As the IRS issues additional guidance on the Foreign Account Tax Compliance Act (FATCA) in Notice 2011-34, just over a year from the day the legislation was first passed, the U.S. government continues its mission to identify U.S. persons with offshore accounts. To find such people and businesses, the government is holding accountable all organizations in its path. FATCA rules enforce that accountability. Specifically, these rules mandate that foreign organizations disclose U.S. persons holding accounts in that foreign organization. If these organizations comply and provide the information required, then there will be no withholding requirement or penalties imposed. If they do not comply, the U.S. government will impose a 30 percent haircut on all cash flows coming out of the U.S. This is the basic impact of the FATCA game — it is essentially a reporting regime. However, if you don’t report, it becomes a withholding regime.

Although FATCA is frequently discussed as a “banking” or “financial services” issue, the broad definitions used in the rules make one thing clear: all sorts of organizations, including commercial U.S. businesses, can fall under the wide net cast by the legislation.

There are of course exceptions to FATCA reporting and withholding, but they are not overly broad. The rules create a variety of complications, some of which may require a great deal of time to sort out. Thankfully, the FATCA rules are not effective until 2013, and more guidance will be forthcoming. That said, we are seeing many organizations already undertaking significant efforts to ensure FATCA readiness and compliance, and we suggest that others do the same.

 1. Introduction

President Obama signed FATCA into law on March 28, 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. (See .) The objective? To prevent the evasion of U.S. tax through the use of offshore accounts and entities. Under the law, a new 30 percent withholding tax will be imposed on various types of U.S.-source payments and proceeds from the sale of U.S. income-producing property. Since enactment, the IRS has issued some guidance, with the latest round issued on April 8, and regulations are expected this summer. As IRS Commissioner Doug Shulman told the Annual Institute on Current Issues in International Taxation on December 9, 2010:

“One of the most important projects we are working on in the international area right now is the implementation of FATCA....This is the most important development in international information reporting in a generation, and it is a big step forward in our efforts to combat tax evasion.”

True to the Commissioner’s point made last December, compliance with the FATCA rules will mean different things for different types of organizations. A one-size-fits-all approach to FATCA compliance is impossible. For example, a foreign organization may become subject to new and onerous tax reporting requirements that will require internal systems changes to ensure compliance. Implementation of this change could take months or even years. In other words, some companies should act immediately, whereas others can afford to wait for additional guidance prior to putting their FATCA compliance strategy into full swing.

2. Mapping Your Organization

The key to understanding these rules is that FATCA will require attention from two major groups of organizations: (1) foreign receivers and (2) U.S. payers (we the authors made these terms up for the sake of explanation). In general, foreign receivers will be responsible for reporting the ultimate owners of the income (i.e., identifying U.S. persons with offshore accounts to the IRS), and the U.S. payers will be responsible for withholding the tax. Your organization will fall into one of these groups, and this classification will likely determine how significant and urgent your efforts should be to ensure you are ready to comply with FATCA on the effective date.

The Foreign Receivers: Act Now
This group consists mainly of (a) foreign financial organizations that have investments in the U.S. or facilitate others’ investments in the U.S. and (b) other companies such as commercial organizations with U.S. activities or investments. Many foreign receivers will be required to gather extensive information about all of their investors and disclose this information to the U.S. Treasury or a withholding agent. Otherwise, they will be considered non-compliant, and their receipt of payments from the U.S. will become subject to the mandatory 30 percent withholding. Many organizations in this category need to focus immediately on planning for the changes necessary to comply with these new rules — especially banks, brokers and funds.

In Germany, for example, according to Christoph Kromer, Tax Partner at Luther Rechtsanwaltsgesellschaft mbH, “The publicly owned German banking institutes, as one of the three pillars of the German banking system, are expecting a conversion and implementation time of 18 months for each banking institute. I would expect that the major stock-quoted international German banking institutes are probably planning even more time and budget to adapt to the FATCA rules. Other companies, like stock brokers and investment fund managing institutes, have also already started to analyze the impact on their organizations.”

The U.S. Payers: Be Proactive
These are the U.S. entities that make so-called withholdable payments (see below) to foreign receivers. Examples of such organizations include U.S. non-financial (herein referred to as “commercial”) businesses with either foreign vendors or foreign owners, U.S. funds with foreign investors, U.S. banks with foreign account holders, and other U.S. investment vehicles. U.S. payers will soon be required to determine whether the foreign receiver is compliant with the FATCA documentation rules. If not, the U.S. payers will likely have a responsibility to withhold taxes on payments. For the major financial service organizations in this grouping, the process of identifying all the possible payment streams that will become subject to these requirements could be daunting, and we suggest immediate action. We see less of an immediate burden to take drastic measures for the other organizations in this grouping, but they should be focused on getting up to speed.

The list of payments subject to withholding under FATCA will be broad, and may include U.S.-source dividends, interest, licensing fees, U.S.-sourced compensation for services, pension or annuity payments under a U.S. plan, payments for legal settlements and litigation awards, rents for real property located in the U.S., insurance premiums or proceeds from U.S. sources, U.S.-sourced sponsorship and guarantee fees.

3. What Does This Mean For Me?

Of course, if your organization is a large bank or broker dealer, you are probably already preparing for these rules. “This is a top priority for the clients in our financial services practice,” says Jeffrey Donaldson, a Managing Director in A&M’s Business Consulting practice who focuses on advising financial services organizations (large and small) in making such systems changes. However, for the rest of the companies sorting out FATCA, time is of the essence. Quick action might be necessary. Jeff adds, “time-intensive systems and process changes may be necessary to gather and maintain investor account information and identify and document the source of payments received.”

To make this process a bit easier, we have broken the groupings down. Here is a quick guide on how your specific organization should be thinking about FATCA today:

Commercial U.S. Multinationals (U.S. Companies):
These rules apply not only to financial companies and foreign entities. They also apply to commercial U.S. businesses that are making payments to foreign receivers that have not complied with the documentation requirements of FATCA. If you are a commercial U.S. multinational, you should be looking closely at your outbound payments. In fact, we suggest the following action plan:

1. Assess the capabilities of accounts payable to identify outbound royalties, dividends or interest, and withhold if necessary;
2. Communicate with withholding agents to assess their commitment and processes to comply with FATCA on your behalf; and
3. Begin informing recipients of these outbound payments of your planned course of action to comply with FATCA.

We anticipate that some U.S. companies will need to modify their IT systems and procedures to comply with these rules. These kinds of systems changes could take a long time to implement.

Non-U.S. Commercial Companies:
You’re probably thinking that if your organization is not a bank or a U.S. company, you don’t need to worry. Not quite. The rules extend beyond non-U.S. financial companies. The good news is that non-U.S. commercial organizations have less onerous reporting requirements. Instead of recurring annual filing requirements with the U.S. government, these companies can avoid the 30 percent haircut if they provide information about their U.S. owners to the withholding agent on the transaction. The problem is that if they don’t provide that information, the withholding agent is required to withhold 30 percent on the entire payment, not just the U.S. shareholder portion. These companies should undertake the following actions:

1. Review their ownership to identify the adequacy of shareholder information for reporting;
2. Identify the receipt of royalties, dividends, compensation for services, rents, interest or other payments from U.S. sources; and
3. Begin coordination and communication with withholding agents.

We anticipate that as more details of the rules get published, many of these companies may qualify for some kind of exception. But only time will tell.

Funds:
Yes, domestic and foreign funds (including mutual funds, private equity, hedge funds and other collective investment vehicles) could be significantly impacted by the FATCA rules. These organizations are frequently designed for cross-border investments and will get easily caught in the FATCA web. The rules could apply at multiple levels within a fund organization, including the funds themselves, the underlying businesses (i.e., portfolio companies), and the investors and third-party administrators. In light of this profile, fund sponsors and investment managers should expect extra scrutiny under FATCA.

U.S. Funds:

Domestic funds are generally U.S. payers and will be required to withhold an amount equal to 30 percent on payments made to non-compliant foreign receivers. This requirement can have a big impact on foreign investors expecting unencumbered cash flows. Ensuring communication with these investors about the process of complying with FATCA will be extremely important and sensitive in the upcoming months as additional guidance is released by the IRS. Managers and sponsors should be educating themselves about these new rules immediately.

Non-U.S. Funds:

These funds are generally foreign receivers and should be concerned about meeting the new documentation reporting requirements to avoid increased withholding on their U.S.-based income. We also suggest the following:

1. Assess the adequacy of investor information as well as their third-party administrators and other service providers;
2. Analyze U.S. investments to determine the types of payments that could become subject to the higher withholding; and
3. Begin communication with investors about the impact.

Labor-intensive systems and process changes may be required to gather and maintain investor account information and identify and document the source of payments received for compliance with FATCA by these funds. Ernie Perez, A&M’s National Practice Leader for International and Transaction Tax, spends a great deal of his time working with the firm’s fund clients and believes, “just about every foreign investment vehicle that receives, directly or indirectly, U.S.-source income, including sales proceeds, and regardless of size will be impacted by the FATCA rules. Those foreign investment vehicles that are impacted will likely be required to enter into agreements with the U.S. Treasury to avoid withholding and will be subjected to a continuous process of due diligence, verification and reporting.”

Real Estate Investments:
Real estate investments are not necessarily exempt from the impact of these rules. According to Frank Walker, our A&M real estate tax guru, real estate structures have become very complicated over the past decade, and each structure is different from the next. That makes uniform application of these rules to the real estate investment base challenging. “We anticipate that many managers in the real estate space will need to evaluate the cost of compliance, the impact on investment returns for noncompliance and alternative investments available to their investors that may be less burdensome,” Frank says. That applies to direct investments in U.S. real estate, ownership though funds or other collective investment vehicles, loans into real estate holdings, REITs and corporate-owned real estate. Some fund managers may have to choose between the costs of compliance with these rules and restricting the types of investors they will accept.

Banks and Broker Dealers:
Of course, it is easy to see why these rules will affect banks and institutions that hold accounts for others, especially those with cross-border investors. For others in this category who have not already taken significant steps towards coming up with a FATCA plan, here is a little more food for thought.

U.S. Banks and Broker Dealers:

Beginning January 1, 2013, these entities will be required to withhold 30 percent on withholdable payments made to non-compliant foreign receivers. In other words, by that date, these organizations will need their systems to automatically track which account holders require compliance and withholding. Based on the vast number of foreign account holders and frequency of withholdable payments made, these organizations will likely need significant systems modifications in order to comply with automated tracking. Although more guidance is expected on how to apply the rules, these organizations should not delay in evaluating their existing capacity and systems efficiencies. We suggest taking action now and, as more guidance comes out, fine-tuning your FATCA compliance strategy down the road. These organizations can’t afford to wait, and many are well on their way to developing comprehensive compliance strategies to allow for fast implantation when that guidance becomes available.

Foreign Banks and Broker Dealers:

With few exceptions, most foreign banks and broker dealers will be required to comply with new onerous annual reporting requirements to the U.S. Treasury by providing data on their account holders. These institutions will likely need widespread systems analysis and modification to ensure FATCA compliance by the effective date. In preparation, we suggest the following:

1. Analyze current and future guidance;
2. Review existing “know your client” and U.S. withholding documentation procedures; and
3. Review local jurisdiction bank secrecy rules that exist today for these entities.

Once regulations are issued, banks and broker dealers can implement more refined solutions for FATCA compliance. However, based on an analysis of the guidance currently available, it is prudent to work towards implementing a FATCA compliance strategy now.

The European Union, in a recent letter addressed to the IRS and Treasury, indicated that the EU has many concerns about FATCA following its in-depth analysis of guidance available to date. It points to the legislation’s wide-ranging application and the necessity for multiple exceptions from FATCA compliance for low-risk activities. The EU has indicated that if the IRS and Treasury ignore its concerns, the rules may force many EU-based financial services companies to abandon the U.S. market. The EU has also raised concerns that FATCA’s override foreign bank secrecy laws conflict with fundamental data protection laws in numerous EU jurisdictions. The impact of these concerns on FATCA implementation is not yet known.

Alvarez & Marsal Taxand Says:
Although the FATCA rules have not been finalized and are subject to change as the program evolves, many if not most organizations should act now in assessing and planning for what comes next. The following are some of the ways your organization can prepare while regulations are in the works:

• Inform management that FATCA is a major initiative of the IRS, and that in some cases, waiting to deal with this new regime is not an option.
• Form a working group made of up leaders in tax, finance, legal, marketing, and IT systems departments.
• Analyze business lines within your organization to determine their status as U.S. payers and/or foreign receivers.
• Assess your current withholding and data system capability to comply with FATCA.
• Develop a methodology for evaluating the cost of compliance and the time required to implement any changes in your current business to comply to allow real-time analysis as more guidance becomes available.
• Begin educating your clients about your reporting and disclosure requirements under FATCA.
• As new guidance comes out, look to A&M to provide more plain English insight.

Disclaimer
As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

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