The Minister of Revenue, the Hon Peter Dunne, recently announced the New Zealand Government’s intention to enter into an Intergovernmental Agreement (IGA) with the US Treasury, regarding the Foreign Account Tax Compliance Act (better known as FATCA).
In this FYI we examine what FATCA is, how it works, how an IGA changes things and what it all means for New Zealand businesses.
What is FATCA?
FATCA was enacted as part of the US Internal Revenue Code in 2010. However, much of the detail of FATCA is found in extensive interpretative regulations (Regulations) that are currently in draft form. The Regulations are expected to be finalised in the near future, as obligations imposed under FATCA will begin to be phased in from 1 January 2013.
The intention of FATCA is to enable the US Internal Revenue Service (IRS) to obtain information about international investments of US citizens, in an effort to better detect and deter tax evasion. This is a particular problem for the US, as it taxes US citizens, wherever they are tax resident, on their worldwide income. This is different from most other jurisdictions (including New Zealand) that only tax residents on their worldwide income.
FATCA will impose obligations on foreign (non-US) financial institutions (FFIs) and non-financial foreign entities (NFFEs) to identify their US account holders or US owners and disclose relevant information to the IRS. The penalty for non-compliance with FATCA by FFIs and NFFEs will be a punitive US withholding tax on their own US investments.
How Would FATCA Work Without an IGA?
The Regulations contain detailed guidance on whether an entity will be considered an FFI. However, the concept broadly includes banks and other deposit taking institutions, entities that hold financial assets on account of others (eg superannuation schemes such as KiwiSaver schemes), entities engaged primarily in investing in securities or other similar interests, and certain insurance companies that offer investment-type products.
There are various categories of exempt or partially exempt FFIs that are considered to pose a low risk of US tax evasion (eg foreign governments and their instrumentalities, non-profit bodies, certain pension funds and certain entities operating solely in the country where they were incorporated). These will have reduced or no reporting obligations.
In the absence of an IGA, FFIs that are not exempt are required to enter into a bilateral agreement with the IRS to carry out certain due diligence activities to obtain relevant information regarding their US account holders, and report this information to the IRS annually. Applications for bilateral agreements with the IRS must be submitted no later than 31 December 2013.
An account holder who does not provide the relevant information requested will be known as a "recalcitrant account holder". Pursuant to the agreement with the IRS, an FFI will be required to deduct a 30% withholding tax (FATCA Tax) from certain US-related payments made to a recalcitrant account holder, or close their account.An FFI that does not enter into and comply with an agreement with the IRS itself faces FATCA Tax on:
- a broad range of passive income (eg interest, dividends, royalties, rent, etc) from US sources (commencing 1 January 2014);
- the gross proceeds from the sale (including redemption) of an asset that produces US-sourced interest or dividends (eg an amount of principal lent under a facility agreement or share sale or redemption proceeds) (commencing 1 January 2017); and
- a payment, known as a "foreign passthru payment", attributable to a US-sourced payment of a kind in (a) or (b) above (commencing 1 January 2017). Further guidance on what types of payments will be considered foreign passthru payments is expected to be included in the finalised Regulations.
Not only US persons, but also compliant FFIs, may be required to withhold FATCA Tax on relevant payments to non-compliant FFIs.
The application of FATCA Tax to the gross proceeds of financial assets means it is significantly wider than an orthodox withholding tax. FATCA Tax charged on gross proceeds will often be ineligible for relief under double tax agreements between the US and other countries (including New Zealand) and will seldom be able to be claimed as a local foreign tax credit.
The starting point is that an NFFE is any foreign entity that is not an FFI, but a large number of entities are excluded from the definition, including publicly traded entities and "active" entities (an entity where less than 50% of its gross income is passive income - eg interest, dividends, royalties, rent, etc).
An NFFE is not required to enter into an agreement with the IRS, but must identify and report to certain US entities with which it transacts, information regarding any substantial (10% or greater) US owners. NFFEs that do not provide such information will have FATCA Tax withheld from US-sourced amounts they receive.
Protection for agreements entered into prior to 1 January 2013
Payments made under, and proceeds from, the disposition of a financial instrument that is outstanding on 1 January 2013 (and later in certain circumstances) will not be subject to FATCA Tax.
Generally, an obligation will be considered outstanding if it has been issued (for a debt instrument) or the relevant agreement has been entered into (for an obligation that is not a debt instrument). Any material modification will result in the obligation being treated as newly issued/executed as of the effective date of the modification.
How Will FATCA Work With an IGA?
FFIs resident in a jurisdiction whose government has entered into an IGA with the US Treasury will not have to enter into bilateral agreements with the IRS. Further, they will generally not be subject to FATCA Tax withholding in relation to their US assets. In addition, FFIs will (in general, but not always) not be required to withhold FATCA Tax on payments they make. Accordingly, New Zealand institutions have welcomed the recent announcement that the Government is seeking to negotiate an IGA.
If New Zealand is successful in entering into an IGA, local institutions will instead have to comply with domestic FATCA-related legislation required under the terms of the IGA. The domestic legislation will impose obligations similar to the base US account due diligence obligations under FATCA. Information will be reported to Inland Revenue which will then provide it to the IRS.
The IGA will also require domestic legislation to provide enforcement powers to Inland Revenue, to ensure local FFIs comply with the domestic FATCA-related legislation. If these enforcement powers do not result in compliance within 18 months, the IRS retains the ability to deem that FFI as non-compliant, causing normal (ie non-IGA) FATCA rules to apply.
The IGA approach should reduce local institutions' compliance costs, particularly by eliminating individual FATCA agreements with the IRS, which in many cases would have necessitated engagement of US advisers. It will also address potential conflicts between FATCA disclosure obligations and domestic privacy laws (such as the Privacy Act 1993). It is expected that domestic FATCA-related legislation will expressly override any conflicting domestic laws.
The IGA discussions may also present the opportunity to negotiate blanket exemptions for certain New Zealand institutions. For example, it has been suggested a blanket exemption for KiwiSaver schemes may be achievable.
NFFEs' FATCA obligations will generally not be relieved or modified by the IGA.
At this stage, the United Kingdom is the only jurisdiction to have concluded an IGA, although the US Treasury is currently in discussions with more than 50 countries, including New Zealand.
What does this all mean for New Zealand businesses?
While the Regulations are yet to be finalised and the form of the IGA between New Zealand and the US is yet to be revealed, the general operation and intended effect of FATCA are clear. Affected local businesses need to ready themselves for the extensive obligations that they will have, even under the IGA approach.
In addition, despite an IGA, where a local business enters into an agreement, such as a cross-border loan, involving payments potentially subject to FATCA Tax, that possibility will still need to be addressed. That is, like any withholding tax, consideration will need to be given to:
- whether any relevant "gross-up" clause should require the borrower to gross-up for FATCA Tax; and
- representations and warranties relating to FATCA compliance.
While FATCA Tax will be particularly relevant when dealing with US parties, given the wide reach of the rules, agreements between two non-US parties will also in many cases need to address the potential FATCA Tax burden.