Brief overview of the Foreign Account Tax Compliance Act (“FATCA”)
FATCA was enacted by the US government as a result of the government’s efforts to combat tax evasion by U.S. persons holding investments in offshore accounts. Essentially, FATCA provides for an obligation of certain U.S. taxpayers holding financial assets outside the United States to report those assets to the Internal Revenue Service (“IRS”).
In addition, FATCA requires foreign financial institutions to report directly to the IRS certain information about financial accounts ultimately held by U.S. taxpayers. Non-compliance with FATCA provisions will result in the withholding of a 30% tax on any US-sourced income payment to non-compliant account holders or non-participating foreign financial institutions (“FFIs”) effective from 2017 onwards.
In the course of the implementation of FATCA, the US government has concluded Intergovernmental Agreements with a number of governments worldwide aiming to streamline compliance with new legislation. There are two types of IGAs, Model 1, under which FFIs in partner jurisdictions will be able to report information on U.S. account holders directly to their national tax authorities, who in turn will report to the IRS, and Model 2, under which FFIs will report information directly to the IRS rather than their local jurisdictions. Cyprus has concluded a Model 1 IGA with the US on 2nd December 2014 (hereinafter “IGA”).
Key FATCA provisions and clarifications
The following considerations arise for professionals in the context of complying with FATCA:
1. Determine whether there is an obligation to register with the IRS and report accordingly;
2. Identify “US accounts” of US persons;
3. Report on these accounts.
1. Obligation to register
Entities which are classified as Foreign Financial Institutions (“FFIs”), as defined in the IGA, have an obligation to register with the IRS. The definition of FFIs covers the following types of entities:
a) Depository institutions (entities that accept deposits in the ordinary course of business);
b) Custodial Institutions (entities of which 20% or more of their gross income is attributable to holding of financial assets);
c) Investment Entities (entities that conduct business in trading in (i) money market instruments and other foreign exchange, interest rate and index instruments, transferable securities or commodity futures, or (ii) in individual and collective portfolio management, or (iii) otherwise investing, administering or managing funds or money on behalf of other persons.
d) Specified insurance company (insurance companies which issue or are obligated to make payments on a cash value insurance or annuity contracts.
Important Note: As the IGA between Cyprus and the US tax authorities includes the managed by rule it is important to examine whether any particular entity- irrespective of its activities- is managed by a third party professional manager and in this case whether this will classify the entity as an FFI.
Each of the above terms is defined in the IGA and further guidelines are expected to be published by the Cyprus Tax Department.
2. Reporting Obligations
2.1 U.S. Persons
Once an entity has registered with the IRS, it should proceed to identify the accounts of U.S. persons. U.S. person is defined in the IGA as follows:
“The term “US person” means a US citizen or resident individual, a partnership or corporation organized in the United States, or under the laws of the United States or any State thereof, a trust if (i) a court within the United States would have authority under applicable law to render orders or judgements concerning substantially all issues regarding administration of the trust and (ii) one or more persons have the authority to control all substantial decisions of the trust or an estate of a decedent that is a citizen or resident of the United States.”
The below U.S. indicia are provided by the IGA which assist in determining whether a client is a U.S. person:
“a) Identification of the Account Holder as a U.S. citizen or resident;
b) Unambiguous indication of a U.S. place of birth;
c) Current U.S. mailing or residence address (including a U.S. post office box);
d) Current U.S. telephone number;
e) Standing instructions to transfer funds to an account maintained in the United States;
f) Currently effective power of attorney or signatory authority granted to a person with a U.S. address; or
g) An “in-care-of” or “hold mail” address that is the sole address the Reporting Cyprus Financial Institution has on file for the Account Holder. In the case of a Pre-existing Individual Account that is a Lower Value Account, an “in-care-of” address outside the United States or “hold mail” address shall not be treated as U.S. indicia.”
2.2 Reportable Accounts
Once an FFI has identified its US clients, an obligation to obtain and exchange information on ‘reportable accounts’ of such persons arises. ‘Reportable accounts’ as well as the information to be exchanged are also defined in the IGA.
Since Cyprus has concluded a Model 1 IGA, reporting by Cyprus FFIs will be made to the Cyprus tax authorities. Guidelines as to the reporting procedure are expected to be issued by the Cyprus Tax Department.
2.3 Classification of non-US clients
FFIs are obliged to classify their non-US clients as well, by completing Form W-8BEN-E based on the income received by the respective client. The available categories are defined in the IGA and various guidelines have been issued by financial institutions assisting with the completion of the form.
Important Note: Although each Financial Institution may provide Guidelines for the classification of their client entities, those guidelines are only for informational purposes and cannot be used for the classification of the company. The responsibility for the classification lies only with the management of each entity and the financial institutions are prohibited by the Law to express any opinion.
There are still many grey areas with respect to FATCA which need to be clarified. One of the main challenges for companies providing administrative services in Cyprus is whether they should register as FFIs or whether they should proceed to register the entities under their administration separately. Each service provider should examine the obligation to register under their own merits and in the context of the guidance available at the moment.
Tax & VAT Committee
AML & Compliance Affairs Committee