Understanding How FATCA Impacts You

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By Stephen Moskowitz and Anthony Diosdi


A. Overview

On March 18, 2010, the HIRE Incentives to Restore Employment Act of 2010 (the “Act”) was enacted into law. Subtitle A of Title V of the Act contains the provisions dealing with “Foreign Account Tax Compliance” also known as “FACTA.” Section 501(a) of the Act added a new Chapter 4 (sections 1471-1474, hereinafter referred to as “Chapter 4”) to the Internal Revenue Code.

Chapter 4 expands the information reporting requirements imposed on foreign financial institutions with respect to certain United States accounts, and imposes withholding, documentation, and reporting requirements with respect to certain payments made to certain other foreign entities. The scope of FATCA is extremely broad. Almost every foreign financial institution (which includes but is not limited to banks, custodians, broker-dealers, insurance companies, certain pension plans, and trustees are a few examples) is within the reach of FATCA.

On February 8, 2012, the Treasury Department released proposed regulations that provide financial institutions with clearer direction in regards to compliance with the new FATCA rules. The proposed regulations leave some unanswered questions. However, while the proposed regulations leave some answered questions, FATCA’s central purpose remains simple. The goal of FATCA is to identify U.S. taxpayers who hold financial assets in non-U.S. financial institutions and other offshore entities, so U.S. taxpayers cannot avoid their U.S. tax obligations.

B. New Withholding and Reporting Methods

The Act introduces a 30 percent withholding tax on certain payments of U.S. source income called “withholdable payments”(1) made to certain financial institutions and other non-financial entities that do not meet the reporting requirements of the Act and other existing relevant guidance. The new reporting requirements applicable to foreign financial institution which, if fulfilled, would eliminate the withholding obligation are different from those applicable to non-financial foreign entities.


A. Overview

Internal Revenue Code contains a regime that is applicable to payments made to foreign financial institutions (“FFI”). It provides that a withholding agent(2) must deduct and withhold a tax equal to 30 percent from any withholdable payment to a foreign financial institution which does not enter into an agreement with the IRS as required by the Act, or that otherwise is not deemed compliant foreign financial institution.(3) An entity is classified as a FFI if it falls within any of the following categories: (4)

The first category would generally include entities that fall within the definition of banks under Section 585(a)(2) of the Internal Revenue Code, savings banks, commercial banks, savings and loan associations, thrifts, credit unions, building societies and other cooperative banking institutions.

The second category may include broker-dealers, clearing organizations, trust companies, custodial banks, and entities acting as custodians with respect to the assets of employee benefit plans.

The third category generally includes, but is not limited to, mutual funds, exchange-traded funds, hedge funds, private equity and venture funds, other managed funds, and commodity pools.
The definition of the term “FFI” was made as broad as possible by the IRS. As such, questions regarding which entities can be classified as an FFI will inevitably be raised in the future. Certain entities which should fall within the definition of being an FFI will nevertheless be released from full obligations of reporting to the IRS. IRS Notice 2010-60 refers in particular to the following cases:

  1. Family trusts and other “small entities” –these are entities with only a small number of account holders or owners who are all natural persons or exempt non foreign financial entities. These small entities will be treated as non foreign financial entities. However, if they identify and document the U.S. persons and exempt non foreign financial entities and report all U.S. persons to the IRS, the small entities can be treated as deemed-compliant FFIs;
  2. Holding companies whose investments are not in the area of financial services;
  3. Newly founded companies (“start-up companies”) in the non-financial services sector;
  4. Companies in liquidation and recently restructured ones active in the non-financial services sector;
  5. Hedging and treasury companies as they are part of a group of companies which is not active in the financial services sector;
  6. Insurance companies, which do not run so-called “cash value” business.
    Notice 2010-60 also provides for exemptions for pension funds and similar institutions, insofar as the retirement plans were set up under local law, they are financed by non-U.S. employer and U.S. persons are prevented from participating in the plan. However, an exemption is made for U.S. persons for the term of their employment with a foreign employer.

B. FFI Requirement to Avoid Withholding

An FFI generally can eliminate the withholding tax required by Chapter 4 if it enters into an agreement with the IRS under which such FFI agrees:

  1. To obtain information regarding each holder of each account maintained by such FFI as is necessary to determine which (if any) of such accounts are United States accounts; (6)
  2. To comply with such verification and due procedures as the IRS may require with respect to the identification of United States accounts;
  3. In the case of any United States account maintained by such FFI to report, on an annual basis, the following information with respect to such account: a) the name, address, and TIN of each account holder which is a specified United States person and, in the case of any account holder which is a United States owned foreign entity,(7) b) the name, address, and TIN of each substantial United States owner of such entity, the account number, c) the account balance or value, and except to the extent provided by the IRS, the gross receipts and d) gross withdrawals or payments from the account; (8)
  4. To deduct and withhold a tax equal to 30 percent of: a) any passthrough payment that is made by such FFI to a recalcitrant account holder(9) which does not meet the reporting requirements required by FATCA, and b) in the case of any passthru that is made to an FFI which elected to be withheld upon rather than withhold on payments to recalcitrant account holders and nonparticipating FFIs, so much of such payments as is allocable to such accounts; (10)
  5. To comply with requests by the IRS for additional information with respect to any United States account maintained by such FFI; and
  6. In any case in which any foreign law would prevent the reporting of any information required by FATCA with respect to any United States account maintained by such FFI: a) to attempt to obtain a valid and effective waiver of such law from each holder of such account, and b) if a waiver is not obtained from each holder within a reasonable period of time, to close such account.

C. Deemed Compliant FFIs

The Treasury may treat an FFI as deemed compliant with Chapter 4 without the need to enter into an FFI agreement if such FFI:

  1. Complies with the procedures that the Treasury may prescribe to ensure that such FFI does not maintain United States accounts, and meets such other requirements that the Treasury may prescribe to accounts of other FFIs maintained by such FFI, or
  2. Is a member of a class of institutions with respect to which Treasury has determined that the application of the Chapter 4 requirements is not necessary. (11)

D. Identification- What is Required on the Customer Side?

When it comes to identifying U.S. accounts, the participating FFIs are obligated to investigate both natural persons and entities when establishing a new account or investigating an account that has been previously opened. In regards to new accounts, which includes any account opened after the effective date of an FFI’s agreement with the IRS (generally July 1, 2013), an FFI will be able to rely on a Form W-8 or other government citizenship or residency documentation- such as a passport- to establish an individual’s status as a foreign payee when opening an offshore account. The FFI is required to review any documentation provided at account opening to determine if U.S. indicia exist. If U.S. indicia are identified as part of the review, the FFI must generally obtain additional documentation. (12)

In regards to accounts that were in place before the establishment of an FFI agreement with the IRS, the FFI will need to make a distinction between deposit accounts with an average monthly balance of less than $50,000 (“small accounts”) and all other accounts. Small accounts can be treated by the FFI as non-US accounts. All other customer information relating to accounts must undergo a due diligence investigation. The Treasury Department will permit an FFI to rely on electronic searches for accounts ranging from $50,000 to $1 million. For accounts with a balance of more than $1 million, FFIs will have to do paper searches that would be limited to documentation, current account files, and certain correspondences. FFIs would also be required to question any relationship managers associated with these accounts to confirm that they don’t have any knowledge that the client is a U.S. person. Searches are not required for accounts of less than $50,000 or for certain insurance contracts of less than $250,000.

The aim of the electronic search is to find U.S. indicia without the FFI having to personally contact the customer. Depending on how strong the indicia is, the FFI must request various documents within one year of entering into the FFI agreement. In concrete terms, in the cases of strong indicia (e.g. U.S. citizenship) FATCA will require the FFI to request a W-9 be completed by the account holder. In the case of weak indicia, request that the account holder complete a Form W-8 BEN or request that the account holder provide documentation proving he or she is not a U.S. taxpayer. If the FFI does not receive the aforementioned requested documentation, the account holder will be considered an uncooperative (“recalcitrant”) account holder. The FFI will be required to withhold the 30 percent FATCA withholding tax.

As far as legal entities are concerned (“entity accounts”), identifying the account holders are far more complex. In general, participating FFI must decide if the legal entities are:

  1. 1. A U.S. account;
  2. Another participating FFI;
  3. A “deemed-compliant” FFI;
  4. A non-participating FFI;
  5. An uncooperative (“recalcitrant”) account holder;
  6. An exempt foreign non-financial entity;
  7. An non-exempt foreign non-financial entity.

In the case of a U.S. account: 1) the FFI must establish whether the account holder is a “specified U.S. person,” who must be reported to the IRS. If the FFI has already treated this account relationship as a U.S. account, the account holder will be given the opportunity to prove otherwise. If documentation proving otherwise is not submitted within one year, this customer will then be considered not participating in FATCA. Such customers will be affected by the FATCA withholding tax.


If a foreign entity is not an FFI, it is a non-financial foreign entity (“NFFE”) for purposes of Chapter 4. An NFFE is also subject to Chapter 4, absent an express exclusion. Under Section 1472 of the Internal Revenue Code, a withholding agent must deduct and withhold from any withholdable payment to a NFFE a tax equal to 30 percent of the amount of such payment if the beneficial owner of such payment is such NFFE or any other NFFE, unless the following requirements are met with respect to the beneficial owner of the payment. (13)

  1. The beneficial owner or the payee provides the withholding agent with either a certification that such beneficial owner does not have any substantial United States owners, or the name, address, and TIN of each substantial United States owner of such beneficial owner;
  2. The withholding agent does not know, or have reason to know, that the information provided is incorrect; and
  3. The withholding agent reports the information to the IRS in such manner as the IRS may provide.(14)

The withholding requirements of Internal Revenue Code Section 1471 will also not apply to withholding payments made to NFFEs if the recipient NFFS is: i) a publicly traded corporation; ii) a member of an affiliated group of corporations; iii) any entity which is organized under the laws of a possession of the United States and which is wholly owned by one or more bona fide residents of such possession; iv) any foreign government, any political subdivision of a foreign government, or any wholly owned agency or instrumentality of any one or more of the foregoing; v) any international organization or any wholly owned agency or instrumentality thereof vi) any foreign central bank of issue; or vii) any class of payments identified by the Treasury for purpose of this exception as posing a low risk of tax evasion. (15)


Chapter 4 provides that every withholding agent that is required to deduct and withhold tax under any provisions of the chapter is liable for such tax and is indemnified against claims and demands of any persons for the amount of any payments made in accordance with the provisions of Chapter 4. (16)


Chapter 4 contemplates a withholding at the source if the reporting requirements discussed above have not been met, and a claim for refund at a later time. The determination of whether a refund is applicable due to an over withholding is done in accordance with the provisions of Chapter 4 of the Code.(17) Importantly, in order for a credit or refund to be allowed or paid with respect to any tax properly deducted and withheld under Chapter 4, the beneficial owner of the payment will need to provide the Treasury such information as the Treasury may require to determine if such beneficial owner is a United States owned foreign entity and the identity of any substantial United States owners of such entity. (18)

There are special rules applicable to FFIs filing for refund. In the case of FFIs that are beneficial owners of a particular payment and that are entitled to a reduced rate of withholding tax under an applicable treaty, the amount of any credit or refund will be limited to the amount of such credit or refund that is attributable to the pertinent reduction rate, and the FFI will not be entitled to interest with respect to such credit or refund. (19)


The United States currently has numerous tax treaties in place with various countries. Under these treaties, a beneficial owner may qualify for reduced withholding rates below 30 percent FATCA rate. Unfortunately, Chapter 4 does not contemplate a reduced withholding rate for an individual who may qualify for reduced treaty rates. Unless an individual or entity complies with the aforementioned FACTA rules, the only way to claim the applicable reduced rate of withholding under a pertinent tax treaty would be to file a refund claim with the IRS. A refund claim would among other activities encompass applying for an Individual Identification Number (“ITIN”) and the filing of a U.S. tax return.
In addition, Chapter 4 does not provide any meaningful guidance as to what level a refund claim may apply in cases in beneficial owners of an entity that may be eligible for treaty benefits. For example, suppose a fund established in the British Virgin Islands is treated as a trust that cannot be classified as a participating FFI or NFFE. However, the beneficial owners of the trust are citizens of the United Kingdom, a country which is eligible for treaty benefits. In such a case, the rules promulgated under Chapter 4 do not clarify whether the British Trust or the citizens of the United Kingdom can file a refund claim with the United States claiming a treaty benefit.

Another problem with the FATCA regime is that it conflicts with the tax information exchange agreements (“TIEA”) that the United States has negotiated with numerous foreign countries. Under a TIEA, the United States may request that a foreign government provide information of a U.S. taxpayer that utilizes offshore entities or foreign bank accounts to avoid U.S. taxes. As drafted, the FATCA rules violate the current TIEA treaties negotiated. This is because the IRS may obtain information in a foreign jurisdiction without having to make a request for information through a foreign government or tax treaty partner under a current existing TIEA. FATCA does not take into consideration existing TIEA agreements or even foreign local law that may preclude an FFI or NFFE from disclosing information compelled under FATCA. Numerous countries such as Canada have strongly opposed the implementation of FATCA due to the massive costs associated with its implementation and concerns that FACTA may violate the application of local law. Although the IRS has acknowledged concerns raised by its foreign counterparts, as of this date, the IRS has provided little in the way of meaningful relief to these objections.


According to the Act, Chapter 4 applies to payments made after December 31, 2012.(20) With that said, the IRS issued Notice 2011-53 which provides for a phased implementation of the various provisions of Chapter 4 due to the significant changes that FFIs and withholding agents need to put in place to comply with FATCA. Below, is a breakdown of the important dates promulgated by the IRS regarding FATCA compliance.
Notice 2011-53

  1. Registration with the IRS begins January 1, 2013;
  2. The registration requires an FFI to enter into an FFI agreement by June 30, 2013 to avoid withholding beginning on January 1, 2014;
  3. U.S. owners of foreign accounts and U.S. owners of non-financial assets must be reported to the IRS beginning in 2016;
  4. Recalcitrant account holders identified and must be reported to the IRS by September 30, 2014;

Under the proposed regulations, the information requirement described above will not become fully implemented until 2016. Until then, the following reporting requirements apply to participating FFIS;


FATCA will likely have a profound effect on global financial institutions and non-financial institutions. Non-U.S. financial institutions, U.S. withholding agents, and non-financial foreign entities will need to comply with FATCA or risk being subject to withholding measures and/or penalties.

FFIs who enter into FFI agreements will have to develop systems that will impact the monitoring of the accounts that are currently in place. Participants will also have to carefully audit new accounts and develop structures for reporting accounts under the terms of FATCA.

U.S. withholding agents with non-U.S. clients will be required to undergo much of the same compliance activity as an FFI. Although withholding agents are not required to enter into an agreement with the IRS, they will be required to withhold on non-participating FFIs. NFFEs will be required to certify to their withholding agents that they have either no substantial U.S. owners or provide the name, address, and TIN of all substantial U.S. owners.

For more information, please call (888) 829-3325 or use the contact form to the right.

  1. “Withholdable payment” means: 1) any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, profits, and income, if such payments is from sources within the United States; and 2) any gross proceeds from the sale or other disposition of any property of a type interest or dividends from sources within the United States. IRC Section 1473(1)(A).
  2. Withholding agent is defined as all persons, in whatever capacity acting, having control, receipt, custody, disposal, or payment of any withholdable payment. IRC Section 1473(4).
  3. IRC Section 1471(a).
  4. Notice 2010-60.
  5. IRC Section 1471(d)(5).
  6. A “United States Account” is any financial account which is held by one or more specified United States person or United States foreign entities (except for individual depository accounts held by an FFI which in the aggregate do not exceed $50,000). IRC Section 1471(d)(1). A “financial account” for this purpose is i) any depository account maintained by an FFI; ii) any custodial account maintained by an FFI; and iii) any equity or debt interest in an FFI (other than interests which are regularly traded on an established securities market). IRC Section 1471(d)(2).
  7. “United States owned foreign entity” means
  8. IRC Section 1471(c)(1).
  9. “Recalcitrat account holder” means any account holder which fails to comply with reasonable requests for information or fails to provide a waiver upon request. IRC Section 1471(d)(6).
  10. IRC Section 1471(b)(3).
  11. IRC Section 1471(b)(2).
  12. The proposed FATCA regulations rely on existing anti-money laundering (AML) know your customer (KYC) policies and requirements.
  13. IRC Section 1472(a).
  14. IRC Section 1472(b).
  15. Prop. Reg. Section 1.1471-6(b).
  16. IRC Section 1474(a).
  17. IRC Section 1474(b)(1).
  18. IRC Section 1474(b)(3).
  19. IRC Section 1474(b)(2)(A).
  20. HIRE ACT, Section 501(d)(1).
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