Q&A: Impact of the US Foreign Account Tax Compliance Act on Lending
The Foreign Account Tax Compliance Act (FATCA), enacted in 2010 as part of the Hiring Incentives to Restore Employment Act encourages foreign financial institutions (FFIs) and certain non-financial foreign entities (NFFE) (over which the US does not generally have jurisdiction) to disclose details of their US account holders to the Internal Revenue Service (IRS).
FFIs that fail to comply with FATCA will face a punitive withholding tax of 30% on certain US-sourced payments.
The purpose of FATCA is to combat the use of offshore accounts by US tax payers to evade US tax.
What amounts will be subject to the withholding tax?
Withholdable payments include:
- US-source interest, dividends, rents, royalties and compensation.
- Gross proceeds from the sale, redemption, repurchase or other disposition of any property of a type that produces US-source interest or dividends.
If a FFI does not comply with FATCA, the 30% withholding tax will apply to payments by US borrowers of interest and principal, i.e. the US borrower will have to withhold the 30% withholding tax from the payments it makes to the FFI.
What can lenders do to avoid the withholding tax?
To avoid the 30% withholding tax, a FFI receiving withholdable payments will need to comply with FATCA information reporting requirements or fall within one of the exemptions for certain foreign entities. The information reporting requirements differ depending on whether a foreign payee is categorized as an FFI or NFFE.
Under the FATCA regime, the FFI must, inter alia, agree to:
- obtain information to determine which account holders are from the US;
- comply with verification and due diligence procedures on such accounts as required by the Treasury;
- report annually (including but not limited to providing account numbers, account summaries and gross realised revenues);
- deduct and withhold the 30% tax on payments to recalcitrant accounts;
- comply with requests for further information; and
- where a foreign law would prevent such reporting, to close the account if a valid waiver of the law cannot be obtained from the account holder.
What is the UK/US Intergovernmental Agreement and how does fit into the FATCA regime?
The UK and the US entered into an agreement on 12 September 2012 whereby UK financial institutions may, rather than having to sign up to FATCA themselves become deemed “FATCA compliant” by registering with the IRS and agreeing to provide information on accounts held by US persons (i.e. US citizens or corporations and entities they control).
What is the impact on loan agreements?
FATCA specific provisions are becoming more standard in loan agreements where the borrower is a US person. Such provisions include:
- carving out the new FATCA withholding tax from the tax gross-up provision (so that a foreign lender will not be grossed up by a US borrower for the FATCA withholding tax);
- excluding FATCA withholding tax from increased cost and indemnity provisions; and/or
- requiring specific documentation from a foreign lender so that the US borrower can comply with its FATCA withholding obligations and determine whether payments are subject to FATCA withholding tax.
Potential issues for lenders?
- If lenders fail to comply with FATCA they will be subject to the 30% withholding tax.
- Lenders may increasingly seek to lend from jurisdictions which have an appropriate Intergovernmental Agreement in place such as the UK and consider carefully assignability issues in the FATCA context.
- Disclosing information to IRS will potentially put lenders in breach of data protection and confidentiality obligations to their customers.
- There may be uncertainty as to who should bear the burden of any withholding tax risk, i.e., the lender or the borrower?
- Drafting of loan agreements will need to be considered carefully.
When will it be implemented and does it apply retrospectively?
FATCA withholding generally applies to withholdable payments of interest made on or after July 1, 2014, and to withholdable payments of principal made on or after January 1, 2017, but there is a “grandfathering” rule for debt obligations outstanding on July 1, 2014 (i.e. they fall outside of FATCA). Accordingly, standard loan agreements entered into before July 1, 2014 are grandfathered. Lines of credit and revolving credit agreements entered into before July 1, 2014 are also generally grandfathered if they include a stated maturity date. Care is needed, however, if agreements are materially amended after that date since that might result in the benefit of grandfathering being lost.
For further information relating to the issues in this article, please contact:
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The information in this article refers to the law at the date the article was written and is provided for general information purposes only. It should not be applied to specific circumstances without prior consultation with a solicitor.
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