The Foreign Account Tax Compliance Act (FATCA), was enacted in 2010 and came into effect on July 1, 2014. The FATCA Act and Regulations require Foreign Financial Institutions (FFIs) to report information on the foreign accounts of US persons to the United States, but do not authorize the US to provide information to foreign jurisdictions.
The FATCA Intergovernmental Agreements (IGAs) were implemented subsequently and the Reciprocal Model 1 IGAs authorize the United States to provide limited information exchange to FATCA IGA partner jurisdictions. In addition, under the Model 1 IGAs, whether reciprocal or non-reciprocal, FFIs report information not directly to the United States, but to their home governments, which then send the information to the United States.
In general terms, if an entity is resident in a jurisdiction that does not have a FATCA IGA, the FATCA Regulations will apply. An entity resident in a FATCA Model 1 IGA jurisdiction is governed exclusively by the IGA and local law, whereas an entity resident in a Model 2 IGA jurisdiction is governed by the Regulations, except to the extent the Regulations are inconsistent with the IGA. However, for purposes of determining whether an entity is an FFI or an NFFE, both Model 1 and Model 2 IGAs IGAs prevail over the Regulations.
Due Diligence Obligations
Under FATCA, FFIs have due diligence obligations to identify US accounts. The Regulations require FFIs to identify United States Accounts, which are held by one or more Specified U.S. Persons or by U.S. Owned Foreign Entities with Substantial US Owners. Under the IGAs, FFIs are required to identify U.S. Reportable Accounts which are held by one or more Specified U.S. Persons or Non-U.S Entities with one or more Controlling Persons that are Specified U.S. Persons.
Foreign Financial Institutions (FFIs)
The Regulations identify 5 types of FFIs: Depository Institutions, Custodial Institutions, Investment Entities, Insurance Companies, and Holding Companies or Treasury Centers. Of these 5 different types of FFIs, the ones most relevant for purposes of this research note are the Investment Entity FFIs, of which there are 3 types under the Regulations: Type A Investment Entities, which are asset management companies and trust companies; Type B Investment Entities, which are portfolio investment vehicles, such as trusts, companies, partnerships and the like; and, Type C Investment Entities, which are collective investment vehicles or funds. Type B Investment Entities must satisfy both the “gross income” test, which requires that 50% or more of its income be attributable to investing or trading in Financial Assets, and the “managed by” test, which requires that the entity be managed with discretionary authority by a Depository Institution, Custodial Institution, Insurance Company, or a Type A Investment Entity.
By contrast, under the IGAs, there are 4 types of FFIs: Depository Institutions; Custodial Institutions; Investment Entities; and, Insurance Companies. However, unlike the Regulations, the IGAs only have two types of Investment Entity FFIs, Type A and Type B investment entities, and do not include Holding Companies or Treasury Centers. Investment Entity FFIs are defined as any entity that conducts as a business, or is managed by an entity that conducts as a business, investing, administering, or managing funds or money on behalf of other persons, etc.
In order to qualify as a Type B Investment Entity, which is the category applicable to portfolio investment vehicles, such as trusts, corporations and partnerships, the entity must be managed with discretionary authority by a professional asset management company, equivalent to a Type A Investment Entity FFI under the Regulations, and not another type of FFI. There is no “gross income” test under the IGAs for Investment Entities, unlike the Regulations.
Note that trusts that are foreign for US Federal income tax purposes are ones that fail either the “court” test or the “control” test. Trusts that are foreign for US tax purposes are treated as FFIs as long as they meet the definition of at least one type of FFI, the only likely category being a Type B Investment Entity FFI. Trusts with US trustees that are FFIs have obligations under the FATCA Regulations to report the pertinent information to the IRS, but are not governed by the Intergovernmental Agreements (IGAs) and have no reporting obligations thereunder.
In general, an equity interest means an interest held in a Type B Investment Entity, which is treated as a Financial Account. In the case of trusts, settlors of so-called “grantor trusts” are treated as holding Equity Interests in trusts under the Regulations and Model 2 IGAs, whereas settlors of both grantor and non-grantor are treated as holding Equity Interests in trusts under the Model 1 IGAs Mandatory beneficiaries hold Equity Interests in trusts, and discretionary beneficiaries are treated as having Equity Interests only for the years in which they received a distribution. In addition, under the Model 1 IGAs “any other natural person exercising ultimate effective control over the trust” is also deemed to have an Equity Interest in a trust. An Equity Interest in a corporation or partnership means stock ownership in the corporation or capital or profits interest in the partnership. There is no de minimis rule, and any Equity Interest is potentially reportable.
Non-Financial Foreign Entities (NFFEs)
Any entity that is not an FFI is an NFFE. In addition, under the IGAs, any NFFE that is not an Active NFFE is a Passive NFFE. In contrast, under the Regulations, any NFFE that is not an “Excepted NFFE” is a Passive NFFE, with “Active NFFE’” being just one type of Excepted NFFE. Under both the Regulations and the IGAs, an Active NFFE means any entity whose passive income is less than 50% of its gross income and less than 50% of its assets produce or are held for the production of Passive Income, while other types of Excepted NFFEs under the Regulations and Active NFFEs under the IGAs include publicly traded companies, holding companies, treasury centers, captive finance companies, etc.
Under the Regulations, in the case of a trust that is a passive NFFE, Substantial U.S. Owner means any Specified U.S. Person that is treated as an owner of the trust under the grantor trust rules, or any person that holds more than 10% of the beneficial interests of the trust. A discretionary beneficiary will be treated as a Substantial US Owner where the beneficiary received more than 10% of the value of either all distributions during the calendar year or 10% or more of the assets held by the trust at the end of the calendar year. A mandatory beneficiary will be treated as a Substantial US Owner where the value of the person’s interest in the trust exceeds 10% of the value of the assets held by the trust at the end of the preceding year. With respect to foreign corporation or partnerships that are passive NFFEs, a Substantial US Owner is any Specified U.S. person that owns more than 10% of the stock, or capital or profits interest in the corporation or partnership.
Under the IGAs, Controlling Persons are defined to mean the natural persons who exercise control over a passive NFFE. In the case of a trust, Controlling Persons means the settlor, the trustees, the protector, the beneficiaries, and any other natural person exercising ultimate effective control over the trust. With respect to corporations and partnerships, identifying the Controlling Persons depends on the ownership structure and may be based on a threshold suggested by the FATF, such as any person owning more than 25% of the corporation or partnership.
FATCA Reporting by FFIs
The financial information that is reported by FFIs under the Regulations is quite similar to the information reported under the IGAs, and depending on the nature of the account, includes the account balance or value, gross receipts, gross payments, etc. Moreover, as we have seen, in the case of the Regulations, Substantial US Owners of Passive NFFEs are reported whereas, in the case of the IGAs, Specified US Persons who are Controlling Persons of Passive NFFEs entities are reported.
Passive NFFEs have no direct reporting obligations under either the Regulations or the IGAs. Instead, their duties are to determine whether they have Substantial US Owners, in the case of the Regulations, or whether they have Specified US Persons who are Controlling Persons, in the case of the IGAs, and to furnish the required identifying information about those to FFIs where they hold accounts.
Under the Regulations, there is no outbound reporting by US FIs to foreign jurisdictions. Under Reciprocal Model 1 IGAs, there is outbound reporting to foreign partner jurisdictions, typically limited to the financial information collected on IRS Form 1042, which includes information on US source income.