On May 2, 2014, there were exactly 60 days until withholding and due diligence rules under the Foreign Account Tax Compliance Act (“FATCA”) became effective. Notwithstanding the fact that the US Internal Revenue Service (the “IRS”) has promulgated well over 1,000 pages of proposed, temporary and final rules, substantial uncertainty continues to exist over how the rules can be competently administered. The IRS, notwithstanding months of reiterating its commitment to the July 1, 2014 FATCA effective date, has just released Notice 2014-33 to provide some relief to affected financial institutions.
Notice 2014-33 provides for an 18-month enforcement transition period for withholding agents and foreign financial institutions (“FFIs”) that undertake “good faith” efforts to comply with FATCA. Specifically, Notice 2014-33 provides that 2014 and 2015 will be regarded as a transition period for purposes of IRS enforcement and administration of FATCA. In addition, the Notice provides other welcome changes that should ease the administrative burden of implementing new FATCA compliant on-boarding procedures, including the IRS’s intention to amend both the standards of knowledge for withholding agents for accounts documented before July 1, 2014 and the definition of a reasonable explanation of foreign status.
IRS Light Touch Enforcement of FATCA Rules
In Notice 2014-33, the IRS announced that it will treat 2014 and 2015 as a transition period for purposes of enforcement and administration of FATCA. While no details are offered by the Notice, presumably this means that no penalties will be asserted for inadvertent failures to withhold, for failures to include FFIs in expanded affiliate group (“EAG”) filings1 or for misclassifications of FFIs. Transition-period treatment is granted only to entities that have put forth “good faith” efforts to comply with the requirements of FATCA. The Notice provides a couple of examples of “good faith” efforts.
First, the IRS will take into account whether a withholding agent has made “reasonable efforts” during the transition period to modify its account opening practices and procedures to document the FATCA status of payees, to apply the standards of knowledge rules provided in FATCA for classifying payees and account holders, and, in the absence of reliable documentation, to apply the required presumption rules. It is worth noting that the general rule uses the phrase “good faith” while this example uses a “reasonableness” standard. In either case, however, the standard leaves substantial discretion with the IRS to determine whether a taxpayer has provided the required level of effort.
In the second example provided by Notice 2014-33, the IRS stated that it will consider an FFI’s good faith efforts to identify and facilitate the registration of each member of its EAG. It is unclear how an entity would demonstrate it has made a good faith effort to identify and register the members of its EAG. It would seem that if one or more entities have been identified as potential EAG members, but have been left out of the EAG filing, the good faith standard should be met if the FFI has maintained internal written documentation for its decision. In addition, the process by which the FFI sought to determine its EAG should be documented.
Extension of Obligations Treated as Preexisting Obligations
An extremely helpful change provided by Notice 2014-33 is the expansion of obligations that constitute “preexisting obligations.” Under the FATCA regulations, withholding agents are generally required to implement new account opening procedures for accounts opened, or transactions entered into, on or after July 1, 2014.2 Accounts opened prior to such time are referred to as preexisting obligations.3
Preexisting obligations generally must be due diligenced by June 30, 2016.4 The due diligence required on accounts opened by entities after June 30, 2014 has been in limbo because the instructions for the Form W-8BEN-E (the new IRS Form for entities to certify their FATCA status) still have not been released. In response to this and other challenges, Notice 2014-33 provides that “preexisting obligations” will be expanded to include obligations issued, opened or executed before 2015 by entities (as opposed to individuals), providing affected financial institutions with an additional 6-months to implement new entity account opening procedures.5 This change to “preexisting obligations” will not be available for obligations held by individuals. Thus, the status of an obligation opened after June 30, 2014 as a preexisting obligation will depend, in part, upon the characterization of the payee. The IRS stated that it created this disparity in favor of entity obligations because the procedures for documenting individual accounts are less complex than those for entities.
This change will also be available to FFIs that are eligible to claim the benefits of an Intergovernmental Agreement (an “IGA”). Treasury intends to update the due diligence procedures described in Annex I of the Model 1 and Model 2 IGAs to incorporate the change to entity preexisting obligations. IGAs that have previously been signed, or jurisdictions that have reached an agreement in substance, will be permitted to adopt the revised due diligence procedures pursuant to the most-favored nation clause contained within its IGA.
Outside of this change to preexisting obligations, the Notice does not otherwise affect the timelines for due diligence, reporting or withholding. Specifically, the Notice does not impact the timing to diligence obligations held by prima facie FFIs opened between July 1, 2014 and December 31, 2014. Furthermore, if a payee identifies itself as a nonparticipating FFI (or a limited branch), withholding is required from and after such time, regardless of whether the obligation would otherwise be a preexisting obligation.
A limited FFI, or a limited branch, is an FFI that is prohibited from complying with FATCA because of local law rules.6 Notice 2014-33 provides certain relief to limited FFIs and limited branches. Pursuant to the Notice, the Treasury Department and the IRS intend to amend the FATCA regulations (i) to permit a limited FFI or limited branch to open US accounts for persons resident in the jurisdiction where the limited branch or limited FFI is located, and accounts for nonparticipating FFIs that are resident in that jurisdiction, provided that the limited FFI or limited branch does not solicit US accounts from persons not resident in, or accounts held by nonparticipating FFIs that are not established in, the jurisdiction where the FFI (or branch) is located and the FFI (or branch) is not used by another FFI in its EAG to circumvent the obligations of such other FFI and (ii) to provide that, if an FFI is prohibited under local law from registering as a limited FFI, the prohibition will not prevent the members of its EAG from being treated as participating FFIs if the FFI is identified as a limited FFI in its FATCA registration by another member of the EAG (the Lead FI).
Indicia of US Status
As previously mentioned, the Notice provides that the IRS further intends to amend both the standards of knowledge for withholding agents for accounts documented before July 1, 2014 and the definition of a reasonable explanation of foreign status. Coordination regulations treat a payer of amounts subject to FATCA withholding as having a “reason to know” that a payee may be a specified US person (subject to FATCA withholding) if the withholding agent has a current telephone number for the account holder in the United States and no telephone number for the account holder outside the United States, or has a US place of birth for the account holder. The coordination regulations also provided a transitional rule to allow a withholding agent that had documented the foreign status of a direct account holder prior to July 1, 2014, to continue to rely on such documentation without regard to whether the withholding agent has a US telephone number or US place of birth for the account holder (absent a change in circumstances).
Pursuant to the Notice, the Treasury Department and the IRS intend to amend these rules to provide that an account holder will be considered documented prior to July 1, 2014, without regard to whether the withholding agent obtains renewal documentation for the account holder on or after July 1, 2014. Accordingly, a withholding agent that has documented an account holder prior to July 1, 2014, will not be initially required to apply the new reason to know standards relating to a US telephone number or US place of birth.
Notice 2014-33 provides welcome relief on a number of pressing FATCA issues. The IRS will not hold taxpayers liable for pratfalls if they have made real efforts to comply with FATCA. Taxpayers and FFIs that desire to take advantage of the IRS largesse will be required to demonstrate that they have been taking FATCA seriously and that compliance failures result from inexperience and not from neglect.