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IRS to consider “good faith” in administering certain FATCA provisions in 2014 and 2015

May 5, 2014

Notice 2014-33, 2014-21 IRB

In a Notice, IRS has announced that, for 2014 and 2015, it will take into account—in enforcing those provisions of the Foreign Account Tax Compliance Act (FATCA) that were modified by temporary regs issued in February, 2014—whether a person who is subject to those provisions made good faith efforts to comply with FATCA regs. The Notice also provides that IRS will be modifying the FATCA regs to liberalize certain aspects of them and provides guidance that taxpayers may rely on until those modifications are actually issued.

Background—in general.On Mar. 18, 2010, the Hiring Incentives to Restore Employment Act of 2010 (P.L. 111-147) added Chapter 4 (Code Sec. 1471 through Code Sec. 1474 , FATCA) to the Code.Chapter 4 requires withholding agents to withhold 30% of certain payments to a foreign financial institution (FFI) unless the FFI has entered into an agreement (FFI agreement) with IRS to, among other things, report certain information with respect to U.S. accounts.(The withholding rules are essentially a mechanism to enforce new reporting requirements.)Chapter 4 also imposes withholding, documentation, and reporting requirements on withholding agents, with respect to certain payments made to certain non-financial foreign entities (NFFEs).The statutory provisions are generally effective for payments made after Dec. 31, 2012, but their implementation has been delayed and phased in over several years.

IRS issued final FATCA regs on Jan. 17, 2013 that, among other things, provided for a phased implementation of the FATCA requirements over the period beginning on Jan. 1, 2014 and continuing through 2017 (see Weekly Alert ¶  12  01/24/2013, Weekly Alert ¶  11  01/24/2013 , Weekly Alert ¶  17  01/24/2013, Weekly Alert ¶  42  01/24/2013 , Weekly Alert ¶  19  01/24/2013 , and Weekly Alert ¶  13  01/31/2013).Subsequently, in Notice 2013-43, 2013-31 IRB 113, Treasury and IRS provided revised timelines for implementing various FATCA requirements with the goal of a more orderly implementation of FATCA (see Weekly Alert ¶  6  07/18/2013).

During 2012, IRS first released Model 1 and Model 2 intergovernmental agreements (IGAs) to facilitate the implementation of FATCA and to avoid legal impediments under local law that would otherwise limit an FFI’s ability to comply with the requirements under Chapter 4. On Apr. 12, 2014, IRS published Ann. 2014-17, 2014-18 IRB 1001, providing that the jurisdictions treated as having an IGA in effect would include jurisdictions that, before July 1, 2014, have reached agreements in substance with the U.S. on the terms of an IGA and that have consented to be included on the IRS list of such jurisdictions, in addition to jurisdictions that have already signed IGAs.An FFI that is resident in, or organized under the laws of, a jurisdiction that is included on the IRS list as having an IGA in effect is permitted to register on the FATCA registration website and is permitted to certify to a withholding agent its status as an FFI covered by an IGA.

Background—temporary regs.On Feb. 20, 2014, IRS released temporary regs (temporary Chapter 4 regs; see Weekly Alert ¶  1  02/27/2014) that clarify and modify certain provisions of the final Chapter 4 regs, including incorporation of the revised timeline for the implementation of FATCA set forth in Notice 2013-43.The temporary Chapter 4 regs accordingly require that withholding agents (including participating FFIs, qualified intermediaries, withholding foreign partnerships, and withholding foreign trusts) begin withholding with respect to withholdable payments made on or after July 1, 2014, unless the withholding agent can reliably associate the payment with documentation upon which it is permitted to rely to treat the payment as exempt from withholding under Chapter 4. On Feb. 20, 2014, IRS also released temporary regs under Chapters 3 and 61, and Code Sec. 3406 (“temporary coordination regs”; see Weekly Alert ¶  25  02/27/2014), to coordinate those regs with the requirements provided in the final and temporary Chapter 4 regs.

Transition period for enforcement.Notice 2014-33 provides that calendar years 2014 and 2015 will be regarded as a transition period for purposes of IRS’s enforcement and administration of the due diligence, reporting, and withholding provisions under Chapter 4, as well as the provisions under Chapters 3 and 61, and Code Sec. 3406, to the extent those rules were modified by the temporary coordination regs. With respect to this transition period, IRS will take into account the extent to which a participating or deemed-compliant FFI, direct reporting NFFE, sponsoring entity, sponsored FFI, sponsored direct reporting NFFE, or withholding agent has made good faith efforts to comply with the requirements of the Chapter 4 regs and the temporary coordination regs.

For example, IRS will take into account whether a withholding agent has made reasonable efforts during the transition period to modify its account opening practices and procedures to document the Chapter 4 status of payees, apply the standards of knowledge provided in Chapter 4, and, in the absence of reliable documentation, apply the presumption rules of Reg. § 1.1471-3(f).Additionally, for example, IRS will consider the good faith efforts of a participating FFI, registered deemed-compliant FFI, or limited FFI to identify and facilitate the registration of each other member of its expanded affiliated group as required for purposes of satisfying the expanded affiliated group requirement under Reg. § 1.1471-4(e)(1).

An entity that has not made good faith efforts to comply with the new requirements will not be given any relief from IRS enforcement during the transition period.Further, IRS will not regard calendar years 2014 and 2015 as a transition period with respect to the requirements of Chapters 3 and 61, and Code Sec. 3406, that were not modified by the temporary coordination regs. For example, IRS will not provide transitional relief with respect to its enforcement regarding a withholding agent’s determinations of the character and source of payments for withholding and reporting purposes.

Liberalization of certain of the regs’ rules.The Notice sets out that IRS will be modifying the regs to liberalize the following five sets of rules, and it also provides guidance that taxpayers may rely on with respect to those upcoming modifications, until those modifications are actually issued.

…Treatment under the regs of certain entity obligations issued, etc. on or after July 1, 2014.Under the existing FATCA regs, withholding agents (other than participating FFIs and registered deemed-compliant FFIs) are generally required to implement new account opening procedures beginning on July 1, 2014.A participating FFI is required to implement new account opening procedures on the later of July 1, 2014, or the effective date of its FFI agreement, and a registered deemed-compliant FFI is required to implement new account opening procedures on the later of July 1, 2014, or the date on which the FFI registers as a deemed-compliant FFI and receives a global intermediary identification number (GIIN).

In light of comments received, IRS intends to amend the FATCA regs to allow a withholding agent or FFI to treat an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before Jan. 1, 2015, as a preexisting obligation for purposes of implementing the applicable due diligence, withholding, and reporting requirements under Chapter 4 (i.e., under Reg. § 1.1471-2(a)(4)(ii), Reg. § 1.1471-1(b)(2), and Reg. § 1.1471-4(c)(3)).The proposed amendments to the FATCA regs described in Notice 2014-33, Sec. IV will be available only to obligations held by entities, and not to those held by individuals.

As a result, a withholding agent that treats an obligation described in Notice 2014-33, Sec. IV as a preexisting obligation will have the additional time provided in Reg. § 1.1471-2(a)(4)(ii) or Reg. § 1.1472-1(b)(2) in order to document an entity that is a payee or account holder of the obligation to determine whether the entity is a payee subject to FATCA withholding.

In addition, an FFI that is a participating FFI or registered deemed-compliant FFI may also treat an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before Jan. 1, 2015, as a preexisting obligation to document the obligation for FATCA purposes within the period permitted under Reg. § 1.1471-4(c)(3)(ii) as if the effective date of its FFI agreement or the date on which the FFI registers as a deemed-compliant FFI and receives a GIIN is June 30, 2014, and may not exclude such accounts from review under Reg. § 1.1471-4(c)(3)(iii).

…Treatment under IGAs of certain entity obligations issued, etc. on or after July 1, 2014.The Model 1 and Model 2 IGAs contain a provision that allows a partner jurisdiction that has entered into an IGA to receive the benefit of certain more favorable terms that are set forth in a later signed IGA (including revisions to the procedures under Annex I of an applicable IGA) unless the partner jurisdiction declines in writing to adopt the update (the “most-favored nation” provision).With respect to FFIs covered by an IGA, the Treasury Department intends to update the due diligence procedures described in Annex I of the Model 1 and Model 2 IGAs to incorporate due diligence procedures consistent with Notice 2014-33.Annex I of the Model 1 IGA contains a provision that allows a partner jurisdiction to permit a reporting Model 1 FFI, and Annex I of the Model 2 IGA contains a provision that allows a reporting Model 2 FFI, to rely on the procedures described in relevant regs to establish whether an account is a U.S. reportable account or an account held by a nonparticipating financial institution.

Accordingly, it is expected that Annex I of future Model 1 and Model 2 IGAs will include new due diligence procedures for an entity account opened on or after July 1, 2014, and before Jan. 1, 2015, to allow an FFI covered by a Model 1 IGA or Model 2 IGA to treat such an account as a preexisting entity account, but without permitting application to such accounts of the $250,000 exception for preexisting entity accounts that are not required to be reviewed, identified, or reported.A partner jurisdiction with an IGA that has been signed or that has reached an agreement in substance will be permitted to adopt the revised due diligence procedures described above under the most-favored nation provision contained within its IGA, once an IGA with the revised procedures has been signed with another partner jurisdiction.

…Modification of the standards of knowledge rules under Chapter 3.The temporary coordination regs revised the reason-to-know standard under Reg. § 1.1441-7(b) to provide that a withholding agent will have reason to know that documentation establishing the foreign status of a direct account holder is unreliable or incorrect if the withholding agent has a current telephone number for the account holder in the U.S. and no telephone number for the account holder outside the U.S., or has a U.S. place of birth for the account holder.(Reg. § 1.1441-7(b)(5); Reg. § 1.1441-7(b)(8)) This provision was added to coordinate with the standards of knowledge applicable to a withholding agent’s reliance on a payee’s claim of foreign status for FATCA purposes.The temporary coordination regs also provide a transitional rule to allow a withholding agent that has previously documented the foreign status of a direct account holder for Chapters 3 and 61 purposes prior to July 1, 2014, to continue to rely on such documentation without regard to whether the withholding agent has a U.S. telephone number or U.S. place of birth for the account holder.The withholding agent would, however, have reason to know that the documentation is unreliable or incorrect if the withholding agent is notified of a change in circumstances with respect to the account holder’s foreign status or the withholding agent reviews documentation for the account holder that contains a U.S. place of birth.(Reg. § 1.1441-7(b)(3)(ii))

In light of comments received, IRS intends to amend the temporary coordination regs to provide that a direct account holder will be considered documented prior to July 1, 2014, without regard to whether the withholding agent obtains renewal documentation for the account holder on or after July 1, 2014 pursuant to the requirements of Reg. § 1.1441-1(e)(4)(ii)(A).Therefore, a withholding agent that has documented a direct account holder prior to July 1, 2014, is not required to apply the new reason to know standards relating to a U.S. telephone number or U.S. place of birth until the withholding agent is notified of a change in circumstances with respect to the account holder’s foreign status (other than renewal documentation that is required under Reg. § 1.1441-1(e)(4)(ii)(A) ) or reviews documentation for the account holder that contains a U.S. place of birth.(Reg. § 1.1441-7(b)(3)(ii))

…Reasonable explanation of foreign status.Under both the final and temporary Chapter 4 regs, Reg. § 1.1471-3(e)(4)(viii) and Reg. § 1.1441-7T(b)(12), IRS provides that a withholding agent may rely on the foreign status of an individual account holder irrespective of certain U.S. indicia if, in certain cases, the account holder provides a reasonable explanation supporting the account holder’s claim of foreign status.However, the final Chapter 4 regs and the temporary regs provide a different description of what qualifies as a reasonable explanation of foreign status.IRS intends to amend the final Chapter 4 regs to adopt the description of a reasonable explanation of foreign status provided in the temporary regs, which allow an individual to provide a reasonable explanation that isn’t limited to an explanation meeting the requirements of final regs (Reg. § 1.1471-3(e)(4)(viii)(A) through Reg. § 1.1471-3(e)(4)(viii)(D))

…Limited FFIs and limited branches.Taxpayers have expressed concern over the status of FFIs and branches of FFIs in jurisdictions that are slow to engage in negotiating IGAs and that have legal restrictions impeding their ability to comply with FATCA, including the conditions for limited FFI or limited branch status under the final Chapter 4 regs.IRS intends to amend the final regs to allow a limited FFI or limited branch to open U.S. accounts for persons resident in the jurisdiction where the limited branch or limited FFI is located, and accounts for nonparticipating FFIs that are resident in that jurisdiction, if the limited FFI or limited branch doesn’t solicit U.S. accounts from persons not resident in, or accounts held by nonparticipating FFIs that are not established in, the jurisdiction where the FFI (or branch) is located and the FFI (or branch) isn’t used by another FFI in its expanded affiliated group to circumvent the obligations of the other FFI under Code Sec. 1471.

In addition, certain jurisdictions are explicitly prohibiting an FFI resident in, or organized under the laws of, the jurisdiction from registering with IRS and agreeing to any status, including status as a limited FFI, regardless of whether the FFI would otherwise be able to comply with the requirements of limited FFI status.IRS intend to amend the final Chapter 4 regs to provide that if an FFI is prohibited under local law from registering as a limited FFI, the prohibition will not prevent the members of its expanded affiliated group from obtaining statuses as participating FFIs or registered deemed-compliant FFIs if the first-mentioned FFI is identified as a limited FFI on the FATCA registration website by a member of the expanded affiliated group that is a U.S. financial institution or an FFI seeking status as a participating FFI (including a reporting Model 2 FFI) or reporting Model 1 FFI.To identify the limited FFI, the member of the expanded affiliated group must register as a Lead FI with respect to the limited FFI and provide the limited FFI’s information in Part II of the FATCA registration website (identifying it as “Limited FFI,” if prohibited from using its legal name by local law).

By identifying a limited FFI in the FATCA registration website, the Lead FI confirms that: (1) the FFI made a representation to the Lead FI that it will meet the conditions for limited FFI status; (2) the FFI will notify the Lead FI within 30 days of the date that the FFI ceases to be a limited FFI because it either (i) can no longer comply with the requirements for limited status or failed to comply with these requirements or (ii) can comply with the requirements of a participating FFI or deemed-compliant FFI and will separately register to obtain its applicable Chapter 4 status; and (3) the Lead FI, if it receives notification or knows of the conditions in (i) or (ii), will, within 90 days of the notification or acquiring the knowledge, update the information on the FATCA registration website accordingly and will no longer be required to act as a Lead FI for the FFI.

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