FATCA

Foreign Account Tax Compliance Act (FATCA)

OVERVIEW

The Foreign Account Tax Compliance Act (“FATCA”) was enacted in the United States in 2010 and will be implemented over the course of the next several years. The rules are designed to compel foreign banks, funds, brokers and dealers, trust companies, and similar foreign financial institutions to collect and report information on their U.S. customers. The legislation is a response to the U.S. government’s perception that, with the assistance of foreign financial institutions, U.S. persons are underreporting vast sums of money that are being hidden in offshore accounts. The rules are directly related to the widely reported scandals surrounding the U.S. government’s attempt to get information from banks such as UBS, which have led to a series of voluntary disclosure programs for U.S. persons to “come clean” with their under-reporting of foreign bank accounts.

On February 8, 2012, Treasury and the IRS issued detailed Proposed Regulations implementing FATCA. Treasury and IRS officials have indicated that final regulations will be issued in the summer of 2012. The bottom line is that beginning in 2013, foreign financial institutions will have to enter into agreements with the IRS to collect, verify, and report certain information about their U.S. customers. If an institution does not enter into the agreement, then, beginning in January 2014, an across-the-board 30-percent withholding tax will be imposed upon all of the institution’s receipts of withholdable payments, and beginning January 2015, the withholding tax will be imposed upon all gross proceeds from the sale of U.S. securities, even if there is no gain on the sale.

Implementation by foreign financial institutions of the rigorous standards to become compliant with FATCA will take time and effort. Key involvement will include oversight by the Board of Directors and perhaps the Audit Committee, as well as detailed involvement of the institution’s Chief Compliance Officer, Chief Information Officer, and Chief Tax Officer and their teams, among others.

Baker Hostetler’s FATCA advisory team is uniquely situated to assist clients in evaluating their situation and strategizing as to the appropriate response to FATCA. Baker Hostetler has significant experience in advising foreign and U.S. financial institutions, trusts and trust companies, hedge funds and private equity funds in connection with compliance matters, U.S. withholding tax issues, information reporting matters, middle-man liability issues, effectively connected income issues, permanent establishment issues and treaty matters. This experience includes representation in IRS examinations, audits, appeals and litigation. The team has been deeply involved in representation of individuals, trusts, and companies in connection with foreign bank account reporting (“FBAR”) requirements as well as civil and criminal representation stemming from the Offshore Voluntary Disclosure Initiatives (“OVDI”), which gives keen insight into what the government is seeking under FATCA. In addition, Baker Hostetler has been appointed by the courts and voluntarily engaged by several financial institutions as an outside “monitor” to oversee efforts to become compliant with governing rules and regulations. The white collar litigation practice has considerable depth in Foreign Corrupt Practices Act (“FCPA”) and “Know Your Customer” areas and the firm’s extensive receivership work in the Madoff and other matters have given it expertise in tracing funds, systems, and record keeping. The multi-disciplinary Baker Hostetler FATCA team understands how to deal with U.S. and foreign governments and includes former U.S. government officials from the Treasury, IRS, Joint Committee on Taxation, U.S. Congress, Department of State, Department of Justice and Tax Court.

A few salient points (the Who What Where When and Why) are summarized below.

FATCA

WHO should care about FATCA? Any Chief Compliance Officer, Chief Tax Officer, or persons in similar roles at foreign banks, trusts or trust companies, hedge funds, or private equity funds, or similar foreign financial institution which expects to earn any U.S.-source income or gross proceeds from sales of U.S. securities. In the long-run, U.S. persons (individuals or companies) who make payments to any foreign financial institution should care as they will become the withholding agent.

WHAT is FATCA? A broad set of requirements under which foreign banks, trusts, hedge funds and similar financial institutions will be required to collect, verify and report information on U.S. customers or face 30-percent withholding on withholdable payments.

WHERE does FATCA apply? FATCA is a U.S. rule that applies to non-U.S. financial institutions and therefore has extraterritorial reach. The penalty for failure to comply is withholding tax on withholdable payments. Accordingly, it is enforced through withholding at the source. There is no enforcement mechanism if the foreign financial institution does not receive withholdable payments directly or indirectly. To date, treaties do not address FATCA. It is unclear whether foreign governments will be able to negotiate special rules or treaty relief.

WHEN is FATCA effective? There are a variety of important dates, but key among them is that withholding tax begins on January 1, 2014. In order to avoid that, foreign financial institutions need to enter into an agreement with the IRS (to collect, perform due diligence, and report information on U.S. customers) between January 1, 2013 and June 30, 2013. Accordingly, it will be important for foreign financial institutions which have not already done so to assess and evaluate their situation and to develop a strategy for compliance in 2012.

WHY should foreign financial institutions respond to FATCA? The foreign financial institution has a choice. It can (i) comply with FATCA; (ii) fail to comply and face the punitive 30-percent withholding tax on withholdable payments; or (iii) choose to forgo business that generates withholdable payments. It is important to emphasize that if the foreign financial institution does not comply and receives withholdable payments, there is no “audit lottery” or other affirmative action that will need to be taken by the IRS. Rather, the requirements are enforced by any payor of a withholdable payment to the foreign financial institution: The payors become withholding agents, essentially deputized enforcers for the IRS. These deputies include compliant foreign financial institutions, which will be required to withhold on payments to non-compliant foreign financial institutions to the extent the payments are attributable to withholdable payments.