Illinois Bar Journal

September 2013Volume 101Number 9Page 446

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Beware FATCA’s broad reach

Think a new law designed to ferret out taxable income parked offshore won't affect any of your clients? You might be unpleasantly surprised, tax experts warn.

Congress enacted a law in 2010 designed to help the federal government identify U.S. citizens using offshore financial institutions to hide their taxable assets from the IRS.

Although a recent six-month delay in implementation means the Foreign Account Tax Compliance Act will not take effect until June 1, 2014, some tax-law experts are encouraging international financial institutions to start establishing policies and procedures now that will enable them to comply with the Act on day one.

"Entities subject to FATCA will have to change a lot of their processes and procedures, with additional due-diligence requirements, identifying new types of income, and putting into place procedures to set aside the [Act's] punitive withholding tax," said Denise Marie Hintzke, who is the global FATCA tax leader for Deloitte Tax LLP. "The regulations are very, very complicated and hard to follow in some areas, so there's going to be some struggle around that" for financial entities subject to the Act.

Hintzke said the purpose of FATCA is to require foreign financial institutions to report directly to the IRS with any information regarding people and entities that are failing to report their offshore taxable assets. Any foreign financial institution, or "FFI" as they are called in the Act, that fails or refuses to disclose this information will be subject to a 30-percent withholding tax on certain U.S.-sourced monetary transactions, regardless of whether the recipient of the payment was a U.S. taxpayer.

The IRS routinely obtains tax-liability information from independent contractors and employers with forms like the 1099 and W2, Hintzke said, but prior to FATCA there was no way for the IRS to obtain similar information regarding taxable assets in private, offshore accounts.

"There was always a hole [in the federal tax-reporting laws] in that, if you had your assets sitting offshore, the government couldn't get that info and had to rely solely on that you were putting all the relevant information on your tax forms," she said. Many people failed to disclose their offshore holdings, and under FATCA "foreign financial institutions are now basically helping to find these people and to tell the U.S. government about them."

'Foreign financial institutions': a surprisingly broad definition

Hintzke cautioned that FATCA's definition of "foreign financial institution" encompasses many more kinds of businesses than just banks, and corporate officers and lawyers alike may be surprised to find that their businesses and clients are subject to the detailed and complicated regulations of the Act.

In addition to standard banks, Hintzke said the FATCA definition of FFIs "pulls in most entities that take deposits, asset custodians, certain insurance companies, treasuries" and many other kinds of businesses. "All FFIs need to register [with the IRS] - they're kind of in the crosshairs of this legislation and they must then identify all account holders, payees" and other kinds of clients and entities.

A second category of organizations that must register with the IRS and comply with the FATCA reporting requirements are "non-financial foreign entities," or NFFEs. Hintzke said the NFFEs are broken down into three subsets: "publicly traded corporations;" "active" entities that are not publicly traded corporations, but that are actively involved in the trade of business; and "passive" entities for which the IRS will pierce the corporate veil to determine whether any U.S. citizens are involved with the business.

Start now before it's too late

Hintzke said that lawyers representing foreign business entities that might be subject to FATCA should immediately begin the process of classifying their clients subject to the Act's definitions, so as to identify those subject to the Act with enough time remaining to establish the necessary procedures to comply with the Act by the time it goes into effect next June.

"I think the message to get across is that, at a minimum, clients need to look at the rules and figure out how they're classified," Hintzke said. "When FATCA comes into effect, they have to have their new policies and procedures in place…and they need to be ready to withhold [the 30-percent punitive tax] in situations where they don't get the proper documentation" from entities with which they perform international financial transactions.

Hintzke said the classification procedures are not based on whether an entity has U.S. clients, but is based on whether it's doing certain kinds of activities that are spelled out in the Act. Essentially, she said that, if any foreign client performs any kind of financial transaction with people who might have U.S. tax-paying obligations, that foreign client should undergo the classification process to determine whether it must comply with FATCA. The Act's coverage, she warned, is quite broad.

"I've been doing withholding reporting across borders for 28 years," Hintzke said. "This is probably the broadest piece of legislation I've seen. It really touches almost everybody, and it doesn't matter what kind of business you're in. And it covers individuals, too."

Adam W. Lasker <> is a lawyer in the Chicago office of Ancel, Glink, Diamond, Bush, DiCanni & Krafthefer.

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