The Impact of FATCA on U.S. and Non-U.S. Real Estate Funds
The FATCA rules may impose additional challenges for real estate funds given the many complicated and diverse investment structures that have become common.
Nearly every business with an international footprint or conducting business outside the U.S. will need to confront new compliance realities.
The U.S. Foreign Account Tax Compliance Act (“FATCA”) is one of the most extensive and complex tax information reporting regimes created by the Internal Revenue Service (“IRS”) and U.S. Treasury. The reach of FATCA will most likely require nearly every business with an international footprint or conducting business outside the U.S. to confront new compliance realities.
Core objective of FATCA is to address perceived abuses by U.S. taxpayers with respect to their offshore accounts and indirect investment income through non-U.S. entities. The regulations impose significant compliance burdens on payors making cross-border payments and liability for any under withholding. FATCA will have a significant impact on funds that directly, indirectly or through certain investment vehicles trade or invest in U.S. assets.
The FATCA withholding tax will be imposed in a similar manner to the existing withholding tax on U.S. source income under the Internal Revenue Code by requiring payors (or withholding agents) of U.S. sourced income and gross proceeds to withhold 30% on payments to non-U.S. entities that do not certify their compliance with FATCA or disclose their substantial U.S. owners. However, FATCA withholding, which is applied before any Chapter 3 withholding, does not allow tax treaty based exemptions or other reductions of the withholding tax rate.
To avoid the tax, Foreign Financial Institutions (“FFIs”) must generally enter into an FFI agreement with the IRS to share the identities of U.S. account and asset holders, if subject to a model 1 Intergovernmental agreements (“IGA”), register with the IRS as a reporting model 1 IGA FFI, or fall within one of the exempt, certified or deemed compliant categories. The IGAs are bi-lateral agreements between the U.S. and foreign jurisdictions to implement FATCA compliance. FFIs that register with the IRS will obtain a Global Intermediary Identification Number to identify themselves as FATCA compliant to other withholding agents. Other affected non-financial foreign entities seeking to avoid the tax will be required to provide appropriate information to the withholding agents relating to any of their substantial U.S. owners or certify to a particular excepted status.
The definition of a withholdable payment is broad and includes U.S.-source payments such as interest (including original issue discount), dividends, or any other fixed or determinable annual or periodic income. Additionally, a withholdable payment also includes the gross proceeds from the sale or disposition of any property that could produce U.S. source interest or dividends. Income which is “effectively connected” with a U.S. trade or business is specifically exempt from FATCA withholding.
As discussed above, withholdable payments made to a FFI will generally not be subject to withholding if the FFI enters into an FFI Agreement with the IRS to identify and report certain U.S. account holders, complies with an applicable IGA, meets a deemed compliant category, or is considered exempt. Withholdable payments to a NFFE will not be subject to withholding if the NFFE provides information about its substantial U.S. owners or is an excepted NFFE.