US-Foreign Account Tax Compliance Act 2009

Introduction

On 18 March 2010, the Hiring Incentive to Restore Employment Act (the Act), which includes provisions similar to those in the proposed Foreign Account Tax Compliance Act (FATCA) – introduced in the US House and Senate in November 2009 – was signed by President Obama. The Act intended to provide the US Treasury Department with tools to identify US persons that use foreign accounts to avoid US tax. This article provides a short overview about the Act, focusing on its most important aspect – the far-reaching scope of a new withholding regime for payments to certain foreign financial institutions and foreign non-financial entities.

What are the changes?

Pursuant to the Act, a new Chapter 4 imposes a 30-percent withholding tax on certain income payments (any Withholdable Payments) from US sources to a certain Foreign Financial Institution (FFI). To avoid the withholding tax, the FFI has to agree to certain reporting requirements of the US Internal Revenue Service (IRS) with respect to its US accounts. To satisfy these reporting requirements, the FFI could choose one of the following two options:

a) Be treated as a “US Financial Institution” and to treat each holder of a US account that is a US person or US owned foreign entity as a natural person and US citizen (and, thus, subject to the IRS Form 1099 reporting on worldwide income as a non-exempt recipient), or

b) Enter into a “Financial Institution Agreement” with the IRS and whereby the FFI will obtain information to identify which accounts are owned by US persons and comply with the verification, due diligence procedures and reporting requirements with respect to these accounts.

Who are affected?

The scope of the new withholding regime includes not only financial institutions that conduct banking transactions as FFIs. It also includes companies in the financial services and asset management industry such as mutual funds, hedge funds, private equity funds and other investment vehicles.

Which groups of customers of

this institution are affected?

Customers affected are specified US persons and non-US entities but in which specified US persons own directly or indirectly at least 10 percent and for whom the FFI maintains a financial account (account/deposit or non-exchange traded investments in capital or liabilities of the FFI). These financial accounts are referred to as the US accounts. 

What are the consequences if the

new rules are not followed?

US payments are subject to a 30-percent withholding tax if the FFIs do not satisfy the reporting requirements of the IRS. Advantages under an agreement for the avoidance of double taxation at the source cannot be claimed by the beneficiaries. In addition, the IRS is entitled to terminate the agreement if the FFI refuses to meet their tax withholding and reporting requirements.

What kinds of payments are affected?

Payments affected include periodical payments (fixed determinable annual or periodical payments) from US sources (e.g. interest, dividends, fees, rents, royalties etc.), as well as any gross proceeds from any sale of US property, which can produce interest or dividends (“Withholdable Payments”). This could also include stock distributions that may arise from tax-free transactions.

Effective date

The new rules apply to all payments made after 31 December 2012. But there are also certain additional reporting requirements with different dates of effect (e.g. some are effective after the date of enactment).

Impact on certain foreign financial institution (FFI)          and foreign non-financial entities

These developments in the US present significant challenges to FFIs concerning the identification and documentation of their US customers, the withholding and the compliance with the new reporting requirements. The requirements for identification and documentation are going beyond the framework of the existing “Know-Your-Customer” rules. The new regulations also require them to identify those structures where US persons are directly or indirectly involved.

The first option discussed above – the US Financial Institution Option – does not materially reduce the reporting requirements of the FFIs. Due to the costs and burdens associated with issuing Forms 1099, it is not anticipated that many FFIs will choose this option.

There are also many potential problems with respect to the FI Agreement outlined above.

1. For most FFIs, there is a current limited or no interplay between their anti-money laundering system and tax withholding and reporting system. The financial burden of modifying their systems to satisfy the requirements of the FI Agreement may prove to be significant leaving them with little choice but either to be subject to the withholding requirements or to cease investments in assets that generate the “Withholdable Payments”.

2.The FI Agreement would require the FFI to report accounts held by affiliates to the extent that such affiliates did not enter into their own FI Agreements. Given that these affiliates may be separate legal entities that have made the business decision not to enter into FI Agreements, it remains to be seen how the FFI could enter into an FI Agreement which could obtain the requisite information from its affiliates that did not. There is the risk then that the FFIs would be unable to comply with the terms of its FI Agreement.

3. The FFI may have difficulty in determining which of its accounts, if any, are US accounts and obtaining the information to enter into an FI Agreement. Certain tiered ownership structures in which a US person has a relatively small interest may present significant compliance challenges that may make it difficult to avoid the 30-percent withholding tax.

The developments in the US require at the level of the affected FFIs extensive adjustments to operating procedures, processes, controls and system. Against this background, the FFIs should ask themselves the business policy question whether to continue investments in the US or to cease investment in assets that generate payments subject to withholding taxes. An evaluation of business relations should be made, if they desire or require to do, or have their investments in assets that generate withholdable payment. The FFI has to decide whether to opt for treatment as a US withholding agent or to enter into a FI Agreement with the IRS.

(Ronny Eggert is a seconded Tax Manager of KPMG Germany to Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected] or [email protected])