Insight Center: Publications

Financial Institutions and Investment Funds Should Prepare Now for FATCA

Author: Steven D. Bortnick


Originally published by Thomson Reuters Accelus at http://accelus.thomsonreuters.com, March 2012. Reprinted with permission.

The enactment of the Foreign Account Tax Compliance Act (FATCA) as in March of 2010 has sent shock waves through financial institutions and investment fund management companies. FATCA aims to obtain information to prevent U.S. persons from evading taxation through the use of foreign entities. Although the law does not fully enter in force until January 1, 2013, the effort to become compliant with FATCA should begin immediately. Some tips on how to do so are noted below.

The legislation is the direct result of the events that led to UBS’ admission that it helped U.S. taxpayers evade U.S. income tax on U.S.-source income. While the goal is the increased collection of tax, the intention is not to create any new tax. FATCA’s goal is accomplished by adding an entirely new chapter to the Internal Revenue Code devoted to due diligence, reporting and withholding. Failure to comply will result in withholding tax at the rate of 30 percent, including withholding on items understood not to be taxable in the hands of foreign persons. While the proposed regulations reduce the burden that initially may have been expected, especially through reduced due-diligence requirements, FATCA compliance still will be an involved and costly process for many financial institutions and investment funds. To the surprise of many, when the proposed regulations were issued, so was a joint statement from the United States, United Kingdom, France, Germany, Italy and Spain regarding an intergovernmental approach to improving international tax compliance and implementing FATCA. These countries have agreed to enact legislation to enforce FATCA and increase tax compliance among the various countries.

FATCA in General Terms

FATCA generally divides the universe of foreign entities into two broad categories: foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs). A withholding agent (generally anyone who has control of payments, including participating FFIs) must withhold tax at 30 percent on any “withholdable payment” to an FFI, unless such FFI is a “participating FFI.” A participating FFI is an FFI that has reached an agreement with the Internal Revenue Service (IRS) to obtain certain information, provide certain information to the IRS and withhold on certain payments. These requirements are discussed further below.

A withholding agent must withhold tax at 30 percent on any withholdable payment to an NFFE, unless the NFFE: (a) certifies that it has no U.S. investors that own 10 percent or more of such NFFE or (b) identifies U.S. investors that own 10 percent or more of such NFFE.

Is Payment Made to an FFI?

The characterization of an entity as an FFI or NFFE has the most critical impact on the obligation of a withholding agent with respect to payments made to the entity, as well as the recipient entity’s obligations under FATCA. An FFI is a foreign entity that:

  • accepts deposits in the ordinary course of a banking or similar business
  • realizes at least 20 percent (over a rolling 3-year period) of its gross income from holding financial assets for the account of others
  • realizes at least 50 percent (over a rolling 3-year period) of its gross income from investing, reinvesting or trading in securities, partnership interests, commodities, notional principal contracts, insurance or annuity contracts or interests (including forwards) therein (or holds itself out as such an entity), and
  • is an insurance company or the holding company of one.

This broad definition is designed to pick up investment funds, including mutual funds, private equity funds, venture capital funds and hedge funds.

Who Is in the FFI's Expanded Affiliated Group?

All members of the Expanded Affiliated Group (EAG) must be either participating FFIs or deemed compliant, or all members may be subject to withholding. The EAG generally is a group of companies connected by greater than 50 percent ownership. For this purpose, various constructive ownership rules apply. Moreover, the EAG may include non-corporate entities. Based on the current drafting of the proposed regulations, an EAG may consist entirely of non-corporate entities.

The proposed regulations contain a transition rule. Participating FFI groups can have members that cannot meet the requirements because of the application of local law (a limited branch) through 2015. However, at least one member of the EAG must not be subject to the rules that prevent compliance (even if it is U.S.), and the limited branch must conduct due diligence and identify U.S. persons to FFIs that are not limited branches. The participating FFIs that are not limited branches must report information about U.S. accounts to the IRS to the extent permitted under the law of the branches’ jurisdiction.

Becoming a Participating FFI

To avoid 30 percent withholding, an FFI must enter into an agreement with the IRS to comply with certain requirements. These agreements will require the participating FFI to:

  • obtain information designed to enable the FFI to identify accounts held by U.S. persons or foreign persons with significant U.S. owners
  • conduct due diligence specified in the proposed regulations
  • report annually certain information with respect to U.S. accounts
  • deduct and withhold a 30 percent tax on other FFIs that have not entered into such agreements, so-called recalcitrant holders and other FFIs that have elected to have tax withheld rather than handle such withholding themselves
  • comply with IRS information requests, and
  • attempt to obtain waivers of bank secrecy/privacy limitations or close U.S. accounts.

Draft model FFI agreements are supposed to be available in early 2012, with final models available in the fall. The IRS has indicated that online registration will be available by January 1, 2013. FFIs generally must have completed the process by June 30, 2013, or risk not having their FFI-EIN (the identification number that withholding agents will need to receive to remit withholdable payments without withholding) in time to avoid withholding.

FFI Due Diligence

FFIs must perform due diligence to determine their U.S. account holders. The proposed regulations limited due diligence to electronic records for account balances under $1,000,000. Moreover, due diligence generally is not required with respect to preexisting accounts with values under $50,000 ($250,000 for preexisting entity accounts with no additional diligence required until the account reaches $1,000,000) or for insurance policies with values with a value not greater than $250,000. The proposed regulations also provide for cases with FFIs may rely on their existing account opening procedures (i.e., know your client or anti-money laundering) for identifying U.S. accounts.

Withholding Obligations

Participating FFIs will be required to withhold on certain payments to non-participating FFIs, recalcitrant holders (i.e., holders who refuse to provide information required by the FFI under the proposed regulations or who refuse to waive provisions of foreign law that would preclude reporting to the IRS) and participating FFIs that elect to be subject to withholding rather than withhold. Withholding obligations begin in 2014 (2015 for gross proceeds and 2017 for certain payments of foreign passthrough payments, discussed below).

Participating FFIs are themselves withholding argents. A participating FFI also has to comply with its FFI agreement with respect to withholding obligations with respect to withholdable payments made to NFFEs.

What Is a Withholdable Payment?

An FFI’s withholding obligations (discussed above) apply to withholdable payments. Withholdable payments are:

  • U.S. source fixed or determinable annual or periodical income (FDAP), such as interest and dividends
  • gross proceeds from the sale or disposition (in a taxable transaction) of any property that produces U.S. source interest or dividends.

The proposed regulations exclude many types of U.S. source FDAP from the definition of withholdable payments, including:

  • interest or original issue discount on short-term obligations
  • income that is effectively connected to a U.S. trade or business, and
  • payments made in the ordinary course of business (including interest on payables from the acquisition of nonfinancial services or goods).

Withholdable payments also include foreign passthrough payments. The Proposed Regulations are reserved as to the meaning of this term. The intention is to prevent the avoidance of withholding on distributions that are themselves foreign source, where they relate to U.S. source income.


FFI’s will be required to report identifying information and account balances or values for U.S. accounts and recalcitrant holders beginning September 30, 2014, and annual reporting for reportable amounts beginning March 15, 2015.

Is the FFI Deemed Compliant?

FFIs can avoid 30 percent withholding if they are deemed compliant. Registered deemed compliant FFIs still must perform diligence to identify U.S. accounts, and must register with the IRS. Registered deemed compliant FFIs are:

  • Local FFIs: These are FFIs that are licensed and regulated in their country of organization as banks or similar organizations, securities brokers or dealers, financial planners or investment advisors. They must not be investment funds, must have no place of business outside their country of organization and not solicit account outside their country of organization. Ninety-eight percent of their accounts must be local, and local tax laws must require information reporting or withholding.
  • Qualified collective investment vehicles: These are entities that are FFIs solely because they are investment funds and must be registered as such in their country of incorporation. Moreover, each holder of debt or equity in such entity in excess of $50,000 must themselves be participating FFIs, registered deemed compliant FFIs, U.S. persons or exempt beneficial owners.
  • Restricted funds: These are entities that are FFIs solely because they are investment funds and must be regulated as such in their country of incorporation. These funds generally must exclude U.S. persons, non-participating FFIs and passive NFFEs with one or more 10 percent U.S. owner, and be distributed by a limited group of distributors.
  • Non-reporting members of participating FFI groups: These members must take steps to avoid having any U.S. accounts.
  • FFIs deemed compliant by intergovernmental agreement.

Generally, requirements applicable to be a registered deemed compliant FFI must be satisfied by all members of the FFI’s EAG. Registration must be renewed every three years.

Certified, compliant FFIs must certify that they are compliant to withholding agents, but need not register with the IRS. These organizations are:

  • Non-registering local banks – These are banks licensed in their country of organization and which have no fixed place of business outside such country, do not solicit account holders outside their country of organization and have no more than $175 million in assets ($500 million among all members of an EAG). Additionally, the FFI must be required under the tax laws of their country in which they are organized to perform information reporting or withholding on resident accounts (or all accounts maintained thereby are no more than $50,000).
  • Retirement funds – An entity organized for the provision of retirement or pension benefits under the law of the country in which it is established and satisfying certain other rules.
  • Nonprofit organizations established and maintained in its country of residence exclusively for religious, scientific, artistic, cultural or educational purposes, which are exempt from tax in their country of residence and which satisfy certain other rules.
  • FFIs (other than investment funds) that maintain no financial account (together with each member of its EAG) with a balance in excess of $50,000, and which have (together with the rest of its EAG) no more than $50,000,000 in assets.

In addition, certain FFIs are treated as deemed compliant with respect to payments from withholding when they agree to report to the IRS all the necessary information and to which the FFI provides with all of the necessary documentation.


Although FATCA does not fully enter into force until January 1, 2013, work to become compliant with FATCA should begin immediately. Here is a list of the things that persons responsible for FATCA should begin doing immediately.

  • determine whether their company is an FFI
  • determine the members of their company’s Expanded Affiliated Group, and determine if any of those entities are FFIs
  • determine whether any members of the EAG may be registered deemed compliant or certified deemed compliant FFIs. In this regard, consider whether by transferring client accounts to affiliates may enable certain members of the EAG to be deemed compliant. This exercise could substantially cut down the number of FFI agreements into which the EAG may have to enter
  • consider whether the EAG’s systems and procedures are sufficient to enable each member of the EAG to comply with the requirements to be set forth in FFI agreements (as described in the proposed regulations and when the model FFI agreements are released in the near future), and update these systems and procedures to permit compliance
  • update offering documents, marketing materials, subscription materials, account opening documents, etc., to ensure that:
  1. members of the EAG obtain sufficient information to comply with FFI agreements from account holders
  2. the documents permit any FATCA holding with respect to recalcitrant holders and non-participating FFIs may be withheld from payments due to those holders
  3. holders and potential holders are aware of the fact that their identities and account information may be disclosed to the IRS, the information they need to provide and the fact that the FFIs will withhold on payments if they fail to comply
  4. they contain any statements required in order to comply with deemed compliant requirements (e.g., in certain cases that no U.S. person may hold an account in the FFI)
  5. these documents permit the FFI to close the account/redeem recalcitrant holders as required by FATCA.
  • if the FFI is an intermediary or flow-through entity, such as a partnership, consider whether the FFI should be a qualified intermediary (QI) or withholding foreign partnership (WFP). There are costs and additional requirements associated with each of these, but whether such an FFI is a QI or WP impacts which entity (the FFI or withholding agent with respect to payments to the FFI) is required to withhold
  • determine the information/documents that account holders must provide to the FFI in order for the FFI to comply with its FFI agreement, including waivers of privacy and similar laws. The IRS will have to begin to issue FFI-EINs and updated W-8s before FFIs can start collecting the required information. Note as well that France, Germany, Italy, Spain and the United Kingdom (as well as others in the future) will be enacting legislation to help implement FATCA compliance and deal with internal laws that otherwise would preclude disclosure. FFIs in these countries will not be required to enter into FFI agreements, but will provide the required information directly to the tax authorities of such countries. Nevertheless, the diligence to be done with respect to financial accounts and the information to be disclosed is expected to be the same or similar.
  • determine the information/documents that their company will have to be provided to entities from which withholdable payments may be received to avoid FATCA withholding
  • determine whether entities from which payments may be received will be FATCA complaint. If payments ultimately bound to the company are routed through an FFI that is non-participating, will be subjected to 30 percent withholding.

Steven D. Bortnick

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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