United States: US IRS Issues Preliminary FATCA Guidance Establishing Due Diligence Procedures and Information Reporting Rules for Foreign Financial Institutions

Originally published September 16, 2010

Keywords: IRS, FATCA, guidance, foreign financial institutions, HIRE, withholding tax, rules, guidance

On August 27, 2010, the US Internal Revenue Service (the "IRS") published Notice 2010-60 (the "Notice") containing preliminary guidance regarding implementation of the so-called FATCA rules.1 The HIRE Act, enacted on March 18, 2010, imposed new information reporting and withholding tax rules contained in chapter 4 of the Internal Revenue Code (the "Code").2

Chapter 4 of the Code generally imposes significant new due diligence, information reporting and control burdens on non-US financial intermediaries and investment entities. These non-US entities include banks, financial institutions, certain insurance companies, and investment funds and other collective investment vehicles (whether treated as a corporation, partnership or trust under US or non-US law), regardless of whether any of these non-US financial intermediaries or investment entities maintain accounts for US persons or, in the case of non-US investment entities, are owned by US persons.3 Failure to comply with the information reporting provisions of FATCA could result in the imposition of a 30 percent withholding tax imposed on a noncompliant institution's portfolio investments in US securities.

Executive Summary

The Notice provides preliminary technical guidance regarding the definition of a foreign financial institution (FFI). It also provides guidance on certain exceptions from FFI status and chapter 4 withholding generally, due diligence procedures for identifying accounts beneficially owned by US persons, information that FFIs must report to the IRS pursuant to an FFI Agreement and the scope of grandfathered obligations exempt from chapter 4 withholding.

As a general matter, and as was widely expected, the preliminary guidance would require FFIs to conduct thorough due diligence intended to fully identify all account holders in order to report information regarding US persons to the IRS. The rules provide few exceptions for traditional financial institutions and do not materially limit the application of these rules to non-US investment vehicles that qualify as FFIs. Accordingly, affected stakeholders will need to reassess whether they are able to comply with these due diligence obligations or whether they might purposefully choose to not comply (and avoid the application of these rules), perhaps by disinvesting from the United States or closing the accounts of US persons.

The Notice also solicits comments on a wide range of topics. Comments are requested by November 1, 2010, presumably to enable the US Treasury Department (Treasury) and the IRS to consider such comments when drafting implementing regulations. Accordingly, it would appear that Treasury and the IRS remain open to working with affected stakeholders to promulgate rules that result in the identification of specified US persons but that are not unduly burdensome. Consideration should be given to submitting comments that propose alternative less-burdensome methods that effect FATCA's disclosure goals.

FFI and NFFE Classification Issues and Examples

As a general matter, the Notice clarifies whether: an entity is an FFI subject to the requirements of chapter 4 of the Code; an FFI that is deemed to be compliant with the requirements of chapter 4, without the need for the entity to enter into an FFI Agreement with the IRS (a "deemed-compliant FFI"); or an entity identified as posing a low risk of tax evasion and exempted from withholding pursuant to section 1471(f). The Notice uses the term "participating FFI" to mean an FFI that enters into an FFI Agreement with the IRS pursuant to section 1471(b) and the term "non-participating FFI" to mean an FFI that has not entered into such an agreement and is, therefore, subject to withholding tax imposed by section 1471(a).

The Notice clarifies that an entity that is excluded from the definition of a financial institution would be considered a non-financial foreign entity (NFFE) and subject to the information reporting and withholding rules applicable to NFFEs. In certain cases where Treasury and the IRS exempt an entity from FFI status, discussed below, Treasury and the IRS will issue rules that also exempt such entity from NFFE status.

The Notice also provides some useful examples of entities that would generally be treated as FFIs.

  • FFIs that are described in section 1471(d)(5)(A) include entities that qualify as banks pursuant to section 585(a)(2) (including banks described in section 581 and any corporation that would so qualify under section 581 except for the fact that it is a non-US corporation), savings banks, commercial banks, savings and loan associations, thrifts, credit unions, building societies and other cooperative banking institutions.4
  • FFIs that are described in section 1471(d)(5)(B) include broker-dealers, clearing organizations, trust companies, custodial banks and other entities acting as custodians with respect to the assets of employee benefit plans.5
  • FFIs that are described in section 1471(d)(5)(C) include mutual funds (or their non-US equivalent), funds of funds (and similar investments), exchange-traded funds, hedge funds, private equity funds and venture capital funds, other managed funds, commodity pools and other investment vehicles.

With respect to section 1471(d)(5)(C) FFIs, the Notice takes a expansive view of determining when such entities are primarily engaged in the business of investing, reinvesting or trading and provides that these terms do not have the same meaning as they do when used elsewhere in the Code. In this regard, isolated transactions that generally would not give rise to a "trade or business" may result in an entity being engaged primarily in the business of investing, reinvesting or trading. The test ultimately requires a review of the applicable facts and circumstances, including a review of the magnitude and importance of the applicable transaction in comparison to the entity's other activities. Treasury and the IRS anticipate issuing regulations that will provide guidelines for determining what types of activity, carried on in whole or in part, constitutes the business of investing, reinvesting, or trading, and when an entity is primarily engaged in such a business.

EXEMPTIONS FROM DEFINITION OF FFI AND OTHER EXCEPTIONS FROM CHAPTER 4 REQUIREMENTS

Treasury and the IRS have exercised the authority granted in section 1471 to exclude certain entities from being considered FFIs or to otherwise limit the application of chapter 4 to certain beneficial owners of withholdable payments.

Companies Excluded from FFI and NFFE Status

The following entities that would otherwise qualify as FFIs solely by reason of section 1471(d)(5)(C) will not be treated as FFIs and will also be exempt from the withholding rules applicable to NFFEs.

  • Holding companies, but only if their subsidiaries are primarily engaged in a trade or business other than a financial institution business. Investment funds, such as private equity funds and similar funds, are excluded from this exception.
  • Start-up companies, but the exception is limited to the first 24 months following the organization of a non-financial institution business.
  • Non-financial entities in the process of liquidation or reorganization.
  • Hedging or financing centers of a non-financial group with respect to transactions entered into with members of such group that are not FFIs.

Insurance Companies

Insurance companies whose business consists solely of issuing property or casualty insurance or reinsurance contracts or term life insurance contracts (without cash value) will be treated as NFFEs.

In the view of Treasury and the IRS, insurance companies that issue life insurance or annuity contracts present the opportunity for US tax avoidance that chapter 4 was designed to prevent. Accordingly, comments are requested regarding the treatment of such insurance companies and these types of insurance products for purposes of chapter 4.

Small FFIs

A large number of section 1471(d)(5)(C) FFIs might have a only small number of direct or indirect account holders, all of whom may not be subject to information reporting or withholding under sections 1471 or 1472 (e.g., family trusts or investment vehicles). Accordingly, the Notice provides that a "small" FFI that qualifies as an FFI only by reason of section 1471(d)(5)(C) will be treated as a deemed-compliant FFI if it provides certain information to the withholding agent that makes a payment to the FFI and if such withholding agent complies with certain information reporting obligations.6

While this exception may appear generous at first glance, these deemed-compliant FFIs will be obligated to effectively conduct the same comprehensive due diligence and disclosure of specified US persons as participating FFIs; however such disclosure would be to the withholding agent that makes a payment to the small FFI and not to the IRS directly. Accordingly, this rule is likely to benefit only those FFIs that have full access to the information of those persons treated as account holders. In many ways this "exception" is similar to the obligations of a non-qualifying intermediary (NQI) under the qualified intermediary rules of section 1441 (i.e., collect information regarding account holders and transmit that information to the withholding agent making a payment to the NQI).

Classes of Persons that Pose a Low Risk of Tax Evasion Under Section 1471(f)

As a general matter, section 1471(f) provides that withholding under section 1471(a) does not apply to payments to the extent that the beneficial owner is part of a class of persons identified Treasury and the IRS as posing a low risk of tax evasion.

Although a retirement plan is considered an FFI, the Notice concludes that certain retirement plans generally pose a low risk of tax evasion and payments made to such plans would be exempt from section 1471(a) withholding tax. In order to qualify for this exception, a retirement plan must (i) qualify as a retirement plan under the laws of the country in which it is organized, (ii) be sponsored by a non-US employer and (iii) not allow US participants or beneficiaries other than employees that worked for the non-US employer in the country in which the retirement plan is established during the period in which benefits accrued. Non-US multinational companies whose US-resident employees participate in the non-US retirement plan of the non-US parent company would not satisfy this rule; therefore, such a retirement plan would continue to be treated as an FFI subject to section 1471(a).

TREATMENT OF OTHER ENTITIES

US Branches of FFIs

Generally, there is no exclusion under section 1471(a) for a US branch of an FFI. Payments made to such branch that constitute effectively connected income (ECI) pursuant to sections 871(b)(1) or 882 are not treated as withholdable payments subject to tax under section 1471(a) (the "ECI Exception"). The ECI Exception, however, is inapplicable to payments received by the US branch on behalf of its account holders or payments that are not otherwise treated as ECI.

Treasury and the IRS do not intend to exempt an FFI from the requirement to enter into an FFI Agreement, even if the FFI only receives withholdable payments through its US branch. Thus, an FFI would be obligated to enter into an FFI Agreement with the IRS in order to avoid section 1471(a) withholding tax, to the extent that its US branch receives withholdable payments that are not subject to the ECI Exclusion. Treasury and the IRS are considering whether a US branch of an FFI that receives a payment as an intermediary may document its account holders using the procedures applicable to US financial institutions (USFIs).

Controlled Foreign Corporations

Prior to the issuance of the Notice, Treasury and the IRS received several comments requesting that a controlled foreign corporation (CFC), as defined in section 957, that would qualify as a FFI pursuant to section 1471(d)(5) should be treated as a deemed-compliant FFI due to the information reporting requirements currently applicable to CFCs. Treasury and the IRS did not adopt this suggestion; therefore, CFCs that qualify as FFIs will be required to enter into FFI Agreements in order to avoid the withholding tax imposed by section 1471(a). It is anticipated that Treasury and the IRS will issue coordination rules intended to avoid duplicative reporting.

COMMENTS REGARDING ENTITY CLASSIFICATION

Treasury and the IRS have requested comments regarding the treatment of entities discussed above. Comments are also requested regarding identifying specific classes of non-US entities that should be (i) excluded from the definition of an FFI, (ii) treated as a deemed-compliant FFI pursuant to section 1471(b)(2) or (iii) identified as posing a low risk of tax evasion pursuant to section 1471(f).

Due Diligence and Reporting Obligations of Participating FFIs

Under the Notice, participating FFIs must make several determinations in order to meet their obligations under sections 1471 and 1472. They must first identify whether individual account holders are to be treated as US persons or other persons, and whether account holders that are entities are treated as US persons, FFIs, entities posing low tax evasion risk described in section 1471(f), or NFFEs. Participating FFIs must then determine whether those entities that are US persons are specified US persons or other US persons; whether FFIs are treated as participating FFIs, deemed-compliant FFIs, or non-participating FFIs; and whether NFFEs are to be treated as US-owned foreign entities (to the extent they have substantial US owners) or whether they are excepted NFFEs. Similarly, USFIs making withholdable payments to entities must make similar determinations as to how to classify such entities.

For purposes of identifying US persons, FFIs will be able to rely on Forms W-9 already collected from their existing account holders for other US tax purposes. In addition, the IRS will issue employer identification numbers (EINs) to participating FFIs as a means of identification, but until such EINs are issued, withholding agents and participating FFIs may rely on certifications provided by FFIs as to their status as participating FFIs, unless the withholding agent or participating FFI knows or has reason to know such certification is incorrect.

The Notice creates two separate due diligence regimes: one for accounts existing as of the date the FFI Agreement becomes effective and another for accounts created after such date.

PREEXISTING INDIVIDUAL ACCOUNTS

Participating FFIs must follow certain steps to determine whether accounts held by individuals as of the date that an FFI Agreement becomes effective are US accounts, accounts of recalcitrant account holders or other accounts. As discussed below, this review is initially based on information contained within electronically searchable databases maintained by the FFI. However, all accounts that are not identified as US accounts are subject to further testing such that all accounts are fully scrutinized within five years of the effective date of the applicable FFI Agreement.

Preexisting individual accounts are tested using a four-step process in order to determine if the account is a US account. First, low balance accounts (i.e., less than $50,000) may be classified as non-US accounts. Second, accounts owned by individuals who have been documented as US persons, generally by providing a Form W- 9, are considered US accounts. Third, accounts are tested for certain US indicia (e.g., notation in file that the account holder is a US citizen or US resident, US address or place of birth, hold mail accounts, power of attorney granted to person with a US address, or standing transfer instructions to an account at a US financial institution or instructions from a US address). Lastly, in cases where such indicia are present, the FFI will obtain a Form W-9 from the account holder or will obtain documentary evidence (and in some cases a W-8BEN) in order to rebut the US indicia.

FFIs must complete this initial review and request any documentation necessary to confirm or rebut the US indicia within one year from the effective date of its FFI Agreement. Account holders must provide the requested documentation within one year from the date of such request or they will be classified as recalcitrant until they provide such documentation.

Accounts that have not been not identified as US accounts under these procedures but which had an average monthly balance exceeding $1 million must be retested using new account procedures, discussed below, within two years after the effective date of the FFI's FFI Agreement. All remaining accounts must be retested using new account procedures within five years after the effective date of the FFI's FFI Agreement. Retesting is not required if the FFI has otherwise collected, reviewed and maintained documentation establishing US or non-US status of the accounts and such status is reflected in electronically searchable information maintained by the FFI.

NEW INDIVIDUAL ACCOUNTS

Steps similar to those applicable to preexisting individual accounts will be required for "new" accounts opened by individuals after the effective date of the FFI's FFI Agreement. A new account is any account established with the FFI after the FFI Agreement effective date, including sub-accounts for existing account holders.

The significant difference between the due diligence procedures for preexisting and new accounts is that for new accounts an FFI is required to obtain and examine documentary evidence establishing the individual beneficial owner's US or non-US person status. FFIs are required to obtain Form W-9s from US persons. It is unclear what kind of documentary evidence is needed to establish an account holder's US or non-US status, particularly in the case where the individual is a non-US citizen who is a US resident or holds dual citizenship.

Notwithstanding the requirement to obtain documentary evidence establishing the individual as a US person or a non-US person, FFIs are still required to test for US indicia with respect to individuals who have presented documentary evidence that they are non-US persons. The question of whether such US indicia suggests that the individual is a US or non-US person may be rebutted or confirmed using procedures similar to those applicable to preexisting accounts. Ultimately, an FFI may be required to retest accounts periodically when the FFI knows or has reason to know that the circumstances surrounding the account's classification has changed. Presumably, future guidance will be issued to help identify when such periodic reviews are required.

PREEXISTING ENTITY ACCOUNTS

The due diligence required for entity accounts is more complex than what is required for individual accounts. As a general matter, an FFI is required to ultimately determine whether an account is a US account subject to information reporting or if not properly documented, to withholding tax. In the course of this process, the FFI is also required to classify whether the entity is an FFI (and if so, whether it is a participating FFI, a deemed-compliant FFI or a non-participating FFI), an NFFE (and if so, whether it is an excepted NFFE), an entity posing a low risk of tax evasion described in section 1471(f), or an account belonging to a recalcitrant account holder.

As in the case of individual accounts, FFIs are permitted to treat entities that have already identified themselves as US persons for other purposes of the Code (presumably by providing the FFI a Form W-9) as US persons for purposes of chapter 4. US persons may provide the FFI, within one year from the effective date of the FFI's FFI Agreement, with documentation that establishes that the US person is not a specified US person. A US person that does not provide such documentation within the one year period will be treated as a specified US person until such documentation is provided.

FFIs will be required to review their electronic databases for indicia of US status (e.g., a place of formation or incorporation within the United States). Entities that have such US indicia will be presumed to be US entities. These presumed US entities may provide documentation to the FFI establishing that they are not US entities or, if they are US entities, that they are not specified US persons. FFIs are permitted to seek clarification regarding the status of the entity within one year of the effective date of the FFI's FFI Agreement. The entity must provide the requested information within one year from the date of the request or it will be classified as a specified US person and a recalcitrant account holder after the one year period expires and until such information is provided.

Entities that are not treated as US entities pursuant to the rules above are presumed to be non-US entities. The FFI must then test the presumed non-US entity to determine whether readily available information clearly indicates that the entity is an FFI.7 If so, the non-US entity will be tentatively presumed to be an FFI and will be requested to provide its FFI EIN and certification of participating FFI status. Upon receipt of the certification and FFI EIN the requesting FFI may treat the entity as a participating FFI, subject to IRS confirmation.8

If no information is provided within nine months after the requesting FFI's FFI Agreement becomes effective, the participating FFI will request (no later than the date that is one year after the effective date of its FFI Agreement) that the presumptive FFI provide documentation confirming whether its is a participating FFI, a deemed-compliant FFI, a non-participating FFI, an entity described in section 1471(f) or an NFFE. If the requesting FFI does not receive such confirmation within one year from the date of the request, the requesting FFI will treat the entity as a non-participating FFI after the expiration of the one year period until such time that documentation is provided confirming the entity's status. During the period when the request for additional documentation is pending, the entity is treated as an excepted NFFE and the account will be considered a non-US account, unless the entity is identified by the IRS as a non-participating FFI on a published list.9

The participating FFI will test entities that are neither a US entity nor an FFI to determine whether the entity is engaged in an active trade or business (other than a financial institution business); if it is, the entity will be treated as an excepted NFFE and its account will be treated as a non-US account.10 In order to conduct this review, the participating FFI will need to examine the entity's file for evidence of business activities, information regarding physical assets used in business activities, persons employed and receivables and payables related to business activities. Participating FFIs may be permitted to rely on third-party credit databases when conducting this review.

Those entities that are not found to be engaged in an active trade or business may provide documentation to the participating FFI that clarifies whether the entity is an FFI (and which type), an NFFE or an entity described in section 1471(f). Documentation existing in the participating FFI's files may be relied upon for this purpose unless the FFI knows or has reason to know such information is unreliable or incorrect.

A participating FFI that requires additional documentation in order to make this determination must request such documentation within one year after the participating FFI's FFI Agreement becomes effective. If no documentation is provided by the entity, the entity account holder will be treated as a non-participating FFI as of the date that is one year following the date of the participating FFI's request until additional documentation is provided.

If the entity account holder is an NFFE, the participating FFI must obtain documentation indicating that the NFFE is an excepted NFFE or must obtain information from the entity that enables the FFI (i) to specifically identify each direct or indirect owner of the entity (other than through ownership of an excepted NFFE, a participating or deemed-compliant FFI, or an entity described in section 1471(f)) and (ii) to comply with its information and withholding tax obligations applicable to US accounts to the extent that a specified US person is found to be a direct or indirect owner of such entity. In other words, the participating FFI is required to fully identify the owners of the entity and report specified US persons that directly or indirectly own an interest in the entity. If no information is provided to the participating FFI with respect to the identified specified US person within two years after the effective date of the FFI's FFI Agreement, the account holder will be treated as a recalcitrant account holder after such period until the date that appropriate documentation is received by the FFI.

NEW ENTITY ACCOUNTS

The same determinations as described above must be made for new entity accounts opened after the FFI Agreement's entry into effect. However, with respect to such new accounts, participating FFIs must make such determinations using all information collected by it (e.g., information collected for opening and maintaining the account, for local anti-money laundering (AML) or know-your-customer (KYC) requirements, etc.), and such information is treated as known by the FFI for determining whether documentation provided by an entity is unreliable or incorrect.

NFFE ACCOUNTS

Participating FFIs are required to utilize the procedures described above that are applicable to entity accounts in order to properly identify and document accounts maintained by NFFEs. The Notice specifically provides that the certification procedures described in section 1472(b) are to be disregarded in favor of the procedures described in the Notice.

Due Diligence and Reporting Obligations of USFIs

A USFI must determine whether to treat entities to which it makes withholdable payments as US persons, participating FFIs, deemed-compliant FFIs, non-participating FFIs, section 1471(f) entities, excepted NFFEs or other NFFEs. In order to ensure consistency between the rules applicable to FFIs and USFIs, the rules applicable to payments made to entity account holders of a USFI will be similar to those of FFIs.

Reporting on US Accounts

IN GENERAL

The Notice provides the preliminary views of Treasury and the IRS concerning an FFI's reporting obligations with respect to US accounts.11 The IRS will develop a new electronically filed form that will used to report information pertaining to the US account. FFIs will be required to provide the account number (or other unique account identifying number), the balance or value of the account and gross receipts and withdrawals or payments from the account.

The Notice provides some needed guidance regarding the manner in which an FFI is required report the value or balance of a US account, and all accounts must be reported in US dollars. Future guidance will provide appropriate currency translation rules. Treasury and the IRS are generally considering using a reporting method that would require FFIs report the highest of the month-end balance to the IRS (or such other period, e.g., quarter-end, if the balance is determined less frequently by the FFI for transmittal to the account holder). FFIs will be required to provide additional account-related information to the IRS upon request (e.g., copies of account statements).

For FFIs that are section 1471(d)(5)(c) FFIs, Treasury and the IRS recognize that valuation of the interest in such entity occurs with less frequency and might differ depending on the valuation method utilized. In such case, Treasury and the IRS may permit such an FFI to report the value based on the method that utilizes more frequent valuations during the year. For instance, if one method of valuation occurs quarterly and another method of valuation is determined annually, the reporting would be based on the average of all quarterly valuations.

Treasury and the IRS have requested comments regarding these preliminary concepts along with other specific issues pertaining to reporting. In particular, comments are requested regarding:

  • Whether there are other administrable valuation methodologies that would not be subject to manipulation by US account holders and currency translation rules;
  • Foreign law prohibitions that could prevent such information reporting and the possible methods that would be used to circumvent such prohibitions, including obtaining waivers from US account holders; and
  • Methods to minimize burdens on participating FFIs with respect to reporting gross receipts and gross withdrawals and payments.

ELECTION BY FFI TO CONDUCT FORM 1099 -TYPE REPORTING

The Notice provides guidance regarding the election that permits an FFI to report information pursuant to the information reporting rules (e.g., via Form 1099) of sections 6041 (payments greater than $600), 6042 (dividends), 6045 (broker reporting of gross proceeds from the sale of US securities, commodities and other specified property) and 6049 (interest) in the same manner as a US financial institution. In this regard, an electing FFI would be obligated to provide the account holder's indentifying information (required pursuant to sections 1471(c)(1)(C) and (D)) but would not be obligated to provide information regarding the account balance or value, and information regarding gross proceeds or gross withdrawals or payments.

Future guidance will provide procedural requirements for making such an election and further specify applicable reporting requirements. Treasury and the IRS are considering whether an FFI may elect to conduct such reporting on an account-by-account basis and request comments in this regard.

REPORTING REQUIRED BY THE FFI WITH MOST DIRECT RELATIONSHIP TO A SPECIFIED US PERSON

Treasury and the IRS recognize that duplicative reporting could occur in the case where a an interest in a section 1471(d)(5)(C) FFI (e.g., a hedge fund) is held by a section 1471(d)(5)(A) or section 1471(d)(5)(B) FFI (e.g., a bank or broker-dealer) on behalf of a specified US person. Accordingly, rather than require information reporting with respect to the specified US person by each of the participating FFIs, only the participating FFI that maintains a direct account relationship with the US person would be required to conduct the reporting required by section 1471(c). The other FFI (in this case, the section 1471(d)(5)(C) FFI) would still be required to comply with its due diligence obligations to identify its account holders. However, this rule would minimize certain costs associated with conducting its otherwise applicable information reporting obligations.

It should be noted that this rule only applies with respect to interests in participating FFIs that are held by other participating FFIs. Thus, a section 1471(d)(5)(C) FFI may be obligated to conduct information reporting (or withhold tax) in cases where interests in such entity are directly owned by non-participating FFIs, NFFEs or specified US persons.

REPORTING WITH RESPECT TO RECALCITRANT ACCOUNTS

The Notice provides that participating FFIs will be obligated to report the number and value of financial accounts held by recalcitrant account holders and non-participating FFIs. In this regard, information regarding recalcitrant accounts that have US indicia will also need to be separately reported to the IRS. The IRS will likely utilize this information to determine whether the incidence of recalcitrant account holders or non-participating FFI account holders warrants a review of whether the participating FFI is in compliance with its FFI Agreement.

Grandfathered Obligations

Section 501(d)(2) of the HIRE Act provides for a rule exempting certain payments made on obligations outstanding on March 18, 2012, or gross proceeds from the disposition of such obligations from the information reporting and withholding tax rules of chapter 4. The Notice provides that regulations will define the term "obligation" to mean any legal agreement that produces or could produce withholdable payments, as that term is defined in section 1473.12 For this purpose, the term obligation would not include any instrument treated as equity for US federal income tax purposes, or any legal agreement that lacks a definitive expiration or term.

Savings deposits, demand deposits and similar accounts are not considered obligations. Similarly, brokerage, custodial and other agreements to hold financial assets for the account of others and to make and receive payments of income and other amounts with respect to such assets are not obligations.

Any obligation entered into on or before March 18, 2012, will be treated as outstanding on March 18, 2012, and any material modification of such obligation will result in that obligation being treated as newly issued as of the effective date of such modification. Whether a modification is considered material will generally be determined using a facts and circumstances test; however, for debt modifications the rules of Treas. Reg. §1.1001-3 will apply.13

Additional Specific Requests for Comment

VERIFICATION PROCEDURES

Treasury and the IRS have requested comments regarding the verification procedures to be utilized to ensure compliance with an FFI agreement; they are considering whether the procedures utilized by an FFI or its auditor to verify the FFI's compliance with its AML/KYC obligations could be utilized to verify compliance with an FFI Agreement. Treasury and the IRS have requested additional information regarding such compliance procedures and the reports generated following such reviews.

Treasury and the IRS are also considering whether certifications of compliance provided by high-level management of an FFI could be sufficient to illustrate compliance with chapter 4 information reporting and withholding obligations. Comments regarding whether these types of representations or certifications are relied on for purposes of AML/KYC audits and examples of such representations or certifications are requested.

TREATMENT OF PASSTHRU PAYMENTS14

The Notice clarifies that the intent of the passthru payment rule is to entice FFIs that indirectly invest in the United States to enter into FFI Agreements in order to avoid being subject to withholding tax. Treasury and the IRS have already received several comments regarding the need for clear rules regarding a method to apportion and allocate withholdable payments to such indirect investors. However, the Notice only requests additional comments regarding the formation of such rules that take into account the administrative burden of allocating and apportioning withholdable payments to indirect investors.

SECTION 1471(B )(3) ELECTION BY FFI TO BE WITHHELD UPON

Section 1471(b)(3) permits a participating FFI to elect, subject to certain to-be-prescribed requirements, to have tax withheld by a withholding agent up the chain of payment, rather than act as a withholding agent itself. Treasury and the IRS have requested comments with a view to solving the administrative challenges raised by this provision, including the scope of such an election, the types of accounts for which an election would be available and the type of information that would be required to be transmitted to the withholding agent by the FFI.

SANCTIONS WITH RESPECT TO RECALCITRANT ACCOUNT HOLDERS

The Notice provides that imposing withholding tax on account holders should not become a permanent substitute for FFIs undertaking the required due diligence and information reporting. Thus, it would not be wise for a participating FFI to take the position that it is acceptable to simply withhold tax on account holders in lieu of complying with the due diligence and information reporting obligations provided in the FFI Agreement. Treasury and the IRS have solicited comments regarding measures that may be used to address long-term recalcitrant accounts, including whether, and in what circumstances, it would be appropriate to terminate an FFI Agreement.

FFIs SUBJECT TO RESTRICTIONS PROHIBITING US ACCOUNT HOLDERS

Treasury and the IRS have received comments regarding certain non-US collective investment vehicles that suggest that such vehicles should be exempted from the requirements of chapter 4 or otherwise treated as deemed-compliant FFIs because certain local rules prohibit US persons from owning of an interest in such vehicles. They have requested additional information regarding these types of prohibitions in order to consider whether such entities should be treated as deemed-compliant FFIs.

APPLICATION OF CHAPTER 4 BY US WITHHOLDING AGENTS OTHER THAN USFIS

Treasury and the IRS are considering allowing US withholding agents that are not USFIs to rely on certifications made by non-US entities regarding such entity's classification for purposes of chapter 4 of the Code. Similar rules would apply with respect to payments made by FFIs and USFIs to NFFEs that are not holders of financial accounts maintained by such financial institution. Treasury and the IRS also expect to provide an exception to withholding on payments made to an NFFE that is engaged in an active trade or business by withholding agents other than financial institutions. Comments are requested regarding the scope of these exceptions and how procedures could be developed to ensure that the NFFE is engaged in an active trade or business.

POTENTIAL MODIFICATIONS TO CHAPTER 4 REQUIREMENTS BASED ON AVAILABILITY OF INFORMATION FORM OTHER SOURCES

Treasury and the IRS recognize that there are instances in which account holder information is already collected by the IRS or readily available to the IRS through other means. Accordingly, Treasury and the IRS are considering whether exceptions to withholding on recalcitrant account holders would be appropriate if a participating FFI transmits sufficient information to the IRS that would enable the IRS to obtain information about the recalcitrant account holder by means of an information exchange request to a non-US jurisdiction that has entered into an information exchange agreement or income tax treaty with the United States.

Footnotes

1. The term "FATCA" is an acronym referring to the Foreign Account Tax Compliance Act of 2009, proposed legislation that was substantially incorporated into Subtitle A of Title V of the HIRE Act.

2. P.L. 111-147. All references herein, unless specified, are to the Internal Revenue Code of 1986, as amended, and the regulations thereunder.

3. For more information, please see our April 20, 2010 Legal Update "Foreign Account Tax Compliance Act of 2009," available at http://www.mayerbrown.com/publications/article.asp?id=8881&nid=6.

4. The fact that an entity is subject to banking or credit laws of the United States, a state or a political subdivision thereof, a foreign country or to supervision and examination by agencies having regulatory oversight of banking or similar institutions is relevant but not determinative of whether the entity qualifies as a section 1471(d)(5)(A) FFI.

5. Similar to section 1471(d)(5)(A) FFIs, entities that are subject to US federal, state or non-US banking or credit laws, or regulatory oversight applicable to broker dealers is relevant but not determinative of whether the entity qualifies as a FFI pursuant to section 1471(d)(5)(B).

6. It is unclear what constitutes "small" for this purpose, but presumably subsequent guidance will provide a fixed number of individuals (e.g., possibly less than 25) who hold an interest in the debt or equity of the section 1471(d)(5)(C) FFI.

7. Presumably, future guidance will identify how a participating FFI will be required to conduct a review that is intended to provide the FFI with the basis to conclude that the tested entity is "clearly" an FFI.

8. Presumably, the IRS will need to create a reasonable procedure that will enable participating FFIs to obtain certifications in a timely manner or to receive notification that the certification provided is invalid.

9. It is expected that FFIs will be required to notify the IRS regarding entities that represent that they are participating FFIs but fail to provide a valid FFI EIN.

10. With little guidance, this rule requires the participating FFI itself to make the potentially challenging determination of whether an account holder is engaged in an active trade or business. Comments have been requested regarding the level of evidence that would be sufficient to establish whether an entity is engaged in a trade or business and methods that could be used to prevent abuse of this rule.

11. As a general matter, section 1471(c) provides that with respect to each US account, the FFI must report certain identifying information (name, address and taxpayer identification number) regarding account holders that are specified US persons or substantial United States owners of US owned foreign entities.

12. The term "withholdable payment" is defined to mean any US source payment (e.g., including but not limited to interest paid by US borrowers, dividends paid by US corporations, rents for the use of property located in the United States, or royalties from the use of intangible property in the United States) and the gross proceeds from the sale or other disposition of property that produces US source income.

13. The Notice provides that, in the case of an obligation that constitutes indebtedness for US tax purposes, a material modification means any "significant modification," as defined under Treas. Reg. § 1.1001-3. Under that section, a modification is generally significant only if, based on all facts and circumstances, the legal rights or obligations that are altered and the degree to which they are altered are economically significant.

14. A participating FFI is obligated pursuant to its FFI agreement to withhold tax on passthru payments made to non-participating FFIs and recalcitrant account holders and to a participating FFI that elects to be withheld upon with respect to passthru payments attributable to accounts maintained by non-participating FFIs and recalcitrant account holders. The term "passthru payment" is defined to mean any withholdable payment or any other payment to the extent attributable to a withholdable payment.

Learn more about our Private Investment Fund, Securitization , Tax Transactions & Consulting and Wealth Management: Trusts, Estates & Foundations practices.

Visit us at www.mayerbrown.com.

Copyright 2010. Mayer Brown LLP, Mayer Brown International LLP, Mayer Brown JSM and/or Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. All rights reserved.

Mayer Brown is a global legal services organization comprising legal practices that are separate entities (the Mayer Brown Practices). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; Mayer Brown JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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