At a time in which the Foreign Account Tax Compliance (“FATCA”) provisions of the “Hiring Incentives to Restore Employment Act of 2010” (‘HIRE Act”) have been coming under increasing criticism within the EU and Asia due to concerns that these provisions will result in significantly increased compliance costs for financial institutions, the IRS has released further guidance in the form of Notice 2011-34 (the “Notice”).
The Notice generally supplements and expands on guidance issued last August in Notice 2010-60, which left a number of issues unresolved to be determined at the discretion of the IRS and the US Treasury. Some of these have now been clarified with the release of the Notice, but a number of significant issues remain unresolved including the proper treatment of trusts and trustees. Treasury and the IRS continue to work on proposed regulations and draft FFI agreements, but no specific release dates have been set.
Summary of Key Provisions
The Notice provides additional guidance with respect to six areas:
- The procedures to be followed by participating Foreign Financial Institutions (“FFIs”) in identifying US accounts among their pre-existing individual accounts. A new “private banking” category will require the disclosure of US citizen and green card account holders where the relationship manager or other personnel know of the account holder’s US status;
- The definition of the term “passthru payment” and the obligation of participating FFIs to withhold on passthru payments have been expanded to generally require withholding on a portion of each payment to a recalcitrant account holder or non-participating FFI, even potentially where those account holders have no US investment whatsoever, except with respect to certain custodial payments;
- The categories of FFIs that will be “deemed compliant”;
- The manner, frequency, and type of information an FFI must report with respect to US accounts;
- The integration of duties of an FFI when it is also a Qualified Intermediary or Withholding Foreign Partnership or Trust under the Qualified Intermediary regime; and
- The application of the FFI regime to expanded affiliated groups.
US Account Identification Procedures
The Notice modifies the procedures provided in Notice 2010-60. The changes introduced by the Notice with respect to the identification of account holders are generally favourable (with the important exception of the new private banking category discussed below), and provide limited relief from certain of the compliance obligations of FFIs previously proposed by Notice 2010-60 with respect to searching records for indicia of US account holder status.
Notably, however, the Notice introduces a new category of “private banking account,” and contains more stringent compliance obligations for private bankers, wealth managers and potentially certain other relationship managers connected to the accounts of high-net-worth individuals. FFIs must ensure that private banking relationship managers identify any client that the relationship manager knows to be a US person, including both US citizens and US green card holders. In addition, the relationship managers will be required to “perform a diligent review” of their paper and electronic files and other records to determine whether a client (or any associated family member) is a US person.
The Notice also requires a responsible officer of the FFI to certify completion of identification procedures, and to certify that FFI personnel did not direct, encourage or advise US account holders as to how to avoid identification of their accounts as US accounts. They will also be required to certify that the FFI has written policies and procedures in place prohibiting employees from advising US account holders on how to avoid having their accounts identified. Based on this guidance financial institutions should now be in a position to begin implementing best practices as to account holder identification procedures.
It remains unclear whether these requirements will apply to trustees; however, because the definition of the term “private banking department” for these purposes includes any department, unit, division or part of an FFI that has employees who “ordinarily provide personalized services to individual clients (or their families), such as banking, investment advisory, trust and fiduciary, estate planning, philanthropic, or other services . . . .” it appears likely that trust companies might also be subject to these heightened due diligence and certification requirements. The IRS has requested comments on the implementation of this new “private banking test,” and additional guidance should be released in response to those comments.
The IRS has refused to limit the application of the “Passthru” Payment rules to directly received withholdable payments or payments directly traceable to such payments, and has instead adopted an approach based on the ratio of the FFI’s US assets to that FFI’s total assets.
This means that any recalcitrant account holder (any individual or entity refusing to provide an FFI information about their US or non-US status where required) and any non-participating FFI investing via a participating FFI would generally be subject to withholding on any payment by the FFI to such account holder in proportion to the ratio of the FFI’s US investments vs. its non-US investments.
The withholding would apply regardless of whether such account holder itself invests into the US through this account.
The primary exception would be where participating FFIs are acting solely as a custodian, in which case the participating FFI’s percentage of US investments would not trigger withholding.
Account holders who have met any additional identification and disclosure requirements created for them under FATCA should not be affected.
The implications for trusts and trustees are unclear.
“Deemed Compliant” FFIs
Many commentators had hoped that the category of entities deemed compliant with the FFI rules would be expanded to include certain non-US funds and/or banks that exclude US persons as clients or investors. The IRS has not adopted such broad exemptions, instead choosing to introduce more limited exemptions for:
(1) Certain local banks that do not operate outside their country of organization, and that maintain procedures designed to ensure that they do not open accounts for non-residents, non-participating FFIs, or Non-Financial Foreign Entities (“NFFEs”) other than “excepted” NFFEs;
(2) Local FFI members of participating affiliated groups that do not maintain operations outside their country of organization (if they comply with account-holder identification procedures and agree that if they identify certain accounts they will either enter into an FFI agreement, transfer those accounts to an FFI, or close such accounts); and
(3) Certain collective investment vehicles if: (i) all holders of record are participating FFIs or deemed compliant FFIs acting on behalf of other investors; (ii) the fund prohibits the subscription or acquisition of interests by any person that it not a participating FFI or deemed compliant FFI; and (iii) the fund certifies that it will calculate passthru payment percentages.
The IRS is still considering whether certain vehicles such as ETFs that are regularly traded on established exchanges and certain categories of non-US retirement plans should be treated as deemed compliant.
Reporting of US Accounts
The Notice modifies the frequency with which an FFI will be required to report the account balance of US accounts, and now requires that the FFI report only year-end account balances or values. It also modifies the manner in which an FFI will be required to report income, in an attempt to avoid imposing what many commentators had suggested would otherwise be too onerous a compliance burden.
Interaction with Qualified Intermediary Rules
All FFIs currently acting as QIs will be required to consent to agree to become participating FFIs unless they qualify as deemed compliant FFIs. Withholding Foreign Partnerships and Withholding Foreign Trusts will be subject to similar requirements.
The Notice introduces the concept of a “coordinated application process” for affiliated groups, as well as options for FFI Groups and Funds with a common asset manager to adopt a centralized compliance approach under which an FFI would be designated the “Compliance FFI,” and that entity would assume an oversight role with respect to the compliance of the FFI Group.
Additional Guidance Needed
The Notice leaves a number of important issues unaddressed. Additional clarity is still needed on questions such as how attribution of ownership should operate for account holder identification procedures in the trust context, as well as how the “Passthru Payment” rules will apply to trusts or trustees. There are also still a number of questions left unanswered with respect to the application of these rules to insurance companies and certain non-US pension arrangements. The Notice still implies that life insurance companies will generally be considered FFIs.
The Notice states that proposed regulations and draft FFI agreements are expected to be forthcoming. Although it is likely the future guidance will address some or all of the questions that remain unanswered, the timing of this future guidance is unclear.
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