HM Treasury (in conjunction with the governments of France, Germany, Italy and Spain – together the 'FATCA Partners') have published the terms of a model agreement (the 'Model Agreement') which they propose to enter into with the US government (the 'IRS') and which is intended to address concerns about FATCA compliance for financial institutions established in the FATCA Partner jurisdictions.
The Model Agreement is intended to allow UK (and other FATCA Partner) financial institutions to comply with their FATCA obligations in situations where domestic law (such as data protection) prohibits the necessary exchange of information. This is achieved by requiring the financial institution to pass relevant information to their tax authorities who in turn will pass it on to the IRS.
What is FATCA?
A brief recount of the thinking behind the FATCA legislation is useful in order to understand the significance of the proposed Model Agreement.
The FATCA legislation is complex US anti avoidance tax law aimed at stopping US citizens and taxpayers 'hiding' income offshore. It is potentially very wide in application and has significant extra territorial scope.
The principal aim of the FATCA rules is to force all non-US 'Foreign Financial Institutions' (FFIs) to report to the IRS information on those 'Financial Accounts' maintained by the FFI that are 'US Accounts'.
The 'stick' to be used by the IRS in the case of 'non-compliant' FFIs is the threat of 30% withholding imposed on 'US Source Withholdable Payments' (ie payments including US source dividends, interest, rents, salaries, and gross proceeds from sale) made to such FFIs. This is known as the 'basic FATCA charge'. However, withholding in respect of the basic FATCA charge will not arise where the FFI signs up to a 'FATCA Agreement' (an agreement with the IRS to annually report information on its US shareholders, policyholders, account holders etc), nor where the FFI is otherwise 'deemed' FATCA compliant.
For completeness, an FFI which signs up to a FATCA Agreement may also be required to withhold, again at 30%, from payments it makes (i) to other FFIs that have not entered into a FATCA Agreement, and (ii) to holders of Financial Accounts who fail to provide information as to their status. This is the so-called 'passthru payment' regime. Beyond making this point, this briefing does not focus on the passthru regime - the details of which have not yet been fully developed.
The basic FATCA charge is due to come into force on 1 January 2014. The commencement date for the passthru regime is unknown but it is not expected to be before 2017.
The Model Agreement
To understand the significance of the proposed Model Agreement, some further background is needed. FATCA provides for some grandfathering rules. Broadly these exclude from FATCA transactions entered into before 1 January 2013 and not 'materially modified' thereafter. Therefore, irrespective that FATCA withholding charges are not expected before 2014, it will in relation to post 1 January 2013 transactions be imperative to have certainty as to whether FFIs would be able to become FATCA compliant. The important question in this regard has been whether an FFI has the ability to comply with FATCA as a matter of law as well as of practice without breaching domestic law rules which are binding on the FFI, such as rules relating to privacy, data protection and confidentiality. In recognition of such difficulties, the US has entered into discussions with various governments, to define by agreement how FATCA compliance may be achieved.
The result of these discussions is the Model Agreement. Under the Model Agreement, a UK established financial institution (UKFI) will be treated as FATCA compliant provided it meets the following conditions:
- it identifies 'US Reportable Accounts';
- in respect of each US Reportable Account it provides to HMRC certain information including (amongst other things) the name, address, account number, account balance or value (as at the end of the calendar or reporting period) and, where relevant, the US tax identification number.
In turn, HMRC will pass on the information to the IRS (similar information gathering and sharing rights will allow the non-US governments similar rights as against the IRS). In consequence, that UKFI will not generally suffer basic FATCA withholding.
Dealing with the FATCA withholding tax risk in practice
Once the Model Agreement takes effect, we expect that most UKFIs will become or will be in a position to become FATCA compliant. The Model Agreement therefore heralds some good news for UKFIs as it should lead to FATCA in practice not being an issue in the majority of cases.
The LMA recently published draft provisions to address the risk of FATCA withholding in the context of bank lending entered into before 31 December 2012. Broadly, one draft provision allocates the FATCA withholding risk to the lender (so no FATCA gross up arises for the borrower), and the other to the borrower (so borrower has to gross up for FATCA withholding in respect of interest paid to the lender). The Model Agreement will when implemented significantly reduce the FATCA exposure for lenders who meet the relevant conditions. How market practice will evolve in the light of the Model Agreement remains to be seen: will lenders, reflecting perhaps the fact that a lender would not normally be grossed up as long as it is able to remain a Qualifying Lender, not expect to be grossed up where it is possible to comply with the provisions of the Model Agreement and thus treated as FATCA compliant or will any residual risks remain with borrowers?
It is likely that the Model Agreement will be rolled out and applied in jurisdictions other than the UK, France, Germany, Italy and Spain. Given the European Union involvement in the negotiations, it is likely that the Model Agreement, once finalised, will become market standard across Europe. A similar type of agreement is also expected between the US and each of Switzerland and Japan.
If you have any questions about how the Agreement or FATCA more generally will affect your business or a current or impending transaction, please contact one of the authors.
IRS Circular 230 Disclosure:
This document is not intended to be fully comprehensive, nor to provide U.S. tax advice. Notwithstanding this, to ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax information contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Recipients of this document should seek advice based on their particular circumstances from an independent, appropriately qualified, tax advisor.