United States: IRS Issues New Guidance On Reporting And Withholding Rules For Cross-Border Payments

Notice 2011-34 Supplements and Modifies Previous Guidance Affecting US Financial Intermediaries and Foreign Financial Institutions

Generally

On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment Act of 2010. That Act imposed new reporting and withholding tax obligations on direct and indirect payments made by US persons to foreign persons. These reporting and withholding rules are often referred to as the "Foreign Account Tax Compliance Act" or "FATCA."

FATCA is intended to force foreign entities, especially foreign financial institutions, to report information about the income earned by US persons. The statutory rules, however, set forth only a framework, leaving to the Internal Revenue Service and other parts of the US Treasury Department ("IRS") much of the responsibility of developing how, and to whom, the withholding and reporting rules apply. The IRS on August 27, 2011, released Notice 2010-60, the first round of guidance for financial intermediaries, financial institutions, and foreign entities that will be subject to FATCA. (See our prior e-Alert: IRS Issues Administrative Guidance on New Reporting and Withholding Rules for Cross-Border Payments).

On April 8, 2011, the IRS released Notice 2011-34 (the "Notice") which provides further guidance on FATCA implementation. The Notice shows that the IRS is responding both to requests for guidance and to criticisms of previous guidance. It is therefore important that foreign financial institutions and other entities affected by FATCA examine the new guidance and engage with the IRS as the IRS attempts to create workable rules to implement FATCA.

Overview of FATCA Withholding and Reporting Rules

Under new section 1471 of the Internal Revenue Code, a U.S. person making a "withholdable payment" to a foreign financial institution ("FFI") generally must withhold 30% of the payment unless the FFI undertakes certain reporting responsibilities. A "withholdable payment" is generally income attributable to US securities or certain other US assets. An FFI that enters into an agreement with the IRS to provide the reporting required under FATCA is called a "Participating FFI." A Participating FFI must withhold on any "passthru payment" it makes to a recalcitrant account holder or a non-participating FFI. A passthru payment is a withholdable payment or a payment attributable to a withholdable payment.

Under new section 1472, a U.S. person making a "withholdable payment" to a non-financial foreign entity ("NFFE") generally must withhold 30% of the payment unless the foreign entity discloses certain information about any substantial U.S. owners it has.

The new rules generally are effective for payments made after December 31, 2012, although any obligation outstanding on March 18, 2012, is "grandfathered" and payments thereunder are not subject to the new withholding rules. This delayed effective date was intended to provide the IRS with time to promulgate the necessary forms and administrative guidance and US payors and foreign payees with time to adjust to and implement the new rules before they came into effect.

Significant Provisions in Notice 2011-34

Notice 2011-34 largely builds on the guidance set forth in Notice 2010-60, but, as discussed below, in certain cases modifies and replaces the rules set forth in Notice 2010-60.

Determination of Whether Accounts Have US Owners

Notice 2010-60 sets forth rules for identifying which accounts have US owners and are therefore US accounts. In reaction at least in part to practical concerns raised by FFIs in response to Notice 2010-60, the Notice replaces the rules for identification of preexisting individual accounts. The new rules distinguish "private banking accounts" from other depository accounts and impose greater responsibilities on FFIs to identify whether such private banking accounts have US owners. The Notice also revises the remainder of the six-step process set forth in Notice 2010-60 for identification of preexisting accounts.

Guidance Regarding "Passthru Payments"

Notice 2011-34 provides detailed guidance regarding the definition of "passthru payment" and the obligation of a Participating FFI to withhold on such payments. In general, under the Notice, a payment that is not a withholdable payment will be considered a passthru payment, and thus be subject to withholding, to the extent of the amount of the payment multiplied by the applicable "passthru payment percentage." The applicable passthru payment percentage generally will be the passthru payment percentage of the payor FFI. The Notice specifies that an FFI calculates its passthru payment percentage generally by (a) dividing the sum of its US assets held on each of the last four quarterly testing dates by (b) the sum of its total assets held on those dates. The Notice sets forth an alternative transition method for computing the passthru payment percentage and requests comments on alternative methods for determining passthru payment percentages, such as permitting reliance upon representations in investor solicitation or proxy materials regarding target percentage holding of US assets. Although it requests comments in a variety of areas, the Notice provides little relief on the definition and treatment of passthru payments. The Notice states that one of the purposes of the passthru payment rules is to encourage FFIs to become participating FFIs. Accordingly, the failure of the Notice to provide much relief in this area should not be surprising.

Certain FFIs to be "Deemed Compliant" Without Entering Into a Full FFI Agreement With the IRS

The Notice provides that certain categories of FFIs will be "deemed compliant" with FATCA. Although an entity that is "deemed compliant" need not undertake FATCA reporting or withholding responsibilities, the entity must apply for deemed compliant status with IRS, obtain an FFI identification number, and certify to the IRS every three years that it continues to meet the requirements for deemed compliant status. Despite requests to broaden the categories of entities that are "deemed compliant," the Notice grants this status only to certain local banks, local FFI members of participating FFI groups, and a very limited category of investment vehicles. The Notice states, however, that the IRS is considering "deemed compliant" treatment for (a) foreign retirement accounts and plans and (b) specified investment funds, such as those that are regularly traded on an established securities market or that are limited to certain investors.

Reporting on US Accounts

The Notice modifies the rules set forth in Notice 2010-60 for determining and reporting a US account's (1) account balance or value and (2) gross receipts and withdrawals, generally allowing FFIs to rely on existing procedures and practices. The Notice also states that the generally applicable "basis reporting" rules will not apply to FFIs that are not US payors and that comply with FATCA reporting. The Notice also states that FFIs will generally be allowed to elect branch-by-branch reporting.

Qualified Intermediaries

A Qualified Intermediary ("QI") that is subject to FATCA reporting must consent to include in its QI agreement the requirement to become a participating FFI, unless it qualifies as a deemed-compliant FFI. This requirement will apply to all QIs on January 1, 2013. Similar rules will apply to FFIs currently acting as foreign withholding partnerships.

Expanded Affiliated Groups of FFIs

The Notice states that the IRS intends to require each FFI affiliate in an FFI-affiliated group to be a Participating FFI or a deemed-compliant FFI. Each such affiliate must enter into an FFI Agreement that will apply to all of its worldwide branches and offices. The Notice sets forth a coordinated application process and coordinated execution procedures, with each FFI-affiliated group to have a "lead FFI" that serves as the primary liaison with the IRS. The Notice also suggests a centralized compliance option for FFI-affiliated groups and certain investment funds.

Next Steps

The IRS reaffirms in the Notice its intention to issue proposed regulations incorporating the guidance provided in Notice 2011-34 and Notice 2010-60 and to publish draft FFI Agreements and draft information reporting and certification forms, though the Notice does not provide target release dates for this guidance. As in previous guidance, the Notice asks for comments on a variety of specific topics.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.