On Dec. 13, 2018, the Internal Revenue Service and the Treasury Department issued proposed regulations addressing various aspect of the withholding and information reporting regime under the Foreign Account Tax Compliance Act. These proposed regs provide significant relief from potential withholding and compliance burdens that U.S. and non-U.S. financial institutions would otherwise be subject to under FATCA. Most importantly, these proposed regs can generally be relied upon until final regs are issued.
No Withholding on Gross Proceeds
As background, FATCA’s main tool to achieve its goal of preventing U.S. taxpayers from holding unreported assets and income offshore is a 30 percent withholding tax imposed on certain U.S.-source payments made to a foreign financial institution that doesn’t agree to provide the U.S. government with the identity of the FFI’s U.S. account holders. FATCA applies to withholdable payments of: (1) interest, dividends, rents and certain other specified items of income from U.S. sources, and (2) gross proceeds from the sale or other disposition of property of a type that can produce interest or dividends from U.S. sources (such as a sale of stock or a debt instrument of a U.S. issuer. Withholding on payments described in (1) above is currently in effect. Withholding on payments described in (2) above is scheduled to come into effect on Jan. 1, 2019.
Based on the broad statutory grant of authority given the IRS and the Treasury to provide exceptions to the definition of withholdable payments, the proposed regs eliminate withholding on gross proceeds entirely. The government determined that financial institutions faced significant administrative burdens attempting to comply with such withholding and that the tax policy underlying FATCA wasn’t substantially affected by such gross proceeds withholding.
Financial institutions that were in the process of preparing to comply with FATCA’s gross proceeds withholding requirements will be relieved of that potential administrative burden.
Withholding on Foreign “Passthru” Payments
The proposed regs also extend the time for withholding on foreign passthru payments made to a reluctant account holder or nonparticipating FFI. Withholding isn’t required on foreign passthru payments made before the date that’s two years after the publication of final regulations defining the term “foreign passthru payment.”
The rationale for suspension of time for withholding on foreign passthru payments is that since the United States adopted FATCA, the U.S. has signed or agreed in principle to over 100 bilateral agreements with other governments that implement FATCA’s goals. These bilateral agreements are commonly referred to as “intergovernmental agreements.” Many of these IGAs between the U.S. and another jurisdiction avoid FFIs in the other jurisdiction when entering into agreements directly with the IRS. Based on the numerous IGAs that the U.S. has negotiated, the preamble to the proposed regs states that both the IRS and the Treasury have determined, at least for now, that withholding on foreign passthru payments isn’t required at this time, pending further analysis and possible guidance.
As with the elimination of withholding on gross proceeds, the suspension of withholding on foreign passthru payments should provide administrative and recordkeeping relief to financial institutions otherwise affected.
Clarification of the Definition of “Investment Entity”
FATCA and implementing regulations defined an entity as an “investment entity” (which includes a financial institution) if the entity’s gross income is primarily due to investing, reinvesting or training in financial assets and the entity is “managed by” certain specified entities (which includes those in the banking or financial asset management business). The existing regulations provide that “managed by” means “discretionary management” over the assets of the investment entity.
The proposed regs clarify that an entity won’t be treated as an “investment entity” solely because it invests in a mutual fund or other pooled investment vehicle that’s widely held and where the financial institution offering interests in the vehicle doesn’t have specific discretionary authority over the entity’s investment.
The author would like to acknowledge Proskauer Tax Talks for background for this article. For more information, see www.proskauertaxtalks.com/2018/12/fatca-significant-relief-in-new-proposed-regulations/.