FATCA Enforcement Softens

Realizing the large administrative burden of FATCA, the IRS has announced a “soft opening” of FATCA and enforcement at the IRS’ discretion for an initial transitional period.  FATCA, which was signed in March 2010, requires foreign banks and other financial institutions to report U.S. account holders who are evading federal taxes, or else risk steep penalties. Foreign financial institutions with U.S. customers who do not enter into reporting agreements with the Internal Revenue Service will face a 30 percent withholding on U.S. income and capital payments, according to the IRS.

Foreign financial institutions that make a good-faith effort to comply with the requirements of the Foreign Account Tax Compliance Act (FATCA) will benefit from lighter enforcement during 2014 and 2015, the IRS announced last Friday (Notice 2014-33). The IRS is treating those years as a “transition period” for the implementation of FATCA by withholding agents, foreign financial institutions (FFIs), and other entities with FATCA reporting and withholding responsibilities.

During the two-year transition period, the IRS says it will take into account the extent to which an entity subject to FATCA has made good-faith efforts to comply with FATCA regulations. Entities that do not make good-faith efforts to comply will not be given any relief from IRS enforcement.

In Notice 2014-33, the IRS has announced that it will treat calendar years 2014 and 2015 as a transition period for purposes of enforcing and administering implementation of the Foreign Account Tax Compliance Act (FATCA) by all withholding agents (including foreign financial institutions). It also announced that:

• Transitional relief will also be provided to all withholding agents regarding the changes announced on February 20, 2014, in the so-called “conforming regulations” to the information reporting and withholding regulations under chapters 3 and 61 (and Section 3406) of the Internal Revenue Code
• It will modify the FATCA regulations to provide that all withholding agents may treat an obligation (which includes an account) held by an entity that is opened, executed or issued on or after July 1, 2014, and before 1 January 2015, as a preexisting obligation
• Limited foreign financial institutions (FFIs) and branches will be provided certain relief to open US accounts for persons resident in the jurisdiction in which the limited FFI (or branch) is located, and for non-participating FFIs resident in the jurisdiction
• FFIs that are prohibited under local law from registering with the IRS in its FATCA portal may be “identified” in the portal by a member of their expanded affiliated group (EAG) as a limited FFI (or branch) to avoid jeopardizing the entire group from obtaining the status of participating FFI or registered deemed compliant FFI

Note: The Notice specifically provides that it does not otherwise affect the timelines provided in the final and temporary FATCA regulations for due diligence, reporting or withholding, and will not modify the starting date for an FFI to implement new account opening procedures for accounts maintained by the FFI that are held by individuals. Also, it does not appear that the cut-off date of June 30, 2014, will be moved for purposes of defining a “grandfathered obligation.”

Implications: Notice 2014-33 does NOT extend the effective date of either FATCA or the conforming regulations. However, similar to the years 1999 — 2001, when the current chapter 3 regulations initially became effective, so long as a withholding agent or FFI makes a good faith effort to comply with its US withholding and reporting obligations, it will not be subject to withholding tax liabilities or penalties for failing to withhold or report in 2014 or 2015. This gives all withholding agents the time to both implement and assess their new withholding and reporting processes and procedures to ensure robust compliance before 2016.

Implications: “Good faith” is clearly a facts-and-circumstances test that each withholding agent, with its advisers, and ultimately IRS examiners, will have to apply. Therefore, withholding agents should “continue the course” of their FATCA programs and modifications to existing procedures required by the conforming regulations, while keeping in mind that the transition period allows them additional time to make and assess changes, as needed.

Implications: If a withholding agent does not collect all new required documentation from an entity account holder opening an account between July 1 2014, and December 31, 2014, since the account will be deemed to be a pre-existing account, the withholding agent will have until December 31, 2014, to collect that documentation if the account holder is a prima facie FFI, and until June 30, 2016, if the account holder is not a prima facie FFI. Therefore, be on alert for any prima facie FFIs identified during the six-month period to ensure they are properly document on January 1, 2015.

Other highlights in the Notice:

• Future Intergovernmental Agreements (IGAs) will treat accounts opened by entities on or after July 1, 2014, and before January 1, 2015, as preexisting accounts, and a partner jurisdiction that previously entered into an IGA will receive the same treatment under the “most-favored nation” provision contained within its IGA.
• A withholding agent that has documented a direct account holder before July 1, 2014, will not be required to apply the new reason-to-know standards relating to a US telephone number or US place of birth until the withholding agent is notified of a change in circumstances with respect to the account holder’s foreign status or reviews documentation for the account holder that contains a US place of birth. While the Notice calls out US telephone numbers and US place of birth as specific new US indicia, presumably, the other new indicia of US status, “classification as a US person” would also not apply in the absence of a change in circumstance. Note that, under the Notice, the receipt of a new Form W-8 does not in and of itself constitute a “change in circumstance.”

Implication: It will be challenging for a withholding agent to distinguish between pre-existing accounts and “new” accounts for purposes of applying US indicia over the long-term. Likewise, distinguishing between a cut-off date for pre-existing individual accounts of July 1, 2014, and January 1, 2015, for pre-existing entity accounts will be very difficult, especially since some FATCA considerations will apply during the six-month period, while others will not.

• When an individual account holder has indicia of US status, an FFI, just like a withholding agent, will be permitted to rely on a reasonable written explanation supporting the account holder’s claim of foreign status; the Notice clarifies that such an explanation is not required to be within the strict confines of the regulations’ requirements for a reasonable explanation provided on a checklist furnished by the withholding agent to the account holder.

Implications: The regulations provide that a checklist furnished by the withholding agent to account holders must provide very specific information, such as the type of visa they might have, or demonstrate that they have not met the substantial presence test, for example, by stating the number of days they have been in the US during the prior three years. Withholding agents have been concerned that account holders may object to giving their financial institution such personal information. Therefore, they should be relieved by this clarification.

• A limited FFI or limited branch may open US accounts and accounts for nonparticipating FFIs, provided that the account holders are residents in the jurisdiction where the limited branch or limited FFI is located, and that the limited FFI or limited branch does not solicit US accounts or accounts held by nonparticipating FFIs that are not residents of, or established in, the jurisdiction where the FFI (or branch) is located and the FFI (or branch) is not used by another FFI in its EAG to circumvent its FATCA obligations.

Overall Summary of Implications: A withholding agent or FFI that has made a good-faith effort to comply with FATCA and the new requirements in the conforming regulations will be granted relief from IRS enforcement for the transition period. However, a withholding agent or FFI that has not made a good faith effort to comply with its obligations will not be granted relief and could be subjected to an IRS audit, or other available enforcement actions for the transition period, and held accountable for any compliance failures. The additional time provided to collect appropriate documentation from new entity account holders appears helpful. However, implementing the revisions provided in the Notice will create practical operational challenges, in particular applying different rules to individual versus entity accounts.

Our law office, which represents many taxpayers throughout the U.S. and around the world with undisclosed offshore accounts, believes that FATCA is a game-changer in international tax compliance. FATCA should encourage more U.S. taxpayers with undisclosed offshore accounts to come forward before the government contacts them.

Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimize) foreign accounts.

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