FATCA Regulations on Cross Border Financing - IPBA 2012

<strong>FATCA</strong> <strong>Regulations</strong> on Cross Border FinancingMarch 2, 2012Inter-Pacific Bar Association Annual MeetingDelhi, India

AgendaI. <strong>FATCA</strong> Overview of Enhanced U.S. Reporting and Withholding RequirementsII.III.IV.Compliance Requirements for Foreign Financial Institutions and Non Financial Foreign EntitiesImplications of Payments Subject to <strong>FATCA</strong>Withholding on U.S. Equity Swaps under Section 871(m)gsblaw.com 2

Key Withholding RequirementsWithholdable Payment30% U.S. WHTUNLESSForeign Financial Institution (FFI)enters into an agreement with theIRS to identify U.S. AccountNon Financial Foreign Entity (NFFE)provides information onsubstantial U.S. owners, if anygsblaw.com 6

Glossary of General Terms‣ Foreign Financial Institution (“FFI”) includes any non-U.S. entity that:• accepts deposits in the ordinary course of a banking or similar business;• holds financial assets for the account of others as a substantial portion of itsbusiness; or• is engaged primarily in the business of investing, reinvesting, or trading insecurities, partnership interests, commodities, or any interest in suchsecurities, partnership interests, or commodities.‣ U.S. Account means any financial account which is held by one or more “UnitedStates persons” or “United States owned foreign entities.”• “United States Persons” generally means U.S. citizens or residents, U.S.corporations or partnerships, and U.S. trusts and estates.• “United States Owned Foreign Entity” means any foreign entity which hasone or more “substantial United States owners.”gsblaw.com 8

Glossary of General Terms‣ Non-Financial Foreign Entity (“NFFE”) means any foreign entity which is not afinancial institution.‣ Substantial U.S. Owner includes any U.S. person who owns directly or indirectlythe following:• More than 10% of the stock (either by vote or value) of a corporation• More than 10% of the profit or capital interest in a partnership• Any U.S. owner of a trust or more than 10% of the beneficial interest in atrust.‣ Special rule for investment vehicles – the ownership interest for a substantial U.S.owner is reduced to zero (i.e., any U.S. owner will be a substantial U.S. owner).gsblaw.com 9

General Exemption from <strong>FATCA</strong>‣ Certain recipients of payments are exempted in their entirety from <strong>FATCA</strong>. Theseinclude payments received by a foreign entity to the extent the beneficial ownerof such payments is one of the following:• a foreign government, its political subdivisions or any wholly-owned agencyor instrumentality thereof,• an international organization or any wholly-owned agency or instrumentalitythereof,• a foreign central bank of issue, or• any other class of persons identified by the Treasury as posing a low risk oftax evasion.gsblaw.com 11

Key Terms Related to “Foreign Financial Institutions”‣ Withholdable payments made to an FFI will be subject to withholding under<strong>FATCA</strong> unless the FFI has entered into an FFI Agreement with the IRS, pursuant towhich the FFI must agree to undertake certain due diligence, reporting andwithholding responsibilities.‣ The <strong>FATCA</strong> legislation anticipates that the IRS will designate certain categories ofFFIs that will be treated as “deemed compliant” under <strong>FATCA</strong> and, as a result, willnot be required to enter into an FFI Agreement with the IRS in order to avoid the30% withholding tax.‣ <strong>FATCA</strong> also provides the IRS with discretion to exclude certain classes of financialinstitutions from the <strong>FATCA</strong> withholding regime to the extent the IRS determinesthat such entities pose a low risk of tax evasion.gsblaw.com 12

Key Terms Related to “Non-Financial Foreign Entity”‣ <strong>FATCA</strong> also requires a withholding agent, subject to certain exceptions, towithhold tax on withholdable payments made to an NFFE and to report certaininformation regarding the “substantial U.S. owners of an NFFE.‣ NFFEs excepted from these rules include:• publicly traded corporations and certain related entities;• entities organized under the laws of a U.S. territory and wholly owned bybona fide residents thereof;• foreign governments, including political subdivisions or wholly ownedagencies or instrumentalities thereof;• certain international organizations or any wholly owned agencies orinstrumentalities thereof; and• foreign central banks of issue.gsblaw.com 13

Phased Implementation‣ On July 14, 2011, the IRS issued guidance outlining phased implementation of thenew U.S. withholding regime and information reporting requirements applicableto foreign entities under <strong>FATCA</strong>.• Withholding on U.S. source dividends, interest and other "FDAP-type"income will apply to payments made on or after January 1, 2014.• Withholding on all "withholdable payments" (including on gross proceeds)will be fully phased in for payments made on or after January 1, 2015.• An FFI will be required to enter into an agreement with the IRS by June 30,2013, to ensure that it will be identified as a "participating FFI" in sufficienttime to allow withholding agents to refrain from withholding beginning onJanuary 1, 2014. The IRS will begin accepting FFI applications through itselectronic submissions process no later than January 1, 2013.• A participating FFI will be required to put in place account openingprocedures described in IRS guidance to identify US accounts amongaccounts opened on or after the effective date of its FFI Agreement.gsblaw.com 14

Phased Implementation• A participating FFI will be required to have completed due diligenceprocedures with respect to pre-existing private banking accounts within oneyear of the effective date of its FFI Agreement. For all other pre-existingaccounts, a participating FFI will be required to complete due diligenceprocedures within two years of the effective date of its FFI Agreement.• An account for which a participating FFI has received a Form W-9 from theaccount holder by June 30, 2014 must be reported to the IRS as a U.S.account by September 30, 2014.• Reporting with respect to recalcitrant account holders identified by June 30,2014 will be required to be filed with the IRS by September 30, 2014.Reporting with respect to 2014 and later years will be required ascontemplated by the preliminary guidance and as implemented in futureregulations.gsblaw.com 15

FFI and NFFE Compliance Requirementsgsblaw.com 16

FFIs and Identification of U.S. Accounts‣ Under <strong>FATCA</strong>, a participating FFI must determine whether existing individualaccounts are U.S. accounts, non-U.S. accounts or recalcitrant accounts.‣ Interim guidance from the IRS provides procedures for FFIs to identify U.S.accounts among their existing individual accounts and also imposes a newrequirement that FFIs to certify that they have completed the identification oftheir existing accounts.‣ The guidance attempts to distinguish between higher-risk and lower-risk accountsfor purposes of identification, with a more thorough review of the former, as wellas a continuing obligation to perform in-depth reviews of information relating toaccounts that become higher-risk accounts.gsblaw.com 17

5-Step Procedure for Identification of PreexistingAccountsPREEXISTING ACCOUNTSStep 1.Documented U.S.AccountsYESStep 3. PrivateBankingProcedures (IfApplicable)NOStep 2. AccountBalance US$500,000NOYESU.S. Account?NOStep 5. Search for U.S.Indica (diligent reviewof account files)YESU.S. AccountNon-U.S. AccountSource: Creating Clarity around <strong>FATCA</strong> – IRS Notice 2011-34 (KPMG LLP)gsblaw.com 18

Indicia of U.S. StatusU.S. IndiciaU.S. citizenship or lawful permanent resident Form W-9Required DocumentationA U.S. place of birthA residence address or a correspondence address in the U.S.(including a P.O. Box)Standing instructions to transfer funds to an accountmaintained in the U.S., or direction regularly received from aU.S. addressAn “in care of” or “hold mail” address that is the soleaddress with respect to the clientA power of attorney or a signature authority granted to aperson with a U.S. addressForm W-9 or Form W-8BEN and a non- U.S. passport (orsimilar government-issued document establishing citizenshipin a country other than the U.S.) and a written explanationfrom the client regarding the client’s renunciation of U.S.citizenship or reason the client was not a U.S. citizen at birthForm W-9 or Form W-8BEN and a non- U.S. passport (orsimilar government-issued document establishing citizenshipin a country other than the U.S.)Form W-9 establishing U.S. status, or Form W-8BEN anddocumentary evidence establishing the non-U.S. status ofthe clientForm W-9 establishing U.S. status, or Form W-8BEN, ordocumentary evidence establishing the non-U.S. status ofthe clientForm W-9 establishing U.S. status, or Form W-8BEN, ordocumentary evidence establishing the non-U.S. status ofthe clientgsblaw.com 19

Private Banking Clients‣ Special procedures apply to with respect to private banking accounts.‣ Private banking accounts are defined as any account maintained or serviced by anFFIs private banking department or maintained or serviced as part of a privatebanking relationship.• An FFI is not entitled to rely on any documentation associated with a privatebanking account if the private banking relationship manager knows, or hasreason to know, that the information is unreliable or incorrect.• The FFI must ensure that the private banking relationship manager identifiesclients they know are U.S. persons and obtain a Form W-9 and perform adiligent review of both paper and electronic files and other records of eachpreexisting individual account they serve.gsblaw.com 20

Certification‣ The chief compliance officer, or another equivalent-level officer of a FFI, mustcertify to the IRS when the FFI has completed review of its preexisting individualaccounts.• Certification is required within one year after the effective date of the FFIAgreement for U.S. accounts, non-U.S. accounts and private bankingaccounts, and within two years for accounts with U.S. indicia and high valueaccounts.‣ The officer also must certify that FFI management did not engage in any activity,or have any formal or informal policies and procedures, to direct, encourage orassist account holders to avoid identification of their accounts as U.S. accounts,and that written policies and procedures were in place as of the effective date ofthe FFI Agreement prohibiting employees from advising U.S. account holders inavoidance tactics.gsblaw.com 21

Reporting on U.S. Accounts and Owners‣ A participating FFI is required to report to the IRS the following information withrespect to each U.S. account:• the name, address, and tax identification number (“TIN”) of each accountholder that is a specified United States person and, in the case of an accountholder that is a United States owned foreign entity, the name, address andTIN of each substantial United States owner of such entity• the account number;• the account balance or value; and• except to the extent otherwise provided by the Treasury, the gross receiptsand gross withdrawals or payments from the account determined for suchperiod as provided by the Treasury.gsblaw.com 22

Election to Report as a U.S. Financial Institution‣ In lieu of reporting on U.S. accounts and owners as discussed above, aParticipating FFI can elect to report on Form 1099 in the same manner as a U.S.financial institution is required to report.gsblaw.com 23

Procedures to Identify and Withhold on Pass thruPayments‣ A participating FFI must also agree to deduct and withhold a tax equal to 30% on:• any “pass thru payment” which is made by the FFI to a “recalcitrant accountholder” or another FFI which does not have an agreement in place; and• in the case of any pass thru payment made to another FFI which has made anelection to be withheld upon, so much of such payment as is allocable toaccounts held by recalcitrant account holders or FFIs which do not have anAgreement in place.‣ Interim guidance sets forth the IRS’ first attempt at establishing rules fordetermining when payments made by an FFI are “attributable” to withholdablepayments received by the FFI. In general, this “pass thru” payment calculationwill need to be made on a quarterly basis, based on the relative percentage of theFFIs U.S. assets to total assets (a so-called “pass thru payment percentage”).• This is very complicated and most commentators expect to see refinement inthe next round of guidance.‣ Participating FFIs will be required to make their pass thru payment percentageavailable to the public on a website or other publicly accessible database.gsblaw.com 24

Working with Persons Making Payments Subject to <strong>FATCA</strong>gsblaw.com 25

Payors of Withholdable Payments Liable asWithholding Agent‣ <strong>FATCA</strong> makes any person in whatever capacity acting, having the control, receipt,custody, disposal, or payment of any withholdable payment a “withholding agent”liable for the 30 percent tax on any withholdable payment required to be withheld.‣ The term withholding agent is not limited to U.S. persons, but can include a foreignperson with control over a U.S. source payment characterized as a withholdablepayment.gsblaw.com 26

Withholding Requirements‣ <strong>FATCA</strong> requires withholding agents to apply a 30% withholding tax onwithholdable payments to non compliant FFIs and NFFEs.• Withholding agents will have to verify payee compliance with <strong>FATCA</strong>Withholding requirements will require payors of withholdable payments, intheir capacity as withholding agents, to make determinations as to the statusof their payees for <strong>FATCA</strong> withholding tax purposes.‣ FFIs. The IRS intends to maintain a database that will permit withholding agentsto confirm whether an FFI is a participating or deemed-compliant FFI.‣ NFFEs. A withholding agent must request the NFFE to provide the payor with thename, address, and U.S. tax identification number of each substantial U.S. ownerof the NFFE, or certify that it does not have any substantial U.S. owners, unless itis an exempt NFFE (e.g., a publicly traded corporation).gsblaw.com 27

Updating Internal Systems‣ Payor’s administrative systems will likely need to be enhanced for bothdocumentation and withholding logic.• Documentation– Is the FFI a participating FFI?– Did the NFFE provide certification regarding any substantial U.S. owners?• Withholding logic– Who is the payee – FFI, NFFE, individual?– Is <strong>FATCA</strong> withholding required – exempt, deemed compliant,participating FFI– Do we have the proper documentation– Apply NRA withholding rulesgsblaw.com 28

“Push Down” of Withholding Obligation‣ Participating FFIs that do not wish to act as withholding agents are permitted toeffectively "push down" the withholding obligation to an alternative agent suchas the FFIs bank or broker.• Participating FFIs will be permitted to elect to have withholding agentswithhold the 30% U.S. tax on withholdable payments or pass thru paymentsmade to the FFI that are attributable to accounts held by recalcitrant accountholders or non-participating FFIs.• Electing FFIs must provide information to withholding agents to enable themto withhold the appropriate amount and must provide withholding agentswith a waiver of the electing FFIs treaty rights.gsblaw.com 29

Withholding Scenarios for FFIsSCENARIO 1FFI has not entered into an FFIAgreement with the IRS$100WithholdingAgentIRSSCENARIO 2FFI has entered into an FFI Agreement,but has a Recalcitrant U.S. account;Elects to withhold$100$30 WithholdingAgentSCENARIO 3FFI has entered into an FFI Agreement,but has a Recalcitrant U.S. account;Elects no to withhold$100WithholdingAgent$15IRS$70$100$85FFIFFI$15IRSFFI$35$35$35$50$35$50U.S.RecalcitrantU.S.CompliantU.S.RecalcitrantU.S.CompliantU.S.RecalcitrantU.S.CompliantResult• 30% withholding tax imposed on FFI• Compliant account holder suffersSource: Cravath, Swaine and Moore, LLPResult• No WHT imposed on FFI• FFI applies 30% withholding tax to $50payment to Recalcitrant account holder• Compliant account holder not harmedResult• U.S. Withholding Agent applies 30%withholding tax to payment allocable toRecalcitrant account holder• Compliant account holder not harmedgsblaw.com 30

Coordination with Chapter 3 Withholding andReporting Requirements‣ The new <strong>FATCA</strong> provisions are in addition to the rules under Sections 1441 and1442 dealing with withholding on certain U.S. payments to foreign individuals andcorporations.‣ <strong>FATCA</strong> withholding applies to a broader class of income than the current U.S.nonresident alien withholding regime (NRA withholding).• Examples:– <strong>FATCA</strong> applies to the gross proceeds of the sale assets that give rise toU.S. source dividends and interest.– <strong>FATCA</strong> applies regardless of statutory or treaty exemptions or reductions.gsblaw.com 31

Interaction with NRA Withholding Rules‣ Withholdable payments made to non-U.S. individuals are not subject to <strong>FATCA</strong>withholding but still subject to NRA Withholding.‣ Section 1474(e) directs the Treasury to provide rules for coordination ofwithholding.• While both Notices acknowledge that there are significant issues regardingoverlapping responsibilities between <strong>FATCA</strong> withholding and the existing U.S.federal withholding tax rules, neither provides any significant guidance withrespect to the coordination between many existing withholding andreporting provisions of the Code and the withholding and reporting regimeintroduced by <strong>FATCA</strong>.gsblaw.com 32

Interaction with NRA Withholding RulesMaking apayment to aforeign entity?Making aYES Withholdable YES Payee an FFI? YESPayment?GotCertification?NOGo to NRA or1099 processing,as appropriateNONOWithhold30% <strong>FATCA</strong>Report asrequiredYESSource: Burt, Staples & Maner, LLCNOPayee an NFFE?NONo <strong>FATCA</strong> W/H,go to NRAprocessingReceive “NoU.S. Owners”Cert?NOU.S. ownersID’d with name,address, TIN?NOWithhold30% <strong>FATCA</strong>Report asrequiredYESYESNo <strong>FATCA</strong> W/H,go to NRAprocessingReport asrequiredGo to NRAprocessing,gsblaw.com 33

<strong>FATCA</strong> and U.S. Income Tax Treaties‣ Section 894(a) provides that the Code is to be applied “with due regard to anytreaty obligation of the United States.”‣ <strong>FATCA</strong> as drafted overrides the reduced rates of withholding tax provided underU.S. tax treaties. In addition, <strong>FATCA</strong> would add in certain cases a newinformation-reporting test not found in U.S. tax treaties.‣ It appears the U.S. Treasury believes that taxes withheld under <strong>FATCA</strong> areconsistent with its authority to administer credit and refund procedures underexisting income tax treaties.• For example, pursuant to this authority the U.S. may require withholding atthe relevant statutory rate at the time of payment and allow treaty countryresidents to obtain treaty benefits through a refund process.gsblaw.com 34

Withholding Tax on U.S. Equity SwapsTemporary and Proposed <strong>Regulations</strong>Issued on January 19, 2012gsblaw.com 35

Withholding on U.S. Equity Swaps‣ Prior to March 18, 2010, the income of foreign taxpayers that entered into equityswaps (respected as notional principal contracts) on U.S. companies was treatedas foreign source income and was not subject to U.S. withholding tax‣ The IRS was concerned about the abusive use of equity swaps by foreigntaxpayers to avoid U.S. withholding on U.S. source dividend income‣ New Section 871(m) treats imposes dividend withholding tax on dividendequivalents. Dividend equivalents are:• Substitute dividend payments on securities lending and repurchasetransactions that directly or indirectly are contingent upon or determined byreference to the payment of U.S. source dividend;• Payments made on a “specified notional principal contract” that arecontingent upon or determined by reference to the payment of a U.S. sourcedividend; andgsblaw.com 36

Dividend equivalents - continued• Substantially similar payments as specified in the regulations.– “Substantially similar” under the proposed regulations includes anypayment of a beneficial owner’s tax liability with respect to a dividendequivalent made by a withholding agent, and any payment, includingpayment of the purchase price or an adjustment to the purchase price,that is contingent upon or determined by reference to a dividend fromsources within the United Statesgsblaw.com 37

Notional Principal Contracts‣ An NPC is a “specified notional principal contract” if:• A long party transfers the underlying security to a short party atcommencement;• A short party transfers the underlying security to a long party upontermination;• The underlying security is not readily tradable on established securitymarkets;• A short party posts the underlying security as collateral with a long party; or• The Treasury identifies the contract as a SNPC‣ In the above situations, the dividend equivalent payment is U.S. source income‣ After December 31, 2012, all NPCs are SNPCs unless they are a type Treasury hasidentified as not having potential for tax avoidancegsblaw.com 38

Temporary <strong>Regulations</strong> Issued January 19, 2012‣ For payments made on or after January 1, 2013, the proposed regulations identifythe seven types of specified NPCs, dividend equivalent payments with respect towhich would be characterized as U.S. source income under section 871(m).‣ The proposed regulations effectively retain the categories of NPCs that aretreated as specified NPCs under the statute, with some modification, and addseveral new categories of contracts that are considered to be specified NPCs.gsblaw.com 39

Specified Notional Principal Contract – January 2013‣ As of January 1, 2013, specified NPCs include any NPC if:• The long party is “in the market” on the day the parties price the NPC orwhen it terminates.• The underlying security is not regularly traded on a qualified exchange.• The short party posts the underlying security as collateral, and theunderlying security represents more than 10% of the collateral posted by theshort party.• The term of the NPC has fewer than 90 days.• The long party controls the short party’s hedge.• The notional principal amount is a significant percentage of the tradingvolume.• The NPC is entered into on or after the announcement of a special dividendand prior to the ex-dividend date.gsblaw.com 40

Proposed <strong>Regulations</strong> - miscellaneous‣ Related persons are treated as a single party to an NPC‣ “Customized Index” – each component security is considered to be an underlyingseparately‣ Credit default swaps clearly fall within scope of NPCgsblaw.com 41

Liability of Withholding Tax‣ Withholding applies to gross amounts used to compute net payments and eachparty to a contract for a dividend equivalent payment is liable for withholdingfrom the gross amount• Timing of withholding – when the payment are made or deemed to be made• Statute: a payment subject to withholding includes any gross amount “usedin computing any net amount which is transferred to or from the taxpayer‣ Parties to swap will need to ensure that tax provisions contemplate not only thegross up of payments to reflect taxes, but also indemnification for taxesotherwise due on the gross obligationgsblaw.com 42

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