FATCA describes certain provisions of the United States Hiring Incentives to Restore Employment (HIRE) Act, which was signed into law by President Obama in March 2010. The HIRE Act includes revised portions of the Foreign Account Tax Compliance Act of 2009, a bill first introduced in the U.S. House and Senate in October 2009 but never enacted, and adds new sections 1471-1474 to the United States Internal Revenue Code. In general terms, FATCA is a revenue-generating measure that targets American offshore tax evasion by broadening required disclosure and reporting by foreign financial institutions (FFIs) in respect of U.S. accountholders. This article provides an overview of FATCA and the very significant compliance issues it presents for Canadian life insurers, together with an update on the process of implementation of FATCA.

A simple example of the intended application of FATCA would be in respect of a U.S. citizen who maintains a deposit or brokerage account with an offshore bank and does not declare the income in the account. FATCA is intended to require the offshore bank in this example to enter into an agreement with the U.S. Treasury to disclose information about the bank's U.S. clients. Otherwise, persons paying interest, dividends and certain other amounts to the bank from all U.S.-source income must withhold a 30% tax on all payments to the bank. The definition of a FFI is very broad, and U.S. Treasury guidance to date has indicated that the definition will capture foreign life insurance companies. However, the requirements for life insurance companies are not yet clear and indeed, to date, most concepts and requirements annunciated in initial FATCA guidance are bank-centric rather than also appearing to readily apply in the life insurance context.

Under FATCA, all "withholdable payments" made to an FFI after December 31, 2012 will be subject to a new 30% withholding tax unless the FFI complies with a new reporting regime. "Withholdable payments" are defined as U.S.-source payments otherwise subject to non-resident withholding and include gross proceeds from the sale of any U.S. issuer debt or equity instruments. While withholdable payments on "obligations" outstanding on March 18, 2012 will be grandfathered and not subject to FATCA withholding, the meaning of "obligations" for this purpose has not been defined to date, but has been clarified somewhat in subsequent initial guidance.

To avoid withholdings, an FFI must enter into an agreement with the U.S. Treasury (a FATCA Agreement) to provide detailed information about the "financial accounts" it maintains that are owned by certain "U.S. persons". Among other things, such a FATCA Agreement will require an FFI to adopt verification and due diligence procedures set out by the U.S. Internal Revenue Service (IRS) and report annually the identity and social security/taxpayer identification number of direct and indirect holders of U.S. accounts and information on the accounts (including related value, gross receipts and withdrawals). FATCA Agreements will also require FFIs to obtain from U.S. accountholders waivers of any foreign laws prohibiting the disclosure, or to close those accounts. Recalcitrant accountholders, being those that fail to provide an FFI with the required information, will be subject to a 30% withholding rate on withholdable payments.

Generally, FATCA has been drafted in broad strokes, with the details expected to be articulated in regulations yet to be released. For example, the definition of an FFI under the legislation is very broad and, as noted above, the U.S. Treasury guidance has indicated that the definition is intended to capture foreign life insurance companies. Ultimately, FATCA is conceptually intended to function as a "stick" rather than a "carrot", but unfortunately, this stick is not well suited for the insurance sector.

The U.S. Treasury, however, has wide latitude to issue regulations exempting classes of FFIs from FATCA requirements where regulation is not considered necessary to curb offshore tax evasion. The U.S. government sought commentary on the proposed implementation of FATCA and was inundated with submissions from around the world, including from the Canadian Life and Health Insurance Association (CLHIA), the Canadian Bankers Association, the Investment Funds Institute of Canada and the Investment Industry Association of Canada. Two rounds of preliminary guidance have been issued to date, with many issues still to be addressed and comments continue to be requested on issues of applicability to the insurance sector. As such, the ultimate shape and nature of FATCA regulation is still very much a moving target.

CLHIA Submissions to Date, Emerging Guidance and Key Potential Compliance Issues for Canadian Insurers


The CLHIA has made three substantial submissions regarding FATCA to the U.S. IRS/Treasury - in June 2010, November 2010 and February 2011. While the CLHIA initially suggested exempting life insurers, or at least Canadian life insurers, from the legislation, the IRS/Treasury made it clear early in the process that life insurance would not be exempted from regulation and that no country-specific exceptions would be adopted. Consequently, the CLHIA's focus evolved to attempting to narrow the proposed scope/impact of FATCA through a more pragmatic approach that would include exempting certain types of policies. Generally, the IRS and Treasury have publicly and privately complimented the CLHIA on its pragmatic, responsive and solution-oriented approach (as opposed to some other life insurance groups' reactions of "throwing their hands up in the air").

Submission #1 - June 2010

In the CLHIA's first submission in June 2010, the CLHIA agreed that while additional information reporting can, conceptually, be a useful tool to combat tax evasion by U.S. persons, the means to realize that goal should be reasonable and avoid creating an excessive burden where there is little or no benefit. In the case of Canadian life insurers, the CLHIA noted that U.S. persons comprise only a small percentage of policyholders and that the types of policies typically issued are not susceptible to the type of tax abuse behind the FATCA provisions. Ultimately, the CLHIA urged the U.S. to exempt Canadian life insurers, or alternatively to limit the application of FATCA, given the difficulties insurers would face in attempting to comply with FATCA (particularly in respect of existing policies), and to carve out specific categories of Canadian policies where there was no realistic possibility of the policy being used to facilitate tax avoidance. The CLHIA noted that most Canadian life insurers' underwriting and marketing guidelines prohibit sales to non-residents, both for administrative and AML/ATF reasons and due to disadvantageous Canadian tax rules (under which the reserves would not be deductible for Canadian tax purposes). Moreover, Canada is not a tax haven - the CLHIA noted in its submission that there was no evidence of the use of Canadian life insurance policies for U.S. tax avoidance purposes and, in fact, such a situation would be highly unlikely as the Canadian tax results are no better (and in some cases, much worse) than the treatment of equivalent policies in the U.S. Further, Canadian tax rates are much higher than in the U.S., thus making Canada very unattractive from a tax avoidance perspective. As the CLHIA noted, "no economically rational United States person who was resident in Canada would ever acquire a Canadian life policy or annuity in order to avoid or minimize his or her total level of taxation". Conversely, a Canadian-issued policy owned by a U.S. resident would not result in tax avoidance, as amounts payable under such a policy would be subject to Canadian withholding tax and reported to the IRS by the Canada Revenue Agency (CRA) under Canada/U.S. tax agreements.

The CLHIA also noted that the FATCA requirements would present numerous compliance issues for Canadian life insurers. One such issue originates from the fact that Canadian life insurers currently do not have the information necessary to determine the policyholder's "tax residency" or whether policyholders are U.S. citizens. Rather, insurers would have to make inquiries of their entire policyholder base. Policyholders, meanwhile, would have no legal or contractual obligation to provide the information requested. Even if the relevant information was obtained, Canadian privacy laws would prohibit disclosure to the IRS unless policyholders specifically consented. Further, Canadian life insurers would have no contractual mechanism to terminate policies of, or to withhold from, recalcitrant policyholders. Among other things, the FATCA requirements would thus result in a higher tax cost to Canadian life insurers in respect of investments in U.S. bonds, presumably resulting in Canadian life insurers increasingly seeking alternative non-U.S. investments. The CLHIA also identified additional issues with respect to group contracts, where less information is gathered or retained respecting members of the group and where it is unclear what effect recalcitrance of an individual member would have in relation to the entire agreement.

With respect to future policies, there is currently no right under Canadian privacy laws for a life insurer to decline to issue a policy if an applicant refuses to provide the required information or consent to the disclosure of information to the U.S. Notably, it is not clear that the PIPEDA exemption for disclosure "required by law" could be relied on, as (i) FATCA is technically voluntary; and (ii) it is not clear whether PIPEDA would apply in the case of a foreign law such as FATCA.

Accordingly, the CLHIA proposed limiting the application of FATCA to future policies, to build in a long lead/implementation timeline, and to exclude policies (i) without a cash value; (ii) that do not permit payments in excess of the adjusted cost basis; (iii) that allow for a return of premium but not a payment of investment return (which would collectively exclude health, disability, travel, property and term life insurance, among others); (iv) which are group policies (including group annuities); or (v) which are registered annuities. The CLHIA also proposed to permit affiliates to individually elect whether to enter into FATCA Agreements, rather than requiring a single approach for an entire group.

August 2010 Preliminary IRS/Treasury Guidance

In August 2010, the IRS/Treasury released initial FATCA guidance in the form of Notice 2010-60, on which comments were due in November 2010. In the Notice, "obligation" for the purposes of grandfathering was proposed to mean any legal agreement that produces or could produce withholdable payments. This would exclude equity instruments under U.S. law, as well as legal agreements lacking a definitive expiration or term. Further, material modification of an obligation after March 18, 2012 would result in an obligation being treated as newly issued as of the effective date of modification.

Significantly, it was proposed that regulations would exempt from the definition of "financial account" insurance/reinsurance contracts without a cash value (e.g. property and casualty insurance contracts and term life insurance contracts) and would exempt from the FFI definition insurance companies primarily in the business of issuing such contracts. However, it was noted that cash value insurance contracts and annuity contracts may present the type of risks at which FATCA was aimed, and the U.S. accordingly requested comments on those types of products. The guidance also proposed special rules for U.S. branches of FFIs.

Most significantly, the initial preliminary guidance contained detailed proposed procedures to determine whether accounts are held by U.S. persons and to differentiate between existing and new accounts and to differentiate between accounts held by individuals and those held by entities. However, much of the guidance respecting existing accounts was significantly subsequently revised in further guidance in the form of IRS/Treasury Notice 2011-34 issued in April 2011 and discussed in greater detail below.

Further, for a five-year introductory period (or two years in respect of accounts having average monthly balances exceeding $1,000,000 during the year before the FATCA Agreement becomes effective), the proposed methodology for existing accounts would be focused on electronically searchable information already available to FFIs and would allow FFIs to rely on existing forms and information in their files. If electronically available information included indicia of potential U.S. status, the FFI would be required to request additional information, depending on the nature of the indicia. Accountholders could be treated as non-U.S. if the FFI's electronically searchable information did not contain any of the relevant indicia.

Generally, FFIs would have one year from the date of their FATCA Agreement to classify existing accountholders and to request the necessary follow-up information. Accountholders would thereafter have one additional year to provide the required information before being treated as recalcitrant. After five years (or in certain circumstances, two years, as noted above), the same rules/requirements would apply to pre-existing individual accounts as applied to new individual accounts. Similar, but even more stringent, determination rules would apply for new individual accounts.

The IRS indicated that it would require FFIs to report the number and aggregate value of financial accounts held by recalcitrant accountholders, recalcitrant accountholders with U.S. indicia and related or unrelated FFIs not entering into FATCA Agreements. It was also noted that future guidance would include a draft proposed FATCA Agreement and draft reporting and certification forms. Comments were requested on specific foreign laws that would hinder reporting and how FFIs might overcome or waive any such hindrances.

Submission #2 - November 2010

In a further submission in November 2010, the CLHIA repeated its previous proposal to exempt Canadian life insurers from the FFI definition for the reasons previously submitted and further proposed exempting the following products from the U.S. account definition, given the minimal tax evasion risk: (i) Canadian government registered retirement or savings plans (RRPs, RRSPs, DPSPs, TFSAs, RESPs, etc.); (ii) policies without cash value; and (iii) group policies not permitting or providing for any cash value to be paid to or benefit group insureds.

In addition, the CLHIA proposed grandfathering existing insurance policies and annuities or, alternatively, eliminating the requirement to obtain documentary evidence after the transition period. Rather, the CLHIA suggested utilizing existing information exchange provisions of the U.S./Canada Tax Treaty or other current periodic solicitation rules. Otherwise, after the expiration of the transition period, Canadian life insurers would technically be required to obtain documentary evidence of the status of their entire policyholder base, which would be practically impossible and, as per the CLHIA's initial submission, there would be no contractual basis to terminate a policy or withhold from a non-responding policyholder. Further, the CLHIA noted that there would be no basis under PIPEDA to report information to the CRA, let alone the IRS, as consent would be needed from the applicable U.S. policyholders, likely resulting in a very large number of recalcitrant policyholders.

For new policies, the CLHIA proposed the adoption of an applicant waiver process to the extent permitted by law, or if prohibited by law, to rely on the information exchange or periodic solicitation approaches noted above. In respect of reporting, the CLHIA proposed that Canadian life insurers be entitled to rely on the current reporting process to the CRA and that no reporting be required on policies until payments are actually made under the policies (having regard to the differences from, for example, investment products).

The submission also included a number of other miscellaneous recommendations, including that (i) self-verification procedures permit certification of compliance methodology by senior management of FFIs rather than external auditors (on the basis that the cost would otherwise generally be out of proportion to the benefit); (ii) corporate entities and groups be able to separately elect whether to enter into FATCA Agreements; and (iii) trustees of a trust be allowed to certify beneficiaries of the trust.

Submission #3 - February 2011

The CLHIA made a further submission in February 2011 on certain residual issues, including proposing that FATCA requirements exempt small life insurance policies (where the death benefit was less than $500,000 or the aggregate annual premium was less than $10,000) and small annuities (where the aggregate premium was less than $350,000), on the basis that each case presented minimal likelihood of use for tax evasion purposes. The February 2011 submission also proposed to exempt reinsurance contracts and to exclude from reporting requirements most insurance policies (including existing life insurance policies and annuities with cash value less than $1,000,000), with existing policies not aggregated.

Additional CLHIA Meetings with Governmental Authorities

In addition, earlier this year, members of the CLHIA working group met with representatives of the Canadian Privacy Commissioner (OPC) and the Department of Finance. The OPC advised that it was seized of the issue and had been in consultation with provincial and foreign counterparts (who have some of the same issues), as well as Industry Canada, OSFI and the Department of Finance. The OPC expects to have completed its analysis in respect of issues presented by FATCA by May or June 2011, including deciding on whether amendments to PIPEDA or other steps are required. The OPC is likely to reach one of three possible conclusions:

  • First, that the FATCA rules are incompatible with PIPEDA (i.e. can't fit under existing exceptions) and, therefore, OPC would recommend amendments to PIPEDA to clarify the regime;
  • Second, that amendments to PIPEDA are necessary, since it is not clear whether PIPEDA allows personal information to flow to the U.S. under the FATCA rules; or
  • Third, that the FATCA rules are not incompatible with PIPEDA and, therefore, while information can be shared, steps must be taken to mitigate the fact that information is flowing to the U.S., such as by negotiating with the U.S. to ensure stringent safeguarding and limitation on other uses of the reported information.

The Department of Finance also advised that the Minister of Finance was engaged on the issue and that it had taken up discussions with the IRS and the U.S. Treasury on the file. This was confirmed in a speech given by Minister Flaherty in February 2011, in which the Minister noted that Canada is neither a tax haven nor a country that restricts the flow of information and that Finance had been in discussions with its U.S. counterparts on this issue. Minister Flaherty also stressed that the proposed regime would impose a very substantial administrative burden on Canadian financial institutions and not accomplish the goal of the FATCA legislation.

April 2011 Further Preliminary IRS Guidance

In April 2011, the IRS released further preliminary implementation guidance in the form of Notice 2011-34, which is open for comment until June 7, 2011. This latest guidance is focused on banks and similar institutions and does not address the issues unique to life insurers. However, in respect of identification of individual existing accounts, the Notice requests comments on whether similar procedures should be applied to life insurers and policyholders, including holders of "private placement life insurance" (a term not defined in the Notice).

The April Notice proposes identification procedures for existing accounts, following six steps, as follows:

Step 1 if the accountholder was already documented as a U.S. person, the accountholder's accounts would be U.S. accounts;

Step 2 if the account balance was less than $50,000, the account could be treated as a non-U.S. account;

Step 3 special steps applicable only to private banking accounts;

Step 4 if not determined to be a U.S. account pursuant to Steps 1, 2 or 3, the FFI would be required to search electronic databases (although not PDF files or scanned documents) for various U.S. indicia (similar to the previous guidance) and, depending on the indicia found, request documentation to confirm U.S. status;

Step 5 if not already identified as a U.S. account, if the account value was greater than $500,000 (a High Value Account), the FFI would be required to perform a diligent review of account files (and not merely a review of electronically searchable databases). If U.S. indicia were found, the FFI would be required to obtain specified documentation within two years of the date of its FATCA Agreement; if the accountholder did not provide the required information, it would be treated as a recalcitrant accountholder; and

Step 6 following the third anniversary of the FATCA Agreement, the FFI would perform Step 5 on all pre-existing accounts that became High Value Accounts in the interim - although this would no longer require retesting of all existing accounts, as would the previous guidance.

Analogous rules would be imposed in respect of U.S. policyholders of FFI insurers and the U.S. government requested comments on how to apply these concepts in the insurance context and whether annuity or insurance analogues existed to private banking accounts.

The Notice also proposed requiring FFI's to certify:

  • completion of Steps 1 to 6;
  • that the FFI hadn't, from April 8, 2011 (the date of the Notice's publication) to the date of the FATCA Agreement, engaged in any activity directing, assisting or encouraging accountholders respecting strategies to avoid identification of accounts as U.S. accounts; and
  • that the FFI has written procedures prohibiting employees from advising U.S. accountholders on how to avoid identification of U.S. accounts.

Importantly, the second certification requirement would result in the need for FFIs to immediately review current policies/procedures to ensure that there would be no issue in subsequently giving this certification.

The Notice also contained more guidance on "passthru payments" in respect of which an FFI would be required to withhold 30% of any passthru payment made to a recalcitrant accountholder or non-participating FFI. Regulations would provide that any payment made by an FFI would be a passthru payment to the extent of (i) the amount of the payment that was a withholdable payment (i.e. the amount directly traceable to a withholdable payment made to the FFI); and (ii) the balance of the payment multiplied by the ratio of the FFI's U.S. assets to total assets (the passthru payment percentage). FFIs would be required to periodically make available their passthru payment percentage information. Importantly, for life insurers, current policy terms and/or a local law may not permit such withholding, potentially exposing the FFI itself to the entire withholding cost. The IRS declined to accept commentators' recommendations to limit passthru payments to directly traceable payments to the FFI.

In addition, regulations would provide that certain categories of FFIs be deemed compliant with FATCA (including certain local members of FFI groups) but that such FFIs apply for that status and recertify every three years that they meet the requirements for deemed compliance.

Finally, each FFI affiliate in an "FFI Group" would be required to be a participating FFI (one that had entered into a FATCA Agreement) or be a deemed compliant FFI. A coordinated application process would be established, under which a lead "Compliance FFI" from each FFI Group would oversee compliance of the entire FFI Group.

Next Steps for Canadian Life Insurers?

Canadian life insurers should continue to closely follow and analyze the U.S. guidance as it emerges, including through the CLHIA process. The CLHIA is currently preparing a submission in response to the April 2010 Notice, will be meeting with the IRS/Treasury in May and is currently liaising with key U.S. politicians.

Canadian life insurers should begin now to develop a plan for implementing compliance with FATCA and to manage the risk of that compliance. This should include immediately beginning to assess current controls, procedures, accounts processes and outsourcing arrangements as against the FATCA compliance requirements. This process could include identifying responsible persons, forming a steering/implementation committee or group and considering budget needs. There would be expected to be key roles in this process for general counsel, chief compliance officers and heads of tax groups.