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After four years in the making, including numerous delays, the Foreign Account Tax Compliance Act (“FATCA”) officially went into effect on July 1, 2014. FATCA was enacted in 2010 by Congress to promote global tax transparency and combat non-compliance by US citizens through the use of foreign bank accounts. In order to accomplish these goals, FATCA requires that foreign financial institutions (“FFIs”) must agree to identify and report information on US account holders, or face withholding on the receipt of certain US source withholdable payments made to those FFIs. Similarly, to avoid FATCA withholding in the case of a passive non-financial foreign entity, the entity must identify its substantial US owners. Since the enactment of FATCA, the IRS has issued numerous regulations and notices to implement FATCA. Many foreign governments have entered intergovernmental agreements (“IGAs”) with the US to ease the burden on financial institutions in their jurisdictions. These IGAs modify the default FATCA rules found in the Code and Treasury Regulations. The IGAs fall into two categories, known as Model 1 and Model 2 Intergovernmental Agreements. Under a Model 1 agreement, FFIs report the relevant information to their respective governments, which then relay that information to the IRS. Under a Model 2 agreement, FFIs will provide relevant information directly to the IRS, with the two governments cooperating to facilitate reporting. Currently, 35 countries have entered Model 1 IGAs and 5 countries have entered Model 2 IGAs. Fifty-three more countries have entered Model 1 IGAs in substance and 8 more have entered Model 2 IGAs in substance. Some governments, who have not entered IGAs, such as in the Soviet Union, have amended local legislation to allow FFI’s located in their country to comply with the FATCA reporting requirements. A withholdable payment is any payment of US source fixed or determinable annual or periodic (“FDAP”) income, such as interest, rents, annuities and dividends. After December 31, 2016, the definition of withholdable payments expands to include gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends, which are US source FDAP income. Thus, the gross proceeds from the sale of stock will generally be a withholdable payment. The definition of withholdable payment excludes income that is effectively connected with a US trade or business, payments of interest or original issue discount on certain short-term obligations, and certain nonfinancial payments made for such things as the use of property, software, transportation and freight. See Treas. Reg. § 1.1473-1(a) for full definition of withholdable payments. As of July 1, 2014, withholding agents must withhold at a rate of 30% on withholdable payments to non-participating FFIs (“NPFFIs”). An NPFFI is any FFI that has not agreed to identify and report information on its US account holders and is not in an IGA jurisdiction. Accordingly, generally all US payors of a withholdable payment, must identify payees for FATCA purposes. Generally, a payee that is an entity identifies itself by completing either a form W-8BEN-E for beneficial owners (e.g. foreign corporations) or W-8IMY for foreign flow through entities or intermediaries (e.g. a foreign partnership). Participating FFIs (“PFFIs”), which generally are FFI’s that have agreed to participate with FATCA reporting requirements, must register with the IRS to obtain a Global Intermediary Identification Number (“GIIN”). An entity that is treated as a reporting Model 1 or reporting Model 2 FFI pursuant to its relevant IGA is also required to obtain a GIIN. An individual payee and account holder merely needs to provide a form W-8BEN to certify his or her non-resident status because individual payees are not subject to FATCA withholding. On the other hand, a foreign entity will need to first determine its FATCA entity classification before completing a withholding certificate. The first step in determining an entity’s classification for FATCA purposes is to determine whether it is a financial institution. According to the Treasury Regulations, a financial institution is any of the following: a depository institution, a custodial institution, an investment entity, a specified insurance company or a holding company or treasury center. However, when an IGA applies, holding companies and treasury centers are generally not considered financial institutions. The Treasury Regulations’ broad definition of an “investment entity” results in many entities being classified as financial institutions. However, in countries where an IGA is controlling, the definition is more narrow. In an IGA jurisdiction, an investment entity generally is defined as an entity that, engages in the business of or is managed by an entity that is in the business of trading for the benefit of customers, portfolio management for the benefit of customers, investing for the benefit of customers or administering activities or operations for the benefit of customers. Thus generally, in an IGA jurisdiction, trading, portfolio management, investing and related activities that relate to the entity’s own investments will not cause the entity to be classified as an “investment entity.” If the foreign country has no IGA in place, the Treasury Regulations list three types of investment entities: A Type A investment entity primarily conducts as a business one or more of the following activities or operations for or on behalf of a customer: (1) trading in money market instruments (checks, bills, certificates of deposit, derivatives, etc.), foreign currency, foreign exchange, interest rate, and index instruments, transferable securities, or commodity futures; (2) individual or collective portfolio management; or (3) otherwise investing, administering, or managing funds, money, or financial assets for the benefit of other persons. A Type B investment entity’s gross income is primarily attributable to investing, reinvesting, or trading in financial assets and the entity is managed by a depository institution, a custodial institution, a specified insurance company, or a Type A investment entity. The gross income requirement is met if 50% or more of the entity’s gross income is attributable to the activities referenced above for the shorter of the three-year period ending on December 31 of the year preceding the year in which the determination is made, or the period during which the entity has been in existence. An entity is managed by another entity if the managing entity performs, either directly or through another third-party service provider, any of the activities conducted by a Type A investment entity on behalf of the managed entity. A Type C investment entity functions or holds itself out as a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets. Generally, under the IGAs and Treasury Regulations, if a foreign entity does not fall under any of the financial institution categories, it will be a nonfinancial foreign entity (“NFFE”). There are two principal classes of NFFEs, active NFFEs and passive NFFEs. For an NFFE to be considered active, it must earn less than 50% of its gross income for the preceding taxable year (calendar or fiscal) from passive income and less than 50% of the weighted average percentage of assets (tested quarterly) held by it as assets that produce or are held for the production of passive income. Any income from interest, dividends, rents, or royalties that is received or accrued from a related person to the extent such amount is properly allocable to income of such related person that is not passive income is excepted from being treated as passive income in making the active/passive NFFE determination. The related person test is provided in Code Section 954(d)(3). If an NFFE is not an active NFFE or another limited category of excepted NFFE, it will be considered a passive NFFE. Passive NFFEs must disclose their substantial US owners to withholding agents to prevent FATCA withholding. Active NFFE’s may elect to be treated as passive NFFE’s to avoid the requirement of quarterly testing of the entity’s assets because it is often simpler to merely provide the names of substantial US owners. FATCA was created so that the US government would receive information about US owners of foreign bank accounts and substantial US owners of passive foreign entities. This information is reported on a Form 8966 to the IRS generally by FFI’s, direct reporting NFFEs, and US withholding agents who make payments to passive NFFE’s that have at least one substantial US owner. Withholding agents that withhold 30% of a withholdable payment are required to complete and file Forms 1042 and 1042-S. By Steven Hadjilogiou and Sean J. Tevel This article was first published in Baker & McKenzie’s North America Tax Practice Group Newsletter Volume XIV


Steven Hadjilogiou is a member of Baker & McKenzie's Tax Practice Group. He has been repeatedly recognized as a leading tax lawyer by Chambers USA and as a "Rising Star" by Florida Super Lawyers. In addition, he is recognized by Best Lawyers of America for Tax Law and as a “40 under 40 Rising Star in South Florida” by the Daily Business Review. He is a three-time recipient of the Florida Bar Tax Section’s Chair's Special Merit Award and has been recognized as an Up & Comer in Florida Trend’s Legal Elite. Mr. Hadjilogiou has written numerous articles and presented on many topics related to his area of practice and was a primary drafter of the amicus curiae brief filed on behalf of the Florida Bar Tax Section in Knight v. Commissioner before the US Supreme Court (2008). Mr. Hadjilogiou is an adjunct professor at the University of Miami School of Law Tax LLM program.

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