In our last article, we discussed the basics of the Foreign Tax Compliance Act (FATCA), as well as considerations for non-financial domestic entities and foreign entities. FATCA withholding began July 1, 2014, and we find many clients still wonder what it all means and why they should care.
Who should be concerned about FACTA requirements?
Any US company that remits withholdable payments to a foreign entity should be in compliance with FATCA. IRC §1473(1)(A) provides that a “withholdable payment” means:
- Any payment of interest, (including original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodic gains, profits, and income, if such payment is from sources within the United States, and
- 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.
In other words, in order for a payment to be withholdable payment, it must be “from sources within the United States.” Payments for services performed outside the United States should not be withholdable payments.
Example 1: USCo purchases product from ForeignCo. Since the transaction does not fall under the above definition, FATCA does not apply.
Example 2: USCo pays interest to a foreign parent company. Since interest is included in the above definition, it is subject to FATCA requirements.
Example 3: USCo pays a technical service fee to a foreign parent company. FATCA applies only if the technical service fee is related to services performed in the United States.
What are the FATCA requirements?
Form W-8BEN-E should be obtained from the foreign entity. This form documents the status of the foreign entity for US income tax, treaty benefits, and FATCA purposes. The 8 page, 30 section form replaces Form W-8BEN which was one page and relatively simple. The good news is most of the new 8-page form will not have to be filled out. The trick will be determining the right sections to complete.
All foreign beneficial owners must complete Part I (Identification of Beneficial Owner) and Part XXIX (Certification). Part I requires information previously reported on Form W-8BEN as well as information related to the FATCA status of the entity. The key element of completing the form is correctly identifying the Chapter 4 status and completing the designated additional parts. The form lists 31 classifications and each entity will fit only one such classification. For a non-financial foreign entity (NFFE), the most commonly used classifications will include:
- An active NFFE which is a foreign entity that is not a financial institution whose gross income comes more than 50% from non-passive sources and more than 50% of its assets are held for the production of non-passive income, i.e. a normal non-financial foreign operating company.
- A publicly traded NFFE is an NFFE that is traded on one or more established securities markets.
- An excepted territory NFFE is an NFFE organized in a possession of the US.
- A passive NFFE is a foreign entity that does not have substantial US owners or has provided the names of the owners and does not meet any of the other NFFE categories.
What steps should you take to ensure FATCA compliance?
In addition to understanding the new form, the following steps have been identified as best practices by the IRS for US persons making payments to foreign recipients:
- Review your organization’s vendor files and identify any foreign payees.
- Review all W-8BEN forms currently on file for foreign payees and update as necessary by requesting a completed Form w-8BEN-E.
- Implement a process to require documentation for all new vendors. US vendors should be required to supply Form W-9 and foreign vendors should be required to supply Form W-8BEN-E.
- Develop a process to identify US-source payments to non-US recipients and determine whether such payments are subject to FATCA withholding. Obtain Form W-8BEN-E when appropriate.
Observation: Implementing internal controls to ensure FATCA compliance may be difficult. Companies may want to consider a policy that requires form W-8BEN-E to be obtained for all foreign vendors, regardless of whether payments made are subject to FATCA or income tax withholding.
What happens if your company does not obtain the updated form?
For US entities, one of the most significant components of FATCA is the additional 30% withholding tax required on payments of US source income and gross proceeds to non-US entities that do not meet FATCA documentation requirements. Unlike withholding required under IRS §1441 and 1442 (which is reported on the Form 1042 series), FATCA withholding cannot be reduced by tax treaties. Unless documentation specified under the FATCA regulations is obtained, a 30% withholding will apply.
If there is no withholdable payment and you are not documenting the status, the IRS can assess penalties equal to the 30% withholding, therefore it is important to ensure the proper documentation is obtained.
What other reporting requirements should you know about?
In prior years the 1042 series was used to report the tax withheld on certain income of foreign persons/entities. The Form 1042 series has been modified from prior years to include separate line items to report payments and amounts withheld under the FATCA regulations.
How the FATCA regulations apply to a particular individual or entity is highly fact dependent. If you are making payments to a foreign person or are a foreign person receiving payments from a US entity, you will need to be prepared to understand the documentation and reporting requirements. For more information on FATCA, speak with your tax advisor or visit www.irs.gov.