The Foreign Account Tax Compliance Act (FATCA) added a new chapter 4 (sections 1471–1474) to the Internal Revenue Code and Treasury Regulations thereunder. While foreign financial institutions (FFIs) have the most substantial compliance burden under FATCA, the new law also affects non-financial foreign entities (NFFEs). The compliance burden on NFFEs is less onerous than the compliance obligations of FFIs, but failure to comply could result in a 30 percent withholding tax on certain U.S.-source payments. NFFEs may be required to make certifications as to their FATCA status even if they do not receive U.S.-source payments, and failure to provide such certifications may result in other administrative burdens, such as forced account closures.
FATCA went into effect on July 1, 2014, after numerous delays and multiple rounds of administrative guidance. Additional guidance and some transitional relief have been issued since FATCA’s effective date. In addition, the United States has entered into, and continues to negotiate, intergovernmental agreements (IGAs) with many non-U.S. jurisdictions with respect to FATCA. IGA partner jurisdictions have been issuing their own FATCA guidance and are expected to issue their own laws implementing FATCA. Thus, FATCA remains in the development stage. Nevertheless, FATCA is currently the law, and most entities should be able to substantially comply under the guidance currently available.
FATCA imposes a 30 percent withholding tax on certain U.S.-source payments made to foreign entities that do not certify to the withholding agent that they are “in compliance” with FATCA. The FATCA compliance obligations vary significantly depending on a foreign entity’s status as either an FFI or an NFFE. The Treasury Regulations define numerous categories of FFIs, including depository institutions, custodial institutions, investment entities and specified insurance companies. The Treasury Regulations also treat certain holding companies and treasury centers as FFIs.
In order to avoid the 30 percent withholding tax under FATCA, an FFI must certify to the withholding agent that it is either a “participating FFI” (i.e., it has registered with the Internal Revenue Service (IRS) and will comply with the terms of an FFI agreement, which requires it to conduct certain diligence and reporting with respect to U.S. accounts, including debt and equity interest held by U.S. persons) or a reporting IGA financial institution (i.e., it has registered with the IRS and will comply with the terms of an applicable IGA), or that it is otherwise “deemed compliant” with FATCA.
An entity that is not an FFI is treated as an NFFE. NFFEs generally are not required to register with the IRS. To avoid the 30 percent withholding tax, an NFFE receiving a withholdable payment must certify to the withholding agent its status as either a “passive NFFE” or an “excepted NFFE.” If the NFFE is a passive NFFE, it also must identify “substantial U.S. ownership” in the NFFE.
In addition to certifying FATCA status to payors of U.S. source income, foreign entities that maintain accounts at non-U.S. financial institutions will be required to certify their FATCA status to those financial institutions in order to enable the financial institutions to comply with their own FATCA obligations.
While a multinational enterprise engaged in a non-financial business might initially believe that the FATCA status of each entity within its group is that of NFFE, and this belief might ultimately be correct, a number of entities within an affiliated structure could, absent the application of a special rule, qualify as FFIs. In particular, holding companies, treasury centers, captive insurance companies and non-U.S. retirement funds warrant special analysis. Even if an entity’s status as an NFFE is correct, the entity must determine its status as either an excepted or passive NFFE. In addition, the FATCA certification forms may require an NFFE to indicate and certify more specifically its FATCA classification. Thus, as a first step in a non-financial enterprise’s FATCA compliance initiative, the group should conduct a review and analysis of each non-U.S. entity within its “expanded affiliated” group (i.e., 50 percent or more group ownership) to determine each entity’s FATCA classification as FFI, NFFE, passive, excepted or otherwise deemed compliant (including an analysis of any applicable IGA).
Entities Requiring Special Review
Holding Companies and Treasury Centers
A holding company is an entity whose primary activity consists of holding all or part of the outstanding stock of one or more members of the expanded affiliated group. Absent a special exception, a holding company may be treated as an “investment entity” that qualifies as an FFI. Similarly, an entity that acts as the treasury center for an affiliated group also may appear to be an FFI, absent an exception. A treasury center is an entity whose primary activity is to enter into investment, hedging and financing transactions with or for members of its expanded affiliated group for one or more of the following purposes:
- Managing price change, currency and interest rate risk with respect to property, borrowing, or the assets or liabilities with respect to group members
- Managing the working capital of expanded affiliated group members
- Acting as a financing vehicle for expanded affiliated group members
The Treasury Regulations provide an exception for certain “excepted non-financial group entities.” Under this exception, a holding company or treasury center generally will not be treated as an FFI if the holding company or treasury center is a member of a “non-financial group.” For this purpose, a non-financial group is broadly defined as an expanded affiliated group whose “passive” income constituted no more than 25 percent of its gross income during the previous three-year period. Passive income generally includes dividends, interest, rents and royalties, and certain other income not derived in an active trade or business. The exception for holding companies does not apply to holding companies that are formed in connection with, or are availed of by, an investment vehicle established with an investment strategy to acquire or fund companies and to treat the interest in those companies as capital assets held for investment purposes.
While the Treasury Regulations provide exceptions for holding companies and treasury centers within non-financial groups, the IGAs do not explicitly address these types of entities. Thus, until guidance is issued by each relevant IGA jurisdiction or by the IRS, the FATCA status of holding companies or treasury centers within IGA jurisdictions technically remains uncertain. However, a few IGA jurisdictions (e.g., the United Kingdom and Ireland) have issued guidance indicating that holding companies and treasury centers formed within their jurisdictions will be characterized using the approach of the Treasury Regulations or will otherwise not be treated as FFIs. Additional IGA partner countries are expected to issue similar guidance.
Captive Insurance Companies
Captive insurance companies used by non-financial enterprises also require special FATCA consideration to ensure that they are not within any of the FFI categories specified by the Treasury Regulations or an applicable IGA. One category of FFI specified in the Treasury Regulations and the IGAs is a “specified insurance company,” which is an insurance company that issues or is obligated to make payments with respect to cash value insurance or annuity contracts. Foreign captive insurance companies likely will not have any cash value insurance policies or annuity contracts, and therefore generally will avoid qualification as a specified insurance company.
A foreign captive insurance company that avoids classification as a specified insurance company may nevertheless be an FFI as a depository institution if it accepts advance deposits for premiums that are callable by the policyholder. In addition, a foreign captive insurance company may qualify as an FFI as an investment entity. Most captive insurance companies will avoid treatment as an FFI under the investment entity classification because the FACTA regulations provide that the “reserving” activities of an insurance company will not cause the entity to be a depository institution, a custodial institution or an investment entity. Captive insurance companies that are not FFIs are generally treated as passive NFFEs in light of their income being limited to premiums and investment income.
The IRS recently has issued guidance with regards to captive insurance companies in relation to the section 953(d) election, which allows a foreign insurance company to be treated as a domestic insurance company for most tax purposes. An insurance company organized outside the United States that has elected to be classified as a U.S. person under section 953(d) is also a U.S. person for purposes of FATCA (and thus is neither an FFI nor an NFFE), provided that either (1) it is not a specified insurance company and is not licensed to do business in any state, or (2) it is a specified insurance company and is licensed to do business in one or more states. The 953(d) election commonly is made by captive insurance companies used by U.S.-headquartered companies, but is not typically used by companies with non-U.S. headquarters. In practice, captive insurance companies rarely are licensed within any state. Thus, captives with a 953(d) election generally will be treated as a U.S. person for purposes of FATCA.
Non-U.S. retirement funds also must be specially analyzed for FATCA purposes. Absent a special exclusion, the entities or trusts generally would be FFIs. The Treasury Regulations provide, however, that non-U.S. retirement plans will avoid FFI status if they satisfy the requirements of one or more special categories listed in the regulations, or are otherwise included in Annex II to an applicable IGA.
The special categories include treaty-qualified retirement funds, “broad participation” retirement funds, certain “narrow participation” retirement funds, 401(a) type plans, investment vehicles used exclusively by retirement funds, and certain retirement funds of entities that are classified as “exempt beneficial owners.” The specific characteristics of each category are listed in the Treasury Regulations, or the applicable IGA or treaty.
A retirement fund organized in an IGA jurisdiction will be exempt from FATCA FFI registration and reporting requirements if the fund is of a type specified in the applicable IGA. Annex II to the applicable IGA may list additional types of funds and other categories of entities that will be exempt from FATCA and that are not otherwise eligible for any of the exemptions described above.
Application of FATCA to NFFEs
Once an entity’s FATCA status as an NFFE has been determined, the 30 percent withholding tax on withholdable U.S.-source payments will be avoided if the NFFE prepares and submits IRS Form W-8BEN-E to the withholding agent certifying its chapter 4 (and chapter 3) status. In addition, if the NFFE is a passive NFFE, it also must disclose any “substantial” U.S. ownership. A passive NFFE is one where more than 50 percent of gross income is passive income (e.g., dividends, interest, rents and royalties, annuities and gains from the sale of passive assets) and more than 50 percent of assets are held for the production of passive income.
NFFEs also may be required to report their FATCA status and substantial U.S. ownership to non-U.S. financial institutions in which they have accounts and in connection with certain contractual arrangements, in order to enable the non-U.S. financial institutions to conduct their own FATCA diligence. The information may be provided by completing IRS form W-8BEN-E or through self-certification or other documentation provided by the financial institution.
FATCA Transitional Period
The IRS has stated that the 2014 and 2015 tax years will be treated as a transitional period during which “good faith” compliance with FATCA will be an acceptable defense to avoid penalties. Non-financial groups should use this period to develop and implement their FATCA compliance plan.