Beginning on July 1, 2014, the Foreign Account Tax Compliance Act (FATCA) will affect virtually all businesses making or receiving payments from the United States. FATCA fundamentally impacts payors and payees of U.S.-source income. At its core, FATCA requires a foreign payee to understand and be able to certify its FATCA status in order to avoid a 30% withholding on payments received from U.S. sources. However, with more than 30 potential FATCA classifications, understanding FATCA status can pose quite a challenge for the foreign payee.
New obligations for withholding agents
Beginning on July 1, a payor of U.S.-source income to a foreign entity (withholding agent) must analyze the payment to determine whether FATCA applies and, if so, either document the FATCA status of the foreign payee or withhold 30% of the payment. As an initial matter, the withholding agent will need to take inventory of its payables to determine whether they fall outside the scope of FATCA or if an exception otherwise applies. For example, the FATCA rules provide that certain payments made in the ordinary course of business will not be subject to FATCA withholding.
If FATCA applies to the payment, the withholding agent must document the FATCA status of the payee (a similar requirement under the current withholding regime has generally been fulfilled through receipt of a completed Form W-8BEN). Sophisticated multinational payees may be well-versed in performing the FATCA analysis and preparing the necessary documentation. However, applying complex FATCA classification rules may present a challenge to foreign entities that have little experience navigating its complex provisions.
Given FATCA’s complexity and the impending withholding obligation, withholding agents are advised to immediately begin documenting whether FATCA applies to any of their payments and, if so, whether they have obtained documentation of the foreign payee’s FATCA status prior to July 1.
New obligations for foreign payees
Foreign payees (including foreign subsidiaries of U.S. companies) will need to determine their FATCA status and be prepared to provide documentation by July 1. A foreign payee that is unable to determine and document its FATCA status by July 1 generally will be subject to a 30% withholding on payments received.
Classifying a foreign payee’s FATCA status requires an understanding of the operations and activities of the foreign payee including, in some instances, the affiliated group of the foreign payee. The rules surrounding the determination of FATCA status are particularly complex for foreign financial institutions such as banks, clearing organizations, investment funds and certain holding companies and treasury centers. To maintain their FATCA status, certain foreign entities are required to comply with not only documentation requirements but also due diligence, reporting and potential withholding obligations.
As FATCA withholding begins July 1, withholding agents and foreign payees have very little time to familiarize themselves with the rules and prepare for implementation. Withholding agents should analyze processes and procedures that will be needed for identifying, withholding, paying, reporting and reconciling accounts. Foreign payees should analyze their FATCA status to position themselves to fulfill any FATCA obligations and provide the appropriate documentation to withholding agents.
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