IRS Releases Additional FATCA Guidance, Although Many Questions Remain

Posted on May 6, 2011 by Mark Snider

In Notice 2011-34 issued April 8, 2011, the IRS provided supplemental guidance regarding foreign financial account reporting requirements under the Foreign Account Tax Compliance Act (“FATCA”). All businesses that makes payments to foreign financial institutions should be aware of these rules which take effect in 2013.  The recently released supplemental guidance, which is expected to be part of extensive future regulations, clarifies certain withholding, documentation, and reporting requirements under FATCA. Because many questions remain, it is expected that the IRS will continue to release additional FATCA guidance.

Background

Beginning on January 1, 2013, a 30% withholding tax will be imposed on certain U.S. source payments (“withholdable payments”) made to foreign financial institutions (“FFIs”). Withholding will be required on payments made to FFIs that do not enter into an agreement with the IRS to provide information on financial accounts held by certain U.S. persons. FATCA is another weapon in the IRS’s arsenal to track and monitor potentially abusive foreign account strategies, although FATCA applies to legitimate and routine business payments as well.

Withholdable payments made to an FFI that has entered into an FFI agreement with the IRS are not subject to withholding under FATCA. Nevertheless, with certain exceptions, each “compliant” FFI is still required to withhold tax on certain payments it makes to any other FFI that has not entered into an FFI agreement or to any account holder that has not complied with information requests under FATCA (a “recalcitrant account holder”). 

Notice 2011-34 provides additional guidance regarding these secondary “pass-thru” payments and rules regarding “deemed-compliant FFIs.”

For further background, see "Why You Should Care About FATCA."

Pass-thru Payments

FATCA generally applies to any “withholdable payment,” which includes any payment of U.S. source (i) income or (ii) gross proceeds from the disposition of property that could give rise to U.S. source dividends or interest. FATCA also applies to pass-thru payments made by a participating FFI to non-participating FFIs and to recalcitrant account holders. Notice 2011-34 provides rules regarding what portion of a payment treated as a pass-thru payment must be withheld upon.

The IRS intends to define a U.S. asset for these purposes to include any asset to the extent it is of the type that could give rise to a pass-thru payment, including any debt or equity interest in a U.S. business entity.

Deemed-Compliant FFIs

Under Notice 2011-34, certain entities are “deemed compliant”:

Banks

A bank with operations confined to a particular country that meet certain other requirements is deemed compliant with FATCA.

Investment Funds

An investment fund will be treated as a deemed-compliant FFI if (i) all holders of record of interests in the fund are participating FFIs, are deemed-compliant FFIs, or are certain exempt entities, (ii) the fund prohibits the acquisition of its interests by any person that is not described in clause (i) above, and (iii) the fund certifies to the IRS that it will calculate and publish its pass-thru payment percentage.  The IRS may also treat an investment fund as a deemed-compliant FFI in certain other situations specified in Notice 2011-34.

Other Issues

Notice 2011-34 provides guidance on other topics under FATCA, including (i) relief for affiliated group FFIs, (ii) procedures for identifying U.S. accounts among preexisting individual accounts, (iii) reporting requirements for U.S. accounts, and (iv) requirements applicable to FFIs that are qualified intermediaries. 

The IRS expects to release further guidance and eventually Proposed Treasury Regulations.
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Tax Court Ruling Negatively Affects Ability to Deduct Some Interest Expenses for "QSub Banks" and Their Owners

Posted on August 11, 2009 by Mark Snider

A U.S. Tax Court ruling issued earlier this year draws into question the ability of “QSub banks” to fully deduct interest expenses related to financing tax-exempt bond investments. If the Tax Court ruling is not overturned on appeal, thousands of shareholders of S corporations may owe millions of dollars in back taxes attributable to interest deductions taken by their S corporation’s wholly owned “QSub bank.”

A “QSub bank” is a bank that is a wholly-owned subsidiary of an S corporation and a bank for which a QSub election has been made. An S corporation is a corporation for which a “S” election has been made, resulting in the corporation being disregarded for federal income tax purposes. Instead, the federal income tax attributes of the an “S” corporation are reported by the shareholders in the S corporation. This contrasts with the treatment of a “C” corporation which is a taxpayer for federal income tax purposes. Many the holding companies of many community banks have found it desirable to elect “S” status.

In general, a QSub is a disregarded entity that is not considered as a separate entity for tax purposes from its S corporation owner, although in the case at issue the Tax Court ruled that the QSub must be considered a separate entity for purposes of the interest deduction rules discussed below, a treatment analogous to the treatment of a C corporation subsidiary .

Section 291 of the Internal Revenue Code requires that tax deductions taken by banks for “interest on debt to carry tax-exempt obligations” (primarily municipal bonds) be reduced by 20%. This provision has been interpreted to require C corporation banks to reduce such interest deductions by 20%. Banks that are S corporations or QSubs, however, have historically deducted their entire interest expense based on a belief that another Internal Revenue Code provision, Section 1363(b)(4), limited the application of the Section 291 deduction limitation to only those S corporation banks that had been C corporations in the previous three years.

The Tax Court disagreed, holding that Treasury Regulations state that “any special rules applicable to banks,” such as Section 291, “continue to apply separately to each QSub that is a bank” as if the QSub election were not in effect. Any QSub deductions are directly reportable on the S corporation’s tax return. Because S corporations are pass-through entities for federal income tax purposes, any additional tax, interest, or penalties resulting from disallowed QSub deductions would be owed by the S corporation’s shareholders.

At least for now, the Tax Court ruling does not negatively impact the amount of interest expenses deductible by S corporation banks, only QSub banks owned by S corporations. The Tax Court case is Vainisi v. Commissioner, 132 T.C. 1 (2009).

Please contact a member of our Financial Institutions or Tax Practice Groups for more details on how the ruling could impact your bank’s ability to deduct interest expenses.


To comply with certain U.S. Treasury regulations, we inform you that any federal tax information contained in this posting is for informational purposes only and is not intended as advice. This posting is not a covered opinion as described in Treasury Department Circular 230 and therefore cannot be relied upon to avoid any tax penalties or to support the promotion or marketing of any federal tax transaction.
 

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