Foreign Account Tax Compliance Act (FATCA) Overview

The 2010 Foreign Account Tax Compliance Act (FATCA) (which was part of a larger jobs bill) contains a number of provisions that are intended to make it more difficult for U.S. taxpayers to use foreign accounts to shelter income from U.S. tax. It also imposes new requirements on certain foreign taxpayers with U.S. investments. Moreover, many of the provisions of FATCA are now subject to final regulations that were issued in January 2013. As someone with overseas connections, you are about to become subject to increased reporting requirements for your financial accounts and increased “know your customer” requirements to avoid being obliged to withhold from payments to foreign vendors and suppliers, even though you are already U.S. tax-compliant and not part of the targeted group. Many of the new requirements are not immediately effective, but we want to be certain that you are aware of them so that you can plan to bring your business into compliance.

 

Mandatory Withholding on Foreign Accounts. Effective July 1, 2014, a U.S. entity that makes virtually any type of payment to a foreign financial institution (FFI) will be required to withhold and remit 30% of the payment to the IRS, unless the status of the FFI has been documented as exempt from the requirement and certain reporting requirements are met. The types of payments subject to withholding include, for example, interest, dividends, royalties, premiums, annuities, and wages. Additionally, this withholding obligation will also, effective January 1, 2017, extend to payments of proceeds from the sale of property that can produce interest or dividends. The recipient FFI may avoid this 30% withholding by entering into an agreement with the IRS to identify all its account holders who are U.S. taxpayers and providing such identifying information to the IRS. The IRS is accepting online registration applications on its website at http://www.irs.gov/Businesses/Corporations/FATCA-Registration. You should begin to familiarize your accounts payable group — and any other department of your business that administers payments — with these rules, what documentation they will need to gather to determine whether FFIs that you pay have entered into an agreement with the IRS, are covered by an alternative exemption, or if it will be necessary for you to withhold on payments made to them.

 

While the requirements for your payments to contractors, suppliers, and vendors that are not FFIs are somewhat less stringent, you still have some “know your customer” documentation to acquire to demonstrate that you will have no obligation to withhold from payments to them.

Finally, you will need to assume that your systems can track payments that must be reported to the IRS under FATCA. Reporting, although not required until March 31, 2015, will cover payments made in 2014 when it begins.

 

Repeal of Foreign Exceptions to Registered Bond Requirement. In 1982, the United States curtailed the use of “bearer” (i.e., unregistered) bonds by U.S. taxpayers, because they could be too easily used for tax evasion purposes. An exception was made for certain bonds held by non-U.S. taxpayers, but the IRS found that this exception was also subject to abuse. As a result, FATCA denies an interest deduction for interest paid on any unregistered bond, effective for bonds issued after March 18, 2012.

 

Disclosure of Foreign Financial Accounts. The Bank Secrecy Act requires that U.S. taxpayers file an annual report with the U.S. Treasury of any foreign financial accounts with an aggregate value of more than $10,000 at any time during the year. This is commonly known as the “FBAR” requirement. FATCA, for the first time, makes a similar requirement part of the Internal Revenue Code, thereby transferring to the IRS the authority to both interpret and enforce reporting. The FATCA provision differs from the Bank Secrecy Act in that it applies the reporting requirements only if the value of specified assets (including financial accounts) exceeds $50,000; so far, the IRS has not integrated this with the FBAR requirement, which continues to have a $10,000 threshold, so duplicate reporting is required. The IRS has suspended this FATCA reporting requirement for domestic entities until final regulations are published, but it applies to individual returns submitted after December 21, 2011.

Penalties for Failure to Disclose Foreign Accounts. In addition to the new reporting requirements, FATCA imposes new penalties for both the failure to disclose a foreign financial account and for any understatement of tax that results from an undisclosed foreign financial account. These penalties will make it very costly for taxpayers who conceal income generated by foreign accounts.

 

Extended Statute of Limitations for Undisclosed Foreign Accounts. The IRS normally has three years in which to audit a tax return after it has been filed. FATCA extends that period to six years in the case of certain unreported income from a foreign financial account.

 

Increased PFIC Reporting. FATCA imposes new reporting requirements for passive foreign investment companies (PFICs). A PFIC is a foreign corporation that generates passive income, i.e., interest and/or dividends, and is often used as an investment vehicle. Foreign hedge funds are usually PFICs. The government is concerned that U.S. taxpayers are not properly reporting their PFIC income, and FATCA requires that U.S. taxpayers who are PFIC shareholders file an annual report with the IRS.

 

Electronic Reporting. FATCA authorizes the IRS to impose electronic reporting requirements on financial institutions that are withholding agents, even if the institution files less than 250 information returns (the current threshold). This provision is designed to better capture information from institutions that currently do not file electronically.

 

Foreign Trust Enforcement. Due to concerns that U.S. taxpayers are using foreign trusts to avoid U.S. tax, FATCA makes a number of changes in the rules governing foreign trusts. Under prior law, a foreign trust was subject to U.S. tax if it was established by a U.S. taxpayer and it had a U.S. beneficiary. FATCA expands the classes of persons considered trust grantors and beneficiaries, thereby bringing more foreign trusts under U.S. tax jurisdiction. FATCA also requires that any person who is taxable as the owner of a foreign trust must provide such information about the trust as the IRS may require. It backs up this requirement with stiff new penalties.

 

Taxation of Dividend Equivalents. Dividends paid by U.S. corporations to foreign individuals and entities are generally subject to a 30% withholding tax, although that tax rate is usually reduced by an applicable tax treaty between the U.S. and the resident country of the recipient. Foreign shareholders have attempted to avoid the withholding tax by taking “dividend equivalents,” such as securities lending transactions, sales-repurchase agreements, or notional principal contracts, in lieu of actual dividends. FATCA makes it clear that such dividend equivalents are to be treated as U.S.-source dividends for tax purposes.

In conclusion, you can see that this legislation is an attempt by Congress to make it more difficult for U.S. taxpayers to avoid tax on overseas accounts. You should begin a review of your transactions with your foreign contractors, vendors, and suppliers to ensure that you are in compliance as the provisions of FATCA come into effect. Click here to contact us to assist you in that effort.

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