Foreign Persons Investing in the United
States (Inbound Investments)
Practising Law Institute
Basics of International Taxation
July 22, 2015
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2
Introduction
Marc Ganz
◦ Partner,
◦ International Tax Services (New York)
◦ 212 773 2229
Jeremy Naylor
◦ Partner
◦ Cooley, LLP (New York)
◦ 212 479 6580
3
Agenda
Inbound Taxation – Overview
Effectively Connected Income (ECI) and the Use of
Blockers
US Taxation of Capital Gains
US Taxation of Interest
◦ Earnings Stripping Rules
◦ Conduit Rules
U.S. Foreign Investment in Real Property Tax Act
U.S. Withholding and Reporting and Foreign Account
Tax Compliance Act (FATCA)
4
Inbound Taxation–Overview
US taxation of non–US persons
◦ Taxable activity or presence in the United
States
Income effectively connected with a US trade or
business (ECI)
Branch profits tax, branch–level interest tax
FIRPTA
◦ Certain types of “passive” US–source income
Fixed or determinable, annual or periodical income
(FDAP)
5
Inbound Taxation–Overview
FDAP
◦ Interest
But not bank deposit interest or portfolio interest
◦ Dividends
◦ Rents
◦ Royalties (not listed in statute)
◦ Generally not capital gains
6
Taxable Presence–Taxation of Non-US persons
Taxation differs depending on type of income earned
◦ Non-business (passive) income
30 percent tax on gross amount of certain US-source income
Collected through withholding at source
◦ US trade/business income
Net basis tax on ECI (at the graduated rates)
Application of US branch taxes
Tax return filing requirements
◦ Tax treaties may alter treatment of both types of income
7
ECI and the Use of Blockers
What is a Blocker Corporation?
◦ A corporation that is placed between the foreign investors and the source of ECI to
prevent pass through of ECI and the associated tax return filing obligation.
◦ Blocker corporations change the character of the underlying income or assets, or both.
The U.S. tax consequences of holding an investment through a blocker
corporation depend on the chosen structure.
Advantages to Blockers:
◦ Convert ECI into “FDAP-type” income which does not necessitate a direct US tax or
reporting obligation from the foreign investor;
◦ Shield foreign entities from US tax exposure; and,
◦ Help manage earnings more effectively.
Disadvantage: The Blocker will be subject to a 35% US federal tax rate and
possible state income tax.
8
ECI and the Use of Blockers
Foreign Investor
► Foreign Investor:
► 35% tax on effectively connected
income
► 30% tax on Branch Taxes (subject to
treaty reduction)
► Disposition – Wind-up of US
business should not be subject to US
tax
► Foreign Investor files US income tax
return
► Foreign Investor:
► 30% tax on interest, dividends and royalties (subject to treaty reduction)
► Disposition – sale of shares not subject to US tax unless US Corp is a US Real Property Holding Company
► Generally not necessary to file a US federal income tax return
► US Corp:
► 35% tax on net income
► US Corp files a US income tax return
Foreign Investor
USTB
US Corp
Interest Interest
The use of a blocker does not necessarily reduce the amount of US tax levied on ECI, but it
does limit the Foreign Investor’s liability and US filing obligations.
USTB
9
ECI and the Use of Blockers – US Blocker Corp
US Blocker Corp is subject to tax on a net basis at
graduated rates on its income from the USTB.
To the extent US Blocker Corp distributes dividends or
makes interest or royalty payments to Foreign Investor,
the payments are subject to a 30% withholding tax
(subject to reduction by treaty).
Pros
◦ Foreign Investor does not have to report ECI or file a US
tax return.
◦ Foreign Investors can limit the amount of income subject to
US tax by allocating limited risks and activities to Blocker
Corp.
◦ Leverage can reduce the US tax base as allowed by the
earnings stripping and thin capitalization rules.
◦ Foreign Investor not subject to US tax on disposition of
stock provided Blocker Corporation is not a US Real
Property Holding Company
Cons
◦ Blocker Corp is subject to US tax on a net basis at a 35%
rate and must meet US compliance obligations.
US Blocker Corp
Foreign
Investor
USTB
Loan
10
ECI and the Use of Blockers – Foreign Blocker
Corp Foreign Blocker Corp is subject to tax on a net basis at
graduated rates on its ECI.
Foreign Blocker Corp is subject to branch taxes at a
rate of 30% (subject to reduction by treaty) on deemed
distributions and deemed interest payments from
USTB.
Pros
◦ Foreign Investor does not have to report ECI or file a US
tax return.
◦ Foreign Blocker Corp can limit the amount of income
subject to US tax by allocating limited risks and activities to
the USTB.
◦ Leverage can reduce the US tax base as allowed by the
earnings stripping and thin capitalization rules.
◦ Foreign Investor not subject to US tax on disposition of
Foreign Blocker Corp stock.
Cons
◦ Foreign Blocker Corp is subject to US tax on a net basis at
a 35% rate and must meet US compliance obligations.
Foreign Blocker
Corp
Foreign
Investor
USTB
Loan
11
ECI and the Use of Blockers - Partnership
This structure is often used when FP acquires a US Target with controlled foreign corporations (CFCs). In order to rationalize the structure, FP contributes its US operating companies to New FHC, and US Target (ECI Blocker) contributes its CFCs to New FHC.
Special allocation to New FHC partners results in ECI from the US Opcos being allocated to US Target (ECI Blocker). Non-ECI from the CFCs is allocated to FP.
US Target (ECI Blocker) can make its investment in New FHC in exchange for a preferred interest, which will effectively freeze US Target ‘s (ECI Blocker’s) interest in any future appreciation of the US and foreign operations.
◦ US Target should be eligible for CFCs’ deemed paid credits provided it constructively owns at least 10% of the CFCs’ voting stock.
FP
US Target
(ECI Blocker)
ECI Income
Non-ECI
Income
US
Operations
Foreign
Operations
New
FHC
12
PE
Fund
ECI and the Use of Blockers – Private
Equity Fund “Downstream” Blocker
Private equity fund has US taxable investors and non-US investors and wants to invest into tax-transparent portfolio company (such as an LLC).
Non-US investors want to avoid incurring ECI
US investors want to maintain flow-through tax treatment.
Fund bifurcates investment – partially through blocker corporation.
◦ ECI converted into dividend income; Special allocations at Fund level
Basic structure shown. Additional features include:
◦ Structuring General Partner carry “pre-tax”
◦ Requirement to exit via sale of blocker shares – maximize returns to non-US investors
◦ Internal leverage to reduce tax at blocker level (subject to earnings stripping and thin capitalization rules)
◦ Separate blocker for each LLC investment – maximize tax efficiency on exit – can be complicated to implement depending on fund economics
Non-US
Investors
US Investors
(including GP)
US Investors’
capital
US
Operations
Portfolio
Company (LLC)
(ECI Blocker)
Non-US
Investors’
capital
13
AIV
ECI and the Use of Blockers –
Private Equity AIV Another common structure for private equity
– alternative investment vehicles (AIVs)
Non-ECI generating investments made through “main” fund
ECI investments made through AIV
Blocker interposed between Non-US investors and AIV (typically, but not always, onshore)
In some respects simpler than traditional “downstream” blocker structure
◦ GP’s carried interest already structurally below the blocker
◦ No need to deal with special allocations and whether substantiality test is met
Some additional risks, however
◦ Aggregation risk with main fund
◦ More complicated to exit via sale of blocker shares
◦ Separate blockers for each deal to avoid dividend withholding tax on exits
Non-US
Investors
US Investors
(including GP)
Portfolio
Company (LLC)
(ECI Blocker)
Main
Fund
Portfolio
Companies
(C Corps)
All Investors
(including GP)
14
Parallel
Fund
ECI and the Use of Blockers –
Private Equity Parallel Fund
Finally, PE fund sponsor could consider a
parallel fund for Non-US investors
Parallel fund invests “in parallel” with main
fund directly into C Corp investments, but
through blockers into LLCs
Main fund invests directly in everything
Essentially dowstream blocker structure
done through separate fund vehicle
◦ No § 875 tax filing issue for Non-US
investors
◦ Still need additional structuring for GP
to tax carried interest pre-tax for
blocked investments
Non-US
Investors
Portfolio
Company (LLC)
(ECI Blocker)
Main
Fund
Portfolio
Companies
(C Corps)
US Investors
15
Taxation of US- Source Capital Gains
US Domestic Law:
◦ US-source capital gain that is not effectively connected with a trade or business in the US
is exempt from taxation in the US, unless it is related to the disposition of a US real
property interest.
◦ Capital Gain is subject to US net basis income tax if it is effectively connected with
taxpayer’s US trade or business (US T/B).
Gain is considered effectively connected only if the asset is used in or held for use in the conduct
of a US T/B or the activities of a US trade were a material factor in the realization of the gain.
US Income Tax Treaties:
◦ The 2006 US Model Treaty allocates taxing rights on capital gains to the source state if
the gains are attributable to the sale of: (i) real property; (ii) moveable property that is
part of a PE; (iii) ships or aircraft used in international traffic; and, (iv) containers unless
they are used solely for transport between places in the state of residency.
◦ Otherwise, taxing jurisdiction is ceded to the state of residency.
16
Taxation of US- Source Capital Gains
Example
Sale of: Taxed by:
US Opco shares Foreign Parent Jurisdiction
Foreign Opco shares Unclear, but not US
US HoldCo shares US
US Real Property US
USTB (or PE) Assets US
Foreign
Parent
US
Opco Foreign
Opco US
HoldCo
US Real
Property
USTB
Assets
US Real
Property
17
Taxation of US- Source Interest FDAP income is defined broadly and generally includes all US-source
income that is not ECI
◦ FDAP includes passive investment income — interest, dividends, rents, royalties, etc.
◦ FDAP does not include capital gain on the sale of real or personal property.
◦ FDAP interest excludes portfolio interest and interest on deposits in US banks.
Requirements for qualification as portfolio interest – registered form; not 10% shareholder; not
contingent interest; bank not lender
Nonresident individuals and corporations are taxed at a 30% flat (or lower
treaty) rate on the gross amount of FDAP income that is NOT effectively
connected with USTB.
Tax is paid through withholding at source by the payor (Withholding
Agent) who remits the withheld tax to the IRS. § § 881 and 1441.
18
Compliance for US - Source Interest
Nonresident corporations receiving FDAP income may be required
to file the following forms to the extent that they qualify for treaty
benefits:
◦ Form SS-4 Application for Employer Identification Number
◦ Form W-8BEN-E Certificate of Foreign Status of Beneficial Owner for United
States Tax Withholding and Reporting (Entities)
Withholding Agents are required to file the following forms:
◦ Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons
,must be filed by the Withholding Agent by March 15th following the calendar
year in which the income subject to reporting was paid, unless an extension of
time to file is obtained.
◦ Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, must be
filed by the Withholding Agent for every foreign payee with respect to which it
paid FDAP income. On each Form 1042-S, the withholding agent must indicate
the amount of each category of income paid to the foreign payee (e.g., dividends,
interest, etc.) and the amount of tax withheld.
19
Section 163(j)–policy Debt capitalization
Equity
capitalization
FP
US
Interest
Loan
FP
US
$ Dividend
► E&P stripped out of US Sub as
deductible interest
► Interest may not be subject to
withholding tax under treaty
► Overall US tax cost is reduced
► Dividend is non–deductible
► Dividend taxable to FP under §1441 (but
may be reduced or eliminated by treaty)
20
Section 163(j)–overview Limits the deductibility of disqualified interest which is:
◦ Interest paid to a related foreign person; or,
◦ Interest paid to an unrelated person on debt guaranteed by a related foreign person.
On interest paid by a US corporation, partnership or branch if the interest income is not subject to US tax or is subject to reduced tax.
Applies if:
◦ Debtor’s debt–to–equity ratio > 1.5:1; and,
◦ Debtor’s net interest expense > 50% of adjusted taxable income (Excess Interest Expense).
The interest expense deduction is deferred by the lesser of the Excess Interest Expense or the disqualified interest.
Excess limitation can be carried forward three years.
21
1991 Proposed Regulations
Contain broad anti–avoidance rules.
Interest income and expense
◦ Determined under §§61 and 163
◦ Nonfunctional currency rules of §988 applicable
◦ Reserved on Interest equivalents
ATI increased by decrease in accounts
receivables and increase in accounts payable.
Contain fixed–stock write–off election.
Definition of affiliated group.
22
To follow or not to follow … the
proposed regs? Not an affiliated group under §1504(a) Affiliated group under proposed regulations
ForCo
Sub 2
US
Sub1
US
Sub2
US
Sub1
US
ForCo
F is not ‘includible corporation’
under §1504(b)(3) Sub1 is seen as indirectly owning 100%
of Sub2, and vice versa, under §318(a)
Interest Interest
23
Section 163(j) Planning Strategies
Substitute interest with other expenses
Increase ATI
Minimize disqualified interest
24
The Conduit Rules: A basic example
Foreign Parent is in a non–US treaty jurisdiction.
FinCo is in a treaty jurisdiction with 0% WHT rates with the US
The result, based on form alone, is 0% WHT on the interest payments from USCo to FinCo
Conduit case law recasts the transaction based on Substance over Form and Business Purpose Doctrines
◦ Case law looks to see if FinCo has “dominion and control” over the funds
Foreign
parent
USCo FinCo
Loan
Loan
25
The Conduit Regulations
Treasury issued the Conduit Regulations under Treas. Reg. §1.881–3 in 1995.
There are four requirements for transactions to fall afoul of the conduit
rules.
1) Is the transaction a “financing arrangement” as defined in the regulations? (financing
arrangement has a broad definition).
2) If yes to 1, does the participation of an intermediate entity reduce the tax imposed
by §881? (30% withholding tax on FDAP).
3) If yes to 2, is the participation of the intermediate entity pursuant to a tax
avoidance plan?
4) If yes to 3, District Director may ignore the existence of the intermediate entity
(or entities) for purposes of §881, if the intermediate entity is:
Related to other parties to the transaction, or
Would not have participated in the arrangement on substantially the same terms but
for the fact that the financing entity engaged in the transaction with the intermediate
entity.
If the arrangement fails the tests set forth above, the loan is recast as being
between the financed entity and the financing entity.
26
FIRPTA – Foreign Investment in US Real Property Tax Act
§897
Congress enacted the Foreign Investment in Real Property Tax Act of 1980
(“FIRPTA”) to prevent abuse of certain rules on taxation of effectively
connected income (“ECI”) of a foreign person.
Prior to enactment it was possible for a foreign investor to avoid US tax on
both operating income and gains on sale of a US real property interest
(“USRPI”), creating a perceived unfair advantage over US investors.
Impact of FIRPTA
◦ Subjects foreign investors to US tax on disposition of a USRPI
The gain is treated as ECI under §897(a).
Such ECI gain, net of allowable deductions allocated to such ECI, is
taxed at graduated rates of regular income tax (§§871(b) and
882(a)(1)).
Enforcement is done in two ways:
Withholding regime.
Reporting requirements.
27
FIRPTA - USRPI
The definition of a USRPI is broad. It includes:
Real Property - Treasury Regulation §1.897–1(b)
◦ Land and unsevered natural products of the land
◦ Improvements to land
◦ Personal property associated with certain uses of real property
Interests other than an interest solely as a creditor (e.g., leasehold interests) - Treasury
Regulation §1.897–1(d)(2).
US Real Property Holding Companies (USRPHC) - Treasury Regulation §1.897–2.
◦ A Corporation is a USRPHC if on any determination date during the lesser of the holding period or 5
years ending on the date of disposition the FMV of its USRPI’s is greater than or equal to 50% of the
FMV of its: (i) USRPI; (ii) foreign real property interests; and, (iii) assets held for use in a trade or
business.
◦ Determination dates include: (i) the last day of the taxable year; and, (ii) any other date that could
trigger USRPHC status.
◦ Alternative - Book value testing.
Exceptions:
◦ Regularly traded interest in a USRPHC– §897(c)(3); and,
◦ Real Estate Investment Trusts (REIT).
28
FIRPTA - Non–recognition exchanges
Section 897(d) and (e) strictly limit the ability of USRPHCs to engage in non-recognition transactions.
The general intent of these rules and exceptions is to preserve the ability of the US government to impose at least one level of tax on USRPI gains.
However, non-recognition treatment is still available if:
◦ USRPI for USRPI requirement (suspended for most foreign to foreign exchanges);
◦ The USRPI received would be subject to tax on its disposition; and,
◦ The foreign transferor complies with the filing requirements of Treas. Reg. §1.897–5T(d)(1)(iii) as modified by Notice 89–57.
If the non-recognition provisions apply, the transferee receives a carryover basis in the property.
29
FIRPTA – Non-Recognition Transaction
Example Steps
► Both Distributing and Controlled are USRPHCs
1. Distributing distributes Controlled to FP under Section 355(a)
2. FP drops Controlled into foreign Newco (“FNewCo”) and waits 12 months
3. FP then distributes FNewCo to Public
Considerations
1. If Controlled is a USRPHC, under the rules of Reg. §1.897-6T(a), the nonrecognition provisions of Section 355(a) apply, and FP does not recognize gain on the deemed exchange of Distributing shares for Controlled shares in step 1. FP’s basis in Controlled is 40M; FP’s basis in Distributing after step 1 is 60M.
2. No gain recognized on the §351 contribution under Reg. §1.897-6T(b)(1)(iii); under that rule, FNewCo must not dispose of Controlled within 3 years of date of receipt. However, Notice 2006-46 reduces this holding period to 1 year. FP’s basis in FNewCo stock is 40M.
3. No gain recognition under Section 355(a); no FIRPTA implications so long as FNewCo holds Controlled for at least 1 year prior to this spin.
Timing
IRS ruling on step 1: 4-6 months; step 2 waiting period: 12 months. Total waiting period approximately 16-18 months
FP
Distributing (USRPHC)
Controlled
(USRPHC)
Public
1 FNewCo
2
Controlled
(USRPHC)
Controlled
stock
3
FNewCo
stock
Distributing
stock
v: $500M
b: $100M
Controlled
stock
v: $200M
30
FIRPTA – Non-Recognition Requirements Failed
FP
Distributing (USRPHC)
Controlled
Public
Transaction
1. Distributing is a USRPHC; Controlled is not a USRPHC.
Distributing distributes Controlled to FP under Section
355(a).
Considerations
► If Controlled is not a USRPHC, under Reg. §1.897-
6T(a)(4), FP is considered to have exchanged
Distributing stock with a FMV of 200M and an adjusted
basis of 40M for Controlled stock with a FMV of 200M.
► FP must recognize gain of 160M under Section 897(a) on
the distribution. FP takes a basis of 200M in the
Controlled stock. FP's basis in the Distributing stock is
reduced to 60M pursuant to Section 358(c).
► Unless an exception applies, or a withholding certificate
is obtained, Distributing is required to withhold 10% of
the amount realized by FP - $20M.
Strategies to make Controlled a USRPHC:
► Have Controlled sell non-USRP assets until USRPHC
determination fraction is > 50%.
► Have Distributing contribute additional USRPI assets to
Controlled.
1
Controlled
Distributing
stock
v: $500M
b: $100M
Controlled
stock
v: $200M
31
1. Operating income and gain from the sale of real estate is ECI to Foreign
Corporation. Foreign corporation must file US corporate income tax
return. State taxes may apply.
2. Foreign Corporation may be subject to an additional 30% US “branch
profits tax” (if not reduced by treaty and exceptions do not apply), which
may increase the 35% federal rate by about 19.5%, such that the total US
federal tax impact may be approximately 54.5%. (BPT might not apply to
certain gains on sale.)
3. No US withholding tax on dividends paid to foreign investors.
4. No US estate tax consequences for foreign individual investors.
5. No filing obligations for investors.
6. Gain on sale of foreign corporation shares not subject to US tax (although
it may be difficult to locate a purchaser of stock).
7. Any US taxes paid by the foreign corporation may be creditable in own
jurisdiction.
8. 897(i) election?
Foreign investors
Foreign
corporation
US real property
Investment Through Foreign Corporation
32
Funds With Domestic and Foreign Investors –
Use of REITs
Domestic
investors
US fund
REIT
Foreign
investors
US real property
Domestic investors
► Avoid expense associated with REIT.
► Any losses will flow through to domestic investors.
► Purchaser of interest can get basis step up in assets.
► No worries about violating REIT rules.
Foreign investors
► Need to pool investors.
► Fund must agree to manage business to comply with REIT rules.
► No US tax return filings for operating income.
Investments in REITs
► Dividend distributions of operating income and non-USRPI sales proceeds
are subject to 30% US withholding tax (subject to treaty reduction).
► Distributions attributable to USRPI gains are subject to FIRPTA. A 35%
withholding tax is imposed, and the investor has a filing obligation. If a REIT
is a USRPHC, its stock generally is a USRPI. These gains recognized by a
foreign corporate investor are subject to branch profits tax.
► A 5% or less holder of a regularly traded class of stock is not taxable under
FIRPTA on a disposition, and the USRPI-gain distributions are not taxable
under FIRPTA (re-characterized as an regular dividend).
► A holder of “domestically controlled” REIT stock is not taxable under
FIRPTA on a disposition of such stock, unless the disposition is part of a
liquidation.
33
Creating Domestically Controlled REIT?
REIT
Foreign
investors
US real property
Domestically Controlled REITs
► Gain on sale of stock of a domestically controlled REIT not generally taxable under
FIRPTA
► Notice 2007-55 overturns this rule in the case of liquidating distribution of
domestically controlled REIT
► “Domestically controlled” = Less than 50% of stock (by value) held “directly or
indirectly” by foreign persons
► “Directly or indirectly” not specifically defined for this purpose
► PLR 200923001 – Effect of using a US corporate “blocker” to establish domestic
control
► Some doubt that the government would again issue this ruling
► Facts of ruling different than accompanying chart, but question at issue is the
same – does indirect ownership of a REIT by non-US persons through a
taxable C corporation count toward the 50% test?
► If ruling is correct, Non-US investors can escape tax on ~ 49% of gain on exit
► US buyer would agree to buy REIT shares and can obtain a basis step-up
upon liquidation of the REIT immediately after acquisition
► US “blocker” would be subject to corporate level gain on exit
► But subsequent liquidating distribution of US blocker could be tax-
free under FIRPTA cleansing sale rule
US “Blocker”
Corp
49% 51%
34
Funds With Domestic and Foreign Investors –
Leveraged Blocker Structure Issue?
► Underlying assets may not be REIT compliant (e.g., dealer
property)
► REITs may not materially reduce tax and filing exposures
Solution?
► Blocker corporation previously discussed
► Shareholder debt provided by foreign investors to reduce tax
leakage within blocker
Issues?
► Debt/equity classification issues (thin capitalization)
► 163(j) – need diversification among investors
► Withholding on interest
► May be reduced under treaty
► Or structure interest to qualify for portfolio interest
exemption
► 10% voting stock limitation
► Dividends subject to 30% FDAP withholding (reduced per treaties)
► Distributions in excess of basis subject to FIRPTA withholding
► Liquidating distribution of blocker following fully taxable
disposition of underlying real estate = tax-free
► Multiple blockers for multiple investments?
Domestic
investors
US fund
Leveraged
Blocker
Foreign
investors
US real property
Debt + Equity
Equity Equity
35
Foreign Account Tax Compliance Act (FATCA)
Foreign Account Reporting – FATCA
◦ Enacted in 2010 – Combat tax evasion by U.S. persons holding offshore accounts
◦ New 30% withholding tax on U.S. source payments to “Foreign Financial Institutions” who fail to disclose U.S. account holders Banks, brokers, dealers, custodians, investment funds, insurance
companies, etc.
◦ First step toward worldwide intergovernmental assistance to combat tax evasion Many jurisdictions now have their own version of FATCA (without
the tax “stick”)
◦ Individual Reporting and Entity Withholding
36
Foreign Account Tax Compliance Act (FATCA)
Foreign Account Reporting – FATCA
◦ Institutional –FFI reporting 2 regimes – FFI Agreement/Intergovernmental agreement
FFI Agreement regime – direct reporting to IRS
IGA regime
Model 1 – reporting to local tax authorities – bilateral cooperation
Model 2 – reporting to IRS
Nearly 70 signed IGAs currently in force
◦ Individual – Account reporting IRC 6038D; IRS Form 8938
◦ Compliance Issues Certifications under US FATCA; self-certifications under local
law FATCA
Not well coordinated
37
Foreign Account Tax Compliance Act (FATCA)
Foreign Account Reporting – FATCA
◦ FFI reporting Disclose to IRS or local tax authority information
regarding U.S. account holders
Name
Address
TIN
Account number
Value of Account
Redemptions/withdrawals
Timeline of reporting different under Final Regulations and IGAs
Form 8966; Local law for Model 1 Reporting FFIs
38
Foreign Account Tax Compliance Act (FATCA)
Foreign Account Reporting – FATCA ◦ Individual Reporting – Foreign Financial Assets
◦ IRC 6038D, enacted in conjunction with FATCA
◦ Effective starting 2011
◦ Reporting of “specified foreign financial assets” above $50,000
◦ Form 8938
◦ Limited to individuals Contrast with reporting of entity account holders by
FFIs
Proposed regulations extend to entities formed or availed of for purposes of holding specified financial assets
39
Foreign Account Tax Compliance Act (FATCA)
Foreign Account Reporting – FATCA
◦ Who must report – Reporting Thresholds Living in the United States
Unmarried - $50,000 at end of year or $75,000 at any time during year (same thresholds for marrieds filing separately)
Married filing joint return - $100,000 at end of year or $150,000 at any time during year
Living outside United States
Unmarried - $200,000/$300,000
Married filing joint return - $400,000/$600,000
Thresholds subject to change
Specific tests for determining residency for these purposes
40
Foreign Account Reporting – FATCA ◦ Specified Foreign Financial Assets Cross-references to FATCA definitions
Any “financial account” maintained by an FFI or by financial institution organized under laws of U.S. possession; and
Following assets held for investment and not maintained in a financial institution: Stock or securities of a foreign issuer
Interests in “foreign entities”
Financial instruments/contracts with foreign issuer/counterparty
Temporary regulations contain examples
Held for investment vs. held in trade or business
Foreign Account Tax Compliance Act (FATCA)
41
Foreign Account Tax Compliance Act (FATCA)
Withholding – FATCA
◦ U.S. Withholding agents are required to withhold the 30% FATCA tax on certain payments to certain foreign financial institutions and NFFEs Several questions embedded here – FATCA compliance for
withholding agents essentially a series of Q&As
◦ First question: Who is a U.S. withholding agent under FATCA? U.S. person
Having control, receipt or custody over the disposal or payment of
A “withholdable payment”
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Foreign Account Tax Compliance Act (FATCA)
Withholding – FATCA
Second question: What is a withholdable payment? ◦ Starting 7/1/2014, U.S. source FDAP income
Interest;
Dividends;
Rents and royalties;
Compensation and other fixed or determinable income; and
◦ Starting 1/1/2017, Gross proceeds from the sale or other disposition of property of a type which can produce interest or dividends from U.S. sources.
◦ Exceptions:
“Grandfathered obligations”
Short-term obligations
ECI
“Excluded nonfinancial payments”
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Foreign Account Tax Compliance Act (FATCA)
Third question: who is the payee?
◦ Identification of payee
In general, payee is the recipient
Look beyond recipient in following situations:
Certain payments through agents/intermediaries
Payments to many non-U.S. flow-through entities
Participating or Deemed-Compliant FFIs (same treatment as
under Chapter 3)
Payments to foreign branches of U.S. persons and certain U.S.
branches of foreign persons
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Foreign Account Tax Compliance Act (FATCA)
Fourth question: how do you categorize the payee? ◦ Need to determine whether the payee is U.S. or non-U.S. and if
non-U.S., whether an FFI, etc. Categorization of payee – U.S. or foreign person?
Determine whether payments are made to intermediaries
Reliance on documentation – W-8 and W-9 forms de facto acceptable
Permanent validity of W-8 forms provided by participating FFIs (“PFFIs”) and Registered Deemed-Compliant FFIs (but not Certified Deemed-Compliant FFIs) if no change in circumstances
3 year period otherwise – obligation to update.
Categorization of payee – status under FATCA In general withholding agents will need to obtain new W-8BEN-E forms unless
recipient is a foreign individual, foreign government or international organization
New W-8BEN-E provides specific categories of each type of entity under FATCA
Specific standards of knowledge can override forms Indicia of U.S. residence, e.g., - mainly common-sense rules
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Foreign Account Tax Compliance Act (FATCA)
Fifth question: must I withhold? ◦ Withhold 30% on withholdable payments to:
Non-participating FFIs;
Participating FFIs that are non-qualified intermediaries if sufficient documentation is not received (i.e., W-8BEN that establishes all of the beneficial owners are exempt under FATCA – similar to current Chapter 3 rules for non-U.S. flow-through entities); or
FFIs that elect to be withheld upon
◦ Timing of payment When amount would be includible in income of beneficial owner
under cash method of accounting principles
For flow-through entities, when amounts subject to withholding are distributed, or if amounts are not distributed, generally when K-1s are issued (similar to Chapter 3 principles)
◦ File 1042 and 1042-S – similar to Chapter 3 withholding
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Questions
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Thank you For your participation and feedback!