On September 9, 2013, the Internal Revenue Service (IRS) issued corrections to the final regulations implementing the Foreign Account Tax Compliance Act (FATCA), issued in January 2013.1 While the corrections are largely technical, e.g., updating citations and cross-references, they also make substantive changes in several areas. The substantive changes include due diligence procedures and the treatment of branches of participating foreign financial institutions (PFFIs). The corrections are effective September 10, 2013.
The corrections increase the burdens associated with the due diligence procedures applicable to high-value accounts. Pursuant to the January 2013 final regulations, a PFFI was not obligated to conduct an “enhanced review” of the client’s file or conduct a relationship manager inquiry (RM inquiry) if the PFFI was able to conduct a comprehensive electronic review of the client’s file. Accordingly, PFFIs that would be able to satisfy the requirements of the enhanced electronic search would not be obligated to conduct an manual review of the client file and would not be obligated to conduct an RM inquiry. The corrections modify this parameter and instead require a PFFI to conduct an RM inquiry even if it would be able to satisfy the enhanced electronic search requirements.
The corrections thus achieve an outcome that is consistent with the approach taken in Annex I of the Model 1 and Model 2 Intergovernmental Agreements (collectively, the IGAs). Commentators had hoped that the US Treasury Department and the IRS would have achieved consistency in the due diligence process by reducing the burdens imposed by the IGAs by eliminating the need to conduct an RM inquiry if the enhanced electronic search requirements were satisfied, rather than by increasing the burden on PFFIs.
Branches of Foreign Financial Institutions
One of the significant substantive changes made by the corrections is to generally treat US branches of Model 1 foreign financial institutions the same as US branches of PFFIs. Pursuant to the January 2013 final regulations, US branches of PFFIs that are treated as US persons for regular tax withholding purposes2 are subject to special rules to fulfill the withholding, due diligence, and reporting requirements under FATCA. Specifically, a US branch of a PFFI that is treated as a US person and satisfies its backup withholding obligations with respect to certain accounts held at the US branch will be treated as satisfying its FATCA withholding obligations with respect to such accounts.3 In addition, a US branch of a PFFI that is treated as a US person is not subject to the due diligence requirements that are applicable to PFFIs—such US branches may (i) rely on the documentation used to determine regular income tax withholding in determining the FATCA status with respect to individual account holders and (ii) may apply the same documentation and due diligence procedures as US financial institutions.4 Finally, a US branch of a PFFI that is treated as a US person is treated as having satisfied the FATCA reporting requirements if it files backup withholding reports with respect to account holders that are US non-exempt recipients and reports on substantial US owners of certain non-financial foreign entities (NFFE) and on certain US persons of owner-documented foreign financial institutions.5 The corrections attempt to coordinate the rules applicable to US branches of Model 1 foreign financial institutions with the rules applicable to US branches of PFFIs, as provided in the January 2013 final regulations.
With regard to “limited branches,” that is, branches or subsidiaries that are not or cannot be FATCA-compliant, PFFIs with one or more limited branches will cease to be a PFFI after December 31, 2015, unless otherwise provided pursuant to an intergovernmental agreement.6 Under the January 2013 final regulations, a branch was required to maintain a separate set of books and records. However, the corrections now defer to the laws of the foreign country to determine whether a business unit or office is considered a “branch” for purposes of FATCA.7 In addition, the corrections remove a date restriction for limited branch status8 and update the amount of time that limited branches are required to retain records of account holders and payee documentation.9
Other Substantive Changes
In many instances the January 2013 final regulations provided an “earlier of” test for the due diligence related to changes in circumstances and recalcitrant accounts. The corrections generally change this analysis to a “90-day” test in such areas. Specifically, following a change in circumstances with respect to an account held by an entity other than a passive NFFE, the January 2013 final regulations required a PFFI to retain a record of appropriate documentation by the earlier of 90 days or the date a payment is made.10 The corrections now require a PFFI to retain the appropriate documentation within 90 days after the change in circumstances. Similarly, the January 2013 final regulations treated accounts with changes in circumstances that fail to provide the required information as recalcitrant accounts beginning on the earlier of the date a payment is made to the account or the date that is 90 days after the change in circumstances.11 The corrections treat an account with changes in circumstances that fails to provide the required information as a recalcitrant account 90 days after such change.
The January 2013 final regulations also required that new accounts that fail to provide the required information be treated as recalcitrant accounts beginning on the earlier of the date a payment is made or 90 days after the account is opened.12 The corrections appear to treat new accounts that fail to provide the required information as recalcitrant accounts beginning on the date that is the earlier of 90 days after the account is opened or the date that a payment of FDAP is made. Based on this amended version of Treas. Reg. § 1.1471-5(g)(3)(ii), a new account will not be treated as recalcitrant if the accountholder receives payments of gross proceeds within 90 days after the account is opened. It is unclear whether this was the intention of the Treasury Department.
The corrections further clarify that an investment advisor that solely provides investment advice is not treated as a foreign financial institution. However, an investment advisor that engages in the management of financial assets on behalf of clients is treated as a foreign financial institution.13
Additionally, certain exceptions to withholding from the January 2013 final regulations promulgated under Section 1471, such as withholding on grandfathered obligations and withholding if the withholding agent lacks control, custody or knowledge, were incorporated into the Section 1472 regulations.14