Richard J. Razook and Alyssa Razook Wan
In recent years, the United States has increased initiatives to counter tax evasion committed by U.S. persons who are not reporting and paying U.S. income tax on earnings derived from foreign financial assets. The Foreign Account Tax Compliance Act ("FATCA") represents the latest major initiative in this regard, having been enacted in 2010 and since that time progressed through various stages of implementation in the United States and around the world.
The primary objective of FATCA is to obtain accurate reporting of foreign financial assets held by U.S. persons; however, FATCA impacts non-U.S. persons as well. To that end, through complicated rules, FATCA seeks to collect information about ownership of assets and sources of income, whether attributed to U.S. and non-U.S. persons.
The cost of not complying with FATCA is a 30% withholding tax that is imposed on certain types of U.S.-sourced passive income and, in the future, certain foreign passthru payments. In order to avoid FATCA withholding tax, certain forms or reports may need to be submitted to a financial institutions maintaining or managing foreign accounts.
Further, foreign private trusts and foreign private investment companies that are professionally managed (if treated as a foreign financial institution) are required to register with the U.S. Internal Revenue Service ("IRS") or be sponsored by an IRS-registered entity. In certain cases, if the proper form is not provided by January 1, 2015, taxpayers may be subject to the 30% withholding tax.
To facilitate obtaining the information required by FATCA, the U. S. government has made agreements with numerous foreign countries, called "intergovernmental agreements" or "IGAs." Those foreign countries, in turn, have passed (or are passing) legislation to implement these IGAs, which generally requires the foreign country's financial institutions to perform due diligence on account holders and report certain types of information about their account holders to their governments.
The foreign government then provides this information to the United States pursuant to the IGA. When there is no applicable IGA, FATCA reporting is still required in accordance with the U.S. Treasury Regulations. The method of reporting is based upon whether the account is held by an individual or foreign entity, and the classification of the foreign entity holding the account.
In general, FATCA requires that all foreign trusts and other entities be classified according to their FATCA status pursuant to a series of complicated rules, regulations and IGAs where applicable. An entity's classification determines the manner and type of reporting. For example, in some cases, the classification will require the foreign entity to register with the IRS and apply for a "global intermediary identification number," generally referred to as a "GIIN."
In other cases, registration with the IRS is not required, and FATCA reporting will be carried out by banks, trust companies, or other financial institutions maintaining or managing the foreign account. In all cases, the names of U.S. persons holding a "substantial" or "controlling" interest in the account must be disclosed, as well as certain information about those U.S. persons and the accounts.
Even though the goal of FATCA is to obtain information about U.S. account holders, FATCA may apply to foreign entities irrespective of whether a foreign entity has U.S. owners or U.S. investments. Depending on the nature of the foreign structure and investments, reporting requirements may vary. For example, when an IGA is not applicable, and a foreign trust holds real estate directly, the trust will generally not be required to register with the IRS. However, if the foreign trust were to hold the same real estate through an underlying company, registration may be required. Note that a trust executed in the United States, which provides U.S. courts with sole jurisdiction, could still be classified as a foreign trust if, for example, the sole trustee of the trust is a nonresident or other foreign person for U.S. tax purposes.
Because certain FATCA classifications are made based upon the source and nature of income of a foreign entity, if the entity's income changes in these respects during the year, the entity's FATCA classification should be reexamined. The classification and reporting requirements may be affected by the change in the source and nature of the entity's income. However, in general, a FATCA classification should be reviewed every three years.
Determining the proper FATCA classification and otherwise complying with FATCA can be challenging, as the FATCA rules are voluminous and complicated, and applicable IGAs always need to be considered. It is important to consult with your tax advisor to ensure compliance.
Please Note: This summary is for general informational purposes only. It is not a detailed or complete presentation of the laws relating to the Foreign Account Tax Compliance Act and does not constitute legal advice. Each case is unique and requires a careful analysis by one's own professional advisor of the specific facts and circumstances in order to arrive to appropriate advice. Any discussion of U.S. tax matters contained herein is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation of programs or schemes to avoid or evade tax, as an inducement to make an investment based on tax or reporting consequences, or for the purpose of avoiding U.S. tax-related penalties.