Notice 2010-60 Provides First Round of Guidance Interpreting the New Rules that Will Apply to Payments to Foreign Financial Intermediaries and Other Foreign Persons
On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment Act of 2010. That Act imposed new reporting and withholding tax obligations on direct and indirect payments made by U.S. persons to foreign persons.
Under new section 1471 of the Internal Revenue Code, a U.S. person making a "withholdable payment" to a foreign financial institution ("FFI") generally must withhold 30% of the payment unless the FFI undertakes certain reporting responsibilities. Under new section 1472, a U.S. person making a "withholdable payment" to a non-financial foreign entity ("NFFE") generally must withhold 30% of the payment unless the foreign entity discloses certain information about any substantial U.S. owners it has. There are a variety of statutory exceptions and special rules, and the Treasury Department ("IRS") is provided with significant regulatory authority to modify and supplement the statutory rules, along with mandates to coordinate the new rules with existing withholding provisions.
The new rules are generally effective for payments made after December 31, 2012, although any obligation outstanding on March 18, 2012, is "grandfathered" and is not subject to the new withholding rules. This delayed effective date was intended to provide the IRS with time to promulgate the necessary forms and administrative guidance and U.S. payors and foreign payees with time to adjust to and implement the new rules before they came into effect. Given the breadth of the new reporting and withholding obligations, the immensity of the task faced by U.S. payors and foreign payees to gather the information required by the new rules, and, for many foreign entities, the need to weigh the costs of complying with the new rules against the benefits of having U.S. investments or U.S. investors, there have been wide appeals for guidance by the IRS and, especially, requests for the IRS to use its regulatory authority to provide exemptions and relief in particular cases.
In Announcement 2010-22, the IRS requested comments regarding guidance projects and issues concerning the interpretation and implementation of the new rules. A variety of companies, industry groups, and professional associations provided comments, and Notice 2010-60 is the first formal response to those comments.
Overview of Notice 2010-60
In deciphering the new rules and guidance, one should keep two points in mind. First, the goal of the new rules is increased reporting of information regarding income earned by U.S. persons. U.S. tax officials have repeatedly said that they will be satisfied if no one ever pays any of the new withholding tax. Rather, the expectation is that foreign financial entities will provide specific information to the IRS simply to avoid becoming subject to the intentionally onerous withholding rules. Second, the statutory rules merely set forth the framework for the new reporting and withholding regime. The IRS is expected to identify the appropriate exceptions, what specifically the new FFI agreements must provide, and how the intricate reporting process will work, especially for payments through chains of intermediaries. Until the IRS issues the applicable guidance and states which regulatory authority it will exercise and which it will not, payors and payees cannot undertake the laborious process of conforming their systems and procedures to the new U.S. withholding and reporting rules.
Notice 2010-60 states that the IRS intends to issue guidance in advance of the December 12, 2012 effective date "to ensure that affected persons have time to implement the systems and processes necessary to comply fully with the new withholding, documentation, and reporting obligations imposed by [the new rules]." The notice states:
- The IRS intends to issue proposed regulations incorporating the guidance provided in the notice and addressing other matters necessary to implement the new reporting and withholding rules.
- In future guidance, the IRS intends to publish a draft FFI Agreement (the document in which an FFI agrees to undertake certain due diligence, reporting, and withholding responsibilities) and draft information reporting and certification forms.
- The IRS requests comments on the issues addressed in the notice and the priority of other issues that should be addressed in future guidance.
The notice therefore includes "preliminary guidance regarding priority issues" in the implementation of the new rules. These priority issues include
- the scope of obligations exempt from the new withholding and reporting rules,
- the definition of FFI,
- the scope of collection of information and obligations of financial institutions to identify persons, and
- the information that FFIs must report to the IRS regarding U.S. accounts.
Finally, the notice states that the IRS intends to require electronic filing of returns for purposes of implementing Internal Revenue Code section 6011(e)(4) as added by section 522 of the Act, beginning with returns filed for taxable years ending after December 31, 2012.
Notice 2010-60 states that the IRS will issue regulations providing that the term "obligation" for purposes of the grandfather rule means any legal agreement that produces or could produce withholdable payments. Those regulations will exclude from the grandfather rule, however, any instrument treated as equity for U.S. tax purposes or any legal agreement that lacks a definitive expiration or term (e.g., savings deposits; demand deposits; brokerage, custodial and similar agreements to hold, or receive payments with respect to, financial assets for the account of others). Any material modification to a grandfathered obligation will result in the obligation being treated as newly-issued for purposes of the effective date, causing it to lose grandfathered status if the material modification is after March 18, 2012.
Financial Entities Subject to or Exempt from the New Reporting and/or Withholding Rules
Section 1471 generally applies to withholdable payments made to an FFI. Notice 2010-60 provides that the definition of "financial institution" includes, but is not limited to,
- entities that would qualify as banks under Internal Revenue Code section 585(a)(2) (including banks as defined in Internal Revenue Code section 581 and any corporation to which section 581 would apply except for the fact that it is a foreign corporation), savings banks, commercial banks, savings and loan associations, thrifts, credit unions, building societies and other cooperative banking institutions;
- broker-dealers, clearing organizations, trust companies, custodial banks, and entities acting as custodians with respect to the assets of employee benefit plans; and
- mutual funds (or their foreign equivalent), funds of funds (and other similar investments), exchange-traded funds, hedge funds, private equity and venture capital funds, other managed funds, commodity pools, and other investment vehicles.
The notice also addresses certain classes of foreign entities that meet the statutory definition of FFI:
- certain holding companies, start-up companies, non-financial entities that are liquidating or emerging from reorganization or bankruptcy, and hedging/financing centers of a non-financial group (these are excluded from the definition of financial institution and also excluded from withholding applicable to NFFEs under section 1472);
- insurance companies the business of which consists solely of issuing property and casualty insurance or reinsurance contracts or term life insurance contracts (these are excluded from the definition of financial institution and treated as NFFEs);
- small investment funds with identified owners that meet certain documentation requirements (these are treated as deemed-compliant FFIs); and
- those entities identified as posing a low risk of tax evasion, such as certain foreign retirement plans.
New Responsibilities Placed on Financial Institutions
To avoid the new 30% withholding tax, an FFI must enter into an FFI Agreement, in which the FFI agrees to undertake certain due diligence, reporting, and withholding responsibilities. Such an FFI is referred to as a "participating FFI". To comply with the obligations imposed by sections 1471 and 1472, participating FFIs will need to determine:
- whether individual account holders are to be treated as U.S. persons or other persons and
- whether account holders that are entities are to be treated as U.S. persons, FFIs, entities described in section 1471(f) (i.e., foreign governmental entities, international organizations, or other entities with low risk of tax evasion), or NFFEs.
Following that initial identification, participating FFIs will then need to determine:
- whether entities that are U.S. persons are to be treated as specified U.S. persons or other U.S. persons;
- whether FFIs are to be treated as participating FFIs, deemed-compliant FFIs, or non-participating FFIs; and
- whether NFFEs are to be treated as U.S.-owned foreign entities. For this purpose, an NFFE will be treated as a U.S.-owned foreign entity to the extent that it is determined to have substantial U.S. owners. Any entity that is an excepted NFFE will be excluded from the definition of a U.S.-owned foreign entity.
To comply with the obligations imposed by sections 1471 and 1472, U.S. financial institutions ("USFIs") will need to make determinations similar to those required of participating FFIs. In particular, USFIs making withholdable payments to entities will need to determine whether to treat those entities as U.S. persons, FFIs, entities described in section 1471(f), or NFFEs.
Following that initial identification, USFIs will then need to determine:
- whether FFIs are to be treated as participating FFIs, deemed-compliant FFIs, or non-participating FFIs, and
- whether NFFEs are to be treated as excepted NFFEs or as other NFFEs.
The notice sets forth detailed procedures for making the required determinations, with separate rules for (a) pre-existing financial accounts held by individuals, (b) new financial accounts held by individuals, (c) pre-existing financial accounts held by other entities, and (d) new financial accounts held by other entities.
FFI Agreement Information
The notice states that the IRS is developing a new form (which must be filed electronically) to provide the information required by the reporting rules. The information must include
- the name, address and taxpayer identification number (TIN) of each account holder which is a specified U.S. person;
- in the case of any account holder which is a U.S.-owned foreign entity, the name, address, and TIN of each substantial United States owner of such entity;
- the account number (or if no account number is used by the FFI, the serial number or other unique number the FFI assigns to the account);
- the account balance or value in U.S. dollars, with the IRS indicating that it will want to see the highest regularly calculated balance of the year and access to additional account-related information, such as copies of account statements and daily receipts and withdrawals; and
- the gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner as the Secretary may provide).
The notice also describes the IRS's current thinking regarding elimination of duplicative reporting and reporting on recalcitrant accounts.
Specific Requests for Comments
Specific requests for comments are spread throughout the first four sections of the notice. These include requests for comments regarding
- entities that will be exempted from withholding under the new rules, particularly how the classes of entities exempted from the definition of FFI and exempt from NFFI withholding may be more specifically defined in regulations, what mechanisms withholding agents could use to identify properly such entities (including self-certification, as appropriate) and whether other classes of entities should be similarly excluded;
- entities that issue, and the appropriate definition of, cash value insurance contracts, annuity contracts, or similar arrangements;
- whether certain small FFIs should be treated as NFFEs;
- the definition of foreign retirement plan and how a foreign retirement plan can identity and document itself and whether other categories of foreign employee benefit or deferred compensation plans should be subject to the same treatment as foreign retirement plans;
- the treatment of other foreign entities, including foreign charitable organizations that may fall within the definition of an FFI;
- specific suggestions for defining and identifying specific classes of foreign entities that should be: (i) excluded from the definition of FFI; (ii) considered deemed compliant FFIs, or (iii) identified as posing a low risk of tax evasion pursuant to section 1471(f);
- the various new obligations on financial institutions to collect information and identify persons;
- the approaches described in the notice to report account balances and other potential approaches that may provide adequate information in a manner that can be administered by participating FFIs without being subject to manipulation by U.S. account holders;
- possible currency translation conventions;
- the specific situations in which foreign laws may prevent the reporting of information required by section 1471 or 1472, along with descriptions of the steps that would be required of a participating FFI (and account holders of U.S. accounts maintained by the FFI) to overcome or waive any such restriction;
- how to minimize burdens on participating FFIs with respect to reporting on gross receipts and withdrawals; and
- whether and in what circumstances a participating FFI that elects to report as though it were a U.S. person should be permitted to make the election for only a subset of its accounts.
In addition, section 5 of the notice specifically requests comments on
- the verification requirements applicable to participating FFIs;
- the treatment of so-called "pass-through payments" (payments that are attributable to a withholdable payment);
- the election by a participating FFI, in lieu of acting as withholding agent for pass-through payments it makes to its account holders, to have the withholding agent that makes the payments to the participating FFI undertake certain withholding responsibilities;
- sanctions with respect to recalcitrant account holders;
- how to treat FFIs that are legally or effectively prohibited from having U.S. investors (along with requests for specific information regarding applicable foreign law and practices);
- procedures that may be followed by U.S withholding agents that are not financial institutions (or for payments by a financial institution to foreign persons who are not holders of financial accounts maintained by the financial institution), such as for arms-length payments made for goods or services in the ordinary course of the withholding agent's trade or business; and
- possible approaches to reduce the burden imposed on participating FFIs, especially regarding information that may be available to the IRS from other sources.
The detailed rules and analysis set forth in Notice 2010-60 give U.S. payors and foreign payees their first glimpse at the burdens and responsibilities that they will be encountering under the new rules. The notice's lengthy list of requests for comments indicates that the IRS remains open to (or is at least unsure of) a variety of implementation issues. This makes it all the more important for affected foreign entities to begin the determination of whether the costs and burdens of complying with the new reporting and withholding rules are worth the benefits of holding U.S. investments or having U.S. investors. For those U.S. payors and foreign payees that know that they are, or potentially may be, subject to the new rules, it is imperative to begin the transition and, if clarification is needed, participate in the development of the guidance process.