Thursday, June 09, 2011

Securities Industry Comments on Pending IRS Draft Regulations under Foreign Account Tax Compliance Act

The securities industry said it was critical that the IRS provide guidance as soon as possible regarding the treatment of US financial institutions under the Foreign Account Tax Compliance Act (FATCA), including what reporting, withholding, or other compliance obligations a US firms will have with respect to payments other than withholdable payments that it makes or processes with respect to foreign financial institutions. In a letter to the IRS, the Securities Industry and Financial Markets Association (SIFMA) asked more broadly how the overlap between the existing U.S. payor reporting rules will be reconciled with FATCA . SIFMA’s letter was responding to IRS Notice 2011‐34 and was designed to assist the IRS with crafting regulations that accomplish FATCA’s goals without unnecessarily disrupting the operations of the capital markets. The IRS is developing proposed regulations to implement the provisions of FATCA, which was Title V of the HIRE Act.

The legislation casts a wide net in search of undisclosed accounts and hidden income. It adds a new Chapter 4 to the Internal Revenue Code, essentially requiring foreign financial institutions to identify their customers who are U.S. persons or U.S.-owned foreign entities and then report to the IRS on all payments to, or activity in the accounts of, those persons. The legislation’s principal focus is tax compliance by U.S. persons that have accounts with foreign financial institutions. The legislation provides substantial flexibility to Treasury and the IRS to issue regulations detailing how the new reporting and withholding tax regime will work.

The Act imposes substantial new reporting and tax-withholding obligations on a broad range of foreign financial institutions that could potentially hold accounts of U.S. persons. The Act broadly defines foreign financial institution to comprise not only foreign banks but also any foreign entity engaged primarily in the business of investing or trading in securities, partnership interests, commodities or any derivative interests therein According to the Joint Committee on Taxation, investment vehicles such as hedge funds and
private equity funds will fall within this definition. The new regime also covers fund entities and fund managers who are not currently within the scope of the Qualified Intermediary program.

Under FATCA, the financial world is essentially divided into foreign financial institutions and US financial institutions. US financial institutions have the first compliance obligations under FATCA as the primary withholding agents for withholdable payments made to foreign financial institutions. While IRS Notices 2010-60 and 2011-34 provide details regarding how participating foreign financial institutions must identify, report, and withhold on their accounts, and how US financial institutions must identify and withhold on some payments to foreign financial institutions, many details regarding US financial institutions have not yet been provided. For both foreign financial institutions and US financial institutions to begin creating the compliance systems and procedures necessary to implement FATCA, said SIFMA, it is critical that additional guidance regarding the treatment of US financial institutions be provided as soon as possible.

There is a question of how to treat an account maintained by a US financial institution, including an offshore branch of such, with a foreign financial institution. Also, how will payments made by foreign financial institution to financial intermediary US financial treated. This would include, for example, a payment made by a foreign financial institution in respect of securities that it has issued that are held for clearing purposes by the Depositary Trust Clearing Corporation. In such a case, SIFMA queries if it will be sufficient for the financial intermediary US financial institution to present a Form W‐9 to the foreign financial institution to avoid FATCA withholding on payments the US financial institution receives.

FATCA provides various exemptions with respect to interests that are regularly traded on an established securities market. SIFMA believes that a consistent, broad definition should be provided for this phrase for all relevant purposes under FATCA, and suggests that the definition should be based on the existing definition provided for publicly traded partnership purposes in existing Treasury regulations.

Utilizing this definition, an instrument should be treated as regularly traded on an established securities market if either the instrument is traded on an established securities market, within the meaning of Treasury regulations Section 1.7704-1(b), which defines an established securities market to include a national securities exchange registered under the 1934 Act, a national securities exchange exempted from registration under the 1934 Act, and any foreign securities exchange that satisfies analogous regulatory requirements under the law of the jurisdiction in which it is organized; a regional or local exchange; and an interdealer quotation system regularly disseminating firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise.

In its prior comment letters, SIFMA suggested that controlled foreign corporations that are foreign financial institutions, as well as U.S. branches of foreign financial institutions, both of which are currently subject to full Form 1099 information reporting requirements as U.S. payors, should be treated as exempt from the foreign financial institution information reporting and withholding provisions of FATCA. In SIFMA’s view, the creation of such an exemption is directly supported by FATCA’s legislative history, which recognizes that U.S. payors already are subject to extensive information reporting requirements. Notice 2010-60, however, did not adopt this suggestion, explaining that the documentation and information reporting requirements to which U.S. payors are currently subject are less stringent than those that apply to foreign financial institutions.

While conceding that the observation in Notice 2010‐60 may have some validity, SIFMA nonetheless urged the IRS to reconsider this proposal to provide a level playing field at least between US financial institutions and U.S. branches of foreign financial institutions. SIFMA is not suggesting that a foreign financial institution with a U.S. branch should be generally exempt from the foreign financial information reporting and withholding provisions of FATCA.

Rather, the idea would simply be that, as to accounts maintained at the U.S. branch of a foreign financial institution, the institution should be able to elect to apply the information reporting rules applicable to US financial institution, including both the existing U.S. payor rules and whatever additional rules are adopted for US financial institutions, rather than the foreign financial institution rules. For accounts maintained at non‐U.S. branches of a foreign financial institution, as well as for payments a U.S. branch of a foreign financial institution receives on behalf of such institution’s foreign offices or customers of its foreign offices, the normal foreign financial institution rules should continue to apply

For controlled foreign corporations that continue to be treated as foreign financial institutions even though they are subject to the current U.S. payor information reporting rules, SIFMA urged the IRS to clarify the circumstances under which the filing of Forms 1099 for U.S. accounts under the U.S. payor rules is sufficient to meet the reporting requirements under FATCA. The overlap between these competing sets of information reporting rules should be eliminated.