The U.S. Department of the Treasury and the Internal Revenue Service have released long-awaited final regulations implementing the Foreign Account Tax Compliance Act (“FATCA”).
Congress enacted FATCA in 2010 as part of the Hiring Incentives to Restore Employment Act (the “HIRE Act”), and it is housed in Sections 1471 through 1474 of the Code. FATCA creates a new tax information reporting and withholding regime for payments made to certain foreign financial institutions and other foreign persons. FATCA requires certain U.S. taxpayers holding foreign financial assets with an aggregate value exceeding $50,000 to report information about those assets on a new form (Form 8938) that must be attached to the taxpayer’s annual tax return.
This Form 8938 is required when the total value of specified foreign assets exceeds certain thresholds. For instance, a married couple living in the U.S. and filing a joint tax return would not file Form 8938 unless their total specified foreign assets exceed $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. The thresholds for taxpayers who reside abroad are higher. For instance, a married couple residing abroad and filing a joint return would not file a Form 8938 unless the value of the specified foreign assets they hold exceeds $400,000 on the last day of the tax year or more than $600,000 at any time during the year. Instructions for Form 8938 provide further information, including details on the thresholds for reporting, what constitutes a specified foreign financial asset and how to determine the total value of relevant assets.
In addition, FATCA will require foreign financial institutions (FFIs) to report directly to the IRS information about financial accounts held by U.S. taxpayers, or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
The primary objective of FATCA is to ensure that any individuals who are liable to pay taxes in the US are paying what they owe, wherever in the world they may be. The rules are designed to detect tax evasion and to prevent U.S. taxpayers who hold financial assets in non-U.S. financial institutions and other offshore accounts from avoiding their tax payment obligations. Where a taxpayer is recalcitrant, FATCA allows 30% to be withheld on payments made to U.S. account holders. Heavy penalties can also be incurred on U.S. account holders if information about U.S. accounts is omitted: failure to file correctly and honestly the required Form 8938 by hiding some assets or income that should have been declared, incurs a penalty of $10,000 per fiscal year.
The regulations finalize the proposed rules issued last February (REG-121647-10), making a number of changes in response to comments. As a result, the 389-page proposed regulations have become 544-page final rules, with a lengthy discussion of which comments prompted changes from the proposed regulations. The Final Regulations incorporate five important changes:
- The new regulations use intergovernmental agreements that foster international cooperation. One area of simplification in the final regulations is the integration of model intergovernmental agreements into the reporting requirements of the regulations. There are two types of intergovernmental agreements: reciprocal and nonreciprocal, which are called Model 1 IGAs and Model 2 IGAs, respectively. FFIs that are in Model 1 IGA jurisdictions report the information about U.S. accounts required by FATCA to their respective governments, which then exchange this information with the IRS. FFIs in Model 2 IGA jurisdictions must comply with the FATCA regulations except to the extent the relevant IGA provides otherwise. The IRS announced that, to date, seven countries have entered into model agreements with the United States: Norway, Spain, Mexico, the United Kingdom, Ireland, Denmark, and Switzerland. Discussions with more than 50 countries are ongoing, and more agreements are expected to be signed in the near future.
- These regulations phase in withholding, due diligence, and reporting requirements over an extended transition period, and align them with intergovernmental agreements. The final regulations phase in over an extended transition period to provide sufficient time for financial institutions to develop necessary systems. In addition, to avoid confusion and unnecessary duplicative procedures, the final regulations align the regulatory timelines with the timelines prescribed in the intergovernmental agreements.
- The new regulations bring about a change in expanding and clarifying the types of payments not subject to withholding, particularly for certain ‘grandfathered’ obligations that are not subject to the rules and certain payments made by non-financial entities.
- The new regulations expand and clarify the treatment of certain low-risk institutions, such as government entities and retirement funds, provide that certain investment entities may be subject to being reported on by FFIs with which they hold accounts rather than being required to register as FFIs with the IRS, and clarify the type of passive investment entity that financial institutions must identify and report.
- These last regulations streamline the compliance and registration requirements for groups of financial institutions, including commonly managed investment funds. The final regulations provide more streamlined registration and compliance procedures for groups of financial institutions, including commonly managed investment funds, and provide additional detail regarding FFIs’ obligations to verify their compliance under FATCA.
- Finally, the final regulations phase in the timelines for due diligence, reporting, and withholding that the IRS had released in Announcement 2012-42. As an overview, withholding agents are required to withhold only for “withholdable” payments made after December 31, 2013. Withholding requirements on gross proceeds and foreign pass-through payments are suspended until January 1, 2017.