Enacted as part of the Hiring Incentives to Restore Employment Act in March 2010, the Foreign Account Tax Compliance Act (“FATCA”) provides new withholding rules designed to encourage information reporting on foreign accounts held by U.S. persons. Last summer the Internal Revenue Service (“IRS”) issued preliminary guidance on implementation of information reporting, withholding, and documentation requirements under FATCA in Notice 2010-60. The IRS recently provided additional FATCA guidance in Notice 2011-34, which was published April 8, 2011.

Background

Effective for payments made after December 31, 2012, FATCA imposes a 30% withholding tax on payments of certain types of income (e.g., dividends, interest, rents, etc.) to foreign financial institutions (“FFIs”) and other foreign entities unless such institutions/entities agree to provide information to the IRS regarding accounts and other interests held by U.S. taxpayers or qualify for an exception to the new withholding tax regime. An FFI includes any foreign entity that (i) accepts deposits in the ordinary course of a banking or similar business, (ii) as a substantial portion of its business holds financial assets for the account of others, or (iii) is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in these assets. This third category is very broad and encompasses private equity funds, venture funds, mutual funds, funds of funds and similar investment vehicles.

An FFI can avoid withholding on payments it receives by entering into an FFI Agreement with the IRS. A non-financial foreign entity (“NFFE”) can avoid the 30% withholding tax by providing the IRS with information on its “substantial U.S. owners” or certifying that it has no such U.S. owners. Under an FFI Agreement, participating FFIs (“PFFIs”) will be required to (i) obtain information regarding each account holder as necessary to determine which (if any) of the accounts maintained by such institution are U.S. accounts, (ii) report certain information with respect to U.S. accounts, and (iii) withhold on certain payments to account holders that fail to provide the PFFI with the requisite information (so-called recalcitrant accountholders). Notice 2010-60, as modified by Notice 2011-34, provides separate procedures for identifying individual financial accounts and entity financial accounts and within these two categories, sets forth different procedures for account identification depending on whether the account is a pre-existing account or a new account.

Notice 2011-34

Notice 2011-34 provides revised identification procedures for pre-existing individual accounts, sets forth the method to calculate the portion of a payment that is a “passthru” payment subject to withholding, and identifies certain classes of FFIs that will be treated as deemed-compliant.

Revised Identification Procedures for Pre-Existing Individual Accounts

Notice 2011-34 provides revised procedures for identifying pre-existing individual accounts that replace the procedures for identifying pre-existing individual accounts set forth in Notice 2010-60. The major change is increased diligence with respect to “private banking accounts” to determine whether such accounts have indicia of U.S. ownership. Under Notice 2011-34, an FFI must perform a diligent review of the paper and electronic files and other records for each client based on the best knowledge of the private banking relationship manager responsible for such account. A “private banking account” is any account maintained or serviced by an FFI’s private banking department or any account with respect to which an FFI provides personalized services such as investment advisory, trust and fiduciary, estate planning or other services not generally provided to account holders. Notice 2011-34 also provides new rules relating to high value accounts (i.e., accounts with a balance of $500,000 or more) and requires an FFI’s chief compliance officer to certify to the IRS when the FFI has completed the procedures for identifying its pre-existing individual accounts.

Passthru Payments

Under FATCA, a PFFI is required to deduct and withhold on any passthru payment made to a recalcitrant accountholder or a non-participating FFI (collectively, “non-participating accounts”). The definition of “passthru payment” is very broad and includes not only the types of income described above as subject to withholding (e.g., U.S. source interest, dividends, rents, etc.) but also a portion of any payment made to a non-participating account based on the ratio of the FFI’s U.S. assets to total assets. In Notice 2011-34, the IRS specifically declined to adopt a tracing method (i.e., to treat only that portion of a payment to a non-participating account attributable to U.S. source income as subject to withholding) and instead adopted a rule that treats a portion of each payment to a non-participating account as a passthru payment subject to withholding based on the FFI’s “passthru percentage”, which is determined by dividing the PFFI’s U.S. assets by its total assets. Accordingly, if a PFFI has some U.S. assets, a portion of any payment to a recalcitrant accountholder or non-participating FFI will be subject to withholding even if the recalcitrant accountholder or non-participating FFI is not actually paid directly from the PFFI’s U.S. investments. Each PFFI will be required to make its passthru percentage available on a website or database readily searchable by the public and a PFFI that does not calculate its passthru percentage and publish its passthru percentage as required will be deemed to have a passthru percentage of 100%.

Deemed-Compliant FFIs

Pursuant to Section 1471(b)(2) of the Internal Revenue Code, Treasury and the IRS may treat an FFI as a “deemed-compliant” FFI if: (A) such entity (i) complies with procedures prescribed by the IRS to ensure that it does not maintain U.S. accounts and (ii) meets such other requirements as the IRS prescribes for accounts of other FFIs maintained by such entity or (B) the entity is a member of a class of institutions for which the IRS has determined that the application of FATCA is not necessary. Notice 2011-34 identifies several additional categories of FFIs that will be deemed-compliant FFIs, including certain local banks, local FFI members of participating FFI groups, and certain investment vehicles. In order to qualify as a deemed-compliant FFI, an FFI will be required to (1) apply for deemed-compliant status with the IRS, (2) obtain an FFI identification number (FFI-EIN) from the IRS identifying it as a deemed-compliant FFI and (3) certify every 3 years that it meets the requirements for such treatment.

You can view the full text of Notice 2011-34 by clicking here.

The deadline for providing written comments on Notice 2011-34 is June 7, 2011. Written comments should be sent to:

CC:PA:LPD:PR (NOT-121556-10),
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044