A. Foreign Account Tax Compliance Act
IRPAC has worked closely with the IRS and Treasury regarding the implementation of the Foreign Account Tax Compliance provisions of Subtitle A of Title V of the HIRE (Hiring Incentives to Restore Employment) Act (commonly referred to as FATCA). IRPAC has engaged in an ongoing dialogue with the IRS and Treasury regarding the guidance released by the IRS to date; specifically, Notices 2010-60, 2011-34, and 2011-53. IRPAC intends to continue this dialogue and provide input with regard to the Proposed Regulations that are expected to be issued by the end of 2011.
Following is a summary of the principal issues that have been discussed.
1. Short-term Debt
IRPAC recommends that interest (including original issue discount) on short-term debt (i.e., debt having a term of 183 days or less) be excluded from the definitions of “withholdable payment” and “financial account” under FATCA, consistent with the terms and policies implemented by the exemption for such amounts under Chapter 3.
FATCA generally imposes withholding and information reporting obligations with respect to “withholdable payments.” The definition of “withholdable payment” includes U.S.-source interest (including original issue discount), but does not provide an explicit exception for interest or original issue discount on short-term debt, unlike the comparable rule under Chapter 3. Similarly, FATCA imposes reporting requirements with respect to “United States accounts,” which include any debt interest in a financial institution, other than interests that are regularly traded on an established securities market. The statutory provisions relating to United States accounts also provide no exclusion for short-term debt instruments.
A long-standing rule under Chapter 3 exempts interest and original issue discount on short-term debt from withholding tax. This exemption was enacted to preserve U.S. borrowers’ access to critical sources of funding. Although FATCA does not include a statutory exemption for short-term debt, Congress clearly recognized the policies served by the Chapter 3 exemption and suggested that Treasury and the IRS consider adopting a short-term debt exemption under FATCA. The Joint Committee on Taxation’s report on the HIRE Act includes the following language:
“The Secretary may determine that certain payments made with respect to short-term debt . . . pose little risk of United States tax evasion and may be excluded from withholdable payments for purposes of this provision.”
The Joint Committee’s report includes comparable language relating to a short-term debt exemption from the definition of “financial account” (which is a component of the definition of “United States account”).
IRPAC believes that continued access to sources of short-term funding, including short-term interbank deposits, Treasury bills, commercial paper, and other similar financing arrangements, is critical to U.S. borrowers, in particular in the current economic environment. IRPAC is concerned that the imposition of FATCA’s reporting and withholding requirements to these financing arrangements will impose undue burdens, in particular given the short-term nature of the transactions, and would risk reducing the availability of critical funding for U.S. borrowers. In addition, IRPAC believes that the low yields and short maturities of short-term debt, as well as the institutional nature of the predominant portion of the holders of short-term debt, mean that there is little risk that creating an exemption for such instruments would result in tax evasion. Thus, IRPAC recommends that interest (including original issue discount) on short-term debt (i.e., debt having a term of 183 days or less) be excluded from the definitions of “withholdable payment” and “financial account,” consistent with the terms and policies implemented by the exemption for such amounts under Chapter 3.
2. Potential Conflicts with Foreign Laws
IRPAC encourages Treasury and the IRS to work with foreign governments to attempt to address the circumstances in which FATCA imposes obligations on foreign financial institutions (FFIs) that would obligate them to violate local legal restrictions. In addition, IRPAC recommends that the IRS take the existence of such restrictions into account in formulating guidance in the proposed and final regulations under FATCA, to the extent such conflicts have not been resolved at the time the regulations are issued.
The obligations that FATCA imposes on FFIs, in particular participating FFIs, potentially conflict with legal constraints imposed on such FFIs under foreign law in a number of respects. For example, FATCA’s reporting requirements potentially contravene the privacy or data protection laws of a number of jurisdictions. (In some jurisdictions, these constraints may be waivable by an FFI’s account holders, but some jurisdictions do not treat such waivers as valid.) Although FATCA provides FFIs with a remedy for addressing this problem – requiring that an account be closed if foreign law prohibits disclosure and the relevant account holder fails to waive the application of such law – a number of jurisdictions prohibit the closing of certain types of financial accounts under “requirement to serve” and similar legislation. In addition, certain types of “accounts” are contractual arrangements (e.g., insurance policies and non-regularly traded debt and equity securities) that by their terms may not be cancellable or redeemable. Thus, FFIs may effectively be precluded from complying with FATCA’s requirement that these accounts be closed. This issue is particularly problematic in light of Notice 2010-60’s suggestion that Treasury and the IRS are considering a rule pursuant to which a participating FFI’s agreement may be terminated if the FFI has an excessive number of long-term recalcitrant account holders. Finally, under the laws of several jurisdictions, FFIs may be precluded from collecting withholding tax required under FATCA, in particular with respect to passthru payments (which, under foreign law, generally would be viewed as local-source income).
IRPAC understands that Treasury and the IRS have been involved in discussions with their counterparts in a number of foreign governments to address these issues. We urge Treasury and the IRS to continue this process, in order to minimize the circumstances in which FFIs will be precluded from signing participating FFI agreements because of local legal restrictions to which they are subject. We also encourage the IRS to be mindful of the legal constraints under which FFIs may be operating in formulating the details of a participating FFI’s obligations under the proposed and final FATCA regulations. In particular, a participating FFI should not be at risk of having its participating FFI agreement revoked by reason of its having long-term recalcitrant account holders, if the FFI is prohibited from terminating the relevant account relationships as a result of local legal restrictions to which it is subject. We also recommend that the IRS consider adopting extended transition rules under the regulations to the extent discussions with foreign governments regarding reconciling conflicting legal obligations are ongoing at the time the regulations are finalized.
3. Notice 2011-53 Transitional Relief
IRPAC discussed with the IRS the FATCA transition relief provided in recently released Notice 2011-53. Specifically, IRPAC raised concerns that Notice 2011-53 may still leave too little time for financial institutions to build the required systems, particularly if the publication of final regulations is delayed or if withholding obligations on certain categories of withholdable payments that are not subject to withholding under Chapter 3 are not excluded or deferred. IRPAC recommends that the IRS apply transition relief consistently across the financial services industry, and issue further guidance that builds in additional time to allow withholding agents to develop the required systems.
In addition, IRPAC understands from discussions with the IRS that it intends to apply Notice 2011-53’s procedures for Chapter 4 withholding on U.S.-source payments to “obvious” FFIs effective January 1, 2014, even if the FFI’s account is a pre-existing account. IRPAC recommends that the IRS provide additional guidance concerning the identification of FFIs and the procedures withholding agents will be required to follow in verifying an account holder is an FFI and its status as a participating FFI.
At meetings prior to the publication of Notice 2011-53, IRPAC discussed with the IRS and Treasury the need for transition relief to allow withholding agents sufficient time to develop, test, and integrate the necessary systems and procedures. IRS and Treasury have received many comment letters suggesting that a minimum of 18-24 months will be required for this process. Notice 2011-53 appears to be responsive to these requests by providing that withholding on U.S. source Fixed, Determinable, Annual, Periodical (FDAP) payments begin January 1, 2014, withholding on gross proceeds begin on January 1, 2015, and that FFI withholding on pass-thru payments begin no earlier than January 1, 2015. IRPAC appreciates the IRS’s recognition of the need for additional time to develop the required reporting and withholding systems, but notes the new dates only provide a maximum 18 month period assuming the IRS publishes final regulations by July 1, 2012. If there is a delay in the publication of final regulations, withholding agents will likely struggle to have the required systems in place within the deadlines imposed by Notice 2011-53.
IRPAC also raised with the IRS the issue that because the FATCA guidance issued to date does not provide relief from withholding or reporting on bank deposit interest or short-term debt, the provisions of Notice 2011-53 require withholding on such payments beginning January 1, 2014. This is inconsistent with the treatment of such payments under the Chapter 3. Moreover, since the intent of Notice 2011-53 was to acknowledge the industry’s need for additional time in order to integrate withholding systems for new types of withholdable payments (for example, by delaying withholding on pass-thru payments until January 1, 2015 or later), the Notice creates a disparity in effective dates for what are essentially the same systems development issues.
IRPAC understands from discussions with the IRS that the IRS intends to apply Notice 2011-53’s procedures for Chapter 4 withholding on U.S. source payments to “obvious” FFIs effective January 1, 2014, even if such FFIs’ accounts are pre-existing accounts. IRPAC notes that Notice 2010-60 set forth a two-year process for soliciting information from account holders and evaluating that information, even in the case of account holders whose names (or other information readily available to the relevant U.S. financial Institute (USFI) or FFI) “clearly indicate” that they are FFIs. Thus, a requirement that withholding be applied with respect to such accounts provides USFIs and FFIs with substantially less time to complete the due diligence process with respect to such accounts than originally indicated in Notice 2010-60. Accordingly, IRPAC recommends that the IRS provide guidance clearly addressing the types of FFI account holders to whom this rule applies and providing clear and straightforward procedures for USFIs and FFIs to easily identify the affected account holders. In addition, IRPAC recommends that the IRS apply these accelerated due diligence requirements only to narrow categories of easily identified FFIs to permit USFIs and FFIs to comply with the due diligence requirements in the shorter time frame that is contemplated.
4. Due Diligence Requirements for Existing Accounts
IRPAC recommends that the account holder file searches provided for in Notice 2010-60, 2011-34, and 2011-53 be limited in scope to a reasonable number of calendar years prior to the date of the search.
IRPAC discussed with the IRS the possibility of limiting the historical timeframe for which documents must be searched for indicia of U.S. status. Particularly for private banking accounts, some financial institutions have years of records that can consist of many thousands of pages of documents, and it would be expensive and time-consuming to research all records. Also, financial institutions retain records various ways, such as on paper, microfiche, CDs and optical images, with older records often being housed in places distant from either the compliance or tax operations personnel who would be assigned the task of searching those records. Therefore, IRPAC recommends that the account holder file searches proposed in IRS Notices 2010-60, 2011-34 and 2011-53 be limited in scope to a reasonable number of calendar years prior to the date of the search. To ensure consistency and avoid confusion, the proposed regulations should address the due diligence research standards that the withholding agent should apply.
5. Revisions of Form 1042-S for FATCA Reporting and Withholding
IRPAC recommends the current Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, be revised to include additional income and recipient codes applicable to FATCA reporting and withholding.
In order to accommodate reporting under Chapter 4, the current Form 1042-S could be modified to include additional income and recipient codes. The revised form would include a check box to indicate whether amounts reported on the form were withheld under Chapter 3 or under Chapter 4. In addition, the revised form would include a space for an FFI-EIN (Employer Identification Number).
6. Revision of Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding
IRPAC recommends that the current Form W-8BEN be split into separate forms for individuals and entities.
The current version of the Form W-8BEN confuses foreign entities that submit that form for Chapter 3 purposes instead of the accurate type of Form W-8 (Form
W-8IMY (Intermediary Certificate for United States Tax Withholding), Form W-8ECI (Foreign Person's Claim of Income Effectively Connected with the Conduct of a Trade or Business in U.S.) or Form W-8EXP (Foreign Organization's Certificate for United States Tax Withholding). In addition, nonresident alien individuals are frequently confused by the current Form W-8BEN because it includes many references applicable to entities. The new Form W-8 to be provided by foreign entities should include statements certifying their entity classification and other issues relevant to their treatment under the new Chapter 4 requirements. This increased complexity is likely to make the form even more confusing for account holders who are required to submit the form. This complexity could be addressed to a significant extent in the case of individuals by creating a separate form, which would not need to address many of the complex issues relevant to entities under Chapters 3 and 4. In addition, it is important for withholding agents to have the opportunity to review a draft of these certification forms contemporaneous with the issuance of proposed regulations. The revised forms should be available for mailings in the second half of 2012 for those existing accounts whose Form W-8 will expire as of December 31, 2012, in order to prevent an additional mailing in 2013 or 2014 to fulfill due diligence requirements contained in the various IRS notices issued to date.
B. Chapter 3 Withholding Tax Issues
IRPAC met with the IRS to discuss Chapter 3 withholding tax issues and made the following recommendations:
Capacity: The determination of whether the capacity of a person who executes a Form W-8BEN for an entity should be considered valid has been an issue for U.S. withholding agents for many years. IRPAC recommends that the IRS issue guidance to the effect that a U.S. withholding agent may treat a person who has executed a Form W-8BEN for an entity as an authorized representative or officer of the entity regardless of the person’s title shown on the Form W-8BEN. IRPAC also recommends that the instructions to the Form W-8BEN be revised to state that an authorized representative means a person who is authorized to sign on behalf of the beneficial owner based on authority granted to that person in, for example, organizational documents, resolutions (or similar documents) or laws applicable to the beneficial owner.
Permanent Residence Address: The instructions to the Form W-8BEN state that the Permanent Residence Address (Line 4) of the beneficial owner should not be the address of a financial institution, a post office box, or an address used solely for mailing purposes. The only address of many offshore investment funds is that of a registered agent or investment advisor. IRPAC recommends that the IRS issue guidance on the acceptability of such an address and the type of additional documentation, if any that is required to validate the form.
Reason for U.S. Address: Current Treasury Regulations require a withholding agent to obtain a reasonable explanation in writing from a payee who provides a Form W-8 with a U.S. address. IRPAC recommends that the IRS issue guidance that the reasonable explanation in writing may be furnished either in a letter from the payee or by a form provided by the withholding agent specifically for this purpose. A form provided by a withholding agent could identify common reasons for a non-U.S. person to have a U.S. address on the Form W-8.
Inconsequential Errors in Documentation: During the course of an IRS withholding tax examination, a variety of errors may be identified on Forms W-8. Some of these errors should clearly invalidate the form because they may impact the reliability of the form itself (e.g., missing information required by the regulations or form instructions, or uncured due diligence issues). However, other detected errors may be minor in nature, and generally should not impact the reliability of the data on the form. IRPAC recommends that the IRS issue guidance stating that errors that do not impact the status of the payee and do not impede withholding agents from processing the Form W-8 correctly should be considered inconsequential in nature, and should not cause the form to be invalid.
Use of copies/faxed/e-mailed Forms W-8: IRPAC met with the IRS and discussed the disparity in standards required under current guidance for the receipt of Forms W-8 and Form W-9, Request for Taxpayer Identification Number and Certification. Specifically, withholding agents may accept Form W-9 via fax, e-mail, or other soft-copy format, but may only rely on Forms W-8 in original hard-copy format. IRPAC recommends that the IRS issue guidance allowing withholding agents to rely on copies of Forms W-8 (including those received via fax, e-mail or other similar forms of electronic transmission) if the form is otherwise facially valid.
Use of retroactive Forms W-8 with affidavits: IRS has stated publicly that forthcoming guidance on Chapter 3 withholding issue will curtail current industry practice of obtaining retroactive Forms W-8 to cure undocumented accounts, including documents received when the withholding agent is under examination, by requiring the provision of additional documentation establishing the account holder’s status in some circumstances. IRPAC discussed with the IRS the issue of when it is appropriate for withholding agents to rely on retroactive Forms W-8 both with and without an accompanying affidavit of unchanged status. IRPAC recommends limiting any change in current accepted practices to be applied prospectively, to payments made on or after January 1, 2012 (assuming the guidance is released prior to that date). IRPAC also recommends that a requirement to obtain additional documentation be limited to cases where a withholding agent has not obtained a Form W-8 prior to the time a payment is made to a payee.
The Form W-8BEN requires the person who signs the Part IV Certification for any entity to enter the capacity in which the person is acting. U.S. withholding agents continue to see many different titles entered for capacity. One major financial institution has compiled a list of over 100 different titles. It is not possible for a U.S. withholding agent to know whether a particular title provides the signer with the actual authority to sign the Form 8-WBEN for a foreign entity. The Certification on the Form W-8BEN does, however, include the following statement, made under penalties of perjury: “I am the beneficial owner (or am authorized to sign for the beneficial owner)….” Based on this language, a U.S. withholding agent should be permitted to treat the signer as authorized, unless the U.S. withholding agent has reason to know that the signer is not authorized.
IRPAC recognizes the need for the Form W-8BEN to contain a permanent residence address that is outside of the United States and that the address should not be a mailing address or an in-care-of address. However, some entities (such as investment funds) have no other address than a mailing or in-care-of address. In such cases the address represents the principal place of business of the entity and generally is the address shown on organizational documents. IRPAC recommends that the IRS issue guidance on the acceptability of such an address and whether any additional documentation (such as an organizational document) is required to validate the Form.
A withholding agent has reason to know that a client’s Form W-8 is unreliable or incorrect for purposes of establishing their status as a foreign person, if a U.S. permanent residence or U.S. mailing address appears either on the client’s Form W-8 or elsewhere in their account information. However, a withholding agent may treat an account holder that is an individual as a foreign person if the withholding agent has in its possession or obtains:
• documentary evidence (which does not include a U.S. address) that has been provided within the past three years, was valid when it was provided, and that supports the account holder’s claim of foreign status; and
• a reasonable explanation, in writing, supporting the account holder’s foreign status.
For a number of reasons, many withholding agents have found it problematic to consistently obtain satisfactorily written letters of explanation from clients. These reasons include, for example, letters that do not contain clear or adequate information to support their foreign status, or letters that are illegible or written in the account holder’s native language. Thus, many financial institutions have found it necessary to develop and implement a more practical and reliable approach – essentially, a checklist of possible reasons for a non-U.S. client to have a U.S. address. In the event a client’s specific reason is not identified on the checklist, the form also includes a blank space marked “other” in which the client is asked to enter their particular reasonable explanation. Most withholding agents that have used this checklist approach have found that is much more effective than reliance on a letter. Withholding agents should be permitted to use a checklist such as the following:
Reason for U.S. Address Checklist
I am a nonresident alien individual and not a U.S. person, but I have provided a U.S. address for the following reason (please initial the one reason below that applies, or initial “Other” and write in the explanation for your U.S. address):
• I have arranged for another person to receive my mail for personal security or convenience purposes. (Do not select this reason if your permanent residence address on Form W-BEN, Line 4, is in the U.S.)
• I am a student at a U.S. educational institution. (F, J, M or Q visa holders only)
• I am a teacher at a U.S. educational institution, a trainee or intern, or a participant in an educational or cultural exchange visitor program. (J or Q visa holders only)
• I am a foreign government-related individual assigned to a diplomatic post, consulate, embassy or international organization in the U.S.
• I am the spouse or unmarried child (under age 21) of a foreign student, teacher, trainee, intern, exchange visitor, international organization employee, or foreign government-related individual, who lives at the same address
• Other (explain) include as much detail as possible. A general explanation (such as “I live here” or “I work here”) is not adequate for U.S. tax purposes.
IRPAC discussed the issue of inconsequential errors that may invalidate a Form W-8 with the IRS. It was agreed that both IRS examiners and withholding agents would benefit from clear guidance on the types of inconsequential Form W-8 errors that should not invalidate the form. The following is a list of examples of the types of errors that IRPAC believes to be inconsequential:
● An obvious individual that does not check the “individual” checkbox on Line 3.
● An obvious corporation, or one for which the withholding agent has articles of incorporation on file, and that has not checked the “corporation” box on Line 3.
● The permanent residence address or mailing address shown on Lines 4 or 5 is obviously in a foreign country (e.g., Champs d L’Elysees, Paris), but the country name is not completed.
● The name of the applicable treaty country is entered on Form W-8BEN, Part II, line 9(a), but the corresponding box is not checked; or a valid TIN is entered on line 6 of Form W-8BEN, but line 9(b) is not checked.
● The name of the country is entered on Line 9(b) or 9(c) of Form W-8EXP, but the corresponding box is not checked.
● The date of an entity’s IRS determination letter is entered on W-8EXP, Part II, Line 12(a), but the corresponding box is not checked.
● The permanent residence address shown on Line 4 does not have a street name or house number but, as may be customary in that jurisdiction, instead contains a local descriptive location along with the city and country (e.g., the name of an estate in the English countryside, university residence hall, or military base).
● The permanent residence address shown on Line 4 contains a street or avenue, city and country, but does not contain the beneficial owner’s house number (which the withholding agent knows from the beneficial owner’s Know Your Customer documentation).
● When required, a valid U.S. TIN (with hyphens) is entered on Line 6 of Form W-8BEN, or on Line 6 of Form W-8ECI, Certificate of Foreign Person’s Claim That Income is Effectively Connected With the Conduct of a Trade or Business in the United States, but the corresponding checkbox to identify the TIN type is not checked.
● A valid U.S. TIN is inadvertently entered on Line 7 of Form W-8BEN (“Foreign Tax ID Number”) rather than on Line 6.
● The use of customary, unambiguous country abbreviations on lines 4 and 5 of Forms W-8. These may include, for example, UK, CA, GR, HK, JA, MX and NL. Coincidentally, each of these country abbreviations corresponds to country codes assigned by the IRS for use on Forms 1042-S.
Under current guidance, it is generally understood that a faxed or e-mailed form is acceptable for the Form W-9, but it is not clear that this is acceptable for Forms W-8. The Regulations under IRC §6049 provide some relief by allowing for a 90-day grace period during which time the withholding agent may rely on a copy. IRPAC discussed this issue with the IRS, noting specifically that withholding agents would like parity in the application of standards of receipt for Forms W-8 and W-9. Furthermore, since an electronic legal document is now uniformly accepted as legally binding (assuming it has an original signature), there is no justification for continuing to require original hard-copy Forms W-8. Unless the withholding agent has reason to know that a Form W-8 via fax or email is not a copy of an original document, then the withholding agent should be able to rely on that form without further due diligence requirements.
IRPAC recognizes that current industry practice on the use of retroactive Forms W-8, with or without an affidavit of unchanged status, to cure accounts with invalid or no documentation at the time of payment is not definitively sanctioned in the regulations or other published guidance. It has, however, become widespread practice within the industry and accepted by many IRS agents during the course of an examination. IRPAC acknowledges the need to ensure withholding agents do not abuse this practice by deliberately failing to collect tax documentation as part of their procedures. Specifically, IRPAC discussed with the IRS the need to differentiate between withholding agents who have documentation compliance procedures in place, and those who are purposefully negligent, and to modify the allowable use of retroactive forms accordingly.
C. Clarification of Information Reporting Requirements Relating to Commercial Paper
On September 15, 2011, IRPAC submitted a comment letter (see Appendix E) recommending that the IRS clarify the applicability of the information reporting exemption for commercial paper following the enactment of the HIRE Act.
The HIRE Act repealed IRC §163(f)(2)(B), effective for debt obligations issued after March 18, 2012. (Section 163(f)(2)(B) generally permits U.S. borrowers to issue debt obligations in bearer form, provided they are issued under arrangements reasonably designed to ensure their sale to non-U.S. persons.) The repeal of this provision has created some uncertainty regarding the continued viability of the information reporting exemption for commercial paper, which incorporates by reference the foreign-targeting procedures of IRC §163(f)(2)(B). IRPAC believes that Congress did not intend to call into question the long-standing information reporting exemption for commercial paper, and believes that maintaining the existing information reporting exemption is important to ensure that the commercial paper market continues to operate efficiently. Thus, on September 15, 2011, IRPAC submitted a comment letter recommending that the IRS clarify that the information reporting exemption for commercial paper will continue in effect following the effective date of the repeal of §163(f)(2)(B). (See Appendix E.)