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FATCA: The UK-US Inter-Governmental Agreement and the UK FATCA Regulations

July 3, 2013

Introduction

Following the UK Government’s entry into the first inter-governmental agreement (the “UK-US IGA”) with the United States government in respect of the United States’ Foreign Account Tax Compliance Act (“FATCA”), the UK’s tax authority, HMRC, issued regulations (the “Regulations”) on 31 May 2013 allowing UK foreign financial institutions to comply with their due diligence and reporting obligations under FATCA and the UK-US IGA. The Regulations are intended to come into effect later this year following enactment of the Finance Act 2013, and apply to those who hold “financial accounts” as at 31 December 2013 or open them after that date.

Under the UK-US IGA and the Regulations, direct reporting to the US has been replaced with a mechanism whereby UK tax resident financial institutions (and UK branches of non-resident financial institutions) will register with the IRS but provide information to HMRC, which will forward the information to the US tax authorities. This regime will allow UK financial institutions to comply with their FATCA obligations without breaching UK data protection laws. Set out in detail in the Regulations are the due diligence and reporting obligations with which UK financial institutions have to comply. These obligations are considerably simpler than those that would apply in the absence of an IGA. Finally, the Regulations confirm the policy that a UK business should be subject to a compliance burden no more onerous than if it were instead subject to FATCA as implemented by the US regulations on the subject.

Background

As discussed in our earlier updates (available here) FATCA imposes a 30 percent gross withholding tax on the payment of certain types of US-source income (including the gross proceeds derived from the sale of certain types of US investments) to certain types of foreign entities unless those entities comply with certain disclosure and reporting requirements. For this purpose, FATCA distinguishes between “foreign financial institutions” (“FFIs”) and “non-financial foreign entities” (“NFFEs”). FFIs are generally subject to more substantial requirements than NFFEs under FATCA. FFIs that are not exempted or deemed compliant generally may avoid FATCA withholding tax only by becoming “participating FFIs,” which involves entering into an agreement directly with the IRS and providing directly to the IRS certain information about the entity’s investors.

In order to avoid potential difficulties for FFIs in reporting information to the IRS, such as local data protection and privacy legislation, and to simplify the international implementation of FATCA, the US government, together with the governments of France, Germany, Italy, Spain, and United Kingdom, issued in June 2012 a model IGA for implementing the broad-ranging provisions of FATCA. The UK-US IGA was entered into on 12 September 2012 and was the first IGA. Since then further IGAs have been released, and the US Treasury has announced that it is engaged in negotiations on IGAs with more than 50 jurisdictions.

The primary advantage of an IGA to an FFI covered by the IGA is that the FFI can comply with the terms of the relevant IGA, which generally are simpler than those provided by the FATCA implementing regulations, to satisfy its FATCA obligations and avoid the penal 30 percent withholding rates that otherwise apply on US source payments to non-FATCA compliant FFIs.

FATCA IGAs take one of two forms. Model 1 IGAs allow for FFIs in the jurisdiction covered by the IGA to report information on accountholders to the local tax authority who will, in turn, pass on that information to the IRS. The UK-US IGA follows this form. Under a Model 2 IGA, FFIs are required by domestic law to directly report information on accountholders to the IRS. If accountholders do not provide the required information to the FFI, the local tax authority will provide that information to the IRS under information exchange agreements.

Regulations

The Regulations will apply to “UK Financial Institutions” (“UKFIs”). UKFIs generally include custodial institutions, depository institutions, investment entities, specified insurance companies, relevant holding companies and treasury companies that are resident in the UK for tax purposes, excluding branches and subsidiaries located outside the UK. UK branches of non-resident financial institutions will be UKFIs as they are obliged to report to HMRC, whereas the branches and subsidiaries located outside the UK of UKFIs are excluded because they do not report to HMRC.

Given the UK tax residence requirement, the UK-US IGA will not be of great application to many investment entities, as the majority are structured to avoid being UK tax resident. Also, the UK tax residency requirement may not be straightforward to determine where UK fiscally transparent entities, such as partnerships or limited partnerships, are used. Having said that, the US is in negotiations to enter into IGAs with a number of jurisdictions that are commonly used for investment entities, including the Cayman Islands, Guernsey and Jersey.

All UKFIs will be “Reporting” UKFIs unless they are deemed-compliant FFIs, exempt beneficial owners or excepted FFIs under the US FATCA implementing regulations or they are otherwise identified as “Non-Reporting” UKFIs under Annex II of the IGA - these are, broadly, governmental or international organisations or certain specified forms of financial institutions that are generally solely UK-focused.

All Reporting UKFIs will be subject to due diligence and reporting obligations, the details of which are set out in the Regulations. As noted above, these obligations are less onerous than under the US regulations. For instance, a UKFI generally will only be classified as a non-participating financial institution (subject to 30 percent withholding under FATCA) if there is significant non-compliance that has not been resolved within 18 months. Moreover, the circumstances in which a Reporting UKFI would be required to perform withholding with respect to “recalcitrant” account holders are modified and lessened. Finally, the Regulations reduce the number of UK entities that will be subject to FATCA, leading to a reduction in the estimated one-off compliance burden from c.£3bn to c.£0.9 – 1.6bn.

However, notwithstanding the Regulations, UKFIs will still need to register through an online FATCA registration portal that will be established by the IRS. An FFI registered with the online FATCA portal will be issued with a “global intermediary identification number” (“GIIN”). The GIIN will be used by the IRS and counterparties to identify which FFIs are not subject to FATCA withholding. The IRS registration portal is slated to be open in July, 2013.

FATCA itself is a significantly complex piece of legislation, and the US implementing regulations are more complex still. The Regulations, while seeking to lessen the compliance burden on Reporting UK FFIs, are nevertheless complicated, and will require careful study by all potentially affected parties.

Circular 230 Disclosure: Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on opinions of counsel that meet specific requirements set forth in the regulations, including a requirement that such opinions contain extensive factual and legal discussion and analysis. Any tax advice that may be contained herein does not constitute an opinion that meets the requirements of the regulations. Any such tax advice therefore cannot be used, and was not intended or written to be used, for the purpose of avoiding any federal tax penalties that the Internal Revenue Service may attempt to impose.

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