FATCA-What are the Foreign Account Tax Compliance Requirements?
The Foreign Account Tax Compliance Act ("FATCA") was passed in 2010 in reaction to the UBS banking scandal and public sentiment that there were wealthy Americans failing to disclose foreign assets and income to the IRS. FATCA was designed with the primary intention of exposing undisclosed overseas accounts of Americans. FATCA imposed a two pronged approach to attempt to uncover foreign assets: (1) Foreign Asset Reporting by U.S. persons, and (2) Foreign Institution Reporting of U.S. accounts. The following provides an overview of each of these prongs.
Foreign Asset Reporting by U.S. Persons
FATCA requires a U.S. person to file Form 8938, Statement of Specified Foreign Financial Assets, if such U.S. person directly holds foreign financial assets that exceed certain threshold values. The Form 8938 is attached to a taxpayer's tax return and is due with the return by the due date including any applicable extensions. Persons required to file include U.S. citizens, resident aliens, and certain nonresident aliens including those that claim a treaty position to be treated as a nonresident alien, those who make an election to be treated as a U.S. resident and residents of certain U.S. possessions. The filing requirements have thus far only applied to individuals, however it may be extended to certain domestic entities when final regulations are issued. As with many of the foreign information reporting forms, significant penalties may be imposed for failure to file.
Foreign financial assets that are required to be reported include financial accounts maintained overseas, interests in foreign mutual funds, stock issued by foreign corporations, capital or profits interests in foreign partnerships, financial instruments with foreign issuers or counter-parties, interests in foreign trusts or estates, and any form of indebtedness issued by foreign persons. The IRS has a chart on their website that can be a helpful quick tool for determining whether assets need to be reported.
The thresholds for reporting are specified foreign financial assets exceeding $50,000 at the end of the year or $75,000 at any time during the year for a single taxpayer. The thresholds are doubled for taxpayers that are married and higher thresholds exist for taxpayers that are living abroad. Note that the Form 8938 filing requirements and the FBAR (Form 114) reporting requirements are duplicative.
Foreign Institution Reporting of U.S. Accounts
FATCA also requires foreign institutions and other foreign entities that meet a widespread definition of a foreign financial institution (“FFI”) to participate in a program where they agree to report U.S. account holders/investors (“owners”) or otherwise face 30% withholding tax on certain types of passive income such as interest, dividends, capital gains, etc. FATCA requires FFIs to register with the IRS, agree to due diligence requirements, information reporting regarding their U.S. owners and implement withholding obligations. The 30% withholding is also imposed on foreign entities that are not considered FFIs if they do not report substantial U.S. owners. The following provides a brief overview of the how FATCA rules operate.
FATCA imposes a 30% withholding tax on U.S. source passive income paid to foreign entities that are non-compliant. The passive income includes what is currently referred to as fixed determinable annual and periodical ("FDAP") income. On January 1, 2017, the 30% withholding tax will be expanded to include
certain capital gain income which is currently not taxable under U.S. tax law. FATCA breaks out foreign entities into two different broad categories: (1) foreign financial institutions (“FFIs”), and (2) non-financial foreign entities ("NFFEs").
To reduce or eliminate the 30% FATCA withholding:
- FFIs not covered by a Model I Intergovernmental Agreement ("IGA") must enter into an FFI agreement with the IRS to report U.S. owner information and withhold on non-compliant owners.
- FFIs covered by a Model I IGA must register with the IRS to obtain a GIIN and will report U.S. owner information directly to their home country.
- NFFEs must certify that they do not have any 10% U.S. owners or submit information related to U.S. owners to the withholding agent or submit proof of "excepted NFFE" status.
FFIs encompass a broad range of entities including foreign banks, certain insurance companies, investment entities, and collective investment vehicles. An investment entity includes an entity that engages in investing, administering, or managing funds, money, or financial assets on behalf of other persons. An investment entity also includes a financial entity that is professionally managed. These include entities managed by other investment entities and the regulations specify that private equity, hedge, and mutual funds are included as FFIs. Holding companies and treasury centers may also be considered FFIs if another member of the affiliated group is an FFI or if the company is used by a collective vehicle. Note that payments made to FFIs may be exempt from FATCA withholding if allocable to exempt beneficial owners including foreign governments, international organizations, and certain foreign retirement plans.
An NFFE is any foreign entity which is not classified as an FFI. As previously mentioned, certain NFFEs are exempt from the general due diligence and identification requirements including publicly traded corporations and their subsidiaries, foreign governments and their subdivisions, international organizations, foreign central banks, and active NFFEs. An active NFFE is an NFFE with less than 50% of its income and assets comprising of passive income and assets.
IGAs entered into between the U.S. and partner countries are designed to facilitate the exchange of information and are specifically geared toward FATCA reporting. When FATCA was first announced there was concern that companies may be violating local laws by disclosing confidential information to the IRS. An IGA clarifies that companies are allowed to disclose the information to the IRS under local law and eases these concerns. Many countries have already entered into IGAs with the U.S. and other countries have agreements in substance which are not yet finalized IGAs. The Treasury maintains a list of countries with IGAs currently in effect.