on the Cayman financial industry
– how to prepare
On 18 March 2010, President Obama signed into law the Hiring Incentives to Restore Employment Act, the principal purpose of which is to stimulate job creation; and, also included was the Foreign Account Tax Compliance Act to prevent United States persons from using tax havens and tax secrecy jurisdictions to evade United States taxes. FATCA seeks to accomplish this objective through a series of reporting and penalty provisions that are applicable to certain foreign entities as well as to United States persons.
These new rules can affect both United States persons and foreign entities in significant ways and will have a direct impact upon all members of the Cayman financial industry whether they are trust companies, banks or investment funds.
The principal provisions of FATCA include
(1) imposition of a 30 per cent withholding regime on United States source payments to foreign financial institutions, foreign trusts and foreign corporations that do not agree to disclose their United States account holders and owners to the Internal Revenue Service (“IRS”);
(2) a requirement that United States taxpayers disclose their foreign accounts on their United States tax returns, and that certain United States shareholders in passive foreign investment companies (“PFICs”) file annual reports with the IRS;
(3) an extension of the statute of limitations to six years for failure by a United States taxpayer to report certain offshore transactions and income;
(4) clarification of when a foreign trust is considered to have a United States beneficiary; and
(5) treatment of substitute dividend and dividend equivalent payments made to foreign persons under “specified notional principal contracts” as dividends for purposes of United States withholding tax. While the effective date of the withholding provisions does not start until 1 January 2013, the effective dates of other FATCA provisions vary.
Many questions of interpretation and enforcement need to be clarified and we now await guidance in the form of Treasury Regulations and other announcements from the IRS. From what we do know so far, we can draw a number of conclusions from which members of the Cayman financial community ought to be guided.
Know your United States customers
FATCA imposes the new 30 per cent withholding tax on certain payments made to foreign financial institutions (“FFIs”) and non-financial foreign Entities (“NFFEs”) that refuse to identify United States account holders and investors. It does not matter whether the United States person invests in United States securities or receives the United States source income directly. “Withholdable payments” that are subject to the 30 per cent tax include both United States source income (eg interest or dividends paid by a United States corporation) and the gross proceeds from the sale of securities that theoretically could generate United States source income.
The goal of the withholding tax is not to generate revenue as much as it is designed to compel transparency. Keeping track of the fiscal status of your customer (or his extended family in the case of trusts with several generations of beneficiaries who may have moved to the United States or perhaps married United States citizens) can be challenging to your financial institution’s relationship manager and most certainly will require additional compliance measures. Without doubt, FATCA makes “KYC” even more important than ever.
Choose whether to comply, withhold or “cut bait”
FFIs and NFFEs have three options: (1) comply with the FATCA rules, (2) accept 30 per cent withholding on United States source payments, or (3) avoid disclosure United States source income and investments altogether. FFIs and NFFEs can avoid withholding, but only by following disclosure rules. FFIs must comply by entering into a “Section 1471(b) Agreement” – with the IRS to identify their United States account holders, follow due diligence rules and withhold on “recalcitrant account holders”[1 ]. NFFEs must disclose any “substantial owners” who are United States persons who own more than 10 per cent of the NFFE, directly or indirectly.
The new rules impact upon not only the international and domestic financial industry, but also upon all other parties deemed to be withholding agents. Failure to comply with the new rules may give rise to significant withholding tax liability on withholding agents.
Understand the broad definition of a Foreign Financial Institution
A controversial element of FATCA is the broad definition of an FFI which may include non-United States investment vehicles, even those which do not solicit outside investors, such as personal investment companies and special purpose vehicles. Depending upon how the Treasury Regulations are written, such a broad interpretation could impose substantial new compliance costs on a wide array of common ownership structures. Moreover, any United States ownership of an FFI, other than by certain exempt entities, is considered “substantial”, no matter how tiny the United States ownership interest is, and therefore must be disclosed to the IRS. “Stay tuned” to find out whether any part of your organisation might be ensnared by the long reach of FATCA.
Help voice your opinion rather than merely “waiting and seeing”
Although FATCA imposes a regime of withholding and penalties, its provisions allow the IRS and the Treasury Department to exercise wide discretion in writing rules and regulations which would interpret and implement the new law. The Secretary of the Treasury has power to completely exempt entities or payments from FATCA if there is a low risk of tax evasion. What procedures withholding agents and non-United States entities must follow have yet to be decided. The IRS has requested comments from all interested parties in Announcement 2010-22, released 7 April 2010; and, I am certain that Cayman Finance is being well advised by its US counsel to let its concerns be known on Capitol Hill prior to these types of decisions being made.
Have a strategic plan – and perhaps a foreign trust audit
Compliance with FATCA by your organisation by the 1 January 2013 effective date of the withholding provisions requires time, energy and expertise across a wide spectrum of disciplines – tax, accounting operations, IT systems and management. Trust companies may also wish to have their US involved trust inventory audited with an eye toward identifying all of the US tax and reporting obligations occasioned by United States settlers or beneficiaries. Be prepared and be forewarned – compliance with FATCA requires your immediate attention.
1 The Section 1471(b) Agreement would require the foreign financial institution to enter into an agreement with the IRS to:
a)Obtain information regarding each holder of an account maintained by the institution to determine which accounts are US accounts;
b)Comply with verification and due diligence procedures prescribed by IRS to identify US accounts;
c) Report annually for any US account, identifying information as to the specified account and any substantial owner of a US-owned foreign entity;
d) Deduct and withhold 30 per cent from certain pass-through payments made to “a recalcitrant account holder” or certain other foreign financial institutions;
e) Comply with IRS requests for additional information for any US account maintained by the institutions; and
f) Attempt to obtain a waiver where a foreign law would (but for a waiver) prevent the reporting of information required by these rules for any US account maintained by the institution, and, if a waiver is not obtained, to close the account. Annual reporting is also required as to account balances and gross receipts and withdrawals from the account.
2 We at Cantor & Webb P.A. have devised a comprehensive “foreign trust audit” for foreign trust companies to help ensure that they and their trust settlers and beneficiaries with United States connections are in compliance with their United States tax and reporting obligations under the HIRE Act.