Foreign Account Tax Compliance Act

FATCA was the US Government response to a series of investigations into US tax evasion scandals in or around 2006. Those interested may refer to report released in August 2006 titled ‘Tax Haven Abuses: The Enablers, the Tools and Secrecy’ and to the report titled ‘Tax Compliance and Enforcement Issues with respect to Offshore Accounts and Entities’ released in March 2009. In substance, these reports conclude that US taxpayers were not necessarily reporting their correct offshore incomes in their US tax returns.

FATCA is intended to increase transparency with respect to US taxpayers investing or earning income through non- US institutions and non-US investment entities. There is the underlying assumption that the US institutions are not encouraging tax evasion by US persons owing to the obligations that the Internal Revenue Code casts upon US institutions and US taxpayers are not omitting from their tax returns details of investments made or income earned through US institutions. It may be noted that US institutions have been subject to significant US regulations in so far as their transactions with US persons are concerned.

Obligations under FATCA
FATCA creates a tax information reporting regime under which financial institutions (FIs), both US (USFIs) and foreign (FFIs) are expected to report certain financial information in respect of a US taxpayer (generally referred to as a ‘US person’). If an FI does not report such information, the FI could be subject to 30% withholding in respect of its own US sourced income. The provisions of FAT CA and the regulations issued initially in February 2012 generated a lot of debate. The original implementation date was pushed back and FAT CA came into effect in two stages on July 1, 2014 and on January 1, 2015.

The global financial community questioned both subtly and overtly, the perceived extra-territorial nature of the FAT CA regulations. Even while this was happening, the enquiry into the nature of business models especially followed by certain businesses came under scrutiny by various Governments around the world. In the US, there were enquires into the US corporations keeping profits outside the US or restructuring themselves under ‘inversion’ structures to get out of the tax rigours applicable to US corporations. In the UK, there were enquires into the way some of the new technology product companies had large sales in the UK but were based out of Ireland. Closer home, the revelation of Indians having accounts in Swiss banks and the directive of the Supreme Court to appoint a Special Investigation Team (SIT) meant that a new era of global transparency in respect of financial transparency was arriving. The G20 endorsed the need for transparency and the OECD even mooted the idea of a multi-lateral tax information exchange agreement (TIEA).

The FATCA regime allowed for the US Internal Revenue Service to enter into agreements with other governments for sharing of information either on reciprocal basis or on unilateral basis. These are called Inter-Governmental Agreements (IGAs) on Model 1 and Model 2 respectively. Since completing negotiations with governments and signing agreements was time consuming, the approach taken was to agree to broad terms i.e. to arrive at an agreement ‘in substance’ with the intent to sign the final agreement by end of December 2014. This approach addressed several objections of various governments and of the financial institutions. In November 2014, the US IRS announced that the agreement in substance would be treated as being in force till the final agreement had been signed. India worked out an agreement ‘in substance’ in April 2014.

FFIs and US person
As stated earlier, FATCA requires reporting by FFIs in respect of certain financial transactions of US persons. The term ‘foreign financial institution’ is very broadly defined and encompasses a number of entities that have not traditionally been considered to be financial institutions. An FFI is any entity organised in a country (including a US possession) other than the US that:

Accepts deposits in the ordinary course of banking or similar business; or

As a substantial portion of its business, holds financial assets for the account of others; or

Is an investment entity; or

Is an insurance company (or the holding company of an insurance company) that issues or is obligated to make payments with respect to a cash value insurance or annuity contract; or

• Is an entity that is a holding company or treasury centre that is part of an expanded affiliated group that includes a depository institution, a custodial institution, a specified insurance company or an investment entity or is formed in connection with (or availed of by) a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund or similar investment vehicle.

As we can see above, the coverage is quite wide and the definition quite complex. There are certain exclusions e.g. group entities that are non-financial foreign entities (NFFEs) and non-financial start-up companies for the first 24 months after the latter type of entities are organised. We now turn to who or what is a US person. The term ‘US person’ means:

An individual who is a US citizen or resident of the US; or

A partnership created or organised under the laws of the US or a State of the US; or

A corporation created or organised under the laws of the US or a State of the US; or

An estate of the decedent, who is a US person; or

Any trust if:

1. A court within the US is able to exercise primary supervision over the administration of the trust (i.e. the “Court test”); and

2. One or more US persons have the authority to control all substantial decisions of the trust (i.e. the ‘Control test”); or

The Government of the US, any State, municipality or other political subdivision, any whole owned agency or instrumentality of such governments.

Registration of FFI and FFI
Agreement

An FFI is, on application to be made electronically, allotted a ‘Global Intermediary Identification Number’ (GIIN). The GIIN is 20 character identification unique to each FFI. An FFI, whose application for GIIN is under process with the IRS, may provide a Form W-8 to its counterparty and state that it has ‘applied for’ against the GIIN field. Such a Form W-8 will be valid for 90 days during which it is expected that the FFI will be granted the GIIN.

An FFI will agree with the IRS to undertake, amongst others, account holder due diligence, reporting and withholding. The nature of the obligations of the FFI varies depending upon whether the FFI is located in an IGA country or outside.

An FFI which agrees to sign (or signs) the agreement with the US IRS is called a participating FFI (PFFI) and one which does not do so in non-participating FFI (NPFFI). A PFFI may also agree that it will do the FAT CA reporting on behalf any other FFI within the group.

Account Holder Due Diligence most FIS have historically never captured data which reveals the tax residency of the account holder. Generally, Know your Customer (KYC) norms have focussed on proof of identity, proof of address, nature of business. more recently, KYC norms tied in with anti- money laundering (AML) initiatives meant that FIs require information about nature of business of the account holder although there may be no loan or credit facility given to the account holder. this is now being further enhanced to capture information about whether the account holder is  a  US  person.  While  FATCA allows  for  FIS  to  accept customer self-declarations, the institution is expected to make sufficient due diligence in respect of new accounts (nadd) opened after the coming into force of FATCA.  it also requires the institutions to do due diligence in respect of pre-existing accounts (Padd). in particular, the due diligence has to focus on uS indicia appearing in the data relating to accounts of individuals. Generally, US indicia in the context of individual accounts are one or more of the following viz.,

•    US citizenship

•     Lawful permanent resident of  the  uS  (i.e.  a  non-uS citizen with a ‘green card’)

•    US place of birth

•     Residence address or correspondence address in the US (this could include a US post box office)

•     US telephone number with no non-uS telephone number associated with the account

•     Standing instructions to transfer funds to an account in the uS

•     Current  power  of  attorney   or   signatory   authority granted to a person with a uS address

•     Care of’ mailing address is the sole address for the account or ‘hold mail’ instruction applies in respect of the account.

In such cases, the institution has to exercise additional due diligence and obtain appropriate ‘cure’ documentation, which differs on the basis of the nature of the defect. For example, uS citizenship cannot be ignored unless the uS certifies that the individual concerned has given up his US citizenship. in the absence of cure documentation, it is presumed that the account holder is a uS person. For non-individuals, the nadd, Padd focuses on whether the entity is an FFI or it is non-financial foreign entity (NFFE). An FFI will have to provide its GIIN     whereas an  NFFE  will have to provide information about its ownership in particular whether it has uS person(s) having substantial i.e. greater than 10% interest in the nFFe.

    An account holder with a PFFI

• Who or which is not an FFI and who fails to comply    with reasonable requests for information necessary to determine if the account is held by a US person; or

•    Fails to provide a valid self-declaration of being a US person (Form W-9); or

•     Fails to   provide   the   correct   name   and   (US)  tax Identification Number (TIN) combination; or

•     Fails to waive the secrecy law which would prevent the participating FFI from reporting information required to reported under FATCA; or

    Is an NFFE which fails to provide the required certification regarding substantial US owners or lack of such ownership; or
 

•   Has a dormant account is treated as a ‘recalcitrant account holder’.

There  are  a  few  peculiar  situations  that  arise  owing  to difference in US law and indian law. For example, a company incorporated under indian law could still be treated as a US person under US tax law. Similarly, the US law does not have any specific provision to address a hindu undivided Family (HUF), which is a traditional family institution peculiar to india.

Reporting
A PFFI will have to report, with respect to the financial accounts of uS persons, the following information in various stages viz.

1.    for the period from july 1, 2014 to december 31, 2014
– name, address, uS tin, account balance for such accounts;

2.    for 2015 – in addition to the information at 1 above, the income associated with such accounts;

3.    for 2016 – in addition to the information at 1 and 2 above, gross proceeds from securities transactions.

The reporting is in all cases required to be done after the end of the calendar year. For FFIs located in countries with an IGA, the reporting deadline is September.

Withholding
As stated earlier, non-compliance with FatCa may result in a FatCa withhold being imposed on an FFI. A PFFI will not be subject to FATCA withholding. FATCA withholding would be imposed in respect of withholdable payments made to NPFFIs, non-compliant NFFE and recalcitrant account holders. after december 31, 2016, withholding may also extend to foreign pass-through payments.

a withholdable payment is a payment of uS  source  fixed or determinable, annual or periodical (FDAP) income.  the  term  FdaP  refers  generally  to  income other than gains from the sale or disposition of property.

It includes interest (discount on issue of debt securities is treated as ‘interest’), dividends, substitute payments (quasi dividends not treated as employment income), royalties, payments on notional principal contracts (derivatives) and annuities.

In addition, from january 1, 2017, gross proceeds from sale or other disposition of property that can produce US source interest or dividend income could subject to FATCA withholding.

The US law treats an FDAP as being US source income on the basis of residence of the obligor. For example, interest paid to an account holder on uS treasury bond or where the borrower is a US corporation is a withholdable payment. in the same manner, dividend in respect of US stocks is a withholdable payment. After december 31, 2016, sale proceeds of stock of a US corporation or of US treasury bond or a bond where the borrower is a US corporation could be treated as withholdable payment.

The complex rules of foreign passthru payments are not discussed here. In the next part of the write up, we will touch upon the local regulatory aspects covering FatCa compliance in india.

Summary
FATCA  is  not  a  tax  but  a  mechanism  adopted  by  the US Government to get information about US persons’ financial accounts with FFIs. It requires due diligence in respect of financial account holders, obtaining relevant documentation and reporting certain information about the US persons financial accounts with the FFI.