Most people hear FATCA and automatically think foreign and banks. While many of the rules do apply to foreign financial institutions, the FATCA documentation requirements are far more reaching than financial institutions. Nearly all domestic entities, regardless of type or size, will have some aspect of FATCA apply to them.
FATCA stands for Foreign Account Tax Compliance Act and became law in March of 2010. The main thrust of FATCA is to reduce tax evasion by U.S. citizens or residents who invest outside of the U.S. or indirectly earn income inside or outside the U.S. through a foreign entity. While FATCA is not intended to raise revenue, it does, effective as of July 1, 2014, impose a 30% withholding tax on “withholdable payments.” “Withholdable payments” are certain expenditures made to FFIs (Foreign Financial Institutions) and NFFEs (Non-Financial Foreign Entities) when such entities are non-compliant with the FATCA documentation requirements. The 30% rate is not reduced by tax treaty.
While a full discussion on what types of expenditures constitute “withholdable payments” is beyond the scope of this article, a brief example may provide some insight into what Congress and the IRS are trying to police. Suppose a U.S. domiciled business makes royalty payments to a foreign company that developed technology used by that U. S. company. Does the U.S. company withhold 30% of the royalty payments and remit it to the IRS? The answer is: it depends. If the FATCA reporting and documentation requirements are met, then the answer is “No,” but the U.S. company may need to withhold at a lower treaty rate (a zero treaty may be applicable). If the foreign company is not compliant, then the answer is “Yes,” it must withhold at 30%.
Generally, payments for goods and services are not considered “withholdable payments.” Payments made to foreign entities for interest expense on loans, dividends and certain royalties, should be reviewed to determine whether withholding is required and the proper rate.
FATCA applies to small and mid-sized businesses and not just to large, multi-national corporations. For example, a $6.0M distribution company that sells its products in the U.S. but sources materials and goods from overseas may have expenditures that qualify as “withholdable payments.” Therefore, at a minimum, we recommend all companies take the following three steps:
- Identify a FATCA responsible officer
- Perform a FATCA risk assessment
- Update accounts payable procedures manual
The IRS will look favorably on companies that made a good faith attempt to comply with the requirements in 2014 and 2015. After 2015, non-compliance will result in interest and penalties in addition to the 30% withholding tax.
We will be happy to review how these new rules apply to your business. If you have any questions on the above or would like to discuss FATCA in more detail please contact a member of your Meaden & Moore client service team or Marne Babich at (216) 928-5386 or firstname.lastname@example.org.
Another post by Marne: Tax Strategy for Taking Advantage of Foreign Sales