FATCA for Multinational Companies

FATCA for Multinational Companies Alan J. Schwartz February 27, 2015 www.mwe.com Boston Brussels Chicago Düsseldorf Frankfurt Houston London Los Angeles Miami Milan Munich New York Orange County Paris Rome Seoul Silicon Valley Washington, D.C. Strategic alliance with MWE China Law Offices (Shanghai) 2013 McDermott Will & Emery. The following legal entities are collectively referred to as "McDermott Will & Emery," "McDermott" or "the Firm": McDermott Will & Emery LLP, McDermott Will & Emery AARPI, McDermott Will & Emery Belgium LLP, McDermott Will & Emery Rechtsanwälte Steuerberater LLP, McDermott Will & Emery Studio Legale Associato and McDermott Will & Emery UK LLP. These entities coordinate their activities through service agreements. This communication may be considered attorney advertising. Previous results are not a guarantee of future outcome.

Background As part of the Hiring Incentives to Restore Employment (HIRE) Act, Congress enacted Sections 1471-1474 (Chapter 4) of the Internal Revenue Code. These provisions and the Treasury regulations that have been issued thereunder are referred to collectively as FATCA, short for the Foreign Account Tax Compliance Act FATCA s goal is to detect and deter tax evasion by U.S. persons who hide money by investing in offshore financial accounts or by using non-u.s. entities to invest in accounts inside or outside the United States To accomplish this goal, Chapter 4 requires foreign financial institutions (FFIs) to identify and report U.S. account holders. Nonfinancial foreign entities (NFFEs) also may be required to provide information regarding their substantial U.S. ownership to withholding agents (i.e. U.S. owners that hold an interest greater than 10% in the NFFE) FFIs and NFFEs that do not comply with the requirements of Chapter 4 suffer a 30% withholding tax on payments to them of certain categories of U.S. source fixed or determinable annual or periodical (FDAP) income, as well as on gross proceeds from the sale or other disposition of debt or equity interests in U.S. issuers www.mwe.com 2

FATCA vs. Existing Withholding Rules FATCA (Chapter 4) is an additional reporting and withholding regime that will apply before the existing non-resident alien/section 1441 regime (Chapter 3), but many of the concepts will converge Chapter 3 vs. Chapter 4 Chapter 3 rules are aimed at withholding tax and reporting U.S.-source FDAP income paid to non-u.s. persons FATCA is not designed to impose a withholding tax, but rather is designed to capture information about U.S. persons withholding generally only applies if there are payments to: NFFEs that fail to either identify and disclose substantial U.S. owners or certify that they have no substantial U.S. owners Nonparticipating FFIs www.mwe.com 3

FATCA Status Timeline FATCA applies to payments of U.S.-source FDAP income as of July 1, 2014: Gross proceeds from the sale or disposition of property that could produce U.S.- source interest or dividends will not be subject to withholding until January 1, 2017 Exceptions: Grandfathered obligations: Debt obligations, derivatives transactions (evidenced by a confirmation pursuant to an ISDA Master Agreement) and agreements to extend credit for a fixed term (e.g., revolving credit facilities) that are outstanding as of June 30, 2014 An obligation will cease to be grandfathered if it is subject to a material modification after June 30, 2014 Preexisting obligations Obligations (including accounts) held by an entity that are opened, executed, or issued on or after July 1, 2014 and before January 1, 2015 Payments with respect to preexisting obligations are not subject to withholding until June 30, 2016, unless the payee is a prima facie FFI www.mwe.com 4

FATCA Compliance Initiatives I. Determination of FATCA Entity Status of Non-U.S. Entity (including non-u.s. retirement plans) II. Withholding Agent Compliance III. Compliance as Payee (or Account Holder of Payee) www.mwe.com 5

I. Determination of FATCA Entity Status of Non-U.S. Entities To avoid withholding tax imposed under FATCA, FFIs and NFFEs are required to certify that they are in compliance with applicable FATCA requirements Different compliance features for FFIs and NFFEs FATCA status is important: To avoid withholding on U.S.-source payments; and To assist FFIs in connection with FATCA diligence www.mwe.com 6

FFI or NFFE FFIs FFIs need to (i) register with the IRS and obtain a Global Intermediary Information Number (GIIN), (ii) identify which of their account holders are U.S. taxpayers and U.S. owned foreign entities and (iii) report financial information about them to the IRS, or in case of Model 1 IGA report to local tax authorities (LTA). Certain FFIs may be exempt or deemed compliant, or may defer or avoid registration with the IRS. FFIs residing in a non-iga country and in Model 2 IGA countries have to sign a FFI Agreement with additional requirements to comply with FATCA. Upon registration at the IRS Portal, the FFIs will obtain a GIIN and will be listed on the IRS website. If the FFI remains non-compliant, it will be treated as a nonparticipating FFI and will be subject to 30% withholding. NFFEs Certain Passive NFFEs are required to disclose certain information to withholding agents who in turn report that information to the IRS. A Passive NFFE must either: certify and disclose the names, address and TIN of its substantial U.S. owners (i.e., more than 10%) and under IGAs of its controlling persons (i.e., more than 25%), or certify that it is not U.S. owned. Excepted NFFEs have no disclosure requirements under FATCA. If a NFFE does not comply, it is subject to 30% withholding www.mwe.com 7

FFI Categories Under the FATCA Treasury regulations, there are five categories of FFIs: Depository Institutions Custodial Institutions Investment Entities Specified Insurance Companies Certain Holding Companies and Treasury Centers Note: Intergovernmental Agreements (IGAs) contain modifications to the definition of FFI. Specifically, the IGAs contain a modified definition of Investment Entity and do not contain provisions for Treasury Centers or Holding Companies. Entities organized in countries with IGAs should refer to the applicable IGA and other official guidance for their FATCA status www.mwe.com 8

FFIs (Depository Institutions) Depository institution: an entity that accepts deposits in the ordinary course of a banking or similar business An entity is considered to be engaged in a banking or similar business if, in the ordinary course of its business with customers, the entity accepts deposits or other similar investments of funds and regularly engages in one or more of the following activities: Makes personal, mortgage, industrial, or other loans or provides other extensions of credit; 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; or Enters into, purchases, or disposes of finance leases or leased assets Includes commercial banks, savings and loan associations, credit unions, and cooperative banking institutions www.mwe.com 9

FFIs (Custodial Institutions) Custodial institution: an entity that holds, as a substantial portion of its business, financial assets for the benefit of one or more other persons In general, 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 holding financial assets and related financial services (with respect to financial assets held in (or to be held in) custody by the entity) equals or exceeds 20% of the entity's gross income over a 3 year period For these purposes, income attributable to holding financial assets and related financial services means custody, account maintenance, and transfer fees; commissions and fees earned from executing and pricing securities transactions; income earned from extending credit to customers with respect to financial assets held in custody (or acquired through such extension of credit); income earned on the bid-ask spread of financial assets; and fees for providing financial advice with respect to financial assets held in (or potentially to be held in) custody by the entity; and fees for clearance and settlement services Includes broker dealers, clearing organizations, trust companies, custodial banks, employee benefits plans www.mwe.com 10

FFIs (Investment Entities) An investment entity is any of the following: a) An entity that primarily conducts as a business one or more of the following activities: trading on behalf of customers in money market instruments (such as checks, bills, certificates of deposit and derivatives), foreign currency, foreign exchange, interest rate, and index instruments, transferable securities, or commodity futures; managing individual or collective portfolios; or otherwise investing, administering, or managing funds, money, or financial assets on behalf of other persons b) An entity whose gross income over a three year period is primarily attributable to investing, reinvesting, or trading in financial assets and it is professionally managed by another entity financial assets are defined as securities, partnership interests, commodities, notional principal contracts, insurance and annuity contracts, or any derivative interests (including futures contracts, forward contract or options) c) An entity that functions or holds itself out as a collective investment vehicle (defined as a mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets) An investment advisor and investment manager are treated as certified deemed-compliant FFIs if they do not maintain financial accounts Includes mutual funds, ETFs, hedge funds, private equity funds, venture capital funds, managed funds www.mwe.com 11

Investment Entities (cont.) The definition of an investment entity under the Model 1 and 2 IGAs is somewhat different: Under the IGAs, an Investment Entity means any entity that conducts as a business (or is managed by an entity that conducts as a business) one or more of the following activities or operations for or on behalf of a customer (for example an account holder): 1. Trading in money market instruments (checks, bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading; 2. Individual and collective portfolio management; or 3. Otherwise investing, administering, or managing funds or money on behalf of other persons The definitions under IGAs may need further clarification and guidance. So far, the UK, Ireland, Luxembourg, the Netherlands, Mauritius, the Cayman Islands and Channel Islands have released guidance to the IGA and some definitions therein have been aligned with FATCA final regulations. The compliance requirement in other IGA jurisdictions will be known for certain only after guidance is issued by these IGA countries. www.mwe.com 12

FFIs (Specified Insurance Companies) A specified insurance company (or a holding company that is in the same expanded affiliated group (EAG) as a specified insurance company) is an FFI if it issues, or is obligated to make payments with respect to, a cash value insurance or annuity contract An expanded affiliated group means each of the entities in one or more chains of corporations or partnerships connected through ownership and where a common parent owns at least 50% of at least one entity in the chain and at least 50% of the vote and value of each entity is owned by other entities in the group Generally, captive insurance companies are not FFIs under this definition, but may qualify as an FFI under one of the other categories of FFI Includes life insurance companies A foreign insurance company that makes a Code Section 953(d) election will be treated as a U.S. person provided that either the foreign insurance company is not a specified insurance company or, if it is a specified insurance company, it is licensed to do business in any state www.mwe.com 13

FFIs (Certain Holding Companies and Treasury Centers) An entity is a holding company if its primary activity consists of holding (directly or indirectly) all or part of the outstanding stock of one or more members of its EAG An entity is a treasury center if its primary activity is to enter into investment, hedging, and financing transactions with or for members of its EAG for purposes of managing the risk of price changes, currency fluctuations, or interest rate changes, working capital, or otherwise acting as a financing vehicle for borrowing funds for use by the EAG (or any member thereof) A holding company or treasury center is an FFI if it is: part of an EAG that includes a depository institution, custodial institution, insurance company, or certain investment entities (described in (a) or (b) above), or is formed in connection with or availed of by a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets www.mwe.com 14

FFIs (Specific Types) Careful consideration should be given to stealth FFIs which conduct financial-type activities: Leasing companies Financing companies Factoring companies Cash management companies Captive insurance companies Non-U.S. retirement plans that are not excluded under FATCA Non-U.S. charitable foundations and organizations (not tax exempt under Code Section 501(c)) Note: These entities technically may not be affiliates, but still may be related for FATCA purposes. See definition of Expanded Affiliate Group on Slide 13 www.mwe.com 15

FFIs (Non-U.S. Retirement Funds) Non-U.S. retirement funds may be classified as investment entities if their gross income is primarily attributable to investing, reinvesting, or trading in financial assets and they are professionally managed by another entity Certain types of retirement funds (i.e., exempt beneficial owners ) are excluded from FATCA reporting requirements. These include: Funds that are entitled to receive benefits under an income tax treaty Broad participation retirement funds Narrow participation retirement funds 401(a)-type plans Funds that are exempt pursuant to an IGA www.mwe.com 16

Deemed-Compliant FFIs There are three categories of deemed-compliant FFIs : 1. Registered deemed-compliant FFIs Local FFIs Nonreporting members of participating FFI groups Qualified collective investment vehicles Restricted funds Qualified credit card issuers and servicers Sponsored investment entities and controlled foreign corporations A registered deemed-compliant FFI is required to register with the IRS, obtain a GIIN and must certify as to its status every 3 years to remain compliant www.mwe.com 17

Deemed-Compliant FFIs (cont.) 2. Certified deemed-compliant FFIs Nonregistering local banks FFIs with only low-value accounts Sponsored, closely held investment vehicles Limited life debt investment entities (transitional) Investment advisors and investment managers A certified deemed-compliant FFI is not required to register with the IRS; rather, it is required to certify its status as a certified deemed-compliant FFI to a withholding agent 3. Owner-documented FFIs An owner-documented FFI is generally meant for smaller passive investment vehicles that are not affiliated with other FFIs. The U.S. owner information is provided to the withholding agent and reported to the IRS www.mwe.com 18

Excluded Nonfinancial Entities Excluded Nonfinancial Entities: Certain categories of entities are specifically excluded from the definition of FFI: Excluded nonfinancial group entities (defined below) Nonfinancial start-up companies or companies entering a new line of business (first 24 months) Nonfinancial entities in liquidation or bankruptcy Excepted inter-affiliate FFIs (defined below) Code Section 501(c) entities (other than Code Section 501(c)(15) insurance companies) Foreign non-profit organizations These entities will be treated as excepted NFFEs (discussed below) www.mwe.com 19

Excluded Nonfinancial Entities Excluded Nonfinancial Group Entities An entity is an excluded nonfinancial group entity if: It is a holding company, treasury center, or captive finance company A captive finance company is an entity whose primary activity of is to enter into financing or leasing transactions with or for suppliers, distributors, dealers, franchisees, or customers of such entity or of any member of such entity's EAG that is an active NFFE. It is a member of a nonfinancial group (defined below) It is neither a depository institution nor a custodial institution (other than for members of its EAG) It does not hold itself out as (and was not formed in connection with or availed of by) an arrangement or investment vehicle that is a private equity fund, venture capital fund, leveraged buyout fund, or any similar investment vehicle established with an investment strategy to acquire or fund companies and to treat the interests in those companies as capital assets held for investment purposes www.mwe.com 20

Excluded Nonfinancial Entities Excluded Nonfinancial Group Entities (cont.) An EAG is a nonfinancial group if: for the 3 year period ending on December 31 of the year preceding the year for which the determination is made: no more than 25% of the gross income of the EAG consists of passive income (defined below); no more than 5% of the gross income of the EAG is derived by members of the EAG that are FFIs (excluding income derived from transactions between members of the EAG or by any member of the EAG that is a certified deemed compliant FFI ); and no more than 25% of the fair market value of the assets held by the EAG are assets that produce or are held for the production of passive income any member of the expanded affiliated group that is an FFI is either a participating FFI or deemed-complaint FFI www.mwe.com 21

NFFE Categories An entity that is not an FFI will be treated as an NFFE Each NFFE must be categorized as either a Passive NFFE or Excepted NFFE to determine its compliance requirements under FATCA There are 6 categories of Excepted NFFEs A Passive NFFE is a residual category that includes any NFFE that is not an Excepted NFFE www.mwe.com 22

NFFEs In General An NFFE is not required to enter into an FFI Agreement or otherwise register with the IRS. Rather, in order to avoid 30% withholding on withholdable payments, it is required to make certain certifications regarding its status to the withholding agent on an applicable IRS form (e.g., IRS Form W-8BEN-E) In addition, a passive NFFE must either (i) certify that is does not have any substantial U.S. owners or (ii) identify its substantial U.S. owners to the withholding agent www.mwe.com 23

Excepted NFFE Categories An Excepted NFFE includes: Publicly Traded Corporations (a corporation the stock of which is regularly traded on one or more established securities markets for the calendar year) Corporations in the same EAG as a publicly traded corporation Territory entities incorporated or organized under the laws of any U.S. territory that are directly or indirectly wholly owned by one or more bona fide residents of the U.S. territory under the laws of which the entity is organized Active NFFEs Excepted Nonfinancial Entities (see above) Direct Reporting NFFEs or Sponsored Direct Reporting NFFEs www.mwe.com 24

Excepted NFFEs Active NFFEs An entity is an active NFFE if: less than 50% of its gross income (based on the preceding taxable year (calendar or fiscal)) is passive income, and less than 50% of the weighted average percentage of assets (tested quarterly) held by it produce passive income www.mwe.com 25

Passive Income For purposes of determining whether an NFFE is an active NFFE, passive income generally includes: dividends, substitute dividend amounts, interest, substitute interest, amounts received from a pool of insurance contracts, rents and royalties, annuities, and the excess of gains over losses from the sale of property that gives rise to the income described above the excess of gains over losses from certain commodities transactions (including futures and forwards), the excess of foreign currency gains over foreign currency losses, net income from notional principal contracts, amounts received under cash value insurance contracts, and amounts earned by an insurance company in connection with its reserves for insurance and annuity contracts Passive income does not include: interest, dividends, rents, or royalties received or accrued from a related person to the extent such amounts are properly allocable to income of the related person that is not otherwise passive ordinary business income of a dealer in securities or financial instruments or derivatives or commodities www.mwe.com 26

Excepted NFFEs Direct Reporting NFFEs or Sponsored Direct Reporting NFFEs Categories of excepted NFFEs added by February 2014 Temporary Regulations A direct reporting NFFE is an NFFE that elects to report on Form 8966 directly to the IRS information about its direct or indirect substantial U.S. owners, in lieu of providing such information to withholding agents or participating FFIs with which the NFFE holds a financial account A sponsored direct reporting NFFE is a direct reporting NFFE that is sponsored by another entity that is registered with the IRS as a sponsoring entity. The sponsoring entity will report on Form 8966 directly to the IRS (on the sponsored direct reporting NFFE's behalf) information about each sponsored direct reporting NFFE's direct or indirect substantial U.S. owners www.mwe.com 27

Intergovernmental Agreements (IGAs) The Treasury Department has published two Model IGAs (referred to as Model 1 and Model 2) to implement FATCA Under a Model 1 IGA: The partner jurisdiction agrees to report to the IRS specified information about the U.S. accounts maintained by all relevant FFIs located in the jurisdiction FFIs organized in the partner jurisdiction identify U.S. accounts pursuant to due diligence rules contained in Annex I of the IGA FFIs report specified information about their U.S. accounts to the partner jurisdiction The partner jurisdiction, in turn, reports such information to the IRS on an automatic basis The exchange of information under a Model 1 IGA may be on a reciprocal or nonreciprocal basis Annex II of the Model 1 IGA includes a country-specific list of financial institutions, products and accounts that are exempt or deemed compliant Under a Model 2 IGA: The partner jurisdiction agrees to direct and enable all relevant FFIs located in the jurisdiction to report specified information about their U.S. accounts directly to the IRS FFIs identify U.S. accounts pursuant to due diligence rules contained in Annex I of the IGA FFIs report specified information about their U.S. accounts to the IRS www.mwe.com 28

FATCA v. IGAs FATCA Regulations IGA Model 1 IGA Model 2 Applicable if the entity resides in a jurisdiction that has not signed an IGA. To become compliant the FFIs register with the IRS as Participating FFI (PFFI) and enter into a FFI Agreement with the IRS which includes additional requirements. PFFIs are required to withhold 30% tax on U.S.-source payments made to non-compliant account holders, to request the U.S. accountholder to waive the privacy or secrecy rights, to close the account if a waiver is not provided and to provide a certification of compliance by a responsible officer Most commonly applied IGA is Model 1A and it requires its local Reporting FIs to report to local tax authorities who will in turn report to the IRS. Model 1A includes reciprocity of exchanging information of residents in IGA countries with U.S. bank accounts. The nonreciprocal version is Model 1B. Entities residing in Model 2 IGA jurisdictions must sign a FFI Agreement with the IRS and comply with the FATCA regulations (almost similar to Participating FFIs in non-iga countries), except to the extent expressly modified by their IGA. www.mwe.com 29

Requirements of a U.S. Withholding Agent For U.S. Withholding Agents (USWAs) making payments, 4 general steps are necessary: Step 1: Identify sources of U.S.-source withholdable payments or gross proceeds on U.S. securities Step 2: Determine status of payee as U.S. or foreign and if foreign, the entity s FATCA classification Step 3: Withhold 30% if appropriate documentation is not provided Step 4: Year-end reporting www.mwe.com 30

Step 1: Identify FATCA Withholdable Payments Withholdable payment is defined as: U.S.-source FDAP income (defined as under 1441 rules) Gross proceeds from disposition of property that can produce interest or dividends that are U.S.-source FDAP (i.e., sale of U.S. securities) Non-U.S.-source income is not included. However, source must be able to be determined FATCA regulations provide exclusions for specified payments defined as nonfinancial Review accounts payable, treasury and any other function involved in payment processing and determination of income (i.e., procurement, legal, tax, business units). You may be surprised what you find! Be prepared to make changes to existing reporting a d withholding systems, policies and procedures www.mwe.com 31

Withholdable Payments Include FATCA withholdable payment types: Bank and brokerage fees Investment advisory fees Custodial fees (e.g., fund manager fees) Payments in connection with lending transactions Forward, futures, option or notional principal contracts Premiums for insurance contracts or annuity contracts and amounts paid under cash value insurance or annuity contracts Dividends on U.S. securities Interest (other than interest on certain short-term obligations (see slide below)) Original issue discount Dividend equivalent payments where the USWA acts as custodian Financing leases Important: Intercompany payments ARE subject to FATCA. www.mwe.com 32

Withholdable Payments Do Not Include Certain types of payments are excluded from the definition of withholdable payment: Payments for tangible goods Excluded nonfinancial payments Effectively Connected Income (ECI) Grandfathered obligations Certain short-term obligations (payable within 183 days or less from date of original issue) Excluded Nonfinancial Payments (ordinary course of business): Fees for nonfinancial services (e.g., litigation fees or wages) Software licenses Interest on accounts payable from acquisition of nonfinancial goods, services, or tangible property Rent for office space Use of property (e.g., royalty or intellectual property) Freight/transportation expenses Interest on deferred purchases (e.g., goods purchase on credit) Lease payments on equipment www.mwe.com 33

Source of Payments FATCA applies to U.S.-source FDAP or gross proceeds from sales of U.S. securities. Foreign source income is generally excluded from FATCA requirements Source must be determined Processes must include documenting source of income where necessary Review all documents and information necessary to determine source of income including contracts, invoices and knowledge of those involved in the transactions Where source is not known, presumption rules require treatment as U.S.-source Test current processes and procedures to ensure they determine source properly and timely (before payment is made) and that source is documented Update processes and systems as necessary www.mwe.com 34

Step 2: Determine Status and Document Step 2 Determine status and document FATCA applies only to payments to non-u.s. entities. Complex presumption rules must be applied in the absence of documentation, generally resulting in the payee being a non-participating FFI, for which withholding at 30% is required. To avoid FATCA withholding, USWAs must obtain a valid withholding certificate from the payee: W-9 used by U.S. persons or entities W-8BEN used by foreign individuals W-8BEN-E used by foreign entities W-8IMY used by flow through entities (still need W-8BEN-E from ultimate beneficiary/payee) W-8ECI used to identify income that is effectively connected with a U.S. trade or business W-8EXP used by foreign governments and certain other foreign organizations to certify exemption Pre-FATCA forms that were provided before January 1, 2015 may be relied up on only in very limited circumstances and only if the USWA otherwise has documentation indicating the payee s Chapter 4 status www.mwe.com 35

Steps 3 & 4: Withhold, Remit and Report Step 3 Withhold Generally, if a payee is compliant, no withholding will be required under FATCA (withholding may still be required under Section 1441) Withhold 30% on U.S.-source income paid to noncompliant payees (vendors, customers and/or accountholders), such as: Non-participating FFI Non-certifying NFFE If withholding is required under FATCA, no Chapter 3 withholding is required Step 4 Report A USWA must report information about substantial U.S. owners of NFFEs that are not excepted NFFEs, to the extent such information is received from the payee or the USWA knows or has reason to know the information New forms, such as 1042-S and 1042, will be used to report recipient information www.mwe.com 36

Important Features of New Form W-8BEN-E Form W-8BEN-E requires foreign entity payees to separately indicate their Chapter 3 and Chapter 4 statuses Chapter 4 status must be included only for withholdable payments Disregarded entities generally provide the form W-8 (or W-9) of their sole owner Form W-8BEN-E remains valid for a period starting on the date the form is signed and ending on the last day of the third succeeding year www.mwe.com 37