The Impact of FATCA on Non-financial Companies

The reach of the Foreign Account Tax Compliance Act
(FATCA) will require nearly every business with an international footprint or
conducting business outside the US to confront new compliance realities.
Although the obvious impact of the new FATCA regime will be on businesses in
the financial services industry, multinational non-financial services companies
that are impacted will also be required to implement US tax documentation, due
diligence, reporting, and withholding processes among other FATCA requirements.
The risk of non-compliance could be costly. The phase-in of FATCA withholding
begins on 1 July 2014 and could result in the application of FATCA withholding
on certain US source income, extending to certain gross proceeds in 2017.

A withholding tax under FATCA will be imposed in a similar manner to
the existing withholding tax on US source income under Chapter 3 (sections 1441
and 1442) of the Internal Revenue Code (IRC) by requiring payors (or
withholding agents) of US-source income and gross proceeds to withhold 30% on
payments to non-US entities that do not certify their compliance with FATCA or
disclose their substantial owners. However, FATCA withholding which is applied
before any Chapter 3 withholding, does not allow tax treaty-based exemptions or
other reductions of the withholding tax rate. To avoid the tax, a foreign
financial institution (FFI) must generally enter into an FFI agreement with the
IRS to share the identities of US account and asset holders or, if subject to a
model 1 intergovernmental agreement (IGA), register with the IRS as a reporting
model 1 IGA FFI.

The IGAs are agreements between the US and foreign
jurisdictions to implement FATCA. FFIs that register with the IRS will obtain a
global intermediary identification number (GIIN) to identify themselves as
FATCA compliant to other withholding agents. Other affected non-financial
foreign entities seeking to avoid the tax will be required to provide
appropriate information to the withholding agents relating to any of their
substantial US owners or certify to a particular excepted status.

Implications of FATCA on Non-Financial Services Industry

The primary impact that FATCA will have on non-financial services
companies is to deem them withholding agents for purposes of FATCA. Although
there is an exception for certain non-financial payments made in the ordinary
course of a business, many payments made by the non-financial services
companies could be subject to FATCA withholding and reporting. At a minimum,
non-financial services companies will need to re-evaluate the current
information reporting and withholding procedures and determine whether any are
impacted by the new FATCA rules.

Certain Non-financial Groups
Caught up in FATCA

A key aspect of FATCA is that it defines
‘financial institution’ very broadly. Any foreign entity conducting financial
transactions may be considered an FFI. Therefore, multinational companies
(MNCs) that have entities within their worldwide group not typically considered
as FIs could come within the definition of an FFI under these rules.

A foreign entity acting as a holding company, treasury centre or captive
finance company would generally fall within the definition of an FFI. However,
it may be excluded if part of an excepted non-financial group. The primary
purpose of this exception is to exclude from the definition those holding
companies, treasury centres or captive finance companies considered to be an
unlikely vehicle for a US person to shield assets. Along those lines, a
non-financial group is limited to holding 25% or less of its assets for the
production of passive income and generating a limited amount of passive income
over a period of time, among other things. The FATCA regulations should be
carefully analysed to determine whether the exception is applicable.

The excepted non-financial group exception does not apply if the affiliated
group contains any private equity funds, venture capital funds, or similar
investment vehicles established with an investment strategy to acquire or fund
companies and to treat the interests in those companies as capital assets held
for investment purposes. These rules were designed to ensure that holding
companies and treasury centres cannot be used by financial groups with
non-participating FFIs or limited FFIs to shelter payments from chapter 4
withholding. As a result, a holding company formed by a private investment fund
to facilitate its investment structure may be subject to FATCA compliance, even
where such company solely holds an interest – directly or indirectly – in a
single non-financial operating subsidiary.

Organizations should also
consider analysing any offshore pension or benefit plans maintained for their
employees. Non-US pension and retirement plans are generally FFIs and may be
impacted by FATCA unless they meet exceptions under the final regulations or
intergovernmental agreements. However, the exceptions available under the
regulations are limited. To protect employee benefit plans, organisations that
maintain or sponsor such plans should ensure that they are either exempt or
compliant under the relevant rules.

Withholdable Payments to
Foreign Payees

A non-financial services company should
determine whether it makes cross-border payments to foreign entities that are
deemed withholdable under FATCA. Withholdable payments include US source fixed,
determinable, annual and periodic payments (FDAP) such as interest, dividends,
premiums for insurance contracts or annuity contracts, investment advisory
fees, custodial fees, and bank or brokerage fees, as well as gross proceeds
from the sale of assets which could produce US source dividends or interest.

The FATCA regulations provide a broad exemption for non-financial
payments defined as those for services – including wages and other forms of
employee compensation such as stock options – the use of property, office and
equipment leases, software licenses, transportation, freight, gambling
winnings, awards, prizes, scholarships, and interest on outstanding accounts
payable arising from the acquisition of goods or services.

Swaps, futures and other hedging transactions: If
with non-US counterparties, these can give rise to FATCA considerations.
Non-financial services companies will need to take a closer look at those
relationships to make a determination as to whether they must withhold tax and
collect documentation from counterparties to substantiate FATCA compliance. If
non-financial services companies determine that any counterparties are
noncompliant, non-financial companies will need to develop and/or implement
withholding and reporting capabilities.

Interest
payments to foreign lenders:
A US borrower who obtains a loan
from an FFI that is not FATCA-compliant may need to withhold on interest
payment as well as on the repayment of the principal. There is an exception
available for certain type of payments (for example, grandfathered
obligations), but analysis will be necessary to determine the extent to which
non-financial services companies can apply the exception, and controls will be
required to track changes in contract terms which might undermine the efficacy
of the exception.

Dividend payments and Stock/bond
redemptions:
Non-financial services companies that act as their
own transfer agents and redeem stock, bonds or makes dividend payments will
need to collect FATCA documentation from their shareholders. Any non-financial
services companies that contract out dividend and redemption payments to third
parties may be afforded some relief from FATCA liability and responsibility,
but the company should consider controls and a clear division of
responsibilities in the event that a third party service provider fails to
properly comply with its delegated FATCA responsibilities. Technically, the
non-financial services company is liable for any failure of its agent, such as
failure to withhold or make a payment of tax even though the agent may be
separately liable for its failure to comply with the FATCA rules. Ultimately,
the same tax, interest or penalties cannot be collected more than once.

Non-Financial Foreign Entities as Payees

From the receiving end, non-financial foreign entities (NFFEs) should be
aware of their FATCA status so that they can provide appropriate documentation
to their withholding agents if required. NFFEs are not required to enter into
an FFI agreement; however, a withholdable payment made to an NFFE is subject to
FATCA withholding unless the NFFE is treated as an excepted NFFE or certifies
to the payor that it does not have any substantial US owners (which generally
includes a US person that owns more than 10% of the entity directly or
indirectly), or provides required information of each substantial U.S. owner to
the payor.

Under the regulations, excepted NFFEs such as publicly
traded corporations, certain start-up companies, certain entities that are
liquidating or emerging from bankruptcy, NFFEs engaged in an active trade or
business and certain other payees are generally exempt from FATCA withholding
if a proper FATCA certification is provided to the payor. NFFEs that do not
qualify for excepted status are classified as passive NFFEs under the
regulations. A passive NFFE is required to disclose its substantial US owners
to a withholding agent, who will use that information to file a Form 8966 with
the IRS.

Next Steps

Non-financial
services entities should conduct a FATCA assessment to determine whether FATCA
applies to their payment types and their operations and, if so, determine the
changes required to comply with the new rules. A typical FATCA assessment
includes the following:

  • Internal entity
    classification:
    Classify the entities within the affiliated group to
    determine their status as US withholding agents with respect to FATCA, FFIs, or
    NFFEs.
  • Impact assessment: Based on the classification
    of your legal entity, identify the business units, operational areas, IT
    systems and legal documents (for example, counterparty agreements and vendor
    contracts) impacted by FATCA. Operational areas that would be impacted include
    onboarding, payment processing, and tax withholding and depositing and
    regulatory reporting.
  • Payee classification: Classify
    payees and other impacted relationships (for example, counterparties for
    derivatives contracts) per the FATCA rules to identify documentation
    requirements.
  • Implementation planning: Make business
    decisions that would reduce the implementation and ongoing costs for FATCA
    compliance. Leverage and modify existing chapter 3 processes and systems to
    further reduce implementation costs and business disruption.
  • Communication: Communicate with internal and external
    stakeholders.
  • Governance: Update policies, procedures
    and legal documents.

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