International Financial Law Prof Blog

Editor: William Byrnes
Texas A&M University
School of Law

Thursday, December 13, 2018

IRS Issues Proposed FATCA Regulations Impacting WIthholding on Gross Proceeds and Insurance Premiums. Kicks the Can on Passthru Withholding.

The Treasury released 50 pages of FATCA proposed regulation changes today. 

For an in-depth discussion, see the 2,500 page Analytical Treatise for FATCA and CRS Compliance here. The Guide to FATCA & CRS Compliance provides 2,500 of analysis and a framework for meaningful interactions among enterprise stakeholders, and between the FATCA/CRS Compliance Officer and the FATCA/CRS advisors/vendors. Analysis of the complicated regulations, recognition of overlapping complex regime and intergovernmental agreement requirements (e.g. FATCA, CRS, Qualified Intermediary, source withholding, national and international information exchange, European Union tax information exchange, information confidentiality laws, money laundering prevention, risk management, and the application of an IGA) is balanced with substantive analysis and descriptive examples. The contributors hail from several countries and an offshore financial center and include attorneys, accountants, information technology engineers, and risk managers from large, medium and small firms and from large financial institutions. Thus, the challenges of the FATCA / CRS Compliance Officer are approached from several perspectives and contextual backgrounds.

  1. Elimination of Withholding on Payments of Gross Proceeds from the Sale or Other Disposition of Any Property of a Type Which Can Produce Interest or Dividends from Sources Within the United States

Under IRC Sections 1471(a) and 1472, withholdable payments made to certain foreign financial institutions (FFIs) and certain non-financial foreign entities (NFFEs) are subject to withholding under Chapter 4. IRC Section 1473(1) states that the term “withholdable payment” means: (i) Any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the United States; and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States.

The 2017 Chapter 4 regulations provide that such withholding will begin on January 1, 2019. Many U.S. and foreign financial institutions, foreign governments, the Treasury Department, the IRS, and other stakeholders have devoted substantial resources to implementing FATCA withholding on withholdable payments. At the same time, 87 jurisdictions have an IGA in force or in effect and 26 jurisdictions are treated as having an IGA in effect because they have an IGA signed or agreed in substance, which allows for international cooperation to facilitate FATCA implementation. The Treasury Department determined that the current withholding requirements under chapter 4 on U.S. investments already serve as a significant incentive for FFIs investing in U.S. securities to avoid status as nonparticipating FFIs, and that withholding on gross proceeds is no longer necessary in light of the current compliance with FATCA.

The 2019 proposed regulations eliminate withholding on gross proceeds by removing gross proceeds from the definition of the term “withholdable payment” in §1.1473-1(a)(1) and by removing certain other provisions in the Chapter 4 regulations that relate to withholding on gross proceeds. As a result of these proposed changes to the Chapter 4 regulations, only payments of U.S. source FDAP that are withholdable payments under §1.1473-1(a) and that are not otherwise excepted from withholding under §1.1471-2(a) or (b) would be subject to withholding under sections 1471(a) and 1472.

2. Deferral of Withholding on Foreign Passthru Payments

An FFI that has an agreement described in IRC Section 1471(b) in effect with the IRS is required to withhold on any passthru payments made to its recalcitrant account holders and to FFIs that are not compliant with chapter 4 (nonparticipating FFIs). IRC Section 1471(d)(7) defines a “passthru payment” as any withholdable payment or other payment to the extent attributable to a withholdable payment.

The 2017 chapter 4 regulations provide that such withholding will not begin until the later of January 1, 2019, or the date of publication in the Federal Register of final regulations defining the term “foreign passthru payment.”  2018’s proposed regulation §1.1471-4(b)(4), a participating FFI will not be required to withhold tax on a foreign passthru payment made to a recalcitrant account holder or nonparticipating FFI before the date that is two years after the date of publication in the Federal Register of final regulations defining the term “foreign passthru payment.” The proposed regulations also make conforming changes to other provisions in the Chapter 4 regulations that relate to foreign passthru payment withholding.

Notwithstanding these proposed amendments, the Treasury Department remains concerned about the long-term omission of withholding on foreign passthru payments. Withholding on foreign passthru payments serves important purposes. First, it provides one way for an FFI that has entered into an FFI agreement to continue to remain in compliance with its agreement, even if some of its account holders have failed to provide the FFI with the information necessary for the FFI to properly determine whether the accounts are U.S. accounts and perform the required reporting, or, in the case of account holders that are FFIs, have failed to enter into an FFI agreement. Second, withholding on foreign passthru payments prevents nonparticipating FFIs from avoiding FATCA by investing in the United States through a participating FFI “blocker.” For example, a participating FFI that is an investment entity could receive U.S. source FDAP income free of withholding under Chapter 4 and then effectively pay the amount over to a nonparticipating FFI as a corporate distribution. Despite being attributable to the U.S. source payment, the payment made to the nonparticipating FFI may be treated as foreign source income and therefore not a withholdable payment subject to Chapter 4 withholding. Accordingly, the Treasury Department continues to consider the feasibility of a system for implementing withholding on foreign passthru payments. 

3. Elimination of Withholding on Non-Cash Value Insurance Premiums Under Chapter 4

The 2019 proposed regulations provide that premiums for insurance contracts that do not have cash value (as defined in §1.1471-5(b)(3)(vii)(B)) are excluded nonfinancial payments and, therefore, not withholdable payments.

4. Clarification of Definition of Investment Entity

The clarification in these proposed regulations is similar to the guidance published by the OECD interpreting the definition of a “managed by” investment entity under the Common Reporting Standard.

5. Modifications to Due Diligence Requirements of Withholding Agents Under Chapters 3 and 4

These proposed regulations include several changes to the rules on treaty statements provided with documentary evidence.

  • Extend the time for withholding agents to obtain treaty statements with the specific LOB provision identified for preexisting accounts until January 1, 2020 (rather than January 1, 2019).
  • Add exceptions to the three-year validity period for treaty statements provided by tax exempt organizations (other than tax-exempt pension trusts or pension funds), governments, and publicly traded corporations, entities whose qualification under an applicable treaty is unlikely to change.[1]
  • Correct an inadvertent omission of the actual knowledge standard for a withholding agent’s reliance on the beneficial owner’s identification of an LOB provision on a treaty statement provided with documentary evidence, the same as the standard that applies to a withholding certificate used to make a treaty claim.[2]

These three proposed amendments will also be incorporated into the 2017 QI agreement and 2017 WP and WT agreements, and a QI, WP, or WT may rely upon these proposed modifications until such time.

Permanent residence address subject to hold mail instruction for Chapters 3 and 4

The proposed regulations provide that the documentary evidence required in order to treat an address that is provided subject to a hold mail instruction as a permanent residence address is documentary evidence that supports the person’s claim of foreign status or, for a person claiming treaty benefits, documentary evidence that supports the person’s residence in the country where the person claims treaty benefits.

Regardless of whether the person claims treaty benefits, the documentary evidence on which a withholding agent may rely is the documentary evidence described in §1.1471- 3(c)(5)(i), without regard to the requirement that the documentation contains a permanent residence address.

Proposed §1.1471-1(b)(62) adds a definition of a hold mail instruction to clarify that a hold mail instruction does not include a request to receive all correspondence (including account statements) electronically.

Revisions Related to Credits and Refunds of Overwithheld Tax

  • Withholding and reporting in a subsequent year
  • Adjustments to overwithholding under the reimbursement and set-off procedures
  • Reporting of withholding by nonqualified intermediaries

[1] See proposed § 1.1441-1(e)(4)(ii)(A)(2).

[2] See proposed § 1.1441-6(c)(5)(i).

Download FATCA 2019 Proposed Regulations

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