The Foreign Accounts Tax Compliance Act (“FATCA”) provisions are included in the Hiring Incentives to Restore Employment (“HIRE”) Act. The provisions impose a 30% withholding tax on certain U.S. source payments made to “foreign financial institutions” (“FFIs”) and “non-financial foreign entities” (“NFFEs”) that refuse to identify certain U.S. investors, even if such U.S. persons directly or indirectly hold only non-U.S. assets. The rules are effective for payments made on or after January 1, 2013.
The 30% FATCA withholding tax is different from the current “Chapter 3” 30% withholding regulations (referred to as the section 1441 or “non-resident alien” (“NRA”) withholding regulations). First, the FATCA withholding tax applies to payments of both U.S. source income and gross proceeds from the sales of securities that could pay U.S. source interest and dividends (under Chapter 3, such gross proceeds paid to non-U.S. persons are not subject to any withholding tax). Second, the 30% FATCA withholding tax rules simply act as a filter to the existing Chapter 3 withholding tax rules. That is, the FATCA withholding rules “filter out” any FFIs or NFFEs that do not comply with the FATCA disclosure rules for U.S. persons and subjects them to the 30% FATCA tax. However, FFIs and NFFEs that do agree to comply with the disclosure rules for U.S. persons are not subject to the 30% FATCA tax, and therefore are able to apply any of the withholding tax exceptions (e.g., portfolio interest) under the existing Chapter 3 withholding rules.
FATCA will be a major challenge for non-U.S. financial and non-financial entities with U.S. investors or owners. FFIs, including most QIs and NQIs, have three basic choices: (1) enter into an agreement with the IRS to put procedures in place to identify and disclose U.S. account holders, (2) accept the 30% withholding tax on U.S. payments, or (3) restructure their businesses to stop serving U.S. customers, stop offering (and owning) U.S. investments, or both.
NFFEs, who generally will be account holders of either U.S. financial institutions or FFIs, must decide whether to disclose any substantial U.S. ownership, accept 30% withholding on U.S. source income and proceeds, or divest themselves of U.S. securities or ownership. QIs and NQIs will need to develop systems and procedures to determine if a non-U.S. payee is an FFI or NFFE to which the rules apply, and then whether such FFI or NFFE is “good” (i.e., FATCA compliant and not subject to FATCA withholding) or “bad” (i.e., FATCA noncompliant and subject to FATCA withholding). Withholding agents who fail to comply with the FATCA rules potentially could be subject to significant liabilities.
Now is the time for QIs and NQIs to assess what steps they can take to ensure they will be compliant with FATCA upon its effective date. The FATCA legislation is quite broad and defers implementation to the Treasury and the IRS. Therefore, one of the first things QIs and NQIs have the opportunity to do, albeit within a short time frame, is to work with the Treasury and the IRS to help them develop practical procedures that minimise the inevitable compliance burden. The IRS and Treasury have very little time to draft the needed regulations given that the rules must be implemented in less than three years time. Within that short time frame, the rules must be written and affected persons must make the required procedural, operational and systemic changes required for compliance. Therefore, QIs and NQIs should begin now to consider the implications of the rules and make their voices heard to the Treasury and IRS.