FATCA goes global New US tax rules offer some relief for retail and local banks, but no mercy for non-participants

UBS E-News for Banks, July 2011

Keywords: FATCA, IRS, US Treasury Department, US tax

Executive Summary

  • The objective of FATCA is for the IRS to receive account information on US persons from non-US financial institutions worldwide.

  • It requires these institutions to report and withhold on these accounts or suffer a 30% withholding tax on US-sourced income.

  • FATCA introduces new – and more complex – identification and documentation requirements for US clients of foreign institutions.

  • Further rules regarding “passthru payments” make FATCA in effect applicable to all foreign financial institutions, whether or not they have US clients or US securities.


On March 18, 2010 US President Obama signed the “Hiring Incentives to Restore Employment Act (HIRE Act)” into law. An integral part of the HIRE Act is the “Foreign Account Tax Compliance Act” (FATCA), the bulk of which is effective on January 1, 2013. In the article below, we provide an update on recent developments regarding this legislation and our preliminary interpretation of what its current provisions may mean to banks around the world. While not yet final and therefore subject to change, FATCA in its current form will add a considerable regulatory burden on banks and financial institutions around the world. It is therefore an imperative for banks to carefully monitor developments in this area.

What is FATCA all about?

The objective of FATCA is for the US Internal Revenue Service (IRS) to receive (bank and securities) account information on US Persons from Foreign Financial Institutions (FFIs) worldwide. FATCA requires all Foreign Financial Institutions (FFIs) to enter into an agreement with the IRS to report and withhold on US accounts (i.e. accounts held by US persons), or else suffer a 30% withholding tax on certain US income, related sales proceeds, and various other payments (see discussion of passthru payments, later).

In August 2010, the IRS issued Notice 2010-60, which provided preliminary guidance for the core FATCA requirements. In April 2011, the IRS published the follow-up Notice 2011-34 (“The new Notice”) providing further guidance in areas uncovered today (i.e. the passthru payment definition) and partly replacing Notice 2010-60. It is expected that the next publication (end of 2011/early 2012) will be the proposed Treasury Regulations.

Know your US clients well

The new Notice entirely replaces the identification and documentation process for preexisting individual clients (= US persons). As beauty lies in the eyes of the beholder, FFIs might read the changes with more or less appreciation.

Foreign retail banks not offering personalized services that could fall within the “Private Banking” definition, can still follow a US indicia process based on electronically searchable information to identify US accounts as long as the account value does not exceed USD 500,000.

Difficulties will occur in the area of the new category of “Private Banking” accounts where, in addition to the indicia process, paper account files and other records must be diligently reviewed. The new Notice allocates this task to the private banking relationship manager, possibly interfering with existing compliance and governance schemes of FFIs.

Other critical changes are the reduction of the time period for review and remediation of the private banking account to one year after effective date of the FFI agreement and the increased evidence requirements for the place of birth in the US of account holders.

Positive developments are the shift from month-end to year-end thresholds with regard to the USD 50,000 de-minimis rule and that non-US P.O. boxes as sole address are no longer a US indicia.

The attached chart provides a broad overview about the new process for preexisting individual accounts (see link below).

Difficult times for non-participating FFIs (NPFFI) beginning 2013

Before issuance of the new Notice, there was only little information available about FATCA coverage beyond the withholdable payment, which was defined as certain income from US sources and gross proceeds related to US assets that can produce US source interest or dividends. Potentially affected FFIs could still hope that not investing in or not offering US securities to their clients could keep them out of FATCA’s reach.

With the extensive definition of the passthru payment in the new Notice and the expressed goal of the IRS and the Treasury Department to encourage FFIs to enter into FFI Agreements – and thus become participating FFIs (PFFIs) – while at the same time ensuring that participating FFIs act as “blockers”, such hope died.

Instead of defining the passthru payment as payments that are either withholdable payments or directly traceable to withholdable payments, and limiting the application to investment vehicle-type FFIs, the IRS and the Treasury Department follow an approach based on the composition of the balance sheet of the issuer of an investment instrument. This results in an overly broad application to basically every FFI in the world even if the FFI is not invested in the US market.

The reason lies in the two subcategories of passthru payment. On one side, there is the custodial payment where a PFFI applies the FATCA withholding tax based on the individual “passthru payment percentage” (PPP) of the issuer of an investment instrument (PPP represents the relation of US assets to total assets on balance sheet). On the other side there is any other payment that relates to payments made by the PFFI acting as principal.

The any other payment scope covers derivatives, structured products, swaps, interest payments and is even applicable to the dividend payment of the PFFI that will be transformed into a custodial payment on the investor level holding a certain PFFI share through another (PFFI) custodian.

In the end, a “non-participating PPFI” (NPFFI) will suffer FATCA withholding tax by simply having a relationship with a PFFI that has US assets on its balance sheet. Whether the underlying in a swap transaction or in a structured product is a US security or not won’t be relevant. Interest on time deposits with a PFFI will be subject to FATCA withholding tax of 30% multiplied with the PPP of the PFFI. Such tax would most probably be levied in addition to a national withholding tax like the “Verrechnungssteuer” in Switzerland. For NPFFIs, investments in the FFI industry such as banks, investment funds or life insurance companies won’t make sense anymore since not only the periodical income, but also any sales proceeds, would be subject to the FATCA withholding tax (to the extent of the issuing FFI’s PPP).

Deemed compliant FFI (DCFFI) – the FATCA shortcut?

The Notice provides much awaited further insights regarding the DCFFI possibilities. Certain local banks, local FFI members of participating FFI groups, certain investment vehicles or other categories (like retirement plans or charitable organizations) might qualify for this status, which in general doesn’t require the implementation of all required functionality similar to the fully compliant PFFIs.

However, there is certainly a price for this relief by accepting strict restrictions with regard to the client base a DCFFI can have, or a limitation to domestic business. Neither soliciting cross-border clients nor having operations in more than a single country are allowed for certain DCFFIs.

Furthermore, the application process, obtaining an FFI-EIN (employer identification number) and the certification every three years that the requirements for DCFFI treatment are met forces a DCFFI to establish control measures similar to those of a PFFI simply to avoid accepting clients that could endanger the DCFFI status. The situation of non-operating companies, treated as FFIs in the IRS’s and the Treasury Department’s view, is unclear with the issuance of the new Notice. It can be hoped that the proposed DCFFI requirements would not apply to the “entities with certain identified owners” approach introduced in the previous Notice. Otherwise, it will be challenging to transform these structures into DCFFIs by meeting the requirements proposed by the IRS.


Although the actual guidance is far from being complete, the aim of the IRS and the Treasury Department is already clear. In order to identify all various types of US persons, FATCA will establish a comprehensive net of PFFIs around the globe affecting a vast number of payments made by such PFFIs and accompanied by a huge cost and administrative burden borne by the non-US financial industry and its clients.

The various and mostly critical industry submissions filed beginning of June show that the “tug of war” is not yet over and still leaves some room for positive developments. Hopefully, these will be visible in the next IRS publication.

Markus Weber and Chip Collins
UBS Group Tax