US Foreign Account Tax Compliance Act ("FATCA")
The Foreign Account Tax Compliance Act (FATCA) contains a number of provisions that are intended to make it more difficult for US taxpayers (individuals, partnerships, trusts, corporations) to use non-US accounts to shelter income from US taxation. FATCA also imposes new requirements on certain non-US taxpayers with US investments. Many FATCA provisions are now supported by final regulations that were issued in January of 2013. As a result, taxpayers with international activity could be subject to increased reporting requirements for financial accounts and increased “know your customer” requirements to avoid being obliged to withhold from payments to non-US vendors and suppliers, even though the taxpayer is already US tax-compliant and not part of the targeted group. Although many of the new requirements are not immediately effective, affected taxpayers should be aware of them so that the taxpayer does't find itself in non-compliance.
Mandatory Withholding on Non-US Accounts. Effective January 1, 2014, a US entity that makes virtually any type of payment to a non-US or foreign financial institution ("FFI") will be required to withhold and remit 30% of the payment to the IRS, unless the status of the FFI has been documented as exempt from the requirement and certain reporting requirements are met. The types of payments subject to withholding include, for example, interest, dividends, royalties, premiums, annuities, and wages. Effective January 1, 2017, this withholding obligation will also extend to payments of proceeds from the sale of property that can produce interest or dividends. The recipient FFI may avoid this 30% withholding by entering into an agreement with the US Internal Revenue Service ("IRS") to identify all its account holders who are US taxpayers and providing such identifying information to the IRS. Because the IRS is expected to start accepting online registration applications by no later than July 15, 2013, taxpayers should begin to familiarize their accounting departments with these rules, what documentation they will need to gather to determine whether FFIs that the taxpayer pays have entered into an agreement with the IRS, are covered by an alternative exemption, or if it may be necessary for the taxpayer to withhold on payments made to them.
While the requirements for your payments to contractors, suppliers, and vendors that are not FFIs are somewhat less stringent, taxpayers still have some “know your customer” documentation that may be required to demonstrate that the taxpayer will have no obligation to withhold from payments to them.
Finally, taxpayers should ensure that their systems can track payments that must be reported to the IRS under FATCA. Reporting, although not required until April 2015, will cover payments made in 2013 and 2014.
Disclosure of Non-US Financial Accounts. The Bank Secrecy Act requires that US taxpayers file an annual report with the US Treasury of any non-US financial accounts with an aggregate value of more than $10,000 at any time during the year. This is commonly known as the “FBAR” requirement. FATCA, for the first time, makes a similar requirement part of the US Internal Revenue Code, thereby transferring to the IRS the authority to both interpret and enforce such reporting. The FATCA provision differs from the Bank Secrecy Act in that it applies the reporting requirements only if the value of specified assets (including financial accounts) exceeds $50,000; so far, the IRS has not integrated this with the FBAR requirement, which continues to have a $10,000 threshold, so duplicate reporting is required. The IRS has suspended this FATCA reporting requirement for domestic entities until final regulations are published, but it applies to all individual returns submitted after December 21, 2011.
Penalties for Failure to Disclose Non-US Accounts. In addition to the new reporting requirements, FATCA imposes new penalties for both the failure to disclose a non-US financial account and for any understatement of tax that results from an undisclosed non-US financial account. These penalties could make it very costly for taxpayers who conceal income generated by non-US accounts.
Extended Statute of Limitations for Undisclosed Non-US Accounts. The IRS normally has three years in which to audit a tax return after it has been filed. FATCA extends that period to six years in the case of certain unreported income from a non-US financial account.
Increased PFIC Reporting. FATCA imposes new reporting requirements for passive foreign investment companies ("PFIC"s). A PFIC is a non-US corporation that generates passive income, i.e., interest and/or dividends, and is often used as an investment vehicle. FATCA requires that US taxpayers who are PFIC shareholders to file an annual report with the IRS.
Electronic Reporting. FATCA authorizes the IRS to impose electronic reporting requirements on financial institutions that are withholding agents, even if the institution files less than 250 information returns which is the current threshold. This provision is designed to better capture information from institutions that currently do not file electronically.
Non-US Trust Enforcement. Due to concerns that US taxpayers are using non-US trusts to avoid US tax, FATCA makes a number of changes in the rules governing non-US trusts. Under prior law, a non-US trust was subject to US tax if it was established by a US taxpayer and it had a US beneficiary. FATCA expands the classes of persons considered trust grantors and beneficiaries, thereby bringing more non-US trusts under US tax jurisdiction. FATCA also requires that any person who is taxable as the owner of a non-US trust must provide such information about the trust as the IRS may require and backs up this requirement with stiff new penalties for non-compliance.
Taxation of Dividend Equivalents. Dividends paid by US corporations to non-US individuals and entities are generally subject to a 30% withholding tax, although that tax rate is usually reduced by an applicable tax treaty between the US and the resident country of the recipient. Non-US shareholders have attempted to avoid the withholding tax by taking “dividend equivalents,” such as securities lending transactions, sales-repurchase agreements, or notional principal contracts, in lieu of actual dividends. FATCA makes it clear that such dividend equivalents are to be treated as US-source dividends for US Federal Income Tax purposes.