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Information reporting and withholding: the impact of Foreign Account Tax Compliance Act (FATCA) on multinational organizations

14 May 2013

IR&W: The Impact of Foreign Account Tax Compliance Act (FATCA) on multinational organizations1

Disclaimer

► Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US.

► This presentation is ©2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young and its member firms expressly disclaim any liability in connection with use of this presentation or its contents by any third party.

► The views expressed by panelists in this session are not necessarily those of Ernst & Young LLP.


Circular 230 disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.


Today’s presenters

John McMahonDawn McGuireSaul Tilmann


Agenda

► FATCA basics► Considerations for US withholding agents► FATCA documentation considerations► Affect of FATCA on the global entity► What multinationals should do now► Specific issues for financial institutions to consider

FATCA basics


What is FATCA?

FATCA overview:► The Foreign Account Tax Compliance Act

(FATCA) is a 2010 US tax law designed to identify US taxpayers who may be avoiding US taxation through investing in offshore investment vehicles

FATCA’s impact on multinational companies:► FATCA applies to all entities, and impact on

each entity will vary based on footprint and business lines

► FATCA presents financial risks and operational challenges for most companies

► FATCA will impact US entities as payors and multinational entities as both payors and payees

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Why is FATCA important?► 30% of withholding tax

applies to noncompliant organizations

► Failure to comply with FATCA will make it difficult to do business with compliant institutions

► FATCA will impact business operating models from vendor onboarding to operations and compliance

► The identification of affected payors and payees needs to be accomplished quickly to enable an effective communication strategy and action plan


FATCA fundamentals

► Expansive new reporting and withholding rules aimed at ensuring that US persons with financial assets outside the US pay their US tax

► Reporting focus is on ultimate shareholders/owners► FATCA categorizes entities as:

► US entities — US withholding agents (USWAs)► Foreign entities — foreign financial institutions (FFIs) and

non-financial foreign entities (NFFEs)► FFIs are generally required to enter into agreements with the IRS to perform

substantial due diligence, information reporting and withholding on their account holders, or incur 30% withholding

► NFFEs will need to certify as to “substantial” US owners or incur 30% withholding

► Phased in effective dates, beginning 1 January 2014


FATCA vs. existing law

► FATCA is an additional reporting and withholding regime that will applybefore the existing non-resident alien (NRA) /Section 1441 regime, but many of the concepts will converge

► NRA vs. FATCA — generally,► Existing NRA rules are aimed at withholding tax and reporting at source on

US source fixed or determinable, annual or periodic (FDAP) income paid to non-US persons

► FATCA is not designed to impose a withholding tax, but rather is designed to capture information about US persons — withholding generally only applies if there are payments to:► NFFEs that fail to either identify and disclose substantial US owners or certify

they have no substantial US owners► Nonparticipating FFIs

Considerations for US withholding agents


Requirements of a USWA as payorUS withholding agents

► For USWAs making payments, four general steps are necessary:► Step 1: Identify payments of US source withholdable payments or gross proceeds

on US securities► Step 2: Determine status of payee as US or foreign and if foreign, the entity’s

FATCA classification► Step 3: Withhold 30% if appropriate documentation is not provided► Step 4: Year-end reporting


USWA as payor Step 1: FATCA withholdablepayments

► Withholdable payment is defined as:► US source FDAP income (defined as under 1441 rules)► Gross proceeds from disposition of property that can produce interest or dividends

that are US source FDAP (i.e., sale of US securities)

► Non-US source income is not included. However, source must be able to be determined.

► FATCA regulations provide exclusions for specified payments defined as “non-financial.”

► Review accounts payable, treasury and any other function involved in payment processing and determination of income (i.e., procurement, legal, business units). You may be surprised what you find!


Types of payments included

► FATCA withholdable payment types:► Bank and brokerage fees► Investment advisory fees► Custodial fees (e.g., fund manager fees)► Payments in connection with lending transactions► Forward, futures, option or notional principal contracts► Premiums for insurance contracts or annuity contracts and amounts paid under

cash value insurance or annuity contracts► Dividends on US securities► Interest of a type not described on next slide (excludes obligations held

183 days or less)► Original issue discount (excludes obligations held 183 days or less)► Dividend equivalent payments where the USWA acts as custodian

All payments including intercompany payments are subject to FATCA.


Types of payments excluded

► Certain types of payments are specifically excluded from the FATCA definition of withholdable payment, including:► Payments for tangible goods► Excluded nonfinancial payments

► Examples of payment types that are excluded:► Fees paid for nonfinancial services (e.g., litigation fees paid for a personal injury

dispute or fees paid to an engineering consultant)► Software licenses► Interest on outstanding bills arising from services► Rent for office space► Use of property (e.g., royalty or intellectual property)► Freight/transportation expenses► Interest on deferred purchases (e.g., goods purchase on credit)► Lease payments on equipment


Source of payments

► FATCA requirements generally only exist for FDAP that is US source or gross proceeds from sales of US securities. Foreign source income is generally excluded from FATCA requirements.

► Source must be determined.► Processes must include documenting source of income where necessary► Review all documents and information necessary to determine source of income

including contracts, invoices and knowledge of those involved in the transactions► Where source is not known, presumption rules require treatment as US source

► Test current processes and procedures to ensure they determine source properly and timely (before payment is made) and that source is documented.

► Update processes and systems as necessary.


USWA as payor — steps 2 through 4: determine status and document, withhold and report

► Step 2 — Determine status and document► USWAs are only required to apply FATCA to non-US entities.► Complex FATCA presumption rules must be applied in the absence of

documentation, generally resulting in the payee being a non-participating FFI, for which withholding at 30% is required.

► Step 3 — Withhold► Generally, if all payees are compliant, no withholding will be required under FATCA

(withholding may still be required under Section 1441).► Withhold 30% on US source income paid to noncompliant payees (vendors,

customers and/or accountholders), such as:► Non-participating FFI ► Non-certifying NFFE

► Step 4 — Report► A USWA generally must report information about substantial US owners of NFFEs

that are not excepted NFFEs, to the extent such information is received from the payee or the USWA knows or has reason to know the information.

► New forms, such as 1042-S and 1042, will be used to report the recipient information.

FATCA documentation considerations


Documentation

► IRS has not issued revised Forms W-8 yet► However, based on drafts:

► Revised form W-8BEN will be used only by individuals to document NRA status and furnish treaty claims

► New form W-8BEN-E will be used by most entities to document FATCA and NRA status and furnish treaty claims

► Revised form W-8IMY

► Upon the issuance by the IRS of updated tax forms, a withholding agent may continue to accept an older version of the form (e.g., the February 2006 version of the Form W-8BEN) for six months after the revision date on the new withholding certificate


Miscellaneous provisions regarding documentation

► Allow tax forms or other written statements to be signed by a director, any foreign equivalent of an officer in the US or any other person granted written authority

► Clarify rule regarding Forms W-8 received late► Permitting the submission of a tax form within 30 days of payment without an

affidavit of accuracy as of the time of payment

► “Inconsequential errors” — very few► Documentation “checklists” — add complexity


Electronic Forms W-8 (faxes and pdfs) for documentation

► A tax form, written statement or other such form (prescribed by the IRS) may be accepted via fax if the withholding agent:► Confirms the individual or entity providing the form is the individual or entity named

on the form► The faxed form contains a signature of the person whose name is on the form (or

such person’s authorized representative), signed under penalties of perjury

► A copy of documentary evidence may be accepted electronically (fax or email) if the withholding agent:► Confirms the person providing the form is the person named on the form► The copy does not appear to have been altered from its original formNote: the final regulations do not require, as in the proposed regulations, documentary evidence furnished electronically to be certified or notarized.


Limited applicability of the ‘eyeball test’ for documentation

► The FATCA regulations change the historic presumption rules for eyeball test purposes

► The following entities can not be ‘eyeballed’ as exempt for FATCA purposes:► Corporations► Financial institutions► Insurance companies► Brokers► Security/commodity dealers► Nominees or custodians► Swap dealers

Affect of FATCA on the global entity


Global legal entity classification

► A US withholding agent must classify its own foreign entities under FATCA for two main purposes:1) To provide appropriate documentation and information to payors from whom the

entity receives withholdable payment, thereby avoiding consequences such as:► Withholding at 30%► Negative effects on flow of business, related income and business relationships► Potential scrutiny by IRS and/or local government

2) To determine whether entity is an FFI and meet the associated requirements, including:► Register with the IRS as an FFI (i.e., participating FFI)► Perform required due diligence with respect to individual and entity payees to

identify US persons, report to IRS and withhold on recalcitrant payees


Determine FATCA status of entity as payee

► A multinational organization must also classify its own entities into three general categories, as follows:1. US entities/US withholding agents2. Foreign financial institutions (FFIs)3. Nonfinancial foreign entities (NFFEs)

► A US entity must generally provide a Form W-9 to payors to document itself as a US person► In the absence of a Form W-9, most US entities will be presumed foreign for

FATCA purposes and will be subject to withholding at 30%

► An FFI must generally provide a Form W-8BEN-E with a US Global Intermediary Identification Number (GIIN)

► An NFFE must generally provide a Form W-8BEN-E and a certification with respect to substantial US owners


Determine FATCA status of entity as payee

► For a USWA, FATCA only applies to payments made to non-US entities.► Note: for an FFI, FATCA applies to payments made to non-US entities

and individuals► Based on documentation and other information about a payee receiving a

withholdable payment subject to FATCA, determine:► Status of payee as individual or entity► Then, if entity, status of payee as US or non-US► Then, if non-US entity, FATCA classification of payee (i.e., FFI, NFFE)► Follow additional requirements depending on FATCA classification, such as:

► If NFFE, generally must receive certification regarding substantial US owner information — if not, withhold at 30%

► If FFI, generally must receive certification as participating FFI (subject to certain exceptions) and verify such status with IRS — if not, withhold at 30%

► New, more complex withholding certificates (Forms W-8) and documentation requirements will necessitate more detailed processes, procedures and controls.


Holding companies, treasury centers and captive financing

► Certain entities that may otherwise meet the definition of a “financial institution” under FATCA may be excluded from the definition if:► The entity is a:

► Nonfinancial holding company: primary purpose is to own (in whole or in part) the outstanding stock of one or more subsidiaries that engage in a trade or business, provided that no such subsidiary is a financial institution

► Treasury center: function is to enter into investment, hedging and financing transactions with or for members of its expanded affiliated group (EAG) in order to manage risk of interest rate, price and currency fluctuations and other functions

► Captive finance company: primary activity is to enter into financing/leasing transactions with suppliers, distributors, and customers of any active NFFE member of the EAG and certain other requirements are met

► An expanded affiliated group generally has a 50% ownership threshold.► The non-financial group test generally looks to levels of passive income and

requires a three-year look-back. It can be complex to apply.


Global legal entity classificationEffect of Intergovernmental Agreements (IGAs)

► To effectively administer FATCA across the globe, the U.S. Department of the Treasury is entering into intergovernmental agreements with various countries to enable local country administration and certain changes to FATCA requirements that the US government deems appropriate based on local country considerations.

► Several countries have executed IGAs.► These can alter the FATCA entity classifications within a local jurisdiction.

For example:► The regulations clarify that for entities resident in IGA countries, the IGA definitions

of FFI and NFFE control, and that the statutory and regulatory definitions apply to entities that are resident in jurisdictions that do not enter into IGAs.

► IGAs of certain countries have their own unique list of excepted and deemed compliant entity types, based on the risk profiles of those entity types within the relevant country.

What multinationals should do now


What multinationals should do now

Corporate footprint► Define and review organizational footprint ► Review entities within the corporate footprint and identify each legal entity’s

FATCA classification (USWA, FFI, NFFE, etc.) ► For categories of entity, identify documentation to be provided to a

withholding agent or participating foreign financial institution (PFFI)Payment streams ► Identify business units making and processing payments and review

FATCA implications ► Review impact on intercompany transactions as well as third-party paymentsCurrent IRW compliance capabilities► Review current information reporting and withholding compliance► Identify process and procedure gaps that may delay or derail FATCA

compliance efforts

Specific issues for financial institutions to consider


Definition of an FFI narrowed

► A narrower definition of FFI is a financial institution that specifies when an “investment entity” will exclude passive, non-commercial investment vehicles that do not conduct trading, investment or portfolio management activities on behalf of customers so long as they are not professionally managed

► FFIs will be treated as passive NFFEs► Will be required to identify substantial US owners (subject to a 10% threshold), but

will not be subject to FFI requirements


Sponsored investment entities and CFCs

► A new registered deemed-compliant FFI status is helpful to foreign entities that have trustees or fund managers (or other third parties) and prefer to have these third parties perform the due diligence and reporting on their behalf

► Also useful for controlled foreign corporations (CFCs) that are owned by a US financial institution where all entities share the same systems

► The sponsored investment entity or CFC (the FFI) appoints a sponsoring entity to do the work, however, the FFI remains liable for any failure of its sponsoring entity to comply with FATCA

► The sponsoring entity is eligible to sponsor if it:► Is authorized to manage the FFI and enter into contracts on behalf of the FFI (such

as a fund manager, trustee, corporate director or managing partner) ► Has registered with the IRS as a sponsoring entity and registers the FFI► Agrees to perform, on behalf of the FFI, all due diligence, withholding, reporting and

other requirements that the FFI would have been required to perform► Identifies the FFI in all reporting completed on the FFI’s behalf


Multiple accounts

► A new account of an existing account holder is treated as a preexisting obligation if:► The account holder has a preexisting obligation► All obligations (new and preexisting) are treated as consolidated ► AML due diligence is satisfied (if applicable)

► Multiple accounts of the same payee► A withholding agent may rely on documentation for multiple accounts of the same

payee if:► The withholding agent aggregates the accounts’ values (when relevant)► The withholding agent shares information across those accounts for purposes of

determining the reliability of the chapter 4 status of the client ► The system accommodates such aggregation and information sharing

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