Insight

FATCA - impact on businesses and individuals

March 2015

Anyone who has encountered US withholding tax may be familiar with Chapter 3 withholding: if a foreign person receives US-source income, withholding tax of 30% applies. However, the taxpayer may reduce or even offset the tax charge completely where a tax treaty exists between the US and the taxpayer's country of residence.

Although FATCA behaves like a withholding tax, this is not its intended purpose. The primary function of FATCA is to act as a penalty. Unlike Chapter 3 withholding, FATCA sets out to identify US citizens who invest in foreign financial assets. FATCA withholding occurs when a non-US entity receives US-source income belonging to a US citizen. More often than not, US entities must withhold 30% of the payment unless the foreign entity can show significant US ownership or produce an exemption certificate.

In the absence of an exemption certificate the US entity must deduct 30% withholding tax. If it does not do so, it will suffer an equivalent charge itself. Because FATCA is not a tax there is no reduced rate (unlike Chapter 3 withholding), nor can a FATCA withholding count as a foreign tax credit. The withholding entity must either collect 30%, or nothing at all because the payment is exempt.

Implications for businesses

Foreign financial institutions (FFIs) will enter into an agreement with the IRS, or their own country's government agency, to disclose information about US citizens who invest outside the US.

What does an FFI look like?

Foreign financial institutions will tend to be financial companies such as banks, investment companies, and insurance companies. However, all companies will be assessed individually so they receive the correct treatment. For instance, any financial entity would seemingly be a candidate for FFI status, but if all it does is lend, rather than engaging in investment activity, it may not be assessed as such.

The FFI agreement

The agreement requires FFIs to identify accounts, keep detailed records and verification procedures, and report annually to the US Treasury. In this report, FFIs must disclose all personal details, account details, account balances, and any investment income, such as dividends, paid to the account holder.

Implications for US citizens

A US citizen who holds specified foreign assets where the value exceeds the reporting threshold must report them using IRS form 8938. Specified assets include not only accounts with an FFI, but also foreign assets held outside a financial institution, for example shares issued by a foreign company.

Reporting thresholds

US taxpayers whose specified assets do not exceed $50,000 in value at the end of the tax year, and have not exceeded $75,000 at any time during that tax year, do not need to file form 8938.

Taxpayers who live outside the US benefit from a higher threshold. If the value of their specified assets does not exceed $200,000 at the end of the tax year no declaration is necessary, unless these assets have exceeded $300,000 at any time during that tax year.

These thresholds are higher still for married taxpayers submitting joint tax returns.

Financial penalties

Anyone who is required to file form 8938 and fails to do so may receive a fine of $10,000 with the potential for further financial penalties of up to $50,000.

Take no chances

If you think you may be subject to FATCA requirements you should seek professional advice to ensure you comply and avoid expensive fines.