- The Foreign Account Tax Compliance Act (FATCA) is U.S. legislation which is designed to enable the U.S. Internal Revenue Service (IRS) to obtain information about offshore accounts held by U.S. taxpayers.
- FATCA generally requires a foreign financial institution (FFI) to report to the IRS certain information on offshore financial accounts held by U.S. taxpayers. A FFI that is non-compliant will generally be subject to a 30% withholding tax on U.S. sourced payments made to the FFI.
- Many Australian funds will not be able to rely on the exemptions in the proposed regulations implementing FATCA.
- FFIs in Australia, including fund managers, should inform themselves about the implications of FATCA and continue to monitor developments.
- The U.S Department of the Treasury recently released a model intergovernmental agreement (IGA) regarding the implementation of FATCA. If it is adopted in respect of Australia, FFIs would have reporting obligations but would not be subject to the withholding obligations.
FATCA is U.S. legislation which was enacted in March 2010. FATCA is designed to enable the IRS to obtain information about offshore investments and accounts held by U.S. taxpayers in an effort to deter tax evasion.
In February 2012, the U.S. Department of the Treasury and the IRS issued proposed regulations implementing FATCA (Proposed Regulations). We understand that the Proposed Regulations are expected to be finalised around October 2012.
FATCA generally requires a FFI to report to the IRS certain information on offshore financial accounts held by U.S. taxpayers. A FFI that is non-compliant will generally be subject to a 30% withholding tax on U.S. sourced payments made to the FFI.
The FATCA legislation is complex and detailed. We set out below some high level comments on the regime and some of the potential implications for fund managers.
Which entities will be affected?
Under FATCA a ‘FFI’ is a financial institution which is a foreign entity.
Under FATCA, a ‘financial institution’ is defined as an entity that:
- accepts deposits in the ordinary course of a banking or similar business,
- as a substantial portion of its business, holds financial assets for the account of others, or
- is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities.
The definition of a FFI is very broad and will generally include trust companies, custodians and relevant investment funds.
Under FATCA, a foreign entity that is not a financial entity is known as a non-financial foreign entity (NFFE). A NFFE will be subject to a 30% withholding tax on ‘withholdable payments’ made to it, generally being:
- U.S. sourced ‘fixed or determinable annual or periodic income’ (FDAP income), and
- the gross proceeds from the sale or other disposition of property of a type that can produce U.S. sourced interest or dividends,
unless it provides:
- a certificate that it does not have any substantial U.S. owners, or
- the name, address and Tax Identification Number of each such owner.
However, there are certain exceptions, including where the payment is beneficially owned by a corporation whose stock is regularly traded on an established securities market.
What is a FFI required to do?
What should a participating FFI do?
FATCA requires a FFI that elects to comply with FATCA to become a participating FFI by entering into an agreement with the IRS (FFI Agreement) to, amongst other things:
- conduct due diligence and verification procedures to identify U.S. accounts (being a financial account held by one or more specified U.S. persons or U.S owned foreign entities),
- report annually to the IRS information about U.S. accounts,
deduct and withhold 30% of any passthru payment (any withholdable payment or other payment to the extent attributable to a withholdable payment) to:
- any recalcitrant account holder (being an investor who fails to comply with reasonable requests for information or to waive its rights under domestic law to enable the FFI to report the information to the IRS), or
- another FFI that has elected not to comply with FATCA (a non-participating FFI), and
- where domestic law would prevent the reporting to the IRS of any such information with respect to any U.S. account, attempt to obtain a waiver of such law from each holder of such account and where such a waiver cannot be obtained within a reasonable period, close the account.
Exemptions and non-participating FFIs
As noted above, generally a FFI that does not become a participating FFI will be subject to a 30% withholding tax on certain payments made to them of U.S. sourced income and gross proceeds.
Under the Proposed Regulations, certain types of FFIs are treated as deemed-compliant FFIs as though they are participating FFIs. Although the Proposed Regulations contain exemptions for retirement plans and investment funds, the exemptions are narrow and many Australian funds will not be able to rely on them.
There are exemptions from the withholding obligations in relation to payments beneficially owned by certain persons, including a foreign government, a wholly-owned agency or instrumentality of a foreign government, a foreign central bank of issue or a class of persons identified by the IRS as posing a low risk of tax evasion.
When does FATCA commence?
FATCA will be implemented in stages commencing on 1 January 2013.
The IRS will begin accepting applications for FFI Agreements on 1 January 2013. A FFI that wishes to comply with FATCA must enter into a FFI Agreement with the IRS by 30 June 2013 to avoid withholding commencing on 1 January 2014.
Under the Proposed Regulations:
- generally payments made under agreements entered into before 1 January 2013 will not be subject to withholding,
- the dates for implementation of the withholding obligations differ according to the types of payment,
- withholding on withholdable payments of FDAP income will not begin until 1 January 2014 and, in respect of all other withholdable payments, will not begin until 1 January 2015,
- withholding on ‘foreign pass thru payments’ (payments attributable to a withholdable payment from a participating FFI to a recalcitrant account holder or a non-participating FFI) will begin no earlier than 1 January 2017, and
- the reporting obligations will also be phased in over time starting in calendar year 2013 with the type of information required to be reported also being implemented in stages.
Model intergovernmental agreement
The requirements under FATCA pose a number of challenges and compliance issues for FFIs, including potential conflicts with relevant domestic laws.
A number of jurisdictions have issued joint statements with the United States setting out plans to pursue an intergovernmental approach to the implementation of FATCA.
The United States has made a joint statement with France, Germany, Italy, Spain and the United Kingdom, a joint statement with Switzerland and a joint statement with Japan. These statements do not contemplate an exemption for any particular jurisdiction. They are intended to address legal impediments to compliance, simplify implementation and reduce costs for FFIs.
On 26 July 2012, the U.S. Department of the Treasury published a model IGA relating to the implementation of FATCA. The model agreement was developed by the United States in consultation with France, Germany, Italy, Spain and the United Kingdom following the release of the joint statement by those countries. This will serve as a model for other IGAs in relation to FATCA.
There are two versions of the model agreement:
- a reciprocal version, and
- a non-reciprocal version.
Under both versions of the model agreement, FFIs in the relevant partner country would not be required to enter into FFI Agreements with the IRS and would not be subject to the withholding obligations under FATCA on the terms set out in the model agreements.
Both versions establish a framework for FFIs to report certain account information to their respective tax authorities followed by the automatic exchange of such information under existing bilateral tax treaties or tax information exchange agreements. Both versions of the model agreement set out in an annex due diligence obligations for identifying and reporting on U.S. reportable accounts.
The reciprocal version of the model agreement provides for the United States to exchange information on accounts held in U.S. financial institutions by residents of the applicable partner country.
The U.S Department of the Treasury has indicated that the reciprocal version will only be available to jurisdictions:
- with whom the United States has in effect an income tax treaty or tax information exchange agreement, and
- where the U.S. Department of the Treasury and the IRS have determined that the recipient government has in place robust protections and practices to ensure the information remains confidential and is used solely for tax purposes.
Industry participants will benefit from the Australian government pursuing an IGA with the United States in order to address the compliance issues associated with the FATCA and its implementation for affected FFIs in Australia.
Implications for fund managers
A number of Australian industry groups such as the Financial Services Council, the Association of Superannuation Funds of Australia and the Australian Bankers Association have been engaged in lobbying for changes to FACTA and have made submissions to the relevant U.S. agencies.
Funds that choose not to become a participating FFI under FATCA will expose their U.S. sourced payments to a 30% withholding tax. This may make it difficult for those funds to remain competitive if they continue to invest in U.S markets. Fund managers should investigate the extent to which a tax credit would be available.
Funds managers should:
- inform themselves about the implications of FATCA and whether they will be caught by FATCA,
- continue to monitor developments including the impact of the final FATCA regulations and the implications of any IGA pursued by the Australian government,
- if necessary, review the investment strategies of affected funds which provide exposure to U.S. sourced income or assets,
- if relevant, determine whether to become a participating FFI and whether doing so is in the best interests of their investors, and
where a fund manager wishes to become a participating FFI and enter into a FFI Agreement with the IRS, confirm whether any amendments are required to:
- relevant fund constitutions to facilitate entry into and compliance with the FFI Agreement, and
- fund disclosure documents and application forms.