Foreign Financial Institutions

Foreign Financial Institutions

February 13, 2012

The Foreign Account Tax Compliance Act (FATCA or the Act), enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, is designed to combat tax evasion by U.S. taxpayers hiding money in offshore accounts.1 FATCA takes a two-pronged approach to fighting tax evasion by imposing new requirements on two primary groups – U.S. taxpayers holding financial assets outside of the U.S. and foreign financial institutions (FFIs) that maintain accounts for U.S. taxpayers. It is the FFIs that, by far, will bear the biggest burden in this tax evasion fight, as they will face new requirements for customer due diligence, recordkeeping, reporting and withholding.

This paper summarizes the FATCA requirements for FFIs and provides some insights on preparing for compliance. It’s certainly fair to say that FATCA is complex and detailed, with tiers of exceptions, multiple deadlines, and additional regulations to be issued. For FFIs, FATCA is not just a tax issue, but a broad-based compliance requirement for which compliance planning should begin immediately. FFIs should review the Act and all guidance in detail because the compliance challenges will be different for each FFI depending on its customer base and service offerings.2


In summary, FATCA requires that an FFI enter into an agreement with the IRS to undertake certain obligations or face 30 percent tax withholding on U.S. source income and gross proceeds from the sale of securities that generate U.S. source income. The obligations for FFIs under the proposed IRS agreement, which are explored in more detail in this paper, include:

  • Conducting due diligence to identify U.S. accounts,
  • Reporting certain information to the IRS regarding U.S. accounts,
  • Verifying compliance with the obligations pursuant to the agreement, and
  • Ensuring that a 30 percent tax on certain payments of U.S. source income is withheld when paid to non-participating FFIs and account holders who are unwilling to provide the required identification information. 

The stated policy objective of FATCA is to achieve reporting on U.S. accounts, rather than withholding. The most recent guidance notes that the IRS, in order to address certain legal issues on information sharing directly with the IRS, is pursuing arrangements with foreign governments to provide for alternative reporting by FFIs to residence country governments, who would share this information with the IRS under a tax treaty or other agreement. Initial discussions are under way with France, Germany, Italy, Spain and the United Kingdom.

The U.S. Treasury Department has issued four significant pieces of regulatory guidance, and additional interpretations and guidance are expected in 2012 and beyond.3 Although there may be some changes in the application of FATCA’s requirements, the core elements of the Act’s provisions are set and will remain unchanged.

This Flash Report reviews the major requirements of FATCA and provides insights on steps that FFIs can take to start preparing for compliance. Even though the effective dates of most provisions are in mid-2013 and beyond, the breadth of requirements demands that planning begin as soon as possible.

FFIs should take immediate steps to analyze the details of FATCA and assemble a multi- disciplinary work group and project management office to direct compliance readiness efforts. Senior management must be briefed on the requirements for compliance and need for resources. Involved parties should include legal, compliance, treasury, operations, IT, systems, audit, private banking, asset management, and risk management, at a minimum.

Defining FFIs

FATCA casts a broad net in defining FFIs, using three broad categories in its definition. The first category includes entities that accept deposits in the ordinary course of a banking or similar business, such as banks, credit unions and building societies. The second category covers entities that, as a substantial portion of their business, hold financial assets for the account of others, such as broker/dealers, trust companies, clearing organizations and custodians. The final definition category includes entities engaged primarily in the business of investing, reinvesting, or trading in securities, partnerships, or commodities, such as mutual funds, hedge funds, venture capital funds and private equity funds.

FFIs entering into an agreement with the IRS are referred to as “participating FFIs.” These organizations agree to undertake the obligations in the agreement and described in this Flash Report. Certain FFIs with a low risk of tax evasion, such as retirement plans and certain investment vehicles, may apply for status as “deemed compliant” FFIs that are not subject to the reporting and withholding requirements. The IRS will establish an online registration system for participating and deemed compliant FFIs by January 1, 2013. Upon registration, participating and deemed compliant FFIs will be issued an employer identification number (EIN).

In an organization with multiple FFIs, a “lead” FFI must be appointed, and each affiliate in the group must execute an FFI agreement in order for all FFIs to be considered participating or deemed compliant FFIs.

Understanding the definitions of FFI under FATCA is not only important for an FFI in determining its own status and the status of affiliates, but also in determining and documenting the status of its financial institution customers.

Due Diligence – Identifying U.S. Accountholders

The central thrust of FATCA is to identify U.S. accountholders who have assets outside of the
U.S. and provide reporting of that information to the IRS. The participating FFIs will have the responsibility to conduct due diligence on their existing and new accountholders, both individuals and entities, to identify U.S. accounts and their owners. The guidance notices issued to date outline a structured approach to due diligence that relies on electronically searchable records supplemented by more detailed account information review under certain circumstances. The FATCA requirements for various categories of accountholders are described in more detail below.

Involving IT and systems experts early in the process will be critical in making due diligence as efficient and effective as possible. Issues that need to be considered include identifying U.S. person indicia, “tagging” accounts of U.S. persons, identifying related accounts, aggregating account balances for an accountholder, searching electronic documentation, tracking compliance efforts, and assembling information required for reporting.

Individual Accounts

The objective of an FFI’s due diligence on individual accounts is to put accountholders into one of three “buckets”:

  • U.S. accounts
  • Recalcitrant accountholders
  • Non-U.S. accounts

Each of these buckets is subject to different withholding and reporting requirements, making a robust tracking and documentation system vital to compliance.

Two important notes on due diligence for individuals: First, FFIs will need to be able to determine if an accountholder is already, or will be, identified as a U.S. person for other U.S. tax purposes; if so, then that accountholder will be classified as a U.S. person for FATCA. Second, FFIs will also need to be able to identify any of the following “indicia” of an accountholder being a U.S. person, which will trigger further due diligence requirements:

  • Identification of an accountholder as a U.S. person;
  • a U.S. birthplace;
  • a U.S. residence address or a U.S. correspondence address (including a U.S. P.O. box);
  • a U.S. telephone number;
  • standing instructions to transfer funds to an account maintained in the United States, or directions regularly received from a U.S. address;
  • an “in care of” address or a “hold mail” address that is the sole address with respect to the client; or
  • a power of attorney or signatory authority granted to a person with a U.S. address.
FFIs should know their “inventory” of electronically available information in order to target due diligence searches of electronic databases. In addition, FFIs will need to develop capabilities for documenting results, tracking missing documentation, and monitoring deadlines.

Pre-existing Individual Accounts

The IRS guidance to-date outlines a sequential approach for due diligence on pre-existing individual accounts, as follows:

Step One: Accounts with a balance or value of less than $50,000 do not have to be reviewed, unless the FFI elects otherwise. This threshold must include the aggregated balances of all accounts owned by an individual to the extent that an FFI’s systems can link accounts through common client numbers, identification numbers, or other means. Each joint holder of an account will be attributed the total account balance for purposes of this aggregation.

Step Two: Certain cash value insurance and annuity contracts held by individual accountholders that are pre-existing accounts with a value or balance of $250,000 or less are exempt from review, unless the FFI elects otherwise.

Step Three: For accounts with a balance or value of less than $1,000,000, the FFI must review electronically searchable information for U.S. person indicia. If no indicia are noted, the account is classified as a non-U.S. account.

Step Four: For accounts with a balance or value in excess of $1,000,000, both electronic and non-electronic file information must be searched for U.S. person indicia, and inquiries of the relationship manager(s) must also be made. If no indicia are noted, the account is classified as a non-U.S. account.

If indicia are present in Steps Three or Four, additional steps and documentation are required to determine whether the accountholder is a U.S. person, such as obtaining an IRS Form W-9, IRS Form W-8BEN and non-U.S. passport, explanation of renunciation of U.S. citizenship, or other specified documentation. Based on the review of the additional documentation requested, accountholders will be classified as U.S. or Non-U.S. Persons. Accountholders who refuse to provide documentation will be classified as “recalcitrant accountholders.”

After going through this exercise to classify pre-existing accountholders, FFIs must annually re- test individual accounts with year-end balances that exceed $500,000 and were not previously subject to a review of account files.

New Individual Accounts

New individual accounts are those opened after the effective date of the participating FFI’s agreement with the IRS, and they include accounts opened by individuals that already have an existing account with the FFI. For new accounts, an FFI will be required to review the information provided at the opening of the account, including identification and any documentation collected under anti-money laundering/know-your-customer (AML/KYC) rules. If U.S. indicia are identified as part of that review, the FFI must obtain additional documentation or treat the account as held by a recalcitrant accountholder. Accordingly, FFIs will generally not need to make significant changes to the information collected during the account opening process in order to identify U.S. accounts, except to the extent that U.S. indicia are identified.

Pre-existing Entity Accounts

FFIs must scrub their entity accounts existing on the date of the FFI’s agreement with the IRS to put accounts into one of the following “buckets”:

  • U.S. accounts (those with one or more “substantial” U.S. owners – defined generally as a 10 percent direct or indirect ownership)
  • Foreign financial institutions
    • Participating
    • Deemed compliant
    • Non-participating
  • Excepted entities (under Section 1471(f) of the Act)
    • Foreign governments or political subdivisions of foreign governments
    • International organizations and their wholly owned agencies
    • Foreign central banks
  • Recalcitrant accountholders
  • Non-financial foreign entities
    • Excepted entity
    • Passive investment entity

Similar to the process for individual accounts, pre-existing entity accounts should be reviewed in a structured manner to determine their proper classification. Accounts already identified as U.S. accounts for other U.S. tax purposes are considered U.S. accounts.

Step One: Pre-existing entity accounts with account balances of $250,000 or less are exempt from review until the account balance exceeds $1,000,000. These thresholds are based on the aggregated balances of all accounts owned by an entity to the extent that an FFI’s systems can link accounts through common client numbers, identification numbers, or other means.

Step Two: For the remaining pre-existing entity accounts, FFIs can generally rely on AML/KYC records and other existing account information to determine account status. For accounts identified as U.S. accounts or passive investment entities, all substantial U.S. owners – generally, direct or indirect 10 percent ownership – will need to be identified.

New Entity Accounts

For new entity accounts opened by a participating FFI after the date of its agreement with the IRS, the same process described above for pre-existing accounts must be followed to determine the FATCA status of the entity, except that all information obtained in the account opening process must be considered, not just electronically searchable information. This includes all information gathered for purposes of opening and maintaining the account, corresponding with the accountholder, and complying with regulatory requirements, including AML/KYC requirements.

Client on-boarding and acceptance processes will need to incorporate identification of FATCA status to facilitate reporting and withholding obligations.


In their agreement with the IRS, participating FFIs agree to report annually the following information to the IRS on their U.S. accounts:

  • the name, address and taxpayer identification number (TIN) of each accountholder that is a specified U.S. person;
  • in the case of any accountholder that is a U.S.-owned foreign entity, the name, address, and TIN of each substantial U.S. owner of such entity;
  • the account number;
  • the account balance or value at year-end;
  • the gross amount of dividends paid or credited to the account;
  • the gross amount of interest paid or credited to the account;
  • other income paid or credited to the account; and
  • gross proceeds from the sale or redemption of property paid or credited to the account with respect to which the FFI acted as a custodian, broker, nominee, or otherwise as an agent for the accountholder.

Reporting on the first four items in the list will begin in 2014; reporting on dividends, interest and other income will begin in 2016; and reporting on gross proceeds will start in 2017. Additional regulations and guidance will be issued on the annual reporting required under FATCA, and the IRS is developing a form that will allow for electronic filing of the required information.

Applicable privacy restrictions, including the ability of customers to waive privacy rights, will need to be reviewed closely for potential conflicts and roadblocks to FATCA reporting requirements.
Systems will need to be tuned or developed to track and assemble the information required for reporting purposes. FFI groups with multiple affiliates will need to assess their needs on an enterprisewide basis.

Verifying Compliance

Under the FFI agreement, participating FFIs must provide certifications of compliance to the IRS. FFIs must adopt policies and procedures for FATCA compliance and periodically conduct reviews of compliance. Based on the results of these reviews, a responsible officer of the FFI (most likely the Chief Compliance Officer) must certify to the IRS the FFI’s compliance. The FFI may be required to disclose certain factual information about compliance and disclose material compliance failures. In certain cases, the IRS may require a third-party audit of compliance. 

A number of specific certifications are also required, including certification that required due diligence on pre-existing accounts was completed by required deadlines. The FFI must also certify that it did not have any formal or informal practices or procedures in place at any time from August 6, 2011, forward to assist accountholders in the avoidance of U.S account identification.

The August 6, 2011, trigger date for prohibitions on advising clients on account identification avoidance means that FFIs must immediately begin an internal awareness and training program on FATCA.
FFIs should also develop a communication strategy for customers to address questions and concerns that may arise with the implementation of these new requirements.


Participating FFIs agree to withhold a tax equal to 30 percent of withholdable and passthru payments of U.S. source income to the following accountholders:

  • FFIs that have not signed agreements with the IRS and that do not fall under an exception. The IRS intends to publish a list of participating FFIs and deemed compliant FFIs to facilitate compliance.
  • Individuals and entities that fail to provide sufficient information to determine whether or not they are a U.S. person (recalcitrant accountholders) or fail to agree to waive applicable restrictions on the reporting of their information to the IRS.

The Act and associated guidance provide definitions of withholdable payment and passthru payment, and examples are provided in Notice 2011-34 on the calculation and application of passthru payment percentages to certain payments to non-participating FFIs.

FFIs will need to establish capabilities and processes to identify incoming funds that are subject to possible withholding, apply proper withholding calculations, and maintain records for reporting purposes.

Effective Dates


FFIs must enter into an agreement with the IRS by June 30, 2013, to avoid withholding on payments received from U.S. withholding agents starting on January 1, 2014. The effective date of any agreement entered into before July 1, 2013, will be July 1, 2013 (important because the effective date becomes the deadline for other requirements), and the effective date of any agreement entered into after July 1, 2013, will be the actual date of the agreement.

Due Diligence

Due diligence procedures for new accounts must be in place as of the effective date of the agreement. Pre-existing high value accounts must be reviewed within one year of the effective date of the agreement, and all pre-existing accounts must be reviewed within two years of the effective date of the agreement.


Reporting requirements will be phased in. The first report of U.S. accountholders to the IRS, which is due in 2014 (covering 2013 data), will only cover identification information (name, address, TIN, and account number) and account balances. Reporting on dividends, interest, and other income will start in 2016, and reporting on gross sales and redemption proceeds will start in 2017.


Withholding requirements will begin for payments of fixed, determinable, annual or periodical (FDAP) income on January 1, 2014, and for payments of gross income generated by certain asset sales on January 1, 2015. Withholding on foreign passthru payments will begin on January 1, 2017.


FFIs are facing a significant compliance challenge with the FATCA requirements. Successful and effective compliance will require senior management support, broad-based input from across the enterprise, centralized project management (for example, through a project management office), possible external assistance, and clear accountability. Implementation efforts, if not already under way, should begin immediately, and additional IRS guidance should be promptly reviewed and factored into the implementation process.

Please note that the information in this Flash Report is not intended to be legal analysis or advice, nor does it purport to address every issue that may impact affected financial institutions. Organizations should seek the advice of legal counsel or other appropriate advisors on specific questions as they relate to their unique circumstances.

1Internal Revenue Code, Subtitle A, Chapter 4.
2The information in this paper should not be considered or relied upon as tax advice. A tax attorney or tax advisor should be consulted for tax advice purposes. 
3(1) Notice 2010-60, 2010-37 I.R B.329; (2) Notice 2011-34, 2011-19 I.R.B. 765; (3) Notice 2011-53 2011-32 I.R.B. 124; and (4) February 8, 2012, Proposed FATCA Regulations.


Carol Beaumier
[email protected]
John Atkinson
[email protected]

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