The Foreign Account Tax Compliance Act (“FATCA”) is a US law designed to counter offshore tax avoidance by US persons. Controversial because of its wide-ranging breadth and application to non-US financial institutions, in the most general sense, FATCA imposes a 30% withholding tax on payments of US source income made to foreign financial institutions (“FFIs”) unless they enter into an agreement with the US Internal Revenue Service (“IRS”) and disclose information about their US account holders.
After having revised the timelines for FATCA’s implementation on several occasions (culminating in an implementation delay of over three years from the date of its adoption in March of 2010), FATCA’s official July 1, 2014 implementation date is on the horizon. As a result, FFIs worldwide have made a mad dash in the race toward FATCA compliance over the last few months.
So why does this matter to non-banking/non-financial institutions? Well, as an initial matter, FATCA’s definition of an FFI is broad, including more types of entities than one might expect. As a result, US entities must make sure they have evaluated their corporate structure to determine whether its network includes an FFI. Under FATCA rules, the following types of entities may qualify as FFIs, subject to certain exceptions:
- Non-US retirement funds and foundations
- Special purpose entities and banking-type subsidiaries
- Captive insurance companies
- Treasury centers, holding companies, and captive finance companies
Additionally, even if an organization’s affiliate network does not include an FFI, US-based entities could be making payments subject to FATCA’s withholding requirements, and therefore, be subject to FATCA’s requirements on withholding agents. Under FATCA regulations, any individual, corporation, partnership, trust, association, or any other entity, including any foreign intermediary, foreign partnership, or U.S. branch of certain foreign banks and insurance companies that has control, receipt, custody, disposal, or payment of any withholdable payment is a withholding agent. Importantly, many multi-national enterprises that are withholding agents are already obligated to report, withhold on payments, and document payees, but FATCA requires changes to these activities. Specifically, FATCA mandates that these businesses evaluate entity payees differently, engage in withholding on certain gross proceeds transactions (a major change from the previously mandated processes) and report different information to the IRS.
Furthermore, a US entity’s non-FFI affiliate may be receiving withholdable payments which, although may not be subject to withholding by virtue of its non-FFI status, could cause some hiccups if the entity has not considered its (potential) FATCA obligations. The key in this instance is for the non-FFI to substantiate its status as a non-FFI to its withholding agents (and thereby, to the IRS).
The costs of FATCA non-compliance can be severe. On its face, the possible loss of 30% of the value of specific payments is no joke. And, among other penalties, neither is FATCA’s rule that a payor who fails to deduct and remit FATCA withholding when required will be liable for 100% of the amount not withheld as well as related interest and penalties. As a result, and in the face of FATCA’s July 1, 2014 implementation deadline, multi-national businesses must work quickly to determine FATCA’s specific impact and to develop a customized course of action for compliance.