The Diligent team

GRC trends and insights

What is FATCA withholding?

In the wake of the financial crisis of 2008, an incredible amount of legislation aimed at restoring the economy was signed into law. One of the less well-known and covered pieces of legislation was the Foreign Account Tax Compliance Act (FATCA). Part of 2010's Hiring Incentives to Restore Employment (HIRE) Act, FATCA imposes a set of regulations for foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) to comply with regarding the reporting of foreign assets by citizens or legal entities to the Internal Revenue Service (IRS). FATCA imposes a withholding tax of 30 percent nonrefundable tax on income from the United States paid to certain types of FFIs and NFFEs.

As the world of FATCA withholdings breaks down into two major categories, FFIs and NFFEs, there is a set of hard and fast rules that are applicable to these groupings – although, in the case of an individual business, it is always best to consult with an attorney or an accountant to ensure correct filing. The way to define NFFEs is in the absence of FFIs; that is, anything that is not an FFI is an NFFE. FFIs include banks, mutual funds, hedge/private equity funds and various types of insurance companies. There are other types of FFIs, but these are the main ones. Where the rubber really hits the road is within each category – different types of NFFEs and FFIs have varied obligations with respect to the FATCA withholding tax.

FATCA Withholding and Foreign Financial Institutions

Within Foreign Financial Institutions, there are four classifications:

1. Exempt Foreign Financial Institutions. These financial institutions are not required to pay any FATCA withholding, and encompass governmental organizations, nonprofits and certain types of small businesses.
2. Participating Foreign Financial Institutions. These financial institutions are exempt from FATCA withholding, and have registered online with the IRS, and are issued a Global Intermediary Number. They also appear on an official FFI list issued every month by the IRS. The registration with the IRS is an agreement to provide information about US account holders, such as name, address, Social Security number and balance information. In certain countries with the correct type of intergovernmental agreement (Model 2), any financial institution that does not belong to the exempt FFI category will be considered as participating.
3. Nonparticipating Foreign Financial Institutions. These financial institutions are subject to the 30% withholding tax. They are those institutions that have not agreed to provide the IRS with information about their US patrons, shareholders, etc. The FATCA withholding is deemed to be necessary on essentially all payments of income sourced from the United States.
4. Deemed Compliant Foreign Financial Institutions. These financial institutions are exempt from the FATCA withholding. The category includes a range of FFIs with low holdings, local banks, retirement plans and companies in countries with an intergovernmental agreement with the US (Model 1).

FATCA Withholding and Non-financial Foreign Entities

The other category of FATCA-subject entities, as discussed, is non-financial foreign entities. NFFEs are entities that are not part of the financial services industry, and under FATCA, they break down into three distinct categories, one of which also contains several subcategories:

1. Active Non-financial Foreign Entities. These NFFEs have holdings that are made up of less than 50% passive income (passive income is income that is earned by shareholders that are not actively involved in the enterprise that is earning the gains). It is also a requirement that active NFFEs have reported less than 50% passive income in the prior reporting period, as well. Governments are considered Active NFFEs.
2. Passive Non-financial Foreign Entities. Passive NFFEs are to active NFFEs what participating FFIs are to nonparticipating FFIs – meaning that almost any NFFE that is not obviously considered to be an active NFFE is considered a passive NFFE. Passive NFFEs break down into three additional subcategories: Direct Reporting, Indirect Reporting and Non-reporting. Only Non-reporting NFFEs are subject to the FATCA withholding tax, and they are defined by a lack of direct agreement with the IRS to report information on their US account holders (this would be direct reporting), and lack of a secondary dispersal of information on US account holders through filings (indirect reporting).
3. Excepted Non-financial Foreign Entities. NFFEs that qualify as excepted are not subject to the FATCA withholding, and include companies that are publicly traded along with their affiliate businesses, some entities that are based in US territories, and entities with non-financial transaction business, such as treasury centers.

Nuances of FATCA Withholding

The essence of these categorizations is that corporations and financial institutions can either report the information of their US citizen account holders to the Internal Revenue Service directly, or passively through information that will eventually be available to the IRS – or not report it, and the institution will either be exempt, or subject to the 30 percent withholding. However, there is room for interpretation in some of the language of FATCA.

The wording of FATCA requires the evaluation of passive income, yet there is not a strictly agreed-upon definition of passive income within the intergovernmental agreements to which NFFEs are subject. Beyond that, the multiple stages and delays of the FATCA rollout have made it impossible for the IRS to enforce the withholding completely to this point. Initially planned to go into full effect in January 2017, application of the withholding to property sales was delayed until the end of 2018.

Leverage Technology for FATCA Withholding

FATCA requires an incredible amount of documentation to stay in compliance. The tracking, organization and distribution of these documents, and all other documentation to run a business that remains astride of compliance, can require a tremendous amount of manpower – but not if you use legal entity management software. Diligent can design a powerful suite of curated entity management tools to streamline the process of managing all of your documentation and compliance needs. This optimization will be carried out by a dedicated team of service professionals, on call to help you maximize the potential of your entity management operation. If this sounds like something you are interested in, please give us a call or reach out to us via email today.