Australia: 30% withholding requirement under the United States Foreign Account Tax Compliance Act (FATCA)

Snapshot

From 1 January 2014, the United States Foreign Account Tax Compliance Act (FATCA) will require the withholding of 30% of certain payments to, or from, a non-US "foreign financial institution" (FFI), if the ultimate recipient of that payment is a US citizen or an entity controlled by a US citizen.

This article highlights some of the 'big picture' issues FFIs will face as a result of FATCA.

Broadly, FATCA has been described as an information sharing and withholding tax regime, but it may be more accurately described as a tax avoidance counter-measure. It restricts the ability of US persons investing offshore or earning income that is passed through FFIs as a means of minimising their US tax burden.

Australian lenders will need to closely assess FATCA's impact not only in the context of compliance and risk management but also in managing/considering new and existing lending transactions, in particular, with respect to loan serviceability as well as the pricing, risk and profitability of a given transaction.

Brief background

FATCA's first elements were enacted by US Congress in March 2010.¹ As its commencement draws near, the extent of its impact on FFIs is becoming clearer.

FFI is expansively defined to include non-US banks, brokers, insurance firms and various investment trusts, funds and capital markets issuers. Even if an FFI's head office is outside the US, those FFIs with US operations could be subject to severe penalties for failure to comply with FATCA. An FFI may also face commercial ramifications if it is required to withhold 30% of certain payments.

The short point is that FATCA's reach is global.

Given the complexity of FATCA, one would expect that it is framed in extremely complex and dense terms. Furthermore, the drafting needs to be read in the context of a multitude of defined terms and interpretation notes. To assist the reader in deciphering FATCA, the meanings of relevant definitions have been footnoted when used in this article.

FATCA withholding

The withholding aspect of FATCA is dual-pronged. Unless an FFI is deemed "participating" by the US Internal Revenue Service:

• a withholding agent² is required to withhold 30% on a withholdable payment³ made to an FFI, and
• an FFI must withhold 30% on any passthru payment⁴ it makes to another FFI or a recalcitrant accountholder.⁵

Legal posturing around potential undue influence, duress and contract vitiation aside, the reality is that an FFI must enter into an FFI Agreement with the US Internal Revenue Service to be deemed "participating".

From a timing perspective, to avoid FATCA withholding from 1 January 2014, an FFI must enter into an FFI Agreement before 30 June 2013. If an FFI Agreement is made after June 2013, the IRS cannot guarantee the relevant FFI will be identified as "participating" before 1 January 2014.

To date, no official pro-forma of an FFI Agreement has been released but FATCA stipulates that the relevant FFI must agree to:

1. Obtain information required by the IRS in respect of suspected US accounts⁶ and comply with verification and due diligence procedures on US accounts as required by the IRS from time to time.
2. Provide annual reports to the IRS including various details (such as gross receipts and gross withdrawals) in respect of each US account and comply with IRS information requests from time to time.
3. Where foreign law would prevent such reporting, to close the US account if a valid waiver of law cannot be obtained from the account holder.
4. Withhold 30% on payments to recalcitrant account holders and certain FFIs.

If an FFI "participates", the circumstances in which an FFI needs to withhold payments are significantly reduced.

Considerations

FATCA poses significant compliance and record-keeping issues. On a non-exhaustive basis, FFIs should consider FATCA's impact, particularly with respect to:

• due diligence, know your customer procedures and categorisation of existing and new accounts
• client reporting, tax withholding and identification procedures
• data systems including entry, organisation and retention of information in respect of accountholders
• annual reporting requirements to the IRS in respect of US accounts or persons or entities with a substantial US ownership and ongoing IRS requisition risk.
• FACTA's general impact on the FFI's systems as well as its risk analysis, pricing and profitability modelling and the selection of new participants and borrowers
• whether entry into an FFI Agreement is required by 30 June 2013 so that an FFI can be identified as "participating" by 1 January 2014 and avoid FATCA withholding.

¹FATCA began as part of the Hiring Incentives to Restore Employment Act 2010 PubL 111-147 (HR 2847), section 501(a) of which inserted Ch 4 (§§ 1471-1474) into the Subtitle A of Title A, Offset Provision of the Internal Revenue Code. The details of this are not discussed in this article.

²"Withholding agent" means any person or entity that has control, receipt or custody of any withholdable payment.

³"Withholdable payment" means a payment of US source income that is fixed or determinable, annual or periodical income (e.g. interest from a US Treasury bond) or the gross proceeds from the disposal of property that produces US source interest or dividend income (e.g. proceeds from the disposal of a US Treasury bond).

⁴"Passthru payment" broadly means any withholdable payment and any payment to the extent it is attributable to a withholdable payment.

⁵"Recalcitrant account holder" means a holder of a US account that fails to comply with requests by the IRS for information it requires to determine whether any withholding is necessary.

⁶"US account" means, subject to a handful of exceptions, any financial account held by a specified US person or US foreign owned entity.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.