Against the backdrop of impending regulations implementing the Foreign Account Tax Compliance Act, Rep. William Lacy Clay (D-Mo) has clarified the legislative intent around the Act’s requirement for foreign financial institutions that have entered into an agreement with the IRS to identify their accounts that are owned by specified U.S. persons or U.S.-owned foreign entities. In a letter to Treasury, he emphasized the importance of providing regulations that do not require a foreign financial institution to solicit all of its accounts to confirm their status as non-U.S. Rather, he suggested that in the case of existing accounts, a foreign financial institution should be deemed to have met the identification requirements under its agreement as long as it complies with all regulations and has anti-money laundering/know your customer procedures in place which are compliant with established verification standards.
Passed as Title V of The Hiring Incentives to Restore Employment Act (HIRE), FATCA creates a new reporting and taxing regime for foreign financial institutions with U.S. accountholders. FATCA 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 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. Firms meeting the definition must enter into agreements with the IRS and report information annually in order to avoid a new U.S. withholding tax.
In the case of new accounts, noted Rep. Clay, the agreement could require further due diligence upon account opening. For example, in the case of individual accounts, in addition to the requirements for existing accounts, the foreign financial institution could be required to obtain documentation to verify the non-U.S. status of the account holder, such as a passport or driver's license In the case of entity accounts, the foreign financial institution would be deemed to be in compliance if it obtains similar information on the beneficial owners of an entity only where the foreign financial institution is required to look through such entity and obtain such information for anti-money laundering/know your customer purposes. Thus, typically, a foreign financial institution would not be required to look through operating entities, agencies and instrumentalities of foreign governments, and non-profit entities. In all cases, a foreign financial institution should
be required to make a determination as to U.S. status only upon establishment of the account.
FATCA provides that a foreign financial institution must agree to comply with such verification and due diligence procedures as Treasury requires. While noting that verification of compliance is necessary for the proper administration of FATCA, Rep. Clay stressed that such verification should not be unduly burdensome or costly. The policy should encourage as many foreign financial institutions as possible to enter into agreements with the IRS. If external audits or reviews are required of all foreign financial institutions that have entered into an agreement, cautioned the Congressman, the system will become extremely costly and unattractive to them. He thus urged that the verification procedures be focused on using a foreign financial institution’s existing internal audit function with audits of applicable procedures, and using an external private sector CPA firm audit requirement only when internal controls do not meet standards established by Treasury or where the IRS has information indicating that the foreign financial institution may not be in compliance with its agreement.
FATCA provides that under an agreement the foreign financial institution must, among other things, agree to withhold any passthru payment to a recalcitrant account holder or another foreign financial institution that has not entered into an agreement. The term passthru payment is defined as any withholdable payment or other payment to the extent attributable to a withholdable payment. This provision was added to the legislation to address the concern that a foreign financial institution might fail to comply with its agreement because it is unable to obtain the necessary information about one or a small group of U.S. account holders or information about beneficial ownership of an account held by a foreign entity. Rep. Clay said that it would be consistent with both the plain language and intent of the legislation for Treasury to clarify that, except in the case of structures designed for avoidance of withholding taxes, a payment is considered attributable to a withholdable payment only where the payment is directly linked to
a withholdable payment received by the foreign financial institution.