In an effort to combat tax evasion by U.S. persons, Congress enacted the Foreign Account Tax Compliance Act (“FATCA”) in 2010.1 FATCA is intended to stop tax evasion by encouraging foreign financial institutions (“FFIs”) to enter into agreements with U.S. authorities or suffer a 30 percent withholding penalty described below. Pursuant to these agreements, the FFI is required to provide U.S. authorities with information regarding the financial accounts at the FFI controlled by U.S. persons (a “U.S. account”). In addition, requiring certain non-financial foreign entities (“NFFEs”) to provide U.S. authorities information about their substantial U.S. owners.

Alternatively, if the U.S. government and the FFI’s (or NFFE’s) host country enter into an agreement and the FFI (or NFFE) reports its U.S. accounts to the host country tax authority, then the FFI would not be required to enter into agreements to report the U.S. account information to the U.S. authorities. The U.S. has already entered into an agreement with the U.K. and is negotiating agreements with several other countries.2 The Treasury Department has prepared a model reciprocal agreement and a model non-reciprocal agreement.

A FFI is an entity organized outside the United States that generally accepts deposits in the ordinary course of a banking or similar business, a substantial part of its business consists of holding financial assets for the account of others, is engaged in the business of investing, reinvesting or trading in securities, or is an insurance company.3

FATCA seeks to encourage compliance by imposing significant withholding penalties on noncompliant FFIs and NFFEs. Specifically, if a FFI or NFFE fails to comply with FATCA, then payors (including other FFIs) making “withholdable payments” to the non-compliant FFI or NFFE are required to withhold thirty percent of the payment.4

Withholdable payments include U.S. source fixed or determinable, annual or periodic gains, profits and income including gross proceeds from U.S. sources that produce fixed or determinable, annual or periodic gains, profits and income.5 Amounts withheld are generally refundable to the beneficial owner.

The Department of the Treasury recently issued proposed regulations implementing the FATCA regime. Among other things, these proposed regulations (i) refine the definition of a financial account, (ii) expand the number of categories of FFIs that are deemed to be in compliance with FATCA (“deemed compliant FFIs”), and (iii) provide guidance regarding the diligence procedures FFIs are required to undertake in order to identify U.S. accounts and to verify compliance. The Department of the Treasury expects to finalize these regulations and the agreements to be entered into with FFIs later this fall.

Definition of Financial Account

The definition of financial account has been modified in an attempt to more narrowly focus on traditional bank, brokerage, money market accounts and interests in investment vehicles.6

Deemed Compliant FFIs

Deemed compliant FFIs are not required to enter into agreements with U.S. authorities and consist of (i) registered deemed compliant FFIs, (ii) certified deemed compliant FFIs, and (iii) owner-documented FFIs.

A registered deemed compliant FFI is required to register with the IRS every three years and certify that it satisfies the requirements of the applicable category. The categories of registered deemed compliant FFIs are (i) local FFIs, (ii) non-reporting members of a participating FFI group, (iii) qualified collective investment vehicles, and (iv) restricted funds.7

Certified deemed compliant FFIs are non-registering local banks, retirement plans, non-profit organizations, and low-value account FFIs. Certified deemed compliant FFIs are not required to register with the IRS. Instead, the certified deemed compliant FFI is only required to certify to the relevant payor that it satisfies the requirements of its applicable category of certified deemed compliant FFI. Such certification is made using IRS Form W-8.8

An owner documented FFI is a FFI that does not accept deposits in the ordinary course of business, does not hold financial assets for the account of others and is not an insurance company (and is not affiliated with such a FFI). In addition, owner documented FFIs cannot maintain financial accounts for non-participating FFIs and cannot issue debt in excess of $50,000 to any person. Owner documented FFIs are not required to register with the IRS, but are required to provide the payor (or withholding agent) sufficient documentation regarding the owner documented FFI’s owners.9

Diligence Procedures

The recently issued proposed regulations provide guidance regarding the diligence steps a FFI is required to undertake to identify U.S. accounts. A FFI that complies with these diligence steps will be deemed to have complied with the requirement that such FFI identify any U.S. accounts. If a FFI does not undertake these steps, such FFI may be strictly liable if it fails to identify U.S. accounts.

For pre-existing accounts of individuals, the FFI is not required to review accounts with a balance or value of $50,000 or less ($250,000 for cash value insurance or annuity contracts). For accounts with a balance or value between $50,000 and $1,000,000, the FFI should review the electronically searchable data for information suggesting the account is held by a U.S. person. Such information includes (i) a U.S. place of birth, (ii) a U.S. address, (iii) a U.S. telephone number, (iv) standing instructions to transfer funds to an account maintained in the United States, (v) a power of attorney granted to a U.S. person, (vi) a U.S. “in-care-of” address, or (vii) an indication that the person is a U.S. person. If the electronic search does not turn up such information, then no further investigation is required. If the account exceeds $1,000,000, then the bank should review both electronic and non-electronic files for any information regarding whether the holder is a U.S. person. Review of non-electronic files is not required if the electronic files contain sufficient information about the account holder.10

For pre-existing entity accounts, FFIs should review the information previously provided by the entity under the existing anti-money laundering and know your customer rules to determine whether the entity is a U.S. person. If the entity is a passive investment entity and has an account balance in excess of $1,000,000, then the FFI should either obtain information from the entity regarding its substantial U.S. owners (if any) or a certificate from the entity that it does not have substantial U.S. owners.11

For new individual accounts, the FFI should review the information provided under the antimoney laundering and know your customer rules for indicia that the account is being opened by a U.S. person. If this information suggests the individual is a U.S. person, then the FFI should obtain additional documents to determine whether the individual is a U.S. person.12

For new accounts opened by passive entities, the FFI is required to determine whether the entity has any substantial U.S. owners. New accounts opened by other FFIs or by entities actively engaged in a non-financial trade or business are exempt from documentation requirements.13