IRS Issues Proposed FATCA Regulations

On December 13, 2018, U.S. Department of the Treasury and the Internal Revenue Service released proposed regulations (the “Proposed Regulations”) that would amend the current regulations relating to the Foreign Account Tax Compliance Act (“FATCA”) and nonresident (“chapter 3”) withholding.

FATCA, enacted as part of the Hiring Incentives to Restore Employment Act of 2010 (the “Hire Act”), generally requires withholding of 30 percent on certain payments made to a foreign financial institution (“FFI”) unless the FFI is, or is deemed to be, compliant with applicable due diligence, reporting and withholding rules with respect to its accountholders. 

The Proposed Regulations generally would reduce the burden for withholding agents, FFIs and nonresident recipients of certain U.S.-source income payments and should be of interest to those operating in the private fund or mutual fund industries, in the securitization industry, and in other areas where withholding agents make payments to non-U.S. recipients (such as dispositions of stock and other securities). 

Most notably, the Proposed Regulations would make the following changes: 

• Eliminate FATCA withholding on gross proceeds from the sale or other disposition of assets that could produce U.S.-source dividends or interest, which under the current regulations is scheduled to apply to payments made on or after January 1, 2019; 
• Defer the effective date for withholding on foreign passthru payments, a “passthru payment” having been statutorily defined in the Hire Act as any withholdable payment or other payment “attributable to” a withholdable payment, until the date that is two years after the date the term “foreign passthru payment” is defined in final regulations; 
• Eliminate FATCA withholding on non-cash value insurance premiums; 
• Amend existing FATCA regulations to clarify that an entity is not viewed as “managed by” another entity for purposes of the FATCA regulations solely because the entity invests all or a portion of its assets in the other entity if such other entity is a mutual fund, exchange traded fund, or a collective investment entity that is widely-held and is subject to investor protection regulations; however, an investor in a discretionary mandate would be viewed as being “managed by” the advising financial institution for purposes of the FATCA rules; 
• Modify certain FATCA and chapter 3 due diligence and documentation requirements, including those relating to (i) claims for benefits under an applicable U.S. income tax treaty and (ii) a permanent residence address subject to a hold mail instruction; 
• Revise the procedural rules for claiming credits and refunds for taxes overwitheld under FATCA and chapter 3 with respect to nonresident partners of partnerships so as to eliminate the potential mismatch (which arises under the so-called “lag method” provided in current instructions to IRS Form 1042) between income allocated to nonresident partners and the withholding on that income; 
• Extend the applicable periods during which a withholding agent may apply the reimbursement and set-off procedures, which are procedures that allow withholding agents to rectify previous overwithholding of taxes under FATCA or chapter 3; and 
• Allow nonqualifying intermediaries that are participating FFIs or registered deemed-compliant FFIs to report taxes withheld under FATCA as those withheld under chapter 3, to assist the accountholders in claiming foreign tax credits in their respective home jurisdictions. 

The elimination of FATCA withholding on gross proceeds and non-cash insurance premiums that are described above also apply to payments made to non-financial foreign entities (“NFFEs”). 

The Proposed Regulations may be relied upon until final regulations are issued except for the revisions relating to credits and refunds of withheld taxes, which may not be relied upon until the IRS Forms 1042 and 1042-S are updated for the 2019 calendar year. The proposed changes relating to (i) the elimination of withholding on non-cash value insurance premiums, (ii) the clarification of the definition of a “managed by” investment entity and (iii) the revised allowance for a permanent residence address subject to a hold mail instruction, may be applied for all open tax years until final regulations are issued. 

Global Observations 

The United States may be the only developed nation that has not adopted the Organisation for Economic Co-operation and Development’s Common Reporting Standard (“CRS”), which, similar to FATCA, is an automatic intergovernmental exchange of tax and fiscal information system. 

One crucial difference between CRS and FATCA lies in the enforcement mechanism employed by the respective regimes. Under CRS, a financial institution that fails to comply with CRS would be subject to penalties imposed by its jurisdiction of residence, which penalties are generally of a far lesser magnitude than the withholding taxes imposed under FATCA. The elimination of FATCA withholding on gross proceeds narrows the gap in penalties imposed under the two regimes, although the prospect of future foreign passthru payment withholding is disappointing.