MoFo Tax Talk, Volume 4, Issue 2 - July 2011

EDITOR'S NOTE

Just as we were going to press bemoaning the impending January 1, 2013 effective date of the Foreign Account Tax Compliance Act ("FATCA"), the Internal Revenue Service ("IRS") and Treasury Department ("Treasury") announced an extension of the new provisions' withholding and reporting requirements. We cover this "breaking news" in this issue along with other recent FATCA guidance. In other breaking news, we provide a brief summary of the tax provisions of the so-called "Gang of Six" deficit reduction plan. We also cover Merck & Co., Inc. v. U.S., in which the U.S. Court of Appeals for the Third Circuit ("Third Circuit") affirmed the U.S. District Court's denial of a refund claim with respect to the taxpayer's assignment of interest rate swaps to its foreign subsidiaries in exchange for lump sum payments. Further, we cover the IRS's temporary suspension of information reporting requirements enacted under the Hiring Incentives to Restore Employment Act (the "HIRE Act"). Finally, our regular features – Press Corner and MoFo in the News – are also included.

IRS ANNOUNCES PHASED IMPLEMENTATION OF FATCA

The IRS and Treasury announced a phase-in schedule that effectively delays implementation of FATCA1 for one year, and in some cases, until 2015. Notice 2011-532 will likely be welcomed by foreign financial institutions ("FFIs"); however, it does not change the basic structure of the FATCA regime, which is designed to enlist FFIs in the hunt for non-compliant U.S. taxpayers.

Participating FFIs

FATCA is constructed around the FFI Agreement, which requires an FFI to provide the IRS with information about its U.S. account holders. Notice 2011-53 announces that the IRS will begin accepting applications for FFI Agreements from FFIs through its electronic submissions process no later than January 1, 2013. In order to avoid potential withholding tax when FATCA withholding begins on January 1, 2014 (under the one-year delay in the Notice), an FFI Agreement must be entered into by June 30, 2013. The June 30, 2013 deadline is designed to make sure there is enough time to allow the relevant FFI to be identified as a "participating FFI" by January 1, 2014. FFIs applying after June 30, 2013, are not assured they will be "in the system" as of January 1, 2014, and therefore may be subject to FATCA withholding when it is initially implemented. Notice 2011-53 also provides that the effective date of an FFI Agreement entered into any time before July 1, 2013, will be July 1, 2013, and that the effective date of an FFI Agreement entered into on or after July 1, 2013, will be the date the FFI enters into the FFI Agreement. Among other things, the effective date is relevant for the application of the due diligence procedures described in the following paragraph.

In previous published guidance, due diligence procedures3 were provided in order for FFIs to identify U.S. accounts. Notice 2011-53 provides a phased implementation for these due diligence procedures based on the type of account at issue. For all accounts (i) that were opened prior to the effective date of the FFI's FFI Agreement, (ii) that are associated with a private banking relationship, and (iii) that have a balance/value of at least $500,000 as of the FFI Agreement's effective date, a participating FFI is required to have completed the due diligence procedures within one year of its FFI Agreement's effective date. A participating FFI has until December 31, 2014, or one year following its FFI Agreement's effective date, to implement due diligence procedures for those private banking accounts with a balance/value of less than $500,000 as of the FFI Agreement's effective date. For all other preexisting accounts, a participating FFI has two years from its FFI Agreement's effective date to implement due diligence procedures. Thus, rather than requiring due diligence procedures to be effective on January 1, 2013, as many FFIs initially feared, Notice 2011-53 grants participating FFIs additional time to implement such procedures in order to properly, and effectively, identify U.S. accounts.

Reporting

FATCA's main focus is on information reporting between FFIs and the IRS. While prior guidance provided information reporting procedures,4 Notice 2011-53 acknowledges the challenges ahead for FFIs and loosens the information reporting requirements for a participating FFI's initial year of reporting. For those accounts for which a participating FFI has received a Form W-9 from the account holder by June 30, 2014, such account must be reported to the IRS as a "U.S. account" by September 30, 2014. A participating FFI is only required to report the following information for the initial year of reporting: (i) the name, address, and U.S. TIN of each specified U.S. person who is an account holder, and in the case of any account holder that is a U.S.-owned foreign entity, the name, address, and U.S. TIN of each substantial U.S. owner of such entity; (ii) the account balance as of December 31, 2013 (or, if the account was closed after the FFI Agreement's effective date, the account balance immediately before its closure); and (iii) the account number.

Withholding

To the surprise of many, rather than requiring withholding procedures to commence on FATCA's January 1, 2013 effective date, Notice 2011-53 states that regulations will implement such withholding procedures in a delayed, two-phase approach. In phase one, withholding agents (including domestic, foreign, and participating FFIs) will be required to withhold only on U.S. source FDAP5 payments made on or after January 1, 2014. In phase two, withholding agents will be required to withhold on all withholdable payments made on or after January 1, 2015, including "gross proceeds," e.g., proceeds from sales of securities. Also, participating FFIs will not be required to withhold with respect to passthru payments6 made before January 1, 2015. Thus, Notice 2011-53 provides participating FFIs and withholding agents an additional one to two years, depending on the source of the payment, to commence withholding.

"Grandfathered Obligations"

Unrelated to the phased implementation of FATCA, Notice 2011-53 also discusses "grandfathered obligations."7 Numerous comments and questions have been raised regarding "obligations" and the Notice states that the term "obligation" will be clarified in future regulations as meaning any legal agreement that produces or could produce passthru payments (including withholdable payments), but not including any instrument treated as equity for U.S. tax purposes, or any legal agreement that lacks a definitive expiration or term. The Notice clarifies that a withholdable payment does, in fact, include passthru payments.

Next Steps

The Notice provides that proposed regulations incorporating guidance provided in Notice 2010-60, Notice 2011-34, and Notice 2011-53 will be published prior to the end of 2012. Final regulations are currently planned to be published in the summer of 2012, along with an FFI Agreement and reporting forms for use by withholding agents and participating FFIs.

THE GANG OF SIX

The Gang of Six (Democratic Senators Mark Warner (VA), Dick Durbin (IL), and Kent Conrad (ND); and Republican Senators Saxby Chambliss (GA), Mike Crapo (ID) and Tom Coburn (OK)) has been meeting in secret since the spring on a "large plan" to reduce the federal deficit and reform federal finance. Building on the findings of the Simpson Bowles Report,8 an outline of the Gang of Six Plan has been circulating in Washington. On July 19, President Obama endorsed the Gang of Six plan. The federal income tax elements of the plan would require the Senate Finance Committee to report tax reform within six months that would "deliver real deficit savings by broadening the tax base, lowering tax rates, and generating economic growth" as follows:

Simplify the tax code by reducing the number of tax expenditures and reducing individual tax rates, by establishing three tax brackets with rates of 8–12 percent, 14–22 percent, and 23–29 percent. Permanently repeal the $1.7 trillion Alternative Minimum Tax. Reform, not eliminate, tax expenditures for health, charitable giving, homeownership, and retirement, and retain support for low-income workers and families. Retain the Earned Income Tax Credit and the Child Tax Credit, or provide at least the same level of support for qualified beneficiaries. Maintain or improve the progressivity of the tax code. Establish a single corporate tax rate between 23 percent and 29 percent, raise as much revenue as the current corporate tax system, and move to a competitive territorial tax system. Of course, tax bills must originate in the House of Representatives and it remains to be seen how the House will react to the Gang of Six Plan or whether any part of the Gang of Six Plan will become part of a deal on the Federal budget limit.

IRS ISSUES SUPPLEMENTAL GUIDANCE ON FATCA REPORTING AND WITHHOLDING REQUIREMENTS

Prior to the issuance of Notice 2011-53, the IRS and Treasury issued supplemental FATCA reporting and withholding guidance in Notice 2011-34.9 Notice 2011-34 addresses seven areas of concern with respect to FFIs, including (1) the procedures to be followed by FFIs in identifying U.S. accounts among their preexisting individual accounts, (2) the definition of the term "passthru payment," (3) certain categories of FFIs that will be deemed compliant, (4) reporting obligations on U.S. accounts, (5) requirements for FFIs that are Qualified Intermediaries ("QIs"), (6) the requirements for expanded affiliated groups of FFIs, and (7) the effective date of FFI Agreements.

Preexisting Individual Accounts

In the case of "preexisting individual accounts,"10 the FFI is...