FATCA Compliance: Riding a Roller Coaster of Regulatory Change


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FATCA will impose new due diligence, withholding, and reporting requirements on financial institutions. This paper outlines the significant regulatory change FATCA brings to provide the IRS with an increased ability to detect U.S. tax evaders—specifically, those among U.S. “persons” (individuals or entities) who maintain foreign accounts and investments either directly or indirectly, through their ownership in foreign entities.

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FATCA Compliance: Riding a Roller Coaster of Regulatory Change

  1. 1. JULY 12, 2013 UPDATES An executive briefing on how firms can support the foreign account tax compliance act FATCA compliance: Riding a roller coaster of regulatory change
  2. 2. 2 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE | EXECUTIVE SUMMARY EXECUTIVE SUMMARY U.S. financial institutions are riding a roller coaster of regulatory change. Specifically, the Foreign Account Tax Compliance Act (FATCA), included in the Hiring Incentives to Restore Employment Act (HIRE), is intended to provide the Internal Revenue Service (IRS) with increased ability to detect U.S. tax evaders who maintain foreign accounts and investments either directly or indirectly through ownership of foreign entities. The ability to quickly identify these challenges will dictate whether the ride reaches a smooth conclusion or causes severe aches and pains for months or even years to come. Considerations for being FATCA compliant: • Resources – Regulatory and business needs are in constant flux. Do you have the required resources to support due diligence requirements and comply in a timely manner? • Cost Effectiveness – Can you efficiently implement withholding systems modifications to capture relevant data? • Maintenance – Managing continuous change demands agile operations and constant attention to functionality. Does your plan cover both Day 1 and ongoing support? • Partnership – Consider whether to partner or build internally. Do you have the proper reporting tools and know-how required for achieving and sustaining compliance?
  3. 3. 3 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE Background FATCA is proving to be one of the more substantial changes to tax compliance in recent history, with far-reaching effects on operations personnel, policies, procedures, and clients. FATCA1 represents more than just red tape and increased due diligence: it is a game-changing regulation affecting how U.S. entities with strong ties to overseas financial investments may need to view their strategies, as well as how financial institutions are interacting with U.S. investors. Once an organization determines it is a financial institution pursuant to FATCA’s broad-based definition, it must establish whether it is either a U.S. financial institution (USFI), meaning a financial institution incorporated in the U.S. or one of its foreign branches, or a foreign financial institution (FFI). For FFIs, the next step is to establish whether the institution intends to be a Participating FFI (PFFI), complete with the responsibilities entailed by an FFI Agreement, a non-participating FFI (NPFFI), or one of myriad types of Certified Deemed Compliant FFIs, (CDCFFI), and Registered Deemed Compliant FFIs (RDCFFI). FATCA imposes substantial new due diligence, withholding, and reporting requirements on financial institutions in pursuit of expanded information reporting regarding U.S. “persons.” U.S. persons can include U.S. citizens and permanent residents, individuals who meet the “substantial presence test” based on the amount of time spent in the U.S., and entities such as corporations, partnerships, and LLCs formed under the laws of a state or the U.S. To date, most attention has been focused on FFI requirements because those requirements are more cumbersome to implement than the requirements for USFIs. However, USFIs cannot afford to postpone planning and should anticipate without delay the significant impact of FATCA on their operations. Due Diligence FATCA due diligence requirements are premised on whether an account is preexisting or new. For purposes of a USFI, “new” is defined as any account, instrument, or contract maintained or executed by the withholding agent on or after July 1, 2014. For FFIs, “new” is defined as an account opened on or after the effective date of the FFI Agreement for a PFFI or the registration date for a RDC FFI. This would be July 1, 2014 at the earliest. “Preexisting” accounts are defined as those held prior to these effective dates. USFIs have no additional due diligence responsibilities with respect to preexisting individual account holders; however, there are requirements with respect to entity account holders. For preexisting entity accounts, a USFI is required to determine FATCA status. For those account holders indicating they are PFFIs, a USFI is required to obtain the FFI-EIN (Employer Identification Number) and to verify this against the IRS database. A similar exercise will need to be completed for all new account holders. In addition, FATCA has expanded the definition of U.S. indicia for which a USFI will need to screen new account documentation. These are certain pieces of data that indicate a high likelihood that a person claiming foreign status could in fact be a U.S. person for U.S. tax purposes. Information needed to screen new onshore account documentation going forward includes: • U.S. citizenship, residency, or country of incorporation • U.S. place of birth • U.S. residence address or U.S. mailing address • U.S. telephone number FATCA non-compliance will be both burdensome and expensive.
  4. 4. 4 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE All of the above information will be indicia of U.S. status and require specific documentary evidence to “cure.” U.S. place of birth and U.S. telephone number will prove the most problematic because these data elements may not have been included previously in customer account onboarding reviews. USFIs will also need to track subtle changes in the U.S. indicia rules when dealing with offshore obligations, while FFIs will need to be compliant with even different U.S. indicia requirements. Furthermore, USFIs need to make plans for the storage of these elements, FATCA status, FFI-EIN, and validation indicators for use during withholding or reporting. The most efficient means for a USFI to seamlessly execute both preexisting and new account due diligence is through the still-to-be-finalized W-8 series. A substantial departure from the status quo. Compliance measures must enable efficient, effective response to this new reality. Continued use of the previous manual approach will be challenging, as the previously one- page Form W-8BEN has now been separated into a Form W-BEN for individuals and a Form W-8BEN-E for entities. The previously one-page certification for entities is now six pages to accommodate all required FATCA certifications. Similarly, the current two-page Form W-8IMY has expanded to seven pages. The W-9 Forms will receive a substantial overhaul as well. Finally, expect to collect significantly more W-9 Forms as FATCA effectively eliminates the concept of the U.S. exempt recipient. FATCA generally presumes undocumented account holders to be NPFFIs and subject to a punitive 30% withholding. Being prepared to capture this data by July 1, 2014 means USFIs quickly need to: • Adopt new account onboarding procedures • Modify systems to capture additional data elements • Revise due diligence checklists Any of these requirements, much less all of these requirements, will pose significant challenges to every organization’s budget and personnel, especially in the current economy. Withholding Firms must consider the increased costs and risks of tax reporting, their own capabilities, and client expectations. At its core, FATCA represents the evolution of a global tax information reporting regime. To compel the provision of required information, FATCA mandates a punitive 30% withholding tax absent required documentation. Withholding on payments of U.S. source fixed, determinable, annual, or periodic (FDAP) income is effective January 1, 2015, while gross proceeds on the sale of U.S. securities are subject to withholding effective January 1, 2017. The IRS has reserved sections related to foreign passthru payments for future guidance; however, foreign passthru payment withholding would be effective January 1, 2017 at the earliest. FATCA mandates withholding on three specific classes of accounts: 1. Recalcitrant Individuals: These are individuals who fail to provide a valid tax certification, appropriate documented evidence, or a waiver allowing a financial institution to report the required data. Recalcitrant individual account holders are not a concern for USFIs, as payments to undocumented individuals are already subject to 28% backup withholding. 2. Non-Compliant Non-Financial Foreign Entities (NFFEs): Passive NFFEs, not otherwise excepted from FATCA requirements, will be required to disclose substantial U.S. owners. Generally, a substantial U.S. owner is defined as owning greater than 10% interest in either a corporation or a partnership. 3. NPFFIs: NPFFIs are foreign financial institutions not qualifying as compliant and declining to enter into an FFI Agreement, as well as “limited” branches and subsidiaries of FATCA compliant institutions not meeting all PFFI requirements due to local legal restrictions.2 With the exception of “limiteds,” it is the account holder’s own actions, or lack of action that trigger withholding, thus making FATCA significantly different from current withholding regimes. FATCA mandates a punitive 30% withholding tax absent required documentation.
  5. 5. 5 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE “To manage FATCA is to manage change. The successful project plan leverages internal and external partners to manage these changes, especially when devoting internal expertise would distract from delivering core business requirements.” Cyrus Daftary, Partner – Burt, Staples & Maner, LLP and Executive Director, Compliance Technologies International, LLP This emphasizes the IRS position that withholding is a lever to trigger additional reporting, as opposed to a means to collect additional tax revenue. USFIs will need to enhance their payment processing and withholding systems in order to initiate FATCA withholding on July 1, 2014. Systems should already be able to identify payments of U.S. source FDAP income as withholding on payments to non-U.S. persons is required under current non- resident alien (NRA) withholding provisions. Special grandfathering provision Grandfathered obligations are debt instruments and contracts with a fixed termination date that are in existence on July 1, 2014 that could be subject to FATCA because they produce U.S. Source FDAP. The payments on these instruments are not subject to FATCA withholding unless they are changed after July 1, 2014 by a “material modification”, which is not defined in the regulation, but relies on Treas. Reg. 1.1001-3(e) as a starting point to define a “significant modification” under the Code, and other events are to be determined using a facts and circumstances test as defined by contract law principles. However, the IRS is indicating that the issuer will be the only one to determine whether a material modification has occurred and absent written communication from the issuer, withholding agents may not determine on their own whether an instrument has lost its grandfathered status. Because of the uncertainty, industry groups are working with the IRS to attempt to establish a uniform method of communication between issuers and withholding agents. In addition, USFIs will ultimately need to identify payments of gross proceeds on the sale of property generating U.S. source dividends or interest by these newly identified account classes as currently such payments are subject to withholding only when paid to an undocumented U.S. person. USFIs will be required to withhold on payments of U.S. source FDAP made to both NPFFIs and non-compliant NFFEs. There is, however, no FATCA withholding on individual account holders. This difference versus FFI requirements is because USFIs are already required to withhold on undocumented account holders. In addition to the systems modifications mentioned previously, USFIs will be required to integrate their FATCA withholding procedures with NRA withholding. FATCA operates in conjunction with current NRA withholding requirements. If FATCA withholding applies, there is no additional withholding. However, if no FATCA withholding applies, a USFI still must determine if NRA withholding should apply. While USFIs should already have the basic withholding mechanics in place given current NRA regulations, there is still considerable work required to prepare for the implementation of FATCA withholding on July 1, 2014.
  6. 6. 6 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE Reporting Managing withholding is essential to FATCA compliance. As mentioned earlier, withholding is merely the lever the IRS will deploy to obtain the ultimate and intended goal of FATCA compliance: additional information reporting on U.S. persons. USFIs are excluded from the new individual USFI REPORTING OBLIGATION SUMMARY EXPLANATION Substantial U.S. owners of certain NFFEs Reporting includes: • Name of the NFFE that is owned by a substantial U.S. owner • Each substantial U.S. owner’s name, TIN, and mailing address • Any other required information Chapter 4 reportable amounts Reporting includes: • The name, address, and EIN of the withholding agent • Description of each category of income or payment and aggregate amount paid in USD • Rate and amount of withholding applied or basis for exemption • The name and address of the recipient and their TIN or EIN (when required) • The name, address, and TIN of any FFI acting as an intermediary, a flow-through entity that is an NFFE, or territory financial institution that is not treated as a U.S. person when the account holder is the beneficial owner of the payment • The country of the recipient and of any entity the name of which appears on the form • Any other required information Owner-documented FFIs that are specified U.S. persons Reporting includes: • The name of the owner-documented FFI • The name, TIN or EIN, and address of the specified U.S. person • Any other required information reporting requirements imposed by FATCA, as these institutions are required to annually report payments to U.S. persons on Forms 1099 and payments of U.S. source FDAP income to non-U.S. persons on Forms 1042-S. However, there are significant new USFI reporting responsibilities with respect to entities as delineated in the chart below.
  7. 7. 7 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE Improving International Tax Compliance The key to FATCA’s success will be the ability of the U.S. Department of the Treasury (Treasury) to remove international conflicts of law that pose a barrier to expansive FATCA reporting by PFFIs. As part of this effort, Treasury issued a joint statement with the governments of France, Germany, Italy, Spain, and the United Kingdom on an intergovernmental approach to improving international tax compliance and implementing FATCA along with the release of the proposed regulations. As part of the statement, Treasury indicated these governments have agreed to initiate discussions on an approach to FATCA implementation that would address legal barriers to compliance, simplify implementation, and reduce the costs associated with FATCA compliance. Governments choosing to engage in this approach would be termed “FATCA Partners.” Since that initial joint statement, Treasury has released both the Model 1 Intergovernmental Agreement (IGA) and the Model 2 IGA, and the United Kingdom, Denmark, Mexico, Germany, Ireland, Norway, Spain, Japan, and Switzerland have signed IGAs. In addition, Treasury is in some level of contact ranging from active discussion or exploratory talks to informational sessions with many other jurisdictions. However, Treasury has had to commit to heightened due diligence requirements and the implementation of information reporting for these governments as a quid pro quo for their cooperation on FATCA compliance. The Model 1 IGA includes both reciprocal and non-reciprocal versions. The reciprocal version would require USFIs to report specific information regarding account holders who are tax residents of a Partner jurisdiction to the IRS, which would then exchange the information with the Partner government. Together these expanded reporting obligations represent a significant challenge for USFIs. While the U.S. would have until September 30 to provide the information to a Partner jurisdiction, the IRS would likely require it to be reported “The key to smoothly delivering on FATCA compliance obligations is to develop implementation plans immediately for worry-free withholding tax compliance.” Glen Bover, Vice President, Broadridge Tax Services, Broadridge Financial Solutions, Inc. to the IRS within a similar timeframe as current reporting is in order to assemble the necessary information required for the information exchange. Furthermore, by requiring FATCA reporting of Chapter 4 reportable amounts on the Form 1042-S, the Form 1042 reconciliation process suddenly has become substantially more complicated. Therefore, it is critical to invest in robust due diligence, withholding and reporting systems now, as opposed to learning a new solution at the same time as learning new requirements. Evaluate FATCA Preparedness Key considerations: • Is internal expertise broad enough to support design and development, know best practices, and understand what and when to design in the future? • What time and development costs are involved in developing an internal solution versus using an external solution? • Are there competing internal development priorities that could impact funding or staffing? • What change management capabilities and resources are required (both financial and personnel)?
  8. 8. 8 FATCA COMPLIANCE: RIDING A ROLLER COASTER OF REGULATORY CHANGE 1 FATCA statutory provisions can be found in Chapter 4, Sections 1471-1474 of the Internal Revenue Code (IRC) and operate in conjunction with the current rules for Chapter 3 non-resident reporting and withholding under Section 1441-1443 of the IRC. 2 FATCA Proposed Regulations §1.1471-4(e). “Each FFI that is a member of an expanded affiliated group must obtain the status of either a participating FFI or registered deemed compliant FFI as a condition for any member of such group to obtain the status” as further expanded by §1.1471-4(e)(2)(iii) “A limited branch is a branch of an FFI that, under the laws of the jurisdiction as of February 15, 2012 and that apply with respect to the accounts maintained by the branch, cannot either report such accounts, close such accounts or transfer such accounts.” Conclusion The key to smoothly delivering on FATCA compliance obligations is developing implementation plans immediately and responding swiftly to subsequent changes. Begin your evaluation of a partner now to deliver seamless solutions and to help you navigate through the complexities of FATCA compliance. Leverage a partner that will provide industry expertise, ongoing maintenance, and offer cost- effective tools required for compliance. Delaying implementation plans to wait for key events will guarantee a bumpy ride. IMPORTANT DATES FACTA effective date for USFIs and FFIs July 1, 2014 Commence withholding on payments of U.S. source FDAP income to certain recipients July 1, 2014 Commence withholding on payments of U.S. source FDAP income paid to undocumented prima facie FFIs January 1, 2015 Commence withholding on payments of gross proceeds of U.S. securities paid to certain recipients January 1, 2017 Earliest effective date for foreign pass-through payment withholding January 1, 2017
  9. 9. No part of this document may be distributed, reproduced or posted without the express written permission of Broadridge Financial Solutions Inc. © 2013 Broadridge Financial Solutions, Inc. Broadridge and the Broadridge logo are registered trademarks of Broadridge Financial Solutions, Inc. MKT_503_14 Contact Us Cyrus Daftary, Partner, Burt, Staples Maner, LLP Executive Director, Compliance Technologies International, LLP +1 617 963 3412 Glen Bover, Vice President, Tax Services, Broadridge Financial Solutions, Inc. +1 201 714 3411 About Broadridge Broadridge Financial Solutions, Inc. (NYSE:BR) is the leading provider of investor communications and technology-driven solutions for broker- dealers, banks, mutual funds and corporate issuers globally. Broadridge’s investor communications, securities processing and business process outsourcing solutions help clients reduce their capital investments in operations infrastructure, allowing them to increase their focus on core business activities. With 50 years of experience, Broadridge’s infrastructure underpins proxy voting services for over 90% of public companies and mutual funds in North America, and processes more than $5 trillion in fixed income and equity trades per day. Broadridge employs approximately 6,400 full-time associates in 13 countries. For more information about Broadridge, please visit broadridge.com. About Compliance Technologies International, LLP CTI’s software and services have been used in multinational corporations and eight of the 10 largest financial institutions in the world since 1998. CTI has a strong team of highly specialized and experienced international and domestic tax and software professionals, including lawyers, accountants, software engineers, and operations experts. CTI’s team is a leader in cutting-edge global tax technology; consulting and outsourcing services specializing in information return reporting and tax withholding. Years of practice have contributed to CTI’s long-standing and solid relationships with worldwide financial institutions, multinational corporations, tax authorities, and governments.