was accepted that the country in which the limited FFI operates would be willing to change its laws to permit the limited FFI to achieve full FATCA compliance, it is unrealistic that such a law change could be enacted and implemented within this short transitional time period. Further, as it is currently understood, to enter into an IGA, a country must have 19

22 an income tax treaty, a tax information exchange agreement, or a local law that would permit the exchange of information with the United States. Any one of these requirements would likely take time to conclude. Given this, the remaining option is to cease operations. This does not make sense, especially in light of the accommodation made under the IGAs. Regardless, the final regulations continue to leave many FFIs in a difficult planning position. Responsible officer certifications, verification, and consolidated compliance program The final regulations parallel the proposed regulations as related to periodic certifications from a PFFI or RDCFFI s responsible officer. Pursuant to the final regulations, the initial certification will relate to the implementation of policies and procedures and an assurance that the due diligence procedures have been carried out in the time frame set forth in the regulations. In addition, the responsible officer must certify that there were no formal or informal practices in place to assist account holders to avoid the impact of the chapter 4 rules. In response to requests, Treasury and the IRS included examples of the types of unacceptable practices this may entail (e.g., suggesting the bifurcation of accounts to avoid certain account identification requirements, suggesting an account holder remove U.S. indicia from the account, or suggesting that the account holder close the account). Interestingly, as it relates to this last example (suggesting the closing of the account), one of the requirements of a PFFI that cannot obtain an adequate waiver to disclose an account is to close the account. It would appear that Treasury and the IRS view a suggestion to close an account as different from mandating its closure. Further, as it relates to compliance, the final regulations provide that a PFFI must establish and implement a compliance program for satisfying its requirements under its FFI Agreement. As part of the compliance program, the PFFI must appoint a responsible officer to establish and oversee its compliance program. The compliance program must include policies, procedures, and processes sufficient for the PFFI to satisfy its requirements under its FFI Agreement. In addition, the responsible officer must periodically review the sufficiency of the established compliance program. The results of these reviews must be considered when the responsible officer makes it periodic compliance certifications to the IRS. The regulations include a consolidated compliance program whereby an expanded affiliated group can elect, instead, to adopt a compliance program on a consolidated basis. For this purpose, it is permissible to include any (or all) PFFIs, reporting Model 1 FFIs or U.S. financial institutions within the group. With respect to the certifications, the responsible officer must certify (on a three-year cycle) that the entity has established a compliance program and that there have been no material failures of the program within the review period or, if there were 20

23 such failures, the actions taken to remediate the failures and to prevent them from occurring in the future. If the material failure has not been remediated, the responsible office must make a qualified certification when, among others, the responsible officer identifies the failures and states what actions will be taken to remedy them. Collective refunds Finally, adopting a provision in the QI Agreement, the final regulations provide that a PFFI or reporting Model 1 FFI can, in certain circumstances, request a credit or refund from the IRS relating to any overwithholding it imposed on an account holder or payee. Similar to the QI Agreement, this procedure is available only to direct account holders (i.e., it cannot be used when the account holder is an intermediary or flow-through entity). In addition, as in the QI Agreement, it is not permissible when the account holder or payee is a U.S. person. A welcomed distinction between the procedure set forth in the regulations and the procedure set forth in the QI Agreement is that the regulations do not require the PFFI or reporting Model 1 FFI claiming the collective refund to first repay the account holders and, instead, permit it to make a representation that it has repaid or that it will repay the amount refunded to the appropriate account holders. Reg. section Section 1471 definitions The final regulations contained some significant modifications to the definitions relating to who holds an account and who maintains an account. Also, in an attempt to harmonize the regulation definitions with the IGAs, they also contain a significantly different definition of financial institution. Finally, the final regulations include new (and/or expanded) definitions of DCFFIs and recalcitrant account holders. Accounts held by The final regulations include rules clarifying who is considered an account holder. They make clear that in the case of a disregarded entity, the owner of the disregarded entity is treated as the account holder. They also provide that an account held by an exempt beneficial owner is treated as held by such only when all payments to the account qualify as exempt payments to that owner. With respect to insurance, the final regulations clarify that an insurance contract is held by each person that can access the contract s value or change a beneficiary. The proposed regulations had focused on the contract owner, and provided further that if the contract owner could not access the value or change a beneficiary, then the contract was treated as held by each beneficiary. 21

24 Under the final regulations, if no person can access the value or change a beneficiary, then the contract is treated as held by any person named in the contract as owner, and by any person entitled to receive a future payment under the terms of the contract. The final regulations provide that when an obligation to an amount becomes fixed, each person entitled to receive a payment is an account holder. The proposed regulations made a similar provision with respect to beneficiaries. It remains unclear whether this provision suspends the account holder status of persons identified as entitled to a future payment until the obligation becomes fixed, or includes, in addition, other persons who may be identified as entitled to payment at that time. Finally, under the proposed regulations, the exception from U.S. account status for certain deposit accounts applied if the account was held by one or more individuals, and the aggregate balance of all depository accounts held by the holder of the account did not exceed $50,000. The final regulations provide that the exception applies if the account is held by one or more individuals, and the aggregate balance of all the depository accounts held by each individual does not exceed $50,000. In the case of joint accounts, however, it is not entirely clear whether the exception is available when the aggregate balance of one joint account holder exceeds $50,000 and the aggregate balance of another does not. Accounts maintained The final regulations clarify that a custody account is maintained by the financial institution that holds custody over the assets (including holding in street name), a deposit account is maintained by the financial institution obligated to make payments with respect to the account (excluding agents of the financial institution), a debt or equity interest in a financial institution is maintained by such financial institution, and an insurance contract or annuity is maintained by the financial institution that is obligated to make payments on the contract. Financial accounts The final regulations modify the definition of financial account. An equity or debt interest in an investment entity is a financial account if the entity is either: (1) an entity whose gross income is primarily attributable to investing, reinvesting, or trading in financial assets and the entity is managed by another investment entity that conducts management activities as a business for customers; or (2) the entity functions or holds itself out as a collective investment vehicle or fund. This definition excludes equity or debt interests in an investment entity that conducts management activities as a business for customers. However, the final regulations include equity or debt interests in such an investment entity, as well 22

25 as interests in other financial institutions, when such institutions would also come within (1) or (2) above. In addition, the final regulations include, as a new category of financial accounts, equity or debt interests in a holding company or treasury center. These are financial accounts if the holding company or treasury center is a member of an expanded affiliated group that includes investment entities (described in (1) or (2) above) or passive NFFEs, and the income derived by such investment entities or NFFEs is 50% or more of the aggregate income earned by the group, the redemption, retirement amount, or return on the equity or debt interest is determined primarily by reference to one or more of those investment entities or NFFEs, the value of the interest is determined primarily by reference to assets that give rise or could give rise to withholdable payments, or the interest was issued with a principal purpose of avoiding withholding or reporting under chapter 4. The final regulations restate the anti-abuse rule including as financial accounts equity or debt interests in financial institutions if the value of the interest is primarily determined by reference to assets that give rise or could give rise to withholdable payments or if the interest is issued with a principal purposes of avoiding the withholding or reporting requirements of chapter 4. For this purpose, the final regulations provide new guidance on when the value of an equity or debt interest is determined primarily by reference to assets that give rise or could give rise to withholdable payments. Specifically, the value of an equity interest is so determined if the amount payable on redemption is secured primarily by reference to such assets or, if unsecured, the amount payable on redemption is determined primarily by reference to such assets. A debt interest is captured if the debt is convertible into stock of a U.S. person, amounts payable as interest or on redemption or retirement are determined primarily by reference to the profits or assets of a U.S. person, or the debt is secured by the assets of a U.S. person. The final regulations also provide guidance on when the redemption or retirement amount or the returns on a debt or equity interest in a holding company or treasury center is primarily determined by reference to one or more investment entities or NFFEs. An equity interest is captured if the return on the interest (including on sale, exchange, or redemption) is determined primarily by reference to value or income of such investment entities or NFFEs or the value or income from assets of the investment entities or NFFEs. A debt interest is captured if it is convertible into the stock of such an investment entity or NFFE, amounts payable as interest or on redemption or retirement are determined primarily by reference to the value or income of such investment entities or NFFEs or the value or income of their assets, or the debt is primarily secured by their assets or is guaranteed by such an investment entity or NFFE. 23

26 With respect to regularly traded securities, the final regulations provide new guidance on when an equity or debt interest is regularly traded on an established securities market for purposes of the exception from the definition of financial account for such interests. They do this by cross reference to Reg. sections (c)(1)(i)(A) and (C), which provide an intricate set of rules for determining when the stock of a corporation is considered to be regularly traded on an established securities market. [Reg. section (c)(1)(i)(B), dealing with initial public offerings of stock is not cross referenced.] These rules require tracking of trading activity and aggregate stock values. It is not entirely clear how these rules should be applied to debt interests. For example, Reg. section (c)(1)(i)(A)(i) requires that one or more classes of stock that represent more than 50% of the total combined voting power of all classes of stock entitled to vote and of the total value of the stock of such corporation are listed on such market or markets during the prior calendar year. Also, the final regulations provide that an interest is not on an established securities market if the holder of the interest (excluding intermediaries) is registered on the books of the investment entity. Relating to excluded accounts, both the proposed and the final regulations excepted certain retirement and savings accounts from the definition of financial accounts. The final regulations loosen the requirements for these retirement and savings accounts. For retirement savings accounts, the requirements that all contributions to the account be from the government, employee, or employer and limited to earned income have been eliminated. The limit on contributions has also been modified from a $50,000 annual limit only to a $50,000 annual limit or a maximum lifetime limit of $1 million. The final regulations do impose a new provision requiring reporting of the accounts to the relevant tax authorities. For non-retirement savings accounts, the final regulations eliminate the requirement that contributions to such an account are limited by reference to earned income and, instead, require the account to be tax-favored. For this purpose, an account is tax favored if: (1) contributions to the account that would otherwise be subject to tax are deductible or excluded from the gross income of the account holder or taxed at a reduced rate; or (2) taxation of investment income from the account is deferred or taxed at a reduced rate. The exception for certain term life insurance contracts is modified in the final regulations to include requirements that the coverage period will end before the insured individual attains age 90, that the periodic premiums (which do not decrease over time) are payable at least annually during the shorter of the period the contract is inexistence or until the insured attains age 90, and the contract has no value that any person can access without terminating the contract. The final regulations also provide new exceptions from the definition of financial account for: (1) accounts held by estates (documentation for which must include the deceased will or death certificate); (2) certain escrow accounts established in 24

27 connection with a court order or a sale, exchange or lease of property; (3) noninvestment linked, non-transferable immediate life annuity contracts that monetize an excepted retirement or pension account; and (4) accounts or products excluded under an IGA. Relating to deposits, the final regulations modify the definition of deposit account to include a credit balance with respect to a credit card account issued by a credit card company that is engaged in a banking or similar business and an amount paid by an insurance company under a guaranteed investment contract or similar agreement to pay or credit interest or to return the amount held. Because a credit balance is considered a deposit, the $50,000 exception for deposit accounts held by individuals will be available. The final regulations also provide a new registered deemed compliant category for qualified credit card issuers (explained below). The final regulations exclude, from the definition of deposit account, a negotiable instrument traded on a regulated or over-the-counter market and held through financial institutions, and certain advance premiums or premium deposits that are excluded from the cash value of insurance contracts. Finally, for financial accounts relating to insurance, the final regulations modify the definition of cash value insurance contract to exclude indemnity reinsurance contracts between two insurance companies, certain term life insurance contracts (described above), and insurance contracts with an aggregate cash value of $50,000 or less. As with the $50,000 deposit threshold, a participating FFI may elect to disregard this threshold by reporting all contracts with a cash value of greater than zero. Financial institutions The final regulations modify the definition of financial institution in numerous ways. First, they expand the definition of financial institution to include holding companies and treasury centers that are members of an expanded affiliated group that includes a depository institution, custodial institution, investment entity (other than a manger), or that is formed or availed of by a collective investment vehicle, fund, or similar investment vehicle. For this purpose, an entity is a holding company if its primary activity consists of holding the stock of one or more members of its expanded affiliated group. An entity is a treasury center if its primary activity is entering into investment, hedging and financing transactions with or for members of its expanded affiliated group for risk management purposes. The final regulations also include entities that are resident in IGA countries that are treated as financial institutions pursuant to an IGA. Second, the final regulations modify the definition of depository institution. As noted above, the final regulations define deposit accounts to include credit balances with respect to a credit card account issued by a credit card company that is engaged in a banking or similar business. It is important to note that this modification may have implications for other lenders that may carry credit 25

28 balances. A welcomed exclusion from the definition of depository is one for certain lessors and lenders that solely accept deposits as collateral or security pursuant to a sale or lease of property or similar financing arrangement between the lessor or lender and the deposit holder. Third, the final regulations modify the definition of custodial institution to include start up entities that expect to meet the 20% gross income threshold based on anticipated functions, assets, and employees. The final regulations also provide a definitive list of the income items that constitute income attributable to holding financial assets and related financial services. Next, the final regulations adopt the definition of investment entity set forth in the IGAs. This is attributable to Treasury and the IRS s attempt to harmonize the final regulations with the requirements set forth in the IGAs. Such harmonization is critical to the compliance success for global institutions that operate both within and without IGA countries. Pursuant to the proposed regulations, the broad definition of a financial institution included any entity that is primarily engaged in the business of investing, reinvesting, or trading in securities, commodities, partnership interests, etc. For this purpose, an entity was considered primarily engaged in such activities if its gross income attributable to such activities equaled or exceeded 50% during the relevant testing period. Given this definition, foreign funds, collective investment vehicles, as well family trusts and passive investment corporations (PICs) would have been considered FFIs and not passive nonfinancial foreign entities (NFFEs). This distinction is significant in terms of compliance requirements. A passive NFFE must provide: (1) a certification that it has no substantial U.S. owners (more than 10% direct or indirect ownership); or (2) the name, address, and taxpayer identification number (TIN) of each such owner. 4 An FFI, on the other hand, must enter into a formal agreement with the IRS and agree to, among other things, identify and report its U.S. accounts or meet one of the deemed compliant or other excepted categories. It would have been possible for a family trust or PIC to satisfy the requirements of a deemed compliant ownerdocumented FFI (ODFFI) if its withholding agent had agreed to treat it as an ODFFI and it had disclosed information (reporting statement and documentation) relating to all of its underlying owners. Pursuant to the IGAs, the definition of this category of FFI changed significantly. Specifically, in lieu of the proposed regulation definition (outlined above), a Partner Country FI includes an Investment Entity which means any entity that conducts as a business (or is managed by an entity that conducts as a business) trading, portfolio management, or investing, administering, or managing funds for or on behalf of a customer. Given this new definition, a 4 Pursuant to the IGA, the Partner FI would obtain self -certifications from the Passive NFFE and its Controlling Person(s) (generally 25% owners). 26

29 fund manager, as well as the funds it manages, are considered FIs. PICs or family trusts if organized in an IGA country, however, are generally not. 5 This is because they do not engage in any of the activities listed above for customers nor are they generally managed by an entity that does. It is significant to note that the IGA definition of Investment Entity also contains a catch-all sentence at the end that provides that the definition shall be interpreted in a manner consistent with similar language set forth in the definition of financial institution in the Financial Action Task Force (FATF) Recommendations. While the definition of financial institution pursuant to the FATF Recommendations is controversial, a self-managed fund generally would fall within the definition and, thus, should be treated as an FI under the IGAs (notwithstanding the fact that it does not meet the literal definition). Conversely, it is also likely that a managed family trust or managed PIC, organized in an IGA country, would not fall within that definition and, thus, should not be considered FIs under the IGAs. The final regulations adopt the IGA s Investment Entity concept, though not in its entirety. This is because the definition of an investment entity under the final regulations does not include the catch-all sentence regarding the definition of a financial institution under the FATF Recommendations. The regulations do, however, explicitly include most collective investment vehicles, managed or not, within the definition of Investment Entity. This leaves an anomaly between the IGAs and the regulations with respect to the treatment of managed family trusts and managed PICs that are organized in an IGA country (FFIs under the regulations and Passive NFFEs under the IGAs). This inconsistency would not necessarily be problematic but for the fact that the documentation requirements, as noted above, are considerably different. Given this, an institution that operates both within and without IGA countries, and that is FATCA compliant with respect to all of its financial accounts, could become non-compliant simply by transferring a line of business or trading desk from a branch operation in an IGA country to one that is not. A noteworthy point relating to this new definition of FFI is found in an example. The example sets forth facts whereby a fund is managed by a fund manager. The fund manager, in turn, hires an investment advisor to provide investment advice. The investment advisor generates more than 50% of its income from providing investment advice (the threshold necessary to primarily conduct as a business one of the listed investment activities). Because of this, the example concludes that the investment advisor is an Investment Entity. There appears to 5 The place of organization is significant because the IGA defines an NFFE as a non-u.s. entity that is not an FFI as defined in the U.S. Treasury regulations and also includes any non-u.s. entity that is organized under an IGA country and that is not a financial institution. Presumably, this latter reference to financial institution is the IGA definition. Consequently, PICs and family trusts that are organized in IGA countries are likely to be treated as passive NFFEs whether they are managed or not. 27

30 be a problem with the example and conclusion, however, because an entity that solely provides investment advice would not ordinarily be engaging in one of the listed investment activities (i.e., it is not trading, performing portfolio management, or investing, administering, or managing funds or financial assets of others). The definition of investment entity also includes a provision for startup entities. An entity with no operating history as of the date of the determination will be treated as an investment entity it expects to meet the 50% gross income threshold based on its anticipated functions, assets, and employees. Finally, the final regulations provide a more articulated definition of insurance company. An insurance company is an entity or arrangement: (1) that is regulated as an insurance business in any jurisdiction where it does business; (2) the gross income (e.g., gross premiums and gross investment income) of which arising from insurance, reinsurance, and annuity contracts for the preceding calendar year exceeds 50% of the total gross income for the year; or (3) the aggregate value of the assets of which associated with insurance, reinsurance and annuity contracts for the preceding calendar year exceeds 50% of the total assets at any time during the year. The final regulations also provide that the reserving activities of an insurance company will not cause it to be a depository institution, custodial institution, or investment entity. Exclusions from financial institution The final regulations also provide exclusions from the definition of financial institution for certain entities that are not insurance companies. Specifically, they provide a new expanded exclusion from the definition of financial institution for excepted nonfinancial group entities. These are foreign entities that are members of nonfinancial expanded affiliated group that are not depository or custodial institutions (other than for members of its group), that are holding companies, treasury centers or captive finance companies, and that do not hold themselves out as private equity funds, venture capital funds, leveraged buyout funds or similar investment vehicles established to acquire or fund companies and treat the interests in those companies as capital assets held for investment. A captive finance company is defined as an entity the primary activity of which is to enter into financing or leasing transactions with suppliers, distributors, dealers, franchisees, or customers of the entity or of any group member that is an active NFFE. The final regulations also provide a complex definition of nonfinancial group, which now excludes groups whose gross income include more than 25% passive income for the three preceding years. The exclusion for start-up companies is expanded to include foreign entities that are investing capital in assets with the intent to operate a new line of business, in addition to entities organized to operate a new business. 28

31 The final regulations provide a new exclusion for excepted inter-affiliate FFIs. An excepted inter-affiliate FFI is a foreign entity that is a member of a participating FFI group that does not maintain financial accounts other than for members of the group, does not hold accounts or receive payments from any withholding agent other than group members, does not make withholdable payments other than to group members that are not limited FFIs or limited branches, and has not agreed to act as agent for chapter 4 purposes for any financial institution, including group members. The final regulations, following the IGAs, add a new exclusion from the definition of financial institution for non-profit entities (and, thus, such entities will now be treated as an excepted NFFE). Under the proposed regulations, non-profit entities were treated as certified deemed compliant FFIs. The definition of a nonprofit entity remains the same. Under the Model 1 IGA, non-profit entities are listed in Annex 2 as deemed compliant FFIs. Deemed compliant financial institutions Coordinating with the IGAs, the final regulations provide that a registered deemed compliant FFI includes a registered deemed compliant FFI under a Model 2 IGA and a reporting Model 1 FFI. The final regulations liberalize, somewhat, the definition of a local FFI. Specifically, the definition is no longer limited to banks, but may include any FFI that is licensed and regulated as a financial institution in its country of organization. A location outside the country of organization will not be considered a fixed place of business (which would otherwise disqualify the entity from deemed compliant treatment) if it is not advertised to the public and if it performs solely administrative support functions. As an alternative to the requirement that the FFI is required by its country of organization to identify resident account holders for purposes of withholding or reporting, the FFI may be required to identify residents for purposes of that country s AML due diligence. The requirement that 98% of the FFI s accounts be held by residents has been changed to a requirement that 98% of the accounts by value be held by residents. Given the other safeguards in place for identifying U.S. accounts held by nonresidents, this modification appears to be unnecessary. On a favorable note, the final regulations extend the time period within which a nonreporting member of a participating FFI group must transfer an account from 90 days to six months. The final regulations provide that qualified investment vehicles must be regulated as either in the country of organization or in all of the countries in which it is registered or operates. The proposed regulations had required that they be regulated in the country of organization. In response to many comments 29

32 submitted, the final regulations provide, further, that a fund will be considered regulated if its manager is regulated with respect to the fund in all of the countries in which the fund is registered and operates. As indicated above, following the IGAs, the final regulations provide that a fund that has issued bearer interests will not be prohibited from qualifying solely for that reason. The fund must have ceased issuing bearer interests after December 31, 2012, must identify shareholders prior to payment, and must redeem all such interests on surrender and establish policies and procedures to redeem or immobilize all such interests prior to January 1, The final regulations make modifications to the requirements for restricted funds that are similar to the modifications discussed above for qualified investment vehicles. In addition, the final regulations clarify that interests issued directly by the fund are redeemed or transferred by the fund rather than sold by investors on any secondary market, and that interests that are issued by the fund through a transfer agent or distributor that are not holding the interests as nominee of the account holder are considered issued directly by the fund. For credit card issuers, the final regulations provide a new category of registered deemed compliant FFI for entities that meet the requirements of a qualified credit card issuer. A qualified credit card issuer is an foreign entity that: (1) is an FFI solely because it is an issuer of credit cards that accepts deposits in the form of excess payments on the balance due and that does not immediately return the overpayment to the customer; and (2) implements policies and procedures either to prevent a customer deposit in excess of $50,000 or to ensure that any customer deposit in excess of $50,000 is refunded to the customer within 60 days. In addition, in response to many comments by members of the funds industry, the final regulations add a new category of registered deemed compliant FFI for sponsored investment entities and controlled foreign corporations. A sponsored investment entity is an investment entity that is not a QI, WP or WT and that has an agreement with a sponsoring entity. A sponsored controlled foreign corporation is an FFI that is a controlled foreign corporation and is not a QI, WP or WT, that is wholly owned by a U.S. financial institution that agrees to act as a sponsoring entity, and that shares a common electronic account system with the sponsoring entity. A sponsoring entity must be authorized to manage the FFI and enter into contracts on its behalf (such as a fund manager, trustee, corporate director, or managing partner), must register with the IRS as a sponsoring entity, must register the FFI with the IRS, must agree to perform (on behalf of the FFI) all due diligence, withholding, reporting and other requirements that the FFI would have been required to perform as if it were a PFFI, and must not have had its status as a sponsor revoked. The IRS may revoke its status when there is a material failure to comply with its obligations by the sponsoring entity with respect to any sponsored FFI. Significant to this, a sponsored FFI remains liable for any failure of the sponsoring FFI. 30

33 For clarity, the final regulations also include in the definition of a certified deemed compliant FFI a nonreporting IGA FFI. In response to comments relating to certain restrictions of certified DCFFIs, the final regulations modify the definition of a nonregistering local bank to include a credit unions or similar cooperative credit organizations that operate without profit. They also incorporate the rule that a fixed place of business does not include a location that is not advertized to the public and from which the FFI performs solely administrative support functions will not, in and of itself, disqualify an entity for meeting the stated requirements. The definition of an FFI with only low-value accounts was also modified. Under the proposed regulations, such an FFI was required to be an FFI only because it was a depository or custodial institution. Under the final regulations, the requirement is that the FFI must not be an investment entity. The final regulations provide a new certified deemed compliant category for sponsored closely held investment vehicles. A sponsored closely held investment vehicle: (1) is an FFI solely because it is an investment entity and is not a QI, WP or WT; (2) has a contractual arrangement with a sponsoring entity that is a participating FFI, reporting Model 1 FFI or U.S. financial institution that is authorized to manage the FFI and enter into contracts on its behalf under which the sponsoring entity agrees to all due diligence, withholding and reporting responsibilities that the FFI would have if it were a participating FFI; (3) does not hold itself out as an investment vehicle for unrelated parties; and (4) has 20 or fewer individuals that own debt and equity interests in the FFI (disregarding interests owned by PFFIs, DCFFIs, certified DCFFIs and an equity interest owned by an entity that is 100% owner and itself a sponsored FFI). The sponsoring entity must register with the IRS, agree to perform on behalf of the FFI the requirements that the FFI would have to perform were it a participating FFI, retain documentation for six years, and not have had its status as a sponsor revoked. The final regulations provide a new, transitional certified deemed compliant category for limited life debt investment entities. Such an FFI must be the beneficial owner of the payment and will be treated as certified deemed compliant until January 1, To qualify, the FFI must be an investment vehicle formed pursuant to a trust indenture that offers interests to unrelated investors, must have been formed prior to December 31, 2011, and required to liquidate on a set date. It must have also been formed for the purpose of purchasing and holding specific types of indebtedness, all payments to investors must be cleared through or made by a PFFI, reporting Model 1 FFI, or U.S. financial institution, and the trustee must only engage in activities designated in the indenture and cannot be authorized to fulfill the obligations of a PFFI. 31

34 As indicated above, the final regulations contained certain modifications to the rules for owner documented FFIs. Specifically, they provide that the FFI must be an FFI solely because it is an investment entity; they eliminate the prior requirement that the FFI must not issue debt in excess of $50,000 to any person; and they clarify that a designated withholding agent is not required to report on an indirect owner of the FFI that holds its interest through a participating FFI, a deemed compliant FFI, an entity that is a U.S. person, an exempt beneficial owner, or an excepted NFFE. Certain modifications were also made to the definition of a restricted distributor. The final regulations include the rule that a fixed place of business does not include a location that is not advertised to the public and from which the FFI performs solely administrative support functions. The distributor is given the option of transferring interests distributed to prohibited persons in addition to causing the restricted fund to redeem or retire them. Finally, if the prior distribution agreement contained only a prohibition on sales to U.S. residents, but not also U.S. entities, the distributor is required to review only entity accounts as preexisting accounts. Recalcitrant account holders The final regulations modify the rules on recalcitrant account holders. As indicated above, the definition of recalcitrant account holder was amended to include an account holder that provides documentation to establish its status as an NFFE but fails to provide a certification regarding its owners. In this circumstance, the Participating FFI (PFFI) must treat the account holder as a recalcitrant account holder and not a NPFFI. Conversely, when the withholding agent is a U.S. withholding agent or a PFFI that does not maintain an account for the Passive NFFE (e.g., a PFFI that has entered into a swap contract with the Passive NFFE), the final rules retain the requirement to treat the entity as an NPFFI. The final regulations also clarify that the rules relating to recalcitrant account holders do not apply to a U.S. branch of a PFFI or RDCFFI. Instead, the U.S. branch must apply the presumption rules under Reg. section (f), as well as chapters 3 and 61, to determine the status of account holders that have not provided the requisite documentation. The final regulations also clarify a prior inconsistency relating to the time when certain accounts will be treated as recalcitrant. For a calendar year beginning after the later of the effective date of the FFI agreement and December 31, 2014, a preexisting high-value account that is defined as recalcitrant in section (g)(2) will be treated as recalcitrant beginning on the earlier of the date a withholdable payment is made to the account following the year in which the account is identified as a high-value account, or the date that is six months after the calendar year-end. New accounts that are defined as recalcitrant will be 32

35 treated as such on the earlier of the date a withholdable payment or foreign passthru payment is made to the account or 90 days after the date the account is opened. Following a change in circumstances, an account that is defined as recalcitrant will be treated as such on the earlier of the date a withholdable payment or foreign passthru payment is made to the account or the date that is 90 days after the change in circumstances. Expanded affiliated group The final regulations modify the definition of expanded affiliated group. Specifically, they provide that an investment entity will not be considered a member of an affiliated group as a result of a contribution of seed capital by a member of the group if: (1) the member of the group that provides the seed capital is in the business of providing seed capital to investment entities that it intends to sell to unrelated investors; (2) the investment entity is created in the course of its business; (3) any equity interest in excess of 50% of the total value of stock of the investment entity is intended to be held for no more than three years from the date of acquisition; and (4) in the case of an equity interest has been held for over three years, its value is less than 50% of the total value of the stock of the investment entity. For this purpose, seed capital is defined as an initial capital contribution intended to be temporary and deemed by the manager of the entity to be necessary or appropriate for the establishment of the entity. As indicated above, the final regulations also include a new anti-abuse rule. A change in ownership, voting rights or form of an entity that results in the entity meeting or not meeting the ownership requirements for an expanded affiliated group will be disregarded if the change is pursuant to a plan with a principal purpose of avoiding withholding or reporting under chapter 4. As stated, this rule may severely limit the ability of an expanded affiliated group to rectify group members that are limited FFIs or limited branches. Reg. section Exempt beneficial owners The modifications to Reg. section include an expanded definition for international organization and certain retirement funds. Broadened definition of international organization Pursuant to the proposed regulations, an exempt beneficial owner includes any entity described in section 7701(18) (international organizations). The final regulations expands this definition to include any intergovernmental or supranational organization if such organization is: (1) comprised primarily of foreign governments; (2) recognized as an intergovernmental or supranatural organization under a foreign law similar to 22 U.S.C f or that has in 33

36 effect a headquarters agreement with a foreign government; and (3) one whose income does not inure to the benefit of private persons. Notwithstanding the above, however, such an organization will not qualify as an exempt beneficial owner if, in relation to the payment, it is engaged in a commercial financial activity similar to the type carried out by an insurance company, custodial institution, or depositary institution unless it undertakes the activity solely at the direction of other exempt beneficial owners and the commercial financial activity is consistent with the purpose of the organization. These same commercial activity prohibitions (and limitations thereon) also apply to foreign governments, foreign central banks of issue, and the governments of U.S. territories. Broaden definition of retirement fund With respect to retirement funds, the proposed rules provided that a retirement fund would meet the definition of an exempt beneficial owner if such fund was: (1) eligible for benefits pursuant to an income tax treaty between the United States. and the fund s country of residence; (2) exempt from income tax in the country of residence; and (3) operated principally to administer or provide pension or retirement benefits. Unfortunately, many otherwise qualifying retirement funds failed to satisfy the requirements of the exception as originally drafted because, in many jurisdictions, such retirement funds are not the beneficial owner. The final regulations clarify that, for purposes of this category of exempt beneficial owner only, the fund will still qualify as exempt even if it is not the beneficial owner. Given this, entities like certain Registered Retirement Savings Plans (RRSPs) in Canada should now meet the requirements of this exemption. This category of exempt entity was also liberalized allowing, for example, alternative sources of contributions apart from employers and employees, funds that meet the requirements of section 401(a), and, in certain instances, plans that also provide disability or death benefits. Reg. section Withholding on NFFEs The final regulations under Reg. section correct the oversight in the proposed regulations relating to the timing of withholding on payments to NFFEs. Specifically, the final regulations make clear that the withholding transition relief afforded to payments withholding agents make to FFIs similarly applies to payments they make to NFFEs. The final regulations also correct an oversight in the proposed regulation s definition of Active NFFE. The Preamble to those prior proposed rules indicated that an entity would qualify as an Active NFFE if less than 50% of its gross income was passive income and less than 50% of its assets produced passive income. The regulation provision, however, had set 34

37 forth an or test. Given this, an NFFE could have actually been engaged in an active business but not successful during the relevant testing period (consequently skewing the income test) and, as a result, been classified as a Passive NFFE. To eliminate this type of unintended result, the final regulations make clear that the test is two-pronged. Reg. section Section 1473 definitions The final regulations contained some significant modifications to several key section 1473 terms, including the definitions of a withholdable payment and a specified U.S. person. Withholdable payments Pursuant to the proposed regulations, the final regulations treat U.S. source payments of Fixed Determinable Annual or Periodic ( FDAP ) income, made after January 1, 2014, as withholdable payments. However, conforming to the revised timeline set forth in Announcement , the final regulations extended the date by which withholding agents need to treat certain gross proceeds as withholdable payments from December 31, 2014, to December 31, Also notable is the exclusion of nonfinancial payments and certain offshore payments from the definition of a withholdable payment. Building on the list of payments not treated as withholdable payments under the proposed regulations, the final FATCA regulations clarify the prior exclusion for ordinary course of business payments, as described in the proposed regulations, to include nonfinancial payments. Specific to this, payments for services (including wages and other forms of employee compensation such as stock options), the use of property, office and equipment leases, software licenses, transportation, freight, gambling winnings, awards, prizes, scholarships, and interest on outstanding accounts payable are specifically noted as falling within the nonfinancial payments exclusion. Nevertheless, as had been hoped by the insurance industry, the final regulations do not exclude premiums on insurance or reinsurance contracts that are subject to excise tax under section 4371 from the definition of withholdable payments. Moreover, the final regulations create a transitional rule that excludes U.S. source FDAP payments from the definition of withholdable payment when the payment is made prior to January 1, 2017, on an offshore obligation, and paid by a person that is not an intermediary. [For example, a U.S. branch of a foreign financial institution making payments of interest on a deposit account.] Finally, the final regulations solidified the provision, introduced in the proposed regulations, which stated that exclusions from withholding under chapter 3 or 35

38 section 881 do not apply for determining whether income constitutes a withholdable payment under FATCA. Controlling persons vs. substantial U.S. owners Relating to the identification of U.S. owners of foreign entities, the IGAs introduced the concept of controlling persons. The IGA due diligence procedures require reporting financial institutions, in FATCA partner jurisdictions, to identify any controlling person(s), of a Passive NFFE, that is a U.S. citizen or resident. In the definition of controlling persons, the IGAs provide that the term be interpreted in a manner consistent with the FATF Recommendations. For purposes of the FATF Recommendations, the ownership threshold generally considered relevant is 25%. However, for high-risk customers, this threshold may fall to 10%. Contrary to the expectations of commentators, however, the final FATCA regulations do not harmonize the IGA concept of controlling persons with that of Substantial U.S. Owners. The proposed regulations defined Substantial U.S. Owners as Specified U.S. Persons owning more than 10% of an entity (directly or indirectly), by vote or value. The final regulations retained this definition, requiring the identification of Substantial U.S. Owners of Passive NFFEs. The variation between the 10% ownership threshold, required by the final regulations, and the 25% ownership threshold, required by the IGAs, presents a challenge for global financial institutions. In part, this variation creates impediments to the implementation of institution-wide uniform practices and procedures. Accordingly, institutions may be forced to adopt the more conservative 10% ownership threshold to maintain uniformity, or face the task of creating separate standards for their operations in different jurisdictions. Also noteworthy, and one of the few instances when the regulations provide relief not explicitly provided in the IGAs, is that the final regulations retain the de minimis threshold relating to potential Substantial U.S. Owners of certain trusts. Specifically, the final regulations state that Specified U.S. Persons receiving $5,000 or less in currency or property distributions from a trust and having an interest in the trust, if the person is entitled to receive mandatory distributions, of $50,000 or less, are not considered Substantial U.S. Owners. This variance may serve to drive behavior, causing Specified U.S. Persons to shift interests to jurisdictions with de minimis threshold limits to avoid identification or reporting. Indirect ownership of stock and U.S. persons The final regulations amended the indirect ownership of stock rule to include a safe harbor for U.S. persons that are not considered Specified. The proposed FATCA regulation had treated stock directly or indirectly owned by a trust, 36

39 partnership, or corporation as proportionally owned by that entity s grantors, partners, or shareholders. The final regulations changed this rule, clarifying that it does not apply when the entity owning the foreign stock is a U.S. person. Accordingly, there is no requirement to look through entities that are U.S. persons. Other changes The final regulations added tax exempt trust[s] under a section 403(b) plan or section 457(g) plan to the list of U.S. persons that are not considered Specified. Neither the Model I nor Model II IGAs, however, exclude these types of exempt trusts from the definition of Specified U.S. Persons. Reg. section Liability for withheld tax and withholding agent reporting The final regulations also contain certain modifications relating to PFFI reporting, as well as some insights between reporting on new Form 8966 and Form S. Aggregate reporting by PFFIs or DCFFIs not making section 1471(b)(3) elections In contrast to PFFIs or DCFFIs that make a section 1471(b)(3) election to be withheld on, PFFIs or DCFFIs that do not make this election are required to complete Forms 1042-S reporting on chapter 4 reportable amounts paid to recalcitrant account holders and Nonparticipating Foreign Financial Institutions ( NPFFI ). However, PFFIs or DCFFIs making the election are only exempt from such reporting if they provide sufficient information to their withholding agents to allow for proper withholding and reporting. For this purpose, Form 1042-S reporting on recalcitrant and NPFFI account holders may be done in pools. However, the pools for recalcitrants and NPFFIs should be separate and should be grouped by type of payee. Example Pooled reporting by PFFIs or DCFFIs that do not elect Recalcitrants NPFFIs Recalcitrant Pool Example #1: Aggregate number and NPFFI Pool Example #1: aggregate balance or value of One or more NPFFIs that fall accounts when the recalcitrant within a particular income code account holders are Passive NFFEs Recalcitrant Pool Example #2: NPFFI Pool Example #2: 37

40 Aggregate number and aggregate balance or value of account when recalcitrant failed to provide a waiver of local law regarding reporting One or more NPFFIs that fall within a particular status code Alternatively, PFFIs or DCFFIs not making a section 1471(b)(3) election may choose to report the chapter 4 reportable amounts paid to each specific payee. Nevertheless, when a PFFI or DCFFI makes payment of foreign reportable amounts to NPFFIs, during calendar years 2015 and 2016, reporting should be done on a payee specific basis, although the amount of all foreign reportable amounts may be aggregated for each year. Interestingly, the definition of foreign reportable amount is inconsistent between the final FATCA regulations and the Model 2 IGA, even though the language of the Model 2 IGA states that the term is in accordance with relevant Treasury Regulations. The final regulations define a foreign reportable amount as a payment of FDAP income that would be a withholdable payment if paid by a U.S. Person, whereas the Model 2 IGA states that a foreign reportable amount is a FDAP payment that would be a withholdable payment if it were from sources within the United States. 6 This ambiguity leaves the term open to interpretation by financial institutions in Model 2 jurisdictions (e.g., should those FIs report payments on non-equity swap transactions that would not be subject to reporting given the definition in the final regulations). Reporting by PFFIs PFFIs are required, under the final regulations, to file an income tax return on Form 1042, information returns on Forms 1042-S, and, if applicable, Form Forms 1042 and 1042-S are due by March 15 of the year following the year being reported. On the Form 1042, PFFIs should report the aggregated amount of chapter 4 reportable payments made during the preceding calendar year, even if withholding was not required. In contrast, PFFIs are required to detail the different types of chapter 4 reportable payments made to specific recipients on its Forms 1042-S. Nevertheless, aggregate reporting is allowed in certain circumstances see discussion under the subtopic Aggregate reporting by PFFIs or DCFFIs not making a 1471(b)(3) election above. The term recipient is defined in the final regulations as including, but not limited to, Qualified Intermediaries, certain Passive NFFEs, and U.S. persons. 6 The HMRC Guidance Notes currently adopt the definition set forth in the Model 2 IGA. 38

41 Moreover, PFFIs are required to report any Substantial U.S. Owners of NFFE account holders and any chapter 4 reportable payments made to Owner- Documented FFIs on a Form The Form 8966 is due by March 31 of the year following the payment. Use of agents The proposed regulations allowed withholding agents to rely on agents to receive withholding certificates, impose withholding, and deposit tax, but required a foreign agent to execute a written agreement with the withholding agent and make its books, records, and personnel information available to ensure compliance. The final regulations introduce the concept of an authorized agent. Although similar to the agent relationship outlined in the proposed regulations, it does not differentiate between foreign and U.S. agents. Rather, it requires all agents to execute a written agreement, and make its books, records, and personnel information available for evaluation. In addition, it also requires that any agent responsible for reporting or making deposits and payments file a Form 8655 with the IRS. Registration process Finally, addressing Treasury and the IRS s third stated avenue, technical complications, the Preamble to the final regulations provides additional insight into the registration process for FFIs. Specifically, the Preamble provides that the FATCA registration portal will be the primary means for financial institutions to interact with the IRS (e.g., complete and maintain chapter 4 registrations, agreements, and responsible officer certifications). The portal will be open for registration and agreement execution, when necessary, no later than July 15, 2013 (more than six months later than prior announcements). The Preamble makes clear that reporting Model 1 FFIs will be required to register on the portal and will be issued a GIIN. The assignments of GIINs will take place no later than October 15, According to the guidance, the IRS will publish the first list of PFFIs and RDCFFIs (including reporting Model 1 FFIs) on December 2, It is anticipated that the list will be updated on a monthly basis. To ensure it is listed on the December 2, 2013 list, a PFFI or RDCFFI must register on the IRS portal by October 25, This new timeline will leave prospective PFFIs with very little time to analyze the specific requirements of the FFI Agreement, once released, and decide whether they will, in fact, enter into the Agreement by that October date. 39