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On February 8, the Internal Revenue Service issued proposed regulations that provide guidance on the “FATCA provisions” contained in sections 1471-1474 of the Internal Revenue Code.1 The purpose of FATCA is to reduce U.S. tax evasion by requiring “foreign financial institutions” and certain other foreign entities to provide information to the IRS about U.S. holders of their debt and equity interests and other “financial accounts,” or else be subject to a 30% withholding tax.
More specifically, FATCA imposes a 30% withholding tax on payments to any foreign financial institution of (i) U.S.-source interest, dividends, rents, royalties, insurance premiums, and other “FDAP income,”2 (ii) gross proceeds from the sale of “U.S. assets” that produce U.S.-source FDAP income, and (iii) foreign-source “passthru” payments from other foreign financial institutions to the extent attributable to their U.S. assets, unless the foreign financial institution enters into a “FATCA agreement” with the IRS to provide the name, address, taxpayer identification number, and certain other information with respect to its U.S. debt and equity holders and other U.S. holders of financial accounts. The FATCA agreement also requires the foreign financial institution to withhold on the passthru payments that it makes to “recalcitrant holders” that do not provide the required information and to foreign financial institutions that have not themselves entered into a FATCA agreement.
The proposed regulations extend FATCA’s “grandfathering” period, delay the effective date for withholding on foreign-source passthru payments, provide potential exemptions from FATCA, and provide greater detail regarding the withholding and reporting obligations that will apply to foreign financial institutions.
This memorandum discusses the aspects of the proposed regulations that are most relevant to foreign investment vehicles, such as foreign hedge funds and their foreign “blockers,” foreign private equity funds, and issuers of “collateralized loan obligations” and “catastrophe bonds.”3 Many of these vehicles are foreign financial institutions that will be required to enter into a FATCA agreement, or else will be subject to FATCA withholding.4 Part II discusses new rules under the proposed regulations. Part III discusses the FATCA implementation timeline under the proposed regulations.
Beginning in 2014
Beginning in 2015
Beginning in 2016
1 FATCA stands for the Foreign Account Tax Compliance Act of 2009, which was the bill that first proposed adding sections 1471-1474. The sections ultimately were enacted in the Hiring Incentives to Restore Employment Act of 2010 (the “HIRE Act”) (P.L. 111-147).
All references to section numbers are to the Internal Revenue Code of 1986, as amended, or to the proposed Treasury regulations promulgated thereunder.
2 FDAP stands for fixed or determinable annual or periodical. FDAP income also includes original issue discount on debt obligations.
3 This memorandum does not discuss the rules applicable to non-financial foreign entities.
4 It is unclear if catastrophe bond issuers are foreign financial institutions under the proposed regulations. In general, a catastrophe bond issuer may be treated as a foreign financial institution under the proposed regulations unless (i) more than half of its business during the calendar year is issuing, being obligated to make payments with respect to, or reinsuring the underlying policies, and (ii) the underlying policies are insurance, are not treated as having cash value, and are not securities for U.S. tax purposes.
5 The proposed regulations explicitly state that swaps may be grandfathered. In addition, the IRS is considering whether equity interests in securitization vehicles that invest only in debt and liquidate within a specified time frame should be grandfathered.
6 The proposed regulations reserve on the definition of foreign-source passthru payments and request comments on how to implement passthru payment withholding.
7 The joint statement also provides that if the United States and another jurisdiction enter into the information-sharing agreement, then foreign financial institutions in the jurisdiction will not be required to “terminate the account of a recalcitrant account holder.”
8 Generally, the jurisdiction must not have been identified by the Financial Action Task Force as being at-risk with respect to its anti-money laundering and combating the financing of terrorism regime. Currently, there are no European Union members on this “at-risk” list. Bermuda, the British Virgin Islands, and the Cayman Islands also are not on the list.
9 It is unclear what it means for a foreign financial institution to be “regulated as an investment fund.”
10 Notice 2011-34, part I.C., 2011-19 IRB 765.
11 The preamble to the proposed regulations provides that Form W-8 will be amended to indicate whether a payee is a foreign financial institution and, if so, whether the payee has entered into a FATCA agreement.
12 With respect to 2013, the foreign financial institution will be required to report only with respect to persons that are also holders on June 30, 2014. For subsequent years, the foreign financial institution will be required to report with respect to persons that were holders during the preceding calendar year.
13 The foreign financial institution generally is not required to report information about U.S. persons that are publicly traded corporations, affiliates of publicly traded corporations, tax-exempt organizations, mutual funds, real estate investment trusts, individual retirement plans, common trust funds, or securities, commodities, or swap brokers or dealers.
14 If the foreign financial institution reports a non-financial foreign entity under this rule, it must also report the name, address, and taxpayer identification number of each U.S. person that owned more than 10% of the voting power or value of the stock or capital or profits interests in the entity.
15 The proposed regulations provide that the reported value of an equity or debt interest in a foreign financial institution is the value “as determined for the purpose that requires the most frequent determination of value.”
16 The IRS intends to release a new form for purposes of FATCA reporting.