Daily Tax Update - August 27, 2010: IRS Issues Guidance Implementing FATCA

THE DAILY TAX UPDATE WILL BE PUBLISHED ON A PERIODIC BASIS UNTIL CONGRESS RETURNS FROM ITS AUGUST RECESS ON SEPTEMBER 13TH.

TREASURY AND IRS ISSUE NOTICE ON PRIORITY FATCA IMPLEMENTATION ISSUES: Today, the Treasury Department and Internal Revenue Service (“IRS”) issued Notice 2010-60, which provides “preliminary guidance regarding priority issues” involving the implementation of the information reporting and withholding requirements of the Foreign Account Tax Compliance Act (“FATCA”) provisions of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147 (the “HIRE Act”). In sum, the Notice addresses the scope of the grandfathered obligations exception of HIRE Act section 501(d)(2), the definition of a foreign financial institution (“FFI”) under new Internal Revenue Code (“Code”) section 1471(d)(4), the scope of information collection under new Code sections 1471 and 1472, and the information about US account holders to be reported by FFIs under an agreement with the IRS.

  • Grandfathered Obligations Exception. Section 501(d)(2) of the HIRE Act provides an exemption from the new withholding requirements for any obligation outstanding on March 18, 2012 (or the gross proceeds from any disposition of such an obligation). The Treasury and IRS intend to define the term “obligation” for purposes of this exception as a legal agreement that produces or could produce withholdable amounts, but excluding equity or any legal agreement that lacks a definitive expiration or term. As a result, savings or demand deposits would not qualify for the grandfathered obligations exception. In addition, the Treasury and IRS also intend to issue regulations providing that any “material modification” of an obligation (which, for obligations constituting debt for US tax purposes, will be defined as any significant modification under Treas. Reg. § 1.1001-3) will result in the obligation being treated as newly issued. As a result, any significant modification after March 18, 2012 of an obligation treated as debt for US tax purposes will cause the obligation to lose its grandfathered status.
  • Definition of Foreign Financial Institution. FATCA generally requires a withholding agent to withhold 30% of any “withholdable payment” made to a FFI that has not entered into an agreement with the IRS in which the FFI agrees to undertake certain reporting, withholding, and due diligence responsibilities. Code section 1471(d)(5) defines a “financial institution” as any entity that accepts deposits in the ordinary course of a banking or similar business, holds financial assets for the account of others as a substantial portion of its business, or is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in certain securities, partnership interests, commodities, or any interest in such items.
    • According to Notice 2010-60, the Treasury and IRS anticipate issuing regulations stating that whether an entity is engaged primarily in the business of investing, reinvesting, or trading in securities must be determined on the basis of all relevant facts and circumstances.
    • The Treasury and IRS intend to exclude certain entities from the definition of a FFI. A foreign entity, the primary purpose of which is to act as a holding company for a subsidiary (or subsidiaries) that primarily engages in a trade or business other than that of a financial institution, will be excluded from the definition of a FFI, unless that holding company acts as an investment fund. Foreign start-up companies investing capital in assets with the intent to operate a non-financial institution business will also be excluded from the definition of a FFI for the first 24 months after the entity’s organization. A foreign entity in the process of liquidating or reorganizing with the intent to continue or recommence operations as a non-financial institution may also be excluded from the definition of FFI if the entity was not a financial institution before its liquidation or reorganization. Foreign entities primarily engaged in financing and hedging transactions with or for members of its expanded affiliated group that are not FFIs may also be excluded from the definition of FFI.
    • Notice 2010-60 addresses whether insurance and reinsurance companies will be considered FFIs. Because Treasury and the IRS “do not view the issuance of insurance or reinsurance contracts without cash value as implicating the concerns of [FATCA],” Treasury and the IRS plan to issue regulations treating entities whose business consists solely of issuing such contracts (e.g., most property and casualty insurance or reinsurance contracts or term life insurance contracts) as non-FFIs. Notice 2010-60 states, however, that contracts that combine insurance protection with an investment component (such as cash value insurance contracts or annuity contracts) “may present the risk of US tax evasion that [FATCA] is designed to prevent.” The Notice requests comments on how entities that issue those types of contracts should be treated under FATCA.
    • Certain investment entities with certain identified owners (such as a small family trust settled and funded by a single person) may also be exempted in future regulations if they meet certain requirements.
    • Under new Code section 1471(d)(4), the definition of FFI does not include a financial institution organized under the laws of a US territory unless otherwise provided by Treasury. According to Notice 2010-60, Treasury and the IRS do not intend to treat such financial institutions as FFIs. They do, however, plan to coordinate with the territorial governments to address certain issues, including “exploring how the existing territorial information reporting regimes might be used to supplement the obligations” of financial institutions organized in the territories. The Treasury and IRS also intend to issue guidance under which a territory-organized financial institution that receives a withholdable payment as an intermediary would be permitted to represent to its withholding agent that it is assuming withholding responsibilities under sections 1471 and 1472.
    • Notice 2010-60 addresses how FATCA may apply to payments received by a US branch of an FFI. Although Treasury and the IRS do not intend to exempt from FATCA an FFI receiving withholdable payments only through its US branch, Treasury and the IRS are considering certain coordination rules to avoid duplicative reporting.
    • Treasury and the IRS do not intend to exempt financial institution CFCs from the FATCA requirements, but do intend to coordinate the FATCA requirements with other US tax reporting obligations to avoid duplicative reporting.
  • FFI-IRS Agreement. Notice 2010-60 addresses the agreement between the IRS and a FFI (“FFI Agreement”) in which the FFI agrees to undertake certain reporting, withholding, and due diligence responsibilities in order to avoid 30% withholding.
    • Under the FFI Agreement, FFIs will be required to undertake certain procedures to identify certain US account holders. These procedures will distinguish between preexisting individual accounts and new individual accounts.
    • For preexisting individual accounts (those existing as of a date that the FFI’s agreement with the IRS becomes effective), the FFI may treat as other than a US account holder a person with depository accounts less than $50,000 (determined by reference to the average of the month-end balances or value during the calendar year preceding the entry into force of the FFI’s FFI Agreement). For the remaining accounts, all account holders already documented as US persons for other US tax purposes will be treated as US account holders. For those accounts not covered by the preceding step, a FFI shall treat an account as other than a non-US account if electronically searchable information maintained by the FFI and associated with the account does not include certain indicia of potential US status. For those accounts with indicia of potential US status, the FFI will be required to obtain certain documentation to establish whether the account is a US account. The FFI will be required to complete these procedures within one year of the effective date of the FFI’s FFI Agreement. Within two years after the effective date, preexisting accounts treated as other than US accounts that had an average monthly balance exceeding $1,000,000 will be subject to certain additional procedures (those that the FFI must apply to new individual accounts, described below) in order to determine whether the account should continue to be treated as a non-US account, unless the FFI has sufficient documentation to establish the status of such accounts. Within five years after the effective date, all preexisting accounts will be subject to such procedures unless the FFI has sufficient documentation to establish the status of such accounts.
    • For new individual accounts, the FFI may treat a depository account as other than a US account under the $50,000 depository test described above. For the remaining accounts, account holders already documented as US persons will be treated as US account holders. For those accounts not covered by the preceding step, a FFI will be required to obtain and examine from individuals documentary evidence establishing US or non-US status. For those accounts not identified as US accounts in the preceding step, the FFI will examine all other information collected in connection with the new account to identify indicia of potential US status. For accounts with indicia of potential US status, the FFI will be required to obtain certain documentation or treat the account holder as a recalcitrant account holder.
    • Certain other procedures will apply to financial accounts held by entities, depending on whether the account is preexisting or new. For preexisting accounts not already identified as held by US persons, the FFI will be allowed to identify potential US account holders by using information in its electronically searchable files. Other procedures, described in Notice 2010-60, also must be undertaken. For new entity accounts, FFIs must determine how to treat such accounts using all information collected by the FFI (e.g., through AML/KYC rules) regardless of whether such information is available in electronically searchable files.
    • Notice 2010-60 also addresses the information that must be reported by FFIs to the IRS under the FFI Agreement. The IRS is developing a new form, to be filed electronically, to be used by FFIs.
  • Request for Specific Comments. Notice 2010-60 requests comments on several specific issues: (1) verification procedures with respect to the identification of US accounts; (2) the treatment of “passthru payments”; (3) the ability for a FFI to elect to be withheld upon rather than act as a withholding agent for passthru payments; (4) sanctions for recalcitrant account holders; (5) FFIs subject to restrictions prohibiting US account holders; (6) electronic filing requirements for financial institutions; (7) application of the new withholding and reporting requirements by US withholding agents; and (8) potential modifications to the withholding and reporting requirements based on availability of information from other sources. Comments are requested by November 1, 2010.
  • Future Regulations and Other Guidance. The Treasury and IRS stated that they intend to issue proposed regulations incorporating the guidance in Notice 2010-60 and other matters concerning the new FATCA information reporting and withholding requirements. The Treasury and IRS also plan to publish a draft of the FFI Agreement.
  • For additional information, contact Philip R. West - pwest@steptoe.com or Amanda Varma -avarma@steptoe.com.

ADVISORY PANEL SUBMITS DRAFT OPTIONS FOR TAX SIMPLIFICATION: Today, a subcommittee of the President's Economic Recovery Advisory Board (PERAB) released a draft report outlining possible options to simplify the tax system, improve taxpayer compliance with existing tax laws, and reform the corporate tax system. According to the report, "The Board was not asked to recommend a major overarching tax reform, such as the 1986 tax reform, the tax plans proposed by the 2005 Tax Reform Panel, or proposals for introducing a value added tax in addition to or in lieu of the current income tax system. We received many suggestions for broad tax reform, and some members of the PERAB believe that such reform will be an essential component of a strategy to reduce the long-term deficit of the federal government. But consistent with our limited mandate, we did not evaluate competing proposals for overarching tax reform in this report."

IRS SEEKS ISSUES FOR INDUSTRY ISSUE RESOLUTION PROGRAM: Today, the IRS said that it is encouraging business taxpayers, associations and other interested parties to submit to the Industry Issue Resolution (IIR) program tax issues for resolution involving a controversy, a dispute or an unnecessary burden on business taxpayers. According to the IRS, "The objective of the IIR program is to resolve business tax issues common to significant numbers of taxpayers through new and improved guidance. In past years, issues have been submitted by associations and others representing both small and large business taxpayers, resulting in tax guidance that helps thousands of taxpayers."

  • Requests for guidance on tax issues under the IIR program can be submitted at any time to IIR@irs.gov. Submissions received are reviewed semi-annually with selections next being made from issues submitted by September 30, 2010.

IRS ISSUES FINAL REGS CLARIFYING COMPUTATION AND ALLOWANCE OF TENTATIVE CARRYBACK ADJUSTMENTS: On August 23, the IRS issued final regulations amending existing regulations under section 6411 of the Internal Revenue Code relating to the computation and allowance of the tentative carryback adjustment. These regulations adopt without change the rules of the temporary regulations, which clarify that, for purposes of allowing a tentative adjustment, the IRS may credit or reduce the tentative adjustment by both assessed and certain unassessed tax liabilities. These final regulations affect taxpayers that file an application for a tentative carryback allowance. The regulations are effective August 24.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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