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      The storm is brewing over accounts and investments held worldwide

      The storm is brewing over accounts and investments held worldwide

      The US Foreign Account Tax Compliance Act (FATCA), enacted on
      18 March 2010, will have a substantial impact on certain accounts held at Foreign Financial Institutions (FFIs). The expansive definition of FFIs will have specific significance for Banks, for the insurance industry and for investment vehicles. On 8 April 2011, the US tax authorities (the Internal Revenue Service, “IRS”) issued a second Notice in order to provide some further guidance on the scope and implementation of FATCA. In an LFF Interview, Kerstin Thinnes, Partner and Amandine Horn, Manager at PwC Luxembourg speak about FATCA’s consequences on the financial services.

      Could you give us a general overview on the FATCA law?

      The FATCA law creates a new chapter in the US tax code, one that is focused on strengthening information reporting and withholding compliance for US persons, including those who invest through or in non-US entities. These provisions will result in an unfavourable 30% withholding tax on any “withholdable payment” made either to a Foreign Financial Institution (“FFI”, including investment vehicles such as hedge funds, private equity funds, and certain insurance products) or to a Non-Financial Foreign Entity (“NFFE”), if they fail to comply with the new reporting, disclosure and related requirements.

      The withholding tax will not only apply on US sourced dividends and interest, but also on gross proceeds from the sale of assets that could produce such interest or dividends. Due to this punitive withholding tax, FFIs are encouraged to sign an FFI Agreement with the IRS. Such agreement would require an FFI to comply with documentation, reporting (name of investor, investment volume, income paid including non-US income, etc.), verification, withholding and due diligence procedures with respect to “US accounts” as defined in the FATCA Law.

      Regarding payments made to NFFEs, a withholding agent shall withhold the 30% tax from withholdable payments, unless the NFFE discloses the name, address and US tax identification number of any substantial (ultimate) US owner (or certifies their absence). If the FFI or NFFE complies with these new requirements, the current withholding tax rules will remain applicable.

      Many of the implementation aspects of the legislation were left for the IRS to determine. On 27 August 2010, the IRS therefore issued a first Notice (Notice 2010-60), which notably provided certain exclusions from FFI status (although carve-outs for investment vehicles were not mentioned).

      The Notice clarified that insurance companies which issue cash value insurance contracts, annuity contracts or similar arrangements would be treated as entities subject to the new FATCA legislation. Notice 2010-60 also provided general guidance on the expected documentation due diligence requirements.

      You only mentioned Notice 2010-60. What about the second Notice issued by the IRS?

      The documentation requirements for preexisting individual accounts defined in Notice 2010-60 will be replaced by the procedures introduced by Notice 2011-34. Based on Notice 2011-34, the FFI now has only two years to perform a diligent review of all accounts that have a balance or value of more than USD 500,000 and to obtain the required documentation. This threshold should be tested annually by the FFI.

      On the contrary, Notice 2010-60 previously allowed two or five years to comply, depending on the circumstances. The documentation requirement in the event of US indicia have also slightly changed and been strengthened compared to Notice 2010-60.

      This new Notice also introduces the concept of “private banking account”, which will be subject to a specific procedure compared to other types of financial accounts. ”A private banking account” will be any account maintained or serviced by a private banking department or as part of a private banking relationship (as defined in Notice 2011-34 and further guidance). 

      In such a case, the deadline to document the account is reduced to one year after the effective date of the FFI Agreement. The review of existing documentation is also strengthened for private banking accounts, as a private banking relationship manager will have to perform a diligent review of the paper and electronic account files (as opposed to only “electronically searchable information” in the case of other types of accounts).

      The concept of “electronically searchable information” has also been defined in Notice 2011-34 as being the information that an FFI maintains in its tax reporting or customer master files and stored in an electronic database system (and not simply scanned documents stored on a computer). The completion of the customer identification procedures mentioned above will need to be certified to the IRS.

      What about passthru payments?

      The new Notice also provides guidance on the definition of the term “passthru payments”, which will include not only withholdable payments, but also any other payment made by an FFI multiplied by either the passthru payment percentage of the entity that issued the interest or instrument (in the case of a custodial payment) or the passthru payment percentage of the payor FFI (in the case of any other payment). 

      In this respect, FFIs (i.e. banks, funds, certain insurance companies, etc.) will need to determine on a quarterly basis the percentage of US assets compared to their total assets (assets held by the FFI as a custodian, agent or nominee will be excluded). This percentage needs to be published and will be the basis for potential taxation of "passthru payments".

      Notice 2011-34 confirms that the IRS will define certain FFIs as deemed-compliant FFIs. Certain local banks and local FFI members of participating FFI groups could be eligible for deemed-compliant status, provided certain requirements are satisfied. 

      What other provisions are worth mentioning?

      Regarding investment vehicles, the IRS confirms that they are currently considering some of the proposals made by lobby groups to define certain investment vehicles as deemed-compliant FFIs. They notably confirm that there will be some conditions linked to restricted investor types and enhanced distribution agreements, but do not give any new information in this regard. 

      Notice 2011-34 also gives more details on the reporting requirements regarding US accounts. For example, participating FFI account balance reporting will be limited to year-end balances or values, and the FFI might apply some simplified procedures regarding classification of income. Regarding the application of FATCA to expanded affiliated groups, each FFI within an FFI group will need to be a participating or deemed-compliant FFI, but all affiliates may apply for such status through a coordinated application process handled by a “lead FFI”.

      What are the implications of FATCA for the financial sector?

      FATCA will have far-reaching consequences on the financial services landscape as well as on investment behaviour. Financial intermediaries cannot afford simply to ignore such US tax requirements, as this could cause their US investments to perform less successfully. Although banks (especially Qualified Intermediaries) are already well informed about these US tax issues, they will need to analyse the new rules in detail, take strategic business decisions, and potentially update their procedures and systems accordingly.

      Asset managers and insurance companies are, however, faced with a whole new set of requirements. The outcome of the discussions between different industry organisations and the US Treasury Secretary should therefore be closely monitored by financial institutions and investors. 

      Notice 2011-34 demonstrates that the IRS and US Treasury have listened to the comments of market participants submitted so far, which should encourage industry organisations to respond to the new request for comments included in the Notice (the deadline is 7 June 2011).

      Based on feedback received from the IRS, this should indeed be the last opportunity to provide comments before the publication of the draft FATCA regulations, which are not expected before the end of the year 2011. With only approximately one year left to update procedures and systems accordingly, all market participants and service providers concerned are now faced with a significant challenge. Interview:CW