What s News in Tax Analysis That Matters from Washington National Tax FATCA and Foreign Leasing Companies The Foreign Account Tax Compliance Act ( FATCA ) imposes withholding and reporting requirements on certain payments made to foreign entities. Foreign leasing companies, especially ones that require advance deposits, could be receiving payments subject to the new FATCA requirements. This article provides an overview of the FATCA requirements and considers how foreign leasing companies might be caught up in the system and what they might be able to do to comply with these requirements, thereby eliminating any potential FATCA withholding. Monday, December 17, 2012 by Kevin Juran, Deanna Flores, and Sam Chen, Washington National Tax Kevin Juran and Deanna Flores are principals and Sam Chen is a senior manager with the Financial Institutions and Products group of WNT. FATCA was enacted as part of the Hiring Incentives to Restore Employment ( HIRE ) Act in order to combat tax evasion by U.S. persons with offshore accounts or investments. 1 Generally, under FATCA, a 30 percent withholding tax applies to withholdable payments made to a foreign financial institution ( FFI ) unless the FFI qualifies for an exemption or enters into an agreement (an FFI agreement ) with the IRS requiring the FFI to undertake certain obligations, including ones with respect to due diligence, disclosure, and withholding (an FFI that enters into an FFI agreement is known as a participating FFI ). 2 In addition, the 30 percent withholding rate also applies to withholdable payments made to a nonfinancial foreign entity ( NFFE ) unless the NFFE qualifies for an exemption or provides the withholding agent with a certification that it does not have any substantial U.S. owners, 3 or if the NFFE has substantial U.S. owners, then the names, addresses, and taxpayer identification numbers ( TINs ) of the U.S. owners. 4 The breadth of FATCA causes concern that many foreign entities could be subject to the FATCA rules, even though upon first glance, they do not appear to be the intended targets of FATCA. One such foreign entity is a 1 2 3 4 Pub. L. 111-147 (H.R. 2847). FATCA was enacted as sections 1471 through 1474 of the Code. Section 1471(a). Substantial U.S. owners means, generally, U.S. persons owning, directly or indirectly, more than 10 percent of the NFFE. Section 1473(2). Section 1472(a). KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative, a Swiss entity.
FATCA and Foreign Leasing Companies page 2 foreign leasing company. This article provides a brief summary of the FATCA rules and highlights some issues relevant to foreign leasing companies. This article focuses on the potential impact of the proposed FATCA regulations issued in February 2012 on foreign leasing companies. The FATCA regulations are expected to be finalized in early 2013, and we will update this article to reflect changes made by the final regulations. Background on Foreign Leasing Companies Many companies leasing assets to U.S. lessees are formed in jurisdictions outside the United States. A number of these jurisdictions have mature and sophisticated leasing industries. Ireland, for example, is an established center for the aviation industry, particularly aircraft leasing companies, offering such companies the ability to do business without barriers within the European Union. Some of these non-u.s. leasing companies are owned predominantly by foreign shareholders, including banks or other financial institutions, while others are owned by U.S. shareholders. Leasing and financing transactions may result in a flow of payments from U.S. entities to the foreign leasing companies, which raises the question of whether FATCA could be implicated. Are Foreign Leasing Companies Entities Subject to FATCA? Unless otherwise indicated, references to section or sections in this article are to the Internal Revenue Code of 1986 (the Code ), as most recently amended, or to the U.S. Treasury Department regulations (the regulations ), as most recently adopted or amended. Foreign Financial Institutions FATCA withholding generally applies to any withholdable payment made to an FFI, unless the FFI enters into an FFI agreement. 5 A withholdable payment is any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income (generally considered to be FDAP income ) if such payment is from sources within the United States. 6 A withholdable payment also includes any gross proceeds from the sale or other disposition of any property of a 5 6 For the requirements of an FFI agreement, see section 1471(b); Prop. Reg. section 1.1471-4. Section 1473(1)(A)(i).
FATCA and Foreign Leasing Companies page 3 type that can produce interest or dividends from sources within the United States. 7 Section 1471(d)(4) defines an FFI to be any financial institution that is a foreign entity. Section 1471(d)(5) defines a financial institution to mean any entity that: Accepts deposits in the ordinary course of a banking or similar business, Holds, as a substantial portion of its business, financial assets for the account of others, or Engages primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities. If finalized, proposed regulations section 1.1471-5(e) would provide some additional guidance regarding FFIs. The proposed regulations define a financial institution as any entity that: Accepts deposits in the ordinary course of a banking or similar business (as defined in the proposed regulations), Holds, as a substantial portion of its business, financial assets for the account of others, 8 Engages primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, notional principal contracts, insurance or annuity contracts, or any interest in such items, or 7 8 Section 1473(1)(A)(ii). While the rest of the discussion below generally focuses on what it means to accept deposits in the ordinary course of a banking or similar business, we note that a leasing company could possibly fit under the second part of the definition of a financial institution as an entity that holds, as a substantial portion of its business, financial assets perhaps including lessee security or maintenance reserve deposits for the account of others. Similarly, lease servicing companies may be considered to hold financial assets of the beneficial owners as part of their services. The proposed FATCA regulations provide that an entity holds financial assets for the account of others as a substantial portion of its business if the entity s gross income attributable to the holding of financial assets and related financial services equals or exceeds 20 percent of the entity s gross income during the shorter of a specified three-year period or the period during which the entity has been in existence. See Prop. Reg. section 1.1471-5(e)(3).
FATCA and Foreign Leasing Companies page 4 Is an insurance company that issues or is obligated to make payments with respect to a financial account. 9 The proposed regulations would also consider an entity to be engaged in banking or a similar business if, in the ordinary course of its business with customers, the entity engages in one or more of the following activities: Accepts deposits of funds Makes personal, mortgage, industrial, or other loans Purchases, sells, discounts, or negotiates accounts receivable, installment obligations, notes, drafts, checks, bills of exchange, acceptances, or other evidences of indebtedness Issues letters of credit and negotiates drafts drawn thereunder Provides trust or fiduciary services Finances foreign exchange transactions Enters into, purchases, or disposes of finance leases or leased assets Provides charge and credit card services. 10 However, it is not clear whether meeting this definition alone is intended to make an entity an FFI. The definition appears to only address what a banking or similar business is, while both the statutory and regulatory definition of a financial institution (and thus, an FFI) requires the entity to accept deposits in the ordinary course of a banking or similar business. 11 However, if the proposed regulations require the entity to accept deposits in addition to meeting the definition of being engaged in a banking or similar business in section 1.1471-5(e)(2), then the first of the eight activities satisfying the definition of being in a banking or similar business (i.e., requiring the entity to accept deposits of funds) would appear to be superfluous. Such a reading of the regulations would seem contrary to the widely recognized rule of interpreting two separate provisions in a way that would not render them superfluous. 12 9 10 11 12 Prop. Reg. section 1.1471-5(e)(1). Prop. Reg. section 1.1471-5(e)(2). Section 1471(d)(5). See, e.g., Sprietsma v. Mercury Marine, 537 U.S. 51, 63 (2003); Bailey v. United States, 516 U.S. 137, 146 (1995).
FATCA and Foreign Leasing Companies page 5 If the proposed regulations only require that an FFI engage in one of the eight enumerated activities, then a foreign leasing company would very likely meet the definition of an FFI because a foreign leasing company would almost certainly enter into, purchase, or dispose of finance leases or leased assets. But even if the proposed regulations do require the entity to accept deposits in addition to being engaged in a banking or similar business, a foreign leasing company could still be an FFI. What qualifies as accepting deposits is unclear. We are not aware of any FATCA guidance that describes what it means to accept deposits. In a comment letter to the IRS, the Tax Executives Institute ( TEI ), a professional association of worldwide in-house tax executives, stated: [E]ven if accepting deposits is a separate and distinct requirement of the first general financial institution definition, an entity that provides charge and credit card services may regularly accept deposits in the ordinary course of its business when customers overpay their credit card bills, depending on what constitutes a deposit under Chapter 4. Similarly, it is a regular practice of businesses that lease real or personal property to require deposits from lessees. To the extent such a business also purchases, or disposes of leased assets, which is very common in conjunction with a leasing business, such a business would nonsensically be a financial institution under the proposed regulations. To state the effect of the rules is to underscore their absurdity: Congress clearly did not intend to require a foreign holding company of an automobile manufacturer or retailer primarily engaged in a non-financial business to enter into a participating FFI agreement with the IRS or to treat landlords and other businesses primarily engaged in leasing real or personal property as financial institutions. 13 TEI suggested the final regulations provide a definition of accepting deposits and exclude from that definition accepting or holding cash deposits as an ancillary part of a business that provides nonfinancial services, goods, or the use of property to customers. It also recommended removing the purchasing and disposing of leased assets from the list of what constitutes a banking or similar business. 13 TEI Comments on Proposed FATCA Regs Focus on Nonfinancial Institutions, 2012 T.N.T. 85-12 (May 2, 2012).
FATCA and Foreign Leasing Companies page 6 There are certain exceptions to FFI status in the proposed regulations even if the general definition of an FFI is met. An FFI does not include certain nonfinancial holding companies, 14 start-up companies, 15 nonfinancial entities that are liquidating or emerging from bankruptcy or reorganization, 16 hedging or financing centers of a nonfinancial group, or section 501(c) entities ( excluded FFIs ). 17 However, while a foreign leasing company may qualify as a start-up company or a liquidating nonfinancial entity at certain points in time, none of these exceptions appears to be generally applicable to a foreign leasing company. Nonfinancial Foreign Entities In addition to withholdable payments to FFIs, section 1472 of the FATCA withholding regime also applies to any withholdable payments made to an NFFE, unless the NFFE meets certain requirements, including providing a certification to the withholding agent that it does not have any substantial U.S. owners (or if it does, then the name, address, and TINs of such owners). 18 An NFFE is defined to be any foreign entity that is not a financial institution. 19 A withholding agent that receives information from an NFFE on its substantial U.S. owners must report certain information to the IRS. 20 Withholding, however, would not apply to certain excepted NFFEs, which include publicly traded corporations, any corporation that s a member of the same expanded affiliated group 21 as a publicly traded 14 15 16 17 18 19 20 21 A nonfinancial holding company is an excluded FFI if substantially all of its activities are the ownership of the outstanding stock of one or more subsidiaries that engage in trades or businesses, provided that none of the subsidiaries is a financial institution. Prop. Reg. section 1.1471-5(e)(5)(i). A start-up company is an entity that is not yet operating a business and has no prior operating history, but is investing capital into assets with the intent to operate a business other than that of a financial institution. However, the exception for start-up companies expires 24 months after the initial organization of such entity. Prop. Reg. section 1.1471-5(e)(5)(ii). A nonfinancial entity that is liquidating or emerging from bankruptcy must not have been a financial institution in the past five years. Prop. Reg. section 1.1471-5(e)(5)(iii). Prop. Reg. section 1.1471-5(e)(5). Section 1472; Prop. Reg. section 1.1472-1(b)(1). Section 1472(d). See Prop. Reg. section 1.1472-1(e). With respect to affiliates, Prop. Reg. section 1.1471-5(i)(2) defines expanded affiliated group to mean an affiliated group as defined in section 1504, determined by substituting more than 50 percent for at least 80 percent and without regard to the exceptions for insurance companies and foreign corporations. A partnership or an entity other than a corporation is treated as a member of the expanded affiliated group if the entity is controlled (within the meaning of section 954(d)(3)) by members of such group (including entities that are members of the group pursuant to this rule). There are some
FATCA and Foreign Leasing Companies page 7 corporation, entities wholly owned by residents of the same U.S. possession under the laws of which the entity is organized, exempt beneficial owners (as described below), active NFFEs, and excluded FFIs (as described above). 22 An entity would be an active NFFE if less than 50 percent of its gross income for the preceding calendar year is passive income and 23 less than 50 percent of the assets held by the NFFE at any time during the preceding calendar year are assets that produce or are held for the production of passive income. 24 Passive income includes interest and rents, but not rents derived in the active conduct of a trade or business conducted by employees of the NFFE. 25 The proposed regulations do not contain further clarification as to what constitutes rents derived in the active conduct of a trade or business by employees of the NFFE. However, the subpart F rules contain a similar concept of excluding active rents from foreign personal holding company income. 26 Under section 954(c)(2)(A), foreign personal holding company income does not include rents that are derived in the active conduct of a trade or business and are received from a person other than a related person. The regulations treat rents from certain property as being derived in the active conduct of a trade or business, including, among other things: Real property with respect to which the lessor, through its own officers or staff of employees, regularly performs active and substantial management and operational functions while the property is leased; and Property that is leased as a result of the performance of marketing functions by the lessor if the lessor, through its own officers or staff of employees located in a foreign country, maintains and 22 23 24 25 26 special reporting and registration rules for members of an expanded affiliated group, but they seem to apply only to affiliates that are themselves FFIs. Prop. Reg. section 1.1472-1(c). The proposed regulations actually use the word or, but that is understood to be an error. The intention of the IRS appears to be to test both gross income AND assets, as evidenced by the definition used in the Draft Form W-8BEN-E and the preamble to the proposed regulations in VIII C. REG-121647-10, 77 Fed. Reg. 9022, 9037 (Feb. 15, 2012). We expect that the test will be gross income AND assets in the final regulations. Prop. Reg. section 1.1472-1(c)(1)(v). Prop. Reg. section 1.1472-1(c)(1)(v)(C). Section 954(c)(2)(A).
FATCA and Foreign Leasing Companies page 8 operates an organization in such country that is regularly engaged in the business of marketing, or of marketing and servicing, the leased property and that is substantial in relation to the amount of rents derived from the leasing of such property. 27 Many foreign leasing companies may satisfy the second criterion above, as they may generally engage in substantial marketing functions to solicit potential lessees. Whether a foreign leasing company maintains and operates an organization in a foreign country that is substantial in relation to the amount of rents is a facts and circumstances determination. 28 However, a safe harbor applies under which an organization is considered substantial in relation to the amount of rents if active leasing expenses equal or exceed 25 percent of the adjusted leasing profit of the organization. 29 27 28 29 Section 1.954-2(c)(1). Section 1.954-2(c)(2)(ii). Id. Active leasing expenses are deductions incurred by the lessor in a foreign country that are properly allocable to rental income and that would be allowable under section 162 to the lessor if it were a domestic corporation, other than (1) deductions for compensation for personal services rendered by shareholders of, or related persons (as defined in section 954(d)(3)) with respect to, the lessor; (2) deductions for rents paid or accrued; (3) deductions that, although generally allowable under section 162, would be specifically allowable to the lessor (if the lessor were a domestic corporation) under any section of the Code other than section 162; and (4) deductions for payments made to agents or independent contractors with respect to the leased property other than payments for insurance, utilities and other expenses, for like services, or for capitalized repairs. Section 1.954-2(c)(2)(iii). Adjusted leasing profit is the gross income of the lessor from rents, reduced by the sum of (1) the rents paid or incurred by the lessor with respect to such rental income; (2) the amounts that would be allowable to such lessor (if the lessor were a domestic corporation) as deductions under sections 167 or 168 with respect to such rental income; and (3) the amounts paid by the lessor to agents or independent contractors with respect to such rental income other than payments for insurance, utilities and other expenses, for like services, or for capitalized repairs. Section 1.954-2(c)(2)(iv). The 25 percent threshold is reduced to 10 percent with respect to rental income from aircraft or vessels leased in foreign commerce (i.e., aircraft or vessels that are used for the transportation of property or passengers between the United States and a foreign country, or between two foreign countries, and used predominantly outside the United States). An aircraft or vessel will generally be considered used predominantly outside the United States for this purpose if more than 50 percent of the miles traversed during the tax year are traversed outside the United States or if the aircraft is located outside the United States more than 50 percent of the time during the tax year. Section 1.954-1(c)(1)(ii) and (v). In the case of property acquired subject to an existing lease, the rules above will also apply to rents from leases acquired from any person if, following the acquisition, the lessor performs active and substantial management, operational, and remarketing
FATCA and Foreign Leasing Companies page 9 Note that the proposed FATCA regulations treat only rents derived from an active trade or business by employees of the NFFE as not being passive income. However, the term employees is not defined in the proposed FATCA regulations. The criteria in section 1.954-2(c)(1) (discussed above) that would cause rent to be classified as active rent for purposes of the foreign personal holding company income rules also reference the term employees, but that regulation does not define such term either. The meaning of the term employees might be gleaned from other sections of the Code and the regulations, as well as the common law. In particular, section 31.3121(d)-1(c) 30 provides that every individual is an employee if under the usual common law rules, the relationship between the individual and the person for whom the individual performs services is the legal relationship of employer and employee. The regulation further states: Generally such relationship exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work, to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor. 31 30 31 (including remarketing for purposes of re-leasing or selling the property) functions with respect to the leased property. Section 1.954-2(c)(1)(vi). Section 1.954-3, which addresses certain income excluded from foreign base company sales income (another category of subpart F income), defines the term employees by reference to section 31.3121(d)-1(c). Section 31.3121(d)-1(c)(i). The IRS has summarized various factors that have been identified as indicating whether sufficient control is present to establish an employer-
FATCA and Foreign Leasing Companies page 10 Thus, rents derived from an active trade or business by independent contractors are not likely to be excluded from passive income for purposes of determining whether an NFFE is an active NFFE. Consequences If Foreign Leasing Companies Are Subject to FATCA FFI Agreements and Requirements Thereunder If a foreign leasing company is an FFI that is not an excluded FFI, 32 then to avoid FATCA withholding with respect to any withholdable payments, the foreign leasing company generally must enter into an FFI agreement with the IRS. Under an FFI agreement, the FFI must agree to: Obtain such information regarding each holder of each account maintained by such institution as is necessary to determine which, if any, of such accounts are United States accounts ; Comply with such verification and due diligence procedures as the Secretary may require with respect to the identification of United States accounts; In the case of any United States accounts maintained by the FFI, to report on an annual basis certain information with respect to such accounts; Deduct and withhold a tax equal to 30 percent of any passthru payment 33 that is made by the FFI to recalcitrant account holders 34 or to other FFIs that have not entered into a valid FFI agreement; Comply with requests by the Secretary for additional information with respect to any United States account maintained by the FFI; and 32 33 34 employee relationship under the common law rules. See Rev. Rul. 87-41, 1987-1 C.B. 296. See Prop. Reg. section 1.1471-5(e)(5) for what constitutes an excluded FFI. See section 1471(d)(7). See section 1471(d)(6).
FATCA and Foreign Leasing Companies page 11 In any case in which any foreign law would prevent the reporting of any information with respect to any United States account, attempt to obtain a valid and effective waiver of such law from each holder of such account, or close the account within a reasonable time if such a waiver is not obtained. 35 Thus, if a foreign leasing company is an FFI, it appears the company generally must enter into an FFI agreement with the IRS. The foreign leasing company s obligations under the FFI agreement depend on whether it has any United States accounts. Under section 1471(d)(1), a United States account is a financial account that is held by one or more specified United States persons or United States owned foreign entities. The term financial account is defined under section 1471(d)(2) to mean any depository account or custodial account maintained by the financial institution, or any equity or debt interest in a financial institution (other than interests that are regularly traded on an established securities market). The proposed regulations also provide that a financial account includes any cash value insurance contract or annuity contract maintained by a financial institution. 36 Furthermore, the proposed regulations define a depository account to mean a commercial, checking, savings, time, or thrift account, or an account that is evidenced by a certificate of deposit, thrift certificate, investment certificate, certificate of indebtedness, or other similar instrument, as well as any amount held by an insurance company under an agreement to pay or credit interest thereon. 37 A custodial account is defined to mean an account for the benefit of another person that holds any financial instrument or contract held for investment. 38 A typical foreign leasing company would not appear at a quick glance to be likely to have any U.S. depository or custodial accounts. However, if a foreign leasing company is owned by U.S. shareholders, either in whole or in part, or has U.S. debtholders, could they be considered to have United States accounts by virtue these equity or debt interests in the leasing company? Could holding U.S. lessee security or maintenance reserve accounts be considered to be United States accounts? Might a lease servicing company be considered to have United States accounts due to 35 36 37 38 Section 1471(b)(1). Prop. Reg. section 1.1471-5(b)(1). Prop. Reg. section 1.1471-5(b)(3)(i). Prop. Reg. section 1.1471-5(b)(3)(ii).
FATCA and Foreign Leasing Companies page 12 its holding of the leases and leased assets on behalf of its principals that are U.S. persons? If so, the foreign leasing company must comply with the due diligence, disclosure, and withholding requirements set forth in its FFI agreement with respect to these United States accounts. Even if the foreign leasing company does not have any U.S. shareholders or debtholders, it still would have to perform the required due diligence to determine that it does not have any United States accounts upon entering into an FFI agreement and on a going-forward basis. NFFEs If a foreign leasing company is not an FFI, then it is an NFFE. As described above, FATCA withholding also applies to any withholdable payments made to an NFFE, unless the NFFE provides a certification to the withholding agent that it does not have any substantial U.S. owners or, if it does have substantial U.S. owners, the names, addresses, and TINs of such owners. A foreign leasing company, however, may be an excepted NFFE. For example, a foreign leasing company may be an excepted NFFE by virtue of being publicly traded. Alternatively, it may be an excepted NFFE by virtue of being an active NFFE, if less than 50 percent of its gross income for the preceding calendar year is passive income and less than 50 percent of the assets held by the company at any time during the preceding calendar year are assets that produce or are held for the production of passive income. As noted above, passive income does not include rents derived from the active conduct of a trade or business conducted by employees of the company. Thus, if a majority of a foreign leasing company s gross income is derived from such active rents, or a majority of the assets held by the foreign leasing company consists of assets that produce active rents, then the foreign leasing company should be an excepted NFFE. Many foreign leasing companies currently analyze whether they generate active or passive rents in order to determine whether they are passive foreign investment companies ( PFICs ). A foreign corporation is a PFIC if either (a) 75 percent or more of its gross income for the tax year is passive income, or (b) if 50 percent or more of the quarterly gross value of its assets averaged over the tax year consists of assets that produce, or that
FATCA and Foreign Leasing Companies page 13 are held for the production of, passive income. 39 For these purposes, passive income keys off the definition of foreign personal holding company income under the subpart F rules discussed above. Since the percent of passive income required to avoid PFIC status is different from the percentage of passive income required to be an active NFFE, a foreign leasing company should not assume that just because it is not a PFIC, it is also an active NFFE. Furthermore, it is not clear what gross income and gross assets mean for purposes of the FATCA rules, as the proposed FATCA regulations and other guidance under FATCA do not define these terms; there are no cross-references to the PFIC or any other rules for this purpose either. Withholdable Payments FATCA withholding only applies to withholdable payments, and lease payments may not be withholdable payments. Withholdable payments generally means U.S.-source FDAP income and gross proceeds from the sale or disposition of any property of a type that can produce interest or dividends that are U.S-source FDAP income. However, section 1.1473-1(a)(4)(iii) of the proposed regulations excludes certain payments, including [p]ayments made in the ordinary course of the withholding agent s business for nonfinancial services, goods, and the use of property that include ordinary course payments for nonfinancial services, wages, office and equipment leases... It is not clear what types of equipment leases are meant to be included in this exception any type of personal property leases or only office equipment leases. If all equipment leases are meant to qualify for the exception, is it only operating leases and not finance or capital leases, since the exception refers to nonfinancial services, goods and the use of property? Likewise, is that meant to signify that any lease from an FFI is not covered by this exclusion from withholdable payments? A greater degree of clarity concerning this exclusion from withholdable payments is needed for the non-u.s. leasing community. 39 Section 1297(a).
FATCA and Foreign Leasing Companies page 14 Other Exceptions to FATCA Withholding We also note that there are certain other exceptions to FATCA withholding, but that foreign leasing companies do not appear to qualify for any of these exceptions. An exception to FATCA withholding applies with respect to FFIs if the payment is made to a deemed-compliant FFI. 40 Deemed-compliant FFIs generally consist of (1) certain foreign local banks, depository institutions, securities broker/dealers, or investment advisers with no fixed place of business outside of its country of organization that do not solicit account holders outside of such country, (2) certain non-reporting members of FFI groups, (3) and certain investment funds all of which are required to register with the IRS. 41 In addition, certain local banks, retirement funds, nonprofit organizations, and FFIs with only low-value accounts, that certify as to its status as a deemed-compliant FFI by providing a withholding agent with specified documentation qualify as deemed-compliant FFIs without being required to register with the IRS. 42 A foreign leasing company, however, does not appear to fall within any of these categories of deemed-compliant FFIs. There is also an exception to FATCA withholding with respect to payments made to certain exempt beneficial owners. These exempt beneficial owners generally consist of foreign governments, political subdivisions, and wholly owned instrumentalities and agencies, international organizations, foreign central banks of issue, certain foreign retirement plans, and certain entities wholly owned by one or more other exempt beneficial owners. 43 Again, a typical foreign leasing company also does not appear to fit into any of these categories of exempt beneficial owners. Treaties Many foreign leasing companies are resident in countries that have entered into a tax treaty with the United States providing relief from double taxation. A payment of U.S.-source FDAP income to a foreign entity is generally subject to withholding under section 1441 at a rate of 40 41 42 43 Prop. Reg. section 1.1471-5(f). Prop. Reg. section 1.1471-5(f)(1). Prop. Reg. section 1.1471-5(f)(2). Prop. Reg. section 1.1471-6(a).
FATCA and Foreign Leasing Companies page 15 30 percent, unless the foreign entity qualifies for a reduced rate of withholding under a tax treaty. 44 FATCA withholding exists separate and apart from section 1441 withholding, and the 30 percent FATCA withholding rate cannot be reduced by treaty. However, a refund or credit may be obtained. Under section 1474(b)(2), if tax was withheld with respect to a payment to an FFI who is the beneficial owner of the payment, and the FFI is entitled to a reduced rate of tax with respect to such payment by reason of a treaty, the FFI may obtain a credit or refund with respect to the tax withheld to the extent the credit or refund does not exceed the reduced amount under the treaty. The FFI is not entitled to any interest on any credit or refund. 45 Note that a credit or refund is only available to an FFI to the extent of a reduction in tax as a result of an applicable treaty. Thus, no credit or refund is available to an FFI as a result of, for example, the portfolio interest exemption. For NFFEs, no such restriction exists, and thus, an NFFE may be entitled to obtain a credit or refund for any reduction in tax as a result of qualifying for an applicable treaty or another exemption. However, the proposed FATCA regulations require an NFFE to provide a certification to the IRS that it does not have any substantial U.S. owners or information on any such U.S. owners in order to obtain a credit or refund. 46 Intergovernmental Agreements In addition to the withholding and reporting regime described above, Treasury and the IRS have outlined an alternative approach to complying with FATCA through intergovernmental agreements negotiated with foreign countries ( IGAs ). 47 Under one type of IGA (the Model 1 IGA ), a foreign financial institution would not enter into an FFI agreement with the IRS and would instead report the information required by FATCA to its residence country government, as required under the IGA, with the residence country government in turn reporting the information to the 44 45 46 47 Section 1.1441-1(b). Section 1474(b)(2)(A)(ii); section 1.1474-5(a)(2). Section 1.1474-5(a)(3). See REG-121647-10, 77 Fed. Reg. at 9023.
FATCA and Foreign Leasing Companies page 16 IRS. 48 The Model 1 IGA may require reciprocal information reporting to the foreign country by the U.S. government, or it may be nonreciprocal. Under a second type of IGA (the Model 2 IGA ), the foreign financial institution would enter into an FFI agreement with the IRS and still report directly to the IRS, supplemented by information exchanges between the IRS and the foreign government, including for customers of the financial institution that do not consent to direct information reporting. 49 The U.S. government is negotiating or has signed IGAs with more than 50 countries to date, including the United Kingdom and Ireland. 50 Under either version of the IGA, non-u.s. financial institutions will be treated as complying with, and not subject to withholding under, FATCA if they meet their obligations as agreed under the IGAs and implemented by their local authorities. 51 Under the IGAs, a financial institution is defined to include any entity that accepts deposits in the ordinary course of a banking or similar business, but unlike the proposed FATCA regulations, the IGAs do not define what the ordinary course of a banking or similar business means. However, the IGAs provide that any term not otherwise defined generally has the meaning that it has under the laws of the country applying the IGA, with any meaning under the applicable tax laws of the country prevailing over a meaning under other laws of such country. If a foreign leasing company s country of residence enters into an IGA with the United States, then the foreign leasing company need only comply with its obligations, if any, under the IGA. However, if a foreign leasing company does business in multiple jurisdictions, it may be required to track different local IGA implementation rules in addition to the FATCA regulations for non-iga countries. 48 49 50 51 See Model 1A and Model 1B IGA templates available at http://www.treasury.gov/resource-center/tax-policy/treaties/documents/fatca-model- 1A-Agreement-to-Implement-Reciprocal-11-14-2012.pdf and http://www.treasury.gov/resource-center/tax-policy/treaties/documents/fatca-model- 1B-Agreement-to-Implement-Nonreciprocal-11-14-2012.pdf. The Model 1A IGA provides for reciprocal information reporting by the U.S. government, while the Model 1B IGA is nonreciprocal. See Model 2 IGA template, available at http://www.treasury.gov/resource-center/taxpolicy/treaties/documents/fatca-model-2-agreement-to-implement-11-14-2012.pdf. Department of Treasury press release, U.S. Engaging with More than 50 Jurisdictions to Curtail Offshore Tax Evasion (Nov. 8, 2012), available at http://www.treasury.gov/press-center/press-releases/pages/tg1759.aspx. There are other benefits of entering into either version of the IGA. Most notably, financial institutions do not have to generally close recalcitrant accounts and they do not have to supply information reporting on Forms 1042 and 1042-S to the IRS (unless they already have agreed to do so in a qualified intermediary agreement with the IRS).
FATCA and Foreign Leasing Companies page 17 Effective Dates under Proposed Regulations Under guidance issued to date, an FFI must enter into an FFI agreement by June 30, 2013, to be identified as a participating FFI by the IRS in sufficient time to allow withholding agents to refrain from withholding beginning on January 1, 2014. Otherwise, the FFI agreement is not effective until the IRS processes it and the IRS may not be able to process it by January 1, 2014. 52 For payments made on or after January 1, 2014, withholding agents, which may include FFIs, will be obligated to withhold under sections 1471(a) and 1472(a) on U.S.-source FDAP payments, subject to certain transition rules that postpone this effective date for payments with respect to certain pre-existing obligations. For payments made after December 31, 2016, withholding agents will be obligated to withhold on all withholdable payments (including gross proceeds from any sale or disposition of any property of a type that can produce interest or dividends that are U.S.-source FDAP income). 53 A participating FFI will be required to file information reports on its United States accounts with respect to the 2013 and 2014 calendar years not later than March 31, 2015. 54 Observation The FATCA regulations are still in proposed form and there likely will be changes in the final FATCA regulations. It is possible that the final regulations will offer more clarity as to the application of FATCA to foreign leasing companies. But as of now, it may be prudent for foreign leasing companies, especially those that require deposits from lessees, to consider that they may be FFIs and that they may receive withholdable payments from their U.S. lessees or other FFIs, and thus may be required to enter into an FFI agreement with the IRS to avoid FATCA withholding. KPMG s What's News in Tax is a publication from Washington National Tax that contains thoughtful analysis of new developments and practical, relevant discussions of existing rules and recurring tax issues. 52 53 54 The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author or authors only, and does not necessarily represent the views or professional advice of KPMG LLP. See Announcement 2012-42, 2012-47 I.R.B. 561 (Oct. 24, 2012); REG-121647-10 supra; Notice 2011-53, 2011-32 I.R.B. 124 (July 14, 2011). Id. Id.