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FATCA: It’s not just for Financial Institutions

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Rödl & Partner Tax Matters Vol 2013 – 4, published in June 2013

 

In 2010, Congress enacted the Foreign Account Tax Compliance Act, known as FATCA. Much has been said about the requirement under FATCA for Foreign Financial Institutions (FFIs), such as German banks and certain German investment entities, to report information to the IRS about financial accounts held by U.S. taxpayers or be subject to withholding. In fact, on 5/31/13, the U.S. and Germany signed a bilateral agreement (FATCA Agreement)¹ which has not entered into force at the time this article went to press, whereby Germany (and vice versa, the U.S.) has to collect the relevant data from the German FFIs and exchange this information on an automatic basis with the U.S. A lesser known fact though is that generally any foreign entity (e.g., a German company doing business in the U.S.) may also have certain reporting obligations under FACTA.

 

¹ "To Improve International Tax Compliance and with Respect to the U.S. Information and Reporting Provisions Commonly knows as the Foreign Account Tax Compliance Act".

 

FATCA joins an existing documentation and withholding regime that has been in place for many years. Withholding agents have long been required to withhold on U.S. sourced „fixed, determinable and annual periodical income"(FDAPI – e.g., interest and dividends) and on „income effectively connected with a U.S. trade or business"(ECI), absent appropriate documentation for reduced or zero withholding. The FATCA regime's purpose is generally not to impose a withholding tax (although it may). In effect, it functions more like a penalty mechanism, forcing foreign entities to provide information. Ultimately, the FATCA regime is intended to bring otherwise non-compliant U.S. citizens and U.S. tax residents into compliance with U.S. tax law.

 

FATCA requires withholding at a rate of 30% on withholdable payments made after 12/31/13 to certain Nonfinancial Foreign Entities (NFFEs) that do not provide information regarding their substantial U.S. owners (unless an exception applies). An NFFE is generally any foreign entity that is not an FFI. A witholdable payment is essentially FDAP income and any gross proceeds from the sale or other disposition of property (that can produce U.S. source interest or dividends), but not ECI². Withholding on a payment to an NFFE is not required if all of the following are satisfied:
  • The NFFE is the beneficial owner of the payment and provides the withholding agent with a certification that it does not have any substantial U.S. owners (as defined below), or provides the name, address, and TIN of each substantial U.S. owner of the beneficial owner.
  • The withholding agent does not know or have reason to know that any information provided about the beneficial owner or the payee is incorrect.
  • The withholding agent reports information regarding substantial U.S. owners, payments made to the NFFE, and any other information that may be required by the IRS.

 

² Exceptions apply for certain types of payments and to certain types of entities.

 

A foreign entity is treated as having a substantial U.S. owner if any specified U.S. person owns directly or indirectly more than 10% of a foreign corporation's stock (by vote or value), a foreign partnership's profits or capital interests, or a foreign trust's beneficial interests (or any portion of a trust treated as a grantor trust). In the case of certain investment institutions, a specified U.S. person that owns any interest (i.e., more than 0%) in the corporation, partnership, or trust is treated as a substantial owner.

 

Documentation of some kind will generally be needed to support each U.S. source payment made to a foreign payee. The redesigned W-8 series of forms will identify foreign payees, indicate their FATCA status, disclose substantial U.S. owners, and claim any available exemptions from withholding. More foreign payees will find it necessary to obtain U.S. tax identification numbers in order to complete W-8 series forms or supply other documentation required to avoid withholding.

 

Withholding on NFFEs is only a small piece of the FATCA puzzle and is only briefly described here. Compliance with FATCA can seem overwhelming, but this is also a good opportunity to evaluate and revamp existing withholding and compliance processes. Businesses are well advised to seek guidance from their tax advisors.

 

 

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