In a burst of extraterritorial fervour, Congress legislated in 2010 to require non-U.S. financial institutions to withhold U.S. tax at 30% on payments made to: (i) account holders that do not provide requested identity information; and (ii) other non-U.S. financial institutions that do not register with the IRS or otherwise comply with FATCA. This legislation departed from the prior practice of only requiring U.S. tax to be withheld upon payments of U.S.-source items; now, a “foreign financial institution” in corporate form, such as a UK commercial bank, would in principle need to withhold U.S. tax on a portion of payments made to some of its account holders and counterparties. The threat of withholding on these so-called “foreign passthru payments” has remained conjectural because: (a) the IRS has not yet defined the term; and (b) the United States has entered into agreements on FATCA with 87 other jurisdictions which removes this obligation, at least temporarily. Nevertheless, the risk of a FATCA tax actually being withheld was considered worth allocating in loans, ISDAs, and many other contracts, and U.S. tax disclosure in bond programmes and IPO prospectuses of non-U.S. issuers customarily refers to potential U.S. withholding on foreign passthru payments in the future.
Today the IRS issued a Proposed Regulation that would push out the effective date of such FATCA withholding to no sooner than two years after the date of publication of Final Regulations defining the term foreign passthru payment. Bonds issued by foreign financial institutions at any time up to six months after the publication date would continue to be grandfathered and exempt from withholding. Taxpayers may rely immediately upon this Proposed Regulation. The U.S. tax/FATCA discussion of any prospectuses and offering memoranda of non-U.S. issuers which currently are in preparation should be reviewed and amended to comply with this new rule.
Providing further relief, the IRS today rowed back from another extraordinary element of FATCA, which is that FATCA withholding tax in principle one day will be collected from the proceeds of a non-compliant foreign financial institution’s disposal of a U.S. security, thus extending the potential withholding obligation to any purchaser of a U.S. security, in addition to U.S. withholding agents and foreign financial institutions. After eight years of negative comments on this potential requirement, IRS has eliminated it.
The IRS also tweaked the “investment entity” limb of the definition of a “financial institution” under the customer rule. Hitherto, entity customers of financial institutions which provided discretionary investment management of financial assets could as a result themselves be considered financial institutions. This led to questions as to the necessary strength and focus of discretionary management; would a charity be considered a financial institution merely because it invested its endowment in a UCITS fund? IRS today clarified that investing in widely held collective investment vehicles benefiting from investor protection legislation does not cause the investor to constitute a financial institution. It cautioned, however, that investing the endowment in a discretionary mandate or separate account could cause the investor to be considered an investment entity financial institution because the discretion is sufficiently focused and “tailored to the investment needs of the entity.” The IRS intended for this change to align its rules with those of the OECD’s Guidance on the Common Reporting Standard on the point. This change is applicable to all open tax years.
Finally, the IRS provided relief for non-financial U.S. entities making payments to non-U.S. insurance companies. If the payment is a premium for an insurance or annuity contract with no cash value (i.e., indemnity insurance rather than investment products), the payor does not need to diligence whether the non-U.S. insurance company is compliant with FATCA. This change is applicable to all open tax years.
Changes relating to the logistics of withholding and reporting under FATCA were also made today.
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