FATCA Reporting for Non-Financial Foreign Entities

FATCA Reporting for Non-Financial Foreign Entities

The requirements may catch them by surprise

In February 2012, the Internal Revenue Service issued proposed regulations regarding the implementation of the Foreign Account Tax Compliance Act (FATCA), a statute that was included in the Hiring Incentives to Restore Employment Act of 2010 as a revenue raiser.  Congress basically drafted FATCA as a reaction to the disclosure of unreported accounts held by U.S. taxpayers at Swiss and other overseas financial institutions.  These accounts were either reported by overseas banks as part of a settlement with U.S. judicial and regulatory authorities or self-disclosed by U.S. individuals who participated in the IRS’ various voluntary disclosure programs.

FATCA introduces a reporting regime that will require foreign financial institutions (FFIs) to enter into a disclosure agreement with the IRS or, starting Jan. 1, 2013, face an automatic withholding of 30 percent on U.S. source income.    

Public commentary about FATCA has generally focused on the compliance costs it imposes on FFIs,-a broad category that includes banks, investment funds, insurance companies and pension funds, but less attention has been devoted to its impact on non-financial foreign entities (NFFEs).

Whereas FFIs have been quite vocal with their comments on FATCA, mostly via their respective industry organizations, it’s expected that, at the end of the day, they’ll also have the institutional infrastructure to handle the significant amount of reporting requirements that FATCA introduces.  Some FFIs already have to report certain information about their accountholders/investors to government regulators in their home jurisdiction, and FATCA basically extends these requirements for U.S. persons.

Since NFFEs are generally less aware of the specifics of FATCA, the impact of this regulation will come as a shock to many of them.  FATCA generally seems to be a sleeper issue for NFFEs, which can turn into a real pitfall after 2013, when the withholding kicks in for NFFEs that don’t comply with FATCA certification requirements.  

Exempted and Non-exempted NFFEs

FATCA distinguishes between exempted and non-exempted NFFEs.  NFFEs are generally exempted from FATCA reporting and withholding by FFIs if they qualify as one of the following entities:

-       Foreign governments, international organizations and foreign central banks;

-       Publicly traded companies and entities within their expanded group of affiliates;

-       Entities organized under the laws of a U.S. possession or governments of such possessions;

-       Active NFFEs that receive less than 50 percent of their gross income from assets that are held for the production of passive income or if 50 percent of their income is passive investment income. 

Once an FFI has entered into an agreement with the IRS, as FATCA requires in order to not be subject to withholding, it must determine whether its NFFE accountholders are exempt or not.  For new obligations, non-exempted NFFEs must disclose substantial U.S. ownership to the FFI via a newly introduced form W-8BEN-E. The IRS just released  a draft version.  For pre-existing obligations of an NFFE, FFIs will apply a complicated transition regime that will end on Jan. 1, 2017.  By then, all NFFE obligations must be documented via new style self-certifications.

Substantial U.S. ownership is generally defined as having direct or indirect interest by U.S. persons of 10 percent or greater. This 10 percent interest threshold covers corporate stocks as well as partnerships and beneficial interests in non-grantor trusts. Once an NFFE has met this threshold, it must report on these U.S. owners to the FFI, when the FFI so requests.  In an increasingly global and interconnected world, many overseas privately held corporations, partnerships and trusts will qualify as NFFEs.  Just think of the many foreign nationals who move to the United States while retaining a substantial interest in a family business in their home country as well as the entrepreneurs, many from Asia and other emerging economies, who repatriate after completing their studies in the United States, while retaining their Green Card.  Whereas these individuals should be aware of and fully comply with their respective U.S. tax filing and reporting requirements, under FATCA, they’ll now also trigger a requirement for the non-exempted NFFE to report their ownership interest to FFI.

Indicia of U.S. Ownership

When determining whether an NFFE client has substantial U.S. ownership, FATCA requires FFIs to look for indicia such as a U.S. mailing address or U.S. passport.  The many NFFEs that use a U.S. mailing address for convenience of security reasons may, thus, find themselves subject to FATCA withholding unless they certify to the FFI that, despite U.S. indicia, they don’t have substantial  U.S. ownership. 


Tiered Reporting System

FATCA is a tiered reporting system, in which every FFI that has entered into an agreement with the IRS must obtain certifications from FFIs and NFFEs up the chain. An NFFE that only has accounts with a local, overseas bank will have to disclose information about its shareholders and members if it’s qualified as non-exempted and has account with an FFI. For example, ”Exposure to Withholding,” below, illustrates that NFFEs will be required to disclose information about U.S. owners/members with an interest of 10 percent or more in case it banks with a qualifying FFI that has entered into an agreement with the IRS.  However, even in cases  in which these NFFEs have provided all FATCA required certifications to the FFI where they have an account, they may still be exposed to withholding if there’s a non-compliant lower tier FFI (for instance, their local bank invests in U.S. instruments via an offshore bank or fund that’s considered a non-complaint FFI for FATCA purposes).   


The NFFEs listed above will likely only become aware of these certification requirements once they receive a notice from their local bank detailing the new FATCA originated reporting rules or iif they’re faced with 30 percent withholding on certain types of investments (when their bank is considered a non-complaint FFI).  Also, FFIs may unilaterally close the accounts of NFFEs if they consider compliance with FATCA regulations is too costly, and the FFI stops providing services to NFFEs with U.S. owners/members.  

Education Required

Because of this lack of FATCA awareness of overseas entities that will qualify as NFFE, it’s incumbent upon wealth planners and financial advisors to educate their clients about the upcoming FATCA reporting and certification.  FATCA is a complex statute and FFIs have been preparing for its implementation and reporting for several years already.  It’s time that NFFEs receive similar education about the FATCA statute and start preparing for the upcoming reporting regime that it introduces.         


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