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Tax News
Notice 2011-34: The Second Round of FATCA Guidance is Released
April 16, 2011
Administrative Actions
So, while I was busy with work and finishing up the private equity tax book I’ve been toiling on, Treasury released the second round of FATCA guidance (on a Friday nonetheless).  Here are my observations:

The guidance comes in the form of another voluminous notice. It is 46 pages which in addition to the 62 pages of Notice 2010-60 comes to a total of 108. Why do I point that out?  I point this out for several reasons.  First, this in my mind equates to a possible 100-150 page proposed regulation, counting the preamble. It seems paradoxical to me to come up with volumes on top of volumes of rules when everybody is talking about simplifying the Tax Code.  I’d venture to say that the proposed regulations in their final form would equal the entire tax code of some nations.  Second, these rules are applicable to foreign institutions.  It is one thing to subject your own citizens to over-burdensome regulation, but inflicting this complexity on foreigners may have an adverse effect. I am not sure exactly when, but at some point, foreign investors will just throw in the towel and say that it is not worth the hassle to deal with the US.  After all, comparable, if not better returns, could be found elsewhere.

Aside from this, what’s in the notice?  Well, there are two major points. Passthrough payments are finally clarified. That said, the IRS’ thinking appears to diverge from that of practitioners.  I for one expected that the “attributable” part of a passthrough payment will be defined based on some tracing formula. This made sense to me. If a foreign fund-of-funds (FoF) invests in a fund with US exposure, I would have expected that the passthrough payment comes into play if in fact the FoF is actually being paid from investments that come from the US.  Well, the IRS decided that this is way too narrow of a concept and that does not comport to the spirit of FATCA. In other words, a foreign FoF may be subject to withholding if it invests in a participating fund even if the FoF actually is not paid from US investments.  So the IRS came up with this rule that provides that a passthrough payment will be tied to the FFI’s passthrough percentage.  The passthrough percentage is based on the ratio of the FFI’s US assets and total assets.  So, as long as the FFI has some US assets, the foreign nonparticipating FoF will be subject to 30% withholding. The IRS has further decided that participating FFIs will have to publish their passthrough percentages. There is one good thing about this for foreign FoFs. Apparently those percentages will be published on the web or a central repository where the information could be easily checked. Thus, a foreign fund or FoF could check this information and simply chose not to invest in an FFI with a high percentage.

The other major part in the notice that deals with funds is the “deemed compliant” guidance.  Everybody has been waiting for some clear indication that some funds would not be subject to the FATCA rules, such as publicly traded funds, funds without US investors etc. I personally did not find Section III.C of the Notice (dealing with investment vehicles) to be too helpful.  Without going in great detail, I will point one thing that seems to be astounding to me. It appears that Treasury is not even certain whether publicly traded funds such as ETFs will be deemed compliant. The IRS points out that despite the fact that these entities do not issue or hold financial accounts within the meaning of the statute they will still have to enter into agreements with the IRS. Frankly, while I am not an expert on publicly traded fund administration, I would surmise that imposing FATCA requirements (whether be it agreement, withholding or such) would be an administrative nightmare, particularly, as to funds such as ETFs.  As a casual observer of the stock market, I’d venture to say that ETFs constitute a predominant part of the volume on most exchanges and are one of the most frequently traded instruments where an individual or a computer program may trade the ETF hundreds of times a day.  Moreover, nobody invests directly in the ETF. Most of the traffic is through third party brokers and other FFIs who may be participating, or non-participating.  I cannot even begin to envision how this complexity will be translated into a withholding mechanism and US investor discovery mechanism.

I would not go in further detail on these issues.  I think that all and all, while the IRS has made some concessions, it still misses the mark of achieving its objective while promulgating an administrable rule of law.  The Notice is attached below.

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Tags: FATCA, Foreign Account Tax Compliance, Notice 2011-34