On June 30, the United States and Israel signed an intergovernmental agreement (IGA) regarding FAT CA.
FAT CA became effective in the US and other countries on July 1 and will officially take effect in Israel once the Knesset passes enabling legislation. But the Bank of Israel has already instructed Israeli financial institutions to start applying FAT CA now. Note that the FAT CA definition of a “financial institution” is very broad; it may include some trusts and many other entities from around the world including Israel.
FAT CA is short for Foreign Account Tax Compliance Act. It encompasses more than 500 pages and is full of abbreviations and jargon.
A small fraction of this is discussed below, so take professional advice if FAT CA may affect you.
What is FATCA about? According to the US Treasury, FAT CA was enacted in 2010 by the US Congress to target noncompliance by US taxpayers using foreign accounts.
FAT CA requires foreign financial institutions (FFIs) to report to the IRS information about financial accounts held by US taxpayers or by foreign entities in which US taxpayers hold a substantial ownership interest.
US individual taxpayers must report information about certain foreign financial accounts and offshore assets on Form 8938 and attach it to their incometax return, if the total asset value exceeds a threshold. Form 8938 reporting is in addition to FBAR reporting.
US financial institutions and other US withholding agents must both withhold 30 percent on certain payments to foreign entities that do not document their FAT CA status and report information about certain nonfinancial foreign entities.
Those payments subject to withholding are US-source fixed or determinable annual or periodic payments such as dividends and interest. After 2016, the gross proceeds of dispositions of property that can produce such payments are also subject to FAT CA.
To avoid being withheld upon, a foreign financial institution may register with the IRS, obtain a global intermediary identification number (GIIN) and report certain information on US accounts to the IRS.
US-Israel intergovernmental agreement The US-Israel IGA modifies the above. Israeli financial institutions must still obtain a GIIN from the IRS, but then report the information on US accounts to the Israel Tax Authority (ITA ). Israeli regulations for this are still on the way.
But the ITA is supposed to start handing over information to the IRS no later than September 30, 2015. This is because the US-Israel agreement is a Type 1 IGA, which means Israeli financial institutions report to the IRS via the ITA .
The IRS may reciprocate by reporting on Israeli-held bank accounts in the US to the ITA . In the case of a Type 2 IGA, reporting is directly to the IRS.
A number of other onshore countries have or soon will have an IGA with the US. But offshore FFIs will generally face full FAT CA exposure, including 30% withholding tax on payments from the US, unless they obtain a GIIN and enter into a FAT CA agreement.
There are two key players in the FAT CA rules: 1) the foreign financial institution (FFI), and (2) the nonfinancial foreign entity (NFFE). These are discussed below.
Foreign financial institution Foreign financial institutions (FFIs) include: (1) deposit institutions (e.g., banks); (2) custodial institutions (e.g., mutual funds); (3) investment entities (very important – see below); (4) insurance companies and their holding companies; (5) holding companies or treasury centers that are part of a financial group.
The FFI regulations and Annex 2 of the US-Israel IGA exempt from registration, reporting and tax withholding requirements: most government entities; most nonprofit organizations; certain small local financial institutions; certain retirement entities.
Subject to this, unless otherwise exempt, FFIs that do not both register and agree to report face a 30% withholding tax on certain US-source payments made to them, commencing July 1, 2014.
Since there is a signed US-Israel signed IGA, albeit not yet ratified by the Knesset, US regulations exempt withholding agents from withholding US tax from Israeli financial institutions until the end of 2014. Offshore FFIs will generally not enjoy this extension.
Note that an “investment entity” above is broadly defined. According to the IGA, an “entity” means a legal person or a legal arrangement such as a trust. And an “investment entity” means any entity that conducts (or is managed by an entity that conducts as a business) on behalf of a customer: (1) trading in money-market instruments, forex, interest rate and index instruments, transferable securities or commodity futures trading; (2) portfolio management; (3) otherwise investing, administering or managing funds or money on behalf of other persons.
Nonfinancial foreign entity A nonfinancial foreign entity (NFFE) is basically any foreign entity that is not an FFI. That typically means it holds assets for itself, not for others. There are active and passive NFFEs.
In the case of an active NFFE, less than 50% of its gross income and assets are passive. With limited exceptions, other NFFEs may be “passive NFFEs” that need not register with the IRS. But 30% US tax may generally be withheld from payments to them if they do not certify that they have no substantial US persons owners or provide information about them.
What the IGA requires The US-Israel IGA refers to US reportable accounts held by one or more specified US persons OR by a non-US entity with one or more controlling person who is a specified US person.
A specified US person basically means most US persons other than publicly traded corporations, the US government, various regulated US financial bodies and securities dealers.
Controlling persons are: natural persons exercising control over an entity; the settlor, trustees, protector, beneficiaries and class of beneficiaries of a trust; and persons in equivalent or similar positions of other legal arrangements.
Israeli reporting financial institutions (if not exempted by Annex 2 mentioned above) must register on the IRS FAT CA registration website.
With respect to 2014, Israeli reporting financial institutions must report to the ITA (for forwarding to the IRS) the US holders and the year-end balances of US reportable accounts.
With respect to 2015, interest, dividends and other income on custodial accounts must also be reported.
With respect to 2016 and subsequent years, income and gross proceeds on depository accounts and any other account must also be reported. Payments to nonparticipating (unregistered) financial institutions and details of recalcitrant (uncooperative) account holders must also be reported to the ITA (for forwarding to the IRS).
Israeli reporting financial institutions do not need to withhold US tax unless they have undertaken to do so, nor close recalcitrant accounts.
In cases of significant noncompliance by reporting Israeli financial institutions, which are not resolved within 18 months after a warning notice, withholding tax may apply to payments to them.
Tax identity numbers of accounts of accounts maintained at June 30, 2014, need not be reported before the beginning of 2017; instead, dates of birth may be used.
Spotting US persons The IGA contains detailed due diligence procedures for spotting US reportable accounts.
In the case of preexisting accounts of individuals as of June 30, 2014, no review or reporting is required if the balance on that date was $50,000 or less.
In the case of preexisting accounts with balances on June 30, 2014, between $50,000 and $1 million, the reporting Israeli financial institution must conduct an electronic search for various “US indicia”: citizenship, place of birth, mailing or residence address, current telephone number, standing instructions to transfer funds to a US account, power of attorney or signatory authority to a person with a US address, or an “in-care-of” or “hold mail” sole address on file.
In the case of preexisting on that date balances on June 30, 2014, over $1 million, if an electronic search does not capture all the above information, a paper-record search is also needed of the current customer master file, and any relationship manager assigned to the account must be asked if that person has actual knowledge that the account holder is a specified US person.
Reporting is required of US reportable accounts that are held by entities that are specified US persons and passive NFFEs with one or more controlling persons that are specified US persons.
Review procedures include checking the place of incorporation and organization and W8 self-certification forms.
Modified alternative procedures, including account closures, are prescribed in the IGA if Israel notifies the US that it lacks the legal authority to require reporting Israeli financial institutions to carry out all the main IGA procedures.
Comments The new US-Israel IGA will certainly complicate things for US persons, reporting Israeli financial institutions, trusts and many companies if they may fall into the FAT CA definition of financial institutions.
There is an effective period of grace in Israel until December 31, 2014, to sort things out and register with the IRS. Also, the IRS has indicated it will tread lightly if bona fide attempts are made to comply with FAT CA in 2014-2015.
Nonfinancial assets such as real estate or works of art may fall outside FAT CA.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.