Tax News and Developments
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April 15, 2014
FATCA Coordinating Regulations
Purpose of the Regulations
On February 20, 2014, the Department of the Treasury ("Treasury") issued a package of final and temporary regulations to conform the existing regulations under Internal Revenue Code Chapters 3 (30 percent withholding on foreign persons' U.S. source income) and 61 (information reporting on and backup withholding from payments made to U.S. persons) with the Chapter 4 (FATCA) provisions. This client alert highlights certain revisions made to the existing regulations under Chapters 3 and 61 that affect payment recipients as well as various classes of withholding agents. Most of the changes made to the existing regulations are highly technical, and therefore the following comments are limited to changes that are likely to be of general interest.
Revisions to Existing Regulations Relating to IRS Forms W-8 and Documentary Evidence
Consistent with the new Form W-8BEN-E (released last month), the regulations require that a beneficial owner withholding certificate (Form W-8BEN) include the beneficial owner's Chapter 4 status.
Who Can Sign
Consistent with the Chapter 4 regulations, the list of persons authorized to sign a withholding certificate includes an officer or director of a corporation, a partner of a partnership, a trustee of a trust, an executor of an estate, any foreign equivalent of the foregoing persons, and any other person authorized in writing to sign documentation on behalf of the individual or entity named on the certificate.
Period of Validity
As a general matter, a withholding certificate (or documentary evidence allowed in certain circumstances to be provided in lieu of a certificate) continues to remain valid for three years or until a change in circumstances makes any information provided on the withholding certificate or in the documentary evidence incorrect. The regulations, however, make several changes to the three-year validity period and exceptions thereto under the existing regulations.
Most notably, a withholding certificate and documentary evidence supporting a claim of foreign status are valid indefinitely when both are provided together by an individual and the withholding agent does not have a current U.S. residence or
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mailing address for the payee, does not have one or more current U.S. telephone
numbers that are the only telephone numbers the withholding agent has for the
payee, and the withholding agent has not been provided standing instructions to
make a payment to an account in the United States.
On the other hand, the new regulations remove the existing regulations' provision
to the effect that a withholding certificate with a taxpayer identification number
("TIN") remains valid indefinitely where the withholding agent reports at least one
payment annually on Form 1042-S.
Consistent with the Chapter 4 regulations, a withholding certificate or
documentary evidence that would otherwise expire under the three year validity
rule on December 31, 2013 will now be treated as valid through December 31,
2014, unless a change in circumstances occurs before that date.
Period of Retention
The existing regulations provide that a withholding agent must retain each
withholding certificate and other documentary evidence for as long as it may be
relevant to the determination of the withholding agent's tax liability under section
1461. In an effort to ease this administrative burden, the regulations allow the
retained withholding certificate or documentary evidence to be the original, a
certified copy, or a scanned document. A withholding agent may also retain a
withholding certificate by other means (such as microfiche) that allows a
reproduction of the document, provided that the withholding agent has recorded
its receipt of the form and is able to a produce a hard copy of the form.
Under the existing regulations a withholding certificate must in certain
circumstances include a TIN—for example, where the beneficial owner claims
that the income is eligible for a treaty benefit or is exempt from 30-percent
withholding on the ground that it is effectively connected with the conduct of a
U.S. trade or business. The regulations add to the list of withholding certificates
requiring a TIN a withholding certificate (i) provided by a withholding foreign trust,
(ii) from a person representing to be a U.S. branch or territory financial institution,
or (iii) provided by an entity acting as a qualified securities lender with respect to a
substitute dividend paid in a securities lending or similar transaction. The new
regulations also provide an exception from the TIN requirement for a withholding
certificate on which a beneficial owner claims treaty benefits where the owner
provides its foreign TIN (if issued by a country with which the U.S. has an income
tax treaty or tax information exchange agreement ("TIEA")).
QI and NQI Certificates
Under the new regulations, a foreign financial institution ("FFI") under Chapter 4
can be a QI only if it is a participating FFI, a registered deemed-compliant FFI
("RDCFFI"), or an FFI treated as a deemed-compliant FFI under an applicable
intergovernmental agreement ("IGA") that is subject to due diligence and reporting
requirements with respect to its U.S. accounts similar to those applicable to a
registered deemed-compliant FFI.
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Principal Changes Made to Withholding Agent Standards and Obligations
Chapter 3 provides a variety of presumption rules for withholding agents to determine a payee's status in the absence of documentation. In general, under Chapter 3, a payment that a withholding agent cannot reliably associate with documentation is presumed to be made to a U.S. person. The temporary regulations institute a series of changes to coordinate the Chapter 3 presumption provisions with those under Chapter 4.
The temporary regulations modify the presumption rules for determining U.S. or foreign status of payees by specifying that, for payments that are also withholdable payments under FATCA, a withholding agent must apply the presumption rules under Chapter 4. The temporary regulations similarly modify the special rules for payments made to foreign intermediaries by providing that, in the case of a payment that is a withholdable payment under Chapter 4, the presumption rules under FATCA apply rather than the rules under Chapter 3. Accordingly, if under those rules an undocumented payee is treated as a nonparticipating FFI, withholding under Chapter 4 will apply and withholding and reporting under Chapter 3 will not.
In addition, the temporary regulations modify the presumption rules applicable to exempt recipients. First, the new regulations alter the indicia a withholding agent can rely upon to treat a payee as a foreign person. Previously, the regulations provided that a payee was presumed to be a foreign person and not a U.S. person if the name of the payee indicated that the entity was the type of entity that was on the per se list of foreign corporations. The temporary regulations retain this rule, but specify that the presumption does not apply if the payee's name contains the designation "corporation" or "company." The temporary regulations also add a new indicium, specific to new accounts only, in providing that a withholding agent may treat a payee as a foreign person if the withholding agent has a telephone number for the person outside of the United States.
The temporary regulations also add a special rule for payments that are also withholdable payments under Chapter 4 made to exempt recipients. Under this new provision, the payee is presumed to be a foreign payee in the absence of documentation establishing the entity as a U.S. person. This rule does not apply, however, to preexisting obligations to payees that the withholding agent already determined, prior to July 1, 2014, were U.S. exempt recipients.
Changes to "Reason to Know" Standards
Chapter 3 provides general rules regarding when a withholding agent that is a financial institution has reason to know that it cannot rely on an account holder's particular claim of status. The temporary regulations revise the standards of knowledge under Chapter 3 to coordinate them with the standards under FATCA, including the new temporary Chapter 4 regulations. In that respect, the Chapter 3 temporary regulations define a financial institution by reference to the definition under FATCA and define account information to include documentation collected for anti-money laundering ("AML") or similar due diligence purposes. In addition, the temporary regulations incorporate the new 30 day AML document review period under Chapter 4, so that the agent will not be considered to have reason to
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know that a person's Chapter 3 claim is unreliable or incorrect based on documentation collected for AML due diligence until the date that is 30 days after the obligation is executed (or, in the case of an obligation for which a financial institution account is opened, 30 days after the account is opened).
Override of Various Chapter 3 and 61 Rules by Chapter 4
In addition to coordinating and integrating the Chapter 3 and Chapter 61 rules with the Chapter 4 rules, the temporary regulations describe certain situations in which the Chapter 4 rules override the others.
Override of Chapter 3 Exemptions
The temporary regulations clarify that certain exemptions from withholding under Chapter 3 apply only for such purposes and not for Chapter 4 purposes. These include the exemption for (i) portfolio interest, (ii) bank deposit interest and similar types of deposit interest, (iii) interest or OID on certain U.S.-source short-term obligations, (iv) certain types of dividends or interest paid by certain U.S. corporations, (v) effectively connected income, (vi) certain compensation income, and (vi) amounts qualifying for benefits under an income tax treaty.
Currently, if an entity is treated as fiscally transparent by an interest holder's jurisdiction with respect to an item of income derived by the interest holder through such entity, the final regulations under Chapter 3 provide that the entity in question will be treated as a flow-through entity and the interest holder can obtain appropriate treaty benefits so long as the fiscally transparent entity provides a proper flow-through withholding certificate (Form W-8IMY), along with documentation supporting the claim for treaty benefits. However, the temporary regulations clarify that even if the Chapter 3 requirements for claiming a reduced rate of withholding under an income tax treaty have been satisfied, a payment of a 'withholdable payment' to a fiscally transparent entity requires the withholding agent to apply the Chapter 4 regulations to determine the payee of the withholdable payment. Chapter 4 withholding may apply depending on the status of the payee, which highlights the expansive application of Chapter 4.
Rules to Ensure No Withholding under both Chapters 3 and 4 or both Section 3406 and Chapter 4
Without coordination and integration, in certain circumstances, a payment subject to withholding under Chapter 4 could also be subject to withholding under Chapter 3 or backup withholding under Section 3406. In light of this possibility, the temporary regulations provide rules to address the potential for overwithholding to ensure that payments are not subject to withholding under both Chapters 3 and 4 or under both Chapter 4 and Section 3406.
Generally speaking, the temporary regulations provide that when a payment is both a Chapter 4 withholdable payment and an amount subject to withholding under Chapter 3, a withholding agent must apply the withholding provisions of Chapter 4 to determine whether withholding is required under Chapter 4. The withholding agent does not need to withhold under Chapter 3 to the extent that it has withheld under Chapter 4.
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Changes Made to QI Rules by New Chapter 4 Regulations
A "qualified intermediary" ("QI") is ordinarily a non-U.S. entity (typically a non-U.S. financial institution) that has entered into an agreement with the Service to undertake certain documentation and withholding responsibilities in accordance with Chapters 3 and 61. In return for the QI's agreement to undertake proper documentation and withholding, the QI agreement provides that the QI is not obligated to reveal the identities of clients and customers.
Under the temporary regulations, in order for an entity to qualify as a QI, a non-US financial institution must become a participating foreign financial institution ("PFFI"), a reporting deemed compliant foreign financial institution ("RDCFFI") or an FFI that is treated as a deemed-compliant FFI under an applicable intergovernmental agreement and such institution must agree to report all its U.S. accounts, not simply those covered by the QI agreement. Under certain circumstances, a non-financial foreign entity ("NFFE") may enter into a QI agreement with the Service where the NFFE may present claims of treaty entitlement on behalf of its shareholders or when it acts as an intermediary for other parties. The temporary regulations have made a variety of revisions to the prior Chapter 3 QI regulations to bring them into conformity with the Chapter 4 regulations.
For additional information please contact the authors of this Client Alert or any member of Baker & McKenzie's North American Tax Practice Group.
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Tax News and Developments is a periodic publication of Baker & McKenzie's North American Tax Practice Group. This Alert has been prepared for clients and professional associates of Baker & McKenzie. It is intended to provide only a summary of selected recent legal developments. For this reason, the information contained herein should not be relied upon as legal advice or formal opinion or regarded as a substitute for detailed advice in individual cases. The services of a competent professional adviser should be obtained in each instance so that the applicability of the relevant jurisdictions or other legal developments to the particular facts can be verified.
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