The Application of FATCA to International
Withholding under the U.S. Foreign Account Tax Compliance Act
(“FATCA”) is scheduled to take effect starting July 1, 2014. This briefing
provides broad‑brush guidance for identifying FATCA withholding
concerns that may arise in certain international transactions. Its focus is
on identifying whether FATCA withholding is a concern in a transaction,
and how parties can get comfortable with knowing whether they have a
The briefing first provides a description of FATCA withholding and its
relationship to the long‑standing U.S. withholding regime. It then
describes in detail the methods that can be used to be comfortable that
FATCA withholding will not apply to various types of payments. Finally,
the briefing outlines certain relevant dates for FATCA implementation.
FATCA Withholding Overview
The United States enacted FATCA to prevent banks and other entities from
helping U.S. taxpayers avoid U.S. federal income tax by hiding income in
offshore accounts. The United States has long had extensive reporting and
withholding tax obligations with respect to payments made from the
United States. However, a U.S. citizen could avoid detection by, for
example, opening a foreign bank account and not filing U.S. tax returns.
FATCA was enacted as an attempt to close this loophole. FATCA was
enacted in 2010, and was initially scheduled to take effect January 1, 2013,
but the effective date has been extended.
FATCA applies in some form to all non‑U.S. entities. There are two
principal categories of non‑U.S. entities, each with different rules. The first
category is a “foreign financial institution” (“FFI”). The definition of FFI
encompasses far more than what is commonly thought of as a “financial
institution,” including for example most investment funds. In general, in
order to comply with FATCA, an FFI must enter into an “FFI agreement”
FATCA Withholding Overview 01
Determining Whether FATCA
Withholding is Required
FATCA Timeline 09
02 U.S. TAX BRIEFING with the U.S. tax authorities, which generally requires the FFI to perform due diligence to
determine who among its account holders are U.S. persons, and to provide reports to the
U.S. Internal Revenue Service (“IRS”) regarding its U.S. account holders.
A non‑U.S. entity that is not an FFI is a “non‑financial foreign entity” (“NFFE”). Although
the reporting and documentation requirements for an NFFE are often much simpler than
those of an FFI, FATCA withholding has the potential to apply to payments made to an
NFFE in the same manner as to an FFI.
In order to ease the burdens of FATCA compliance for foreign entities, the U.S. Treasury
has entered into “intergovernmental agreements” (“IGAs”) with many country
counterparties. It is expected that eventually, most major participants in the world of
international finance and commerce will be covered by an IGA. There are two model
IGAs. The Model 1 IGA (which comprises the majority of currently effective IGAs) allows
FFIs to provide information and make reports to their home jurisdiction tax authorities,
rather than the IRS, and the home‑jurisdiction authorities pass the information along to
the IRS. The Model 2 IGA (which applies to a smaller number of jurisdictions), eases
FATCA compliance somewhat, but still requires foreign entities to make reports to the
IRS. The IRS has announced that certain IGAs that are agreed in substance but not yet
signed may be treated as if they were in effect.
B. FATCA Withholding and Standard U.S. Source Withholding
1. Two Withholding Regimes
If FATCA withholding applies to a payment, any person making the payment to a foreign
entity generally will be required to collect and pay over to the U.S. Treasury 30% of the
amount paid. (The obligation also extends to persons who have custody or control over
such a payment, such as an agent or middleman.) The 30% withholding tax is similar to
and builds on the standard 30% U.S. withholding tax (“U.S. Source Withholding”). Like
U.S. Source Withholding, there are many exceptions to FATCA, but the rules and
exceptions to FATCA are not the same as those for U.S. Source Withholding.
2. Exceptions to FATCA and U.S. Source Withholding
a. Treaty Exemptions
Many U.S. treaties exempt or reduce U.S. Source Withholding on payments to
residents of the treaty country. Those treaty exemptions or reductions do not,
however, eliminate FATCA withholding.
b. Non U.S. Source Payments
Neither FATCA withholding nor U.S. Source Withholding is required on income that
is not “income from sources within the United States” (often referred to as “U.S.
Source Income”). (FATCA withholding may also apply to “passthru payments” that
are not U.S. Source Income, as described briefly below.) The determination of
whether a payment represents U.S. Source Income can be complex, as discussed in
greater detail below.
c. Non‑Financial Payments
FATCA withholdable payments generally include financial payments, such as
interest, dividends and swap payments. On the other hand, most non‑financial
payments such as payments for services, payments for the use of property (i.e., lease
payments), and payments for freight and transportation are not subject to FATCA
withholding. These types of payments are nonetheless subject to U.S. Source
Withholding if they constitute U.S. Source Income (unless another exemption, such as
a treaty exemption, applies). Guidance on what constitutes a non‑financial payment
reductions do not,
U.S. TAX BRIEFING 03
for this purpose is discussed below.
Great care must be exercised in using this exception. The characterization of a
payment for U.S. tax purposes may be very different from its characterization in the
transaction documents or under local law (or even U.S. law other than tax law)
because what type of payment is being made is determined under U.S. tax
principles. For example, a “lease” or “charter” with “financing” characteristics may
well be a debt instrument for U.S. tax purposes, and the payments under it may well
not be payments for use of property or services, but rather debt service.
d. Grandfathered Obligations
“Debt obligations” issued prior to July 1, 2014 are grandfathered from FATCA, and
therefore payments under these instruments are not subject to FATCA withholding
unless the instrument is amended in a fashion that ends the “grandfather”
protection. (The original cut‑off date was March 18, 2012, two years after FATCA
was enacted, but this has been extended many times.) These types of payments are
nonetheless subject to U.S. Source Withholding (although they may qualify for a
Treaty exemption or the exemption for “portfolio interest”). Guidance on what
transactions qualify for the FATCA grandfather exception is discussed below.
e. Offshore Payments
Until January 1, 2017, FATCA withholding is not required on certain payments made
from an offshore party to another offshore person. U.S. Source Withholding may
apply. A short description of the temporary “offshore payments” exception to
FATCA is given below.
f. Gross Proceeds Payments
Starting January 1, 2017, FATCA withholding will also apply to the gross proceeds
from the sale or other disposition of an asset (e.g., a loan or shares of stock) that can
produce U.S. source withholdable payments. This means, for example, that if a
lender makes a $100 loan to a U.S. borrower and then sells the loan for $100, the sale
will be subject to a $30 withholding tax unless the lender is FATCA‑compliant or
otherwise establishes an exemption. Generally, U.S. Source Withholding does not
apply to gross proceeds payments.
g. Pass‑Through Payments
Also starting in 2017, FATCA withholding is scheduled to be imposed on certain
“passthru payments,” even if those payments are not from a U.S. source. Although
the meaning of “passthru payments” is not yet defined, this category is designed to
provide the U.S. tax authorities with a weapon to prevent abuse. U.S. Source
Withholding does not apply to passthru payments (with an exception for certain
“conduit” payments). Passthru payments will be grandfathered and not subject to
FATCA withholding for debt obligations executed six months or less after the date
that regulations defining “passthru payments” are finalized.
Determining Whether FATCA Withholding is Required
Starting July 1, 2014, any payor making a payment, and any payee receiving a payment,
needs to know whether FATCA withholding is required. Before an agreement is signed or
a payment is made, the payor and payee should confirm that no FATCA withholding is
required and arrange for the requisite documentation.
Watson, Farley & Williams June 2014
“Starting July 1,
2014, any payor
payment, and any
payee receiving a
payment, needs to
04 U.S. TAX BRIEFING The best way to do this is to collect U.S. tax forms establishing that FATCA withholding
does not apply at the time the transaction closes and to require updates of those forms
from time to time. If exemption forms are not available, other avenues for comfort are to
determine that no FATCA withholding is required because one of the following is true:
The payments are not of a type that makes them withholdable payments.
The payments are not “U.S. source.”
The payments are grandfathered.
For payments made before January 1, 2017, the payments qualify as payments on
Each of these rules involves a potential complex analysis of U.S. tax law. The following
sections describe, first, the documentation that can be relied upon to establish an
exemption, and then the relevant other exemptions.
B. Establish that the recipient is entitled to an exemption
To a large extent, FATCA piggybacks on the long‑standing U.S. Source Withholding tax
regime. The U.S. Source Withholding regime generally requires the recipient of a payment
to provide to the payor an IRS Form W‑8 or W‑9 in order to establish an exemption from
or reduction in the rate of U.S. withholding tax. The Form W‑9 is for a U.S. recipient. The
Form W‑8 is for a non‑U.S. recipient, and includes several subcategories of Forms W‑8. If
there is any possibility that FATCA withholding may apply to any payment, a payee
should be required to provide tax forms to the payor (and any other party to the
transaction who may have possession or control of the paid funds, such as a facility agent
in a credit facility) demonstrating that it is entitled to the exemption. Often the
requirement to deliver U.S. withholding tax forms is already present in the
documentation for transactions with U.S. Source Income. Typically, the payee will deliver
a Form W‑8BEN‑E (to indicate that it is the beneficial owner of the income represented by
the payment) which has been adapted to cover FATCA. The documentation that
demonstrates that the payee is exempt is described briefly in the sections below.
There may be instances in which collection of forms is impracticable (for example, where
the payee is a partnership or other intermediary entity with multiple beneficial owners
who are not fluent in the language of U.S. tax). In those cases, the other exceptions
described below should be explored.
1. Payee is a U.S. person and provides an IRS Form W‑9
FATCA withholding does not apply to payments to U.S. persons, namely:
Other individuals resident in the United States.
Corporations and partnerships organized in the United States.
U.S. trusts and estates.
A payee who is entitled to this exemption should provide an IRS Form W‑9 to evidence its
status as a U.S. person.
An entity which is treated for U.S. tax purposes as a disregarded entity and which is
owned by a non‑U.S. person is not a U.S. person for this purpose. If the payee is merely
receiving the payment as an agent for some other principal, the principal should provide
its tax form to claim exemption from FATCA withholding. (Special rules apply to U.S.
financial institutions acting as agents for foreign persons.)
“Each of these
rules involves a
analysis of U.S.
U.S. TAX BRIEFING 05
2. Payee provides an IRS Form W‑8BEN‑E, W‑8BEN or W‑8IMY demonstrating FATCA
compliance or claiming an exemption
IRS Form W‑8BEN‑E (the “BEN” refers to beneficial ownership, and the “‑E” refers to
entities as opposed to individuals) is the primary form that non‑U.S. entities that receive
payments should submit to prevent FATCA withholding. A non‑U.S. individual payee
generally should submit Form W‑8BEN. A non‑U.S. payee that is an intermediary acting
on behalf of another beneficial owner should deliver a Form W‑8IMY (the “IMY” refers to
intermediary), and generally must also provide an applicable Form W‑8 or W‑9 from the
person or persons for whom it is acting as an agent. For this purpose, the U.S. tax rules
treat a partnership (or entity treated as a partnership for U.S. tax purposes) as merely an
agent of the partners (or owners), so a non‑U.S. partnership generally is required to
deliver a Form W‑8IMY for itself together with an applicable Form W‑8 or W‑9 for each
partner (or owner).
An entity filling out either form must select the appropriate one of roughly thirty possible
FATCA classifications. From the standpoint of a payor, these can broadly be classified
into five simplified categories:
1. “Participating FFI” (or “Reporting FFI”)
This is a foreign financial institution (FFI) that either has entered into an FFI agreement
with the IRS, or is eligible to claim the benefits of a Model 1 intergovernmental agreement
(IGA) between the United States and the FFI’s home jurisdiction or branch jurisdiction, as
applicable. The participating FFI must obtain from the IRS and include on the Form W‑
8BEN‑E a “global intermediary identification number” (“GIIN”), which is the principal
identifying number for FATCA.
A payor receiving a W‑8BEN‑E with a GIIN is responsible for verifying the GIIN
provided against the list of GIINs maintained and publicly available on the IRS
website. The first list of FFIs that have registered for FATCA (roughly 77,000 entities)
was released on June 2, 2014. The list can be searched either by entity name or by
A payor who receives a pre‑FATCA IRS Form W‑8BEN prior to January 1, 2017 can
accept it as the basis for exemption if it also obtains and confirms the FFI’s GIIN and
satisfies certain other documentary requirements.
A payor to an FFI or FFI branch that is subject to a Model 1 IGA is not required to
verify the FFI’s GIIN until January 1, 2015 (although an FFI subject to a Model 1 IGA
should nevertheless obtain its GIIN well in advance of January 1, 2015 to ensure that
it is included in the official GIIN list by that date).
2 . “Exempt FFI” (or “Non‑reporting FFI”)
This is an FFI that is subject to one of several exemptions from FATCA (including certain
entities exempted by an IGA). These entities generally are not required to obtain a GIIN.
3. “Active NFFE”
A non‑financial foreign entity (NFFE) — a foreign entity that is not passive and is not an
FFI. An active NFFE does not need to enter into an FFI agreement or obtain a GIIN.
4. “Passive NFFE”
A passive NFFE is a passive foreign entity that is not an FFI. A passive NFFE does not need
to enter into an FFI agreement or obtain a GIIN, but it does need to provide certain
information as to its U.S. owners (if any) that beneficially own at least a 10% interest in
Watson, Farley & Williams June 2014
“An entity filling
out either form
must select the
appropriate one of
06 U.S. TAX BRIEFING 5. “Non‑participating FFI”
This is an FFI that is not exempt, does not qualify for the benefits of an IGA and has not
entered into an FFI agreement. The payor must withhold a 30% tax on all payments to the
payee that are U.S. source withholdable payments.
3. Payee provides an IRS Form W‑8ECI claiming payments are effectively connected with
a U.S. trade or business
A non‑U.S. payee can also provide an IRS Form W‑8ECI (the “ECI” stands for “effectively
connected income”), which certifies that the payments received will be subject to
ordinary U.S. income tax because the payments are effectively connected with the payee’s
U.S. trade or business. Such payments are exempt from FATCA withholding.
C. Payee establishes that the payments are not U.S. source
If the payor is certain that the payments are not “U.S. source” then it need not withhold.
The rules for whether a payment is U.S. or non‑U.S. source are complex. Moreover, there
are no clear guidelines regarding the evidence a payor needs to possess to establish that
the income is not U.S. source. It is rarely safe to rely on payments being non‑U.S. source to
avoid FATCA withholding. However, the following is a general summary of situations in
which a reasonable level of comfort is available that payments will not be U.S. source.
(Note that even non‑U.S. source payments can be subject to FATCA withholding if they
are “passthru payments”; however, because passthru payments will be subject to
grandfathering protection for some time, withholding on passthru payments is unlikely
to be relevant in the near future.)
1. Interest and guarantee payments
Whether interest is treated as U.S. source or non‑U.S. source depends on the identity
and/or activities of the payor.
1. Interest paid by a U.S. corporation (even if its business is conducted entirely outside
the United States) or a U.S. partnership (even if all its partners are non‑U.S. persons)
is U.S. source, by definition.
2. Interest paid by a non‑U.S. corporation or partnership will be U.S. source if
attributable to a U.S. trade or business. Whether interest is attributable to a U.S.
trade or business can be complex, so a non‑U.S. corporation or partnership generally
cannot be confident that none of the interest it pays will be U.S. source unless it is
engaged in no U.S. trade or business. In addition, if a non‑U.S. partnership is engaged
in a U.S. trade or business to a significant extent, all of the interest it pays may be
3. Interest paid by an entity that is disregarded for U.S. tax purposes is characterized
based on the identity and activities of its non‑disregarded parent.
An entity’s U.S. tax classification is determined by the “check‑the‑box” rules, which
means that the entity often has the ability to elect its U.S. tax classification. If no
owner of the entity has liability for the debts of the entity, the default U.S. tax
characterization of the entity is likely to be that of a corporation.
4. The source of payments on a guarantee of a debt obligation is the same as the source
of the payments on the underlying debt obligation. Therefore, payments by a
guarantor under a loan agreement are sourced based on the identity and/or activities
of the underlying borrower.
“It is rarely safe to
rely on payments
source to avoid
U.S. TAX BRIEFING 07
In certain cases (e.g., where the borrower is very thinly capitalized), the guarantor
may be treated as the “true” borrower for U.S. tax purposes.
5. Under a special rule, foreign flag shipping companies generally do not have any
income that is effectively connected with a U.S. trade or business, so the interest paid
by these companies generally is not U.S. source. This rule may not apply to a
taxpayer that has a fixed place of business in the United States whose shipping
business consists almost wholly of operating liners or ferries or almost wholly of
bareboat charters. The rule also does not apply to shipping companies that earn nonshipping
income that is effectively connected with a U.S. trade or business.
Dividends from a non‑U.S. corporation are non‑U.S. source, unless a substantial amount
of the non‑U.S. corporation’s gross income is effectively connected with a U.S. trade or
Swap payments received by a non‑U.S. person will usually be non‑U.S. source (even if the
payor is a U.S. person).
This rule applies only if the payments are treated as “notional principal contract”
income, and not as embedded interest or another type of payment.
This rule does not apply to payments attributable to the recipient’s U.S. trade or
This rule does not apply to swaps with significant upfront or termination payments
which have an embedded interest component.
Payments on a swap that is identified as a hedge or part of an integrated transaction
with an underlying debt instrument generally have the same source as the
underlying debt instrument.
4. Lease Payments, Payments for Services, Rents, Freight Charges, etc.
All of these payments, if properly characterized for U.S. tax purposes in accordance with
their form, are not subject to FATCA withholding regardless of their source, as described
D. Establish that the payments are not financial payments
FATCA withholding applies only to financial payments (generally, interest, dividends
and most payments on swaps or other derivatives). No withholding is required on nonfinancial
payments, including lease/rent payments, payments for services and charter
payments for a bareboat, time or voyage charter. However, the U.S. tax characterization
of a payment determines whether this exemption applies. The U.S. tax characterization of
a payment can be very different from the legal form of the payment: the rules are based on
the “substance of the transaction” and on analysis of all related agreements and
understandings, not merely the individual contract giving rise to the payment in
1. Lease Payments
A lease may be characterized for U.S. tax purposes as a “true lease,” a financing, or some
other type of transaction. All agreements and documents must be examined together to
determine a lease’s characterization (so for example, a lease that appears to be a “true
lease” may be characterized as a financing or a current sale if the lessee or an affiliate also
has an option to purchase the leased property that is substantially certain to be
exercised). If the lease is intended by the parties as a financing or intended as the collateral
Watson, Farley & Williams June 2014
“The U.S. tax
a payment can be
very different from
the legal form of
08 U.S. TAX BRIEFING for a financing, it is likely that the lease will be treated as a financing for U.S. tax purposes.
2. Payments for Services
Payments for services are usually easier to characterize than lease payments. However,
there are circumstances where payments purportedly made in return for services will be
treated as financial payments. For example, a time charter normally is treated for U.S. tax
purposes as providing a service, but some agreements designated as time charters are
treated as financings.
3. Vessel Charters
Bareboat charters are generally subject to the same rules as leases. Time or voyage charter
income is generally characterized as income for services. (Note that if a charter is treated
for U.S. tax purposes as not a financing, U.S. Source Withholding does not apply. Instead,
U.S. source gross transportation income is subject to a 4% U.S. gross freight tax, unless an
exemption under a treaty or under Section 883 of the U.S. Tax Code applies.)
E. Establish that the payments are grandfathered
Payments that would otherwise be withholdable payments will not be subject to FATCA
withholding if they are “grandfathered” obligations. The cut‑off date for grandfathered
obligations is July 1, 2014.
Grandfathered obligations include:
Loans and other debt instruments issued prior to July 1, 2014.
Guarantees of loans granted prior to July 1, 2014.
Draws on credit facilities under an agreement that was signed and fixed as to
material terms (including amount and maturity date) prior to July 1, 2014.
Most swap and other derivative payments entered into pursuant to an ISDA master
agreement evidenced by a confirm prior to July 1, 2014, excluding payments on
instruments that are treated as equity for U.S. tax purposes.
Payments on collateral posted in respect of a grandfathered obligation.
A grandfathered obligation that is modified “materially” on or after July 1, 2014 loses its
grandfathered status. Whether a modification is “material” is often unclear. Certain
modifications are per se material, such as changing the interest rate of a loan by more than
a de minimis amount. Other changes are tested under a “facts and circumstances” test.
A payor other than the borrower or its agent is required to treat a modification as
material only if it has “actual knowledge” of the modification and that it was material. If
a modification of a grandfathered obligation is not per se material under the regulations,
and a payor has not received notice from the borrower stating that the modification was
material, the payor is permitted to assume conclusively that the obligation remains
grandfathered. The borrower and its agent are required to treat a modification as
material if they have “actual knowledge or reason to know” that the modification is
F. Establish that the payment falls within the temporary exception for offshore payments
The regulations include a temporary exception to withholding: until January 1, 2017, a
payment made with respect to an account maintained outside the United States generally
is not subject to FATCA withholding except for payments on debt or equity issued by a
U.S. person. Thus, an interest payment on a loan by a non‑U.S. borrower (even if the
borrower has substantial U.S. ties) paid to a non‑U.S. account is not subject to FATCA
payments will not
be subject to
U.S. TAX BRIEFING 09
withholding prior to 2017. However, the exception for offshore payments does not apply
to U.S. Source Withholding. In addition, if the relevant agreement extends past January 1,
2017, payments made in or after 2017 will be subject to FATCA withholding. Accordingly,
this exception should be viewed as a “last resort”, to be relied upon only when there is no
other exemption from FATCA withholding (and even then, a payor must confirm that the
payment is not subject to ordinary U.S. Source Withholding).
The following is a timeline of relevant dates to be aware of in the implementation of
FATCA. In the case of an intergovernmental agreement, some of these dates may be
modified. Also, these dates have been extended before, and may be subject to future
First half of
FFIs are eligible to enter into FFI agreements and obtain GIINs (special
FATCA identification numbers)
June 2, 2014
First list of registered FFIs and corresponding GIINs released, to be
July 1, 2014
FATCA withholding in effect; new debt obligations cease to be
grandfathered; all FFIs not subject to a Model 1 IGA should have
registered and obtained a GIIN well before this date
First date FFIs in Model 1 IGA countries need a GIIN (FFIs should
obtain GIINs well before January 1 to ensure that they are included in
the official GIIN list)
First FATCA reports due by FFIs (other than FFIs in Model 1 IGA
countries); reports due annually thereafter
First FATCA reports due by FFIs in Model 1 IGA countries; reports
due annually thereafter
FATCA withholding on gross proceeds and passthru payments in
effect (later if “passthru payments” is still undefined); exception from
withholding on offshore obligations ceases to apply; pre‑FATCA
Form W‑8BEN no longer valid
Watson, Farley & Williams June 2014
should be viewed
as a “last resort,”
to be relied upon
only when there is
10 U.S. TAX BRIEFING
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