Foreign Account Tax Compliance Act (FATCA) - Payment of U.S. Income: An Article Authored by Paul Oliveira, CPA from KLR - Accounting Firm Boston, Massachusetts, Providence, Rhode Island

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Foreign Account Tax Compliance Act (FATCA) - Payment of U.S. Income

posted Jan 20, 2012 by Paul Oliveira, CPA

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As we enter 2012, the countdown to the January 1, 2013 implementation of the Foreign Account Tax Compliance Act (FATCA) is now officially under one year.  FATCA is a set of laws that impose mandatory U.S. federal withholding on payments of U.S. source income to the following two types of non-complying entities:

  1. Foreign financial institutions
  2. Nonfinancial foreign entities

The definition of a foreign financial institution includes banks and brokerage firms.  These types of organizations are commonly thought of as financial institutions.  However, the definition also includes private investment funds which would include hedge, private equity and venture funds. 

The FATCA rules are very complex.  In simple terms, to avoid the mandatory 30% U.S. withholding, FATCA requires each foreign entity listed above to fully disclose any US persons who are beneficial owners of the US source income or certify that there are no U.S. persons who are beneficial owners.  Failure to do either will result in the entity being non-compliant and force the payor of the US source income to withhold on behalf of the payee.  Failure to withhold can subject the payor to substantial monetary penalties.

The purpose of FATCA is to prevent U.S. taxpayers from avoiding U.S. tax by hiding behind foreign entities.  The U.S. government was not particularly happy with the number of U.S. taxpayers engaged in significant income tax evasion through the use of foreign accounts at UBS and other similar offshore banks.  FATCA now forces foreign financial institutions to fully disclose its U.S. account owners or be subject to the mandatory withholding. 

A few items to consider regarding FATCA:

  1. Making it more difficult to evade U.S. taxes is good thing.  However, at what cost? FATCA relies on the international investment community’s need to invest in U.S. equity markets to enforce compliance.  However,  many commentators on this subject feel that the complexities associated with FATCA will drive foreign investment funds to invest more of their capital outside the U.S.  Available capital leaving U.S. equity markets is not a good thing for an already slow growing U.S. economy.
  2. A U.S resident or citizen is taxable on his worldwide income.  This includes both US source income and foreign source income.  FATCA is designed to prevent U.S. tax evasion on U.S. source income.  It does not enforce U.S. tax evasion on foreign source income.  My sense is that there is an equal amount of foreign source income out there that goes unreported.  In addition, will tax evaders simply shift their portfolios from investments that produce U.S. source income to investments that produce foreign source income to avoid FATCA?  Again, the Treasury is hoping that the strength of the U.S. equity markets would make doing so a very difficult investment decision.
  3. The 30% FATCA withholding can apply to the gross proceeds realized on security sales.  This is true even if the security is sold at a loss.  U.S. and foreign investment funds should review the tax distribution provisions contained within their operating agreements and determine how potential FATCA withholding under various scenarios would be treated under such provision.  Now is the time to revise these provisions if necessary.

Now is the time to plan out the implementation of FATCA and determine whether there is a withholding obligation on any payments which your business may owe to a foreign financial institution or other nonfinancial foreign entity. Remember that the obligation to withhold falls on the US payor and penalties can be quite severe.

If you have any questions regarding FATCA and how it may apply in your business, please email or call any member of your service team at KLR.