As we move into 2015 (a.k.a. “the second “transitional” year of the implementation of the Foreign Account Tax Compliance Act) it is very important to understand the impact this Act has on your business. This Act, known as FATCA, was implemented to attempt to curb tax evasion by requiring and encouraging the voluntary reporting of foreign financial assets by U.S. taxpayers, foreign and domestic financial institutions, and foreign governments. The most startling aspect of this new tax law is its reach to virtually all U.S. businesses making payments overseas. The penalties for failing to comply with these new provisions under FATCA can be very punitive and substantial. Accordingly, with this law now in effect, all businesses that have global business operations, maintain offshore accounts/assets, or who make payments to offshore individuals or entities should have a working knowledge of FATCA and its general requirements. In addition to the impact on U.S. businesses, FATCA also imposes additional disclosure/reporting obligations on individual U.S. taxpayers who maintain foreign bank accounts and other foreign assets (including ownership interests in foreign entities). Suffice it to say, the reach of the FATCA is vast.
There are three general areas of enforcement and regulation under FATCA. The first area of compliance imposes an additional filing requirement (i.e., the IRS Form 8938) on taxpayers with specified foreign assets over $50,000. This new form is in addition to the annual FBAR filing obligation for similar foreign accounts. Unlike the FBAR reports, this new form and filing obligation requires the disclosure of more than just financial bank accounts. Specifically, this new form, which is appended to the taxpayer’s annual income tax return, discloses all foreign financial accounts in addition to certain other foreign investment assets. Like the FBAR, there are substantial penalties that can be imposed against taxpayers who fail to include the Form 8938 with their income tax return. The failure to report could result in a minimum penalty of $10,000 and a maximum penalty of $50,000 for each reporting failure. There are also related criminal penalties that can be imposed for willful failures to file this disclosure form.
The second area of regulation and compliance under FATCA is designed to encourage worldwide financial transparency by encouraging foreign governments to enter into Intergovernmental Agreements (IGA) with the United States for purposes of sharing of information on U.S. taxpayers with offshore accounts and assets. In these agreements, foreign governments basically agree to assist the IRS in obtaining information regarding these types of U.S. taxpayers. Quite surprisingly, the United States’ foreign diplomacy efforts to obtain agreements from many foreign governments have been very fruitful. To date, the United States successfully obtained agreements from 34 countries under the Model 1 IGA and 5 countries under the Model 2 IGA.
The final area of regulation requires certain foreign entities to register with the IRS and enter into agreements to provide information related to U.S. account holders or foreign entities that are owned by U.S. taxpayers. FATCA forces this compliance on foreign entities by requiring this registration in order to avoid a 30% withholding on their U.S. sourced payments. Specifically, FATCA requires any U.S. business (i.e., withholding agent) making these types of payments to a foreign entity to first ensure that the foreign entity is FATCA compliant. If FATCA compliance cannot be confirmed, the U.S. withholding agent is required to withhold the 30% from the payment. If the U.S. withholding agent fails to withhold the required 30% from the payment, it will be responsible for this withholding amount plus potential penalties for failure to withhold. Accordingly, the burden for ensuring FATCA compliance lies with the payors of the U.S. sourced income.
A U.S. business making this type of payment overseas is required to engage in 30% withholding if the following apply:
- The payor is a withholding agent obligated to withhold under FATCA;
- The payment being made is a “withholdable payment”;
- The payment is being made to a payee who is a foreign financial institution (FFI) and the FFI is not FATCA compliant or compliance cannot be verified.
- The payment is being made to a payee who is a non-accepted non-financial foreign entity (NFFE) and the NFFE has not properly disclosed its substantial U.S. owners.
Most important of these factors is whether the entity receiving the payment is a FFI or NFFE. In general, a FFI includes (but is not limited to) depository institutions (i.e., banks), custodial institutions (i.e., mutual funds), investment entities (i.e., hedge funds, private equity funds), and certain types of insurance companies. In addition to determining whether the payee is a FFI, there are also potential withholding obligations on payments to non-foreign financial entities (NFFE). If the payment is being made to a FFI, or a non-exempt, 30% withholding will apply UNLESS FATCA compliance can be established.
FATCA compliance can be established through obtaining a withholding certificate from the payee. This withholding certificate is generally provided on some variation of the IRS Form W-8 (foreign entities and individuals) or the W-9 (for US entities and individuals). There are complex record retention requirements with respect to these withholding certificates that must be implemented by U.S. businesses.
Many experts, in reviewing the requirements under FATCA, estimate that the overall compliance costs to U.S. businesses will be substantial. These substantial costs arise due to the enormous reach of FATCA on virtually all U.S. sourced payments made overseas. In addition, FATCA compliance is even more complicated by the ever changing and evolving IRS notices, the voluminous Treasury Regulations, the dozens of Intergovernmental Agreements, and the newly released IRS forms. These substantial compliance costs, however, can quickly be out paced by the punitive monetary penalties that can be imposed against taxpayers who fail to properly withhold under FATCA. As such, most American businesses with global operations will be forced to stomach these compliance costs in order to avoid the IRS’s examination and penalties.
In order to ensure FATCA compliance, U.S. businesses should obtain a FATCA impact assessment that analyzes the regulatory impact of FATCA on business operations. A comprehensive compliance plan should also be put in place to ensure that the accounts payable departments are properly verifying FATCA compliance before making overseas payments. Additionally, document collection and retention policies need to be established to ensure that the proper FATCA withholding certificates and verifications are properly maintained.
The tax attorneys with Terrence A. Grady & Associates, Co., LPA can assist you in reviewing your business model and ensuring that the proper procedures in place to ensure FATCA compliance. Contact attorney Kate Dodson today at 614-849-0376 or firstname.lastname@example.org.