The Foreign Account TaxCompliance Act (FATCA)is a new set of U.S. tax rules that will affect many aspects of theday-to-day activities of the corporate treasury function. FATCA wasenacted by Congress in 2010 to detect and deter tax evasion by U.S.citizens and businesses hiding money in foreign countries.

The legislation, which has a general effective date of January1, 2014, is creating a new tax information reporting andwithholding regime through which foreign financial institutions(FFIs) are expected to identify their U.S. account holders andreport their account balances and other information.

For corporations with operations, activities, business partners,or counterparties outside of the United States, FATCA is creatingan array of issues, starting with the fact that some of theirentities may qualify as FFIs under the law.

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FATCA Basics

FATCA is being implemented directly by the IRS and indirectlythrough a network of intergovernmental agreements between the U.S.government and certain foreign countries. Under this new regime,FFIs—which include non-U.S. banks, custodians, investment vehicles,and insurance companies—must report to the IRS or to theappropriate foreign government certain information regardingaccounts held by “U.S. persons.” Failure by an FFI to provide suchreporting will result in the imposition on the FFI of a 30 percentwithholding tax on payments of certain categories of U.S.-sourcefixed or determinable annual or period income (FDAP), andeventually on gross proceeds from the sale of debt or equityinterests in U.S. obligors or issuers. Interest and dividends arethe types of FDAP most likely to be subject to FATCA.

Entities that make payments (either directly or indirectly) fromsources within the U.S., which the law refers to as “withholdingagents,” must also provide certain information to the IRS.Specifically, withholding agents may need to identify FFIs andcertain non-financial foreign entities (NFFEs) that havesubstantial U.S. ownership. If an NFFE fails to provide the propercertification, or if an FFI is not compliant, the withholding agentis required to withhold a 30 percent tax on certain payments. TheIRS is currently modifying tax withholding certificates, such asthe Forms W-8, so that market participants can document their FATCAstatus to their withholding agents.

Information reporting under FATCAbegins with certain data collected for year-end 2013. Thewithholding provisions of FATCA apply to payments made on or afterJanuary 1, 2014, although withholding on gross proceeds and certainforeign payments is delayed until 2017.

Due to the complexity of the rules, many entities have alreadybegun assessing the impact of FATCA on theiroperations. However, many multinationalswhose primary business activities are outside of the traditionalfinancial services industry mistakenly believe that they will notbe impacted by the law. Treasurers in these organizations may besurprised to learn that FATCA could have a substantial impact onhow they do business, both within and outside the UnitedStates.

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The Hunt for FFIs

Financial services companies will bear much of the burden ofFATCA, but the new regime will affect most multinationals in oneway or another. As a starting point, many treasurers will besurprised to learn that their global affiliated group may containentities that fall within the law's definition of a “foreignfinancial institution.” Often, these entities have a close nexuswith the treasury function, but the treasury team may not think ofthem as financial institutions. Common examples include:

Deposit-taking institutions. Somemultinational corporations have established deposit-takinginstitutions in order to enjoy low-cost funding provided bythird-party depository accounts outside the United States, whereregulations are favorable. Others have set up substantial customerdeposit programs to secure contract performance. In addition, manymultinationals establish special-purpose securitization vehicles asan efficient way to float debt. Each of these types of entities mayqualify as an FFI under FATCA, in which case it will need to complywith the new regime.

Stealth FFIs. Under FATCA, the term“foreign financial institution” can include entities that may notbe viewed as affiliates of the multinational corporate for non-taxpurposes. These “stealth FFIs” may include:

• offshore leasing or financing companies or factoringentities,
• captive insurance companies,
• foreign retirement plans that do not meet the limitedexclusions in the FATCA regulations (or in the intergovernmentalagreements, as applicable), or
• non-U.S. foundations and other non-U.S. charitableorganizations that are not tax-exempt under Section 501(c) of theInternal Revenue Code.

Treasury centers and holding companies. In certain circumstances, holding companies and treasury centersare defined as FFIs under FATCA. There are exceptions that allowcertain treasury centers and holding companies to be excluded fromthe definition of an FFI. These exclusions, however, may not coverall offshore investment treasury centers that invest offshore cashand engage in other similar arrangements.

FATCA was intentionally drafted with a broaddefinition of “foreign financial institutions” so that the labelfits some entities that are not typically considered financialinstitutions, such as companies engaged in third-party industrialleasing and financing, or in the factoring of receivables. Whilethe law does make exceptions for investment vehicles that arethought of as posing a low risk of tax evasion, such as retirementplans and tax-exempt entities, criteria for these exceptions havebeen circumscribed to ensure they are limited to low-riskvehicles.

Multinational corporations have only a few months to identifyall the prospective FFIs within their organization because theyneed to undertake some key activities in mid to late 2013 to avoidthe substantial tax consequences of noncompliance. For one thing,every legal entity that meets the definition of a “foreignfinancial institution” must register through an IRS website thatwill open later this month. Most companies with affiliated groupsthat contain FFIs will want to register with the IRS before October25, 2013, to ensure timely receipt of FATCA-related information bycounterparties and other business partners.

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FATCA's Effects on Global Cash Management

Even if a multinational company contains no entities thatqualify as FFIs, FATCA may have a substantial impact on theorganization's treasury function, potentially affecting itsrelationships with counterparties, banks, and externalstakeholders. In general, certain payments made by a treasurycenter in the U.S. may be treated as U.S.-source income. If theyare, FATCA reporting may apply, and withholding may apply ifrecipients of the payments fail to provide proper FATCAdocumentation.

Where a corporate treasury department uses third-party foreignbanks to assist with cash management, treasurers ought to workclosely with their tax teams to examine their legal relationshipsand assess whether each relationship creates FATCA-relevantresponsibilities. If it does, the business must determine whetherthe FFI/advisor will be FATCA compliant. This is relevant for tworeasons: First, to determine whether the multinational corporationor its subsidiaries might be required to withhold under FATCA, andsecond, to ensure that the multinational's investment with theforeign bank or advisor will not be subject to the 30 percentwithholding tax as a result of the service provider'snoncompliance.

Common transactions that may be impacted by FATCA include cashsweep arrangements (physical, zero-balance, and notional) andtreasury investments held by a foreign custodian. In some cases,the treasury department's derivatives, swaps, and other hedgingarrangements might also be affected. These types of transactionsfrequently involve counterparties outside the U.S., whetherdirectly or through assignment through a multibranch or multipartyInternational Swaps and Derivatives Association (ISDA)agreement.

Prior to FATCA, most ISDA agreements required the exchange oftax documentation and provided certain indemnifications ifwithholding were imposed. Because FATCA changes the scope of thepayments that may be subject to withholding, these provisions aremore important now. If a multinational corporation or itssubsidiary makes U.S.-source payments to an FFI that is not incompliance with FATCA, it will need to withhold tax at the rate of30 percent. Although the FATCA rules do not change the normal U.S.tax rules for determining whether derivatives and foreign currencytransactions are sourced within or outside the U.S., they mayhighlight U.S.-source payments in unexpected places, such ascollateral arrangements, up-front payments, and transactions withrespect to U.S. equities.

Some nonfinancial payments are excluded fromthe scope of FATCA, but these types of transactions are unlikely tobe undertaken by the typical treasury function. There are also somegrandfathering rules that might limit the impact of FATCA; however,these rules are of limited applicability. Many FFIs are alreadybeginning to request changes to their ISDA agreements to addressFATCA. Accordingly, companies need to enhance their focus on propertax documentation and relevant tax representation in order tomanage the risk of FATCA noncompliance.

FATCA's requirements are similar to existing informationreporting and withholding requirements, but the documentation thatmultinational corporations will begin receiving from payees (e.g.,Forms W-8 and Forms W-9) under the new law will be enhanced tosatisfy its requirements. For example, they will include new taxcertifications and payee statuses. In addition, the withholdingregime will become more complex as the current withholding regimeis transitioned to meet these new requirements.

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Next Steps

For most multinational corporations, complying with FATCAinvolves not only identifying and registering their FFIs, but alsoscrutinizing cash management and banking relationships to ensurethat all their banking partners are FATCA-compliant. Multinationalsmay also be required to provide additional documentation to FFIswith which they have existing cash management, banking, and creditrelationships.

Although this article focuses on the impact of the rulespromulgated by the IRS in the United States, companies also need toassess the impact of FATCA through the United States'intergovernmental agreements with foreign governments. Financialrelationships maintained by a multinational's non-U.S. subsidiariesor non-U.S. branches located in countries where compliance withFATCA conflicts with local law may lead to significant challenges.The expanding network of intergovernmental agreements may helpmitigate these challenges, but in some jurisdictions, gettingrequired information or documentation may remain impossible.

As an initial step, multinationals need to assess the status ofall their legal entities and determine the impact of FATCA onpayments both made and received by their affiliated group. Treasurydepartments need to coordinate with affected stakeholders,including the legal and tax departments, to ensure that allrelevant information is appropriately gathered or provided.Reporting functions will need to be enhanced to capture and reportthe additional data required by FATCA, and treasury departmentsthat process tax documentation, determine withholding, or ensureproper reporting will have to adapt to these changes.

Because they are already inspecting their global financialstructure to determine the application of FATCA, a number ofmultinationals are taking the opportunity to review the informationreporting and withholding processes performed by their treasurydepartments. Withholding agents that currently make U.S.-sourceFDAP payments to non-U.S. persons are generally required to reportthe payments to the IRS and withhold 30 percent. Compliance reviewsrelated to U.S.-source FDAP payments made to non-U.S. persons areoccurring because these issues are required to be reviewed duringan IRS examination. Consequently, preparation for FATCA presents agood opportunity to verify that the organization is in compliancewith current requirements.

Given the impact of these changes, and the fact that FATCAwithholding will begin for certain payees on January 1, 2014, it istime now for multinational corporations to begin revising theirreporting and withholding policies and procedures, developing newprocesses for validating payee certifications, and developingtraining for personnel involved in the reporting and withholdingprocess. Corporate treasurers need to closely coordinate theseactivities with their colleagues in the tax and legal department toensure that all relationships and entities are appropriatelydocumented. The cost of failure to comply includes not only a 30percent withholding tax, but penalties, interest and reputationalrisk as well.

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Rebecca E. Lee is aprincipal with PwC US (PricewaterhouseCoopers LLP) who specializesin the taxation of complex financial transactions, includingtreasury activities. Rebecca can be contacted at [email protected].