Non-US Account Tax Compliance Act FATCA[T]

By Anna Bouhail Educational head: SAIFM

Introduction FATCA, the Non-US Account Tax Compliance Act (coined by some in the US as FATCAT) came into effect in the United States (US) on the 18th of March 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act of 2010. With the new legistlation the US is effectively attempting to initiate a worldwide exchange of information on US persons aimed at curbing the use of non-US entities by US individuals to evade US taxes. The FATCA rules goes considerably further than the current Qualified Intermediary (QI) regulations which will remain in place - and will have a significant impact on the financial sector worldwide. A key feature of the legislation is the requirement that South African and other non-US financial insitutions enter into an agreement with the United States Internal Revenue service(IRS) to report information about US account holders or face a 30% withholding tax on all payments from US sources. Information and processes currently available at non-US financial institutions are not sufficient to provide the IRS with the required data, especially as the onus of accurate reporting to the IRS lies with the financial institutions. The new reporting requirements applicable to South African and other non-US financial insitutions will start from the beginning of 2013. It is essential for financial institutions to gain a detailed understanding of the new act to allow enough time to adapt processes and systems to the new regulations. What FATCA is all about? The provisions of FATCA are intended to promote compliance with US law demanding US persons to report income from offshore accounts. Although the new rules hold important implications for individuals, FATCA is also of great importance for financial entities throughout the world. Its provisions will substantially affect non-US investment in the United States by and through South African and other non-US entities. Under the new act new reporting and disclosure requirements for non-US assets will be phased in between 2010 to 2013. FATCA has essentially five parts that is summarized below. The rules are however considerably more detailed, but the summary should however be sufficient to demonstrate that FATCA is legislation of enormous reach and serious depth.

Increased disclosure of beneficial owners

Applicable to non-US financial institutions and certain non-US non-financial entities In order for non-US financial institutions and non-US non-financial entities to have access to US capital markets without being subjected to a 30% withholding tax, these entities will have to provide information to the IRS about their US accounts on an annual basis. FATCA also attempts to limit non-registered obligations by repelling the interest deduction for the issuer of bearer bonds issued to non-US persons.

Under reporting with respect to non-US assets

Applicable to individual U.S. persons who hold non-US assets If non-US assets are valued in excess of $50 000 the US taxpayer must attach certain information to their income tax returns. FATCA would impose heavy penalties for failure to disclose such information and penalties for underpayments due to undisclosed non-US financial assets. In the event of substantial omissions of gross income derived from assets the statue of limitations would be extended from three to six years.

Other disclosure provisions

Applicable to U.S. persons that are shareholders of non-US passive investment companies FATCA requires US shareholders of passive non-US investment companies to file annual information returns with the IRS.

Provisions related to non-US trusts

Applicable to non-US trusts with U.S. beneficiaries The new rules make it more difficult to avoid having a US beneficiary of a non-US trust and states clearly that uncompensated use of trust property is treated as a new distribution. There is also a new reporting requirement for US owners of non-US trusts and a new minimum penalty of $10 000 for failure to report.

Substitute dividends and dividend equivalent payments

FATCA will treat certain substitute dividends and dividend equivalent payments under principal contracts (such as total return equity swaps) received by non-US persons as US source income.

FATCA effective dates Different provisions of FATCA are subject to different effective dates. The 30% US withholding tax on payments to non-US financial institutions that do not enter into an information exchange agreement with the IRS will be effective as from the 1st of January 2013. However, no amount must be deducted or withheld from any payment under any obligation outstanding on 18th of March 2012 referred to as grandfathered obligations. The effective date for the new dividend equivalent rules is payments made as from the 14th of September 2010. All other provisions are effective for tax years beginning after the 18th of March 2010. On the 27th of August 2010 the IRS issued notice 2010-60 (the Notice ) which providing preliminary guidance on the implementation of certain sections of FATCA. The Notice is the fist step in the efforts of the IRS to accelerate the publication of guidance to allow affected persons and entities time to implement the systems and processes necessary to comply fully with the new withholding, documentation and reporting obligations resulting from FATCA. How will FATCA implement automatic exchange of information? FATCA invites all non-US financial institutions and non-US entities covered by FATCA to enter into a contract with the IRS. With this agreement, the institutions undertake to identify US customers and to report their assets to the IRS on an annual basis. Any non-US financial institution who does not enter into an agreement with the IRS will be penalized by a 30% withholding tax on US revenues and proceeds from sales of instruments which yield revenues from US sources. US revenues include: y y y y y Dividends Rents Salaries Wages Premiums y y y y y Annuities Compensations Remunerations Emoluments Other fixed or determninable gains, profits and income

This consititutes the automatic exchange of information by non-US financial institutions to the IRS. These disclosure and reporting requirements could be in addition to any requirements imposed under the Qualified Intermediary (QI) program. How will reporting under FATCA work? Reporting the necessary information to the IRS will require four recurring steps, illustrated below.

i.

ii.

Identification of all US accounts The non-US financial institutions to which FATCA apply must identify all US accounts. Obtaining waivers from account holders Non-US financial institutions must obtain a waiver from each account holder, so that they can report the required customer data to the IRS. In such cases, banking secrecy is lifted and the exchange of information with the IRS is approved. If a customer refuses the waiver request, the act requires that the financial institution close the account or abstain from entering into a new business relationship. It is still unclear as to what happens if the local law does not allow for unilateral termination of the business relationship on the part of a bank.

iii.

iv.

Annual reporting By signing the contract non-US financial institutions undertake to provide the IRS with required information on US accounts annually in electronic format. Penalisation of uncooperative non-US financial institutions and US account holders A 30% withholding tax is deducted from payments to non-US financial intermediaries that do not enter into a contract with the IRS and to US account holders who do not sign a waiver.

Information to be reported by non-US financial institutions

y y y y y Name, address and US taxpayer identification number of the account holder who is a US person The account number Account balance or value Receipts in the financial account (US & non-US) Withdrawals/payments from the financial account

The FATCA umbrella US persons covered by FATCA Non-US financial institutions must report to the IRS information about a financial account which is a United States account whatever the income is a US source income or a non-US source income. y y y Depository account Custodial account Equity or debt interest in a non-US financial institution such as interest in non-US hedge funds or non-US private equity funds (other than interests that are traded regularly on an established exchange)

Financial account

Any finanical account which is held byUS account y y y y y y US person y y y US owned non-US entity one or more US person/s An US owned non-US entity US citizens US residents Green card holders Persons who have stayed in the US for several consecutive days during the past three years persons meeting the substantial presence test US corporations other than publicly traded companies and its more than 50% controlled affiliates US partnerships US trusts

A non-US entity which has one or more substantial US owner/s Any company, partnership or trusts where any US person holds directly or indirectly more than 10% of share on interest therein This does not apply to a non-US entity that is engaged primarily in the business of investing or trading in securities, commodities or any interest in such securities. This would include investments in non-US hedge funds, non-US private equity funds and other non-US investment vehicles. Any investment in such non-US entities would constitute a US owned non-US owned entity and is subject to FATCA even if the investment is 10% or less

Substantial US owner

Non-US Financial Institutions and other Non-US enitities Covered by FATCA FATCA applies toy y non-US financial institutions non-US entities that is the benificial owner of payments unless the entitiy certifies that it does not have a substantial US owner or provide to the IRS the required information about any substantial US owner. This exludes publicly traded companies,governments, international organisations and central banks.

FATCA does not apply to material advisors such as asset managers.

Non-US financial institution

Any financial institution which is a non-US entity Any entity thaty accepts deposits in the ordinary course of a banking or similar business is engaged in the business of holding financial assets for the account of others is engaged primarily in the business of investing or reinvesting or trading in securities

Financial institution

y y

Securities for FATCA purposes include the following: y y y y y y y y Shares Interest in public traded partnerships Debt Swaps Most derivatives products Actively traded commodities Commodity swaps Derivatives referencing commodity prices

Securities

Non-US entities excluded from FATCA reporting (notice 2010-60)

y y Holding companies that are not investment funds and that hold only subsidiaries that are not financial institutions Start-up companies that are intent to start non-financial institution businesses. However this exclusion will expire after the first 24 month of the entity s organization Non-financial entities that are liquidating or in the process of reorganizing pursuant to bankruptcy Hedging or financing entities that service only a non-financial expanded affiliated group that does not include any financial institutions Insurance companies that issue insurance or reinsurance contracts without cash value, such as most property and casualty insurance companies, reinsurance companies and life insurance companies that issue only term life insurance contracts Retirement plans that qualify as retirement plans under law, that are sponsored by a non-US employer and do not allow US participants other than generally employees that work for the non-US employer

y y y

Investment funds and other entities that have only a small number of direct or indirect account holders will be subject to less burdensome reporting requirements for example a family trust settled and funded by a single person for the sole benefit of his/her children. Financial institutions organised under the laws of US territory will not be treated as non-US financial institutions.

Type of income subject to FATCA Both US source income and non-US income is subject to reporting. Non-US financial institutions with election an alternative?

FATCA offers non-US financial institutions an alternative instead of deducting the withholding tax for uncooperative institutions or account holders, they can decide that an upstream non-US financial institution shall deduct the withholding tax. In this case, the upstream custodian requires all information on account holders and the corresponding payments so that the withholding tax can be deducted in advance. This option is suitable for small financial institutions, although it similarly calls for major adjustments to internal processes and systems. Furthermore non-US financial institutions with election are not relieved of the heightened customer identification obligations.

Strategic and operation challenges FATCA represents a major challenge for South African and other non-US financial institutions. The scope is significantly broader than that of the current QI regime and the act cannot be adhered to with current processes and systems. South African financial institutions must gain a clear understanding of how their business should look in the coming years and how they want to position themselves in the new environment. Financial institutions should be asking the following questions: y y Should US persons still belong to the clientele? Will US securities be included in the product portfolio?

If an institution answers these questions with yes ; the institution will be required it to enter into an agreement with the IRS and to adapt its operating model accordingly. In the event of complete withdrawal, it is also advisable to check whether continuation of the QI agreement is still appropriate. Belonging to an expanded affiliated group has far-reaching consequences, because a financial intermediary that is a part of a group of companies that includes at least one other non-US financial institution which has signed the agreement with the IRS is also obliged to adhere to the requirements of FATCA. However, this financial intermediary is free to enter into its own agreement with the IRS. In principle, membership of an expanded affiliated group is assumed if at least 50% of a company is controlled directly or indirectly. In order to enable adherence to these requirements, the flow of information between the various companies in a group must be expanded considerably and the processes must be harmonised. If a South African financial institution decides to comply with FATCA and to enter into an agreement with the IRS, it must closely examine its operating model. The identification and documentation of customers, as well as reporting thereon, is fundamental. The products offered must also be assessed with regard to US source and flagged accordingly in the systems. Anyone offering their own products must also check the sales restrictions which apply to US persons. The forms and procedures used to date are inadequate for providing the IRS with the information required by FATCA. Therefore a new set of processes and forms is required. Finally the training of compliance officers, relationship managers and staff is an essential task to be considered by institutions. In closing In the process toward more efficient international tax cooperation, FATCA may be a significant step toward automatic exchange of information. It may presage the greater involvement of financial institutions in the mechanics of automatic exchange of information. Therefore the biggest question remains WILL OTHER COUNTRIES FOLLOW SUIT?

This article is only a general discussion of FATCA. The specific facts of each particular situation should be carefully reviewed

Works Cited
Memorandum on the U.S Non-US tax compliance act circular by David Spencer (TaxJustice) Mastering the challenges of the new US regulation circular by Ernst & Young Non-US Account Tax Compliance Act for South African financial institutions circular by Deloitte U.S. Internal Service Notice 2010-60