United States: Announcement 2012-42: Timelines For Due Diligence And Other Requirements Under FATCA

Keywords: Announcement 2012-42, due diligence, FATCA, foreign financial institutions, FFIs, grandfathered obligation

On October 24, 2012, the Internal Revenue Service (IRS) and the US Department of Treasury (Treasury) issued "Announcement 2012-42: Timelines for Due Diligence and Other Requirements under FATCA" (the Announcement).¹ FATCA generally requires a 30% withholding tax be imposed on (i) foreign financial institutions (FFIs) that do not comply with certain documentation and reporting requirements and (ii) account holders that do not provide proper documentation to participating FFIs (FATCA withholding tax).

In general, the Announcement provides new timelines for withholding agents and FFIs to complete due diligence and certain other requirements. Additionally, the Announcement provides guidance regarding whether certain instruments meet the definition of a "grandfathered obligation." The Announcement also extends the timeline regarding the imposition of FATCA withholding tax on certain gross proceeds. Generally, the Announcment is inapplicable to FFIs that are subject to an Intergovernmental Agreement (IGA) because the Announcement only sets forth modifications that are to be contained in the forthcoming final FATCA regulations.

FFI Agreement Effective Date Delayed Six Months

Under the proposed FATCA regulations and the FATCA notices² issued to date, an FFI would have been obligated to enter into an FFI Agreement by June 30, 2013 in order to avoid the imposition of the FATCA withholding tax that would have been imposed beginning on January 1, 2014. Such an FFI Agreement would have been effective as of July 1, 2013.

The Announcement states that the effective date of all FFI Agreements entered into prior to January 1, 2014 will be January 1, 2014. The effective date of an FFI Agreement entered into after January 1, 2014 will be the date on which such agreement is stated to be effective.

The Announcement does not address the date on which an FFI must enter into an FFI Agreement in order to avoid the imposition of FATCA withholding tax with respect to certain payments made on or after January 1, 2014. Thus, FFIs may still need to enter into such agreements by June 30, 2013 in order to avoid the imposition of FATCA withholding tax on any new accounts opened on or after January 1, 2014. As is discussed below, the rule for accounts that exist as of December 31, 2013 differs.

Due Diligence Timelines Harmonized for US Financial Institutions and FFIs

A primary purpose of the Announcement appears to be to provide rules that align the FATCA effective dates that affect US financial institutions with the relevant corresponding effective dates that affect FFIs. The Announcement aligns the dates on which FATCA due diligence relating to different categories of preexisting accounts must be completed.

PREEXISTING OBLIGATIONS

As a preliminary matter, the Announcement provides that the definition of preexisting obligation will be modified in final regulations and will continue to have separate meanings depending on whether the withholding agent is a participating FFI, a registered deemedcompliant FFI, or neither a participating FFI nor a registered deemed-compliant FFI (e.g., a US financial institution). In the case of a withholding agent other than a participating FFI or a registered deemed-compliant FFI (e.g., generally US financial institutions) the term preexisting obligation will mean any obligation existing prior to January 1, 2014. In the case of a participating FFI, the term preexisting obligation will mean any obligation existing prior to the later of January 1, 2014 or the date on which such FFI's FFI Agreement is effective.

In the case of a registered deemed-compliant FFI, the term preexisting obligation will mean any obligation existing prior to the date on which the registered deemed-compliant FFI must implement any required account opening procedures (e.g., the later of January 1, 2014 or the date on which the FFI registers as a deemedcompliant FFI). As a result, both participating FFIs and US financial institutions will be able to treat accounts opened prior to January 1, 2014 as preexisting obligations. FFIs that are subject to a relevant IGA, and therefore treated as registered deemed-compliant FFIs, may also treat accounts opened prior to January 1, 2014 as preexisting obligations unless they register with the IRS after that date.

PREEXISTING PRIMA FACIE FFIs: DUE DILIGENCE AND WITHHOLDING TAX

For US withholding agents, the Announcement modifies the time frame for documenting preexisting prima facie FFIs.³ Under the proposed regulations, a prima facie FFI that receives a payment of US source FDAP⁴ from a US financial institution would be subject to FATCA withholding tax as of January 1, 2014. The same payment, if made by a participating FFI, might not have been subject to FATCA withholding tax until July 1, 2014, because the proposed regulations provided that a participating FFI had until June 30, 2014, to conduct due diligence to identify prima facie FFIs and obtain such FFI's FFI-EIN, the unique FATCA identification number provided by the IRS to each FFI that registers with the IRS as a participating or deemed-compliant FFI.

The Announcement provides that US financial institutions will have an additional six months to document prima facie FFIs, but does not give participating FFIs any additional time to identify and document such prima facie FFIs. The Announcement also clarifies that no FATCA withholding tax can be imposed on a prima facie FFI that is undocumented for purposes of FATCA prior to July 1, 2014. However, if documentation indicating that the prima facie FFI is a nonparticipating FFI (e.g., an IRS Form W-8BEN-E that identifies the FFI as a nonparticipating FFI) is provided to the withholding agent (including a participating FFI) prior to June 30, 2014, the withholding agent is required to withhold tax on payments of US source FDAP to such FFI. As a result, a participating FFI will receive less time after the effective date of its FFI Agreement to identify and document prima facie FFIs, because it will now have to document such FFIs within six months, rather than one year, after the effective date of its FFI Agreement.

PREEXISTING ENTITY OBLIGATIONS (OTHER THAN PRIMA FACIE FFI OBLIGATIONS)

The Announcement harmonizes the time frame in which due diligence pertaining to a preexisting obligation held by an entity (other than one held by a prima facie FFI) must be completed by participating FFIs and withholding agents other than participating FFIs (e.g., generally US withholding agents). As a result, all due diligence relating to such entities must be completed by the later of December 31, 2015, or the date that is two years after the effective date of the FFI's FFI Agreement.⁵ As of January 1, 2016, withholding agents (including participating FFIs) will be obligated to treat any undocumented non-US entity (other than a prima facie FFI) as a nonparticipating FFI until appropriate documentation is provided to the withholding agent.

PREEXISTING INDIVIDUAL ACCOUNTS (APPLICABLE TO PARTICIPATING FFIs ONLY)

The Announcement extends by six months the time frame under which a participating FFI must document preexisting individual accounts. As a result, participating FFIs have until the later of December 31, 2014, or one year after the effective date of the FFI's FFI Agreement, to identify and document preexisting high-value individual accounts (i.e., accounts exceeding $1 million) and until the later of December 31, 2015, or two years after the effective date of the FFI's FFI Agreement, to identify and document preexisting individual accounts that do not exceed $1 million.⁶ A participating FFI's obligation to withhold on recalcitrant account holders (i.e., accounts that do not meet certain documentation requirements), is thus also postponed an additional six months and will begin on the date following the date documentation is required to be completed. Unlike the rule described above with respect to preexisting obligations of prima facie FFIs and entities, no FATCA withholding tax can be imposed on an individual that holds a preexisting obligation until the relevant time period expires because an individual cannot be treated as a recalcitrant client before such time period expires.

Information Reporting

The Announcement also provides guidance regarding the date on which a participating FFI would be obligated to comply with the applicable information reporting for the 2013 and 2014 calendar years. In particular, the Announcement provides that information reporting for the 2013 and 2014 calendar years must be filed by a participating FFI by March 31, 2015. Under the proposed regulations, information with respect to the 2014 calendar year is already required to be reported by March 31, 2015. The proposed regulations would have required information with respect to the 2013 calendar year to be reported by September 30, 2014. Unless a participating FFI agreement explicitly provides for the FFI to conduct information reporting during the 2013 calendar year, the year prior to the effective date of such agreement, it is unclear how the IRS would compel an FFI to conduct information reporting with respect to a calendar year that precedes the effective date of the FFI agreement.

Gross Proceeds Withholding Further Delayed

Under the proposed regulations, a withholding agent would be obligated to withhold tax on payments of gross proceeds from the sale of certain property that produces or that could produce US source dividends or interest income made on or after January 1, 2015. The Announcement delays the imposition of FATCA withholding tax on gross proceeds by two years and only requires withholding on payments of such gross proceeds from dispositions of property occurring after December 31, 2016.

This delay may have been necessary to permit the development of a suitable gross proceeds withholding regime. Its secondary purpose may be to harmonize such future rule relating to gross proceeds withholding with the timeline for negotiations relating to this subject as described in the UK-US IGA and Model I IGAs.

Grandfathered Obligations

The Announcement also expands the scope of grandfathered obligations to cover three additional categories of obligations: (i) an obligation that produces or could produce a foreign passthru payment but not a withholdable payment, (ii) an instrument that gives rise to a withholdable payment solely because it is treated as giving rise to a dividend equivalent pursuant to section 871(m),⁷ and (iii) any obligation to make a payment with respect to, or to repay, collateral posted to secure obligations under a notional principal contract that is a grandfathered obligation.

For instruments that produce foreign passthru payments but not withholdable payments, the testing date for the grandfather rule will be the date that is six months after the term "foreign passthru payment" is defined in final regulations.

The applicable grandfather rule for instruments that give rise to a withholdable payment solely because the instrument is treated as giving rise to a dividend equivalent pursuant to section 871(m) applies to instruments that are outstanding six months after such instrument is first treated as giving rise to a dividend equivalent. This creates the possibility of a bifurcated testing date for those dividend equivalents that are treated as such pursuant to the statute, and those that are treated as such under applicable regulations.

Because Treasury and the IRS have extended the effective date of the proposed dividend equivalent regulations to January 1, 2014, instruments that are not already identified in section 871(m) and Treas. Reg. § 1.871-16T as giving rise to dividend equivalents and that are outstanding on July 1, 2014 may be treated as grandfathered obligations under this rule.

Footnotes

1 The term "FATCA" is an acronym referring to the Foreign Account Tax Compliance Act of 2009, proposed legislation which was substantially incorporated into Subtitle A of Title V of the Hiring Incentives to Restore Employment (HIRE Act). Pub. L. No. 111-147 (Mar. 18, 2010) and is contained within Chapter 4 of the Internal Revenue Code of 1986, as amended (the Code) . All references herein, unless specified, are to the Code, and the regulations thereunder (including proposed Treasury Regulations sections 1.1471-0 through 1.1474-7).

2 Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities, 77 Fed. Reg. 9022 (proposed Feb. 15, 2012) (to be codified at Treasury Regulations sections 1.1471-0 through 1.1474-7) (proposed regulations). Notice 2010-60, 2010-37 I.R.B. 329 (Aug. 27, 2010); Notice 2011- 34, 2011-19 I.R.B. 765 (Apr. 8, 2011); Notice 2011-53, 2011- 32 I.R.B. 124 (July 14, 2011) (FATCA notices).

3 A prima facie FFI is defined in Prop. Treas. Reg. § 1.1471- 2(a)(4)(ii)(B) to generally include certain financial institutions for which the FFI has electronically searchable information indicating that the payee is an FFI.

4 The term fixed, determinable, annual, or periodical (FDAP) income consists of virtually all payments of income, subject to certain specific exceptions. Income that is not FDAP income is generally: (i) gains derived from the sale of real or personal property (including market discount and option premiums, but not including original issue discount) and (ii) items of income excluded from gross income, without regard to the US or foreign status of the owner of the income, such as tax-exempt municipal bond interest and qualified scholarship income.

5 Under this definition, an FFI whose FFI Agreement has an effective date of January 1, 2014 will utilize the "later of" convention such that the relevant date will not be December 31, 2015 but will be January 1, 2016. This raises the possibility that information reporting would begin during the 2016 calendar year and not the 2015 calendar year.

6 See supra footnote 4.

7 It should be noted that a dividend equivalent payment will not be grandfathered for purposes of Chapter 3 of the Code and would remain subject to withholding tax under section 1441 or 1442 if paid to a non-US person, including an FFI

Originally published on November 1, 2012

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