Foreign Reporting and Withholding Tax Rule Changes

Presented by: Cynthia J. Hoffman, CPA, J.D. Director of International Tax Advisory Services Schneider Downs & Co., Inc. August 14, 2014

List of U.S. Reporting Requirements: Investment In or Payments To Foreign Persons

• Form 5471, Form 8865 and Form 8858 – Investments in foreign corporations, partnerships and disregarded entities

• Form 926 – U.S. Transferor of Property to a Foreign Corporation • Form 1042 – Annual withholding tax reporting for U.S. Sourced income of foreign

persons • Form 8938 – Reporting specified foreign financial assets (currently applies to

individuals only) • Form 114 (formerly FBAR) – Foreign Bank Account Reporting • Form 5713 – International Boycott Report • Form 3520 – Reporting transactions with foreign trusts

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U.S. Withholding Taxes on Payments to Foreign Persons

• Existing withholding rules on certain payments under Chapter 3, Section 1441

• New – Foreign Account Tax Compliance Act (“FATCA”) creates separate set

of withholding rules on certain payments under Chapter 4

Reporting on Form 1042 has changed Required documentation for payments to foreign persons has changed

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What is FATCA? Foreign Account Tax Compliance Act (“FATCA”) Part of HIRE Act enacted March 18, 2010 Adds new Chapter 4 to Internal Revenue Code Effective July 1, 2014

• Purpose to gather information on U.S. tax evaders with offshore assets earning income not reported Increase transparency for the IRS with respect to U.S. persons that are investing and

earning income through non-US institutions

• Requires certain foreign entities to disclose significant U.S. investors & accountholders Foreign entities who fail to comply suffer penalty of 30% U.S. tax withholding on

payments made to them from “U.S. persons”

• Final regulations package issued February 20, 2014

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Why Should I Care About FATCA? • U.S. and Foreign withholding agents are required to administer the new rules

This creates an additional set of withholding and reporting rules for U.S. persons who make payments to foreign persons

July 1, 2014 for NEW vendors and new obligations o Transitional rules on preexisting obligations

• New information reporting by U.S. persons of specified foreign financial accounts Form 8938 (beginning with 2011 tax year)

This casts a WIDE NET, since it applies to any U.S. person

• Penalties – Withholding agent secondary liable – Failure to report on Form 1042 – Failure to file Form 8938 (if applicable)

• Up to $10,000, plus criminal prosecution

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Not-for-Profit Entities – Common Transactions

• Common items of concern for NFP’s:

Payments for funding of off-shore investments (hedge funds, private equity, foreign partnerships, etc.)

Management fees to off-shore investment managers Payments for services to foreign persons (where services are performed in the U.S.) Payments to foreign pensioners Royalty, interest and other FDAP payments

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How Does FATCA Work?

• Foreign Financial Institutions (“FFI’s”) Required to register and enter an agreement with the U.S. Department of

Treasury Determine which accounts are “U.S. accounts”, comply with verification and

due diligence procedures, annually report the U.S. accounts to the U.S. Treasury, withhold 30% on recalcitrant account holder and “nonparticipating FFI’s”

• Certain Non-Financial Foreign Entities (“NFFE’s”) Provide information regarding U.S. owners, or Certify eligibility for exempted “low-risk” status

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What is a “Foreign Financial Institution”?

• What is a “Foreign Financial Institution”? - Any foreign entity that:

Accepts deposits in the ordinary course of banking or similar business;

Holds financial assets for the account of others as a substantial portion of its business; OR

Is engaged in primarily in the business of investing, reinvesting, or trading in securities, partnership interests, or commodities

This may include investment vehicles such as hedge funds and private equity funds which the NFP invests in

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What is a “Non-Financial Foreign Entity”?

• What is a Non-Financial Foreign Entities? - Any foreign entity that is not a financial institution - Exempted Status:

Publicly traded corporations and members of an expanded affiliated group that includes a publicly traded corporation

Certain nonfinancial holding companies and captive finance companies Entity organized under the laws of a US possession and wholly owned by bona

fide resident(s) of the possession Foreign government or any political subdivision thereof International organization Active NFFE’s

o Derives less than 50% of gross income from passive sources, and less than 50% of its assets are passive assets

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Existing Withholding Rules – Chapter 3 IRC §1441 under Chapter 3

• U.S. Withholding Tax on payment of: U.S. sourced; Fixed, determinable, periodic income

• Does not apply to Effectively Connected Income (“ECI”) • Does not apply to Portfolio Interest

• Rate is currently 30%, unless reduced by income tax treaty • Reduction (or exemption) on withholding must be requested by receiving:

Form W-8BEN, Form W-8BEN-E, Form W-8ECI, Form W-8IMY, Form 8233 (compensation) Note there are some New & Revised Forms as of April 2014 – what happens with existing

forms?

• Form 1042 & Form 1042-S Reporting Report Gross Income of US Sourced Payment & Tax Withholding (if applicable) Annually report to foreign recipient

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FATCA Withholding Rules – Chapter 4 IRC §§1471–1474 of Chapter 4

Starts with Section 1441 (existing rules), adds gross proceeds (from sale of U.S. securities), then subtracts non-financial payments and grandfathered payment. Note that all payments are reportable, just not withholdable. • U.S. Withholding Tax on payment of:

U.S. sourced; Fixed, determinable, periodic income AND Gross proceeds from sale of U.S. securities

• Rate is currently 30%; CANNOT be reduced by income tax treaty

• “Grandfathered” debt: Payments under obligations outstanding on July 1, 2014 No material modification of underlying obligation

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FATCA Withholding Rules – Chapter 4 (cont.)

• Revised Form W-8BEN (Individuals) • New Form W-8BEN-E

Now 6 pages long including over 20 entity classification types List of registered FFI’s and GIIN published by June 2, 2014

• Form W-8BEN-IMY (pass-through payments) Certificate of Foreign Intermediary, Foreign Flow-through Entity, or Certain U.S. Branches for

US tax Withholding Intermediary /agent payments have expanded to include “financial institutions” under the

Chapter 4 definition, thereby including investment entities and specified insurance companies • Form 1042 & Form 1042-S Reporting – REVISED FORMS

– Reporting may include additional information your systems are not currently capturing

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FATCA (Chapter 4) Withholding Timelines

• July 1, 2014 Withholding starts on all U.S. source FDAP payments to new vendors and on new

obligations

• January 1, 2015 Withholding starts on U.S. source FDAP payments under preexisting obligations to non-

participating FFI’s

• March 15, 2015 Forms 1042 and 1042-S due for 2014 reportable payments on or after July 1, 2014

• July 1, 2016 Withholding and reporting starts on U.S. source FDAP payments under preexisting

obligations to remaining FFI’s

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Documentation – Forms W-8BEN, et. al.

New Form W-8BEN-E – Released on March 29, 2014 • To be used by entities to certify beneficial owner status of income • Should be collected by payor prior to making payment

Individuals will continue to use Form W-8BEN (finalized as of March 4, 2014)

Validity of existing forms • General rule – Form W-8BEN will remain valid for a period starting from date it

is signed and ending on last day of 3rd succeeding calendar year • Prior W-8 Forms that were valid until December 31, 2013 will now be treated

as valid until December 31, 2014 (extended from June 30, 2014) 3-year validity rule & exceptions – Chapter 3 changed to agree with Chapter 4

Advise clients to begin collecting new forms from foreign payees ASAP 14

New Withholding Rules under FATCA - Examples USCo makes a management fee payment to its investment advisor, ForCo . The services provided by ForCo are performed in the Cayman Islands. There is no income tax treaty with the Cayman Islands. Are these services subject to withholding tax under:

– FATCA (Chapter 4)? – Section 1441 of Chapter 3? – Subject to reporting on Form 1042?

Same facts above, but the services are performed in the U.S.?

USCo makes a quarterly payment of interest to a bank located in Switzerland. There is an income tax treaty with the Switzerland. Is this interest subject to withholding tax under:

– FATCA (Chapter 4)? – Section 1441 of Chapter 3? – Subject to reporting on Form 1042?

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Action Steps • Identify who is going to take responsibility for FATCA compliance • Undertake an assessment to identify the relative impact of FATCA on the

organization and budget needed to address steps necessary to comply • Due diligence procedures need to be in place to assess whether payments to

foreign persons have been properly classified and documented – Determine if a withholdable payment exists – Determine a course of action regarding FORMS to be obtained – Determine if any exceptions for relief apply to either the type of payment or the type of

entity receiving the payment – Procedures for withholding, paying withheld tax and reporting

Written policies and procedures – IRS will ask for this upon audit Be prepared for questions from foreign payees about forms W-8BEN

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FATCA Help - Websites

• IRS Tax Map for FATCA materials (Complete list IRS resources currently available through website) – http://taxmap.ntis.gov/taxmap/ts0/foreignaccounttaxc_o_62bff6a0.htm

• IRS FAQ List – http://www.irs.gov/Businesses/Corporations/Frequently-Asked-

Questions-FAQs-FATCA--Compliance-Legal#Financial • Model Intergovernmental Agreements – http://www.treasury.gov/resource-

center/tax-policy/treaties/Pages/FATCA.aspx#ModelAgreements

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Q&A

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