The U.S. Treasury on July 26, 2012 released a model intergovernmental agreement (the model IGA) that is designed to implement, and in certain cases simplify, the reporting and withholding provisions of the Foreign Account Tax Compliance Act (FATCA). Developed in consultation with France, Germany, Italy, Spain and the United Kingdom, the model IGA establishes a framework within which partner countries will collect and report to the U.S. government detailed information from resident financial institutions about financial accounts held by U.S. persons, in some cases in exchange for similar information from the U.S. government.
Although the model IGA provides welcome clarity on a number of fronts, it does not fully and clearly address the important issue of withholding on foreign passthru payments made by or to foreign financial institutions. Accordingly, developing market practice dealing with FATCA in the documentation of many international capital markets, syndicated lending, securitization, derivatives, and other transactions involving such institutions is unlikely to be affected immediately by the release of the model IGA.
FATCA imposes a 30% U.S. withholding tax on certain payments (generally, U.S.-source payments and certain as-of-yet-undefined "foreign passthru payments") to foreign financial institutions (FFIs) that do not comply with FATCA (nonparticipating FFIs), with the goal of compelling FFIs to report information about financial accounts held by U.S. persons (U.S. accounts) to the U.S. government. While the implementation of FATCA presents numerous challenges, among the most difficult are bank secrecy and data protection laws that prohibit FFIs from disclosing account information to anyone other than the government of the jurisdiction in which the account is located. Without some other means of reporting the information sought by FATCA, FFIs in these jurisdictions face the unpleasant choice of violating local laws or incurring the FATCA withholding tax.
Account Reporting Obligations under the Model IGA
The model IGA seeks to resolve the conflict of laws issue outlined in the prior paragraph by requiring that an FFI in a country that has signed the model IGA (a FATCA Partner) report U.S. account information to its own government, which will then provide this information annually to the U.S. government under existing tax treaties or tax information exchange agreements. In general, any FFI or branch of an FFI that is a resident of, or is located in, a FATCA Partner jurisdiction (a Reporting FATCA Partner FFI or RFPFFI) will be subject to such account information reporting requirements, although the model IGA envisions a category of FFI that will be exempt from such reporting requirements (a Non-Reporting FATCA Partner FFI or NRFPFFI). The details concerning eligibility for NRFPFFI status have been left for future bilateral negotiation.
A FATCA Partner's information collection and exchange obligation, and consequently each RFPFFI's U.S. account reporting obligation, will phase in over time, with basic U.S. account balance and identification information required for 2013 and 2014, and more comprehensive U.S. account information, including with respect to interest and gross proceeds from the sale or other disposition of property which can produce interest or dividends from U.S. sources, due in subsequent years. In a liberalization of the proposed FATCA regulations issued in February, the model IGA extends until December 31, 2013 the date by which an account must be opened in order to qualify for the less stringent reporting requirements for "preexisting accounts". The model IGA also simplifies account due diligence procedures by aligning them more closely with existing anti-money laundering requirements under local law.
In a further relaxation of existing FATCA guidance, the model IGA indicates that certain categories of financial products will not be treated as financial accounts, and therefore will not be subject to the U.S. account reporting requirements outlined above. As with eligibility for NRFPFFI status, however, the details will be worked out later on a bilateral basis.
RFPFFIs, Recalcitrant Account Holders, and Non-compliance
In general, an RFPFFI that provides the required information to its government will not be subject to withholding under FATCA. The model IGA is also explicit that a U.S. account will not be treated as a "recalcitrant account" under FATCA (and therefore will not be subject to withholding or termination) if the information required under the model IGA is reported to the U.S. government. It is unclear, however, whether a RFPFFI will still be required to withhold on or close U.S. accounts for which such information is not furnished. In any event, an RFPFFI must still withhold on U.S.-source payments to nonparticipating FFIs if it has elected to assume primary withholding responsibility for such payments (e.g., as a qualified intermediary). Where it has not elected to assume primary withholding responsibility with respect to a U.S.-source payment, an RFPFFI must furnish such information as is necessary for withholding to occur.
Where the U.S. finds "significant non-compliance" on the part of an RFPFFI with respect to its obligations under the model IGA, that RFPFFI will have 18 months to regain compliant status or it will be treated as a nonparticipating FFI subject to withholding under FATCA. The model IGA does not specify when the U.S. will consider an RFPFFI to be in significant non-compliance with its obligations, but the FATCA Partners will be responsible for addressing the non-compliance in the first instance.
In a nod to the multinational nature of today's financial institutions, an RFPFFI with an affiliate or branch located in a jurisdiction where FATCA compliance is not possible will still be treated as compliant with the model IGA if it agrees to treat its affiliate or branch as a nonparticipating FFI for reporting and withholding purposes. It must also ensure that its affiliate or branch reports U.S. account information to the U.S. government to the extent legally possible and does not solicit accounts held by U.S. persons or nonparticipating FFIs outside of its jurisdiction.
Reciprocal Account Reporting by the U.S.
The model IGA comes in two versions, once of which provides that the U.S. will have a reciprocal obligation to collect and report information relating to accounts held in U.S. financial institutions by residents of FATCA Partners. This reciprocal version of the model IGA will only be available to jurisdictions that have an income tax treaty or tax information exchange agreement in effect with the U.S. and which have appropriate safeguards to ensure that such information is used only for tax purposes. While the reciprocal model IGA at presently contemplates a fairly limited U.S. reporting obligation, the U.S. has pledged to pursue legislation that would broaden the scope of its reporting obligation to match that of its FATCA Partners.
Passthru Payment Withholding Reserved
As expected, the model IGA does not fully address whether and to what extent foreign passthru payments or gross proceeds from the sale or other disposition of property that could produce U.S.-source interest or dividends will be subject to withholding when paid by or to an RFPFFI, although it does make a commitment to developing "a practical and effective alternative approach to achieve the policy objectives of foreign passthru payment and gross proceeds withholding that minimizes burden [sic]." By stating that each RFPFFI "will be treated as complying with, and not subject to withholding under" FATCA, however, the model IGA suggests that payments received by RFPFFIs (e.g., from domestic transactions wholly within an IGA jurisdiction, from non-IGA jurisdictions, and from U.S. sources) will not be subject to such withholding. On the other hand, RFPFFIs may still be required to withhold on foreign passthru and gross proceeds payments they make to nonparticipating FFIs. International financial transactions will therefore potentially still be subject to foreign passthru payment and gross proceeds withholding, even when participants from IGA jurisdictions are primarily those involved. In light of this, and given that the model IGA has not yet been adopted formally, developing market practice regarding the disclosure and allocation of FATCA withholding risk in the documentation of many international capital markets, syndicated lending, securitization, derivatives, and other transactions involving FFIs is unlikely to be affected immediately by the release of the model IGA.
Adoption of the Model IGA
At present, no country has signed the model IGA, nor is there a timetable as to when any countries will do so. However, in a joint communiqué, France, Germany, Italy, Spain, the United Kingdom and the United States stated that they "look forward to a speedy conclusion of bilateral agreements based on the model, including by other jurisdictions."
Circular 230 Disclosure
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