By Alon Harnoy, Esq. and Meital Dror, Esq.
The Foreign Account Tax Compliance Act of 2009 (FATCA), introduced by the United States Congress on October 27, 2009 and supported by President Obama and Treasury Secretary Timothy Geithner, is part of a larger initiative by the United States to combat tax evasion through the use of offshore intermediaries.  With an estimated annual loss of over $100 billion, FATCA imposes new tax reporting criteria aimed at locating currently undisclosed assets while discouraging further tax evasion.  While the main goal is to  promote the tax and fiscal interests of the United States, additional objectives include inhibiting money laundering and financial fraud.
Under FATCA, U.S. taxpayers holding financial assets outside the United States are required to report those assets to the IRS. FATCA reporting requirements are broader than the current requirements set forth under the Report of Foreign Bank and Financial Accounts (FBAR), and thus individuals who do not have a FBAR filing obligation may still be subject to the reporting requirements under FATCA. In addition, FATCA requires foreign financial institutions (FFIs) to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
Under the current plan, U.S. taxpayers will be required to report to the IRSs any“ specified foreign financial assets” with an aggregate value exceeding $50,000.  Specified foreign financial assets include: (1) any account maintained by a foreign financial institution; (2) any stock or securities issued by a foreign entity (including foreign hedge funds or equity funds); (3) any contract or financial instrument held for investment purposes where the issuer or counterparty is a foreign entity; and (4) any interest in a foreign entity.
FACTA reporting must include the maximum value of the asset during the tax year as well as the name and address of the financial institution along with the taxpayer’s account number or, in the case of stock or securities, the name and address of the issuer along with the class or issue of the stock or security. Similar identification must be disclosed for other types of assets.
Failure to report foreign financial assets will result in a $10,000 penalty, which increases by $10,000 for each thirty-day period (or portion of such period), if the failure to file continues for more than ninety days after notification by the IRS. Moreover, underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent.
FACTA also imposes new reporting requirements for passive foreign investment companies (PFICs). A foreign corporation will qualify as a passive foreign investment company if (1) 75% or more of its gross income in the tax year is passive income, or (2) on average during the tax year, at least 50% of the assets held by the corporation produce passive income or are held for the production of passive income. FATCA requires shareholders in a PFIC to file an annual information return disclosing their ownership of the PFIC. Under previous law, such disclosure was required only when taxpayers made a qualifying elective fund election, received certain distributions from the PFIC, or disposed of their interest in the PFIC.
Generally, the IRS has three years from the filing of a return in which to audit a taxpayer and assess additional tax. Under FATCA, the statute of limitations can be extended beyond three years for understatements triggered by omissions of more than $5,000 of gross income relating to one or more specified financial assets. Accordingly, even if the taxpayer does not have a substantial understatement, the IRS may have six years to conduct an audit.
FATCA also requires foreign financial institutions to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. The FFIs are required to keep track and report not only when accounts are opened, but also throughout the “life” of the account.
A foreign financial institution is any financial institution which is a foreign entity. A financial institution is any entity that (1) accepts deposits in the ordinary course of a banking or similar business, (2) as a substantial portion of its business, holds financial assets for the account of others, or (3) is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities. Accordingly, FFIs include foreign banks, foreign brokerage firms, foreign trust companies, foreign mutual funds, foreign hedge funds, foreign private equity funds, and other foreign funds engaged primarily in investing or trading in U.S. or foreign securities.
FACTA imposes 30% U.S. withholding on “withholdable payments” made to FFIs that fail to meet certain reporting and withholding requirements. FATCA also imposes 30% U.S. withholding tax on withholdable payments made to certain foreign entities that are not FFIs. Deterrence is accomplished not by giving FFIs incentive to report, but instead by giving them a disincentive for failure to report on their U.S. account holders. The effective date of the FATCA provisions regarding FFIs is January 1, 2013.
“Withholdable payments” are generally defined to include U.S. source dividends, interest on obligations of U.S. corporate or non-corporate obligors (including bank deposit interest and portfolio interest), the gross selling price or proceeds of redemption of U.S. corporate stocks or obligations of U.S. obligors, and certain other U.S.-source investment income.
In order to properly comply with these new reporting requirements, an FFI will have to enter into a special agreement with the IRS by June 30, 2013.Under this agreement a “participating” FFI will be obligated to: (1) undertake certain identification and due diligence procedures with respect to its accountholders; (2) report annually to the IRS on its accountholders who are U.S. persons or foreign entities with substantial U.S. ownership; and (3) withhold and pay over to the IRS 30% of any payments of U.S. source income, as well as gross proceeds from the sale of securities that generate U.S. source income, made to (a) non-participating FFIs, (b) individual accountholders failing to provide sufficient information to determine whether or not they are a U.S. person, or (c) foreign entity accountholders failing to provide sufficient information about the identity of its substantial U.S. owners. These requirements also apply to each FFI that is a member of the same expanded affiliated group.
A specified U.S. person, whose account must be reported, is generally any U.S. person other than: (1) a publicly traded U.S. corporation and its majority owned subsidiaries; (2) a U.S. tax-exempt U.S. charity, U.S. pension plan or IRA; (3) a U.S. governmental entity or agency; (4) a U.S. bank, U.S. REIT, or U.S. mutual fund; or (5) a common trust fund, a CRAT or CRUT, or certain special classes of nonexempt trusts. Certain individual accounts of less than $50,000 at a FFI may also be excluded.

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