September 2010
FATCA: The Global Financial
System Must Now Implement a New
U.S. Reporting and Withholding
System for Foreign Account Tax
Compliance, Which Will Create
Significant New Exposures—
Managing This Risk (Part III)
T
his article will be a separated into a three-part
series that appears in the July, August and Sep-
tember editions of TAXES—The Tax Magazine.
The article will address the new reporting and withhold-
ing regime imposed upon foreign financial institutions
and non–financial foreign entities, its impact on banks,
insurance companies, multinational corporations and
investment and mutual funds, as well the new reporting
requirements for uncertain tax positions for U.S. and
foreign corporations including life, property and casu-
alty insurance companies and new tax compliance for
individuals with foreign assets. In addition, the article
will compare the qualified intermediary rules to the
new rules for foreign financial institutions, changes to
the tax treatment of substitute dividends and dividend
equivalent payments received by foreign persons, the
Dean Marsan was a first vice president and a senior tax
counsel formerly with Lehman Brothers Inc. in New York City
for the past 20 years. He was a participant on the American
Bar Association Tax Section ad hoc committee for the “Com-
ments on H.R. 3933 (H.R 3933, S. 1934) Foreign Account Tax
Compliance Act of 2009 (FATCA),” which was submitted by
the American Bar Association Tax Section on December 3,
2009, to the U.S. Senate Finance Committee and the House
Ways and Means Committee and most recently a participant
on the ABA Tax Section FATCA and 871(l) comment commit-
tees and on the New York State Bar Association Tax Section ad
hoc committee for its report on FATCA. He can be reached at
dmarsan@deloitte.com.
©
2010 D. Marsan
Taxes—The Tax Magazine ®
Electronic copy available at: http://ssrn.com/abstract=1726093
By Dean Marsan
repeal of certain foreign exceptions to the registered
bond provisions, foreign trust provisions, IRS U.S. with-
holding tax and information reporting examinations,
liabilities for U.S. withholding tax, interest and penal-
ties, U.S. account exposures, prophylactic planning
and action steps, corporate governance and compli-
ance to manage the U.S. account risk.
This third part of this article discusses a comparison
to pre-FATCA U.S. withholding tax law; the impact of
FATCA on audited financial statements and FIN 48/
FAS 5 exposures; IRS audits of Tier I issues and the
potential impact on financial institutions; reduction of
FATCA/FDAP exposures—contractually outsourcing
withholding and reporting responsibilities; product
certifications of FATCA compliance; common types
of withholdable payments; investor disclosure for
FATCA; Treasury guidance on customer accounts, leg-
acy accounts and systems; use of statistical sampling
techniques to determine U.S. accounts, waivers for
U.S. accounts and problems closing accounts; scope
of the term “financial account”—U.S. brokers, swap
dealers or nominees and DAP payments; investment
fund FATCA issues, trusts—FATCA issues; reporting
responsibilities—gross receipts and withdrawals;
Treasury consolidated or separate FFI agreements;
distinguishing between foreign financial institutions
and non–financial foreign entities; comparison of
the qualified intermediary rules to the new rules
21
New U.S. Withholding System for Foreign Account Tax Compliance
for foreign financial institutions; pass-through pay-
ment issues; audit considerations; exclusions of U.S.
branches and agencies; clarification of whose treaty
rights are waived if the FFI elects out of withholding
responsibility; failure of NFFE to obtain information
about substantial U.S. owners; FFI withholding, re-
fund and treaty issues; the general FATCA provisions;
confidentiality, effective date and grandfather rules;
comments on the successful implementation of Chap-
ter 4 and coordination with Chapter 3 and related
prioritization issues; reporting of foreign financial
assets and the definition of “specified foreign finan-
cial asset”; the new PFIC reporting rules; electronic
filing of certain information returns; abusive equity
swaps; the Stop Tax Haven Abuse Act proposal to
withhold on dividend equivalents; the 2010 Green
Book proposal to prevent the avoidance of dividend
withholding taxes; the tax treatment of substitute divi-
dends and dividend equivalent payments received by
foreign persons; the repeal of certain foreign excep-
tions to the registered bond provisions; foreign trust
provisions; IRS U.S. withholding tax and information
reporting examinations; the IRS Industry Directive
on total return swaps; liabilities for U.S. withholding
tax, interest and penalties, including the new six-year
statute of limitations, new penalties for failure to dis-
close foreign financial assets and the new 40-percent
accuracy related penalty for undisclosed foreign fi-
nancial assets; U.S. account exposures, prophylactic
planning and action steps; and corporate governance
and compliance to manage the U.S. account risk.
[E]very stick crafted to beat on the head of a tax-
payer will metamorphose sooner or later into a
large green snake and bite the [IRS] commissioner
on the hind part.
—Martin D. Ginsburg
Overview—Comparison to
Pre-FATCA U.S. Withholding
Tax Law
According to one commentator:1
[T]he existing (that is pre-FATCA) withholding
and reporting rules of [Code] Sec. 1441 (and
the related qualified intermediary program ) are
designed to ensure that the correct withholding
and reporting occur on payments of U.S. source
fixed and determinable annual or periodical
22
Electronic copy available at: http://ssrn.com/abstract=1726093
(FDAP) income based on the beneficial owner
(U.S. or foreign) of that income. Thus, identify-
ing the beneficial owner of that income is a key
element of the current system. Problems with this
system can arise, however, when U.S. investors
limit their investments to foreign assets or make
their investments through foreign entities that are
the beneficial owners of the income.
Specifically, under the current rules, payments of
foreign source income to U.S. persons outside the
United States by non-U.S. payors (for example,
payments to U.S. persons who invest in foreign
markets through foreign banks [with offices outside
the U.S.] are not subject to 1099 reporting. As a re-
sult, the IRS has no record regarding some offshore
investments of U.S. persons. The same issue arises
when U.S. persons have made investments through
foreign entities that, under U.S. tax principles are
the beneficial owners of the income. For example,
if U.S. persons invest in the U.S. markets through a
foreign corporation or a foreign complex trust, the
[Code] Sec. 1441 rules generally treat the corpo-
ration or trust as the beneficial owner and do not
require a U.S. withholding agent to look through
to the identities of its owners.
By contrast if U.S. persons invest in the U.S.
markets through a foreign partnership, the [Code]
Sec.1441 rules look through the partnership to
determine the beneficial ownership. Nevertheless,
some U.S. investors in foreign partnerships have
chosen to remain undisclosed to U.S. withhold-
ing agents (that is, they have failed to provide
documentation regarding their U.S. status to a
foreign partnership or intermediary for submission
upstream to the U.S. withholding agent). Although
undocumented partners are subject to 30 percent
withholding on their shares of the partnership’s
U.S. source FDAP, such withholding may be at
a lower rate than such persons would otherwise
have been subject [and may be creditable in
their local country of residence]. Further, gross
proceeds from security sales currently are not
subject to reporting and withholding (assuming
the U.S. withholding agent does not have actual
knowledge of the person’s U.S. status and the
amount of proceeds allocable to such person.
Once effective [January 1, 2013], the newly en-
acted withholding rules ([Code] Sec. 1471-1474),

summarized below, will require U.S. withholding
agents to impose 30 percent withholding on U.S.
source FDAP and gross proceeds unless the foreign
entity receiving the payment agrees to disclose
specific U.S. persons to the IRS. The new regime
seeks to accomplish its objectives, not by a system
aimed at the beneficial owners of the U.S. source
income, but rather by focusing on foreign entities
investing in U.S. markets that fail to fully disclose
U.S. persons who maintain accounts within the
foreign entities or who have ownership interests
in the foreign entities … the new rules also will
require foreign partnerships to look through upper-
tier foreign entities to identify the U.S. partners.
Will FATCA Work?
There is some real concern that the withholding and
reporting regime under FATCA while increasing the
cost and stakes of the prior U.S. withholding system
will not bring Americans into compliance. One group
of commentators2 was more specific and stated:
On paper, [FATCA] seems like an effective way to
encourage compliance by imposing a 40% negli-
gence penalty. Practically speaking, however, the
steep penalty may do little to encourage compli-
ance and may discourage those taxpayers who
have not yet made voluntary disclosure from do-
ing so while the IRS has greatly publicized the fact
that it had 17,000 formal voluntary disclosures
by 10/15/09, as a practical matter that is a “mere
drop in the bucket” compared to the amount of
money still undeclared. Given that the U.S. vol-
untary disclosure program penalty framework has
expired and taxpayers are no longer guaranteed a
certain result, many people who otherwise may
have considered voluntary disclosure may now
avoid compliance altogether, rather than run the
risk of being subject to higher penalties.
See “Liability for Withholding Tax, Interest, Penal-
ties and Statute of Limitations.”
Impact of FATCA on Audited
Financial Statements
FIN 48 Exposures
Many taxpayers are currently required by FASB In-
terpretation No. 48, Accounting for Uncertainty in
Taxes—The Tax Magazine®
September 2010
Income Taxes (FIN 48) to identify and quantify un-
certain tax positions in their tax return for financial
statement purposes. Consider a foreign financial in-
stitution or non–financial foreign entity who prepares
U.S. audited financial statements and is subject to
FIN 48. If after 2012, the foreign financial institution
or non–financial foreign entity fails to comply with
either the requirements under new Code Sec. 1471(b)
or 1472(b), it is likely that these entities will have
exposure to the IRS for any tax that should have been
withheld under new Code Sec. 1471(a) or 1472(a)
under the transferee liability rules under Code Sec.
6901 or in equity (e.g., unjust enrichment).
Thus, if a foreign financial institution or non–finan-
cial foreign entity failed to comply for a number of
years, the withholdable payments that were received
by such entities presumably could be grossed up by
the Treasury for the unpaid 30-percent U.S. with-
holding tax, together with interest and penalties. It
is not inconceivable that the combined impact of the
liability may exceed the balance in the U.S. accounts,
and in some egregious cases may cause the entity to
file bankruptcy unless the IRS agrees in the closing
agreement to favorable payment terms (e.g., install-
ment payments over a number of years to satisfy the
deficiency, interest and penalties).3 In any event, for
financial statement reporting purposes it is likely that
this exposure will have to be reflected as a FIN 48
tax reserve and may in fact require the restatement
of earlier financial statements if material.
FAS 5 Exposures
Financial Accounting Standards Statement Number
5 (FAS 5), Accounting for Contingencies, was issued
over 30 years ago by the Financial Accounting Stan-
dards Board (FASB). After 2012, withholding agents
and payors (including foreign financial institutions that
are withholding agents or payors responsible for with-
holding on withholdable payments to noncompliant
foreign financial institutions or non–financial foreign
entities under new Code Sec. 1471(a) or 1472(a) or on
pass-through payments to recalcitrant account holders
and non-participating foreign financial institutions
under new Code Sec. 1471(b)(1)(D) or 1471(d)(3))
will be personally liable for the tax required to be
withheld as well as interest and penalties.
Based on history, it is not an understatement to say
that many withholding and transaction taxes may be
overlooked. However, given the potential huge finan-
cial exposure of a withholding agent or payor who
fails to withhold under FATCA, it can be expected
23
New U.S. Withholding System for Foreign Account Tax Compliance
that firms who have annual audits of their financial
statements will now be under increased scrutiny by
their auditors to ensure the FAS 5 reserves relating
to FATCA withholding (and Chapter 3 withholding
taxes) are reported properly on their financial state-
ments. To that end, firms should ensure all FATCA and
Chapter 3 taxes required by FAS 5 are accrued for and
fully documented and that withholding procedures
and manuals are updated for the new withholding
regime as soon as guidance is provided by the IRS
on FATCA.
Alvarez provided the following excellent analysis
for FAS 5 as it relates to sales and use taxes,4 which
may be useful in the U.S. withholding tax area:
Background. It is important to understand the
definition of a contingency. In March 1975, the
FASB issued FAS 5, outlining the appropriate ac-
counting for contingencies. Paragraph 1 defines a
contingency as “an existing condition, situation,
or set of circumstances involving uncertainty as
to possible gain or loss to an enterprise that will
ultimately be resolved when one or more future
events occur or fail to occur.”
Examples of loss contingencies include pend-
ing litigation and actual or possible claims and
assessments. Risk detection should not be con-
sidered in reporting loss contingencies regarding
taxes. For example, the likelihood of being caught
if a company does not comply with the law (i.e.,
does not file a return, does not collect the tax) is
not a valid reason for not recording the liability.
In addition, if an assessment is pending, the tax
practitioner must assume all the evidence will be
reviewed by the examiner when determining the
likelihood of the outcome. Next, it is important to
know what contingencies need to be disclosed.
Paragraph 8 of FAS 5 states “an estimated loss
from a loss contingency shall be accrued by a
charge to income if both of the following condi-
tions are met: (a) information available prior to
issuance of the financial statements indicates that
it is probable that an asset had been impaired or a
liability had been incurred” and “(b) the amount
of the loss can be reasonably estimated.” Prob-
able is defined in paragraph 3 as “the future event
or events are likely to occur.”
If one or both of these conditions are not met
related to a contingency, disclosure of the con-
24
tingency must be made when there is at least a
reasonable possibility that a loss or an additional
loss may have been incurred. The disclosure
must indicate the nature of the contingency and
estimate the possible loss or state that such an
estimate cannot be made (paragraph 10). “Rea-
sonably possible” is defined in paragraph 3 as
“the chance of the future event or events occur-
ring is more than remote but less than likely.”
Once it has been determined that a contingency
exists and that it must be disclosed, the contin-
gency must be estimated. FASB Interpretation No.
14 (FIN 14) provides an interpretation of FAS 5
on how to provide for a reasonable estimation
of the amount of a loss. But although guidance
is provided on pending litigations and the use
of ranges to estimate the liability, FASB does not
provide substantial guidance on methods that
may be used to calculate the contingency. Once
you have determined that a contingency exists,
you must determine whether the contingency
may be reasonably estimated. Unfortunately,
FAS 5 provides minimal guidance as to what is
reasonable. Merriam-Webster’s dictionary de-
fines reasonable as “being within the bounds of
reason.” Since sales and use taxes are transaction
based, quantifying any of the above-mentioned
potential contingencies could require reviewing
large amounts of data even to calculate an esti-
mated amount of liability or a range of liability.
There are several factors to consider when quan-
tifying a FAS 5 contingency:
Customer obligations/indemnifications—When
quantifying your exposure, consider customer
obligations. For example, your company may
have failed to collect sales and use taxes, some-
thing that could result in the need for an accrual.
However, contact your customer to see if they
have already self assessed and paid the tax, paid
the tax as a result of a tax assessment, should
have issued a resale or exemption certificate, or
would be willing to be invoiced for the tax. If so,
and assuming it can be reasonably estimated,
your exposure should be modified to take this
into account [There is no analogous principle
under FATCA—the fact that the payee has paid
the withholding tax does not alleviate the with-
holding agent or payor from its own responsibility

to withhold under new Code Sec.s 1471(a) and
1472(a).5]
In addition, review all agreements related to
recent acquisitions to verify which party will be
responsible for any taxes due associated with an
acquisition. The agreement may also contain an
indemnification clause that could relieve your
company from all or part of the liability, and this
could affect your estimated contingency.
Contingency estimate by state or legal entity—If
you plan to perform a sample or use an alter-
native method to estimate the contingency, be
prepared to identify the amount of the exposure
by state, by legal entity and by period. This will
be necessary to properly account for the accrual
in the financial statements and to update the ac-
crual periodically. In addition, if a sample period
is selected to estimate the exposure related to
non-taxed purchases, consider using total ac-
counts payable data to apply to the error rate to
calculate the exposure. [At present there are no
provisions for FATCA that permit use of a sample
or other acceptable methods to estimate the
withholding tax liability under new Code Secs.
1471(a) and 1472(a) although the IRS has used
statistical sampling techniques in it 1441 audits
for several years.]
Penalties and interest—Most states impose
penalties and/or interest associated with an as-
sessment; therefore, these additional costs should
be included when calculating an estimated con-
tingency. However, several factors could occur
that would not require including penalties and
interest. For example, if the liability is associated
with failure to collect the tax in a particular state,
and if the company may participate in a voluntary
disclosure program or an amnesty program that
may provide for full or partial waiver of penalties
and/or interest, perhaps no additional liability
need be included.
Review by the external auditors—Bottom line,
make sure you have proper documentation on
file to support your accrual. It may be several
months before the auditors will review your
documentation. The schedules should speak for
themselves and not require any explanation. If
you performed a sample, make sure you have
Taxes—The Tax Magazine®
September 2010
documented the methods you used to design and
select your sample, as well as any assumptions
made. Understand how the external auditors plan
to audit the accrual you have calculated. Most au-
ditors have experience doing samples; however,
if they plan to test your sample, make sure you
understand how they plan to project their results
in case they find any errors.” [The Treasury has
not yet put out guidance on the documentation
or account verification procedures it will require
to support a withholding agent’s accrual.]
Because FATCA issues are likely be material and
significant (e.g., withholding on gross proceeds from
the disposition of U.S. stock or securities) when they
arise as a result of failing to withhold a 30-percent
tax under new Code Sec. 1471(a) or 1472(a) for
withholdable payments made to a foreign financial
institution or non–financial foreign entity, respec-
tively, or from the failure to withhold a 30-percent
tax on pass-through payments to recalcitrant account
holders or non-participating foreign financial institu-
tions under new Code Sec. 1471(b)(1)(d) or 1471(d)
(3), it is likely that a financial statement reserve issue
may arise either on the basis of FAS 5 or FIN 48.
In many cases, it is likely the withholding agent,
the foreign financial institution, the non–financial
foreign entity or the intermediaries in the payment
and reporting chain may end up in litigation if the
Treasury finds a Chapter 4 deficiency, interest and
penalties. This exposure may arise by contract (e.g.,
an indemnity by a servicer or administrator or a third
party who has undertaken the FATCA withholding or
reporting responsibilities) or as a result of their posi-
tion as a fiduciary (e.g., manager or sponsor), or in
equity on a transferee liability theory among others.6
Thus, a firm will have to contend with how to ac-
count for what may be very material and significant
loss contingencies on their financial statements as
well as what parameters (e.g., indemnities, insurance,
etc.) must be considered to mitigate the amount of
the reserve or its reversal.
Perkins Cole7 has put together the following cogent
analysis which goes into an analysis of FAS 5 that
may be helpful:
Determining when and how to account for loss
contingencies is an important decision for com-
panies that have been sued. Reserving funds for
possible litigation losses may significantly affect
reported earnings. Worse, failing to book appropri-
25
New U.S. Withholding System for Foreign Account Tax Compliance
ate reserves may lead to restatements of earnings,
which could invite an SEC investigation or share-
holder litigation. Apart from reserves, the mere
decision whether to disclose pending litigation in
financial statements can also have major financial
and legal ramifications. Moreover, both public and
nonpublic companies are affected because both
must properly account for and disclose litigation
loss contingencies to comply with Generally Ac-
cepted Accounting Principles (“GAAP”).
Unfortunately, setting loss reserves is not as easy
as following simple steps or plugging numbers
into a formula. The accounting standards are
muddled and applying them requires a great deal
of discretion and judgment. Even the disclosure
rules are fraught with peril.
When Is a Litigation Loss Reserve Required?
Under Financial Accounting Standard No. 5
(“FAS 5”), a company must create a litigation loss
reserve if (1) a loss is probable and (2) the amount
of the expected loss is material and reasonably
estimable.
(1) Is a Litigation Loss “Probable”?
The first challenge is to figure out when a loss
is “probable.” FAS 5 identifies three categories
of likelihood: “probable,” “reasonably possible”
and “remote.”
Probable. According to FAS 5, a future event is
“probable” if it is “likely to occur.” FAS 5 does
not define “likely,” except to say that “probable”
does not infer “virtual certainty.” Formal defini-
tions aside, “probable” is usually interpreted in
practice as meaning “highly likely.”
In evaluating the probability of an unfavorable
litigation outcome, factors to consider include:
(a) the nature of the litigation, claim or assess-
ment; (b) the progress of the case; (c) the opinions
of legal counsel and other advisers; (d) the ex-
perience of the company and others in similar
cases; and (e) any deci­sion by management as
to how the company will respond to the lawsuit.
Deter­mining whether a loss is probable requires
consider­able judgment, and the assessment may
change as the litigation progresses.
26
Reasonably Possible. If the “chance of the
future event or events occurring is more than
remote but less than likely,” the adverse out-
come is deemed “reasonably possible.” A loss
reserve is not required, but disclosure may be
(see below).
Remote. If the chance of an adverse outcome
is slight, the event considered is “remote,” and
that ends the analysis. No reserve or financial
statement disclosure is required. Periodic re-
assessments of pending and threatened litigation
may be necessary, however, to determine whether
a loss that once seemed remote is now probable
or reasonably possible.
(2) If a Loss Is Probable, Is the Amount of the Loss
Reasonably Estimable?
If a company determines that a loss is probable,
it next must consider whether the amount of the
loss will be material and if it can be estimated. If
the loss is not material or cannot be reasonably
estimated, no reserve is required. Even if it is
impossible to estimate the exact amount of prob-
able loss, however, a company should attempt to
estimate the range of possible losses. If no amount
within the range appears to be the best estimate,
the company should reserve the low end of the
range and then dis­close the remaining amount,
up to the high end of the range, as a “reasonably
possible” loss.
When Is Disclosure Required?
If a company determines that a loss is only “rea-
sonably possible” or that a loss is “probable,”
but the amount is not reasonably estimable, the
company need not establish a reserve, but it still
must disclose the nature of the possible loss and
give an estimate of the possible loss or range of
loss. The key is to ensure that the financial state-
ments are not misleading.
In addition to the disclosure requirements of FAS
5, public companies must also disclose signifi-
cant legal proceedings under SEC Regulation S-K
Item 103, which requires disclosure of material
legal proceedings in both the annual report (on
Form 10-K) and the quarterly report (on Form
10-Q), unless the claims represent less than 10
 September 2010

percent of the company’s current Chart 1

assets. SEC Reg. § 229.103. Thus,
in some instances Regulation S-K
may require disclosure of pending
litigation that need not be disclosed
under FAS 5. [Chart 1] illustrates the
decision process[.]

Practical Tips

Companies that either fail to es-

tablish sufficient litigation loss
reserves or overstate litigation loss
reserves (so that the company can
“manage earnings” by releasing
reserves into income in bad years)
have faced private litigation and
SEC enforcement actions. The
following tips may help avoid com-
mon pitfalls.

Tip 1: Establish a company reserve

policy and apply it consistently. A
written and consistently applied
reserve policy may help a company defend a
decision not to book a reserve. Establishing and
following the policy helps the company avoid
appearing opportunistic in setting and maintain-
ing reserves.
Tip 2: Err on the side of disclosure where there
is any chance that a litigation loss could be
considered “reasonably possible.” Failing to
disclose the possibility of a material litigation
loss can result in lawsuits and enforcement ac-
tions if it later becomes clear that reserves were
inadequate and company executives knew or
should have known that a material loss was
reasonably possible.
Tip 3: Book a reserve only where a loss is prob-
able and the amount of loss can be reasonably
estimated. A reserve should not be booked unless
both FAS 5 requirements are satisfied. The SEC
views creation of reserves for an improbable
amount of loss to be a form of earnings man-
agement. If a loss is only reasonably possible,
the company should disclose the nature of the
contingency and an estimate of the possible loss
or range of loss (or state that such an estimate
cannot be made).
Tip 4: Reverse a reserve only where a change
in facts makes the reserve (or a portion of the
reserve) unnecessary. The SEC looks unfavorably
on a company’s release of reserves into income
where no specific development or change
justifies the release. Reversing a reserve in a
bad year is particularly likely to be viewed as
opportunistic.
Tip 5: Do not create general reserves to cover
unspecified claims. Litigation reserves should be
determined on a case-by-case basis and should
not be created for general future litigation costs
and expenses.
Tip 6: Periodically reassess pending and threat-
ened litigation to determine the adequacy of
reserves. The probability of a loss and the abil-
ity to estimate the amount of the loss will likely
change as the litigation progresses. A litigation
loss considered remote when the suit was filed
may later become reasonably possible or prob-
able if dispositive motions are unsuccessful or
discovery reveals damaging facts. It is also impor-
tant to reassess the amount of existing reserves.
If the underlying case settles, for example, the
reserves must be reversed into income.

Taxes—The Tax Magazine® 27

New U.S. Withholding System for Foreign Account Tax Compliance
IRS Audits of Tier I Issues
and the Potential Impact upon
Financial Institutions
IRS realigns and renames Large Business Division
and enhances the focus on international tax admin-
istration. On August 4, 2010, in IR-2010-0888 (the
“Notice”), the IRS announced as part of a continuing
effort to improve global tax administration efforts,
the realignment of the Large and Mid-Size Business
(LMSB) division to create a more centralized orga-
nization dedicated to improving international tax
compliance. As part of the organizational shift, the
name of the IRS’s large corporate unit—LMSB—will
change on October 1, 2010, to the Large Business
and International (LB&I) division.
As part of the notice, IRS Commissioner Doug Shul-
man stated: “Executing our international strategy is
a top priority, and our work continues to intensify in
this area, Every day, we are moving forward in our
international compliance efforts. Bringing together
our top international personnel in this new group
will help us advance our global tax administration
efforts and ensure focus and fairness in a critical area
for our nation.”
The Notice indicates the new LB&I organization
will enhance the current International program, add-
ing about 875 employees to the existing staff of nearly
600. Most of the additional examiners, economists
and technical staff are current employees who spe-
cialize on international issues within other parts of
LMSB. The realignment will strengthen international
tax compliance for individuals and corporations in
several ways, including identifying emerging inter-
national compliance issues more quickly, removing
geographic barriers, allowing for the dedication of
IRS experts to the most pressing international issues,
increasing international specialization among IRS
staff by creating economies of scale and improving
IRS international coordination, ensuring the right
compliance resources are allocated to the right cases,
consolidating oversight of international information
reporting and implementing new programs, such as
the FATCA, coordinating the Competent Authority
more closely with field staff that originate cases,
especially those dealing with transfer pricing and
otherwise centralizing and enhancing the IRS’s focus
on transfer pricing.
Heather C. Maloy will continue serving as Com-
missioner of LB&I. Michael Danilack, Deputy
Commissioner, International, will head the realigned
28
global unit. Paul D. DeNard will continue serving
as Deputy Commissioner (Operations). The new
international unit will include a transfer pricing di-
rector, who will continue piloting the new transfer
pricing practice, and a chief economist, who will
oversee the IRS’s economic positions pertaining to
transfer pricing.
“The realigned organization will let us focus on
high-risk international compliance issues and handle
these cases with greater consistency and efficiency
as we continue to increase our work in this area,”
Shulman said.
In addition, the realigned LB&I will continue to
serve the same population of taxpayers—corpora-
tions, Subchapter S corporations and partnerships
with assets greater than $10 million as well as
certain high wealth individuals. The Notice further
indicates that the announcement marks the latest in
a number of efforts the IRS has made to increase in-
ternational tax compliance. The IRS has taken major
steps to address offshore tax evasion, including the
investigation of the misuse of undisclosed offshore
accounts by U.S. taxpayers. Last fall, the IRS created
a Global High Wealth Industry unit to better monitor
tax compliance by high income individuals and their
related enterprises.
The Notice indicates that LB&I is also charged with
overseeing the implementation of FATCA, which
will substantially improve international information
reporting, increasing international transparency and
compliance, and notes the IRS and the Treasury have
also worked to revise tax treaties and tax information
exchange agreements (TIEAs) to increase transpar-
ency and to make it more difficult for taxpayers to
evade taxes just by crossing international borders.
IRS “Rules of Engagement.” In 2007, the IRS issued
its so-called Rules of Engagement for examinations
under which examining agents will have certain
ranges of discretion in applying guidance to a tax-
payer’s facts and circumstances with respect to issues
deemed to pose the greatest compliance risk.9 The
Rules of Engagement classify issues into three cat-
egories: (i) Tier I, issues of high strategic importance;
(ii) Tier II, issues of significant compliance risk; and
(iii) Tier III, issues of industry importance.
Tier I issues are those that have significant impact
on one or more industries and include areas involving
a large number of taxpayers, significant dollar risk,
substantial compliance risk or high visibility where
there are established legal positions and/or large- or
medium-size business division (LMSB) direction. Tier

II issues reflect areas of potential high noncompliance
risk to LMSB or an industry and includes areas where
the law is fairly well established, but there is a need
for further development, clarification, direction and
guidance on LMSB’s position. Tier III issues are those
issues that represent the highest compliance risk for
a particular industry and which require unique treat-
ment for an industry.10
Code Sec. 1441 reporting and withholding of U.S.
source FDAP income made a Tier I issue. On March
18, 2009, the IRS stepped up its enforcement effort to
enforce cross-border compliance by announcing that
cross border withholding would be treated as a Tier
1 issue (“U.S. Withholding Agents—Code Sec. 1441
Reporting and Withholding on U.S. Source FDAP
Income”).11 In a separate document, the IRS explained
its rationale for designating U.S. source FDAP income
as a Tier I issue by stating the “potential use of total
return swaps to minimize withholding tax.”12
On June 17, 2010, Michael Danilack, Deputy
Commissioner (International), at the 22nd Annual
Forum on International Tax and Withholding and
Information Reporting Conference presented by EEi,
explained that while the FATCA legislation has an
effective date on December 31, 2012, the IRS is not
going to relax its efforts to enforce the existing U.S.
withholding tax laws under Chapter 3 for QIs and
non-QIs and under Code Sec. 1461 which addresses
withholding agent liability.
Thus, it can be anticipated withholding agents at
major financial institutions will likely be subject to a
so-called Tier I audit during the next 30 months prior
to the effective date of FATCA which will not only cre-
ate tax exposures for these institutions, but will give
the IRS a pretty good idea of those institutions who
may not be willing to become fully compliant with
FATCA, either as a withholding agent or as a foreign
financial institution or non–financial foreign entity.
In addition, once IRS agents become thoroughly fa-
miliar with U.S. information reporting audits under
Code Sec. 1461, it will be easier for the IRS to train
its examiners on how to conduct an audit to enforce
the FATCA rules.
Code Sec. 1461 audits. It can be expected that
IDRs13 will be forthcoming which will analyze the
methods, operating manuals, checklists, procedures,
processes and systems and internal audit reports used
by U.S. withholding agents to process new accounts,
including identification of the payee, fiduciary op-
erations, customer account opening and validation
procedures and processes for recording customer
Taxes—The Tax Magazine®
September 2010
transactions. In addition, the IDRs will likely ask for
flowcharts, diagrams and other material that describes
how customer account information is incorporated
into each company’s EDP system for, among other
things withholding and tax reporting purposes. The
names and titles of all individuals familiar with the
withholding and reporting systems and manuals and
procedures will likely also be requested.
Importantly, the IDRs will likely also request cus-
tomer ledgers or other records pertaining to each
entity’s U.S. withholding and information reporting
that record, report, identity or show information
about customers who have been classified as foreign
residents for withholding and reporting purposes
and may also include a request for e-mail and other
computer and manual records.
As an integral part of the withholding examination,
the examiner will likely review the W-9s, W-8BENs,
W-8ECIs, W-8EXPs and W-8IMYs.
Among other areas, the IRS examiner will review
the U.S. withholding agent’s systems to determine
whether it considers the following: (i) beneficial
owner processing, (ii) exempt entity processing,
(iii) “no documentation” requirements process-
ing, (iv) processing for intermediaries, (v) interest
withholding and exemptions, (vi) securitized trans-
actions, (viii) REIT processing, (ix) original issue
discount, (x) eligible securities, (xi) U.S. branch
processing, (xii) affiliate transactions, (xiii) inter-
national organizations, (xiv) exempt recipients,
and (xv) backup withholding.
As part of this exam, the IRS will review the ac-
count opening procedures and examine how the
identity of each payee is established upon entry into
the bank/brokerage/insurance/custodial account
system. Among other questions, the IRS will seek to
know whether the U.S. withholding agent properly
identifies appropriate account withholding treatment,
whether it ensures the proper separation of duties with
respect to opening and processing of accounts as part
of the internal control description (e.g., employees
whose duties include opening accounts are not part
of the retention, custody, or accounting for records)
and how exceptions by the firm are addressed.
As part of the IDRs, the IRS will likely ask for a
copy of all Forms 1042, Annual Withholding Tax for
U.S. Source Income of Foreign Persons filed for all
the open tax years and a copy of the Form 1042-S,
Foreign Person’s US. Source Income Subject to With-
holding for each entity in the consolidated group
and any workpapers or other supporting documents
29
New U.S. Withholding System for Foreign Account Tax Compliance
used in preparing these documents, and if complete
forms are not available, the (i) name of each payor,
(ii) name of each payee, (iii) the country in which the
payee is located, (iv) the amount paid (v) the dates of
payment, (vi) the type of payment, (vii) the amount
withheld and rate withheld, and (viii) any applicable
treaty reductions.
After this information is obtained, it is likely the IRS
will apply statistical sampling techniques to examine
the accounts. To this end, the examiner may group
the transactions into strata according to dollar value
or other areas of interest or concern including but
not limited to (i) accounts grouped by withholding
rate, (ii) accounts grouped by amount, (iii) account
grouped by the recipient’s country from Form 1042-S,
(iv) amounts grouped by the recipient’s code from
1042-S, (v) accounts grouped by the expected docu-
mentation to be reviewed such as W-8IMY, W-8BEN
and W-8EXP, (vi) accounts grouped by business unit,
product, platform, legal entity or cost center, and
(vii) accounts grouped by margin account, sweep
account, and other specialized depository, custodial
and escrow accounts.
Presumably, a Computer Audit Specialist will be
brought with the assistance of the Statistical Sampling
Coordinator to determine the appropriate sample
size and the validity of the sample. In most cases, the
sample size will be at least 100 accounts excluding
all the strata tested on a 100-percent basis to support
the use of the ratio and regression estimators.
Once the sample is identified the examiner will
request the account file and documentation informa-
tion from the U.S. withholding agent for each account
selected. In addition to the information identified
above, to see if the payee provided the appropriate
documentation, the verification of the payee status
and classification as foreign status, the examiner will
consider the type and source of income in determin-
ing if the withholding is correct. Among other types
and sources of income the examiner will look at (i)
securities lending, (ii) interest paid by U.S. obligors,
(iii) the sale of property and assumption of bonds,
(iv) margin accounts, (v) interest coupons in default,
(vi) domestic corporations paying to foreign affiliates,
(v) original issue discount, (vi) bank deposit interest,
(vii) portfolio interest, (viii) interest and real property
mortgages, (ix) interest paid to controlled foreign
corporations, (x) notional principal contract income,
(xi) dividends, (xii) eligible securities, (xiii) effectively
connected income, (xiv) U.S. branches, (xv) REIT
distributions, and (xvi) international organizations.
30
Pre-2013—U.S. withholding and reporting audits
of syndicated loans—Code Sec. 1441. As a Tier I
issue, the IRS will be particularly interested in how
a financial institution which is a withholding agent
complied with the U.S. withholding and reporting
law for its syndicated loans. A syndicated loan results
when financial institutions collectively participate
in funding a single loan. Generally, one of the par-
ticipants will act as an administrator and distribute
the interest income to the other participants. The
administrator will be the withholding agent.
Code Secs. 871(h) and 881(c) generally provide
that a non-U.S. person is exempt from the 30-percent
withholding tax on portfolio interest. There are several
limitations on this exemption such as the “bank loan
exception.” The portfolio exemption does not apply
to any interest received by a bank on the extension
of credit made pursuant to a loan agreement entered
into in the ordinary course of its trade or business.14
Accordingly, foreign banks, which are participants
in the syndicated loan, should not benefit from the
portfolio exemption.
Often the participants will change. For example,
when the original participants sell all or a portion of
their interests in the loan to another bank, withhold-
ing related documentation is required from each of
the new participants. An audit concern is to deter-
mine if required Forms 1042 and 1042-S were not
filed and/or Forms W-8 were not secured.15
2013 and Forward—U.S. withholding and report-
ing audits of syndicated loans—Code Secs. 1441 and
1471–1474. The IRS will likely continue examining
and putting resources toward examining syndicated
loan and other structures at major financial institu-
tions as a Tier I issue to ascertain if the financial
institutions are complying with FATCA under new
Code Secs. 1471–1474, as well as under Code Sec.
1441 and the FDAP rules.
Since merger and acquisition deal making is cur-
rently anemic with only a smattering of multi-billion
dollar deals in 2010, the market activity for syndi-
cated loans has been severely curtailed. However, as
the economy begins to improve next year, it is likely
that many undervalued and vulnerable companies
will become targets by both private equity and strate-
gics alike. Presumably, this will again create a buyers’
market and demand for these companies and also a
heavy demand on the debt markets.
However, many bank balance sheets are currently
“risk constrained.” That is, because of the lessons
learned from the recession, unless a major bank is

meaningfully involved, knows the company well for
many years, its strengths and weaknesses and its credit
and liquidity it will not fund the entire loan itself. This
is likely true even for the biggest banks with the horse
power of huge balance sheets—they will undoubtedly
seek the lower risk of a syndicated loan with other
mid- and smaller sized banks, funds and private equity
investors to partner up with as part of a loan consor-
tium to reduce their risk in any one deal.
For U.S. tax purposes, each mega deal may now
create huge tax exposure that in the past was not
present (e.g., FATCA 30-percent withholding tax is
not only based on FDAP income, but is also applied
on the gross proceeds from the sale or disposition
of U.S. stock or securities received by a noncompli-
ant FFI/NFFE) unless these deals are properly vetted
for both FATCA and FDAP reporting and withhold-
ing purposes. To that end, the term sheet and other
loan documentation should be reviewed before the
deal goes hard to ascertain who are the withholding
agents in the syndicated loan structure for purposes
of the two regimes, and who is responsible for the
U.S. withholding and reporting. Since there may be
more than one withholding agent responsible, the
deal documents should by contract spell out the re-
sponsibilities and obligations of each of the lenders,
borrowers and their intermediaries or their agents
and other professionals.
Under both withholding tax regimes, it is critical
to ascertain whether the U.S. borrower has obtained
a loan directly from a lead bank that has then gone
out and obtained separate loans from other partici-
pant banks and lenders, or whether the borrower has
entered into a loan directly with a loan syndication
group including the lead bank. It may prudent to
obtain an opinion from outside counsel as to whether
the lead bank has provided one large mega loan for
a buyer in an M&A deal (or its holdco) or whether
the syndication loan group has provided the funding
based upon each participants share of the aggregate
debt as individual debt holders.
Thus, if IBM in its capacity as a borrower goes to a
U.S. bank (or to a foreign bank’s office in the United
States) and obtains a large loan to facilitate its acquisi-
tion of a strategic target, the financing will likely by
treated by the IRS as a loan between the equivalent
of two U.S. persons (assuming the foreign bank’s U.S.
branch is excluded from FATCA when the IRS pro-
vides guidance) for withholding tax purposes and not
subject the payments under the loan to withholding
taxes under either the FATCA or the FDAP rules.
Taxes—The Tax Magazine®
September 2010
However, if that same bank then goes and obtains
financing for this loan by obtaining various loans
from foreign banks, offshore funds and other foreign
entities which may have U.S. accounts, it is possible
for the lead bank (or its agents and administrators)
to be treated as withholding agents for FATCA, as
well as for purposes of Code Sec. 1441 (Note: FDAP
withholding may be triggered if an exemption does
not otherwise apply even if these foreign entities do
not have U.S. accounts).
As the withholding agent, the lead bank will likely
have to obtain Forms W-8 (or equivalent for FATCA)
that its subordinate lenders are compliant FFIs or
NFFEs and to determine whether it (or its administra-
tor) must withhold and report under Code Sec. 1441.
If the foreign subordinate lenders to the lead bank
are not compliant FFIs or NFFEs, it is likely the lead
bank will be required to withhold under new Code
Sec. 1471(a) or 1472(a). Similarly, if the portfolio
exemption does not apply because the one or more
of the loans was made by subordinate lenders in the
ordinary course of its business, another exemption
does not otherwise apply or U.S. treaty relief is not
available to reduce the rate of withholding it is likely
the lead bank will have to withhold a 30-percent tax
and report under Code Sec. 1441 the interest paid
to the foreign subordinate lenders.
It should be noted if FATCA withholding applies in
the first instance to withholdable payments (FDAP
and gross proceeds from the sale or disposition of
the loan) made by lead bank to the foreign subordi-
nate lenders, there will not be a second obligation
to withhold by the lead bank under Code Sec.
1441 for the FDAP income on the loans. However,
if the foreign subordinate lenders are compliant
FFIs or NFFEs, it is very possible that the lead bank
may have an obligation to withhold on the FDAP
income (e.g., interest income) if an exemption does
not otherwise.
On the other hand, if IBM in its capacity as a bor-
rower entered into a loan with a group of banks,
offshore funds and other foreign entities, it is likely
IBM (or its custodian or agent) will be the with-
holding agent responsible for obtaining directly
from these lenders Forms W-8 (or its equivalent for
FATCA) to ensure that they are compliant FFIs or
NFFEs. Here again, IBM will have the obligation to
withhold on any withholdable payments received
by noncompliant FFIs or NFFEs. If these lenders
are otherwise found to be compliant for FATCA
purposes, IBM may have an obligation to withhold
31
New U.S. Withholding System for Foreign Account Tax Compliance
on any FDAP income if an exemption does not
otherwise apply.
It is possible that the lead bank or other intermediar-
ies or agents that helped arrange the consortium may
also be viewed as a withholding agents for FATCA and
FDAP purposes in addition to IBM unless the underly-
ing facts and documentation support the position that
the lead bank or others were not acting as persons
having control, receipt, custody, disposal or payment
of any such payment in whatever capacity.16
Reduction of FATCA/FDAP
Exposures: Contractually
Outsourcing Withholding or
Reporting Duties, Product
Certifications of FATCA
Compliance—Preliminary
Thoughts
As the IRS provides guidance on how to implement
the new legislation it may be prudent for foreign
financial institutions, non–financial foreign enti-
ties, withholding agents, intermediaries, servicers,
managers, sponsors and other third-party vendors
who decide to outsource the reporting or withhold-
ing duties (including withholding on pass-through
payments to recalcitrant account holders or nonpar-
ticipating foreign financial institutions) to consider
the possible increased FAS 5 or FIN 48 exposure
to ultimately resolve the private litigation that may
arise in the case of noncompliance under FATCA
or the FDAP rules and possible mitigants that may
reduce the FATCA/FDAP exposures and permit an
adjustment or reversal of these reserves.
It is likely that some firms or offshore funds or
securitization vehicles will want turn-key FATCA/
FDAP reporting and withholding services and want
to be protected in case of process or other material
errors, while other will want to outsource only the
withholding duties and will undertake the account
identification, diligence and on-going reporting and
verification themselves (or visa versa) with varying
degrees of contractual protection agreed upon by
the parties.
Menu of FATCA/FDAP services by vendors.
Presumably, vendors providing these services will
establish price points for a menu of services, which
may mitigate the FATCA/FDAP exposure depend-
ing on among other factors how well the existing
32
U.S. information reporting platforms function and
upon how much resource the firm has allocated to
FATCA/FDAP implementation and the development
of robust FATCA/FDAP processes, which will need to
be coordinated with the Chapter 3 (Code Sec. 1441)
and the QI withholding and reporting regime. Some
firms may be want to go further to reduce their aggre-
gate global FATCA/FDAP risk by obtaining “FATCA/
FDAP insurance,” if insurers decide that the various
FATCA/FDAP risks for certain products or platforms
is a line of business they want to get into once the
IRS provides guidance on how FATCA/FDAP is to be
implemented.
Certification of FATCA/FDAP compliance for
certain products by financial sponsors. In addition,
some firms may elect to certify some of their finan-
cial products, investment vehicles or platforms with
FATCA/FDAP exposure to investors and the market
place that the FATCA/FDAP risks have been ring
fenced by outsourcing the reporting and withhold-
ing responsibilities, contractual indemnities, FATCA/
FDAP insurance, or a combination thereof in hopes
of gaining some competitive advantage over other
similar products marketed by other financial spon-
sors. However, this “good housekeeping seal” may
be costly to obtain and may give investors and other
intermediaries’ additional rights to litigate in the event
the IRS finds that the foreign financial institution is
not FATCA/FDAP–compliant unless the disclosures in
the prospectus or offering documents are drafted very
carefully. (See “Investor Disclosure for FATCA”).
For firms with FATCA/FDAP withholding, report-
ing or other responsibilities, it can be expected
that it will be expensive for a third-party insurer to
underwrite the legal and reputational risks (includ-
ing the impact on its goodwill and other business
platforms) for FATCA/FDAP withholding taxes (es-
pecially since the 30-percent FATCA withholding
tax is geared in part to withholdable payments from
the gross proceeds from the sale of U.S. stock or se-
curities), which may be triggered in many cases by
process and reporting errors for the U.S. accounts
that are not remediated to the satisfaction of the
Treasury. Once the legislation becomes effective
in 2013, these FATCA risks will likely have to be
borne by the firms that are the withholding agents
making withholdable or pass-through payments
to foreign financial institutions or non–financial
foreign entities, or the FFIs or NFFEs themselves
that are responsible for the reporting, diligence and
verification of the U.S. accounts.

Common Types of
Withholdable Payments
The IRS has identified the following items as examples
of FDAP income that may be treated as “withholdable
payments” for purposes of new Chapter 4: compen-
sation for services; dividends; interest; original issue
discount; REMIC excess inclusion income; pensions
and annuities; real property income, such as rents,
other than gains from the sale of real property; royal-
ties; scholarships and fellowship grants; other grants;
prizes and awards; sales commissions paid or credited
monthly; commissions paid for a single transaction;
distributable net income of an estate or trust that is
FDAP income and that must be distributed currently
or has been paid or credited during the tax year, to
a nonresident alien beneficiary; distributions from a
partnership that is FDAP income or such an amount
that although not actually distributed is includible in
the gross income of a foreign partner; taxes, mortgage
interest or insurance premiums paid to or for the
account of a nonresident alien landlord by a tenant
under the terms of a lease; prizes awarded to nonresi-
dent alien artists for pictures exhibited in the United
States; and purses paid to nonresident alien boxers for
prize fights in the U.S. prizes awarded to nonresident
alien professional golfers in golfing tournaments in
the United States.17In addition, REIT distributions to
foreign financial institutions or non–financial foreign
entities giving rise to ordinary dividends, capital gains
or return of basis and income received under life
insurance or annuity contracts issued by a U.S. life
insurance company or a foreign branch of a U.S. life
insurance company18 may be considered withhold-
able payments when the IRS provides guidance.
Since an individual is not included in the definition
of foreign financial institution or non–financial foreign
entity, the above payments, which are paid directly to
an individual and not to his or her foreign entity, will
not be treated as withholdable payments for purposes
of new Chapter 4, but may continue to be subject to
U.S. withholding tax under Chapter 3.19
Exclusions. While not currently excludable from the
term “withholdable payment,” the following income
was not generally subject to tax withholding under
the U.S. tax law prior to the HIRE Act and may be
excluded as withholdable payments as the Treasury
provides guidance in the near future: portfolio interest
on bearer obligations or foreign-targeted registered
obligations if those obligations meet certain require-
ments (see “Repeal of certain foreign exceptions to
Taxes—The Tax Magazine®
September 2010
registered bond requirements”); interest on deposits
(bank deposit interest that is not effectively connected
with the conduct of a U.S. trade or business); original
issue discount on obligations payable 183 days or less
from the date of original issue; original issue discount
paid on the sale of an obligation other than a redemp-
tion; amounts paid as part of the purchase price of
an obligation sold between interest payment dates;
nonbusiness gambling income of a nonresident alien
playing blackjack, baccarat, craps, roulette or big-6
wheel in the United States; and insurance premiums
paid on a contract issued by a foreign insurer. 20
Presumably, the fact that the FDAP income has not
actually been currently paid to the payee will not mat-
ter for purposes of new Chapter 4. Thus, a dividend
which is declared but unpaid will likely be includable
in the term “withholdable payment.” Because new
Code Sec. 1473(1) includes in the term “withhold-
able payment” “any gross proceeds from the sale or
other disposition of any property of a type which can
produce interest or dividends from sources within the
United States,” it is unclear whether a corporation
making a distribution with respect to its stock or any
transfer agent or other intermediary making a pay-
ment of such a distribution is required to withhold on
the distribution to a noncompliant foreign financial
institution or noncompliant non–financial foreign
entity for the following distributions: a nontaxable
distribution payable in stock rights; a distribution in
part or full payment in exchange for stock; a disposi-
tion of Code Sec. 306 stock,21 a distribution that is
not paid out of current or accumulated earnings and
profits; and a distribution that represents a capital
gain distribution or an exempt interest dividend by a
regulated investment company or is already subject
to withholding under Code Sec. 1445 (withholding
on the disposition of U.S. real property interests and
the distribution corporation is a U.S. real property
holding corporation) or qualified investment entity.
Financial products. It is quite likely that the Treasury
will also include in the concept of “withholdable
payments” payments from various financial products
that may generate U.S. source income. One approach
may be for the Treasury to use the same definition (as
expanded by regulatory guidance in the near future)
that they decide to use for new Code Sec. 6038D
for purposes of individual reporting of “specified for-
eign financial assets,” or “SFFAs,” on an individual’s
income tax return if the aggregate value of all such
assets exceeds $50,000 beginning for tax years in
2011. New Code Sec. 6038D(b)(2)(A) includes “any
33
New U.S. Withholding System for Foreign Account Tax Compliance
financial instrument or contract held for investment
that has an issuer or counterparty which is other than
a United States person.”
Presumably, forward contracts, repurchase
agreements or repos, sweep accounts, securities
lending—substitute dividends and interest, certain
options, various types of derivatives such as caps,
collars and floors, commodity based derivatives and
certain contracts, annuities and many other structured
financial products that may be packaged as invest-
ment units or wrappers may be swept in under this
definition. In addition, it can be expected that with-
holdable payments under new Code Sec.1471 will
include certain payments arising in connection with
securities lending and notional principal contracts
including (i) rebate fees (interest paid by U.S. lenders),
(ii) U.S. source borrow fees paid by U.S. borrowers,
(iii) substitute U.S. interest/dividend payments, and
(iv) outbound repo spreads (interest).22
Withholding on gross proceeds. The new law
also includes within the term “withholdable pay-
ments” “any gross proceeds from the sale or other
disposition of any property of a type which can
produce interest or dividends from sources within
the United States.”23
In general, Code Sec. 6045 requires the reporting
by a broker (i.e., the person that effectuates sales
for another person)24 of the gross proceeds from the
sale of certain securities. Reg. §1.6045-1(a)(9)de-
fines a “sale” to mean “any disposition of securities,
commodities, regulated futures contracts or forward
contracts for cash, and includes indebtedness, and
entering into short sales … .” (Emphasis added.) The
instructions to Form 1099-B, Proceeds From Broker
and Barter Exchange Transactions, indicate a broker
must file a Form 1099-B for each person for whom the
broker has sold (including short sales) stocks, bonds,
commodities, regulated futures contracts, foreign
currency contracts (pursuant to a forward contract
or regulated futures contract), forward contracts,
debt instruments, etc., for cash, who received cash,
stock, or other property from a corporation that the
broker knows or has reason to know has undergone
a reportable change in control or substantial change
in capital structure, or who exchanged property or
services through a barter exchange.
One commentator has suggested that the phrase
“or other disposition” in the final version of the
law “actually goes far beyond [Code Sec.] 6045
requirements for withholding domestically on
gross proceeds.”25
34
Investor Disclosure for FATCA
The new law is effective for payments made after
December 31, 2012.26 However, the new law has a
grandfather rule that does not require any amount to
be withheld from any payment under any obligation
outstanding on the date that is 2 years after the date
of enactment (e.g., March 18, 2012) or from the gross
proceeds from the disposition of such obligation.27 If
a new or existing offshore securitization, mutual or
investment fund with U.S. accounts or other offshore
vehicle with substantial U.S. owners seeks to raise
capital by going to the debt or equity markets (as-
suming the Treasury takes a broad view of the term
“obligation”—see “Effective Date and Grandfather
Treatment for Outstanding Obligations”), it may be
prudent to include appropriate FATCA disclosure,
which at a minimum discusses the requirements for
a foreign financial institution or non–financial foreign
entity under new Code Sec. 1471(b) or 1472(b), if
any exemptions apply and importantly the conse-
quences for failure to be FATCA compliant after the
effective date. Presumably, grandfathered offerings,
which by their terms offer investors the possibility of
reinvestment after March 18, 2012, may need this
disclosure now.
Treasury Guidance on
Customer Accounts and Best
Practices for Customer Accounts
The IRS is planning to issue guidance this summer
on FATCA and it looks like the initial guidance will
address customer identification issues. This may
be favorable news because it may reflect that the
Treasury is taking a practical view and permitting a
reasonable approach to address the identification of
a huge number of accounts, most of which will not
be U.S. accounts at all.
According to Steven Musher, Associate Chief Coun-
sel at a recent Federal Bar Association conference, the
IRS is planning to include as many issues as it can in
the first wave of guidance on FATCA and suggested
that it is seriously being considered to have different
levels of obligations for existing versus new accounts
and that the government would be taking a process
oriented approach—that is, focusing on compliance
processes hopefully from a macro perspective.
Rather than reinventing the wheel, it is hopeful
the Treasury will accept existing AML and KYC

rules with some necessary tweaks for FATCA (e.g.,
the Treasury may need to require follow-up rules
on certain documentation issues when AML/KYC
procedures allow reliance on work done in other
countries, especially those which are not U.S. treaty
partners with robust information sharing clause. We
are hopeful the Treasury will allow foreign financial
institutions to take reasonable steps to modify its ac-
count opening procedures to gather information that
reasonably would identify U.S. tax residents, such as
place of birth, citizenship, home address, TINs and
country of residence.28
This information can be cross-checked against
any AML and KYC information that might also be
collected during the account opening process (e.g.,
passports, driver licenses, identity cards, etc.). It may
be a good idea to adopt non–U.S.-centric require-
ments for foreign financial institutions so that they can
begin to collect information and coding their systems
with information that ultimately may be required by
the tax authorities of other jurisdictions.
Legacy Accounts and Systems
It is likely procedures to verify legacy accounts will
have to be provided by the Treasury and provide
phased-in effective dates with a longer time horizon
then the current 2013 effective date for the balance
of the FATCA provisions.
In the case of investments in U.S. securities foreign
financial institutions typically can collect either a
U.S. tax document (e.g., W-8, W-8BEN or W-9) or an
appropriate KYC-type document to establish status
for Chapter 3 purposes, and presumably could do
the same for Chapter 4 or FATCA purposes. If the
information collected conclusively established U.S.
tax status (e.g., a U.S. passport was provided), then
the foreign financial institution can solicit the U.S.
person’s TIN and code its system accordingly. If the
information only gave rise to a reasonable believe
of U.S. tax status (e.g., a U.S. tax address), then the
foreign financial institution can gather additional
information and/or documentation to conclusively
establish U.S. or non-U.S. status.29
The regulations should be flexible enough to
provide for the use of different AML and KYC pro-
cedures and other cross-checks to identify the status
of customer accounts that in many cases will be in
different countries and that may have different AML
and KYC standards, as well as consider the fact that
many systems and processes will now be manual
Taxes—The Tax Magazine®
September 2010
processes or excel spreadsheets in some cases, or
will be coded in different programming languages or
have a limited number of fields and may now provide
information for regulatory and other purposes which
is not relevant to the information FATCA requires
about the accounts.
Put simply, the IRS when drafting these regulations
must consider the fact that automated (and manual)
processes and systems of many foreign financial
institutions with global footprints are not integrated
systems with state of the art technology platforms, but
represent separate systems set up along business lines
and/or country-specific requirements and have been
cobbled together over time as a result of acquisitive
or merger activity.
Use of statistical sampling techniques to determine
U.S. accounts and other verification processes. Will
the IRS permit a foreign financial institution to use ac-
ceptable statistical sampling techniques as a method
to either determine or validate its U.S. accounts? In
the past in other areas the IRS has permitted the use of
probability samples and has issued at least two Field
Directives30 on the use of such samples, one of which
was issued as recently as November, 2009. This Direc-
tive was not aimed at any particular credit, deduction
or tax issue but instead provided general guidance as
to when a sample may be appropriate for a taxpayer.
Under this Directive probability samples are con-
sidered appropriate whenever there is a compelling
reason to use them and more accurate information
does not exist. For this purpose, appropriateness to use
includes the time and cost required to analyze large
volumes of data requiring facts and circumstances
determinations.31Presumably, the IRS will provide
guidance which will establish guidelines to use statis-
tical sampling techniques to determine U.S. accounts
including the amount of precision required (e.g., the
accuracy of the sample estimate) or confidence inter-
val, the acceptable margin of error or sampling error,
the relative precision (e.g., the margin of error divided
by the estimate) and any exemptions or exclusions
from having to sample entire account populations and
permit the use of smaller samples where appropriate
because of the low risk of tax evasion.
Waivers for U.S. Accounts and
Problems Closing Accounts
In recent comments32 to the Treasury, the RBC Fi-
nancial Group raised a number of issues relating to
obtaining waivers of privacy laws for U.S. accounts
35
New U.S. Withholding System for Foreign Account Tax Compliance
and problems which may arise with closing the ac-
counts if a waiver cannot be obtained:
Under the terms of an FFI Agreement, if there is
any foreign law that would prevent the reporting
of information with respect to any United States
account, the financial institution is required to
attempt to obtain a valid and effective waiver of
such law from each holder of such account, and
if such a waiver is not obtained within a reason-
able period of time, to close the account.
As these provisions only apply to United States
accounts, in the case of an account that is recalci-
trant as a result of the FFI not being able to obtain
sufficient information in order to determine
whether or not the account is a United States
account, the account should not be treated as a
United States account, particularly where there
are no U.S. indicia. The implications of these
requirements are complex and require further
research into the relevant laws of several juris-
dictions. We understand that various comments
have already been submitted to Treasury and the
IRS on this subject, including the fact that FFIs
are entering into FFI agreements voluntarily and
therefore may not be able to rely on provisions in
the legislation of some jurisdictions which would
otherwise permit the disclosure of information
without consent if the such disclosure is for the
purposes of complying with foreign laws.
Some of the other issues that we are still reviewing
include the following: obtaining waivers in the case
of a United States owned foreign entity to permit
the disclosure of information related to the entity;
obtaining waivers in the case of joint accounts
where the account is set up in the name of all par-
ties to the account, some of whom may not be U.S.
persons; the inability to “close the account” in the
case of an annuity contract, life insurance policy
or a trust (where the FFI is also trustee).
Clarify Scope of the Term
“Financial Account”: U.S.
Brokers, Swap Dealers or
Nominees and DAP Payments
U.S. brokers, swap dealers or nominees. The term
“U.S. account” means any financial account that
36
is held by one or more “specified United States
persons” or U.S-owned foreign entities. 33 One
commentator a the recent KPMG webcast34 sug-
gested that while the new law provides for certain
exclusions from the definition of specified U.S.
person,35 it does not explicitly exclude U.S. brokers,
swap dealers or nominees so that the reporting
requirements now apply to accounts held by these
individuals [and presumably other U.S. persons
unless excluded by the statute or by the Treasury]
in these categories as well.
DAP payments. In recent comments36 to the Trea-
sury, the RBC Financial Group raised the issue that
delivery against payment or “DAP” accounts with
broker dealers be excluded from the definition of
financial accounts because these accounts present a
low risk of tax evasion with the following analysis:
We also recommend that delivery against pay-
ment (“DAP”) accounts with broker dealers(also
known by such other names as “cash on de-
livery”, “delivery versus payment”, etc.) be
excluded on the basis that the broker dealer is
simply the intermediary that is executing trades
on behalf of the beneficial owner, and such
transactions are also reported by a financial in-
stitution (“FI”) that maintains a custodial account
for the beneficial owner. As all transactions pro-
cessed by the executing broker are also reported
by the FFI that maintains the custodial account,
we suggest that the reporting by the executing
broker would be duplicative. In addition, if an
FFI that maintains the custodial account is not
a participating FFI, all withholdable payments
made to the non-participating FFI for the benefit
of the account holder would be subjected to
30% withholding. Therefore, we propose that
DAP accounts be excluded on the basis that re-
porting would be duplicative and that the other
reporting with respect to these types of accounts
ensure that they present a low risk of being used
by U.S. persons for tax evasion.
Investment Fund—FATCA Issues
Several investment fund FATCA issues have re-
cently surfaced which may be worthwhile briefly
discussing. One commentator37 has focused on
the Code Sec. 1471(b) compliance requirements
by focusing on interests sold through distributors/
intermediaries which are foreign financial institu-

tions and investments made by foreign financial
institutions and in the context of fund of funds
(FOFs) by providing:
In the case of a collective investment fund
(whether widely-held or otherwise) which sells
its interest via a distributor or intermediary, there
may be valid commercial reasons which preclude
the distributor/intermediary from disclosing the
identities of the underlying investors in the fund.
To illustrate this point, we wish to highlight a
scenario which is common in practice.
A Luxembourg issuer distributes paper with
UCITs brand name through DL bank. 38 DL Bank
is solely a distributor/paying agent and it places
the Luxembourg issuer’s paper with its own pri-
vate wealth clients. DL Bank acts as agent with
respect to payments, although it does not tell the
Luxembourg issuer the identity of the owners of
the paper. The reason for this is that DL Bank does
not want to disclose its own private wealth clients
because the Luxembourg issuer is connected to a
rival bank that will try to poach those clients.
The paper is either debt or equity interest in
the Luxembourg issuer and therefore an ac-
count. Assuming DL Bank is an FFI, it will have
entered into an FFI agreement and reported
the holders of the paper as custodial account.
Where the Luxembourg issuer is also an FFI, it
will need to obtain information as to the U.S.
and foreign accounts and report to the IRS. The
Luxembourg issuer would need to now who
owns its paper in order to comply with an FFI
agreement with the IRS. However, because DL
Bank will not disclose who is holding the paper,
the Luxembourg issuer cannot comply with the
FFI agreement. Thus, absent an exemption, the
Luxembourg issuer will suffer U.S. withholding
tax on U.S. source dividend or interest income
that is linked to the paper which is distributed
by DL Bank.
The same issue is likely to arise in the context
of a fund of funds (FOF), i.e., a fund which
invests in other underlying funds. A FOF will
generally resist disclosing its investors to an
underlying fund to prevent them competing
for the FOF’s clients. Provided the FOF has en-
tered into an FFI agreement and disclosed the
Taxes—The Tax Magazine®
September 2010
relevant information to the IRS, we believe that
the underlying fund should be deemed to meet
the reporting requirements of [Code Sec.1471
if it obtains a statement from the FOF which
certifies that the FOF has entered into an FFI
agreement with the IRS and has complied with
its reporting obligations in relation to any U.S.
accounts. Similarly, in the first scenario above,
it should be sufficient that the Luxembourg is-
suer obtains a statement from DL Bank that the
distributor has entered into an FFI agreement
and provided all relevant information to the
IRS. This solution would, in our view, be con-
sistent with the objectives of FATCA whilst at
the same time preventing duplicative reporting
and/or unnecessary withholding. As to a related
point, the regulations should provide guidance
on whether an administrator of an FFI can rely
on certification provided by a third party. For
example, in the FOF example above, it would
be more practical if the underlying fund’s ad-
ministrator could rely on a statement provided
by the FOF’s administrator rather than having to
obtain certification from the FOF directly.
RBC Comments on investment funds. The RBC
Comments 39 provided the following discussion
pertaining to investment funds and in particular
addressed the implementation of pass-through
payments to offshore investment fund recalcitrant
account holders by providing:
RBC will be impacted from a number of perspec-
tives by the requirements contained in the final
FATCA regulations and guidance as they may
apply to funds (and other collective investment
vehicles (“CIVs”) and their investors. In addition
to offering a wide-range of RBC-managed mutual
and pooled funds in Canada, Jersey, Guernsey
and Switzerland, RBC offers a variety of services
to funds and their investors. For example, RBC
and third party Canadian retail funds can be
purchased, sold and held by clients through
accounts opened and maintained with RBC’s
Canadian bank branches. RBC and third party
funds can also be purchased, sold and held by
clients through accounts opened and maintained
with RBC’s broker/dealers and several RBC enti-
ties that offer custodial services. RBC provides
a variety of services to the funds themselves,
including investment management, trusteeship,
37
New U.S. Withholding System for Foreign Account Tax Compliance
custody, fund accounting, net asset valuation,
and unit holder recordkeeping. It is important
to note that it is not unusual for RBC to provide
only some of these services to a fund. A fund may
engage separate service providers for different
fund-related activities.
The manner in which the units of many funds
are distributed, registered and held creates sig-
nificant practical operational challenges that
would make it very difficult (if not impossible)
for most funds to comply with the requirements
of an FFI Agreement as an FFI. The funds them-
selves may have very little information about the
unit holders of the funds if units of the funds are
distributed through other intermediaries or even
a chain of intermediaries. This makes it opera-
tionally difficult for the fund to be responsible
for the identification and reporting of any United
States accounts.
Another aspect of FATCA (as it might apply to
funds) that concerns RBC relates to any potential
requirement to withhold on pass-through pay-
ments made to recalcitrant account holders. It
is difficult to see how this could practically be
implemented in the case of funds (or other CIVs).
Some of the challenges include the following:
Determining at what point withholding should
be applied (e.g., when a withholdable pay-
ment is made to the fund, when a distribution
is made from the fund to an investor, etc.).
Identifying recalcitrant accountholders subject
to withholding on any pass-through payment
where the entity that is identified as respon-
sible for withholding is not the entity that
identifies recalcitrant accountholders. This
requires that information be communicated
between intermediaries, or potentially through
a chain of intermediaries. This would be an
extremely burdensome process which would
likely need to be performed manually.
Measuring the portion of a payment made
to a recalcitrant account holder that would
be considered to be a pass-through payment
subject to withholding and applying the tax.
Given that a unit holder of a fund does not
generally have a dividend interest in any of
the assets of the fund and, in many funds,
investors change on a frequent basis, it is
38
unclear how this amount would be calcu-
lated. This would seem to be particularly
true in the case of proceeds, given that funds
generally only allocate net capital gains to
unit holders. Any effort to allocate proceeds
would be a potentially greater challenge. In
Canada, most funds only make capital gains
distributions to investors holding units at the
end of the taxation year. Given that the vast
majority of fund units are held in accounts
with other FFIs that may be participating
FFIs which would be taking steps to identify
United States accounts and to report such
accounts to the IRS, we submit the following
for consideration:
Exclude funds from the definition of “financial
institution,” in which case the FATCA provi-
sions applicable to NFFEs would apply. Funds
or groups of funds that have the ability to com-
ply with the terms of an FFI agreement could
be given the option to elect FFI treatment.
Provide an exclusion from the definition
of ”United States account” for funds that
are widely-held. (We understand that sev-
eral interested parties have suggested that
“widely-held” should be defined to include
funds with more than 100 investors, and we
support this recommendation.) Given that
most funds will likely be held in accounts
with participating FFIs, it is likely that in-
vestors in such funds will be identified and
reported by such FFIs. To also impose report-
ing requirements on the fund would result in
duplicative reporting.
As a general rule, exempt any portion of a
U.S. source payment made to a fund with
recalcitrant account holders, as well as any
payment made to a recalcitrant account
holder receiving a distribution from a fund
that receives U.S. source income and pro-
ceeds, from Chapter 4 withholding. As a
minimum, we suggest that any such with-
holding requirements be suspended during
an appropriate transition period in order to
allow time to address any recalcitrant ac-
count holder situations. We anticipate that
most participating FFIs will have very few
recalcitrant accounts among new accounts
opened on or after the effective date for
the new requirements. If it is felt that there
are situations where there is the potential

of abuse, the more immediate application
of the withholding requirements should be
directed to those situations (e.g., funds that
have a significant percentage of units held
by recalcitrant accounts holders).”
Trusts—FATCA Issues
The RBC Comments40 provided an extensive dis-
cussion of FATCA issues relating to trusts and trust
companies with the following excellent analysis:
The application of FATCA to trust companies
and personal trusts (i.e., trusts settle by and for
the benefit of private individuals as opposed to
commercial trusts or collective investment ve-
hicles, an interest in which is typically defined
by reference to units, which a beneficiary (or
investor) acquires for consideration) is an area
of concern to RBC. A number of RBC entities in
several jurisdictions act in a fiduciary capacity
as trustee of such personal trusts. In addition,
the majority of RBC FFIs have accounts for
entities that are trusts. These trusts may have
corporate or personal trustees. In that con-
nection, we submit that the regulations and
guidance should clearly define the application
of the FATCA rules to various types of trusts and
trust arrangements.
1. Trust Companies as FFIs versus Trusts as
NFFEs. FATCA defines a “financial institution”
to include any entity that, “as a substantial por-
tion of its business, holds financial assets for the
account of others”. While it could be argued
that a corporate trustee holds financial assets for
the benefit of beneficiaries of a trust, we recom-
mend that a distinction be made between trust
companies that retain custody of trust assets (i.e.,
effectively providing both trustee and custodial
services) and trust companies that open financial
accounts with other FFIs which hold custody
of trust assets (i.e., providing trustee, but not
custody services).
In the first situation, the trust company will have
robust custodial recordkeeping and reporting
systems, and generally have the capabilities to
make the changes necessary to comply with the
terms of an FFI Agreement. In the second situ-
ation, the trust company may not have robust
Taxes—The Tax Magazine®
September 2010
electronic recordkeeping systems, especially
with respect to the recording and reporting of
transactional data, as they have not had the need
for such systems in order to fulfill their fiduciary
responsibilities. Instead, they may rely on the
recordkeeping and reporting services provided
by the financial institutions where they maintain
financial accounts.
In the case of a trust company that opens fi-
nancial accounts for trusts with other FIs (i.e.
“holding FIs”), we propose that the final regula-
tions and guidance provide flexibility to allow
the trust company to have the holding FI treat
the account as an account for the trust company
as an FF1, or to treat the account as an account
for an NFFE (i.e., the trust). In the first situation,
the trust company will be responsible for the
identification and reporting of any trusts that
are United States owned foreign entities. In the
second situation, the trust company will either
provide the holding FI with a certification that
the trust does not have any substantial United
States owners, or will provide the name, ad-
dress and TIN of each substantial United States
owner of the trust.
2. Identification of “substantial United States
owners” of a Trust. In the case of trusts that are not
collective investment vehicles, FATCA generally
defines a “substantial United States owner” to be
any specified United States person: treated as an
owner of any portion of the trust under the U.S.
grantor trust rules, and to the extent provided by
the Secretary in regulations or other guidance,
who holds, directly or indirectly, more than 10
percent of the beneficial interests in the trust.
Unless the regulations and guidance provide
greater clarity regarding the identification of
substantial United States owners of a trust, we an-
ticipate that making this determination will create
significant on-going problems, including client
frustration and dissatisfaction, administrative
costs related to the additional time that will be
spent on such accounts, and frequent uncertainty
as to whether the rules have been applied cor-
rectly. Given that the majority of these accounts
are unlikely to be United States accounts, it is our
view that the burden on the FFI will significantly
outweigh any benefit derived by the IRS.
39
New U.S. Withholding System for Foreign Account Tax Compliance
In that connection, we are familiar with the
difficulties that can arise as a result of to ap-
plying complex U.S. tax rules to non-U.S.
entities in an effort to determine the type of
documentation that is required under QI Agree-
ments. Given that the number of accounts that
will likely be affected by FATCA is far greater
than the relatively small number that currently
operate under QI Agreements, it is our sincere
hope that such uncertainty can be addressed for
participating FFls under the proposed FATCA
regime. In that connection, it should also
be noted that these difficulties will likely be
even more pronounced for the non-corporate
trustees of trusts for which RBC has financial
accounts. Many of these trusts are small and
have non-professional trustees.
We submit that non-U.S. trustees should not be
expected to engage U.S. tax advisors to advice
on the application of these complex U.S. defini-
tions to their trusts. Similarly, the employees of
FFls should not be expected to assist clients in the
interpretation of the U.S. trust provisions.
Issues of particular concern include the following:
Identification of an owner under the complex
grantor trust rules. We are concerned that the
far-reaching definition could result in a non-
U.S. inter-vivos trust inadvertently having a
U.S. owner as a result in a change of residence
of a contributor or beneficiary of the trust.
Identification of persons with a beneficial in-
terest in a non-grantor trust. We propose that
such persons be limited to those beneficiaries
having a current vested entitlement to revenue
and/or capital from the trust.
Measurement of a person’s beneficial inter-
est in a non-grantor trust. Although this may
be simpler to measure in the case of a non-
discretionary trust, there is still uncertainty as
to how to measure against the 10% threshold
when some beneficiaries’ entitlements may be
limited to a fixed share of only the revenue or
only the capital of the trust. In the case of a
discretionary trust, the basis for measurement
is even less clear. Given that a discretionary
beneficiary has no actual entitlement until the
trustee takes the necessary steps to exercise its
discretion in favour of the beneficiary, it could
40
be argued that in the case of a discretionary
trust, no beneficiary has a beneficial interest
in excess of 10%.
Similar issues would exist under U.S. tax rules
that require a U.S. person to report certain in-
terests in passive foreign investment companies
(“PFICs”). We understand that there is little or
no guidance regarding the attribution of stock
ownership in a PFIC to a beneficiary of a fully
discretionary trust. We also understand that the
IRS considered this in a private letter ruling, in
which it suggested that patterns of distributions
and mortality tables based on the age of each
beneficiary could be analyzed to determine the
actuarial interest of a beneficiary.
Equally, in the case of trusts where the distribution
of capital is contingent on a future event (such as
the death of the revenue beneficiary), the indi-
viduals entitled to the capital, and their respective
share, cannot be determined definitively until
that future vent occurs. We suggest that it would
be very difficult for non-U.S. trustees to correctly
interpret, analyze and apply these rules.
3. Privacy and Other Regulatory Concerns. In the
case of a trust (or other NFFE) that is determined
to be a United States owned foreign entity, it is
not only the information relating to the United
States substantial owner that is being reported to
the IRS, but also the information relating to the
entity itself. We have not yet had an opportunity
to consider the more complex issues that may
arise in this situation as a function of the varied
and robust privacy and confidentiality laws which
govern our operations.
4. Requirement to Close a United States Ac-
count. Under the terms of the FFI Agreement,
a participating FFI may be required to close a
United States account that does not provide a
waiver of a foreign law that would otherwise
prevent the reporting of required information
related to the account to the IRS. Although it may
be possible for an FFI that has a United States
account for a trust to close the financial account,
it seems less likely that a participating FFI that
is trustee can simply “close” or ‘terminate” the
trust. Being a fiduciary relationship (as opposed
to a contractual account), the FFI trustee faced

with this position might have two options: (i)
retire as trustee in favour of another trustee that is
likely to be faced with the same issue and there-
fore may be difficult to find; or (ii) appoint the
assets to a beneficiary, thereby terminating the
trust. Any such fiduciary decisions not taken in
the best interests of the beneficiary could leave
the trustee exposed to a breach of trust claim.
This issue is being considered further.
5. Inter Vivos Trusts versus Testamentary Trusts and
Estates. Given our understanding of the policy rea-
sons behind the FATCA legislation, we propose that
consideration be given to limiting the application
of FATCA to inter vivos trusts (i.e, trusts created
during the lifetime of the settlor), and exempting
estates and testamentary trusts (i.e., trusts arising
under the will of an individual following their
death). In our Canadian trust business, where
RBC acts as corporate executor and trustee, the
majority of the accounts are estates or testamentary
trusts. Canadian anti-money laundering legislation
and regulation also reflects the policy difference
between inter vivos and testamentary trusteeships
and has tailored the collection of information and
reporting requirements accordingly. We propose
that estates and testamentary trusts be excluded
on the basis of presenting a low risk of being used
by U.S. persons for tax evasion.”
FATCA Reporting
Responsibilities—Gross Receipts
and Withdrawals
RBC Comments on FATCA reporting. The RBC Com-
ments41 discussed numerous FATCA reporting issues
which the Treasury may want to address with the
following analysis:
We are concerned that the reporting of financial
information, particularly gross receipt and gross
payments/withdrawals from an account may
prove to be of limited value to the IRS and would
at best only identify potential U.S. persons for
further review. The information would not neces-
sarily be indicative of amounts to be reported on
a U.S. tax return.
Given that reporting of information based on
transactional data is generally more complicated
Taxes—The Tax Magazine®
September 2010
and costly from a systems perspective than report-
ing static data such as name, address and TIN,
and account balance/value which is captured at a
particular point in time, we recommend that the
reporting of gross receipts and gross withdrawals/
payments not be required as part of the annual
filing, and that Treasury instead exercise its au-
thority under the terms of the FFI Agreement to
request the FFI to provide additional information
with respect to any United States account.
We also suggest the benefit of reporting account
balance/value be reconsidered to ensure that IRS
will in fact be able to make effective use of the
information to warrant the cost to FFIs of provid-
ing such information.
If Treasury and the IRS do conclude that the
reporting of any financial information is neces-
sary, we suggest a deferral of the effective date
of such reporting be provided to reduce the
strain that implementing the FATCA provision
will place upon the
Information Technology resources of FFIs. We also
suggest the following with respect to reporting -
The default reporting period should be the
calendar year.
The filing deadline should be no sooner than
June 30th following the year-end.
There should be no requirement to send cop-
ies of the information reported to the IRS to
the account holder or substantial United States
owner, although most FFIs would likely advise
such persons that information regarding their
account will be reported to the IRS.
If FFIs are required to report account value/
balance:
The amount should be reported as at close of
business on December 31.
The FFI should be permitted to report in the
base currency of the account.
The method for determining account value
should be based on existing procedures and
practices. For example, if there are holdings
in an account that an FFI does not currently
value because of the difficulty of obtaining a
current value, there should be no requirement
to obtain a value for purposes of reporting
under the FFI agreement.
41
New U.S. Withholding System for Foreign Account Tax Compliance
There may be other amounts and adjustments
being posted to accounts that do not represent
receipts or withdrawals/payments. For many
FFIs, it may be difficult and costly to segregate
such amounts from actual receipts; withdraw-
als and payments. Given the values will be of
limited use in any case, we recommend that
FFIs be permitted to simply report total debits
and total credits to an account.
Many FFIs that offer a variety of products
will have accounts on a number of different
systems. FFIs should be permitted to submit
the required reporting information separately
for each system. Similarly, if members of the
same expanded affiliated group are covered
under a single FFI agreement, each member
should be permitted to submit their report-
ing separately. We submit that there should
be no requirement for an FFI to aggregate
their annual reporting to the IRS. Such a
requirement would place an unnecessary
financial and administrative burden upon
FFIs, particularly in situations where filing is
done electronically.
One commentator42 also raised several relevant
issues relating to the FATCA reporting requirements
by providing:
[The] forthcoming Treasury regulations under
FATCA should clarify four main issues for tax-
payers regarding the scope and scale of the
reporting requirements. They must: (i) clearly
define what is to be reported and provide ex-
amples (including those applicable to reporting
by foreign investment funds) (ii) clarify whether
the IRS requires a complete transcript of ac-
count movements, or information about certain
transactions only (iii) clarify that the investment
activity of an FFI – for example, an investment
fund –itself does not need to be reported, but
only U.S. account holders’ subscriptions and
redemptions and (iv) address how foreign enti-
ties whose values are denominated in foreign
currencies should be reported.
FATCA also requires reporting of the account
balance or value, as well as the gross receipts
and withdrawals of all Reportable Accounts. In
lieu of reporting account values, receipts and
withdrawals, an FFI may elect and report under
42
[Code] Sec. 6041, 6042, 6045, and 6049 as if
it were a U.S. person. The reporting guidelines
should clarify that neither a complete record
of account movements nor a description of a
fund’s investment activities is required. A clause
specifically excluding such information from the
requirements should be added.
FATCA also requires reporting of each Report-
able Account’s account number, but private
investment funds generally do not have account
numbers. Therefore, this requirement should be
deleted or perhaps replaced with the date on
which the account was created. For account
balance or value, a figure such as year-end net
asset value would be most appropriate and useful
reporting requirement for most hedge funds, as
hedge funds generally do not calculate net asset
value on a daily basis.”
Financial Accounts. Guidance is required which
clarifies and limits the definition of a “financial
account”—as defined in [Code] Sec. 1471(d)
(2)—in connection with certain financing
and hedging transactions. Certain investment
products—such as total return swaps and other
derivatives –provide exposure to a fund’s per-
formance, but should be expressly excluded
from ‘financial account’ classification, given
that a fund does not have access to the party to
the derivative and the party has not ultimately
invested in the fund. The Secretary should also
make clear whether short-term obligations or
short-term deposits that pose a low risk of U.S.
tax evasion (e.g., those with a term of no more
than one year) will be treated as “financial ac-
counts” under FATCA.
The Regulations should also establish whether,
for purposes of Section 1471, “regularly traded
on an established securities market”—given
the cross border context—will retain the same
meaning used in [Code] Sec. 897, 1445, and
6039C: Treasury Regulation Section 1.897-1-
(m)—Established securities market. For purposes
of [Code] Sec. 897, 1445, 6039C, the term ‘es-
tablished securities market” means: (i) A national
securities exchange which is registered under
section 6 of the Securities Exchange Act of 1934
(15 U.S.C. 78f) (ii) a foreign national securities
exchange which is officially recognized, sanc-

tioned, or supervised by governmental authority,
and (iii) any over-the-counter market. An over-
the-counter market is any market reflected by
the existence of an interdealer quotation system.
An interdealer quotation system is any system of
general circulation to brokers and dealers which
regularly disseminates quotations of stocks and
securities by identified brokers or dealers, other
than by quotation sheets which are prepared and
distributed by a broker or dealer in the regular
course of business and which contain only quo-
tations of such broker or dealer.
Regulations should address over-the-counter
markets specifically. FATCA provisions as en-
acted will also require further clarity in debt
and distress market contexts. The Regulations
should clarify what debt interests are considered
“financial accounts” and address situations that
include (i) private placements debt where third
party invests are unknown to the fund, and re-
purchase agreements, total return swaps, and
other leverage undertaken with dealers who
themselves may be U.S. persons or FFIs where
such arrangements do not pose a significant
risk of tax evasionDeep-in-the-money options,
non-debt open transactions—for example, pre-
paid forward contracts and credit default swaps
will also require consideration in published
guidance if FFIs are to understand how to ap-
ply FATCA.
Consolidated or Separate
FFI Agreements
It is presently unclear whether the Treasury will per-
mit the Code Sec. 1471(b) agreement to be entered
into on a consolidated basis for the foreign financial
institution and its global businesses or whether
separate FFI agreements may be entered into. If a
global business has multiple foreign financial institu-
tions and the IRS permits consolidated or separate
filing, the business may want to consider whether
principles under Reg. §1.1502-6 may be followed—
that is, will all members of the expanded affiliated
group who have entered into a consolidated FFI
agreement be jointly and severally liable for the
FATCA requirements of each member of the group?
Will the same FATCA exposure be present for the
expanded affiliated group even if the FFIs each have
a separate FFI agreement?
Taxes—The Tax Magazine®
September 2010
In addition, if a company purchases another
foreign financial institution that was a party to a con-
solidated FFI agreement, will the acquiring company
be responsible not only for the FATCA liabilities of
the acquired foreign financial institution’s, but also
the FATCA liabilities of the other foreign financial
institutions that were a party to the consolidated
FFI agreement, absent contractual indemnities to
protect itself?
Distinguishing Between Foreign
Financial Institutions and
Non–Financial Foreign Entities
There will undoubtedly be pressure to distinguish be-
tween foreign financial institutions and non–financial
foreign entities. As a preliminary matter, for purposes
of analysis and in order to make sure as many carve-
outs from FATCA are identified as possible, it may be
a good idea to bucket the foreign entities into various
categories, such as (i) foreign financial institutions
(ii) excluded foreign financial institutions (from FFI
status) (iii) non–financial foreign entities (including
possible FFI “lite” entities) (iv) excluded NFFEs (e.g.,
nonfinancial publicly traded corporations) (v) foreign
financial institutions and non–financial foreign enti-
ties excluded from Chapter 4 completely, and (vi)
entities excluded from Chapter 4 by statute (e.g., an
international organizations). After the IRS provides
guidance, these categories may be reduced to three
buckets each with separate rules (or lack thereof) (i)
foreign financial institutions (ii) non–financial foreign
entities (including FFI lite entities), and (iii) FATCA-
exempt entities.
Why Is It Important to
Distinguish Between FFIs
and NFFEs?
Increased Reporting Requirements
and Zero Ownership Threshold in
Foreign Investment Vehicles
(a Wider Net)
A foreign financial institution’s reporting require-
ments for its U.S. accounts will be considerably more
onerous than for a non–financial foreign entity. It will
be required to report the name, address, TIN, account
number, account balance or value and possibly the
43
New U.S. Withholding System for Foreign Account Tax Compliance
gross receipts and gross withdrawals or payments
from the account. 43
For this purpose, a U.S. account includes the
financial accounts held by specified U.S. persons
or United States owned foreign entities.44 The term
“U.S. owned foreign entity” means any entity that
has one or more substantial U.S. owners45 —a for-
eign investment vehicle will be deemed to be U.S.
owned foreign entity since zero-percent ownership
will trigger the reporting requirement.46 A non–
financial foreign entity may also be a U.S.-owned
foreign entity if the foreign entity has one or more
substantial U.S. owners based on the higher more
than 10-percent vote or value test.47
Reporting. A foreign financial institution must re-
port the “financial accounts” held by specified U.S.
persons regardless of the amount of ownership48 (un-
less the aggregate value of the depository accounts
held by an individual does not exceed $50,000)49
or U.S. owned foreign entities with substantial U.S.
owners (generally more than 10 percent by vote or
value,50 unless the entity is a investment vehicle and
the ownership threshold goes to zero).51 Financial ac-
counts for this purpose include depository accounts,
custodial accounts and non–publicly traded debt
and equity in such foreign financial institution.52 A
non–financial foreign entity must generally report the
identity of the specified U.S. persons who own more
10 percent of the entity or certify it has no substantial
U.S. owners of the entity.53
Type of information reported. A foreign financial
institution must report the name, address, TIN of
each specified U.S. person and the name, address
and TIN of each more-than-10-percent owner of
each U.S. owned foreign entity (or zero percent
for investment vehicles), the account number,
account balance or value and possibly the gross
receipts and gross withdrawals of payments from
the account.54 A non–financial foreign entity must
report the name, address and TIN of each substan-
tial U.S. owner. 55
Alternative to FATCA reporting. A foreign financial
institution may make an election under new Code
Sec. 1471(c)(2) to elect to be subject to the same
reporting as a U.S. financial institution (e.g., 1099
reporting). A non–financial foreign entity does not
have a similar alternative to reporting.
Verification and due diligence. A foreign financial
institution will be subject to more robust verification
and due diligence with the IRS.56 A non–financial
foreign entity must either certify that the beneficial
44
owner does not have any substantial U.S. owners or
provide the required information with respect to each
substantial U.S. owner.57
Requests for additional information. A foreign
financial institution must comply with requests for
additional information about the accounts under its
Code Sec. 1471(b) agreement with the IRS.58 A non–
financial foreign entity has no such requirement.
Obtain valid waiver of privacy laws. A foreign
financial institution must attempt to obtain a valid
waiver of any foreign privacy laws or close the ac-
count within a reasonable time.59 A non–financial
foreign entity does not have to obtain a privacy
waiver or close the account if it does not obtain the
beneficial owner information under new Code Sec.
1472(b), although it may itself be subject to a 30-
percent tax on withholdable payments it receives.
Deduct and withhold 30 percent from any pass-
through payment. A foreign financial institution must
withhold 30 percent from any pass-through payment
to a recalcitrant account holder or noncompliant
foreign financial institution unless the foreign finan-
cial institution has elected to be withheld upon.60 A
non–financial foreign entity that does not indentify
all its substantial U.S. owners or certify that it has no
such owners will be subject to a 30-percent tax on the
withholdable payments it receives.61 There is currently
no mechanism for a non–financial foreign entity to
withhold on payments made to a recalcitrant account
holder in the case of less than flawless disclosure of
its substantial U.S. owners.
Expanded affiliated group. A foreign financial in-
stitution may have to enter into an agreement62 with
the IRS for not only itself but for each member of its
expanded affiliated group.63 A non–financial foreign
entity does not have to enter into an agreement with
IRS agreeing to comply with the requirements in new
Code Sec. 1471(b).
Exemptions from reporting and withholding.
The exemptions for reporting for foreign financial
institutions and for exemption from withholding
for non–financial foreign entities are different. For
example, payments to a foreign publicly traded cor-
poration or corporations in its expanded affiliated
group will be exempt from non–financial foreign
entity withholding and reporting under new Code
Sec. 1472(c)(1)(A)–(B). A foreign publicly traded
corporation may be a foreign financial institution
subject to the reporting, verification and diligence
requirements as well as pass-through withholding
to recalcitrant account holders and noncompliant
 September 2010

foreign financial institutions and itself subject to
withholding under Code Sec. 1471(a) for noncom-
pliance. A foreign pension plan may be a foreign
financial institution unless excluded by the Treasury
and could be a non–financial foreign entity since it
is not excluded under Code Sec. 1472(c).
Elections to be exempt from FATCA—Bypassing the
FFI agreement. A foreign financial institution may be
able to make an election under new Code Sec. 1471(b)
(2) as meeting the requirements for reporting (and pre-
sumably withholding) if it complies with procedures
to be prescribed by the IRS and otherwise satisfies
any other requirements by the Treasury to ensure it
does not have U.S. accounts. While a non–financial
foreign entity can either disclose its substantial U.S.
owners (generally those with more than 10-percent
ownership by vote or value) or certify that it has no
such owners, it cannot make this election.
Reason-to-know requirement. In addition, the
withholding agent of a non–financial foreign entity
must not know or have reason to know that the infor-
mation provided about the substantial U.S. owners
is incorrect. 64 Withholding agents do not have to
now have a similar requirement for the information
obtained about U.S. accounts by foreign financial in-
stitutions, regardless of whether the foreign financial
institution directly withholds on any pass-through
payments made to recalcitrant account holders or
nonparticipating FFIs under new Code Sec. 1471(b)
(1)(D), or whether the foreign financial institution
makes an election to be withheld upon and pro-
vide such information as may be necessary for the
withholding agent to determine the amount of the
withholding under new Code Sec. 1471(b)(3).
Shawn P. McKenna, a senior manager at Deloitte
Tax LLP, recently put together as part of a draft
article Table 1, which compares the impact of the
new FATCA reporting and withholding rules for
foreign financial institutions and non–financial
foreign entities.65

Table 1.
Qualifying Entities
Income Subject to Withholding
Withholding Rate
Waiver of Withholding on [Withholdable
Payments]
Who to report U.S. Account(s) to
Reduction of Withholding
FFI
Non-U.S. entities including banks, securities brokers
and dealers, hedge funds, private equity funds,
CDOs, CLOs, family investment vehicles1 [unless
otherwise exempted]
In general, withholdable payments include:
• Any payment of interest (including any original
issue discount), dividends, rents, salaries, wages,
annuities, and other fixed or determinable annual
or periodical (FDAP) income, gains, and profits, if
such payment is from sources within the United
States
• Any gross proceeds from the sale of U.S. property
of a type that can produce interest or dividends
• Interest paid by foreign branches of U.S. banks3
• [portfolio interest unless exempted]
30%5
Enter into [and complying with] a information report-
ing agreement with U.S. Treasury (“FFI agreement”)7
IRS9
If no FFI agreement is entered into, the entire entity is
withheld on.11
If a FFI agreement is in place, withholding is only
required on the portion of non-U.S. entity’s specific
owners, partners, shareholders, [debtholders,] trust-
ees not in compliance with FFI agreement12 unless
FFI elects to be withheld upon by withholding agent
NFFE
Any foreign entity that does not meet
the FFI definition, such as operating
businesses2 [unless otherwise exempted]
In general, withholdable payments
include:
• Any payment of interest (including
any original issue discount), divi-
dends, rents, salaries, wages, annui-
ties, and other fixed or determinable
annual or periodical (FDAP) income,
gains, and profits, if such payment is
from sources within the United States
• Any gross proceeds from the sale
of U.S. property of a type that can
produce interest or dividends
• Interest paid by foreign branches of
U.S. banks 4
• [portfolio interest unless exempted]
30%6
Providing withholding agent with: cer-
tification that entity does not have any
substantial U.S. owners OR the name,
address, and taxpayer identification
number (TIN) of each substantial U.S.
owners8
Withholding agent10 [who provides to
IRS]
None available. Entire non-U.S. entity is
withheld on unless waiver of withhold-
ing information is provided to withhold-
ing agent13

Taxes—The Tax Magazine® 45

New U.S. Withholding System for Foreign Account Tax Compliance
Alternatives for Withholding
Types of Accounts Reported
U.S. Account Information Reported
Alternatives for Reporting U.S. Account
Information
Specified U.S. Persons Included in Report-
ing
U.S. Accounts Exempt from Reporting and
Exempt from inclusion as Specified U.S.
Persons
Foreign Accounts Exempt from Withhold-
ing
46
FFI
Elect to be withheld upon by entity making withhold-
able payment14
Any specified U.S. persons15
Depository accounts maintained by a natural person
and whose aggregate balance is less than $50,000
across all accounts with the financial institution are
exempt from reporting.16
• Name, address, and TIN of specified U.S. person.
For U.S. owned foreign entities: name, address and
TIN of each [more than] 10% owner per above, or
0%, as applicable
• Account number
• Account balance or value
• Gross receipts and gross withdrawals of payments
from account17 [if ] required by IRS
Elect to be subject to full Form 1099 reporting for
U.S. accounts19
Any U.S. person including:
• Citizens or residents of the United States
o Foreign persons holding green cards or meeting
substantial presence test are treated as U.S. resi-
dents20
• Domestic partnerships
• Domestic corporations
• Any estate (other than foreign estates)
• Any trust controlled by U.S. persons and able to be
administered by a U.S. court21
• Any corporations regularly traded on an estab-
lished securities market
• Any corporation where an affiliate that is regularly
traded owns more than 50% of vote [and] value
• Certain tax exempt organizations and individual
retirement plans
• Any U.S. agency
• Any State, municipality, or U.S. possession
• Any bank, REIT, RIC
• Any common trust fund
• Certain charitable trusts24
Any payment beneficially owned by:
• Foreign governments and their political subdivi-
sions or wholly owned agencies
•Any international organization
• Foreign central banks26
• Other classes of persons, identified by the Secre-
tary, who pose a low risk of tax evasion27
NFFE
None available
Specified U.S. persons, directly or indi-
rectly, owning [more than]:
• 10% of corporation by vote or value
• 10% of partnership by profits or capi-
tal interest
• 10% of beneficial interest of such
trust
•Name, address and TIN of each [more
than] 10% owner per above18
None available
Any U.S. person including:
• Citizens or Residents of the United
States
• Foreign persons holding green cards
or meeting substantial presence test
are treated as U.S. residents22
• Domestic partnerships
• Domestic corporations
• Any estate (other than foreign estates)
• Any trust controlled by U.S. persons and
able to be administered by a U.S. court23
• Any corporations regularly traded on
an established securities market
• Any corporation where an affiliate
that is regularly traded owns more
than 50% of vote [and] value
• Certain tax exempt organizations and
individual retirement plans
• Any U.S. agency
• Any State, municipality, or U.S. pos-
session
• Any bank, REIT, RIC
• Any common trust fund
• Certain charitable trusts25
Any payment beneficially owned by:
• Foreign governments and their politi-
cal subdivisions or wholly owned
agencies
• Any international organization
• Foreign central banks28
• Other classes of persons, identified by
the Secretary, who pose a low risk of
tax evasion
• Corporations regularly traded on an
established securities market
• Any corporation where an affiliate
that is regularly traded more than
50% of vote [and] value
• Entities organized under the laws of
a possession of the United States and
owned by a bona fide resident29
 September 2010

Ability to Combine Reporting
FFI NFFE
Members of an expanded affiliated group where a None Available
common parent owns more than 50 percent of the
vote and value may agree to combined reporting and
enter into one FFI agreement.

Either all members of the expanded affiliated group

need to participate in the election or none can par-
ticipate30 except as otherwise provided by Treasury.

Refunds Requirement to identify substantial U.S. owners—
No refund generally allowable unless the beneficial
owner of the payment provide the IRS with informa-
tion to determine whether the beneficial owner is
a U.S. owned foreign entity and the identity of any
substantial U.S. owners31
Special rule where FFI is beneficial owner of
payment—refunds only generally allowed to FFI by
treaty and no interest is allowed.32
Requirement to identify substantial U.S.
owners—No refund generally allow-
able unless the beneficial owner of the
payment provide the IRS with informa-
tion to determine whether the beneficial
owner is a U.S. owned foreign entity
and the identity of any substantial U.S.
owners.33

1
Code Sec. 1471(d). 12
Code Sec. 1471(b)(3). 23
Code Sec. 7701(a)(30).
2
Code Sec. 1472(d). 13
Code Sec. 1472(b). 24
Many of these terms are further defined in Code
3
Code Sec. 1473(1) separately excludes 14
Code Sec. 1471(3) also requires your FFI Sec.s provided under Code Sec. 1473(3).
income effectively connected with the agreement to waive any US treaty protection 25
Id.
conduct of a U.S. trade or business as a on amounts withheld. 26
Unless the foreign central bank is acting as
withholdable payment. 15
Code Sec. 1473(3). an intermediary for clients.
4
Id. 16
Code Sec. 1471(d)(1)(B) FFIs can elect to not 27
Code Sec. 1471(f).
5
Code Sec. 1471(a). have this exemption apply. 28
Unless the foreign central bank is acting as
6
Code Sec. 1472(a). 17
Code Sec. 1471(c). an intermediary for clients.
7
Code Sec. 1471(b)(1). 18
Code Sec. 1472(b)(1)(B). 29
Code Sec. 1472(c).
8
Code Sec. 1472(b)(1). 19
Code Sec. 1471(c)(2). 30
Code Sec.1471(e).
9
Code Sec. 1471(b)(1)(C). 20
Code Sec. 7701(b). 31
Code Sec. 1474(b)(3).
10
Code Sec. 1472(b)(3). 21
Code Sec. 7701(a)(30). 32
Code Sec. 1474(b)(2).
11
Code Sec. 1471(a). 22
Code Sec. 7701(b). 33
Code Sec. 1474(b)(3).

Comparison of Qualified members may remain nonqualified intermediaries.

Intermediary Rules to Foreign
Financial Institution Rules
At a recent Executive Enterprise Institute Confer-
ence, Chip Collins from UBS, Cyrus Daftary, from
Burt Staples and Maner, LLP and Laurie Hatten-Boyd
from KPMG LLP compared the differences between
the qualified intermediary or QI rules and the new
foreign financial institution rules.66
QI Member Status Is Elective—
Conformity Rule for Foreign
Financial Institutions
They noted that while QI status is purely elective,
foreign financial institutions status applies to those
entities that enter into a Code Sec. 1471(b) agree-
ment with the IRS. An entity with a QI agreement
must affirmatively invoke QI status with Form W-8
IMY certifying QI status for identified accounts.
If an affiliated group has a QI member, other
Conversely, if a foreign financial institution enters
into a section 1471(b) agreement with the IRS, that
entity together with its expanded affiliated group as
defined under new Code Sec. 1471(e)(2) will likely
have to be parties to the agreement unless the Trea-
sury provides exemptions under regulations.
QI Duties Limited to U.S. Source
Income—Foreign Financial Institution
Duties Broader for U.S. Accounts
In general, a QI’s compliance obligations relate
only to accounts receiving U.S. source income
(e.g., reportable amounts). A QI must disclose
U.S. persons only if they receive U.S. source
income (and possibly non-U.S. source income if
paid inside the United States). A foreign financial
institution must identify any U.S. account held
by a specified U.S. person or U.S. owned foreign
entity under new Code Sec. 1471(d)(1), including
accounts receiving only non-U.S. source income.

Taxes—The Tax Magazine® 47

New U.S. Withholding System for Foreign Account Tax Compliance
The foreign financial institution must then report
this information to the IRS for such accounts un-
der new Code Sec. 1471(b)(1)(C) and 1471(c) or
close the account in the case of legal prohibitions
to disclose the U.S. persons under new Code Sec.
1471(b)(1)(F)(ii).
QI Limited Withholding on Sales
Proceeds—Foreign Financial
Institution Withholding on Sales
Proceeds for Recalcitrant Holders
Backup withholding is required for sales proceeds of
U.S. securities only when a QI has actual knowledge
that the account holder is a U.S. individual (e.g.,
nonexempt recipient) who refuses to be disclosed. A
foreign financial institution must deduct and withhold
a tax equal to 30 percent on any pass-thru payment
which is made by such institution to a recalcitrant
account holder or a noncompliant foreign financial
institution under new Code Sec. 1471(b)(1)(D), un-
less the foreign financial institution has elected to be
withheld upon under new Code Sec. 1471(b)(3). For
this purpose, a pass-thru payment will include with-
holdable payments such as from the sale of U.S. stock
or securities which are allocable to the accounts of
held by recalcitrant account holders or noncompliant
foreign financial institutions under new Code Sec.
1471(b)(3)(B).
Scope: Only Intermediaries for QIs
In order to have QI status, a financial institution must
act as an intermediary. However, different agreements
are available for transparent entities and certain
trusts and partnerships. It is presently unclear under
the foreign financial institution rules whether a sec-
tion 1471(b) agreement will include nontransparent
investment funds and other investment vehicles in
addition to intermediaries and how entities which
are disregarded under the check-the-box rules will
be treated for purposes of FATCA.
At this same conference, John Staples,67 from Burt
Staples & Manner, LLP, raised the following QI-specific
issues: Will the QI agreement automatically be modified
to include the foreign financial institution requirements?
Can the IRS modify QI agreements on a different time-
table than that which would apply to the nonqualified
intermediary population? Will a QI agreement be modi-
fied to eliminate the Form 1099 reporting obligations
that can arise based upon “where payment is made”
and “where sales are effected?” Are QIs subject to the
48
cost basis reporting rules only if they elect Form 1099
reporting in place of the foreign financial institution
annual report required under new Code Sec. 1471(c)?
What if QIs currently have segregated accounts with
U.S. withholding agents and Form 1099-B reporting
is currently being performed? Can FATCA result in less
Form 1099 reporting—for example, a QI elects FFI
reporting in place of current Form 1099 reporting?
QI Entities—Suggest Relieving
QI Entities from 1099-B Reporting
Requirements
The RBC Comments suggested that the Treasury
consider relieving QIs of Form 1099-B reporting re-
quirements because of resource constraints by many
QIs with the following discussion:
We understand that at some point in the fu-
ture, Treasury will introduce changes to the Ql
Agreement to provide for the coordination of
the provisions of Chapter 3 with the new provi-
sions in Chapter 4. At that time, we suggest that
consideration be given to amending the current
definition of “reportable payments” contained
in section 2.44 of the QI Agreement, to limit the
Form 1099 reporting requirements of a non-U.S.
payor QI to reportable amounts, as defined in
section 2.43 of the Agreement. The current defini-
tion of “reportable payments” makes reference to
the regulations that address where payments are
made and where sales are effected. These rules
are vague and difficult to apply, particularly with
respect to non-U.S. source payments.
Given the additional expectations being placed
upon QIs and their affiliates under FATCA, the
additional information reporting that will be
provided for United States accounts, and the
authority given to the Secretary under the FFI
Agreement to request additional information with
respect to United States accounts, it seems unnec-
essary to retain the current reporting requirements
as set out in the definition of reportable payments,
particularly given that these requirements gener-
ally apply in only very limited situations.
Relieving QIs of Form 1099-B reporting require-
ments would also exclude them from the onerous
cost basis reporting requirements that were
recently enacted. Given the resources that QIs

and their affiliates will expend to implement the
FATCA requirements, we submit that it would be
overly burdensome to also impose the cost basis
reporting requirements upon them, particularly
given the very small number of accounts that
would be subject to the reporting obligations.
The RBC Comments68 explored in depth some of
the problems relating to the implementation of the
pass-through payment regime with the following
analysis:
The definition of pass-thru payment should be
clarified to apply only to limited situations where
there is a reasonable concern steps are being
taken to deliberately attempt to avoid withholding
under Chapter 4 and there is a traceable link be-
tween the account holder and the withholdable
payment. Interest paid on deposit accounts or
short-term investment certificates by a non-U.S.
bank should not be considered to include any
portion that is a U.S. source withholdable pay-
ment or pass-thru payment, …
Similarly, U.S. source payments (e.g., U.S.-source
pension payments) deposited into a client bank
account outside the U.S. should not be viewed as
pass-through payments subject to any withholding
on the part of the receiving FFI if the account holder
is recalcitrant. It should be the responsibility of the
U.S. payor to determine the status of the beneficial
owner of the payment, and withhold and report
accordingly. The FFI is simply an agent receiving
the payment on behalf of its account holder.
As a general rule, a portion of U.S. income or
sales proceeds received by a foreign collective
investment vehicle when distributed to an investor
in a fund should not be defined to be a pass-thru
payment. As was experienced with these types of
payments under the QI Agreement, withholding
on only a portion of a payment received or made
creates significant operational challenges, and most
often requires manual processing. For example,
certain investment entities that are treated as flow-
through entities for QI purposes (e.g., partnerships)
make distributions throughout the year, but the
allocation of the payment between U.S. source
and non-U.S. source, and taxable or non-taxable
is generally not available at the time of payment.
Details of the composition of the payments are
Taxes—The Tax Magazine®
September 2010
generally not available until after year-end, at
which time QIs often rely on manual processes to
make adjustments to refund excess tax withheld
throughout the year and to effect required U.S. tax
reporting. Considerable effort is often required to
gather such information. Similar challenges occur
with distributions from U.S. mutual funds where a
portion of distributions made throughout the year
includes a non-taxable return of capital. It is very
difficult and costly to implement systems changes
that allow withholding to be taken on only a por-
tion of a payment, particularly because that portion
is frequently not determinable at the time of distri-
bution. Given that the number of accounts that will
be subject to the terms of FFI Agreements will be
significantly more numerous than those under QI
Agreements, reliance on manual processes needs
to be avoided. The administrative cost and risk of
error will be too high for larger FFIs.
There are other instruments which also cause sig-
nificant challenges for QIs, including instruments
that may be issued by a non-U.S. entity, but are
deemed to pay U.S.-source income for U.S. tax
purposes (e.g., dual-source securities). We are
seeing an increasing number of such instruments,
particularly in Canada. Most QIs find it necessary to
implement manual procedures to review such pay-
ments and make adjustments to take any additional
U.S. withholding and to issue the appropriate re-
porting after year-end. It is also a challenge for QIs
to identify such instruments when they are initially
acquired. We anticipate that a very small portion
of new accounts will be recalcitrant. As such, we
suggest that payments on these types of instruments
should be excluded from the definitions of with-
holdable and pass-through payments.
Audit Considerations
The RBC Comments69 also raised several FATCA audit
issues with the following discussion:
For large financial institutions with large numbers
of clients, compliance will generally require highly
automated procedures and processes. We recom-
mend that the information that must be gathered to
determine whether or not an account is a United
States account be very clear, with no need for in-
terpretation by the client or the employees of the
FFI. Many products offered by FFIs are high volume
49
New U.S. Withholding System for Foreign Account Tax Compliance
and “low touch”, and the client is often dealing
with junior level staff who cannot be expected to
understand or explain technical U.S. tax rules.
If the process is sufficiently integrated and im-
bedded into routine procedures, there is low
risk of significant non-compliance if policies and
procedures are being followed and subsequent
systems changes do not alter processing logic. For
FFIs with large numbers of accounts and robust
systems, we recommend that verification focus
on actions taken by the FFI to implement policies,
procedures and systems to achieve and maintain
maximum compliance. Testing of actual accounts
should be on an infrequent or exception basis.
We appreciate that developing detailed require-
ments and regulations related to audit procedures
may not be a current priority. However, it is
important for FFIs to have a reasonable under-
standing of the nature of the audit procedures that
will apply if they enter into FFI agreements for
purposes of assessing the cost and potential risks
and exposure that may arise. In addition, as FFIs
are making systems and procedural changes to
comply with FFI agreements, it would be benefi-
cial if Treasury and the IRS could identify specific
due diligence procedures that might facilitate the
subsequent verification process.
Exclusion of U.S. Branches
and Agencies
At least one commentator70 has raised the issue that
guidance is needed to exempt the U.S. based branch
or agency that is not within a separate U.S. entity from
FATCA by providing the following analysis:
[C]ertain classes of FFIs may be treated as meeting
the disclosure and reporting requirements of FAT-
CA if the Treasury Secretary determines that the
application of FATCA to the class is not necessary
to carry out the purposes of FATCA. [Code] Sec.
1471(b)(2)(B). The Joint Committee on Taxation
Technical Explanation of the HIRE Act provides
some insight into how Congress intended the
Treasury Department and IRS to implement this
deemed compliance provision, stating:
‘[T]he Secretary may identify classes of institu-
tions that are deemed to meet the requirements
50
of this provision if such institutions are subject
to similar due diligence and reporting require-
ments under other provisions in the Codes. Such
institutions may include…certain U.S. branches
of foreign financial institutions that are treated as
U.S. payers under the present law.’71
It is our understanding that FATCA would not apply
to the U.S. operations of an FFI if those operations
are conducted through a subsidiary that is a sepa-
rate entity organized in the United States, since the
entity would not be a foreign entity. However, many
FFIs conduct U.S. operations though a U.S. based
branch or agency that is not within a separate U.S.
entity. The financial services provided though such
operations tend to be very specialized and limited
in scope, and generally do not include taking
FDIC-insured deposits or providing other U.S. retail
banking services. Therefore, even in the absence of
FATCA, the ability of U.S. citizens or residents to
open accounts at these branches or agencies—for
purposes of evading U.S. Federal income taxes or
otherwise—does not exist as a practical matter.
Stated differently, tax evasion-mined U.S. individu-
als will not look to park their financial assets at a
U.S. branch or agency of an FFI because the secrecy
that they seek is totally unavailable.
Furthermore, and more pertinent to the legisla-
tive history … , U.S. branches and agencies of
FFIs already are generally subject to the same
tax information reporting requirements and must
comply with IRS information requests to the same
extent, as U.S. financial institutions. For instance,
the information reporting requirements for brokers
([Code] Sec. 6045), interest payments ([Code] Sec.
6049), dividend payments ([Code] Sec. 6042), and
other transactions requiring the filing of Form 1099
or similar forms all apply to U.S. branches and
agencies of FFIs, so the IRS has the ability to issue
a third-party summons to such branches pursuant
to [Code] Sec. 7602(b) and enforce the summons
pursuant to [Code] Sec. 7604.
Even in the absence of the specific guidance
concerning U.S. branches and agencies of FFIs
provided in the legislative history … excluding
these branches and agencies because of tax in-
formation reporting and IRS information request
compliance requirements that are comparable
to those of U.S. financial institutions is permit-

ted and supported by the statutory definition of
a United States account” which excludes any
account the holder of which is otherwise subject
to information reporting requirements which the
Treasury Secretary determines would make the
reporting required by FATCA duplicative.
The RBC Comments72 also raised the issue that
the definition of “withholdable payment” should be
amended to exclude payments to a U.S. branch of a
foreign bank with the following discussion:
In our view, it would be beneficial to limit the scope
of the “withholdable payment” definition in the
case of certain foreign entities that already have
robust U.S. tax information reporting responsibili-
ties, in order to reduce the potential for numerous
additional FFI agreements and because there is a
low risk of tax evasion. U.S. branches of foreign
banks are treated as U.S. persons for most informa-
tion withholding and reporting rules, and thus are
required to fully comply with all U.S. information
reporting and withholding laws and regulations.
For example, U.S. branches of foreign banks must
file IRS Forms 1099 with respect to payments to
non-exempt recipients. In addition, they are subject
to IRS audits. Consequently, they should be treated
as U.S. withholding agents that are not FFIs for
purposes of [Code] Sec. 1471 and 1472.
In addition to the fact that they must already
comply with U.S. laws, branches (and agencies)
of foreign banks conduct extensive operations in
the United States and engage in hundreds of mil-
lions of financial services and other transactions
each year. Unless payments to such branches are
treated as satisfying the FATCA requirements, each
payor of a withholdable payment to such a branch
would need to ensure that the bank has entered
into an FFI agreement before making payments
to the branch. Such a requirement would place
U.S. branches of foreign banks at a competitive
disadvantage compared to U.S. banks.
This exclusion is contemplated in the JCT Technical
Explanation of the FATCA provision wherein it states:
“Additionally, the Secretary may identify classes of
institutions that are deemed to similar due diligence
and reporting requirements under other provisions
in the Code. Such institutions may include certain
controlled foreign corporations owned by U.S. finan-
Taxes—The Tax Magazine®
September 2010
cial institutions and certain U.S. branches of foreign
financial institutions that are treated as U.S. payors
under present law.
Clarify Whose Treaty Rights
Are Waived if Foreign Financial
Institution Elects out of Withholding
Responsibility
Code Sec. 1471(b)(3) permits a foreign financial in-
stitution to enter into a agreement with the Treasury
under which it would not perform the withholding,
but would agree to provide sufficient information to
the withholding agent or payor that makes a with-
holdable payment to the foreign financial institution
so that the withholding agent can determine how
much of the payment is allocable to recalcitrant ac-
count holders or nonparticipating foreign financial
institutions and withhold on that portion of the pay-
ment to the foreign financial; institution.
In addition to the electing foreign financial in-
stitution providing sufficient information for the
withholding agent to determine the proper amount
to withhold from recalcitrant account holders and
nonparticipating foreign financial institutions who
have financial accounts with the foreign financial
institution, the foreign financial institution will be
required under Code Sec. 1471(b)(3)(C)(ii) to have
to include in the agreement with the IRS a “waiver
of any right under any treaty of the United States
with respect to any amount deducted and withheld
pursuant to an election …”
While there may be valid policy reasons to preclude
a credit or refund to a recalcitrant account owner or
nonparticipating foreign financial institution who has
failed to provide the required U.S. account information
to the electing foreign financial institution, it is firmly
established under general U.S. tax treaty principles
that another juridical entity cannot affirmatively waive
another person’s rights under a U.S. tax treaty. Rather,
such person must waive his or her own treaty rights in
the manner and time prescribed by the Treasury. In this
case, Code Sec. 1471(b)(3)(C)(ii) may be read to require
a foreign financial institution who wants to elect out of
its withholding responsibilities to be required to waive
its own rights to a reduced rate of tax under a U.S. treaty
and therefore a credit or refund otherwise available to
it under Code Sec. 1474(b)(2)(A)(i)(I).
It is unclear if the drafters intended such a harsh
result for the electing foreign financial institution who
may want to be otherwise compliant with the reporting
51
New U.S. Withholding System for Foreign Account Tax Compliance
requirements under Code Sec. 1471(b)(1)(A) and Code
Sec. 1471(c), but who would prefer to put the withhold-
ing responsibility with respect to its recalcitrant account
holders and nonparticipating foreign financial institu-
tions on the withholding agents who have resources and
systems already in place to withhold such U.S. tax and
deposit it on a timely basis with the IRS. If the Treasury
concludes that the provision mandates that an foreign
financial institution must enter into its own waiver to
preclude it from claiming a reduced rate of tax under
a U.S. treaty as a refund or credit then very few foreign
financial institutions, if any, will decide to elect out of
new Code Sec. 1471 withholding in favor of the with-
holding agents who are much better suited to effectuate
the required withholding under this new provision.
The Treasury may want to provide guidance to
clarify whether the election is intended to require an
electing foreign financial institution to provide its own
waiver of any rights it may have under a U.S. treaty
and thereby likely precluding an electing foreign
financial institution from otherwise being entitled
to a refund or credit under a treaty with the United
States, or whether the provision should be read to
require the electing foreign financial institution to
obtain such waivers from the recalcitrant account
holders or nonparticipating foreign financial institu-
tions who have financial accounts with the electing
foreign financial institution.
What if the NFFE Cannot Get the
Reporting Information About Its
Substantial U.S. Owners?
It is likely that there will be many foreign structures in
which foreign entities are owned by multiple tiers of
other foreign entities that may have one or more sub-
stantial U.S. owners based on the more-than-10-percent
vote or value test, even though the reporting NFFE has
no knowledge about such substantial U.S. owners. If
the information about these substantial U.S. owners
is not provided on a timely basis (or ever) because of
foreign privacy laws, contractual privacy protections
or otherwise what procedures can a non–financial
foreign entity implement to be compliant under new
Code Sec. 1472? At present, there is no mechanism
for a non–financial foreign entity to withhold on re-
calcitrant account holders or non-participating foreign
entities who refuse to provide information about their
accounts. Rather, the non–financial foreign entity must
be withheld upon for any withholdable payments it
receives under Code Sec. 1472(a).
52
FFI and NFFE Withholding
and Refund Issues
It may be helpful to go through a hypothetical to
illustrate the possible application of the FATCA
withholding and refund rules in the context of an
investment entity which is a foreign corporation for
U.S. tax purposes.
Assume the following facts: A non–publicly traded
foreign investment entity is organized in a country that
has a treaty with the U.S. that permits a reduced rate of
withholding for U.S. source dividend and interest. The
canton where the entity is located has a strict privacy
law precluding debt and equity holders from divulg-
ing any information about them and their accounts in
the entity. In 2013, the investment entity entered into
a Code Sec. 1471(b) agreement with the IRS to be
treated as a participating FFI. The FFI will be treated
as a corporation for U.S. tax purposes. As a means of
obtaining working capital the foreign corporation is-
sued a non–publicly traded zero coupon promissory
note, which will paid at maturity to among other lend-
ers, two debt holders who have refused to provide the
information about their accounts (e.g., name, address,
TIN, account number, etc.) that the FFI must obtain
and report to the IRS.73 In addition, one U.S. individual
shareholder who owns eight percent of the stock and
has an 11-percent voting right has not responded to a
notice requesting the U.S. account holders provide a
valid and effective waiver of the canton’s privacy law.74
During the year, the FFI earned both U.S. and foreign
source interest, dividends and capital gains from its
global stock and securities investments, but decided
because of the recession not to pay any dividends in
2013 and the foreseeable future.
Query, if the bank is the withholding agent, will
it have a responsibility to withhold under FACTA?
Presumably, the FFI is still compliant in 2013 under
Code Sec. 1471(b) notwithstanding the fact that there
are three recalcitrant account holders. Therefore,
no withholding should be imposed in 2013 upon
the withholdable payments attributable to the U.S.
source FDAP income earned by the FFI or on the gross
proceeds from the disposition of U.S. stock or securi-
ties received by the FFI.75 However, the FFI may have
to close the shareholder’s account if a valid privacy
waiver is not obtained within a reasonable time.76
Unless the FFI makes an election to be withheld
upon,77 rather than withholding on the pass-through
payments made to the two recalcitrant debt holders
and the recalcitrant shareholder the withholding

responsibility, if any will fall upon the FFI for any
pass-through payments made to these recalcitrant
account holders.78 It should be noted under current
law, the FFI does not have to obtain the consent of
the bank to make this election, provided it gives the
bank notice of the payment and provides such other
information as is necessary for the withholding agent
to determine the appropriate amount to withhold and
include a waiver of any right under any treaty of the
United States with respect to such amount withheld
pursuant to the election.79 At this time, it is not clear
whether the FFI or the recalcitrant account holders
are required to waive their U.S. treaty rights under
the new statute—presumably it is the later.80
If the bank is the payor because the FFI made the
election to be withheld upon, or if the bank is the FFI
(changing the facts somewhat)—what is the amount
of the “pass-through payment” to the recalcitrant
account holders? The term “pass-through payment”
means “any withholdable payment or other payment
to the extent attributable to a withholdable payment.”81
In this case, the OID on the promissory note will likely
be treated as foreign source income.82 However, it is
possible the IRS when it provides guidance will adopt
a look-through rule approach following Subchapter K
partnership principles or PFIC/CFC rules. Since the FFI
received both U.S. source and foreign source income
from its own trading activities which were in part fi-
nanced through the proceeds from the promissory note
and the shareholders equity investment, it is possible
the IRS will provide guidance which allocates a portion
of the FFI’s U.S. source income to each recalcitrant debt
holders sufficient to at least equal to the amount of the
annual OID or interest earned by each debt holder, and
in some cases may include the gross proceeds paid on
the retirement, sale or other disposition of the promis-
sory note by the recalcitrant debt holders. Since the
recalcitrant shareholder did not receive a dividend, and
in any event, it would generally be treated as foreign
source,83 one would think that there was no pass-
through payment made to such shareholder. However,
the IRS may provide guidance which allocates a portion
of the FFI’s U.S. source income or gross proceeds from
the sale of disposition of U.S. stock or securities to the
recalcitrant shareholder notwithstanding these facts
and create a deemed pass-through payment.
If the bank withholds on the pass-through pay-
ments to the recalcitrant account holders, will these
investors be able to obtain refunds, and can the bank
in its capacity as the U.S. payor if the FFI makes the
above election be withheld upon84 or can the FFI
Taxes—The Tax Magazine®
September 2010
obtain a refund on the investors’ behalf? Under the
current law, there is no reclaim procedure for either
the bank or the FFI to make an application for a refund
or credit on behalf of its investors who have been
withheld upon under FATCA. Rather, these investors
will have to file their own timely claims for refund
under new Code Sec. 1474 as if such withholding
tax had been withheld under Chapter 3 (dealing with
withholding of tax on nonresident aliens and foreign
corporations)85 generally by filing a Form 1040NR or
1120F if they otherwise qualify as non-resident aliens
or foreign corporations86 or generally a Form 1040 or
1120 if they are U.S. persons claiming a refund.
However, since the FFI failed to provide the re-
quired information about the recalcitrant account
holders (who will be treated as substantial U.S.
owners of a U.S. owned foreign entity),87 no credit or
refund will be allowed under new Code Sec. 1474(b)
(3), unless the IRS provides guidance otherwise. As
this time, it is not clear whether the recalcitrant ac-
count holders who may have rights under an existing
U.S. tax treaty to a refund or credit as is the case here
will lose these rights under new Code Sec. 1474(b)
(3), or whether this limitation only applies to the FFI
and not to the recalcitrant account holders.
Special rule limiting FFI refund claims and interest.
If the FFI was treated as the beneficial owner of a with-
holdable payment (e.g., U.S. source FDAP income or
gross proceeds from the sale of U.S. stock or securities)
which the Bank withheld upon under new Code Sec.
1471(a) (e.g., the FFI failed to close the shareholder’s
account or otherwise failed to satisfy the requirements
in the Code Sec. 1471(b) agreement with the IRS and
was treated by the IRS as noncompliant and presum-
ably was required to notify the bank of this fact), new
Code Sec. 1474(b)(2) imposes a special rule limiting the
entitlement of the FFI to a refund only for a payment
entitled to a reduced rate of tax by reason of a treaty
obligation with the U.S. and no interest will be allowed
with respect to such credit or refund.88
It is presently unclear whether testing for compli-
ance under Code Sec. 1471(b) will be done on a
year-by-year basis by the IRS (or other acceptable
auditor) or on some other time period (e.g., every
three years) and if an FFI is treated as noncompliant,
whether the FFI will lose its refund rights retroactively
or prospectively. It is also unclear how an FFI goes
about curing such deficiencies with the IRS and if the
FFI remediates the deficiencies will the IRS permit an
FFI to obtain refunds relating to earlier noncompliant
tax years.
53
New U.S. Withholding System for Foreign Account Tax Compliance
FATCA refund issues under U.S. tax treaties. Since a
U.S. treaty may only apply to income or capital taxes
or substantially similar taxes on income it is still an
open question whether a noncompliant FFI or NFFE
subject to tax imposed under new Code Sec. 1471(a)
or 1472(a) will be within the taxes covered by a U.S.
treaty, and therefore potentially subject to a reduced
rate of tax under a U.S. treaty. In addition, since these
FATCA provisions require a withholding agent to with-
hold on the gross proceeds from the sale of U.S. stock
or securities whether or not a taxable gain or loss is
recognized by the noncompliant FFI or NFFE, even if
this tax is within the scope of the taxes covered by a
U.S. treaty, it is still an open question whether an FFI
or NFFE will have a right to a reduced rate of tax under
a U.S. treaty as the FATCA withholding may not be
based on “gains” from the sale of personal property,
Presumably, recalcitrant account holders who have
been withheld upon under new Code Sec. 1471(b)(1)
(D) or new Code Sec. 1471(b)(3) who are claiming a
refund under a U.S. tax treaty will have the same issues
as well absent guidance from the Treasury.
FATCA withholding agent exposure even if FFI has
paid U.S. tax. If the bank withholds a 30-percent tax
on withholdable payments made to an FFI because
the FFI either failed to enter into FFI agreement or
because the FFI is not compliant with such agreement
to the satisfaction of the IRS, the fact that the FFI has
no U.S. tax liability (e.g., the withholdable payment
can be based on the gross proceeds from the sale
or disposition of any property of a type which can
produce interest or dividends from sources within the
United States even if it is sold at a tax loss)89 is irrel-
evant. Similarly, if the Bank withholds a 30-percent
tax on pass-through payments either because the FFI
has elected to be withheld upon, or because it is itself
the FFI, the fact that the recalcitrant account holders
do not have a U.S. tax liability is also irrelevant.
In this case, the U.S. withholding tax is in the nature
of a penalty for noncompliance with the FATCA rules
for U.S. accounts. Contrast this result with the with-
holding regime under Chapter 3 (withholding tax on
nonresident aliens and foreign corporations), Chapter
61 (Form 1099 reporting and backup withholding
for U.S. persons) and Chapter 25 (federal income tax
withholding), which generally permits a withholding
agent to obtain relief from a withholding tax liability
(excluding interest and penalties)—see Code Sec. 1463
for purposes of Chapter 3. In the case of FATCA, the
withholding tax is a gross withholding tax which is in-
tended to penalize FFIs and U.S. account holders who
54
are not compliant. Thus, unless the Treasury provides
guidance which grants relief to a withholding agent, if
a noncompliant FFI or recalcitrant account holder does
not have a U.S. tax liability, the withholding agent will
continue to be liable for U.S. withholding tax under
new Code Sec. 1474(a).
NFFE considerations. Changing the fact some-
what, if the bank is a withholding agent and makes
payments to the same foreign corporation and such
corporation is not treated as an FFI because it is
engaged in other business activities and does not
accept deposits, hold financial assets for the account
of others or is engaged in the investment or trading
in securities or other financial products,90 it will be
treated as a NFFE.91
As such, the NFFE will be required to either certify
that it does not have any beneficial owners who are
substantial U.S. owners or report the name, address
and TIN of each substantial U.S. owner, and have the
withholding agent certify that that it does not know
or have reason to know that any such information
provided is incorrect.92
In this case, there are two debt holders and one
equity holder that are noncompliant account holders.
However, because a substantial U.S. owner must own
more than 10 percent of the stock of the corporation (by
vote or value)93 only the equity shareholder will likely
be treated as a substantial United States owner because
the shareholder owns more than 10 percent by vote or
value (in this case, 11 percent by vote).94 If the NFFE
does not obtain and report the required information
about this shareholder after a reasonable inquiry, the
statute directs the withholding agent to withhold a 30-
percent tax on any withholdable payments received by
the NFFE.95 Thus, any U.S. source FDAP income and
the gross proceeds from the sale or disposition of U.S.
stock or securities received by the NFFE (again, even
at a tax loss) will likely be subject to this 30-percent
tax. Unless the IRS provides guidance permitting either
the withholding agent or the NFFE to withhold on the
pass-through payments of a noncompliant account
holder similar to Code Sec. 1471(b)(1)(D), withholding
agent’s like the bank will have no choice but to with-
hold to protect themselves from liability under Code
Sec. 1474(a). The flush language of the statute indicates
that the withholding agent will be “indemnified against
the claims and demands of any person for the amount
of any payments made in accordance with the provi-
sions of [Chapter 4].”96
If Bank withholds on payments made to the NFFE,
no credit or refund will be allowed or paid with

respect to any tax withheld unless the beneficial
owner of the payment provides the Treasury with the
information it may require to determine whether such
beneficial owner is a U.S. foreign entity97 and the
identify of any substantial U.S. owners of such entity.98
Since the information about the shareholder has not
been reported to the IRS presumably the NFFE has
no entitlement to a refund or credit for such withheld
tax. However, it is presently unclear whether the NFFE
has a right under a U.S. treaty for a claim for refund
as is the case here or whether this new provision can
preempt pre-existing or new treaty rights.99
Similarly, if the bank withholds a 30-percent tax on
withholdable payments made to the NFFE because the
NFFE failed to satisfy the reporting requirements for sub-
stantial U.S. owners or certify that it has no such owners,
the fact that the NFFE or the substantial U.S. owners have
paid their U.S. tax and have no liability is irrelevant as
to whether the bank, in its capacity as a withholding
agent must withhold to avoid liability for the Code Sec.
1472(a) tax under new Code Sec. 1474(a).
6038D reporting of FFI/NFFE interests by U.S.
individuals. Beginning in 2011, individuals with any
interest in a “specified foreign financial account” or
“SFFA” must attach a statement to their 1040 if all such
assets exceed $50,000.100 For this purpose, an SFFA will
include any financial account,101 any stock or security
issued by a person other than a U.S. person or any
financial instrument or contract held for investment
that has an issuer or counterparty which is other than a
U.S. person and any interest in a foreign entity.102 Thus,
the IRS will have a roadmap of an individual taxpayer’s
U.S. accounts a full two years before FFIs and NFFEs
have to commence reporting on these accounts, which
presumably increases the stakes of failing to identify
the U.S. accounts properly as of the general effective
date of this legislation—January 1, 2013.103 See “Re-
porting of Foreign Financial Assets.”
General Provisions
Confidentiality
No person may use information under the new law
except for the purpose of meeting any of its require-
ments or for purposes permitted under Code Sec.
6103.104 However, the identity of foreign financial
institutions that have entered into a Code Sec. 1471(b)
agreement with the IRS is not treated as return infor-
mation for purposes of Code Sec. 6103.105 The failure
to comply with these confidentiality provisions of
Code Sec 6103 can result in civil penalties.106
Taxes—The Tax Magazine®
September 2010
Account holder information is confidential. Under
the new reporting tax regime, foreign financial institu-
tions and each U.S. account holder and substantial
U.S. owner and non–financial foreign entities will
provide either a certification or detailed information
about each substantial U.S. owner. While the identity
of the foreign financial institutions and presumably its
affiliates will be publicly available information, com-
mentators have recommended that all account holder
information derived by foreign financial institutions as
part of their responsibilities under the section 1471(b)
agreement or by non–financial foreign entities as part
of the certification or disclosure process be subject
to the full confidentiality protections of Title 26 (e.g.,
Code Sec. 6103). It is also unclear whether the identity
of non–financial foreign entities will be able to be
disclosed by the IRS under new Code Sec. 1474(c).
Truncation should be required for FATCA payee
statements furnished electronically. Notice 2009-93107
issued on November 19, 2009, created a pilot program
that permits filers of certain information returns (forms
in series 1098, 1099 and 5498) to truncate individual
identification numbers on paper (but not electronic)
payee statements as a means to curb misuse and mis-
appropriation of individual tax identification numbers
and identity theft. Under the pilot program, the IRS will
permit a taxpayer’s TIN to be truncated by replacing
the first five of the nine digit number with asterisks
(***-**) or X’s on payer payee statements.
On July 22, 2010, the ABA Tax Section submitted
Comments on Notice 2009-93 Concerning the Pilot
Program to Truncate Taxpayer Identification Numbers
on Certain Payee Statements,108 and recommended
among other comments that truncation should be
required for payee statements furnished electronically
with the following discussion:
The delivery of payee statements electronically
does not necessarily reduce the rates of non-
delivery and misappropriation of TINs; therefore,
the Notice should be expanded to include
electronic payee statements as well. Requir-
ing truncation for electronic statements would
help to ensure that TINs are not inadvertently
disclosed by filers to unauthorized third-parties
while attempting to comply with information
reporting requirements.
Electronic receipt of information statements by
payees typically involves delivery by way of
electronic mail (“email”) or by the download-
55
New U.S. Withholding System for Foreign Account Tax Compliance
ing of information through a payor’s website.
Delivery of statements by either manner is
inherently insecure. Incidents of hacking, spoof-
ing, insecure connections, open Wi-Fi (wireless
internet connections that are susceptible to radio
interception), computer viruses designed to steal
information, malware (malicious software that
is used to control a person’s computer), web
browser history misuse and other problems in
security are common. There have even been re-
ported incidents of hacking by organized crime
syndicates and unfriendly governments.
Not only should truncation of TINs be permitted
on payee statements that are delivered elec-
tronically, but truncation should be required.
If truncation of TINs is merely permitted rather
than required in the case of electronic delivery
of return information, we believe that many filers
will disregard truncation and the goal of the Ser-
vice to reduce TIN misuse will not be furthered.
Therefore, final rules on the truncation of TINs
should require the truncation of TINs on both
paper and electronic payee statements.
Coordination with Other
Withholding Provisions
The Treasury will provide for coordination of new
Chapter 4 with other withholding provisions, includ-
ing providing for the proper crediting of amounts
deducted and withheld under the new law against
amounts required to be deducted and withheld un-
der other provisions of the Code.109 Presumably, this
provision was broadened in the new law in response
to the SIFMA Comments and others that the FATCA
Bill’s coordination provisions were too narrow.110
See “SIFMA Comments for Coordination with Other
Withholding and Information Reporting Provisions”
below. The Treasury may provide further coordinating
rules to prevent double withholding, including in situ-
ations involving tiered U.S. withholding agents.111
SIFMA Comments for coordination with other
withholding and information reporting provisions.
The SIFMA Comments to the proposed FATCA legisla-
tion recommended that the provisions be coordinated
with other withholding and information reporting
provisions by stating:112
Although the Bill provides appropriate language
with respect to the existing withholding provisions
of Code Sec. 1441 (withholding tax on nonresi-
56
dent aliens) and Code Sec. 1445 (withholding tax
on dispositions of U.S. real property interests), ad-
ditional coordination language should be added
with respect to other sections, including but not
limited to Code Sec. 1442 (withholding tax on
foreign corporations), Code Sec. 1446 (withhold-
ing tax on foreign partners’ share of effectively
connected income), Code Sec. 3402 (wage with-
holding), Code Sec. 3405 (withholding tax on
pension, annuities, and other deferred income),
Code Sec. 3406 (backup withholding tax), and
Code Sec. 4371 (foreign insurance excise tax).
In addition, the Bill should provide the appropri-
ate coordination language with respect to existing
reporting provisions, including but not limited to
Code Sec. 6041 (information at the source), Code
Sec. 6041(A) (returns regarding payments of remu-
neration for services and direct sales), Code Sec.
6042 (returns regarding payment of dividends),
Code Sec. 6045 (returns of brokers), and Code Sec.
6049 (returns regarding payment of interest).
Authority to Prescribe Regulations
The U.S. Treasury has been specifically granted the au-
thority to prescribe such regulations or other guidance
as may be necessary or appropriate to carry out the pur-
pose of the new law.113 The ABA Tax Section Comments
to the proposed FATCA legislation specifically requested
that the Treasury be granted broad authority under the
new tax reporting and withholding regime by stating:114
“We recommend that the Bill authorize Treasury to pro-
vide workable guidelines for FFIs to follow regarding the
information-gathering and reporting obligations, data
measurement, disclosure, account holder monitoring,
verification and error correction that, if followed, would
be deemed satisfactory compliance.”
Effective Date and Grandfather
Treatment for Outstanding Obligations
The new law applies to payments made after Decem-
ber 31, 2012.115 However, the law does not require
any amount to be deducted or withheld from any
payment under any obligation outstanding on March
18, 2012, the date that is two years after the date of
enactment or from the gross proceeds from the sale
or disposition of such obligations.116 Unless the grand-
father provision is read very broadly, most historical
U.S. accounts will be subject to the new diligence,
verification, reporting and withholding regime for

payments made with respect to such accounts after
December 31, 2012. See “U.S. Account” and “U.S.
owned foreign entity.” It is likely this date is overly
optimistic since there are significant issues for the
implementation of the new information reporting and
withholding system—the original qualified intermedi-
ary took over six years to implement and its effective
date was delayed several times.
The grandfather provision no longer requires the terms
of a debt obligation that is registered for tax purposes
to include a gross-up provision that would be triggered
as a result of enactment of the new law.117 While the
term “obligation” is not defined in the new law or leg-
islative history; presumably, the grandfather provision
extends to both short- and long-term obligations, as
well as registered and unregistered debt obligations.
It is also presently unclear whether the grandfather
provision will apply to stock or other equity instru-
ments (e.g., qualified and nonqualified stock options,
stock appreciation rights, restricted stock units, etc.).118
Notice 97-34119 dealing with information reporting on
transactions with foreign trusts and on large foreign
gifts defined the term “obligation” to include “… any
bond, note, debenture, certificate, bill receivable, ac-
count receivable, note receivable, open account, or
other evidence of indebtedness, and to the extent not
previously described any annuity contract.”
Query, if an obligation is exempt from withholding
under new Code Sec. 1471(a) under the grandfather
provision, will pass-thru payments which are made to
recalcitrant account holders or noncompliant foreign
financial institutions under new Code Sec. 1471(b)
(1)(D) be subject withholding or will these payments
also be exempt based on the rationale that the for-
eign financial institution is itself is exempt under the
grandfather exception?
Application of material modification rules. It is
anticipated that the Treasury may provide guidance
as to the application of the material modification
rules under Code Sec. 1001 in determining whether
an obligation is considered to be outstanding on the
date that is two years after the date of enactment
and how to treat nontaxable refinancing or recapi-
talizations.120
Delay effective date to permit the Treasury to
promulgate rules for implementation of the new
reporting and withholding regime. Several commen-
tators to the FATCA legislation recommended at least
an 18-to-24-month implementation period to ensure
full and robust compliance by foreign financial insti-
tutions and non–financial foreign entities.
Taxes—The Tax Magazine®
September 2010
FATCA’s effective date had permitted a one-year
implementation period and generally applied to
payments made after December 31, 2010.121 Under
a grandfather rule, the proposed withholding and
reporting provisions would not have applied to any
obligation outstanding on the date of the first com-
mittee action, if such obligation was in bearer form
or if the obligation includes (on the date of the issu-
ance of such obligation) a provision under which the
issuer would (but for this provision) be obligated to
make additional payments under such obligation by
reason of the provision.122
Even though the reporting and withholding provisions
under new law were extended for two years and will be
generally applied to payments made after December
31, 2012, the new law may nonetheless presents severe
administrative challenges for both foreign financial in-
stitutions and non–financial foreign entities. Under the
new law, foreign financial institutions will have to enter
into a section 1471(b) agreement with the IRS to avoid
the 30-percent withholding tax, while non–financial
foreign entities must provide information about their
substantial U.S. owners.
At least one Tax Director at a large foreign bank indi-
cated that it is critical that foreign financial institutions
develop an automated process that can handle the
transaction volume without a significant error rate. The
law as now written contemplates a a low tolerance for
errors which is not a likely outcome or realistic prob-
ability given the high volume of transactions subject to
the new reporting and withholding regime.
Several commentators have recommended that the
law authorize the Treasury to provide guidance which
will address the rules foreign financial institutions must
follow including details on the information-gathering
and reporting obligations, data measurement, dis-
closure, account holder monitoring, verification and
other requirements foreign financial institutions must
follow for error correction, withholding and refunds.
NYSBA Tax Section Comments—Effective date
flexibility. The NYSBA Tax Section Comments
strongly advocated permitting the Treasury to have
the flexibility to extend the effective date of the new
law by stating:123
Financial entities and non-financial entities will
need time to implement the requirements im-
posed by Code Sec. 1471-1474. Many of these
requirements will be set forth in the regulations,
which may not be available immediately. Given
the complexity and delicacy of the task, those
57
New U.S. Withholding System for Foreign Account Tax Compliance
regulations will take time to draft and will need
to be fully vetted when released in proposed form
(likely more than once). After the substance of the
rules is available, implementation of the necessary
compliance systems will take considerable effort,
and some requirements may take financial entities
and the IRS longer to implement than others.
We appreciate that the [Extender’s Act] has deferred
the effective date of these provisions to December
12, 2012, but we strongly recommend that the
Treasury Department have the express authoriza-
tion to extend the effective date, in whole or part,
as it deems necessary or appropriate. To this end,
the legislative history should acknowledge the
significant amount of time that will be required
for the Treasury Department to issue the necessary
extensive guidance implementing the rules under
Chapter 4 and the time the financial services indus-
try will need to understand the rules and prepare
procedures and systems in order to comply with
the rules. This flexibility will give the Treasury De-
partment time to prepare the necessary guidance,
which it may decide to phase in over time, and will
give the financial services industry time to prepare
for compliance and for a critical mass of section
1471(b) agreements to be signed.
Proposed Code Sec. 1474(d)(2) would grandfather
“any amount to be deducted or withheld from any
payment under any obligation outstanding” on the
date two years after the date of the enactment of
the [Extender’s Act]. The legislation is ambiguous
in two important ways: first, it should clarify what
is intended to be covered by the statutory term
“obligation”. In particular, it is not clear whether
only debt obligations would constitute an “obli-
gation” for this purpose or whether contractual
obligations (like licenses or annuities) or equity
securities would constitute “obligations” subject
to grandfathering. We would recommend that,
except as provided in regulations, the term “obli-
gation” should include all contractual obligations
(debt and other contractual obligations such as
licenses and annuities) but should exclude equity
securities. Second, we strongly recommend that
the legislation clarify that a “payment under any
obligation” under Sec. 1474(d)(2) includes any
payments of proceeds from the sale, redemption or
other disposition of any obligation. Without greater
clarity on the precise nature of which payments and
58
which obligations are to be grandfathered under
proposed Code Sec.. 1474(d)(2), we are concerned
that the grandfathering provision may not be fully
effective in avoiding market disruption during the
period that the precise requirements under [the Ex-
tender’s Act] are being developed. In the absence of
clarification, issuers and investors would not know
whether or not they are subject to these rules. Ac-
cordingly, we strongly recommend that Congress
revise the language of proposed Code Sec. 1474(d)
(2) to clarify the definition of an “obligation” and
to explicitly provide that payments of proceeds
on the sale, redemption or other disposition of an
obligation are included as grandfathered payments
under Code Sec. 1474(d)(2).
In addition, we would recommend that the
two-year grandfathering provision apply to any
“obligation” issued pursuant to a commitment
undertaken by the issuer of the obligation, or an
option granted to the issuer by the lender/holder/
counterparty of the issuer, during the two-year pe-
riod. We are concerned that grandfathering only
obligations outstanding during that period may
inadvertently make it difficult for U.S. borrowers
to obtain, during the two-year period, revolving
credit facilities, loan commitments (e.g., loans
that can be drawn only after certain benchmarks
are met, rather than by a date certain), and stand-
by credit facilities and letters of credit.
EBF FATCA Comments—Effective date. The EBF
FATCA Comments helpfully address many of the
needed steps both Treasury and foreign financial
institutions will have to go through before they
can implement the new reporting and withhold-
ing regime:124
We recommend that new Chapter 4 (Code Sec.
1471—1474) should be effective only when and
to the extent provided in Treasury regulations. We
understand that Congress may wish to express
in legislative history an appropriate timetable
for the Treasury Department to issue any such
implementing regulations. In addition, it would
be helpful if the legislative history encourages the
Treasury Department to adopt regulatory effec-
tive dates that will allow for an orderly transition
by the financial industry and the IRS to the new
withholding tax regime envisioned by Chapter 4
after final regulations are issued.

In particular, the legislative history should clarify
that Congress anticipates that Treasury will adopt
effective dates that enable financial institutions
to put in place, or adapt, automated systems to
effectuate the new rules, and to train personnel in
applying the new rules. Likewise, the legislative
history should encourage the Treasury Depart-
ment to consider the time necessary for the IRS to
publish a form of agreement with foreign financial
institutions under Section 1471(b) and to finalize
such agreement; to sign up those FFIs deciding to
enter into such agreements and to publish a list of
such qualifying FFIs; to revise Forms W-8 to better
collect data related to the new rules; and to put
in place streamlined refund and credit processes
for any over-withholding that results from the new
rules. (Based upon the financial industry’s experi-
ence with the implementation of the QI regime,
we believe it likely that three years from the time
the implementing regulations are finalized will be
required to accomplish the above tasks.)
Rationale. Proposed Code Sec. 1474(d)(1) pro-
vides that new Chapter 4 will generally apply
to payments made after December 31, 2010
[extended to December 31, 2012 under the
new law]. Chapter 4, however, simply sets forth
a framework that requires extensive guidance
by the Treasury Department before it can be
implemented, and grants to Treasury substantial
flexibility in issuing regulations detailing how
those rules will work in practice.
We support the approach of providing Treasury with
the flexibility to work with the financial industry
and the IRS to find an appropriate balance between
the compliance goal of the Bill to combat U.S. tax
evasion and the inevitable costs and burdens as-
sociated with that goal. Such a balancing effort is
crucial in order to try to minimize the disruptions to
the U.S. capital markets if a critical number of FFIs
were not to “buy in” to the new regime because
the costs and risks associated with FFI status were
disproportionate to the compliance goal.
We believe that the sort of flexible approach envi-
sioned by the Bill necessarily calls for an effective
date that is tied to the issuance of regulations and a
sufficient time period to permit their orderly imple-
mentation by the financial industry. No FFI will be
in the position to determine if it should sign an FFI
Taxes—The Tax Magazine®
September 2010
agreement without understanding what costs and
risks are associated with that agreement as detailed
in the implementing regulations. Furthermore, a
failure to provide sufficient time for the financial
industry to build the systems and processes to
comply with any final regulations could lead to
massive amounts of over-withholding, contrary to
the intent of the Bill. Accordingly we strongly urge
Congress to provide the Treasury Department with
the authority to design an appropriate timetable for
implementation and not tie its hands with a statu-
tory effective date as of a date-certain.
ABA Tax Section Comments to delay effective
date to permit guidance and implementation of
new reporting and withholding regime. The ABA Tax
Section Comments to the proposed FATCA legislation
also addressed extending the effective date of the
proposed legislation by stating125:
The section 101 effective date generally only
permits a one-year implementation period and
will strain the administrative capabilities of FFIs.
We recommend that the provisions not be effec-
tive prior to such time as Treasury may determine
is reasonable to permit compliance by FFIs and
NFFEs, which may be two or more years follow-
ing enactment.
Under the Bill, FFIs would have to enter into an
agreement with the IRS to avoid the 30 percent
withholding tax and would have to collect account
information not only for its own accountholders
and non-regularly traded equity and debt holders
but for those of its 50 percent affiliates. In practice,
whether entering into a section 1471(b) agreement
would be acceptable to an FFI would depend on
the particular requirements underlying the section
1471(b) obligation. The Bill offers little guidance
on the extent of the obligations, including the fre-
quency of measurement of the financial data, and
the extent of verification procedures required. It
is critical that this guidance be made available for
FFIs to decide whether to change their systems to
continue to invest in U.S. securities, and if so, to
allow the time to do so before any effective date.
Section 101 of the Bill is intended to promote
compliance by U.S. persons and to obtain in-
formation, not to result in a large of withholding
tax or frighten investors or intermediaries from
59
New U.S. Withholding System for Foreign Account Tax Compliance
U.S. markets. In order that this may occur, it is
essential that FFIs are confident that they can de-
velop processes to handle the transaction volume
without a significant error rate.
SIFMA Tax Comments requesting a delay of the ef-
fective date. SIFMA also commented upon delaying
the effective date for the proposed FATCA legislation
by stating, in part:126
The Bill would require an unprecedented level
of U.S. tax information gathering and reporting
by foreign entities that have not traditionally en-
gaged in such efforts. Even for a seasoned U.S.
financial institution, expanding existing U.S. tax
information reporting systems to satisfy the re-
quirements of the Bill would be time consuming
and expensive. For an FFI that has no existing U.S.
tax information reporting systems, complying with
the requirements of the Bill will be a monumental
task, which will require hiring numerous addi-
tional employees, the creation of new information
technology systems, and the training of large
numbers of current workers. The ability of FFIs to
engage in such efforts on a short time frame (or
indeed, at all) cannot be presumed.
EBF/IIB Comments on effective date. The EBF/IIB
had the following comments regarding the FATCA
effective date provision and future phase in dates:
… the guidance that is provided on a priority basis
regarding the identification of U.S. accounts and
related due diligence should stratify the population
of business lines and existing accounts based on the
likely risk of U.S. tax avoidance and burdensome-
ness of implementation, and should provide for
extended, phased-in effective dates for those cat-
egories that are less likely to present a high risk of
U.S. tax avoidance and/or raise serious implemen-
tation burdens. For example, we would expect that
private banking and custodial securities investment
accounts would have a higher priority than retail
banking, and FFIs might prioritize their attention
on such business lines first. Similarly, as discussed
above, we believe that FFIs will need considerably
more time to identify U.S. owners of entities than
direct account holders. In this regard, the govern-
ment should specify what expectations it has for the
financial community as of FATCA’s effective date
of January 1, 2013 and as of future phase-in dates.
60
In addition to clear phase-in rules for various cat-
egories of business lines and accounts, we would
also ask that Treasury and the IRS provide a sort of
general safe harbor for “good citizen” institutions
that make reasonable efforts to comply in time for
2013, even if not all systems are up and running
because of the magnitude of the technological,
procedural, control and training tasks presented by
FATCA. We make these requests because we read
the statute as immediately effective for payments
made after December 31, 2012 with the exception
of grandfathered securities, and we remain quite
concerned that the financial community will be
faced with the daunting task of trying to implement
a comprehensive withholding tax regime within a
potentially unrealistic time frame if regulations are
not finalized fairly quickly.
Comments on Successful
Implementation of Chapter 4
In Announcement 2010-22, the Treasury requested
comments from taxpayers on Subtitle A of Title V of the
HIRE Act entitled “Foreign Account Tax Compliance.”
The successful implementation of the new disclosure,
reporting and withholding regime will require guid-
ance from industry to the Treasury, together with and
prudent and carefully drafted rule-making and other
guidance by the government which will address among
other issues: (1) coordination between reporting and
withholding system for foreign financial institutions
(new Code Sec. 1471) and non–financial foreign enti-
ties (new Code Sec. 1472); (2) coordination between
the existing nonresident withholding and qualified
intermediary reporting rules (Code Secs. 1441–1446)
and the new regime (new Code Secs. 1471–1474);
(3) proper crediting and amounts deducted and with-
held under the HIRE Act against amounts required
to be deducted and withheld under other tax rules;
(4) coordination between the Chapter 3 and new
Chapter 4 refund systems; (5) the recordkeeping and
verification requirements to satisfy the section 1471(b)
or FFI agreement; (6) rules which address the new
information reporting requirements and exclusions
or exceptions; (7) rules which address inadvertent
mistakes or footfalls by foreign financial institutions
and non–financial foreign entities or withholding
agents and other U.S. payors and tolerance limits for
mistakes; (8) rules that address the status of payees; (9)
rules which address direct and indirect ownership of
entities; (10) anti-abuse rules; (11) rules which address

treaty compliance including required documentation
and certifications; (12) procedural issues and the ap-
plication of the extended statute of limitations; (13)
addressing the new penalty provisions; (14) granting
appropriate extensions of time as necessary to imple-
ment the new regime properly (15) rules that address
privacy waivers and closing the accounts, if necessary,
and (16) rules that address the use of statistical sam-
pling techniques to identify U.S. accounts.
Prioritization Issues
The EBF/IIB Comments127 have helpfully suggested
to the Treasury that they focus on the following pri-
orities as it decides on what guidance to provide to
taxpayers:
Implementation of FATCA on a timely basis will be
a monumental task for both the government and
the financial community. As we have previously
noted, the financial community will likely need at
least two years from the issuance of comprehen-
sive and final guidance to set up the systems and
perform the due diligence to be able to comply
with FATCA. It is desirable and tempting to talk
about prioritizing the guidance, so that the finan-
cial community has more time to put in place those
items that will require more time to implement.
Unfortunately, however, so much of the guidance
is necessarily and integrally interrelated, and thus
it is unlikely to be practical for the financial com-
munity to begin to create new systems, begin due
diligence or train personnel until a substantial
portion of the guidance is finalized. Nonetheless,
we provide the following suggestions regarding the
overall guidance project and its prioritization.
[I]n terms of prioritization, it will be very helpful for
the IRS at an early point in time to (i) indicate the
overall architecture of the new regime it proposes
to implement, focusing on the categories of FFIs
(e.g., those that must enter into FFI agreements
under section 1471(b), and those that will be eli-
gible for alternative rules, such as the FFE and SFIE
approaches that we propose herein, or that will be
exempt altogether), and (ii) provide detailed guid-
ance regarding what FFIs will be expected to do
regarding the identification of U.S. accounts in the
case of both existing and new accounts (i.e., the
issues discussed in Paragraph 2 above). This guid-
ance should be sufficiently precise so that FFIs can
Taxes—The Tax Magazine®
September 2010
begin to set up their identification and due diligence
systems. the EBF and IIB are concerned that Trea-
sury and the IRS may view their immediate task as
limited to publishing first proposed and then final
regulations. However, we believe that substantial
guidance in addition to the admittedly vital regu-
lations are crucial if the FATCA withholding tax
system is to operate reasonably well. We respect-
fully request that these items be published in draft
form so that the financial community can provide
comments to you to make the items more useful to
the IRS and less burdensome to the industry. Specifi-
cally, we request that the IRS complete action on
the following items by the end of 2010:
A new Form W-8BEN for individuals that allows
the beneficial owner to certify to non-U.S. tax
status and that provides more relevant indicia of
U.S. tax status through certifications related to
such status (e.g., dual citizenship, place of birth,
green card status, substantial presence, etc.). We
believe that in conjunction with this change in
the Form W-8BEN, the section 1441 regulation re-
quiring a “reasonable explanation” in writing for
a U.S. address be eliminated. The rule is largely
meaningless in effect and the government’s con-
cerns regarding U.S. tax status should be more
directly addressed by the Form
A new Form W-8BEN for entities (including a
checkbox that would enable the entity to certify its
nature for U.S. tax purposes, that it does not have
substantial U.S. owners and/or that it satisfies an
exception to NFFE status, and a way for an NFFE to
provide information about its U.S. owners). It should
also allow an FFI acting with regard to its own ac-
count to certify if is a participating FFI or not. We
urge the IRS to issue clear and detailed instructions
in connection with such a new Form W-8BEN to
help entities determine both the U.S. tax classifica-
tion of their particular entity and how to determine
and measure substantial U.S. ownership.
Sample formats or an official form for an NFFE
to provide information regarding substantial
U.S. owners in the event that a Form W-8BEN
cannot be collected.
A new Form W-8IMY that includes a way: (1)
for an FFI to certify if it is a “participating” FFI
(that is, one that has an agreement with the
IRS); (2) for an FFI to elect to have another with-
61
New U.S. Withholding System for Foreign Account Tax Compliance
holding agent do the Chapter 4 withholding on
any recalcitrant account holders and provide
allocation information to accomplish this end;
(3) for an FFI-type entity to certify that it should
be treated as an FFE; and (4) for an FFI or an FFE
to certify that it has no U.S. customers.
The FFI Agreement and instructions on how
to file it.
It will be quite key that FFIs and FFEs under-
stand any proposed audit requirements as
soon as possible so that they can complete the
cost/benefit analyses that will be necessary to
ensure that being a participating FFI or FFE is
commercially feasible.
Forms (or amended versions of existing forms)
for reporting taxes withheld under FATCA, as
well as a revenue procedure or other guidance
describing how taxes withheld under FATCA
should be deposited.
Sample formats (for electronic filing) or an of-
ficial form for the FFI annual report regarding
its U.S. customers.
Sample formats (for electronic filing) or an of-
ficial form for the U.S. account holder reports
required under FATCA for FFEs
A revenue procedure or other guidance describ-
ing how a beneficial owner can establish that it is
entitled to a refund of tax withheld under FATCA.
As discussed above, it is particularly crucial that a
robust refund mechanism be instituted, especially
since gross proceeds will also be subject to with-
holding for the first time. The new requirements
are likely to be relatively unknown to many FFIs,
FFEs and NFFEs, particularly smaller entities.
A web site listing (1) all participating FFIs and
those deemed by the IRS to be non-participat-
ing FFIs, (2) those FFI-type entities electing
FFE status, (3) FFEs that the IRS determines
are non-participating FFEs, and (4) electing
1471(b)(2) FFIs (i.e., those without U.S. cus-
tomers). We recommend that the IRS commit
to updating this web site on a monthly basis
so that withholding agents can code their
systems with more accurate data.
The EBF and IIB believe that FATCA’s effective
date should be delayed until at least 18 - 24
months after all of these items are published so
that systems and procedures can be developed
to accommodate the new requirements. At a
62
minimum, the IRS should provide that no with-
holding liability or penalties will be imposed for
failure to comply with FATCA before that date.
Reporting of Foreign
Financial Assets
Income Tax Return Reporting for
Foreign Financial Assets
A U.S. person who transfers assets to and hold inter-
ests in foreign bank accounts or foreign entities may
be subject to self reporting requirements under both
Title 26 (the Internal Revenue Code) and Title 31 (the
Bank Secrecy Act) of the U.S. Code. Under current
law, Treasury Department Form TD F 90-22.1, Report
of Foreign Bank and Financial Accounts (the FBAR),
must be filed by June 30 of the year following the year
in which the $10,000 filing threshold is met.128
More specifically, an FBAR is required if the follow-
ing conditions are met: (1) the filer must be a U.S.
person; (2) the filer must have financial account(s);
(3) the financial account must be in a foreign coun-
try; (4) the filer must have a financial interest in
the account or signature authority over the foreign
financial account; and (5) the aggregate amounts in
the accounts valued in dollars must exceed $10,000
at any time during the calendar year.129 A financial
interest includes an account held by an entity where
a U.S. person directly or indirectly owns more than
50 percent of the corporation or partnership, or has
a beneficial interest in over 50 percent of the assets
or income of a trust that owns a non-U.S. account.
It should be noted the new tax return reporting re-
quirements discussed below are not intended as a
substitute for compliance with the FBAR reporting re-
quirements, which are unchanged by the new law.
Under the new law (which is the same was in the
Extenders Act), if an individual holds any interest in
a “specified foreign financial asset,” or “SFFA,” he
will be required to attach to his tax return an an-
nual disclosure statement declaring the asset and
certain other “6038D required information,” if the
aggregate value of all such assets exceeds $50,000
(or any higher amount prescribed by the IRS) at any
time during his tax year.130 The term “specified foreign
financial asset” or “SFFA” means131:
any “financial account” maintained by a foreign
financial institution (including any non–publicly
traded equity and debt of a foreign financial
institution, and

any of the following assets that are not held in an
account maintained by a foreign financial institu-
tion including (i) any stock or security issued by a
person other than a U.S. person, (ii) any financial
instrument or contract held for investment that has
an issuer or counterparty that is other than a U.S.
person, and (iii) any interest in a foreign entity.
An individual is not now required under these new
rules to disclose foreign interests that are held through
a U.S. financial institution. At present, it is not clear
how or when a taxpayer is supposed to calculate the
“aggregate value.” Query, is this amount based on gross
assets or net assets? For an explanation of financial ac-
count and foreign financial institution, see “Financial
Account” and “Foreign Financial Institution.” Since the
new reporting requirements are not the same as the
FBAR reporting requirements, individuals would be
wise to review any “foreign accounts” or interests in
foreign entities to ensure the proper U.S. tax reporting is
done to avoid penalties under either the FBAR regime or
the new reporting regime. See “Liability for Withholding
Tax, Interest, Penalties and Statute of Limitations.”
Information required to be attached to return.
Although the nature of the information required is
similar is to the information disclosed on an FBAR,
it is not identical. For example, a beneficiary of a
foreign trust who is not within the scope of the FBAR
reporting requirements because his interest is less
than 50 percent may nonetheless be required to dis-
close the interest in the trust with his tax return under
this provision if the value of the threshold is met.
The information to be included on the statement
includes identifying information on each asset and
its maximum value during the tax year. In the case of
an account the information to be attached to an indi-
vidual’s tax return with respect to any such asset is the
name and address of the financial institution in which
such account is maintained and the account number of
such account. In the case of any stock or security, the
name and address of the issuer and such information as
is necessary to identify the terms and class or issue of
which such stock or security is a part. In the case of any
other instrument, contract or interest such information
as is necessary to identify the instrument, contract or
interest, the nature or terms of such instrument, contract
or interest, the names and addresses of all issuers and
counterparties with respect to such instrument, contract
or interest. In each case the maximum value of the asset
during the year must be disclosed.132
One commentator133 has suggested that clarity is
needed for the phrase, “any financial instrument or
Taxes—The Tax Magazine®
September 2010
contract,” and asks what does this definition include?
Among other questions this commentator asks is
whether this will require reporting for (i) foreign
social security programs, (ii) private pension funds,
(iii) private life insurance contracts, (iv) mortgages, (v)
futures, options and derivatives, and (vi) other con-
tracts. 134 Presumably, even foreign real estate and art
work purchased through a foreign entity will have to
be reported. It is not clear whether the IRS will issue
a new form for the disclosure or whether a taxpayer
can simply attach a statement to his or her tax return
(Form 1040) or whether the Form 8275 (the general
disclosure statement) should be used.
An individual is not required to disclose interests
that are held in custodial account with a U.S. fi-
nancial institution, nor is an individual required to
identify separately any stock, security, instrument,
contract or interest in a foreign financial account
disclosed under this provision. Under the new law,
the Secretary is permitted to issue regulations that
would apply these reporting obligations to a domestic
entity in the same manner as if such entity were an
individual if that domestic entity is formed of to hold
such interests directly or indirectly. See “Penalty for
Failure to Disclose Foreign Financial Assets.”
The Secretary is directed to prescribe guidance to carry
out the purposes of this provision and to provide appro-
priate exceptions from its application for classes of assets
that would be duplicative of other disclosures, nonresi-
dent aliens and bona fide residents of U.S. possessions.135
This provision will apply to tax years beginning after
March 18, 2010 (i.e., 2011 for individuals).136
New PFIC Reporting Rules
In general, active foreign business income derived by
a foreign corporation with U.S. owners is not subject
to current U.S. taxation until the corporation makes
a dividend distribution to those owners. However,
certain rules restrict the benefit of deferral of U.S. tax
on income derived through foreign corporations. One
such regime applies to U.S. persons who own stock
of passive foreign investment companies (PFICs).
A foreign corporation (subject to certain exceptions
for banks and insurance companies) is a PFIC if either
(1) 75 percent or more of its gross income for the tax
year consists of passive income, or (2) the average of
the percentage of its assets during the tax year that
produce passive income or that are held for the pro-
duction of passive income is at least 50 percent.137
Various sets of income inclusion rules apply to U.S.
persons that are shareholders in a PFIC, regardless of
63
New U.S. Withholding System for Foreign Account Tax Compliance
their percentage ownership in the company. One set
of rules applies to PFICs under which U.S. sharehold-
ers pay tax on certain income or gain realized through
the companies, plus an interest charge intended to
eliminate the benefit of the deferral.138 A second set of
rules applies to PFICs that are “qualified electing funds”
(QEF), under which electing U.S. shareholders currently
include in gross income their respective shares of the
company’s earnings, with a separate election to defer
payment of tax, subject to an interest charge, on income
not currently received.139 A third set of rules applies
to marketable PFIC stock, under which electing U.S.
shareholders currently take into account as income (or
loss) the difference between the fair market value of the
stock as of the close of the tax year and their adjusted
basis in such stock, subject to certain limitations and
referred to as “marking-to-market.”140
Under prior law, a U.S. person that was a direct or
indirect shareholder of a PFIC must file Form 8621
for each tax year in which the U.S. person recognizes
gain on a direct or indirect disposition of PFIC stock,
receives direct or indirect distributions from a PFIC
or makes a reportable election.141
The new law amends Code Sec. 1298 by requiring
each U.S. person who is a shareholder of a passive
foreign investment company to file an annual in-
formation return containing the information as the
Secretary may prescribe. The legislative history indi-
cates the Treasury will exercise regulatory authority to
avoid duplicative reporting under Code Sec. 6038D
with respect to foreign financial assets. See “Income
Tax Return Reporting for Foreign Financial Assets”
The effective date of this provision is March 18, 2010.
Some commentators have suggested that PFIC annual re-
ports will be required by shareholders of PFICs for 2009
and earlier tax years PFIC returns which will be filed after
March 18, 2010, the date of enactment. However, the
IRS, in Notice 2010-34,142 made clear that the Treasury
is developing further guidance regarding shareholder
PFIC reporting under new Code Sec. 1298(f), and in
the meantime only persons who were required to file
Form 8621 prior to the new law must continue to file
the information return as provided in the instructions
to the Form (see explanation above). Shareholders of a
PFIC that were otherwise not required to file Form 8621
annually prior to March 18, 2010, will not be required
to file an annual report as a result of the new law for tax
years beginning before March 18, 2010.
Because most taxpayers and many tax advisors do
not specialize in cross-border matters, it is possible
that many are either unaware or not entirely aware of
64
the complicated PFIC rules. It is likely that this new
reporting requirement will identify “PFIC problems”
long after it is too late to make a PFIC election for the
first PFIC year. In certain circumstances, it may be
possible to make a deemed sale or deemed dividend
election (the “purging elections”), or in extremely
limited circumstances a retroactive QEF election
with the special consent of the IRS. The amount of
deemed gain or deemed income recognized as a
result of such purging elections will be still subject
to the excess distribution regime, and the total tax
and interest charge may be quite onerous.
In fact, in egregious cases of the long-term failure to
file PFIC returns and therefore make a QEF election,
the tax may exceed the entire gain on the sale of the
PFIC stock and in some cases the amount realized for
an effective tax rate of over 100 percent. The alterna-
tives left for such a taxpayer in such a predicament are
quite sparse, since any sale or disposition of the PFIC
shares in either a taxable or nonrecognition transac-
tion, or a conveyance via a gift would nonetheless
likely trigger the tax. Presumably, if the taxpayer is
elderly he or she may wait until death and have his or
her estate claim a deduction for the tax. On the other
hand, some commentators have suggested that this
provision will likely not generate much revenue for the
government because the existing PFIC requirements
have been followed and because the new law does
not add significant exposure for such investors.
The three-year statute of limitations period will not
begin to run until “completed” PFIC returns together
with the information required by the new law is pro-
vided to the IRS.
Electronic Filing of
Information Returns
Under prior law, corporations and tax-exempt or-
ganizations that have assets of $10 million or more
and file at least 250 returns during a calendar year,
including income tax, information, excise tax and
employment tax returns are required to file electroni-
cally their Form 1120/1120-S income tax returns and
Form 990 information returns for tax years ending on
or after December 31, 2006. Private foundations and
charitable trusts that file at least 250 returns during a
calendar year are required to file electronically their
Form 990-PF information returns for tax years ending
on or after December 31, 2006, regardless of their
asset size. However, taxpayers can request waivers of
the electronic filing requirement if they cannot meet
the requirement due to technological constraints or

if compliance with the requirement would result in
an undue financial burden.
The new law provides an exception to the general
annual 250 return threshold and permits the Secretary
to issue regulations to require filing on magnetic media
for any return filed by a “financial institution” with
respect to any taxes withheld by the financial institu-
tion for which it is personally liable. (For a definition of
“financial institution” see “Financial Institution.”) The
Secretary is authorized to require a financial institution
to electronically file returns with respect to taxes with-
held under Code Sec. 1461 (e.g., FDAP withholding) or
1474(a) (FATCA withholding) by a financial institution,
even if the financial institution would be required to
file fewer than 250 returns during the year.
The provision also makes a conforming amended
to Code Sec. 6724, permitting the IRS to assert a
failure to file penalty under Code Sec. 6721 against
a financial institution that fails to comply with the
electronic filing requirements. This provision applies
to returns required filed after March 18, 2010, without
regard to extensions.
Authorize a Measurement Tool to
Quantify Progress Made by Treasury
to Combat International Tax Evasion
Several members of Congress at the FATCA hearing on
November 5, 2009, and commentators have recom-
mended that the Treasury provide Congress with periodic
reports that quantify the extent of U.S. tax evasion by
Americans which can be used to evaluate whether the
new law is working as it was intended by the Treasury.
Commentators have also pointed out that while taxpay-
ers are in favor of the new laws, there is a desire to get
periodic feedback confirming that their tax dollars for
international compliance effort are being spent wisely.
Substitute Dividends and
Dividend Equivalent Payments
Received by Foreign Persons
Treated As Dividends—New
Code Sec. 871
Background
Payments of U.S. source “fixed or determinable an-
nual or periodical” (FDAP) income including interest,
dividends and similar types of investment income
made to foreign persons, such as nonresident alien in-
Taxes—The Tax Magazine®
September 2010
dividuals, foreign corporations or foreign partnerships
are generally subject to a 30-percent withholding
tax.143 The rate may be reduced where dividends are
paid to a resident of a jurisdiction with which the
United States has entered into a tax treaty.144 Divi-
dends paid by a domestic corporation are generally
U.S. source under Code Sec. 861(a)(2) and therefore
potentially subject to U.S. withholding tax.
Source rules. The source of notional principal con-
tract income is generally determined by reference to
residence of the recipient of the income.145 Thus, a
foreign person’s income related to a notional princi-
pal contract or so-called equity swap that references
stock of a domestic corporation including any amount
attributable to dividends paid on the stock generally
is foreign source and not subject to U.S. withholding
tax. In contrast, under current law a substitute dividend
payment made to the transferor of stock in a securities
lending transaction or sale-repurchase is generally
sourced in the same manner as actual dividends and
therefore subject to U.S. withholding tax.146 Dividends
paid by a domestic corporation are generally U.S.
source147 and therefore potentially subject to withhold-
ing tax when paid to foreign persons.
The source of notional principal contract income
generally is determined by reference to the residence
of the recipient of the income.148 Consequently, a
foreign person’s income related to a notional prin-
cipal contract that references stock of a domestic
corporation, including any amount attributable to,
or calculated by reference to dividends paid on the
stock generally is foreign source and is therefore not
subject to U.S. withholding tax.
Substitute dividend payment. In contrast, a substitute
dividend payment made to the transferor of stock in
a securities lending transaction or a sale-repurchase
transaction is sourced in the same manner as actual
dividends paid on the transferred stock.149 Accordingly,
because dividends paid with respect to the stock of a
U.S. company are generally U.S. source, if a foreign
person lends stock of a U.S. company to another
person (or sells the stock to the other person and later
repurchases the stock in a transaction treated as a loan
for U.S. federal income tax purposes) and receives sub-
stitute dividend payments form that other person, the
substitute dividend payments from that other person,
the substitute dividend payments are U.S. source and
are generally subject to U.S. withholding tax.150
Notice 97-66. In 1997, the Treasury issued final
regulations governing withholding on securities lending
transactions. In response to concerns by the financial
65
New U.S. Withholding System for Foreign Account Tax Compliance
services industry that a “cascading withholding tax”
could cause U.S. withholding tax to be due on pay-
ments of interest or dividends made on securities that
were lent multiple times, Notice 97-66151 was issued by
the IRS which addressed the tax treatment of substitute
dividend payments made between foreign persons and
generally sought to impose limitations on the imposi-
tion of withholding tax in such cases. More specifically,
the Notice provided that, “the amount of U.S. with-
holding tax to be imposed under Treasury Regulation
Sec. 1.871-7(b)(2) and 1.881-2(b)(2) with respect to a
foreign-to-foreign payment will be the amount of the
underlying dividend multiplied by a rate equal to the
excess of the rate of U.S. withholding tax that would be
applicable to U.S. source dividends paid by a U.S. per-
son directly to the recipient of the substitute payment
over the rate of U.S. withholding tax that would be ap-
plicable to U.S. source dividends paid by a U.S. person
directly to the payor of the substitute payment.”
Congressional Hearings—September 2008. On
September 11, 2008, the Senate Permanent Subcom-
mittee on Investigations had a hearing to investigate
transactions structured by financial institutions that
was aimed, in part, at enabling non-U.S. clients to
avoid U.S. withholding taxes by using equity swaps or
stock lending transactions. The Hearing culminated in
a report entitled, Dividend Tax Abuse: How Offshore
Entities Dodge Taxes on U.S. Stock Dividends, which
discussed so-called, “abusive equity swaps” and raised
concerns that Notice 97-66 was being used by taxpay-
ers to justify tax avoidance transactions including where
a foreign person would lend U.S. stock to a foreign
financial institution who would then sell the stock to
a related U.S. person and at the same time enter into
a total return equity swap with this U.S. person. At the
hearing, IRS Commissioner Douglas Shulman was
strongly requested to remedy the problem.
In the Obama Administration’s fiscal year 2010 bud-
get, the Treasury has announced that to address the
avoidance of U.S. withholding tax through the use of
securities lending transactions, it plans to revoke Notice
97-66 and issue guidance that eliminates the benefits of
those transactions but minimizes over-withholding.152
Stop Tax Haven Abuse Act. On March 2, 2009,
Senator Carl Levin introduced legislation entitled
the “Stop Tax Haven Abuse Act” (S. 506, H.R. 1265)
(the “Levin Bill” or “Bill”). As part of this legislation
proposal, Section 108 entitled, “Closing the Offshore
Dividend Loophole,” was included in the Bill to en-
sure non-U.S. persons pay taxes on U.S. dividends
whether cast as equity swaps, stock loans or other
66
arrangements. Bill Section 108(d) provided that the
provision would be effective and apply to payments
made on or after the date that is 90 days after the
date of enactment.
The Bill included the following dividend equivalent
provisions:
Withholding tax on dividend equivalents and sub-
stitute dividend payments. Section 108(a) of the Bill
would add new Section 871(l) to the Code and impose
a 30-percent withholding tax on dividend equivalents
and substitute dividend payments which would be
treated as a dividend for purposes of Code Secs. 871
and 881, and therefore subject to U.S. withholding tax
under Code Secs.1441 and 1442. Under new Code
Sec. 871(l)(1)(A) the term “dividend” shall include
“dividend equivalents” and “substitute dividends,”
and new Code Sec. 871(l)(1)(B) and (C) would source
a dividend equivalent with stock of one or more
domestic corporations as sourced within the United
States, and a substitute dividend payment would be
sourced in the same manner as a dividend distribution
with respect to the transferred security to which the
substitute dividend relates. Although not specifically
indicated, presumably the Levin Bill would require
withholding on gross payments rather than net.
Definition of “dividend equivalent.” The Levin Bill
defined a “dividend equivalent” as any payment that
is made pursuant to a notional principal contract and
is contingent upon, or referenced to, the payment
of a dividend on stock or the payment of a dividend
on property that is substantially similar or related to
stock (determined in a manner similar to the manner
under Code Sec. 246(c)(4)(C)). For this purpose, the
term “notional principal contract” means a financial
instrument that provides for the payment by one party
to another at specified intervals calculated by refer-
ence to a specified index upon a notional principal
amount in exchange for a specified consideration or
a promise to pay similar amounts.
The Levin Bill would define a “substitute dividend”
as a payment made to the transferor of a security in
a securities lending transaction or a sale-repurchase
transaction, of an amount equivalent to a dividend
distribution which the owner of the transferred se-
curity is entitled to receive during the term of the
transaction. A “securities lending transaction” means
a transfer of one or more securities that is described
in Code Sec. 1058(a) or a substantially similar trans-
action and a sale-repurchase transaction means an
agreement under which a person transfers a security
in exchange for cash and simultaneously agrees to

receive substantially identical securities from the
transferee in the future in exchange for cash.
Exceptions to dividend withholding. Unlike the
Green Book Proposal and FATCA, the Levin Bill does not
contain any exceptions for dividend equivalency with-
holding, and unlike the Extenders Act does not expressly
authorize the Treasury to write such exceptions.
Avoidance of over-withholding. Under proposed
new Code Sec. 871(l)(5) the Levin Bill provides that
in the case of any dividend equivalent or substitute
dividend that is subject to withholding under this Sec-
tion or Code Sec. 881, the Secretary may by regulation
reduce such withholding, but only to the extent that the
taxpayer can establish that the dividend for which the
payment to be withheld upon is a dividend equivalent
or a substitute dividend that was previously withheld
upon under this Section or under Code Sec. 881.
Regulatory directive for netting of payments and
other transactions. Under Section 108(b) of the Levin
Bill, the Treasury is authorized to issue regulations to
address the imposition of withholding in cases where
dividend equivalent payments under notional princi-
pal contracts are netted with other payments under
the same instrument, in cases where fees and other
payments are netted to disguise the characterization
of a payment as a substitute dividend, and in cases
where option or forward contracts or similar ar-
rangements achieve the same or substantially similar
economic results as the notional principal contracts
covered under new Code Sec. 871(l).
Qualified intermediaries. Under Section 108(c)
of the Bill, the Treasury was directed to ensure that
any qualified intermediary withholding agreement
that the United States enters into or renews after the
date of enactment with a foreign financial institution
or foreign branch of a U.S. financial institution con-
forms with the amendments made by this section to
ensure appropriate withholding related to dividend
equivalents and substitute dividends.
Green Book proposal. On May 11, 2009, the
Obama Administration released the General Explana-
tion of the Administration’s Fiscal Year 2010 Revenue
Proposals (the “Green Book Proposal”). While the
Administration did not release statutory language as
part of this proposal, the Green Book provided sig-
nificant detail about the Administration’s Fiscal Year
2010 budget proposal. As part of the Green Book
Proposal, the Administration had a provision entitled,
“Prevent the Avoidance of Dividend Withholding
Taxes,” which would be effective for payments made
after December 31, 2010.
Taxes—The Tax Magazine®
September 2010
Reasons for change. The Green Book proposal
points out that foreign portfolio investors seeking to
benefit from the appreciation in value and dividends
paid with respect to stock of a domestic corporation
are not limited to holding stock in the corporation.
Instead, such an investor can enter into an equity
swap. The U.S. tax consequences of these two alterna-
tive investments differ significantly. By entering into
equity swaps, foreign portfolio investors receive the
economic benefit of dividends paid and appreciation
in value with respect to U.S. stock without being
subject to gross-basis withholding tax.
Securities lending. In order to address the avoidance
of U.S. withholding tax through the use of securities
lending transactions, the proposal contemplates that
the Treasury would revoke Notice 97-66 and issue
guidance that would address over-withholding, that
is, address the concern involving a “cascading effect”
of a dividend withholding tax while still closing the
door to abusive transactions.
Equity swaps—General rule. Income earned by
foreign persons with respect to equity swaps that
reference U.S. equities would be treated as U.S.
source to the extent that the income is attributable
to, or calculated by reference to dividends paid by
a domestic corporation and subject to withhold-
ing. The Green Book Proposal does not indicate
whether withholding would be imposed on gross
or net payments.
Exception to equity swap withholding. An excep-
tion to the general rule imposing U.S. withholding
tax on equity swaps would apply to swaps with all
of the following characteristics under the Green
Book Proposal:
The terms of the equity swap do not require the
foreign person to post more than 20 percent of
the value of the underlying stock as collateral.
The terms of the equity swap do not include any
provision addressing the hedge position of the
counterparty to the transaction.
The underlying stock is publicly traded.
The notional amount of the swap represents less
than both five percent of the total publicly traded
float of that class of stock over which the equity
swap is executed, and less than 20 percent of the
30-day average daily trading volume.
The foreign person does not sell the stock to the
counterparty at the inception of the contract (i.e.,
there is no crossing-in) or buy the stock from the
counterparty at the termination of the contract
(i.e., there is no crossing-out).
67
New U.S. Withholding System for Foreign Account Tax Compliance
The prices of the equity that are used to measure
the parties entitlements obligations are based on
an “objectively observable price.”
The swap has a term of at least 90 days.
The Treasury would be given regulatory authority
to provide exceptions to implement the purpose of
the rule.
FATCA—Section 501. On October 27, 2009, Sena-
tors Baucus and Kerry, together with Representatives
Rangel and Neal introduced the Foreign Account
Tax Compliance Act (H.R. 3933, S.1934), (“FATCA”
or the “Act”). As part of this legislative proposal, Sec-
tion 501 entitled, “Dividend Equivalent Payments
Received by Foreign Persons Treated as Dividends,”
was included in the Act to prevent taxpayers from
avoiding U.S. withholding tax by using swaps and
other arrangements marketed as a means of avoiding
U.S. withholding tax. Section 501(b) of the FATCA
provided “The amendments made by this section shall
apply to payments made on or after the date that is 90
days after the date of the enactment of this Act.”
FATCA included the following dividend equivalent
provisions:
Withholding tax on dividend equivalent payments.
Section 501(a) would add new Code Sec. 871(l) to
the Code and would treat a “dividend equivalent” as
a dividend from U.S. sources for purposes of Code
Secs. 871 and 881 and thus subject to the U.S. with-
holding tax under Code Secs. 1441 and 1442.
Meaning of “dividend equivalent.” A dividend
equivalent under new Code Sec. 871(l)(2)(A) is any
payment made under a notional principal contract
(i.e., a swap) that is directly or indirectly contingent
upon or determined by reference to a dividend from
U.S. sources within the United States and grants
the Treasury the authority to identify as dividend
equivalents any other transactions or payments that
are substantially similar to dividend equivalents.153
The Joint Committee on Taxation Explanation also
mentions payments under forward contracts or other
financial contracts that reference stock of U.S. cor-
porations may be dividend equivalents.154
SIFMA Comments on FATCA “dividend equiva-
lent.” The Securities Industry and Financial Markets
Association comments to the House Ways and Means
Committee and the Senate Finance Committee on
November 19, 2009 on FATCA had the following
discussion related to the term155:
What is a “dividend equivalent payment,” and
what is its amount in any given case? Under the
68
provision, if a foreign investor promises to pay a
U.S. counterparty an amount equal to LIBOR mi-
nus a dividend, that will be treated as a dividend
equivalent payment going in the opposite direc-
tion (i.e., from the U.S. counterparty to the foreign
investor), even though the foreign investor doesn’t
receive anything. Does it follow that if a contract
provides for a payment equal to twice LIBOR mi-
nus twice dividends, the foreign investor is deemed
to receive two dividend equivalent payments? In
any case, presumably this novel treatment should
only be applied where the relevant contract also
provides for payments based on the value of
relevant equities, but this is not clear from the
language of the provision. Even if we assume that
to be necessary, however, it is not clear how we
should treat contracts that have embedded caps,
floors or collars, such as the sort that are currently
found in prepaid forward contracts.
Suppose, on the other hand, that a contract pro-
vides a foreign person with the right to benefit
from appreciation in the value of U.S. equities
but does not provide for any change in payments
based on changes in the amount of dividends paid
on those equities. This is often the case where
the relevant U.S. corporation rarely changes the
amount of its dividends, since the anticipated
amount of dividends to be paid over the life of
the contract can in that case simply be reflected
in the opening or closing price of the contract.
It is not clear from the language of the Provision
whether such a contract should be deemed to
provide for embedded dividend equivalent pay-
ments. It is likewise not clear whether and how
much it would matter if the word “dividends” was
referenced somewhere in the contract.
It is also not clear whether the provision would
apply if payments changed when dividends unex-
pectedly increased, but not when they decreased;
or if they changed when dividends decreased, but
not when they increased; or if they changed by
only a small amount in relation to the amount
of the change in dividends. Many equity related
contracts (especially forward contracts) provide
for a change in payments if and when dividends
change by an “extraordinary amount.” It is not
clear whether (and when) such a provision would
be viewed as giving rise to dividend equivalent
payments, and if so, whether such payments

would be deemed to accrue in the absence of
any such extraordinary event.
SIFMA Comments on the timing of the accrual of
dividend equivalent payments. The SIFMA Comments
on FATCA also addressed issues related to the timing
of the accrual of dividend equivalent payments by
providing156: “What would the timing of the accrual of
these dividend equivalent payments be? It is not clear
to us, for example, whether a payment at maturity
of a contract that was determined by reference to a
“look back” at the difference between interest rates
and dividend rates over the life of the contract would
give rise to deemed dividend equivalent payments
only at maturity of the contract or whether dividend
equivalent payments would instead be deemed to ac-
crue periodically over the life of the contract.
SIFMA Comments suggest difficult issues for
system implementation and enforcement. The
SIFMA Comments suggest that the new provision
would create difficult issues of implementation and
enforcement for this novel system and raised the
following issues157:
The provision would constitute a novel means of
imposing tax on foreigners and would raise difficult
issues that were matters of first impression for systems
implementation and enforcement. More specifically,
the proposal would impose tax not on payments
received by foreigners, but rather on hypothetical de-
rivative rights.158 For example, suppose a foreign person
enters into an equity swap and later closes out the
swap with no payments made by either party. Under
the proposal, the foreign person might be subject to
substantial U.S. withholding tax, because the net zero
payment on termination of the swap might notionally
reflect a deemed payment from the foreign person to
the U.S. person reflecting either notional interest or
a decline in the value of the underlying equity offset
by a deemed payment from the U.S. person to the
foreign person reflecting deemed dividend equivalent
payments. By contrast, current law does not even im-
pose tax on original issue discount accrued by foreign
persons unless and until they receive a payment.159
A complex and well-thought-out regime currently
exists to allow financial institutions to withhold and
remit to the IRS a portion of any amounts that they
actually pay to foreign persons (including dividend
or interest payments, and in some cases gross sales
proceeds). This regime itself took a substantial amount
of time and thought to develop. By way of example,
the modification of withholding systems that was
Taxes—The Tax Magazine®
September 2010
implemented when the Code Sec. 1441 withholding
tax rules went into effect on January 1, 2001 took
three years to implement.160 But no regulatory regime,
no standard form legal agreements, no enforcement
methodologies, no collateralization programs and no
computer systems currently exist to allow financial
institutions to impose and collect a tax in the absence
of any such payments.
How, moreover, will computer systems analyze the
terms of each of a large volume of equity derivative
contracts to determine not just the amount of the
payments they provide for, but:
whether they contain embedded “dividend
equivalent payments,”
what is the amount of these dividend equivalent
payments,
whether the contracts themselves constitute “no-
tional principal contracts” within the meaning of
relevant regulations, and
whether the contracts themselves fall within the
terms of the relevant safe harbor?
The novel tasks that need to be performed to allow
financial institutions to navigate these unchartered
waters will be in addition to those that need to be
performed in connection with any major change to
withholding tax procedures.161
Meaning of “notional principal contract.” The Act
does not define the term “notional principal contract”
proposed by Code Sec. 871(l), but the Staff of the
Joint Committee on Taxation Explanation for FATCA
at footnote #213 references Reg. §1.863-7(b)(1),
which provides, “A notional principal contract is a
financial instrument that provides for the payment of
amounts by one party to another a specified intervals
calculated by reference to a specified index upon a
notional principal amount in exchange for specified
consideration or a promise to pay similar amounts.”
The SIFMA Comments on FATCA162 raised the follow-
ing issues relating to the definitional clarity for the
term notional principal contract:
What is a “notional principal contract for this purpose?
Reg. §1.863-7(a)(1) (like Reg. §1.446-3(c)(1)) currently
defines a notional principal contract as a financial
instrument that provides for the payment of “amounts”
by one party to another at specified “intervals.” Does
this mean that financial institutions can safely enter
into bullet equity swaps (which provide for payments
only at maturity) without any risk of withholding
tax penalties? The answer could conceivably be no,
because the current-law definition serves primarily
69
New U.S. Withholding System for Foreign Account Tax Compliance
as a “gateway” to a desirable tax treatment—i.e.,
residence-based sourcing—and is therefore arguably
limited in nature. But if there is a risk of imposition
of withholding tax on bullet swaps, then what about
dividend adjusted equity forward contracts, since they
are economically equivalent to bullet swaps? What
about dividend-adjusted prepaid forward contracts?
What about economically equivalent exchange traded
notes? And what about derivative positions in pub-
lished stock indexes, such as the S&P 500? There are
very large volumes of these sorts of contracts currently
outstanding on capital markets.
Exceptions to dividend equivalency withholding.
Proposed Code Sec. 871(l)(2)(B) grants the Treasury
the authority to exclude any payment that it deter-
mines does not have the potential for tax avoidance
and lists the following six nonexclusive factors that
the Treasury may take into account163:
The term including provisions for early termina-
tions and the existence of offsetting financial
contracts
The amount of each party’s investment and the
amounts of any collateral posted
Whether the price of the equity used to measure
the parties entitlements or obligations is based
on an objectively observable price or the parties
actual execution prices
Whether either party sells directly or indirectly
to the other party the stock or security giving rise
to the dividends from sources within the United
States (“cross-in/cross-out”),
Whether there are terms that address the hedge
position of either party or other conditions which
would compel either party to hold or acquire the
stock or security giving rise to dividends from
sources within the United States
Such other factors as Treasury deems appropriate
Neither the Act nor the Joint Committee on Taxa-
tion specifies the relevance of the factors. The list
indicates that the exceptions should have a fairly
broad application.
The Treasury may determine based on these and oth-
er factors that it may take into account that a contract
with a short term that includes a dividend payment
date or a contract under which a party hedges its
obligations to make dividend-based payments by
holding the underlying stock is more likely to have the
potential for avoidance of dividend withholding tax
than a contract with a longer term or contract under
which the party does not hedge its obligations.164
70
FATCA proposed effective date is unrealistic. Un-
der FATCA, all dividend equivalent payments would
be subject to a 30-percent withholding tax unless,
within 90 days of enactment, the Treasury issues
regulations that except payments on certain swaps.
SIFMA in its FATCA Comments has serious concerns
about the ability of the industry to implement the new
structure in a timely fashion as well as issues related
to forced terminations of a broad range of equity
derivative contracts that have already been entered
into and economic concerns about hedging and other
structures which have already been implemented
prior to the date of enactment. SIFMA Comments
related to these issues are as follows165:
In our view, the provision’s proposed effective
date is not realistic. As currently drafted, the
Provision would take effect for all payments
deemed made 90 days or more after the date
of enactment (a) regardless of whether or when
the Treasury Department actually promulgated
regulations, and (b) regardless of whether finan-
cial institutions had the means of implementing
such withholding. There are a number of serious
problems with this approach.
First, drafting the necessary regulations is going
to take time, and we do not think it is realistic
to suppose that the Treasury Department could
accomplish the task in 90 days, especially given
the other projects that the Bill will put on its
plate. At the very least, the Treasury Department
will need to develop the “safe harbor” that has
become so central to the concept of the Provi-
sion. But numerous other questions will have
to be resolved, some of which have already
surfaced, but others of which may only come
to the fore as the Treasury Department and the
legal community begin to focus on the question
of how to implement the new regime.
By way of example, set out below are a few of the
questions that industry tax directors have already
been asking themselves in their efforts to prepare
for the potential implementation of the Provision.
These questions arise directly from the terms of
contracts that are currently being entered into in
substantial volume, and it is clear that investors,
traders, bankers and back office staff will be actively
asking them as soon as the provision is enacted. We
think the Treasury Department will want to provide

answers in time to avoid triggering a large-scale, and
unintended, termination of equity-related financial
contracts (and an associated disintermediation by
financial institutions in U.S. equity-related financial
relationships). We note, in this regard, that financial
institutions serve primarily as intermediaries in fi-
nancial markets and earn a relatively thin “spread”
in respect of this role. This is a legitimate and im-
portant role in the U.S. economy, but there is little
room in it for the risk of imposition of unanticipated
taxes or penalties on the gross amount of deemed
underlying cash flows; such taxes and penalties
would quickly dwarf any associated profits. We
also think the Treasury Department will want to
answer these questions to avoid forcing the trading
desks of financial institutions to compete with each
other partly on the basis of their interpretation of
ambiguous legal authority.
Third, the relevant persons (including Treasury
officials, financial institutions, their inside
and outside counsel, and their compliance
departments) cannot begin working on the nec-
essary regulatory regimes, standard form legal
agreements, enforcement methodologies, col-
lateralization programs and computer systems
until Treasury completes its work of fleshing out
the circumstances under which it deems it appro-
priate to impose a withholding tax on notionally
embedded dividend equivalent payments. As
noted above, this is going to take some time.
Fourth, if the proposal were to take effect before
the Treasury Department had issued detailed
regulations (or after Treasury had issued such regu-
lations but before the relevant persons mentioned
above had an opportunity to develop the contracts,
systems and programs mentioned above), then fi-
nancial institutions and their counterparties would
be forced to immediately terminate a broad range
of equity derivative contracts with no clear notion
of what might replace them.
For example, few notional principal contracts,
forward contracts or other equity derivative
contracts currently provide for the payment by a
foreign counterparty of U.S. withholding taxes.
To the contrary, such contracts generally provide
that payments under the contract will be made
free and clear of any such taxes and they require
the U.S. counterparty to gross the foreign counter-
Taxes—The Tax Magazine®
September 2010
party up for the amount of any U.S. withholding
tax imposed on the counterparty. Neither are
there any legal systems, computer systems or
administrative systems in place that might allow
a financial institution to distinguish contracts that
might safely be left in place (because they would
probably not be subject to withholding) from
contracts that had to be terminated immediately
(because they would probably be subject to with-
holding). Given that potential penalties would
be imposed on the gross amount of deemed em-
bedded payments, rather than on relatively slim
net profits, financial institutions would therefore
likely be forced to terminate most of their equity
derivative contacts and there could be substantial
disruption in equity markets.
Similarly, many financial institutions have struc-
tured their internal affairs in manners that presume
the absence of any U.S. withholding tax on cross-
border equity derivative contracts. Suppose, for
example, that a U.K. investor enters into an equity
swap over a U.S. stock with the U.K. affiliate of a
financial institution. The U.K. affiliate will normally
hedge by entering into a “mirror” equity derivative
transaction (e.g., an equity swap) with a U.S. affili-
ate, which U.S. affiliate will then hedge its resulting
short position by acquiring a long position (e.g.,
the U.S. stock itself, or a long swap position in the
U.S. stock) in the more liquid U.S. market. Yet this
approach would suddenly result in the imposition
of two U.S. withholding taxes—one on payments
from the U.S. affiliate to the U.K. affiliate, and one
on payments from the U.K. affiliate to the U.K. in-
vestor. Such internal structures cannot be easily, or
instantly, changed. Most major financial institutions
operate both inside and outside the United States,
and a complex web of market forces, systems ca-
pabilities, U.S. regulatory rules, foreign regulatory
rules, accounting issues, compensation-related is-
sues and other factors govern the internal structures
through which they offer, hedge and maintain their
financial positions. Moreover, there is absolutely no
room in the “margins” of these transactions for the
imposition of a 30 percent gross U.S. withholding
tax on internal cash flows.
Conclusion. For the reasons set out above, we
recommend that the imposition of withholding
tax on dividend equivalent payments be delayed
until a date that is at least 18 months after the
71
New U.S. Withholding System for Foreign Account Tax Compliance
date on which the Treasury Department promul-
gates currently effective guidance that (i) sets out
the requirements for availability of a safe harbor
from the implementation of withholding on divi-
dend equivalent payments (ii) defines dividend
equivalent payments for this purpose (iii) defines
notional principal contracts for this purpose, and
(iv) defines any other equity derivative contracts
to which the provision is intended to apply.
ABA Tax Section Comments on FATCA. The ABA
Tax Section Comments made the following recom-
mendations relating to new Code Sec. 871(l):
1. Effective Date Should Allow Treasury Time to
Implement Exceptions to Dividend Equivalents
and to Allow Institutions Close-out of Existing
Swaps. “Guidance implementing the authorized
exceptions should be promulgated sufficiently in
advance of the provision’s effectiveness to allow
institutions to assess their outstanding contracts
and come into compliance. This is not necessarily
provided under the current effective date, in that
it is not tied to the promulgation of guidance and
may be an inadequate period even if the rules
were known on enactment.
For the most part, outstanding equity swaps that
would be adversely affected under Section 501
would be terminated if the Bill is enacted, either
pursuant to the terms of the swap (i.e., as a result
of a Change of Tax Law or Change of Law provi-
sions under standard ISDA documentation) or
my mutual agreement between the counterpar-
ties, to avoid a gross-up for amounts withheld.
A mutual agreement may take a longer period
than provided by the effective date for Section
501 of the Bill, particularly for a party that has
entered into numerous equity swaps.
2. Consider Grandfathering of Existing Contracts.
We recommend that existing contracts be except-
ed from the application of section 871(l), at least
for some period, so that taxpayers are not unfairly
penalized for their outstanding equity swaps and
derivatives that were entered into based upon cur-
rent law and may close out existing swaps in an
orderly fashion. We recommend that this apply
to such contracts entered into before, or pursu-
ant to a binding agreement in existence before
October 28, 2009.
72
3. Exceptions from Dividend Equivalents. A pay-
ment made under a notional principal contract
that is directly or indirectly contingent upon or
determined by reference to the payment of a U.S.
source dividend would be treated as a dividend
equivalent subject to U.S. withholding tax unless
identified as non-abusive, commercial transac-
tion by Treasury. Conversely, other transactions
are so treated only if first identified by Treasury,
either under the five factors identified in FATCA
or “any other factors” it deems appropriate.
We agree that deferring the issue of demarcating
between abusive and non-abusive transactions to
Treasury are the appropriate approach for such
a complex and fact-specific subject matter and
that the relevant factors are generally set forth in
sufficient breath to permit rles to be developed.
We understand why the statute would be drafted
with a residual rule treating dividend equivalents
in respect of notional principal contracts as U.S.
source withholdable payments. Our primary
concern, as noted above, is that sufficient lead
time be permitted in the statute initially and by
delegation of authority to Treasury, to allow for the
creation of appropriate exceptions in a timely way.
The normal Treasury regulation process would put
taxpayers on fair notice and allow for consulta-
tion with taxpayers and industry groups with the
appropriate expertise and knowledge about the
market place. Thus, we recommend that the re-
sidual rule for sourcing not become effective until
appropriate exceptions have been identified.
4. Avoid Double Withholding on Equity Swaps.
There is an issue of possible double withholding
because of the way equity swap business is done
at a number of taxpayers. Firms often centralize
their swap trading activities in one legal entity to
achieve netting benefits for credit and balance
sheet purposes. However, the risk for the posi-
tions may be managed in a different legal entity
so there is a mirror internal swap for each client
swap. The mirror swap creates the potential for
double withholding. We recommend that consid-
eration should be given to an exemption for the
second withholding tax when the taxpayer is able
to demonstrate to the IRS that an internal mirror
situation exists and withholding tax actually was
imposed at gross on the first client swap.

Further, we believe the legislation could apply
to swaps between two foreign parties. In such a
case, if the first foreign party has been subject to
withholding on a dividend or dividend equivalent
to which the swap relates, the payment to the
second foreign party should not again be subject
to withholding (other than to the extent the ap-
plicable withholding rates on such payment may
be higher than the rate applicable to the initial
payment). A similar problem was addressed by
the IRS in connection with the securities lend-
ing166 and a similar approach should be adapted
to the proposed legislation.
Avoidance of withholding—Comparison of FATCA
to Green Book proposal. David Miller167 from Cad-
walader Wickersham & Taft LLP recently compared
the Green Book Proposal to the FATCA proposal in
order to avoid U.S. withholding tax based on the
following discussion:
1. Maximum 20 percent Collateral. Under the
Green Book Proposal, the foreign person cannot
post collateral with a value that exceeds 20 percent,
while FATCA would consider the amount of each
party’s investment and the amount of collateral
posted. While 100 percent collateral looks like
an investment in stock, inadequate collateral ex-
poses a U.S. counterparty to credit risk of a foreign
counterparty. What is the proper percentage? 40
percent?, 50 percent? When should it be tested? If
testing is continuous, what happens if the collateral
exceeds 20 percent of the value for one day only?
Does the 100 percent of all future dividend pay-
ments then become subject to withholding? What
if the underlying stock becomes more volatile or
the counterparty’s credit profile changes?
2. Counterparty’s Hedging Strategy. To avoid
withholding, the Green Book Proposal would
prohibit an equity swap from addressing the
hedging strategy of the counterparty to the swap.
FATCA would consider whether there are terms
that address the hedge position of either party
or other conditions which would compel either
party to hold or acquire the security giving rise
to U.S. source dividends. It’s not clear what this
means. Presumably, the foreigner cannot vote
the shares held by its counterparty. The Green
Book Proposal appears to prohibit execution
pricing (i.e., the price at which the counterparty
Taxes—The Tax Magazine®
September 2010
purchases securities used to hedge its position).
3. Fungibility/Liquidity of the Underlying Stock.
To avoid withholding the Green Book Proposal
would require the swap to refer to only publicly
traded stock and must only represent less than five
percent of the total public float of that class of stock
subject to the swap, and more than 20 percent of
the 30-day average daily trading volume of the
stock Under this proposal when would this test be
made—at the inception or on an ongoing basis?
What if an issuer buys back its outstanding stock?
What if the underlying stock becomes less actively
traded? FATCA would consider whether there are
conditions which would compel either party to hold
or acquire the stock and would limit cross-border
equity swaps to only the most liquid stocks.
4. No Cross-In/No Cross-Out. Under the Green
Book Proposal the foreign person cannot sell the
stock to the counterparty at the beginning of the
contract or buying it from the counterparty at the
termination of the contract. FATCA would consider
whether either party sells directly or indirectly to
the other party the stock. Presumably, cross-ins
and cross-outs suggest an agency relationship.
Under either proposal, can the foreigner sell the
stock into the market at the market-on-open or
market-on-close price and enter into a swap at the
same price? If the counterparty also purchases its
hedge at the same price, would that be viewed as
a constructive or indirect cross-in or cross-out?
5. Objectively Observable Price. Under the Green
Book Proposal, to avoid withholding the prices of
the equity that are used to determine what the par-
ties will receive and pay under swap must be based
on objectively determinable prices. FATCA would
require that the price of the equity used to measure
the parties’ entitlements or obligations is based on
an objectively observable price or the parties’ actual
execution prices. Do “market-on-open” (“MOO”),
“market-on-close” (“MOC”) volume-weighted av-
erage price (“VWAP”), and time-weighted average
price (“TWAP”) satisfy this standard? If market-on-
open and market-on-close satisfy the standard, does
it matter if the counterparty buys its hedge at the
same price? What about a one minute TWAP?
6. Term of the Swap. To avoid withholding under
the Green Book Proposal the swap must have a
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New U.S. Withholding System for Foreign Account Tax Compliance
term of at least 90 days. FATCA considers the
term including provisions for early terminations
and the existence of offsetting financial contracts.
It is very likely that a one-day swap over the
dividend record date is abusive, regardless of
whether the swap is actually terminated or offset
by another swap. Will 90 days be a proper term?
How about 15 days (Code Sec. 901(k); 30 days
(Code Sec. 1091); 46 days (Code Sec. 246)? If
the foreigner enters into an offsetting swap with
another counter party within 90 days, how would
the first counterparty know to withhold? What if
the termination of a swap with 90 days has no
relationship to the payment of dividends (e.g.,
statistical arbitrage trade)? What if the counter-
party goes bankrupt within 90 days? What if the
swap is entered into on day 1, dividend paid on
day 10, and swap terminated on day 45? Does
the counterparty have an obligation to withhold
after the fact?
7. Dividend Equivalency Withholding Based on
Gross Amount. New Code Sec. 871(l)(2)(C) pro-
vides the dividend equivalent amount subject to
U.S. withholding tax would be based on the gross
amount used rather than net amounts transferred
to, or from the taxpayer under a notional principal
contract. A party to a total return swap may be
obligated to withhold and pay tax to Treasury on
a gross dividend-based amount even though the
party is not required to make an actual payment
to its foreign counterparty.
For example, under a typical “total return swap”
referencing stock of a domestic corporation (an
example of an notional principal contract to
which FATCA applies), a foreign investor enters
into an agreement with a counterparty under
which amounts due to each party are based on
the returns generated by a notional investment in
a specified dollar amount of the domestic corpo-
ration’s stock. The investor agrees for a specified
period to pay to the counterparty (1) an amount
calculated by reference to a market interest rate
(such as the London Interbank Offered Rate (“LI-
BOR”) on the notional amount of the domestic
corporation’s stock and (2) any depreciation in
the value of the stock. In return, the counterparty
agrees for the specified period to pay the investor
(1) any dividends paid on the stock and (2) any
appreciation in the value of the stock.
74
Amounts owed by each party under this swap
are a net amount determined in part by other
amounts (for example, the interest amount and
the amount of any appreciation or depreciation
in value of the referenced stock). Accordingly,
a counter party to a total return swap may be
obligated to withhold, and remit tax on the gross
amount of a dividend equivalent even though,
as a result of netting of payments due under the
swap, the counterparty is not required to make
an actual payment to the foreign investor.
8. Control over Payment. Each person that is a
party to a contract or other arrangement that
provides for the payment of a dividend equivalent
will be treated as having control over the payment
for purposes of Chapter 3 of the Code (with-
holding of tax on nonresident aliens and foreign
corporations) and Chapter 4 (taxes to enforce
reporting on certain foreign persons).168
Green Book 2011 proposal. The Green Book 2011
Proposal also has a provision that addresses dividend
equivalent payments,169 which appears to be the same
as the proposals in the Extenders Act enacted into
law. See “HIRE Act—Section 541.”
HIRE Act—Section 541. The HIRE Act incorporated
and made changes to the dividend equivalency provi-
sions under Section 501 of FATCA. The new provision
became Section 541 and is now entitled, “Substitute
Dividends and Dividend Equivalent Payments Re-
ceived by Foreign Persons Treated as Dividends.”
HIRE Act—Effective date of dividend equivalency
provisions. Section 541(b) of the HIRE Act states: “The
amendments made by this section shall apply to pay-
ments made on or after the date that is 180 days after
the date of enactment of this Act.”170 Thus, a 30-percent
dividend withholding tax will apply to payments for
equity swaps or other arrangements if the notional
principal contract meets the four conditions specified
under new Code Sec. 871(l)(3)(A) beginning Septem-
ber 14, 2010 (e.g., for any payments made on or after
180 days after the date of enactment), or is otherwise
identified by the Treasury as such a contract.171
Beginning on this same date a 30-percent withhold-
ing tax will be imposed on any substitute dividend
payment made pursuant to a securities lending or
sale-repurchase transaction that is directly or indi-
rectly contingent upon or determined by reference
to the payment of a U.S. source dividend to a foreign
party. In addition, it can be expected that withhold-

able payments under new Code Sec.1471will include
certain payments arising in connection with securities
lending and notional principal contracts including
(1) rebate fees (interest paid by U.S. lenders), (2)
U.S. source borrow fees paid by U.S. borrowers, (3)
substitute U.S. interest/dividend payments, and (4)
outbound repo spreads (interest).172
The new law,173 however, delayed application of
U.S. withholding tax for payments made within two
years of the date of enactment for notional principal
contracts not subject to withholding under new Code
Sec. 871(l)(3)(A). More specifically, under new Code
Sec. 871(l)(3)(B), the new term “specified notional
principal contract” will also include payments made
on any notional principal made after the date which
is after March 18, 2012 (e.g., two years after the date
of the enactment of Section 541), unless the Treasury
determines that such contract is of a type which does
not have the potential for tax avoidance.174 See “De-
layed Application of Withholding for Certain Notional
Principal Contracts Not Otherwise Subject to With-
holding Tax Under New Code Sec. 871(l)(3)(A).”
Withholding tax on dividend equivalent payments.
Section 541(a) of the HIRE Act would add new sec-
tion 871(l) to the Code and would treat a “dividend
equivalent” as a dividend from U.S. sources for
purposes of Code Sec. 881 (and presumably Code
Sec. 871), and as a consequence subject to U.S.
withholding tax under Code Secs.1441 and 1442.175
The new law specifically references the application
of Chapter 3 of the Internal Revenue Code (dealing
with withholding under Code Secs. 1441–1446) and
new Chapter 4 (dealing with withholding under new
Code Secs. 1471–1474), as well as makes reference
to Code Sec. 4948(a) (dealing with withholding of tax
on gross investment income of foreign private founda-
tions subject to the Code Sec. 4948(a) excise tax).
Under new Code Sec. 871(l)(2), the term “dividend
equivalent” will mean:
any “substitute dividend” made pursuant to a
securities lending or sale-repurchase transaction
that (directly or indirectly) is contingent upon,
or determined by reference to, the payment of a
U.S. source dividend;
any payment made pursuant to a “specified
notional principal contract” that (directly or
indirectly) is contingent upon, or determined
by reference to, the payment of a U.S. source
dividend; and
any other payment determined by the Secretary to
be substantially similar to a “substitute dividend”
Taxes—The Tax Magazine®
September 2010
or a “specified notional principal contract” that
is contingent on, or determined by reference to
a U.S. source dividend.
For this purpose, a dividend equivalent includes
any substitute dividend as defined in Reg. §1.861-3(a)
(6).176 While both FATCA and the HIRE Act proposals
have a catch-all for the Treasury to identify transac-
tions substantially similar to payments arising under a
notional principle contract, the HIRE Act specifically
adds “substitute dividends” to the definition, and then
defines a new term, “specified notional principal
contract” as a dividend equivalent.177 In addition, the
Treasury may conclude that payments under certain
forward contracts or financial contracts are dividend
equivalents.178
Specified notional principal payment. Under new
Code Sec. 871(l)(3)(A) a “specified notional principal
contract” means any notional principal contract if:
in connection with entering into such contract, any
long party transfers the underlying security to any
short party to the contract (i.e., “crossing-in”),179
in connection with the termination of such con-
tract, any short party transfers the underlying
security to any long party to the contract (i.e.,
“crossing out”),180
the underlying security is not readily tradable on
an established securities market,181
in connection with entering into such contract,
the underlying security is posted as collateral by
any short party to the contract,182or
such contract is identified by the Secretary as a
specified notional principal contract. 183
Based upon this definition, dividend withholding
will apply to any equity swaps or other arrangements
that satisfies each of the identified first four conditions
above, or is otherwise identified by the Treasury as
such a contract for any payments made beginning
September 14, 2010.
Definition of “long party,” “short party” and
“underlying security.” For purposes of these char-
acteristics the term “long party” means with respect
to any underlying security of any notional principal
contract, any party to the contract which is entitled to
receive any payment pursuant to such contract which
is contingent upon, or determined by reference to, the
payment of a dividend from sources within the United
States with respect to the underlying security.184 The
term “short party” means with respect to any underly-
ing security of any notional principal contract, any
party to the contract which is not a long party with
respect to such underlying security.185
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New U.S. Withholding System for Foreign Account Tax Compliance
The term “underlying security” means with respect
to any notional principal contract, the security with
respect to which the dividend referred to in new
Code Sec. 871(l)(2)(B).186 For this purpose, any in-
dex or fixed basket of securities will be treated as a
single security.187
Agency relationship and treatment of foreign
party as beneficial owner—No inference intended.
The legislative history provides that no inference is
intended as to whether the definition of specified
notional principal contract, or any determination
under the new law that a transaction does not have
the potential for the avoidance of taxes on U.S.
source dividends, is relevant in determining whether
an agency relationship exists under general tax prin-
ciples or whether a foreign party to a contract should
be treated as having beneficial tax ownership of the
stock giving rise to U.S. source dividends.188
Delayed application of withholding for certain
notional principal contracts not otherwise subject
to withholding tax under new Code Sec. 871(l)(3)
(A). Under new Code Sec. 871(l)(3)(B) the new term
“specified notional principal contract” will also include
payments on any notional principal contract made
after the date which March 18, 2012 (e.g., two years
after the date of the enactment of Section 541), unless
the Treasury determines that such contract is of a type
which does not have the potential for tax avoidance.
Thus, the HIRE Act will delay the application of U.S.
withholding tax for certain payments made within two
years of the date of enactment, in the case of notional
principal contracts which does not otherwise satisfy
the four conditions enumerated under new Code Sec.
871(l)(3)(A) or is otherwise determined by the Treasury
to be a specified notional principal contract.
Exceptions to dividend equivalency withholding.
The FATCA proposal authorized the Treasury to make
an exception from withholding for any payment under
a contract or other arrangement it identifies which does
not have the potential for tax avoidance. See “Excep-
tions to Dividend Equivalency,” and “Avoidance of
Withholding—Comparison of FATCA to Green Book
Proposal.” In making this determination the proposal
specified factors which the Treasury may take into
account. While the HIRE Act continues to permit
the Treasury to identify exceptions from dividend
equivalency withholding, it no longer will be based
upon a nonexclusive list of factors which the Treasury
under FATCA or the Green Book Proposal had been
requested to take into account in determining whether
a payment has the potential for tax avoidance.
76
Dividend equivalency withholding based on gross
amount. The HIRE Act continues to follow FATCA and
provides in new Code Sec. 871(l)(5) the term “pay-
ment” includes any gross payment which is used in
computing any net amount which is transferred to or
from the taxpayer.189
The example of a “total return swap” referencing
stock of a domestic corporation (an example of a
notional principal contract to which the provisions
applies), illustrates the consequences of this rule.
Under a typical total return swap, a foreign investor
enters into an agreement with a counterparty under
which amounts due to each party are based on the
returns generated by a notional principal contract
in a specified dollar amount f the stock underlying
the swap. The investor agrees for a specified period
to pay the counterparty (1) an amount calculated by
reference to a market interest rate (such as the Lon-
don Interbank Offered Rate (LIBOR) on the notional
amount of the underlying stock, and (2) any deprecia-
tion in the value of stock. In return, the counterparty
agrees for the specified period to pay the investor
(a) any dividends paid on the stock, and (b) any ap-
preciation in the value of the stock.190 Amounts owed
by each party under this swap typically are netted so
that only one party makes an actual payment.
The provision treats any dividend-based amount
under the swap as a payment even though any actual
payment under the swap is a net amount determined in
part by other amounts (for example, the interest amount
the amount of any appreciation or depreciation in value
of the referenced stock). Accordingly, a counter party to
a total return swap may be obligated to withhold and
remit tax on the gross amount of the dividend equivalent
even though, as a result of netting of payments due un-
der the swap, the counterparty is not required to make
an actual payment of the foreign investor.191
Prevention of over-withholding. New Code Sec.
871(l)(6) provides in the case of any chain of dividend
equivalents one or more of which is subject to tax
under this Section or Code Sec. 881, the Treasury
may reduce such tax, but only to the extent that the
taxpayer can establish that such tax has been paid
with respect to another dividend equivalent in such
claim. For purposes of this definition, a dividend will
be treated as a dividend equivalent.192
If there is a chain of dividend equivalents (under,
for example, transactions similar to those described
in Notice 97-66,193 which will now presumably be
void after the new provision becomes effective), and
one or more of the dividend equivalents is subject to

tax under the provision or under Code Sec. 881, the
Treasury may reduce that tax, but only to the extent
that the taxpayer established that the tax has been
paid on another dividend equivalent in the chain. An
actual dividend is treated as a dividend equivalent
for purposes of this rule.194
Control over payment. For purposes of Chapters
3 and 4, each person that is a party to any contract
or other arrangement that provides for the payment
of a dividend equivalent will be treated as a having
control of such payment.195
Treasury authority to provide additional guidance.
The new law which is intended to treat dividend
equivalents as U.S.-source dividends is not intended
to limit the authority of the Treasury (1) to determine
the appropriate source of income from financial ar-
rangements (including notional principal contracts)
under Code Sec. 863 or 865, or (2) to provide
additional guidance addressing the source and char-
acterization of substitute payments made in securities
lending and similar transactions.196
The dividend equivalent provisions of the bill should
not be self-executing. The Treasury should consider
providing this additional guidance since the dividend
withholding rules need more clarity to identify the
transactions and products that are abusive, whether
called an equity swap, derivative, forward contract,
financial contract or goes by another name.
Unfortunately, the new law does not provide taxpay-
ers with bright lines rules or examples to determine
which transactions will be considered dividend equiv-
alents and therefore subject to withholding and those
that are not. For example, the identified factors which
define a specified notional principal contract do not
identify among other considerations, the term of the
contracts which will qualify for non-abusive treatment,
the amount (fixed or percentile) of each party’s invest-
ment or collateral, what is an objectively observable
price, the terms that are relevant to analysis of the par-
ties hedge position and the relevancy of the intentions
of the parties for the sale of the securities giving rise
to the dividends which are critical for an exemption
from withholding. There is also no articulation about
whether one or more of the factors should be weighted
more (or less) heavily in making the determination.
Importantly, Treasury is directed to consider substan-
tially similar transactions with no clear delineation of
what is meant by that term in the statute.
Avoid potential double withholding on equity swaps.
Under the law, the payments that are treated as U.S.
source dividends are the gross amounts that are used
Taxes—The Tax Magazine®
September 2010
in computing the net amounts transferred to or from
the taxpayer. Thus, a withholding tax could be imposed
under the new law on a gross basis even if no actual
payment was made after the netting. There may still be
an issue of possible double withholding because of the
way the equity swap business is done at a number of
firms. Firms often centralize their swap trading activities
in one legal entity to achieve netting benefits for credit
and balance sheet purposes. However, the risk for the
positions may be managed in a different legal entity
so there is a mirror internal swap for each client swap.
This mirror creates the potential for double withhold-
ing. It is recommended that consideration be given to
an exemption for the second withholding tax where
the taxpayer can demonstrate to the IRS that an internal
mirror situation exists and withholding tax was actually
imposed at gross on the first client swap.
Avoid overriding existing U.S. treaties. Many U.S.
tax treaties generally permit treaty benefits (e.g.,
reduced withholding taxes) if a foreign person can
establish he or she is “qualified resident” of a treaty
jurisdiction based on objective tests. The law may
add a new information reporting test not found in our
treaties. The law provides that the Secretary has the
authority to provide guidance ensuring that taxpay-
ers are eligible for treaty benefits and those taxpayers
claiming credits or refunds of amounts withheld under
the law supplies appropriate documentation establish-
ing that they are the beneficial owners of the payments.
Where the law conflicts with the treaty, the law may
preempt the treaty and override it. As a matter of good
tax policy and comity, it is recommended that Treasury
make clear that the new law is not intended to override
existing treaty provisions.
Effect of the HIRE Act on outstanding equity swaps.
The Cadwalader Hire Act Comments had the follow-
ing concerns regarding the impact of the new law on
outstanding equity swaps:197
If a foreign person has entered into an equity swap
under a standard (unmodified) ISDA Master Agree-
ment prior to March 18, 2010, and is subject to
withholding under the [HIRE] Act on a dividend
equivalent payment made on or after September
14 (because, for example, the foreign party trans-
ferred stock to its counterparty in connect with
the transaction),the foreign counterparty will be
entitled to a “gross up” payment that results in
the foreign counterparty receiving the same pay-
ment it would have received had no amount been
withheld. 198 Under the terms of the IDDA Master
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New U.S. Withholding System for Foreign Account Tax Compliance
Agreement (unless otherwise modified), a party
will be obligated to pay a gross up amount on
the next scheduled payment date under the swap
(referred to as the Affected Party”) may take the
following steps to terminate the swap.199
First, the Affected Party must promptly notify the
foreign counterparty of the impending gross-up
obligation.200 Second, the Affected party must
make reasonable efforts to transfer the swap
within 20 days.201 If the Affected Party is un-
able to mitigate its gross-up obligation through
a transfer within the 20-day period,202 it must
notify the foreign counterparty within the 20-
day period, and the foreign counterparty than
has the option within 30 days to transfer the
swap to an affiliate that would not be subject
to withholding (e.g., to a U.S. affiliate).203 If the
foreign counterparty does not transfer the swap
to an affiliate that is not subject to withholding
within the 30 day period, the Affected Party may
designate a termination date for the swap upon
not more than 20 day notice.204
For equity swaps entered into after March 18,
2010, which remain outstanding on September
14, 2010, and (i) involve cross-in or cross-out
(ii) with respect to which the underlying stock is
not readily tradable on an established securities
market (iii) the underlying stock is posted as col-
lateral to the foreign party, or (iv) are identified
as being subject to withholding prior to the date
they were entered into, the foreign party will be
entitled to a gross-up, but the counterparty will
have the right to terminate the swap.
Notice 2010-46—Securities
Lending Transactions
On May 20, 2010, the IRS issued Notice 2010-46 (the
“Notice”) providing the long awaited guidance on sub-
stitute dividend payments received by foreign taxpayers
that lend U.S. dividend paying securities in a securities
lending transaction and revoking Notice 97-66. The
Notice outlines a proposed regulatory framework to
address potential over withholding that may occur as
a result of new Code Sec. 871(l) and provides transi-
tion relief with respect to substitute dividend payments
made between the September 14, 2010, and the date of
the issuance of final regulations anticipated to be effec-
tive on and after January 1, 2012. The Notice provides
78
the framework that the future regulations will take in
order to address information reporting and withholding
tax for substitute dividend payments.
Background
On October 14, 1997, final regulations were published
in the federal register205 that source substitute interest
and substitute dividend payments made pursuant to
a securities lending transaction described in Code
Sec. 1058 or a substantially similar transaction or
a sale-repurchase transaction (a “securities lending
transaction”) by reference to the income that would be
earned with respect to the underlying transferred debt
security or stock. The final regulations also provide
that substitute interest and dividend payments that
are from sources within the United States under the
regulations are characterized as interest and dividends
for purposes of determining the fixed or determinable
annual or periodical income of nonresident alien indi-
viduals and foreign corporations subject to tax under
Code Secs. 871(a), 881 and 4948(a) and Chapter 3
and for purposes of granting tax treaty benefits with
respect to interest and dividends. As promulgated, the
final regulations were made applicable in all respects
for substitute interest payments (as defined in Reg.
§1.861-2(a)(7)) and substitute dividend payments (as
defined in Reg. §1.861-3(a)(6)).
Some taxpayers expressed concern that the total
U.S. gross basis tax paid with respect to a series of
securities lending transactions—that is, a chain of
related securities lending transactions with respect
to identical securities could be excessive. To permit
relief from such cascading taxation, the Treasury
Department issued Notice 97-66 which generally
limits the aggregate U.S. gross basis tax on a series
securities lending transactions, which could give rise
to withholding on multiple substitute payments.
Notice 97-66
Notice 97-66 provided a formula based approach to
calculate the amount of U.S. withholding tax to be
imposed on a foreign-to-foreign substitute payment.
Under this method, the amount of U.S. withhold-
ing tax was the amount of the underlying dividend
multiplied by a rate equal to the excess of the rate
of U.S. withholding tax that would be applicable to
U.S. source dividends paid by a U.S. person directly
to the recipient of the substitute payment over the rate
of U.S. withholding tax that would be applicable to
U.S. source dividends paid by a U.S. person directly
to the payor of the substitute payment.206 The Notice

also stated that the Treasury intended to provide de-
tailed guidance on how substitute dividend payments
made by one foreign person to another foreign person
were to be treated.
For example, if a borrower is eligible for a 15-percent
rate under a U.S. tax treaty on U.S. source dividends makes
a substitute dividend payment to a lender that is resident
in a non-treaty jurisdiction subject to a 30-percent U.S.
withholding tax on U.S. source dividends, the amount of
tax imposed on the substitute dividend payment gener-
ally will be limited to 15 percent (i.e., the payee’s tax rate
of 30 percent less the payor’s rate of 15 percent). Notice
97-66 also provides in an example, if a securities lender’s
tax liability has already been reduced in prior withholding
within a cascading lending transaction that the borrower in
its capacity as a withholding agent is permitted to reduce
the lender’s liability by such amount.
HIRE Act Provisions—
Securities Lending Transactions
In the JCT Report to the HIRE Act, it was explained
that Congress, in enacting new Code Sec. 871(l), was
concerned that some taxpayers have taken the position
that Notice 97-66 sanctioned the elimination of U.S.
withholding tax in certain transactions such as through
the use of securities lending transactions.207 New Code
Sec. 871(l) provides that certain dividend equivalent
payments are treated as U.S.-source dividends effective
for payments made on or after September 14, 2010.
The term “dividend equivalent” is defined for this
purpose to include “any substitute dividend made
pursuant to a securities lending or sale-repurchase
transaction that (directly or indirectly) is contingent
upon, or determined by reference to, the payment of a
dividend from sources within the United States.”208 New
Code Sec. 871(l)(6) authorizes the Secretary to reduce
tax with respect to a chain of dividend equivalents “but
only to the extent that the taxpayer can establish that
such tax has been paid with respect to another dividend
equivalent in such chain or is not otherwise due or as
the Secretary determines is appropriate to address the
role of financial intermediaries in such chain.”
When Is Notice 97-66 Withdrawn
and Can Taxpayers Continue to
Rely upon It?
Notice 97-66 will be withdrawn effective for
payments made on or after September 14, 2010. Tax-
payers can continue to rely on Notice 97-66 prior to
September 14, 2010, except that a withholding agent
Taxes—The Tax Magazine®
September 2010
or foreign lender may not rely on this guidance if the
withholding agent or foreign lender knows or has
reason to know that a securities lending transaction
or series of such transactions has a principal purpose
of reducing or eliminating the amount of gross basis
tax that would have been due in the absence of such
transaction or transactions.
For example, a person may not rely on Notice
97-66 to reduce or eliminate the amount of U.S. tax
on the substitute dividend it is obligated to pay the
foreign lender when it structures or participates in an
arrangement where it:
borrows shares of a domestic corporation from a
foreign person in a transaction described in Code
Sec. 1058 after a dividend declaration;
sells that stock to a related U.S. person before the
ex-dividend date; and
enters into a total return swap agreement with that
related person in order to hedge its risk.
Notice 2010-46 indicates that no inference is
intended as to whether any transaction entered into
prior to May 20, 2010 (the date of the Notice), is
eligible for the relief described in Notice 97-66, and
the IRS may challenge transactions under existing law
including by applying existing judicial doctrines.
Query, will the new Code Sec. 7701(o), which
“codifies” the “economic substance doctrine,” and
became law in March 2010, as part of the Health
Care and Education Affordability Reconciliation Act
of 2010209 be used by the IRS to challenge securities
lending transactions entered into after March 30, 2010,
the effective date of the new provision? New Code
Sec. 7701(o) provides both a definition of economic
substance and a new strict liability penalty that may
apply if a taxpayer enters into a transaction that fails to
have economic substance. If a tax credit transaction is
found to not have “economic substance,” then some
or all of the credits and related deductions will be
disallowed and either a 20-percent penalty will apply
if the transaction is disclosed on the taxpayer’s return
or a 40-percent penalty if it is not disclosed.
What Will Be the New Withholding
and Reporting Framework for the
Final Regulations?
The Notice indicates the Treasury and the IRS intend to
issue regulations under its authority described in new
Code Sec. 871(l)(6).210 As noted above, these regulations
are expected to replace the formulary approach dis-
cussed above under Notice 97-66 with a documentation
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New U.S. Withholding System for Foreign Account Tax Compliance
based system under which withholding agents will be
able to reduce withholding to the extent that withholding
is shown to have been made on another substitute pay-
ment or dividend with respect to identical securities.
The new withholding and reporting framework will
consist of two sets of rules, the qualified securities
lender rules and the credit forward rules. In order to
reduce instances of potential excessive or cascading
taxation and to properly account for the role of finan-
cial intermediaries in securities lending transactions,
the qualified securities lender rules are expected to
exempt certain eligible foreign financial institutions
from being subject to withholding on receipt of sub-
stitute dividend payments provided that they assume
responsibility and liability for properly withholding,
reporting, depositing and paying U.S. tax with respect
to substitute dividend payments.
The credit forward rules will be applicable if the
qualified securities lender rules do not otherwise
apply and will permit a withholding agent to reduce
the withholding on amounts previously withheld on
a substitute dividend payments provided there is suf-
ficient evidence that the tax was actually withheld.
However, the Notice indicates the IRS can administer
compliance by participants by disqualifying noncom-
pliant taxpayers from eligibility for the relief provided
in this Notice in appropriate cases.
What Is the “Qualified Securities
Lender” Framework?
What is the tax treatment for withholding agent?
Under the regulations to be issued, a withholding
agent making a substitute dividend payment to a for-
eign financial institution that is a “qualified securities
lender” will not be required to withhold U.S. tax with
respect to such payment provided the withholding
agent obtains the required certifications from such
institution. See “What Certifications Are Required by
a Qualified Securities Lender?”
What certifications are required by a qualified se-
curities lender? The regulations are expected to relieve
a withholding agent of its liability to withhold U.S. tax
with respect to any substitute dividend paid to a qualified
securities lender only if the withholding agent receives a
written certification from the qualified securities lender
either on a form prescribed by the IRS or as otherwise
provided by regulation. This certification must include
a statement that the recipient of a substitute dividend is
a qualified securities lender and that with respect to any
substitute dividend it receives from the withholding agent
it will withhold and remit or pay the proper amount of
80
U.S. gross basis tax with respect to substitute dividend
payments that it receives or makes.
What is the tax treatment for a qualified securities
lender? Rather, it is anticipated that these regula-
tions will impose the withholding obligation on the
qualified securities lender and also coordinate the
obligation of a qualified securities lender to withhold
on substitute dividend payments that it makes, pay
and deposits tax on substitute dividends it receives,
and report on substitute dividends it makes (on behalf
of itself or any other person). The new regulations are
expected to define these obligations in terms of two
distinct categories of substitute dividends that quali-
fied securities lenders pay or receive.
Will a qualified securities lender have to withhold
where it receives and pays a substitute dividend pay-
ment? In circumstances where a qualified securities
lender receives a substitute dividend payment (the
“first substitute dividend payment”) and is obligated
to make an offsetting substitute dividend payment
with respect to identical securities (the “second
substitute dividend payment”), a qualified securities
lender will not be liable for U.S. withholding tax on
the first substitute dividend payment under Code Sec.
871(a) or 881(a), but must properly withhold under
Code Secs. 1441 and 1442 and report with respect
to the second substitute dividend payment.
In circumstances where a qualified securities lender
receives a substitute dividend payment for which it
has no obligation to make an offsetting substitute
dividend payment with respect to identical securities,
the qualified securities lender remains liable for tax
under Code Sec. 871(a) or 881(a) by virtue of the
receipt of such substitute dividend payment as the
beneficial owner of such payment.
Is there an anti-abuse rule for structures which
facilitate the avoidance of tax? The IRS intends to
monitor qualified securities lenders for compliance
with the rules described in the Notice and may revoke
an institution’s status as a qualified securities lender
for noncompliance. For example, circumstances in
which an institution structures or participates in ar-
rangements designed to facilitate the avoidance of
U.S. gross basis taxation by foreign persons that hold
or held U.S. equities, as well as circumstances in
which an institution does not withhold and deposit
tax at the proper rate when it acts as a custodian on
behalf of both a borrower and lender in the same
securities lending transaction.
What is the definition of a “qualified securities
lender”? For purposes of the relief described above,

the regulations are expected to provide that a foreign
financial institution is a qualified securities lender
only if it satisfies all of the following conditions:
It is a bank, custodian, broker-dealer, or clear-
ing organization that is subject to regulatory
supervision by a governmental authority in the
jurisdiction in which it was created or organized,
and is regularly engaged in a trade or business that
includes the borrowing of securities of domestic
corporations (as defined in Code Sec. 7701(a)
(4)) from, and lending of securities of domestic
corporations to, its unrelated customers.
It is subject to audit and summons power by the IRS
under Code Sec. 7602 or in the case of a qualified
intermediary (QI) that appropriately amends its QI
agreement with the IRS, by an external auditor. It
is likely further guidance will specify the require-
ments of such an amendment to the QI agreement.
In general, however, the amendment will require
the QI to report, withhold, deposit, and pay U.S.
tax. See “What Are the Information Reporting Re-
quirements for Substitute Payments?”
It files an annual statement on a form prescribed
by the IRS certifying that it satisfies the conditions
necessary to be a qualified securities lender. See
“What Certifications Are Required by a Qualified
Securities Lender?”
What Is the Credit
Forward Framework?
According to the Notice, the Treasury and the IRS
believe that the vast majority of instances of exces-
sive or cascading taxation arising in connection with
substitute dividend payments will be relieved through
the qualified securities lender rules. To address the
remaining instances of excessive or cascading taxation
not addressed by the qualified securities lender rules,
the regulations are expected to provide a document
based credit forward system.
Will there be a credit or relief for prior withhold-
ing? The regulations are expected to provide that a
withholding agent may limit the aggregate U.S. gross
basis tax within a series of securities lending trans-
actions to the amount of U.S. gross basis tax, if any,
applicable to the foreign taxpayer (other than in the
case of a qualified securities lender that is obligated to
make an offsetting substitute dividend payment) bear-
ing the highest rate of U.S. gross basis tax on either a
substitute or actual dividend with respect to the un-
derlying security transferred in the series. As a result,
the aggregate taxes paid in such transactions should
Taxes—The Tax Magazine®
September 2010
not exceed the 30-percent statutory rate applicable to
U.S. source dividends paid to foreign persons.
The regulations are also expected to provide that
a withholding agent may relieve excessive tax on
substitute dividends by reducing withholding on a
substitute dividend payment that the withholding
agent is obligated to make by an amount not to exceed
the amount that has been previously withheld within
the same series of securities lending transactions, but
only to the extent that there is sufficient evidence that
tax was actually withheld on a prior dividend and/or
substitute dividend paid to the withholding agent or a
prior withholding agent within the same such series.
No payee in a series of securities lending transac-
tions may claim a refund (or claim a credit against any
other liability) solely because a prior payee in the same
series was subjected to a higher rate of gross basis U.S.
tax. Moreover, no taxpayer or withholding agent in
a series of securities lending transactions may credit
any tax withheld with respect to a substitute dividend
payment in such series against any tax imposed with
respect to a substitute dividend payment in a different
series of Securities Lending Transactions.
How can evidence of prior withholding be sub-
stantiated? The regulations are expected to provide
that sufficient evidence of prior withholding will be
deemed to exist where there is written documenta-
tion that identifies amounts previously withheld by
another withholding agent with respect to actual
dividend distributions or substitute dividends in the
same series of securities lending transactions or as
otherwise prescribed by the IRS in future guidance.
For example, the regulations are expected to provide
that a withholding agent may presume that tax has been
withheld by a prior withholding agent in a series of
securities lending transactions if that agent (i) receives
a substitute dividend net of U.S. withholding taxes,
(ii) receives a written statement from the immediately
prior withholding agent setting out the amount of such
taxes, (iii) identifies the person who withheld such tax
and the recipient of the payment against which such tax
was withheld, and (iv) does not know or have reason to
know that the written statement is unreliable. For these
determinations, a withholding agent may not rely upon
evidence of a sale of the underlying security as a basis
to determine that tax has been paid or withheld.
Is there an anti-abuse rule? Finally, the regula-
tions are expected to provide a separate anti-abuse
rule which will provide that a withholding agent or
a qualified securities lender may not rely on any
of the foregoing rules (including any certifications
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New U.S. Withholding System for Foreign Account Tax Compliance
provided by a qualified securities lender) when the
withholding agent or qualified securities lender
knows or has reason to know that a securities
lending transaction, or series of such transactions,
has a principal purpose of reducing or eliminating
the amount of U.S. gross basis tax that would have
been due in the absence of such transaction or
transactions. In such a case, a withholding agent or
qualified securities lender must withhold and the
recipient of such payment is subject to U.S. tax at 30
percent (subject to reduction under an applicable
income tax treaty) on each substitute dividend pay-
ment with respect to such transaction.
What Are the Information
Reporting Requirements for
Substitute Payments?
In cases in which a withholding agent (including a
qualified securities lender) makes a substitute dividend
payment and in reliance on the regulations reduces the
withholding or is exempted from withholding, the with-
holding agent should include on Form 1042 and Form
1042-S the gross amount of the substitute dividend
payment to which the recipient would have otherwise
been entitled before consideration of any withholding
tax obligations and the amount of tax withheld by the
withholding agent and shown to have been withheld
by other withholding agents in the series of securities
lending transactions based on the documentation and
information as described above.
In addition, a withholding agent (including a quali-
fied securities lender) that makes a substitute dividend
payment to a U.S. person will be required to report
and withhold to the extent required under Chapter
61 and Code Sec. 3406. Thus, if a withholding agent
or qualified securities lender makes a substitute divi-
dend payment and is either exempt from withholding
or withholds at a reduced rate the withholding agent
will report on Form 1042 and Form 1042-S the gross
amount of the substitute dividend payment and the
amount of U.S. tax withheld by it or other withholding
agents in the series of securities lending transactions.
What Are the Transitional Rules for
the Period from September 15, 2010,
Until January 1, 2012?
The Treasury and the IRS anticipate that the regula-
tory framework outlined above will be effective for
transactions entered into on or after January 1, 2012.
82
Until such regulations are issued and after September
14, 2010 (the “transition period”), Code Sec. 871(l)
will apply with the potential for U.S. tax due on a
series of securities lending transactions that exceeds
30 percent in the aggregate. In order to avoid exces-
sive or cascading tax in these situations, withholding
agents may rely on the transition rules which adopt a
modified qualified securities lender framework.
Under this framework a withholding agent will
not be required to withhold if it receives an annual
certification from the counterparty that substantially
complies with the above certification requirements, is
an eligible foreign financial institution and is subject
to audit and summons power of the IRS or is a quali-
fied intermediary that is subject to audit by an external
auditor. This certification must include a statement
that the recipient of a substitute dividend is a qualified
securities lender and that with respect to any substitute
dividend it receives from the withholding agent it will
withhold and remit or pay the proper amount of U.S.
gross basis tax with respect to substitute dividend
payments that it receives or makes.
The maximum aggregate U.S. gross basis tax due,
if any, with respect to a series of securities lending
transactions and any related dividend payment is
the amount determined by the tax rate paid by the
foreign taxpayer (other than in the case of a quali-
fied securities lender that is obligated to make an
offsetting substitute dividend payment) bearing the
highest rate of U.S. gross basis tax in the series. Ac-
cordingly, the aggregate U.S. gross basis taxes paid
in such transactions generally should not exceed the
30-percent statutory rate applicable to U.S.-source
dividends paid to foreign persons.
What presumptions can a withholding agent rely
upon to establish a U.S. tax has been paid on sub-
stitute dividend payments? A withholding agent that
is obligated to make a substitute dividend payment
pursuant to a securities lending transaction may
presume that U.S. tax has been paid in an amount
equal to the amount implied by the net payment if
all of the following are satisfied:
The withholding agent receives a substitute
dividend or dividend payment with respect to
identical securities that reflects a reduction for
withholding of U.S. gross-basis tax.
The withholding agent does not know or have
reason to know that tax was not withheld and
deposited or paid. For this purpose, a withholding
agent has a reason to know that tax was not with-
held if, for example, the amount of any lending

fee or similar fee is increased directly or indirectly
in whole or in part by the difference between the
gross amount of the substitute dividend and the
net amount received.
The withholding agent is a person subject to audit
under Code Sec. 7602, or in the case of a QI, by
an external auditor.
Can a payee claim a refund or credit if a prior payee
was subject to a higher rate of tax than the current
payee? No payee in a series of securities lending trans-
actions may claim a refund (or claim a credit against
any other liability) solely because a prior payee in the
same series was subjected to a higher rate of gross basis
U.S. tax. Moreover, no taxpayer or withholding agent
in a series of securities lending transactions may credit
any tax withheld with respect to a substitute dividend
payment in such series against any tax imposed with
respect to a substitute dividend payment in a different
series of securities lending transactions.
How will the qualified securities lender rules apply
during the transitional period? During the transition
period, a withholding agent may adopt a system that
reasonably implements the principles of the quali-
fied securities lender system. In particular, during the
transition period, a withholding agent is not required
to withhold on a substitute dividend payment made to
a qualified securities lender if the withholding agent
receives, at least annually, a statement from its counter-
party that substantially complies with the certification
requirement. A foreign financial institution may make
such a certification only if it reasonably determines
that it meets the requirements to qualify as a qualified
securities lender (without regard to the requirement
that a qualified securities lender file an annual state-
ment with the IRS). It is anticipated that future guidance
will provide that all qualified securities lenders taking
advantage of the transition relief may be required to
identify themselves to the IRS (in a manner to be speci-
fied) before the end of 2010. A QI that provides such a
certification will be deemed to have agreed to amend
its QI agreement for these purposes as necessary to
report, withhold, deposit and pay U.S. tax.
Is there a kick-out rule for purposes of the transitional
rules? Withholding agents may not rely on this transition
relief with respect to a securities lending transaction or
series of such transactions that are entered into with a
principal purpose of reducing or eliminating the ag-
gregate amount of U.S. tax that would have been due
in the absence of such transaction or series of transac-
tions. A foreign financial institution that is determined
to have structured or engaged in one or more of the
Taxes—The Tax Magazine®
September 2010
above transactions on or after May 20, 2010, will not
qualify as a qualified securities lender for a period of
five years from the date of such determination.
What methods can a qualified securities lender use
to determine the securities which have actually been
borrowed and lent? A qualified securities lender may
use any reasonable method, consistently applied, to
determine which securities within a pool of fungible
securities available to borrow have actually been bor-
rowed and lent. Withholding agents will be required
to perform information reporting.
Will a withholding agent be entitled to an exten-
sion to file information returns for 2010? To the
extent that Code Sec. 871(l) applies to any substitute
dividend payments in respect of any transaction de-
scribed in Code Sec. 871(l)(2)(A), withholding agents
will be granted an automatic six-month extension of
time to file information returns such as Form 1042
and Form 1042-S pursuant to Reg. §1.1461-1(c) with
respect to the 2010 calendar year.
However, the time for filing information returns
pursuant to Reg. §1.1461-1(c) shall not be extended
beyond the date on which the withholding agent
provides a copy of the return to the recipient. In addi-
tion, withholding agents will be granted an automatic
extension for making deposits of withheld tax from
such substitute dividend payments until January 31,
2011, for the 2010 calendar year.
What are the effective dates of the notice? The
modification of Notice 97-66 is effective for amounts
paid on or after May 20, 2010, and before Septem-
ber 14, 2010. The transition rules are effective for
amounts paid on or after September 14, 2010.
Has the government requested comments in
connection with the new regulations? The Treasury
and the IRS have requested comments on the fol-
lowing issues:
The definition of a qualified securities lender
The treatment of substitute dividends paid to a
qualified securities lender where that entity holds
the relevant position in a proprietary account
Whether additional rules are required to address
abusive securities lending transactions that avoid
U.S. tax in addition to the anti-abuse regulation
discussed above
The treatment of substitute dividends paid with re-
spect to securities transferred from a commingled
account containing securities held by a qualified
securities lender in its proprietary capacity and
other securities held in connection with transac-
tions for customers
83
New U.S. Withholding System for Foreign Account Tax Compliance
Whether a qualified intermediary with qualified
securities lender status (a “Lender QI”) should
be required to provide the withholding rate pool
information of its customers to another qualified
intermediary (a “Borrower QI”) that has borrowed
securities in a securities lending transaction
Whether a Borrower QI should be required to
withhold and carry out information reporting on a
substitute dividend payment made to a Lender QI
based upon the withholding information provided
by a Lender QI with respect to its customers
The definition of a series of securities lending
transactions, and how related securities loans in a
series should be identified, including appropriate
methods pursuant to which a qualified securities
lender may determine which securities within
a pool of fungible securities are attributable to
particular securities lending transactions
Will the qualified securities lender framework ap-
ply to substitute interest payments? At present, it is
an open question whether these new rules will apply
to substitute interest payments.
Repeal of Certain Foreign
Exceptions to Registered Bond
Requirements
Background
In general, a taxpayer may deduct all interest paid
or accrued within the tax year on indebtedness.211
For registration-required obligations, a deduction
for interest is allowed only if the obligation is in
registered form. Generally, an obligation is treated
as issued in registered form if the issuer or its agent
maintains a registration of the identity of the owner of
the obligation and the obligation can be transferred
only through this registration system.212
A registration-required obligation is any obligation
other than one that (i) is made by a natural person, (ii)
matures in one year or less, (iii) is not of a type offered
to the public, or (iv) is a foreign targeted obligation.213
In applying this requirement, the IRS has adopted
a flexible approach that recognizes that a debt
obligation that is formally in bearer (i.e., not in
registered) form is nonetheless “in registered form”
for these purposes where there are arrangements
that preclude individual investors from obtaining
definitive bearer securities or that permit such se-
curities to be issued only upon the occurrence of
an extraordinary event.214
84
A foreign targeted obligation to which the registra-
tion requirement does not apply is any obligation
satisfying the following requirements:
there are arrangements reasonably designed to
ensure that such obligation will be sold (or resold
in connection with the original issue) only to a
person who is not a U.S. person,
interest is payable only outside the United States
and its possessions, and
the face of the obligation contains a statement
that any U.S. person who holds this obligation
will be subject to limitations under the U.S. in-
come tax laws.215
In addition to the denial of an interest deduction, an
excise tax is imposed on the issuer of any registration-
required obligation that is not in registered form.216
The excise tax is equal to one percent of the principal
amount of the obligation multiplied by the number of
calendar years (or portions thereof) during the period
beginning on the date of issuance of the obligation
and ending on the date of maturity.
Moreover, any gain realized by the beneficial own-
er of a registration-required obligation that is not in
registered form on the sale or other disposition of the
obligation is treated as ordinary income (rather than
capital gain), unless the issuer of the obligation was
subject to the excise tax described above.217 Finally,
deductions for losses realized by beneficial owners
of registration-required obligations that are not in a
registered form are disallowed.218
For the purposes of ordinary income treatment and
denial of deduction for losses, a registration-required
obligation is any obligation other than one that (i) is
made by a natural person, (ii) matures in one year or
less, or (iii) is not of a type offered to the public.
Treatment as portfolio interest. Payments of U.S.
source “fixed or determinable annual or periodical”
income, including interest, dividends and similar types
of investment income, that are made to foreign persons
are subject to U.S. withholding tax at a 30-percent
rate, unless the withholding agent can establish that
the beneficial owner of the amount is eligible for an
exemption from withholding or a reduced rate of
withholding under an income tax treaty.219 In 1984,
Congress repealed the 30-percent tax on portfolio in-
terest received by a nonresident individual or foreign
corporation from sources within the United States.220
The term “portfolio interest” means any interest
(including original issue discount) that is:
paid on an obligation that is in registered form and
for which the beneficial owner has provided to the

U.S. withholding agent a statement certifying that
the beneficial owner is not a U.S. person; or
paid on an obligation that is not in registered form
and that meets the foreign targeting requirements
of Code Sec. 163(f)(2)(B).221
However, portfolio interest does not include inter-
est received by a 10-percent shareholder,222 certain
contingent interest,223 interest received by a controlled
foreign corporation from a related person224 or interest
received by a bank on an extension of credit made
pursuant to a loan agreement entered into in the
ordinary course of its trade or business.225
Requirement that Treasury obligations be in reg-
istered form. Under Title 31 of the U.S. Code, every
“registration-required obligation” of the Treasury must
be in registered form.226 For this purpose, a foreign
targeted obligation is excluded from the definition of
a registration-required obligation.227 Thus, a foreign
targeted obligation of the Treasury can be in bearer
(rather than registered) form. Neither the Levin Bill
nor the Green Book Proposal for 2010 contained
provisions repealing the exceptions to the above-
described registered bond requirements.
FATCA: Section 102—Repeal of certain foreign
exceptions to registered bond requirements—Repeal
of the foreign targeted obligation exception to the
registration requirement. The provision repeals the
foreign targeted obligation exception to the denial of a
deduction for interest on bonds not issued in registered
form. Thus, under the provision, a deduction for inter-
est will be disallowed with respect to any obligation
not issued in registered form, unless that obligation (i)
is issued by a natural person, (ii) matures in one year
or less, or (iii) is not of a type offered to the public.
In addition, under the provision, the foreign target-
ed obligation exception is not available with respect
to the excise tax applicable to issuers of registration-
required obligations that are not in registered form.
Thus, the excise tax generally applies with respect
to any obligation that is not in registered form un-
less the obligation (i) is issued by a natural person,
(ii) matures in one year or less, or (iii) is not of a type
offered to the public.
Further, under the provision, the foreign targeted ob-
ligation exception will not be available with respect to
the ordinary income treatment of any gain realized by
the beneficial owner of a registration-required obliga-
tion that is not in registered form on the sale or other
disposition of the obligation. Thus, any gain realized
upon the sale or other disposition of an obligation that
is not in registered form is treated as ordinary income
Taxes—The Tax Magazine®
September 2010
(rather than capital gain), unless the obligation (i) is is-
sued by a natural person, (ii) matures in one year or less,
or (iii) is not of a type offered to the public, or the issuer
of the obligation was subject to the excise tax described
above. The provision includes a conforming change to
Title 31 of the U.S. Code that repeals the foreign targeted
exception to the definition of a registration-required
obligation. Thus, a foreign targeted obligation of the
U.S. government must be in registered form.
Repeal of treatment as portfolio interest. The provi-
sion repeals the treatment as portfolio interest of interest
paid on bonds that are not issued in registered form but
meet the foreign targeting requirements of Code Sec.
163(f)(2)(B). Under the provision, interest qualifies as
portfolio interest only if it is paid on an obligation that
is issued in registered form and for which the benefi-
cial owner has provided the withholding agent with a
statement certifying that the beneficial owner is not a
U.S. person. Thus, under the provision, interest paid to
a foreign person on an obligation that is not issued in
registered form is subject to U.S. withholding tax at a 30-
percent rate, unless the withholding agent can establish
that the beneficial owner of the amount is eligible for
another exemption from withholding or a reduced rate
of withholding under an income tax treaty.
Effective date. The provision applies to debt obliga-
tions issued after the date which is 180 days after the
date of enactment.
The bearer bond provisions of the law should
not be self-executing. Congress determined over
25 years ago that U.S. individuals holding bearer
bonds in foreign accounts created the potential for
tax evasion and determined that new laws needed to
be enacted to prevent U.S. individuals from holding
such assets. At that time, Congress was also aware that
the Euro-dollar market was primarily a bearer bond
market and an important source of debt financing
for many U.S. corporate borrowers. The current law
and regulations adopted a flexible approach to the
problem and permitted issuers to issue bearer bonds
outside the United States in capital markets that are
either customary or required, while setting up rules
designed to ensure their sale to only non-U.S. persons
under the foreign-targeted obligation rules.
FATCA would require these bonds to be in regis-
tered form and repealed the so-called TEFRA C and
TEFRA D bearer bonds issued 180 days after enact-
ment. These bearer bonds would have been subject
to a one-percent excise tax on the principal amount
each year and interest on such bonds would no lon-
ger be subject to the portfolio interest exemption to
85
New U.S. Withholding System for Foreign Account Tax Compliance
avoid the U.S. withholding tax. The collateral impact
of this change would have been to treat any gain
recognized on the disposition of these bearer bonds
as ordinary income, unless the excise tax was paid
and any losses would be disallowed.
Some commentators have suggested the FATCA has
the potential to disrupt global debt markets unless the
provision is subject to the promulgation of Treasury
regulations and guidance as to how the new rules will
be applied. For example, by removing the foreign-
targeted obligation rules, the Bill has the unintended
consequence of making all foreign issuers of bearer
bonds subject to a likely unenforceable U.S. excise
tax. In addition, any foreign debt of U.S. middlemen
(e.g., a London branch of a U.S. financial institution)
would result in U.S. information reporting requirements
even though both the issuer and investors are non-U.S.
persons. Lastly, there are concerns that bearer bonds
issues that are subject to this rule have already been (or
are being marketed) to foreign investors on the basis
that no U.S. excise tax or withholding tax will apply.
ABA Tax Section Comments on FATCA—Repeal of
the foreign targeted obligation exception for bearer
bonds (Section 102 of the bill). The ABA Tax Section
Comments on FATCA recommended that (i) Congress
authorize the Treasury to allow issuers to issue foreign
targeted bearer obligations in one or more specified
jurisdictions, subject to periodic review if a specified
jurisdiction is determined to be important to capital
markets and that meeting the registration requirements
under established local practice is not feasible; (ii) for-
eign issuers, other than, generally, controlled foreign
corporations or partnerships or disregarded entities
owned by U.S. persons, issuing foreign targeted bearer
bonds not be subjected to the Code Sec. 4701 excise
tax; and (iii) the effective date for the bearer bond
exception from FATCA withholding be consistent
with the effective date repeal of the current statutory
exception for foreign targeted obligations.228
Background. More specifically, the ABA Tax Section
Comments provide:229
Under present law, a “registration-required”
obligation that is not issued in registered form
generally carries with it punitive tax consequences
for both the issuer and the holder: the issuer cannot
deduct interest paid or accrued on the obligation
and must pay an excise tax equal to one percent
of the principal amount of the obligation multi-
plied by the number of calendar years (or portions
thereof) from the date of issuance to the date of
86
maturity; interest paid on the obligation does not
qualify for the portfolio interest exemption to the
30-percent withholding tax on U.S.-source interest
imposed by Code Sec.s 871 and 881; and any loss
recognized on the sale or other disposition of the
obligation is disallowed to its holder.
When these provisions were enacted over 25 years
ago, Congress determined that U.S. individuals
holding bearer bonds created the potential for tax
evasion. Congress was also aware, however, that
certain markets were primarily bearer bond markets
and an important source of debt financing for many
U.S. corporate borrowers. The current law and reg-
ulations therefore adopted a flexible approach to
the problem and permitted issuers to exempt from
the registration requirement bearer bonds that are
“foreign targeted obligations.” As noted in the Joint
Committee explanation, in applying this require-
ment, the IRS has adopted a flexible approach that
recognizes that a debt obligation that is formally in
bearer (i.e., not in registered) form is nonetheless
“in registered form” for these purposes when there
are arrangements that preclude individual investors
from obtaining definitive bearer securities or that
permit such securities to be issued only upon the
occurrence of an extraordinary event.230
Obligations are “foreign targeted” if there are ar-
rangements reasonably designed to ensure that the
obligation will be sold (or resold in connection
with the original issue) only to non-U.S. persons;
interest is payable only outside the United States
and its possessions; and the face of the obligation
contains a statement that any U.S. person holding
the obligation will be subject to limitations under
U.S. tax laws. The so-called TEFRA C and TEFRA
D regulations currently specify detailed rules for
meeting these requirements.231
Summary of provision. Under section 102(c)
of the Bill, the exception for foreign targeted
obligations would be repealed. Thus, foreign tar-
geted obligations would be registration-required
obligations and, therefore, subject to the above
penalty in the case of an issuer and additional tax
consequences for the issuer and holders, unless
issued in registered form.232
Obligations that are made by a natural person,
that mature in one year or less or that are not of a

type offered to the public, which are currently ex-
cepted from the registration requirement, would
be unaffected by the repeal of the exception for
foreign targeted obligations.
Repeal would be effective for debt obligations
issued more than 180 days after the date of en-
actment. However, because FATCA withholding
would apply under section 101 of the Bill to
U.S.-source payments made after December 31,
2010, on bearer bonds issued after the date of first
committee action on the Bill, the effective date
for the repeal and the effective date for FATCA
withholding do not coincide.
Comments. We generally believe that the repeal
of the foreign targeted exception is a reasonable
measure in light of the overall purpose of the Bill.
It would be inconsistent with the approach of sec-
tion 101 of the Bill to continue to allow the use
of bearer instruments, notwithstanding that they
are structured to meet the foreign targeting rules.
Accordingly, if the approach in section 101 of the
Bill is adopted, then from a consistency standpoint
the effective elimination of U.S. issuers from the
bearer instrument market as a result of the with-
holding tax and sanctions for registration-required
obligations makes sense as a general rule. We note,
however, the following considerations.
The repeal seemingly would increase, at least
to some extent, borrowing costs of affected is-
suers. This is because there appear to be still,
at least for the time being, certain markets in
which it is not feasible to issue instruments in
registered form (or in bearer form but under
arrangements causing them to meet the regis-
tered form requirements for U.S. tax purposes,
or when they are issued in registered form
but the necessary W-8BEN compliance is not
feasible). We are not qualified to express a
view on what additional cost may be entailed,
which may in any given case differ depending
on whether the funds are needed locally or
used globally. A possible approach to address
this issue would be to authorize Treasury to
allow issuers to continue to issue foreign
targeted bearer obligations in a specified ju-
risdiction or jurisdictions that are determined
to be important to the capital markets and in
which meeting the registration requirement is
Taxes—The Tax Magazine®
September 2010
not feasible, subject to periodic review of the
continued need for an exception.
As currently drafted, the repeal would apply
to all issuers, wherever located, resident or
organized, including all non-U.S. issuers. The
repeal would therefore on its face apply the
Code Sec. 4701 excise tax to non-U.S. issuers
that issue foreign targeted bearer bonds with-
out any connection to interstate commerce.
Even if the excise tax in such cases might not
be enforced as a practical matter, we recom-
mend that, subject to specific exceptions as
described in paragraph 3 below, the excise
tax be made inapplicable to non-U.S. issu-
ers issuing foreign targeted obligations. We
believe that it would not be unreasonable
to subject certain U.S.-owned issuers to the
excise tax on the issuance of bearer form
obligations (other than in excepted markets
as described in paragraph 1 above). Specifi-
cally, the foreign issuers that we recommend
for exemption from the excise tax would not
include disregarded entities owned by U.S.
persons or, in general, controlled foreign
corporations within the meaning of Code
Sec. 957233 or controlled foreign partnerships
within the meaning Code Sec. 6038(a)(5) or
their respective disregarded subsidiaries.
The inconsistency in effective dates noted
above would in effect prohibit the issuance of
foreign targeted bearer bonds after the date of
first committee action, which is earlier than
the effective date for section 102 of the Bill.
We believe that this is an unintended incon-
sistency, and the effective date for FATCA
withholding and reporting on newly issued
bearer bonds should be conformed to the
effective date for the repeal of the exception
for foreign targeted bearer bonds. That is, we
believe the exemption from Section 101 of the
Bill should apply to bearer bonds issued prior
to 180 days after date of enactment and not
merely payments prior to January 1, 2011.
SIFMA Comments on FATCA. The SIFMA Tax Com-
ments on FATCA recommended that (i) the repeal
of the foreign-targeted bearer bond exception be
deferred until it can be studied further, and (ii) the
grandfather rule is simplified and extended for exist-
ing registered debt.234 More specifically, the SIFMA
Tax Comments on FATCA provide:235
87
New U.S. Withholding System for Foreign Account Tax Compliance
Defer repeal of the foreign-targeted bearer bond
exception until it can be studied further. The con-
sequences of the repeal of the foreign-targeted
bearer bond exception should be subjected to
further study before such exception is repealed,
in order to prevent restricting U.S. issuers’ access
to non-U.S. markets. Additionally, the disparity
between the repeal’s effective date and the effec-
tive date of the new information reporting and
withholding rules should be eliminated.236
Since 1982, the “TEFRA” rules generally have al-
lowed U.S. issuers to issue debt obligations in bearer
form, so long as the obligations are issued under
“arrangements reasonably designed to ensure”
their sale to non-U.S. persons (the “foreign-targeted
bearer bond exception”). The Bill would repeal this
exception to the registration requirement.
SIFMA believes that the repeal of the foreign-tar-
geted bearer bond exception may restrict access
to a number of non-U.S. markets in a manner
that would adversely affect U.S. borrowers. In a
number of markets, securities traditionally have
been issued in bearer form. In some of those mar-
kets (e.g., Japan), it may not be feasible to issue
securities in registered form, or there may not be
sufficiently well developed mechanisms in place
to permit the effective collection of Form W-8s.
Thus, U.S. issuers would be unable to issue debt
in such markets under the Bill, or would be able
to do so only in a manner that causes interest on
the obligations to be subject to withholding tax
at a 30 percent rate, effectively precluding them
from raising funds in these markets. In addition,
even in markets in which it is feasible to issue
securities in registered form, the transition to such
issuances may create substantial market disrup-
tions if it is not the current market norm.
In this regard, it is worth noting that most bearer
bonds are currently bearer in only a very tech-
nical sense, since most beneficial interests in
such bonds are held through Euroclear or other
book-entry clearing systems. As a consequence,
it seems unlikely that such instruments would
pose any special risks of tax evasion under the
Bill, since the information reporting and with-
holding provisions of the Bill could generally be
applied to payments in respect of such securities
in the same manner as for payments in respect of
88
registered bonds (in each case for bonds issued
after the applicable grandfather date).
In order to prevent unwarranted disruption to the
borrowing ability of U.S. issuers in situations where
the risk of U.S. tax evasion seems miniscule, SIFMA
recommends that the Congress direct the Treasury
Department to study the potential consequences
of the repeal of the foreign-targeted bearer bond
exception and prepare a report regarding such a
repeal before any action is taken. In this regard, one
alternative to a complete repeal that the Treasury
Department might wish to consider would be a more
limited prohibition that focused solely on bearer
bonds in definitive form (i.e., those not held through
Euroclear or other book-entry clearing systems).
In addition to the foregoing considerations, there
appears to be an inadvertent glitch in the effective
date provisions of the Bill relating to the repeal
of the foreign-targeted bearer bond exception. In
general, the repeal of the foreign-targeted bearer
bond exception would be effective for obligations
issued more than 180-days after the date of the
Bill’s enactment. The new information reporting
and withholding rules, however, would apply to
any bearer-form obligation that is issued by a U.S.
issuer after the date of first Committee action. As a
consequence, the Bill would create two categories
of U.S.-issued bearer bonds, one that is subject to
the new information reporting and withholding
regimes and one that is not. SIFMA believes that
this result was not intended, and suggests that, if the
repeal of the foreign-targeted bearer bond excep-
tion is retained, the effective date of the information
reporting and withholding rules should be con-
formed, by grandfathering bearer-form obligations
issued prior to the effective date of the repeal of the
foreign-targeted bearer bond exception.”
Simplify and extend the grandfather rule for ex-
isting registered debt. To avoid market confusion
and disruption, the grandfather rule for existing
registered debt should be simplified and extended
to exempt all registered debt instruments that
are outstanding on the effective date of the new
information reporting and withholding regimes
and that contain an issuer gross-up provision.237
The FFI and FE information reporting and with-
holding regimes are proposed to be effective for

all registered form debt instruments of U.S. issuers,
unless the debt is outstanding on the date of first
Committee action and includes a provision under
which the issuer would be obligated to make gross-
up payments by reason of the Bill. This grandfather
provision has already led to substantial market
uncertainty as to whether many instruments will
or will not be eligible for its protection, and would
be very difficult for withholding agents to apply. As
one example, gross-up provisions frequently allow
an issuer to elect either to make a required gross-
up payment or to redeem a debt instrument early.
In such a case, it may be questioned whether the
issuer is “obligated” to make gross-up payments for
purposes of the grandfather provision. As another
example, gross-up provisions frequently contain
carve-outs for withholding taxes that would not be
imposed but for a failure by a holder or beneficial
owner of an instrument to make a certification or
comply with information reporting requirements.
In such a case, because the information reporting
obligations contemplated by the Bill would apply
to intermediaries in a chain of ownership that may
not be holders or beneficial owners for purposes
of the gross-up provision, it may be questioned in
some instances whether a failure to enter into an
information reporting agreement with the IRS under
the Bill constitutes such a failure, and whether the
issuer would be required to make gross-up pay-
ments for purposes of the grandfather provision.
More generally, SIFMA notes that many large
U.S. financial institutions and other U.S. issuers
derive billions of dollars of funding through debt
issuances to foreign investors. In some cases (e.g.,
debt issuances to foreign retail investors), it may
be impossible to effect issuances while the ap-
plication of the new information reporting and
withholding provisions of the Bill remain uncertain,
because the issuance structures will not tolerate
the uncertainty—either as a reputational matter
for the issuer and underwriters or oftentimes as a
local securities law matter—that an intermediary
in a chain of payments could fail to comply with
the information reporting provisions of the Bill
with the result that a foreign investor would suffer
a withholding tax through no fault of its own. If the
grandfather rule for registered debt contained in the
Bill continues to apply only up to the date of first
Committee action, U.S. issuers may accordingly
be required to cease some or all of their registered
Taxes—The Tax Magazine®
September 2010
debt issuances in foreign markets after that date
until uncertainties regarding the application of the
information reporting and withholding provisions
of the Bill are resolved.
If retained in its current form, SIFMA anticipates
that the grandfather rule for existing registered debt
could lead to substantial market confusion and
disruption. In order to minimize such confusion
and disruption, and the legal and other disputes be-
tween issuers, holders, and withholding agents that
could result, SIFMA recommends that the grandfa-
ther rule for existing registered debt be simplified
and extended to exempt all registered debt instru-
ments that are outstanding on the effective date of
the new information reporting and withholding
regimes and that contain an issuer gross-up provi-
sion, regardless of whether that gross-up provision
would in fact be triggered by the Bill. Because
even this simplified grandfather rule would place
substantial compliance burdens on withholding
agents needing to determine the status of numer-
ous debt instruments, SIFMA further recommends
that withholding agents be permitted to presume
that a registered debt instrument outstanding on the
grandfather date qualifies for the grandfather rule,
unless the withholding agent knows or has reason
to know that it does not qualify.”
Green Book 2011 Proposal—Repeal certain
exceptions to registered bond requirements. Al-
though the 2010 Green Book Proposal did not have
a provision equivalent to this proposal, the Green
Book 2011 Proposal related to registered bonds238
appears to be equivalent to the proposals in the
HIRE Act enacted into law. See “HIRE Act: Section
502—Repeal of certain foreign exceptions to regis-
tered bond requirements.”
HIRE Act: Section 502—Repeal of certain foreign
exceptions to registered bond requirements—Repeal
of the foreign targeted obligation exception to the
registration requirement. The new law makes a
fundamental change to existing law by repealing
the current exemption to the TEFRA rules for “for-
eign-targeted obligations,” which will impact both
holders and issuers. More specifically, the new law
repeals the foreign targeted obligation exception to
the denial of a deduction for interest on bonds not
issued in registered form. Thus, under the new law,
a deduction for interest is disallowed with respect to
any obligation not issued in registered form, unless
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New U.S. Withholding System for Foreign Account Tax Compliance
that obligation (i) is issued by a natural person, (ii)
matures in one year or less, or (iii) is not of a type
offered to the public.
This denial of the interest expense deduction can be
expected to severely limit if not end the issuance of
bearer bonds by U.S. issuers other than in dematerial-
ized form (which will not be treated as bearer debt for
U.S. tax purposes). See “Dematerialized book-entry
systems treated as registered form.”
According to at least one commentator, 239 this
denial may also limit the issuance of bearer bonds
by controlled foreign corporations (CFCs) because
CFCs will not be able to decrease their earnings and
profits by the amount of the interest expense and
upon (actual or deemed) repatriation of funds from
the CFC to its U.S. parent, an amount equal to the
interest on bearer bonds will in effect be treated as
a taxable dividend to the CFCs.
However, the law preserves the ordinary income
treatment under present law of any gain realized by
the beneficial owner from the sale or other disposi-
tion of a registration-required obligation that is not in
registered form. Similarly, the law does not change the
present law rule disallowing deductions for losses re-
alized by a beneficial owner of a registration-required
obligation that is not in a registered form.
Preservation of exception to the registration re-
quirement for excise tax purposes. In addition, the
foreign targeted obligation exception is available
with respect to the excise tax applicable to issuers
of registration-required obligations that are not in
registered form.240 Thus, the exception from the one-
percent excise tax will continue to apply to foreign
targeted bearer bonds. According to the Sullivan and
Cromwell Comments, this “effectively permits most
non-U.S. issuers to issue foreign-targeted bearer
bonds.”241 Thus, the excise tax applies with respect
to any obligation that is not in registered form unless
the obligation:
is issued by a natural person,
matures in one year or less,
is not of a type offered to the public, or
is a “foreign targeted obligation.”
Repeal of treatment of portfolio interest. It should
be noted that the new law repeals the treatment as
portfolio interest of interest paid on bonds that are not
issued in registered form but meet the foreign targeting
requirements of Code Sec. 163(f)(2)(B).242 Under the
provision, interest qualifies as portfolio interest only if
it is paid on an obligation that is issued in registered
form and either (i) the beneficial owner has provided
90
the withholding agent with a statement certifying that
the beneficial owner is not a U.S. person (e.g., on an
appropriate IRS Form W-8); or (ii) the Treasury has de-
termined that such statement is not required in order
to carry out the purposes of the provision.
It is anticipated that the Treasury may exercise its
authority under this rule to waive the requirement of
collecting Forms W-8 or other certification in circum-
stances in which the Secretary has determined there
is a low risk of tax evasion and there are adequate
documentation standards within the country of tax
residency of the beneficial owner of the obligations
in question.243 Generally, however, as a result of the
provision, interest paid to a foreign person on an
obligation that is not issued in registered form is
subject to U.S. withholding tax at a 30-percent rate,
unless the withholding agent can establish that the
beneficial owner of the amount is eligible for an
exemption from withholding other than the portfolio
interest exemption or for a reduced rate of withhold-
ing under an income tax treaty.
Dematerialized book-entry systems treated as regis-
tered form. The new law provides that a debt obligation
held through a dematerialized book entry system or
other book entry system specified by the Secretary
will be treated, for purposes of Code Sec. 163(f), as
held through a book entry system for the purpose of
treating the obligation as in registered form.244 A debt
obligation that is formally in bearer form is treated, for
the purposes of Code Sec. 163(f), as held in a book-
entry system as long as the debt obligation may be
transferred only by book entries and the holder of the
obligation does not have the ability to withdraw the
obligation from the book-entry system and obtain a
physical certificate in bearer form in the ordinary course
of business.245 Thus, this provision codifies the existing
administrative practice246 and will permit the Treasury
to exempt bonds that are legally in bearer form from
U.S. withholding tax if they are issued through the
European and Japanese clearing systems.247
Repeal of exception to requirement that Treasury
obligations be in registered form. The new law in-
cludes a conforming change to Title 31 of the U.S.
Code that repeals the foreign targeted exception to
the definition of a registration-required obligation.
Thus, a foreign targeted obligation of the Treasury
must be in registered form.
Effective date. The provision applies to debt obliga-
tions issued after March 18, 2012 (e.g., the date that
is two years after the date of enactment). In contrast,
under FATCA the bearer bond provision would have

applied to any obligation issued more than 180
days after the date on which FATCA was enacted.
Thus, obligations that are issued before the date of
enactment will not be effected by the new provision.
Similarly, obligations that are is issued by a natural
person, which mature in one year or less, and are of
a type not of a type offered to the public will not be
impacted by this provision.
NYSBA Tax Section Comments. The New York State
Bar Tax Comments on the foreign account tax compli-
ance legislation which was part of the Extender’s Act
raised two issues with respect to the foreign targeted
obligation rules, one relating to the imposition of the
excise tax and the other with respect to effective dates
with the following discussion:248
Under current law, “foreign-targeted obligations”
in bearer form (as determined for U.S. federal
income tax purposes) that comply with certain
requirements with respect to their offer and sale
outside the U.S. are exempt from the TEFRA sanc-
tions on bearer bonds, i.e., (i) denial of interest
deductions to the issuer (ii) an excise tax on the
issuer equal to 1 percent of the obligation’s prin-
cipal amount multiplied by the number of years
to maturity and (iii) denial to the foreign holders
of such obligations the exemption from the 30
percent U.S. withholding tax on interest generally
available for portfolio interest paid on U.S. issued
debt. The [Extenders Act] would repeal this exemp-
tion for “foreign-targeted obligations” in bearer
form (excluding bonds if the rights to principal and
interest payments under the bond are transferred
through a dematerializied book entry system, in
which case the bonds would be treated as regis-
tered bonds under the [Extenders Act].249
In essence, this change in law would require U.S.
issuers to issue bonds worldwide in registered form
to avoid the imposition of a 30 percent withhold-
ing tax on non-U.S. holders. The effect of requiring
U.S. issuers to issue bonds in registered form for
tax purposes is to require the beneficial owners
of the bonds to certify as to their non-U.S. status
(on IRS Form W-8-BEN) or otherwise comply with
the rules designed to establish that status, unless,
under proposes Code Sec. 871(h)(2)(B)(ii)(II), the
Treasury Department affirmatively determines that
such certification is not required. We believe that
the revised legislation gives the necessary authority
to the Treasury Department to exempt this certifica-
Taxes—The Tax Magazine®
September 2010
tion requirement where appropriate and applaud
this grant of additional authority to the Treasury.
In addition, we appreciate that the revised legisla-
tion has significantly restricted the applicability
of the excise tax on bearer bonds so that bearer
bonds issued by non-U.S. issuers are exempted
from the excise tax, so long as (i) there are ar-
rangements reasonably designed to ensure that
the bonds will be sold or resold only to non-U.S.
persons (ii) interest is payable only outside the
U.S., and (iii) there is a legend on the face of the
obligation to the effect that any U.S. person who
holds the obligation will be subject to limitations
under the U.S. income tax laws. However, we
believe that the application of the excise tax is still
over-broad, as the new rule would require foreign
issuers issuing bearer debt to foreign investors to
add a U.S. legend to the bearer obligations, even
where there is no connection to the U.S. markets
or U.S. investors as all. Under the current law, the
legend is not required if the issuance satisfies the
TEFRA C rules.250 Accordingly, we believe that the
exemption from the excise tax should conform
to existing rules. In addition, to the exemption
from the excise tax obligations meeting the three
requirements of the TEFRA D rules described
above, we believe that obligations that conform to
the TEFRA C rules should also be exempt, so that
foreign issuers would be exempted from the ap-
plication of the excise tax if they are issued outside
the U.S., interest is payable only outside the U.S.,
and the issuer is not significantly engaged in U.S.
commerce with respect to the issuance.
We appreciate that the revised legislation has
amended the effective date so that the new rules
will apply to obligations issued after two years
from the date of the enactment of [the Extenders
Act]. However, we would recommend that the
Treasury Department be granted the authority to
phase in the effective date of these provisions as
it deems necessary or appropriate, particularly
with respect to certain select markets where it
may not be feasible to issue registered debt or
collect taxpayer certifications. Significant time will
be required in order for various foreign markets
and clearing systems to develop mechanisms
for handling Forms W-8 processing and for U.S.
companies to adapt their capital raising plans to
accommodate the repeal of the foreign-targeted
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New U.S. Withholding System for Foreign Account Tax Compliance
bearer bond exemption. In addition, issuers will
need considerable time to unwind and/or revise
their debt programs to adapt to the new rules.
Foreign Trust Provisions
Use of Foreign Trust Property
Under Code Sec. 643(i), a loan of cash or market-
able securities made by a foreign trust to any U.S.
grantor, U.S. beneficiary or any other U.S. person
who is related to a U.S. grantor or U.S. beneficiary
generally is treated as a distribution by the foreign
trust to such grantor or beneficiary. This rule applies
for purposes of determining if the foreign trust is a
simple or complex trust or computing the distribution
deduction for the trust or determining the amount of
gross income of the beneficiaries, and computing
any accumulation distribution. Loans to tax exempt
entities are excluded from this rule.251 A trust treated
under this rule as making a distribution is not treated
as a simple trust for the year of the distribution.252
This rule does not apply for purposes of determining
if a trust has a U.S. beneficiary under Code Sec. 679.
A subsequent repayment, satisfaction, or cancella-
tion of a loan treated as a distribution under Code
Sec. 643(i) is disregarded for tax purposes.253 This
Code Sec. applies a broad set of related party rules
that treat a loan of cash or marketable securities to a
spouse, sibling, ancestor, descendant of the grantor
or beneficiary, other trusts in which the grantor or
beneficiary has an interest, and corporations or part-
nerships controlled by the beneficiary or grantor or
by family members of the beneficiary or grantor, as a
distribution to the related grantor or beneficiary.254
The new law expands Code Sec. 643(i) to provide
that any use of trust property by the U.S. grantor or U.S.
beneficiary (or any U.S. person related to such person)
is treated as a distribution equal to the fair market value
of the use of the property effective after March 18, 2010.
Thus, the rent free use of real estate, yacht, art work or
other personal property (wherever located including
the United States) or an interest-free or below-market
loan of cash or uncompensated use of marketable se-
curities will trigger a distribution equal to the FMV for
the use of such property to the extent of distributable
net income or DNI. Presumably, the valuation of such
use may be difficult to determine (e.g., the use value
of art work) and may require independent third-party
appraisals to substantiate this FMV to the IRS.
According to at least one commentator the provision
was targeted at taxpayers who were using the offshore
92
trust vehicle to avoid U.S. taxation on their assets by
putting their U.S. mansions, luxury yachts or art work
into a foreign trust without imposing a charge on the
beneficiaries for the use value or underlying cost of
maintaining such assets (assuming this equates to the
fair market value of the use of such property).
Exception. If the trust is paid the fair market value
for the use of property or the market rate of in-
terest on a loan by the trust, the new provision
will not trigger a deemed distribution to the U.S.
person. The new law does not apply to domestic
trusts. Thus, individual may want to consider
using domestic trusts (or domesticate existing
foreign trusts) or paying the fair market value for
the use of the trust property.
When does a foreign trust have a U.S. beneficiary?
Under the grantor trust rules a U.S. person that directly
or indirectly transfers property to a foreign trust255 is
generally treated as the owner of the portion of the trust
comprising the transferred property for any tax year
in which there is a U.S. beneficiary of any portion of
the trust.256 This treatment generally does not apply to
transfers by reason of death or to transfers of property
to the trust in exchange for at least the fair market value
of the transferred property.257 A trust is treated as having
a U.S. beneficiary for the tax year unless (i) under the
terms of the trust, no part of the income or corpus of
the trust may be paid or accumulated during the tax
year to or for the benefit of a U.S. person; and (ii) if the
trust were terminated at any time during the tax year,
no part of the income or corpus of the trust could be
paid to or for the benefit of a U.S. person.258
Regulations under Code Sec. 679 employ a broad
approach in determining whether a foreign trust is
treated as having a U.S. beneficiary. The determina-
tion of whether the trust has a U.S. beneficiary is
made for each tax year of the transferor. The default
rule under the statute and regulations is that a trust
has a U.S. beneficiary unless during the U.S. transf-
eror’s tax year the trust meets the two requirements
as stated above. Income or corpus may be paid or
accumulated to or for the benefit of a U.S. person if,
directly or indirectly, income may be distributed to
or accumulated for the benefit of a U.S. person or
corpus of the trust may be distributed to or held for
the future benefit of a U.S. person.259
The determination is made without regard to whether
income or corpus is actually distributed, and without
regard to whether a U.S. person’s interest in the trust in-

come or corpus is contingent on a future event. A person
who is not a named beneficiary and is not a member of
a class of beneficiaries will not be taken into account
if the transferor can show that the person’s contingent
interest in the trust is so remote as to be negligible.260
In considering whether a foreign trust has a U.S.
beneficiary under the terms of the trust, the trust in-
strument must be read together with other relevant
factors including (i) all written and oral agreements and
understandings related to the trust, (ii) memoranda or
letters of wishes, (iii) all records that relate to the actual
distribution of income and corpus, and (iv) all other
documents that relate to the trust, whether or not of any
purported legal effect.261 Other factors taken into ac-
count in determining whether a foreign trust is deemed
to have a U.S. beneficiary include whether the terms
of the trust allow the trust to be amended to benefit a
U.S. person, the trust instrument does not allow such
an amendment, but the law applicable to the foreign
trust may require payments or accumulations of income
or corpus to a U.S. person or the parties to the trust
ignore the terms of the trust, or it reasonably expected
that they will do so to benefit a U.S. person.262
If a foreign trust that was not treated as a grantor
trust acquires a U.S. beneficiary and is treated as a
grantor trust under Code Sec. 679 for the tax year, the
transferor is taxable on the undistributed net income263
computed at the end of the preceding tax year.264 Any
additional amount included in the transferor’s gross
income as a result of this provision is subject to the
interest charge rules of Code Sec. 668.265
Under the grantor trust rules, a U.S. person a U.S.
person that directly or indirectly transfers property to
a foreign trust will generally treated as the owner of
the trust for tax purposes, unless (i) under the terms
of the trust, no part of the income or corpus of the
trust may be paid or accumulated for the benefit of
the U.S. person, and (ii) were the trust terminated, no
income or corpus could be paid to the U.S. person. In
determining whether a person is a U.S. beneficiary of
a foreign trust, the IRS will consider any agreement or
understanding whether written, oral or otherwise. The
new law “clarifies” the rules for determining when a
foreign trust has a U.S. beneficiary. For this purpose,
a foreign trust will have a U.S. beneficiary even if:
the U.S. person’s interest in the trust is contingent
on a future event (e.g., a contingent or future
beneficiary); and
the U.S. person has discretionary authority under a
trust agreement, power or other document) to make
a distribution to or for the benefit of a U.S. beneficia-
Taxes—The Tax Magazine®
September 2010
ry unless (i) the terms of the trust specifically identify
the class of persons receiving such distributions, and
(ii) none of those persons are U.S. persons.
Presumption: A Foreign Trust
Has a U.S. Beneficiary
Under the grantor trust rules, a U.S. person that
directly or indirectly transfers property to a foreign
trust266 is generally treated as the owner of the portion
of the trust comprising that property for any tax year
in which there is a U.S. beneficiary of any portion
of the trust.267 This treatment generally does not ap-
ply to transfers by reason of death, or to transfers of
property to the trust in exchange for at least the fair
market value of the transferred property.268
A trust is treated as having a U.S. beneficiary for
the tax year unless, (i) under the terms of the trust,
no part of the income or corpus of the trust may be
paid or accumulated during the tax year to or for
the benefit of a U.S. person, and (ii) were the trust
terminated at any time during the tax year, no part
of the income or corpus of the trust could be paid to
or for the benefit of a U.S. person.269
Code Sec. 6048 imposes various reporting obliga-
tions on foreign trusts and persons creating, making
transfers to, or receiving distributions from such trusts.
Within 90 days after U.S. person transfers property
to a foreign trust the transferor must provide written
notice of the transfer to the Secretary. 270
The new law creates a rebuttable presumption ef-
fective after March 18, 2010, if a U.S. person directly
or indirectly transfers property to a foreign trust, the
Treasury may treat the trust as having a U.S. ben-
eficiary. However, the U.S. person can avoid such
characterization by submitting information (as the
Treasury may require) and demonstrate to the satisfac-
tion of the IRS that (i) under the terms of the trust no
part of the income or corpus of the trust may be paid
or accumulated during the tax year to or for the benefit
of a U.S. person, and (ii) if the trust were terminated
during the tax year, no part of the income or corpus
could be paid to or for the benefit of a U.S. person
Reporting Requirements of
U.S. Owners of Foreign Trusts
Code Sec. 6048 imposes various reporting obligations
on foreign trusts and persons creating, making trans-
fers to or receiving distributions from such trusts. If a
U.S. person is treated as the owner of any portion of
a foreign trust under the grantor trust rules, the U.S.
person is responsible for ensuring that the trust files an
93
New U.S. Withholding System for Foreign Account Tax Compliance
information return for the year and that the trust pro-
vides other information as the Secretary may require
to each U.S. person who (i) is treated as the owner
of any portion of the trust, or (ii) receives (directly or
indirectly) any distribution from the trust.271
In other words, if a U.S. person is treated as the
owner of a foreign trust under the grantor trust provi-
sions, the U.S. person is responsible for ensuring that
the trust files an information return for the year and
that the trust provides other information to the IRS
as the Treasury may require to each U.S. person who
is treated as the owner of any portion of the trust or
receives any distribution from the trust.
The new law requires a U.S. person that is treated
as the owner of a foreign grantor trust to provide
information to the Treasury as it may require with
respect to the trust, in addition to ensuring that the
trust complies with its reporting obligations effective
after March 18, 2010.
Penalty for Failure to Satisfy Reporting
Obligation for Foreign Trusts
Code Sec. 6048 imposes various reporting obliga-
tions on foreign trusts and persons creating, making
transfers to, or receiving distributions from, such
trusts. Generally, a trust is a foreign trust unless a U.S.
court is able to exercise primary supervision over the
trust’s administration and a U.S. trustee has authority
to control all substantial decisions of the trust.272
If a U.S. person creates or transfers property to a
foreign trust, the U.S. person generally must report this
event and certain other information by the due date
for the U.S. person’s tax return, including extensions,
for the tax year in which the creation of the trust or the
transfer occurs.273 Similar rules apply in the case of the
death of a U.S. citizen or resident if the decedent was
treated as the owner of any portion of a foreign trust
under the grantor trust rules or if any portion of a for-
eign trust was included in the decedent’s gross estate.
If a U.S. person directly or indirectly receives a dis-
tribution from a foreign trust, the U.S. person generally
must report the distribution by the due date for the
U.S. person’s tax return, including extensions, for the
tax year during which the distribution is received.274 If
a U.S. person is the owner of any portion of a foreign
grantor trust at any time during the year, the person
is responsible for causing an information return to be
filed for the trust, which must, among other things,
give the name of a U.S. agent for the trust.275
If a notice or return required under the rules just
described is not filed when due or is filed without
94
all required information, the person required to file
is generally subject to a penalty based on the “gross
reportable amount.”276 The gross reportable amount
is (i) the value of the property transferred to the for-
eign trust if the delinquency is failure to file notice of
the creation of or a transfer to a foreign trust, (ii) the
value (on the last day of the year) of the portion of
a grantor trust owned by a U.S. person who fails to
cause an annual return to be filed for the trust, and
(iii) the amount distributed to a distributee who fails
to report distributions.277
The initial penalty is 35 percent of the gross report-
able amount in cases (i) and (iii), and five percent
in case (ii).278 If the return is more than 90 days late,
additional penalties are imposed of $10,000 for every
30 days the delinquency continues, except that the
aggregate of the penalties may not exceed the gross
reportable amount.279
In no event may the penalties imposed with respect
to any failure to report under Code Sec. 6048 exceed
the gross reportable amount.280
If these reporting obligations are not met, the new
law increases the minimum and maximum penalties
with respect to the failure to report on certain foreign
trusts. Under the new law, an initial minimum penalty
of $10,000 or 35 percent of the gross reportable amount
may be imposed for failing to report where the Treasury
has insufficient information to determine the gross re-
portable amount of the property transferred to a foreign
trust under Code Sec. 6048. The additional penalty for
every additional 30 days of delinquency will continue
to apply. The maximum penalty for failure to report may
exceed the gross reportable amount. However, to the
extent the taxpayer provides sufficient information for
the Treasury to determine that the aggregate amount of
the penalties exceeds this amount, the IRS is required
to refund such excess to the taxpayer. A requirement
that a U.S. person ensures that a foreign trustee or other
fiduciary complies with U.S. reporting requirements
for a foreign trust may be unworkable. This provision
is effective to notices and returns required to be filed
after December 31, 2009.
U.S. Withholding Tax and
Information Reporting
Examinations
Introduction
On July 29, 2008, the IRS published Internal Revenue
Manual (IRM) 4.10.21 entitled, “U.S. Withholding

Agent Examinations—Form 1042,” which provides
guidance to IRS agents on how to audit U.S. with-
holding agents reporting of U.S. income payments to
U.S. persons. It remains to be seen if and when the
IRS will update the IRM to address U.S. withholding
audits for the new law. However, the existing guid-
ance by the IRS for FDAP audits should be helpful in
addressing the resource needs and processes which
will be necessary to remain compliant with the new
law and avoid excess exposure.
IRM 4.10.21 covers two types of U.S. withholding
agent audits. The first part of provides general guidance
for audits of U.S. financial institutions, which may have
nonresident alien (NRA) withholding tax and report-
ing requirements in connection with their custodial or
brokerage activities. The second part provides general
guidance for audits of U.S. nonfinancial entities that
may have NRA withholding and reporting respon-
sibilities with respect to their payments to foreign
persons for obtaining services or other entitlements.
The IRM does not discuss the qualified intermediary
or QI external audits required under the QI Agreement
between the QI and the IRS. It was recommended that
the examiner should also view, as an additional refer-
ence, the Industry Directive on Examinations of Forms
1042, dated October 31, 2003, for certain guidance
with regard to U.S. withholding agent audits.281
Form 1099 Backup Withholding Tax vs. NRA With-
hholding Tax. The Form 1099 backup withholding
and NRA Withholding Tax regimes share some basic
similarities. Both systems require the reporting of cer-
tain types of income and the withholding of taxes in
certain cases. Both have an annual income tax return
requirement, which is Form 945282 with respect to
backup withholding and Form 1042283 with respect to
reporting certain U.S. source payments made to foreign
persons and amounts withheld. In addition, both have
informational reporting requirements with respect to
income recipients (Forms 1099 and Forms 1042-S284
for U.S. and foreign recipients, respectively). Apart
from these separate reporting requirements, withhold-
ing and reporting occurs under these regimes based
on different criteria. As a result, despite some general
similarities, a major determination for a withholding
agent is in properly documenting or otherwise clas-
sifying a recipient as either a U.S. or a foreign person.
When a recipient is a U.S. person, NRA withholding
is inapplicable, and Form 1099 reporting and backup
withholding is sometimes required. When a recipient
is foreign person, NRA withholding and reporting is
required with respect to certain income payments and
Taxes—The Tax Magazine®
September 2010
no Form 1099 or backup withholding requirements
are triggered.285
Although this IRM section deals principally with
NRA Withholding, Form 1099 reporting and backup
withholding also needs to be considered as part of
an integrated audit. Auditing Form 1042 information
can result in collateral adjustments to Forms 1099 and
945 when, for example, persons classified as foreign
by a withholding agent need to be reclassified as U.S.
persons subject to backup withholding and Form 1099
reporting. Additionally, deficiencies in a withholding
agent’s Form 1042 related systems may indicate a
generic problem in its tax reporting systems.286
Important items to consider for pre-audit planning.
An audit of Form 1042 may result in an adjustment to
both Form 1042 and Form 945.287 Therefore, when au-
diting Form 1042, the examiner must always determine
the statute of limitations on the audit years for both
Form 1042 and Form 945. If applicable, the examiner
is required to obtain and have executed Form 872 and
Form SS-10 to protect the statute of Form 1042 and
Form 945, respectively.288 It is highly recommended
that the examiner determine whether the taxpayer has
entered into any agreements with the IRS in regard
to their withholding systems, policies, procedures or
other requirements, such as (i) submissions under the
Rev. Proc. 2004-59289 voluntary compliance program
(“the Code Sec. 1441 VCP” ), including any applicable
remediation agreement; (ii) closing agreement; (iii) pre-
filing agreement for the audit year; or (iv) memorandum
of understanding (including one covering an on-line
Form W-8 system). If so, the examiner should obtain a
copy of the memorandum, agreement or submission for
background and to ensure that the taxpayer has satisfied
any of its conditions applicable to the audit year.290
U.S. financial institution withholding tax audit.
Commercial banks and brokerage firms are examples
of financial institutions that act as U.S. withholding
agents. Certain of these institutions act as intermediaries
with respect to their clients’ investments in securities
and deposits. As a result, these institutions may make
investments and receive payments in a fiduciary or
custodial relationship with their clients. For example,
when a foreign person’s account is credited by a
broker-dealer with U.S. source FDAP income that the
broker-dealer has received on the foreign person’s be-
half, the financial institution may have NRA reporting
and withholding responsibilities with respect to the
income. This type of audit will focus on determining
if such amounts paid to account holders have been
properly subjected to NRA withholding and reporting,
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New U.S. Withholding System for Foreign Account Tax Compliance
including whether any payments treated as paid to for-
eign persons should have been instead been subjected
to backup withholding under Code Sec. 3406.291
Functional review of NRA operational procedures &
written procedure and training manuals. The examiner
should perform a functional review of the U.S. with-
holding agent’s NRA withholding tax related operating
procedures.292 The first step is a review of written proce-
dure and training manuals such as the following:
Summaries of withholding tax systems
System flow charts covering payments made to
account holders
Internal control, audit reports or other information
which relate to the withholding tax function
Manuals related to functions that may have
withholding tax implications, including the fol-
lowing:
Payment system design
Account opening procedures
Validation procedures for Form W-8
Procedures for determining or classifying
undocumented accounts
Application of presumption rules
Training manuals for personnel for departments
that control the following functions:
NRA Withholding tax determinations or
implementation
Opening new accounts
Preparing Forms 1042 & 1042-S
Evaluation of the above written procedures (or lack
thereof) may provide the examiner with an indicator
of the overall reliability of the taxpayer’s withholding
tax functions. This assessment may assist in determin-
ing the extent of additional audit procedures, such
as the review of account files statements and with-
holding certificates.293
Review of Forms 1042 and 1042-S—Form 1042.
Reconciliation—The gross income and net tax liability
reported on Form 1042 should agree to the gross
income and taxes withheld as determined by com-
bining these amounts from all Forms 1042-S filed. To
verify this, the examiner should obtain the taxpayer’s
reconciliation workpapers and Forms 1042-S. The
examiner can also request for a computer audit spe-
cialist (CAS) to perform reconciliation in certain cases
of payments contained in computer sensitive files. The
examiner should account for line 66 of Form 1042,
credit for amounts withheld by other withholding
agents, during the reconciliation process.
Deposit Requirements—The tax liability for each ap-
plicable period of the year (normally quarter-monthly,
96
which is the seventh, 15th, 22nd and last day of the
month) is required to be shown in the Record of Fed-
eral Tax Liability section on Form 1042. The examiner
should ensure that the withholding agent did not in-
stead complete this section, in some situations, based
on deposit dates, as this error may prevent identifica-
tion of late deposits. The examiner should otherwise
insure that deposits were made timely by reviewing the
taxpayer’s payments and deposits records. Due dates
for deposits and associated penalties follow:
If the total withholding tax for a calendar year is
less than $200, the tax can be paid when the tax
return (Form 1042) is timely filed.
If at the end of any calendar month the total
amount of withholding tax is more than $200
but less than $2,000, the withholding agent must
deposit the taxes within 15 days after the end of
the month.
If at the end of any quarter-month period the with-
holding tax is $2,000 or more, the withholding
agent must deposit taxes within three banking
days after the end of the quarter-monthly period.
A quarter-monthly period ends on the seventh,
15th, 22nd, and last day of the month.294
Form 1042-S. With the assistance of the CAS, year-
end account statements (or the information included
on them) should be obtained on a sample basis. The
Forms 1042-S for these accounts should be compared
to verify the correctness of such items as (i) gross
income (box 2), (ii) tax withheld (box 7), (iii) income
code (box 1), (iv) tax rate (box 5), (v) exempt code
(box 6), and (vi) recipient code (box 12).295
Account opening and updating procedures. Nor-
mally the status of an account holder, the withholding
rates and other information are entered into the
withholding agent’s systems. Generally, this can be
expected to occur when an account is opened. These
procedures are critical in determining (i) the status of
the account holder as a foreign or U.S. person; (ii) the
type of account holder (i.e., as an individual or entity);
(iii) for foreign persons, the basis of any treaty claims;
and (iv) ultimately the withholding rate, if any.296
New account examination procedures. The exam-
iner should review the procedures for new accounts
using the following criteria: any information, other
than withholding certificates (i.e., Forms W-9 and
W-8), used to determine if the account is held by a
U.S. person or a foreign person, such as (i) residence
and mailing addresses shown on account opening
applications; (ii) documentation submitted by the ac-
count holder for identification purposes (i.e. passports,

driver’s license, articles of incorporation, etc.); and (iii)
account-file information or correspondence. 297
Procedures should be used to determine an account
holder’s status for withholding purposes, including
when the account is not documented with a withhold-
ing certificate or when information provided during
account opening is inconsistent with the information
showing on the certificate. The examiner should fur-
ther determine if the information noted above is used
for withholding purposes in lieu of the presumption
rules for undocumented account holders.298
The information noted in above cannot be used
in lieu of presumption rules for undocumented ac-
count holders. The U.S. withholding agent can rely
on a valid withholding certificate (i.e., Form W-8),
documentary evidence only in the case of off-shore
accounts, or the regulations’ presumption rules to
determine the status of a payee. This information is
relevant, however, because if for a specific account
holder the information contradicts claims on a with-
holding certificate or documentary evidence, such
documents may be unreliable or invalid based on
the applicable standard of knowledge imputed to
the withholding agent.299 See “Requirement to rely on
presumption rules” and “Validation process.”
Review procedures for separation of functions. For
example, an individual who solicits Forms W-8 should
be different from the individual who validates the Forms.
In addition, the individual that validates should be from
a different department than the individual who solicits
the form. In addition, the procedures for recording and
updating information into the withholding and account
systems (i.e., master files) to reflect information received
via Forms W-8 and opening procedures should be
reviewed. The following minimum information should
be captured by the NRA Withholding and accounting
systems from Form W-8: (i) foreign person status, (ii) type
of Form W-8 (BEN, EXP, IMY, or ECI) used to document
the account holder, (iii) type of entity (corporation, trust,
etc.), (iv) treaty claim (Part II of Form W-8BEN) and
limitations or conditions set forth on this form, and (v)
expiration date of Form W-8 (if applicable).300
Due diligence—Standard of knowledge. The ex-
aminer should insure that the withholding agent has
applied the due diligence standards set forth in Reg.
§1.1441-7(b)(1) in its determination of the correct
reporting and withholding to be applied. Under
this regulation, if a withholding agent knows or has
reason to know that a withholding certificate (e.g.,
Form W-8BEN) or documentary evidence provided
by the payee is unreliable or incorrect, the withhold-
Taxes—The Tax Magazine®
September 2010
ing agent must withhold and report at a full rate of
30 percent. If a withholding agent relies on another
agent to obtain documentation, the withholding agent
is generally considered to know, or have reason to
know, facts within the knowledge of its agent. The
account file information is relevant information for
an examiner to make any such determinations.301
Reason to know. Generally, a withholding agent
will be considered to have known a claim of foreign
status or for a treaty-based withholding rate to be
incorrect or unreliable if the statements contained
in the withholding certificate or in other informa-
tion which the withholding agent has, would cause
a reasonable person to question the claims made. A
more specific reason to know standard applies with
respect to payments by financial institutions.302
Actual knowledge. Despite representations made
on an otherwise valid withholding certificate, a with-
holding agent must withhold and report based on
its actual knowledge of facts concerning the recipi-
ent when that knowledge results in a higher rate of
withholding than would have been applied by sole
reliance on the certificate. For example, if a with-
holding agent makes a payment to a U.S. person and
the withholding agent has actual knowledge that the
U.S. person is acting as an agent for a foreign person,
the withholding agent must treat the payment was
made to a foreign payee. (This does not apply when
the U.S. person is a financial institution.)303
Application of presumption rules. If a withholding
agent cannot reliably associate a payment with a valid
withholding certificate (or documentary evidence for
offshore accounts), the withholding agent must follow
the presumption rules contained in Reg. §1.1441-1(b)
(3) to determine the status of the payee for withholding
and reporting purposes, subject to the above knowl-
edge standards. If the withholding agent fails to comply
with the presumption rules, it may be liable for the
correct withholding tax, interest and penalties.304
Classification of entity. The withholding agent must
generally presume that a payee is an individual, a trust,
an estate, a corporation or one of the persons enumer-
ated under Reg. §1.6049-4(c)(1)(ii)(A)(i) through Reg.
§1.6049-4(c)(1)(ii)(Q), or a partnership by following
the rules under Reg. §1.1441-1(b)(3).305
U.S. vs. foreign status. Generally, a payment that
a withholding agent cannot reliably associate with
valid documentation is presumed made to a U.S. per-
son.306 However, the payee will be presumed to be a
foreign person if the payee is an exempt recipient and
there are certain indicia of foreign status.307 Indicia
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New U.S. Withholding System for Foreign Account Tax Compliance
of foreign status is also relevant for determining the
status of a partnership as U.S. or foreign.308
Foreign vs. U.S. status of partnership. If it is pre-
sumed or know that a payee is a partnership, the
withholding agent must determine the classification
of the partnership as foreign or domestic. A partner-
ship is presumed to be foreign when its EIN begins
with “98,” where the payer’s communications with
the partnership are mailed to an address in a foreign
country, or where the payment is made outside the
United States. In all other circumstances, the payer
may presume that the partnership is domestic (in
which event no NRA withholding tax is applicable,
however, backup withholding may be triggered).309
Requirement to rely on presumption rules. A with-
holding agent that withholds at a rate less than that
applicable under the presumption rules or based on
its actual knowledge will be liable for the tax required
to be withheld (or backup withheld) without the ben-
efit of a reduced rate, unless the withholding agent is
able to demonstrate that the proper amount of tax was
paid.310 Even if the withholding agent establishes that
the proper amount of tax was paid by the recipient,
the withholding agent may be subject to penalties.311
However, a withholding agent may not rely on a payee’s
presumed status if it has actual knowledge or reason to
know that the status or characteristics of the payee or
beneficial owner differ from its presumed status and a
greater amount of withholding tax would apply based
on such knowledge.312
Validation. This section provides general guidance for
the review of Forms W-8. It also provides guidance to
determine the corrected withholding tax and/or reporting
requirements if the forms are found to be invalid or un-
reliable. A U.S. withholding agent may generally rely on
a properly completed withholding certificate (i.e., Forms
W-8), as defined in Reg. §1.1441-1(c)(16) to establish
a recipient’s foreign status or a claim of treaty benefit.
Documentary evidence can instead be used with respect
to offshore accounts. The withholding certificate must be
completed with respect to any item on the form that is
relevant to the claim made by the direct account holder
and must not contain claims which are inconsistent
with claims made in any part of the form. The certificate
might also be invalid if it contradicts or is inconsistent
with other information known to the withholding agent.
In this connection, a withholding agent must rely on its
actual knowledge or the reason to know standard in the
regulations when such knowledge results in a higher
withholding tax rate than would have occurred through
reliance on the withholding certificate.313
98
Account review. The following should generally be
requested for each account reviewed: (i) withholding
certificates or documentary evidence (for offshore ac-
counts); (ii) account file information for information
needed to administer and open the account such as,
mailing instructions and addresses, information sup-
porting the account holder’s status as an individual,
corporation, or other entity; (iii) authorization for
certain transactions (i.e., buy or sell stock); and (iv)
other account instructions and correspondence ac-
count application forms and updates.314
Validation process. The U.S. withholding agent can
generally rely on a valid Form W-8 to determine the
correct taxes to be withheld and the correct reporting
of income. If the withholding agent does not have a
valid Form W-8, the withholding agent must generally
use the applicable presumption rules to determine
the attributes of the account holder relevant for pre-
scribing the rate of withholding. If the withholding
agent does not rely on the presumption rules when
required to do so, the withholding agent may be li-
able for taxes under withheld as well as interest and
penalties. It is recommended that the validation of
Form W-8 be performed in three steps:
1. Line by line review to ensure that the form is
complete and consistent on its face. Note that a
failure on any one line item does not necessarily
invalidate the certificate and all claims made
therein. However, the examiner should consider
such failures carefully and shall take special
caution in the case of systemic failures.
2. Comparison of information on the Form W-8
with the information in the account file and/
or account application form. A material con-
tradiction may invalidate the Form W-8. In this
connection, the examiner should review account
file information and new account application
forms and updates for indication of U.S. status
(i.e., U.S. mailing address, or a copy of a U.S.
driver’s license used as identification to open
the account) or information that would indicate
residence in country other than that claimed on
the Form W-8 for an account holder making a
treaty based claim.
3. Check of expiration of Form W-8 to ensure
valid with respect to the applicable payment. It
should also be noted that, in general, an invalid
W-8 cannot be perfected by other supporting
documentation, except for curing address. The
examiner should exercise sound judgment in
applying these guidelines.315

Permanent and mailing address considerations. The
examiner should pay special attention to the address
lines on the withholding certificates and the addresses
otherwise reported by the account holder or shown
in the account files and customer master files.316
A person’s permanent residence address is an address
in the country where the person claims to be a resident
for purposes of that country’s income tax. In the case of
a certificate furnished in order to claim a reduced rate of
withholding under an income tax treaty, the residence
must be determined in the manner prescribed under
the applicable treaty.317 The permanent address on Form
W-8 cannot be a U.S. address. For NRA withholding
purposes, the permanent address cannot be a financial
institution (unless that financial institution is the ben-
eficial owner), in care of address, or any other similar
type which does not indicate a physical location.318 The
examiner should check addresses indicated on records
such as the customer master files, which may include
changes in circumstance (i.e., new U.S. addresses or
addresses outside treaty country) that have not been
considered by the withholding agent for updating its
certification forms.
The withholding agent has reason to know that a
Form W-8 is unreliable or incorrect to establish a
direct account holder’s status as a foreign person if
a U.S. mailing address is listed on this line, subject
to the below cure provision.319
The U.S. withholding agent can rely on a Form W-8
with a defective address line to establish foreign status
or treaty claims if it has obtained additional docu-
mentation from the account holder as prescribed in
Reg. §1.1441-7(b)(5)(i). Examples of such additional
documentation would be: for individuals, a govern-
ment issued document with documentary evidence
such as a non-U.S. photo ID (e.g., passport, driver
license). The document must be valid when submit-
ted to the withholding agent and must be submitted
to the withholding agent within three years of the date
of the payment; and reasonable written explanation
from the account holder supporting foreign status must
be included. For entities, documentation that proves
entity status or, for an account maintained outside the
United States, a tax information statement filed with a
country with which the United States has an income
tax treaty in effect, should be included. These examples
show the documentation that can be accepted:320
Entity documentation
Corporation: Articles of incorporation
Partnership: Partnership agreement
Trust: Trust agreement
Taxes—The Tax Magazine®
September 2010
Form W-8 provided after the date of payment.
The examiner may consider, among other factors,
the following in determining whether a withhold-
ing certificate received after the date of payment (or
other documentation or evidence if it is an offshore
account) should be accepted for purposes of allowing
a reduced withholding rate with respect to payments
to foreign persons:
Whether information and representations on
a later secured withholding certificate (or on
other documentation if it is an offshore account)
provided are consistent with information in the
account file or in other records maintained by the
withholding agent, the examiner should request
and review all account files as a result
Whether the withholding certificate (or other
documentation if it is an offshore account) estab-
lishes facts in existence at the time the relevant
payments were made
Example. The Form W-8 was signed June of 2006
to support foreign status and treaty benefits for a
payment received in January of 2005. The exam-
iner should ask the taxpayer how they confirmed
that residency of the beneficial owner was the
same in January 2005.
In general, the examining agent should consider all
the underlying facts and circumstances when validating
a Form W-8 provided after the date of payment, and
should accept any such documentation only when en-
tirely satisfied with its reliability and veracity. If the proof
consists of showing that the tax was paid by the account
holder, the withholding agent may still be subjected to
interest and penalties under Code Sec. 1463.321
Use of statistical sampling. Validating Forms W-8
will normally require statistical sampling of accounts
because of the number of accounts and volume of
payments made. A referral for CAS assistance should
normally be submitted early in the audit process. The
starting point for sampling of a financial institution’s
NRA payments should be, as noted above, a thorough
analysis of the withholding agent’s systems to ensure,
among other things, that all applicable payments and
payees are incorporated into the withholding and
reporting system. Potential sampling units to consider
in developing a sampling plan include total payments
made to an account holder, total payments made to
an account, reportable amounts per Forms 1042-S
issued by the withholding agent and individual
payments. Regardless of the sampling unit chosen,
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New U.S. Withholding System for Foreign Account Tax Compliance
withholding certificates and account file information
should be reviewed for every account holder receiv-
ing a payment selected for review. In order to reduce
audit time, the CAS may request that the withholding
agent review the sampling plan to provide input to
improve its efficiency or raise other issues.
Input may include, but is not limited to, determining
the sampling unit, sample size and stratum criteria, along
with appropriate statistical and auditing justifications.
The use of statistical sampling as an audit tool by the IRS
does not require the approval of the taxpayer.322
Stratification by factors other than just reportable
amounts should be considered, including (i) lines
of business, (ii) type of W-8 (BEN, EXP, ECI or IMY),
(iii) type of income (dividends, interest, other), (iv)
type of recipient per Form 1042-S recipient code,
(v) withholding tax rates, (vi) type of transaction, and
(vii) recipient’s country of residence for tax purposes
per Form 1042-S.323
Withholding and reporting verification. In de-
termining the correct rate of NRA withholding and
backup withholding for a single payment or group
of similar payments, account documentation, ap-
plicable presumption rules, type of payment being
made, and any applicable tax treaties should first
be taken into account. Once the correct rate of tax
is determined based on these factors, steps should
be taken to ensure the correct rate was applied for
withholding purposes, and that amounts withheld
were accurately reported via Forms 1042-S or Forms
1099, as applicable. In instances where additional
NRA withholding, additional backup withholding,
or assessment of penalties results from the use of a
statistical sample, the results should be extrapolated
to the sample population where appropriate.
To this end, account statements and similar records
that show the type of income earned and tax withhold-
ing should be obtained for each applicable payment
and the associated payees. Account records that show
how the withholding agent has classified payments
along with records that show how those same pay-
ments were classified by the payee of the income to
the withholding agent may also be requested.
Copies of all Forms 1042-S and Forms 1099 filed
by the withholding agent to report all payments
under review should be obtained to ensure proper
reporting, including cases in which the examiner is
not proposing any change to the withholding rate.
All information appearing on Forms 1042-S that
might affect withholding tax (e.g., income codes and
amounts, exemption codes, recipient code, recipient
100
country for tax purposes, amounts repaid to account
holders, etc.) should also be reviewed for accuracy
and completeness, and should be compared to the
documentation reviewed by the examiner.324
Transactions and other items requiring special
treatment by withholding agents. NRA withholding
and reporting for the transactions listed below require
application of special rules. In order for the with-
holding agent to comply with these requirements,
the withholding agent should establish procedures
to identify and to ensure the correct withholding and
reporting for each type of transaction. After identi-
fying their existence, the examiner should ask the
taxpayer for a detailed explanation of the withholding
and reporting procedures for each of these types of
transactions. If the procedures are deficient or incom-
plete, the examiner should expand the examination
to ensure that the transactions were properly reported
and that taxes were properly withheld.325
Real estate investment trust distributions. REIT
distributions to foreign shareholders are subject to
NRA withholding, except when the distribution is
designated as a capital gain dividend, a return of
basis, or a distribution in excess of the shareholder’s
basis in the REIT stock.326 For capital gain dividends, a
35-percent withholding tax applies under Code Sec.
1445.327 As enacted under the American Jobs Creation
Act of 2004, however, capital gain distributions are
not taxed under Code Sec. 1445 for foreign share-
holders owning REIT stock regularly traded on a U.S.
exchange that have not held over five percent of such
class of the REIT’s stock at any time during the year of
the distribution. Such distributions are instead subject
to NRA withholding. The examiner should question
how the withholding agent determines the correct rate
and should spot check several REIT distributions.328
Original issue discount (OID). Generally, no NRA
Withholding applies to the sale of debt obligations,
even though accrued interest or OID is included in
the amount paid by the purchaser to a foreign seller.
The major exception is for sales where the principal
purpose is to avoid tax and the withholding agent
has actual knowledge or has reasons to know of such
purpose. The sale is not reportable on a Form 1042-S
unless NRA withholding was required under this
principal purpose test. Redemptions of obligations
that carry OID are subject to NRA withholding tax.
The amount subject to withholding tax is the amount
accrued to the holder from the date of purchase, as
determined by the withholding agent. If the withhold-
ing agent has not been provided with reliable date of

purchase information or cannot otherwise calculate
the amount of OID to the holder, then the withhold-
ing agent must withhold on the entire amount of OID
accrued since the obligation’s issuance. In determin-
ing the taxable amount of OID, a withholding agent
may rely on information provided in IRS Publication
1212, List of Original Issue Discount Instruments. The
amount of taxable OID (or treated as taxable) is re-
portable on Form 1042-S. Short-term OID obligations
(i.e., with a maturity of 183 days or less from the date
of original issue) are not subject to NRA withholding
tax or reporting on Form 1042-S.329
Securities lending. When a loan of securities is
outstanding during the record date for a dividend
or interest payment, the lender of the securities is,
among other things, typically entitled to a payment
from the borrower to account for the foregone divi-
dend or interest (i.e., since the lender is not the holder
of record on the record date). The payment made by
the borrower of securities is called a “substitute divi-
dend” or “substitute interest,” which may be subject
to NRA withholding tax if paid to foreign persons.
For NRA withholding purposes, a “look-through”
rule applies to define the character and source of the
substitute amount paid in connection with the loan
of any securities. Based on the “look-through” rule, a
substitute interest amount is treated as portfolio interest
if the underlying security generates portfolio interest
in connection with the payment. These rules further
apply to security lending transactions between foreign
counterparties, subject to provisions to mitigate over
withholding that could result from repeated lending of
the same underlying security.330
Transactions and other items requiring special
treatment by withholding agents—One-night depos-
its (sweep accounts). Commercial banks sometimes
offer their larger accounts preferred treatment. One
of these benefits is earning interest on the balance at
the close of the business day. Typically the balances
are combined and used to purchase interest bearing
securities. The next business day the interest earned
is credited to the customers account.331
Repurchase agreements (REPOs). Under U.S. tax
principles, a REPO is typically characterized as a
collateralized loan where the purchaser of the un-
derlying security is deemed to be a lender of funds
to the seller in the amount of the purchase price. The
seller of the security is treated as the borrower. The
loan is for the period until the REPO matures, when
the securities are sold back to the original seller (i.e.,
the cash borrower). Typically, the repurchase price
Taxes—The Tax Magazine®
September 2010
exceeds the original sales price, giving rise to a charge
consisting of financing interest.
If the financing interest is U.S. sourced and paid
to a foreign person, it may be subject to NRA with-
holding. However, see the exception for certain short
term obligations referenced in Reg. §1.1441-2(a). In
addition, an examiner may find substitute payments
(dividend or interest) made by the cash lender to the
borrower as part of the REPO. These substitute pay-
ments are similar to those typically seen in securities
lending transactions, whose sourcing is determined
with respect to the underlying security for withhold-
ing and reporting purposes.332
Syndicated loans. A syndicated loan results when
financial institutions collectively participate in fund-
ing a single loan. Generally, one of the participants
will act as an administrator and distribute the interest
income to the other participants. The administrator
will be the withholding agent. The following issues
should be considered related to syndicated loans:
Bank loan exception. Code Secs. 871(h) and
881(c) generally provide that a non-U.S. person
is exempt from the 30-percent withholding tax
on portfolio interest. There are several limitations
on this exemption such as the “bank loan excep-
tion.” The portfolio exemption does not apply to
any interest received by a bank on the extension
of credit made pursuant to a loan agreement
entered into in the ordinary course of its trade or
business.333 Accordingly, foreign banks, which are
participants in the syndicated loan, should not
benefit from the portfolio exemption.
Change in circumstances events. Often the
participants will change. For example, when the
original participants sell all or a portion of their
interests in the loan to another bank, withholding
related documentation is required from each of
the new participants. An audit concern is to de-
termine if required Forms 1042 and 1042-S were
not filed and/or Forms W-8 were not secured.334
Payments to foreign intermediaries and foreign
flow-through entities. Reportable amounts that with-
holding agents pay to foreign intermediaries or foreign
flow-through entities require specific treatment because
intermediaries and flow-through entities are not ben-
eficial owners of income. Examples of flow-through
entities are foreign partnerships, simple and grantor
trusts, and disregarded entities. Foreign intermediaries
and flow-through entities must provide the U.S. with-
holding agent a Form W-8IMY. This form indicates that
the account holder is not the beneficial owner of the
101
New U.S. Withholding System for Foreign Account Tax Compliance
reportable income. The form also indicates whether
the account holder has entered into an agreement with
the IRS to act as a withholding agent. Foreign financial
institutions can enter into an agreement with the IRS to
act as a qualified intermediary (QI). All foreign interme-
diaries that do not have an agreement with the IRS to
act as QIs are, by default, nonqualified intermediaries
(NQIs).335 Foreign partnerships and simple or grantor
trusts can elect to enter into an agreement with the IRS
become a withholding partnership (WP) or a withhold-
ing trust (WT). A foreign flow-through entity that has
not become a withholding partnership or a withhold-
ing trust is, by default, a nonwithholding partnership
(NWP) or a nonwithholding trust (NWT).336
Withholding and reporting on payments to qualified
intermediary. The QI can elect whether or not to assume
primary withholding responsibilities. The U.S. withhold-
ing agent will be notified about this decision with a valid
Form W-8IMY that the QI furnishes to the withholding
agent. If the QI has assumed primary withholding re-
sponsibilities, the U.S. withholding agent is not required
to withhold NRA taxes with respect to those payments
associated with QI-designated accounts. However, it
is still subject to reporting on these payments. The U.S.
withholding agent will report payment amounts paid to
the QI with respect to such accounts on Form 1042-S
with zero-percent taxes withheld. These Form(s) 1042-S
will be issued to the QI by the U.S. withholding agent.
If the QI has not assumed primary withholding respon-
sibilities, the withholding agent will withhold based on
withholding statements provided by the QI with respect
to QI-designated accounts. The QI is not required to
provide specific client names and client details to the
withholding agent. Instead the QI will provide Form(s)
1042-S that indicate the total dollar amount and amounts
withheld on a “pooled basis,” i.e., amounts subject to
withholding at the 15-percent withholding rate would be
one pool, amounts subject to withholding at the 30-per-
cent withholding rate would be another pool, etc. There
will be a separate Form 1042-S for each pool. Assuming
the QI assumed primary withholding responsibility, the
Forms 1042-S will show taxes withheld. 337
Under the QI contract with the IRS, the QI is re-
quired to designate the accounts that are covered
under the QI contract. For accounts that the QI did
not designate as covered by the QI contract, or for in-
direct account holders of the QI the below described
NQI procedures shall be followed.
Withholding and payments to NQIs. An NQI
should provide to the withholding agent a Form W-8
IMY and the appropriate documentation for each of
102
the beneficial owners that are to receive the income
paid by the withholding agent to the NQI. The NQI
must also provide a withholding statement to the
withholding agent for allocating payments of income
to the beneficial owners and for determining the ap-
plicable withholding rates. If the NQI has provided
all the above information, the U.S. withholding agent
may generally withhold and report based on the in-
formation provided by the NQI. Information reporting
is made by the withholding agent to each beneficial
owner on a separate Form 1042-S rather than under
the pooling approach generally applicable to pay-
ments made by U.S. withholding agents to QIs.
If the NQI does not provide the above information
to the U.S. withholding agent, the U.S. withholding
agent must withhold the maximum NRA withholding
rate (30 percent) on all U.S. sourced FDAP income.
Unallocated payments (i.e., the remaining amounts
after allocation based on the withholding statement
took place) are reported on a separate Form 1042-S
as paid to an unknown account holder, with with-
holding generally determined under the applicable
presumption rule.338
Withholding and reporting for payments to with-
holding partnership/withholding trust (WP/WT).
U.S. withholding agents generally do not withhold
NRA taxes on a foreign partnership or trust that have
provided a valid Form W-8IMY indicating their status
as a withholding partnership or a withholding trust.
Withholding partnerships and trusts must assume
primary withholding responsibilities. The income
paid to the WP or the WT will be reported on Form
1042-S with zero-percent taxes withheld.339
Withholding and reporting for nonwithholding
partnership/nonwithholding trust (NWP/NWT). The
treatment of a nonwithholding partnership (NWP) or a
nonwithholding trust (NWT) is generally similar to the
treatment of a NQI. The NWP or the NWT should pro-
vide the withholding agent with names of all partners/
beneficiaries, together with applicable documentation
of their status and a withholding statement containing
an allocation schedule for each payment of income.
If the NWP or the NWT does not provide the above
information to the U.S. withholding agent, the U.S.
withholding agent must generally withhold in accor-
dance with the applicable presumption rule.340
Portfolio interest, foreign targeted bearer obligations,
registered obligations. Code Secs. 871(h)(1) and 881(c)
(3) generally exempt from NRA withholding interest
payments (including OID) on foreign targeted bearer
obligations and registered obligations.341

Foreign targeted bearer obligations. A bearer
obligation is one that is not in registered form.
The bearer obligation is foreign targeted when it
meets the following three requirements: (i) there
are arrangements to ensure that the obligations
are not sold to U.S. persons; (ii) payment of in-
terest is made outside the United States and its
possessions; and (iii) the face of the obligation
states that any U.S. person who owns the obliga-
tion will be subject to U.S. taxation.342
Registered obligations. An obligation is registered
when it meets the requirements specified in Reg.
§1.871-14(c). Among these requirements is that
the withholding agent obtain a withholding certifi-
cate or documentary evidence that the beneficial
owner of the payment is not a U.S. person. Such
documentation must be provided before expira-
tion of the beneficial owner’s limitation period for
claiming a refund with respect to such interest.343
This documentation requirement does not apply
in cases of foreign targeted registered obligations,
which have separate requirements.344
Exceptions. The following are interest income pay-
ments that do not qualify for the portfolio interest
exemption even when the interest is paid with
respect to a registered or foreign targeted bearer
obligation: (i) interest that is paid to a foreign person
who owns 10 percent or more of the entity paying
the interest, (ii) interest that is paid to a foreign bank
on the extension of credit made pursuant to a loan
agreement entered into in the ordinary course of
the bank’s trade or business, (iii) interest that is paid
to a foreign controlled corporation from a person
related to that foreign controlled corporation, or (iv)
contingent interest paid to a foreign person.345
U.S. financial institution—Consideration of pay-
ments to foreign vendors. Many U.S. financial
institutions are multinational corporations that make
payments to foreign persons in a proprietary capacity.
Therefore the examiner should review their payments
to foreign vendors and other related and unrelated
foreign persons for possible withholding tax and
reporting requirements.346
Suggested initial information document requests
(IDR). The information document requests are pro-
vided as a general guide to the examiner and are
recommended that they be adapted by the examiner
to fit the needs of the audit.
Request 1. The examiner should request copies
of Forms 1042 and Forms 1042-S, along with
supporting documentation.
Taxes—The Tax Magazine®
September 2010
Request 2. The examiner should request infor-
mation relating to policies and procedures of
fiduciary (custodial) accounts. Areas covered
should include account opening, documenta-
tion validation, renewal of Forms W-8, sourcing
and characterization of income. The examiner
should consider requesting operating manuals,
and interviewing relevant personal.
Request 3. The CAS, with the assistance of the
examiner, should attempt to identify all systems
involved in any aspect of processing and tracking
transactions that are potentially subject to NRA
withholding and reporting. Some withholding
agents may use many different systems, so con-
sideration should be given to requesting data flow
diagrams at a system’s level.
Request 4. The CAS, with the assistance of the
examiner, should attempt to identify the systems
along with the specific files or tables to be used as
sources of information needed to identify all pay-
ments potentially subject to NRA reporting and
or withholding. Special consideration should be
given to ensuring all payments requiring special
treatment by the withholding agent are accounted
for through the custodial systems.
Nonfinancial Institutions
Withholding Agent Audits
(Payments of FDAP U.S. Sourced
Income to Foreign Persons)
The audit will focus on companies or other entities
that make payments to foreign persons in their busi-
ness activities in connection with obtaining services
or the use of property or financing. Commonly, the
relationship is one of a payer for services rendered
by foreign persons (vendor payments). Many of these
payments can be expected to have been affected or
recorded by an account payable or similar depart-
ment. When payments made to a foreign vendor
consist of U.S. sourced income, there will generally
be reporting and withholding tax requirements.
There is an additional reporting requirement with
respect to certain U.S. taxpayer’s transactions with
related foreign persons. These transactions will be
reported on Forms 5471 and 5472.347
Introduction. U.S. entities that make payments in
a proprietary capacity to foreign persons for services
or other entitlements may have NRA withholding and
reporting requirements. For example, this may occur
when a U.S. entity makes a payment to a foreign ven-
103
New U.S. Withholding System for Foreign Account Tax Compliance
dor in exchange for U.S. sourced services. Another fact
pattern illustrating these responsibilities is as follows.
A large multinational pharmaceutical company pays
royalties to a foreign company for drugs it sold within
the United States. The royalty payments would typi-
cally constitute U.S. source FDAP income to a foreign
company. Therefore, the income would be subject to
NRA reporting (Forms 1042 and Form 1042-S), and
a NRA withholding tax of 30 percent absent a valid
treaty or ECI related claim. In addition to payments to
foreign vendors of U.S. source FDAP income, there are
other payments that may generate NRA withholding
and reporting (i.e., dividend payments). The exam-
iner should examine all material payments to foreign
persons as possible U.S. sourced FDAP income pay-
ments. The below sections provide a three-step audit
procedure to determine payments that may generate
NRA withholding and reporting responsibilities.348
Payments to foreign vendors—Three-step audit
procedure. The examiner can use these procedures
to test if payments made by the accounts payable
department and other departments making payments
to foreign persons require NRA reporting and with-
holding. The majority of these payments will be made
to foreign vendors by the accounts payable depart-
ment. Therefore, the examiner should obtain from the
taxpayer the following: (i) the account payable file
and similar files that contains all vendor payments,
and (ii) the vendor record (file containing all vendor
names and vendor information).
In order to determine those payments that are sub-
ject to NRA reporting and withholding tax, steps one
and two require analysis of the taxpayer’s accounts
payable file and vendor file. It is recommended that
a Computer Audit Specialist (CAS) be requested to
assist in each of these three steps: (i) determining
all foreign vendors, (ii) determining all payments of
FDAP income to them, and (ii) determine any such
FDAP Income (from step two) that is U.S. sourced
and the applicable withholding rate, if any.
Line-by-line review of a withholding certificate
(i.e. Form W-8) is necessary to ensure that the form is
complete and consistent on its face. Note that a failure
on any one line item does not necessarily invalidate
the certificate and all claims made therein. However,
the examiner should consider such failures carefully
and shall take special caution in the case of systemic
failures. It should also be noted that, in general, an
invalid Form W-8 cannot be perfected by other sup-
porting documentation. The examiner should exercise
sound judgment in applying these guidelines.349
104
Determine all foreign vendors (step 1). This first
step requires the analysis of the vendor file to identify
vendors that may be foreign persons. The vendor file
is a listing of all vendors, including names and other
pertinent information relating to the vendor. All vendors
who meet one or more of the following criteria should
be considered to be a possible foreign vendor: (i) ven-
dor’s EIN starting with 98-xxxxxxx; (ii) vendor’s ITIN
starting with 9xx-7/8x-xxxx; (iii) address fields: country:
not U.S. or blank, zip code: not U.S. format, state: not
a U.S. state or blank, City: foreign city; (iv) vendor
number, if coded for foreign vendors; and (v) any other
factors which indicate possible foreign status.
The above are recommended indicators to determine
that the vendor may be foreign. The examiner should
review the vendor file to set any other criteria that
may be used for the particular taxpayer. Some of the
vendors selected may be U.S. vendors. Therefore, it is
recommended that this list of possible foreign vendors
should be presented to the taxpayer for their review. If
the taxpayer can establish that the vendor is not foreign,
the name should be removed from further review.350
Determine all payments of FDAP income to foreign
vendors (step 2). In step two, payments to foreign ven-
dors are ascertained. Not all payments to the foreign
vendors selected in step one would be FDAP income.
The examiner should decide which payment would
most likely result in FDAP income to the vendor. Some
of the most common expenses paid by the taxpayer
that may result in FDAP income payments to the ven-
dors are (i) interest; (ii) royalties, patents, copyrights
(intellectual assets); (iii) royalties—natural resources
(timber, oil, coal); (iv) personal service fees, wages;
(v) annuities and pensions; and (vi) rents. The above
is not an all-inclusive list of possible expenses, which
may result in FDAP income payments to the foreign
person. The examiner should consider the facts and
circumstances of each taxpayer in determining all
possible payments which may result in FDAP income
to the foreign person.
It is recommended that the examiner should first
test the accuracy of how expenses are categorized
by the taxpayer before step two is performed. Often
expenses are not accurately categorized by the tax-
payer. For example, some portion of a large contract
for computer hardware might pertain to training
and maintenance functions. That portion would be
personal service fees, which would be FDAP income
if performed within the United States but the entire
payment may have been incorrectly treated as com-
puter hardware expense by the taxpayer.

Once the examiner has determined the validity
of the categorization, the step two’s analysis can be
performed. The examiner should at least review ma-
terial payments that may be FDAP even though the
taxpayer did not correctly categorize them as such.
The examiner should compile all payments of the
selected expenses paid to the foreign vendors.351
Determine foreign vendors’ FDAP Income that
was U.S. sourced (step 3). At this point the examiner
has determined payments to foreign vendors which
are FDAP income. The source of the income (U.S.
sourced versus foreign sourced) should now be de-
termined. Reg. §1.1441-2(a) requires that the income
payments be presumed U.S. source when the source is
not known to the payer. Therefore, any FDAP income
determined in step 2 that the source is unknown to
the payer is presumed to be U.S. sourced and subject
to a 30-percent withholding tax. The taxpayer has the
burden of proof to overcome the presumption. 352
Notional Principal Contracts.
Industry Directive on Total Return
Swaps (TRS) Used to Avoid
Dividend Withholding Tax
As noted above, on July 29, 2008, the IRS added to
the IRM §4.10.21.8 as guidance for examining agents
to use to determine whether a financial institution
has complied with its withholding and reporting ob-
ligations under Code Sec. 1441. See “U.S. Financial
Institution Withholding Tax Audit.”
Notional principal contracts (NPC). More spe-
cifically, examining agents were directed to IRM
§4.10.21.8.7.6 when auditing notional principle
contracts which provided the following far-from-
clear advice:
There is no NRA withholding obligation on pay-
ments made under NPCs to foreign persons.353 If,
however, these payments are ECI as to the foreign
person, or are presumed so under the regulations,
income reporting is required on Form 1042-S.354
The ECI presumption may be rebutted by a with-
holding certificate representing that the payments
are not effectively connected with the conduct of
a U.S. trade or business. Instead of a withholding
tax certificate, a payee may represent in a master
agreement governing the transactions in NPCs
between the parties that the counterparty is a U.S.
person or a non-U.S. branch of a foreign person.
Income on NPC’s that are regarded as embedded
Taxes—The Tax Magazine®
September 2010
interest or recharacterized as certain other pay-
ments under U.S. tax principles might be subject
to NRA withholding and reporting.355
LMSB issues industry directive on total return
swaps. On January 14, 2010, the LMSB issued an
industry directive entitled, “Industry Directive on
Total Return Swaps (TRSs) Used to Avoid Dividend
Withholding Tax”356 regarding the examination of
U.S. financial institutions. For this purpose, a “U.S.
financial institution” is defined as a “domestic orga-
nization that provides financial services and financial
products” and U.S. branches of foreign banks.
At least one commentator has suggested the IRS
intends to assert deficiencies against the financial insti-
tutions who presumably have the deep pocket and not
directly against the non-U.S. persons on the basis that
the equity swaps constituted disguised agency relations
more akin to a broker-dealer relationship. In such case,
Table 2.
Sourcing Determinative factors (as may be modi-
Rules Type fied or excluded by an applicable treaty)
of Income
Personal Generally where services are performed,
Services subject to potential allocation under
Reg. §1.861-4 and to a limited exclusion
based on temporary U.S. presence. Even
for U.S. source income, withholding
under Code Sec. 1441 is not required to
the extent the compensation is subject to
withholding as wages.
Dividends Generally depends on whether paying
corporation is domestic or foreign.
Interest Generally depends on whether payor is
domestic or foreign (where Incorporated).
Interest paid by a U.S. branch of a foreign
corporation is U.S. source income. Code
Sec. 884(f)(1)(A). For original issue dis-
count, see Code Sec. 871(g)(3).
Rent Where the property is located
Royalties, Where the property is used (benefits
Patents and derived)
Copyrights
Royalties-
Natural Where the property is located
Resources
Pensions Generally depends on where the related
services were performed, though earnings
on a U.S. plan are U.S. source income.
For allocating between employer contri-
butions and earnings for defined-benefit
pension plans, See Rev. Proc. 2004-37.
Also reference the income exclusion pro-
vided under Code Sec. 871(h) for certain
payments from qualified annuity plans
under Code Sec. 403(a)(1).
105
New U.S. Withholding System for Foreign Account Tax Compliance
the financial institutions would have the duty to with-
hold as the withholding agent.357 The IRS refers to these
guidelines as industry director directive or “IDD”).
Purpose of TRS guidelines. This industry director
directive (IDD) is intended to provide the field with
guidance and information document requests (IDR) for
uncovering and developing cases related to TRS trans-
actions that may have been executed in order to avoid
tax with respect to U.S. source dividend income paid to
non-resident alien individuals, foreign partnerships and
foreign corporations (each, a “foreign person”). Such
dividend withholding tax avoidance transactions have
recently been identified as part of a new Tier I issue,
U.S. Withholding Agents—Reporting and Withholding
on U.S. Source FDAP Income. Some taxpayers and
withholding agents contend that the payments made
pursuant to certain transactions are foreign source pur-
suant to Reg. §1.863-7 and therefore are not subject to
U.S. withholding tax and Form 1042-S reporting.
The intent of this IDD is to provide guidance on
developing facts for determining when a transaction
that is in form a TRS will be respected in substance
as a notional principal contract, and when such a
swap will be recharacterized in accordance with
its substance as an agency agreement, repurchase
agreement, lending transaction, or some other form
of economic benefit by the Foreign Person.  In such examinations, the field is instructed to use one
The purpose of this IDD is to provide guidance for
teams examining the withholding tax obligations of
U.S. financial institutions (including U.S. branches of
foreign banks) that engaged in TRS transactions with
foreign persons. Agents examining the income tax
liabilities of such foreign persons under Code Secs.
871 and 881, as well as the withholding liabilities,
may use this IDD as a resource in the development
of those cases.
One commentator358 as summarized the IDD as
follows:
The IDD principally focuses on transactions in
which a foreign investor terminates its investment
in a U.S. dividend-paying stock which retaining
identical economic exposure to the stock through
the TRS. Subsequently, the TRS is terminated and
the foreign investor reacquires the physical posi-
tion in the same stock. In the interim, a dividend is
paid on the stock and the foreign investor receives
a dividend equivalent under the TRS that is not
subject to withholding tax, assuming the form of
the transaction is respected. However, the Direc-
tive also addresses situations in which the foreign
106
investor never makes a physical investment in the
equity or equities underlying the TRS.
Examination guidance. This IDD describes four
factual situations, each of which presents a varia-
tion of a typical TRS transaction. After describing the
basic facts of each situation, this IDD instructs the
field how to proceed with an examination of each
situation. In situations in which this IDD recom-
mends that the field pursues an examination, the
field should develop facts showing that the form
of the TRS should be disregarded for U.S. federal
income tax purposes or recast as “an agency agree-
ment, repurchase agreement, lending transaction or
some other form of economic benefit” by the foreign
investor. In these situations, the field is directed to
develop facts supporting a legal conclusion that the
Foreign Person retained ownership of the reference
securities for U.S. federal income tax purposes even
though the foreign person may have transferred the
legal title to such securities. 
The four factual situations described in this IDD
are representative examples of common variations of
TRS transactions. The field should note that particular
transactions under examination may not fit exactly
within any one of the four situations discussed below.
or more of four situations and recommendations de-
scribed in this IDD to tailor its examination of the facts
and circumstances of a specific transaction. Thus, one
total return swap informal document request (TRS IDR)
template is provided for each of the situations.359
The four situations are (1) cross-in/cross-out with the
same parties executing both the TRS and purchase/
sale of the underlying equity; (2) cross-in/inter-dealer
broker out involving a third party inter-dealer broker as
an intermediary to effectuate a cross-out; (3) cross-in/
foreign affiliate out involving an affiliate of the dealer-
counterparty to effectuate the cross-out; and (4) a
foreign investor who never owns the equity or equities
underlying the TRS. The IDD provides templates or
pro forma information document requests or IDRs for
the first three situations which the examining agent is
directed to use to obtain information regarding TRSs
from taxpayers during the audit.
According to at least one commentator:360
The Directive also discusses the types of facts
that indicate that the form of a TRS should not be
respected. For example, the Directive discusses
the use of “MOC” (market on close) and “MOO”

(market on open) pricing for both the termination
payment under the TRS and the foreign investor’s
reacquisition of the underlying equity from the TRS
counterparty. The IRS views this risk elimination
strategy as the equivalent of a cross-out because
the buyer and seller in these markets ‘know that
their respective sales price and purchase price will
be exactly the same.’ The Directive also indicates
that the IRS views the use of an inter-dealer bro-
ker as “prima facie” evidence of a cross-out and
that it maintains a list of such brokers that have
participated in these transactions.
Situation 1 (cross-in/cross-out). A foreign person
owns an equity security issued by a publicly traded
U.S. corporation (a “U.S. equity security”).361 The
U.S. corporation pays regular and/or extraordinary
dividends with respect to the U.S. equity securities.
The field needs to determine whether these payments
by the U.S. financial institution to the foreign person
give rise to a tax liability of the foreign person under
Code Secs. 871 or 881 and whether the U.S. financial
institution or the foreign person has a withholding
obligation under Code Secs. 1441, 1442 and 1461.
The foreign person sells its U.S. equity security to a
U.S. financial institution acting as a broker-dealer.  Expiration Procedures. The MOC orders eliminate risk
Simultaneously, the foreign person enters into a TRS
with the same U.S. financial institution as the swap
counterparty. The TRS references the same U.S. equity
securities sold to the U.S. financial institution by the
foreign person and the notional amount of the TRS
equals the fair market value of the U.S. equity securi-
ties sold to the U.S. financial institution. Pursuant to
the terms of the TRS, the foreign person is required to
make payments to the U.S. financial institution based
on an interest component (such as a LIBOR-based pay-
ment) and any depreciation with respect to the notional
investment in the U.S. equity securities (an “equity
equivalent position”). The U.S. financial institution is
required to make payments to the foreign person in an
amount equal to any appreciation with respect to the
notional investment in the U.S. equity securities and
any dividend paid with respect to the U.S. equity securi-
ties (a “synthetic issuer position”). Payment obligations
with respect to the equity equivalent and synthetic is-
suer positions may be netted against each other.
The simultaneous sale of U.S. equity securities and
acquisition of an equity equivalent position pursuant to
a TRS is referred to below as a “cross-in.” The foreign
person holds the equity equivalent position in the swap
over the record date or dates.362 After the record date
Taxes—The Tax Magazine®
September 2010
or dates, the foreign person terminates the swap and
at the same time repurchases the U.S. equity securities
from the U.S. financial institution (also described be-
low as a “cross-out”). The fair market value of the U.S.
equity securities on the cross-in, and the repurchase
price on the cross-out, are likely to be determined
in such a manner that insures the foreign person has
no pricing risk on the cross-in and the cross-out, but
retains the overall ownership risk in the U.S. equity
securities. To determine the notional principal amount
of the TRS and the appreciation or depreciation with
respect to the U.S. equity security referenced by the
TRS, the documents may reference the same pricing
mechanism (e.g., market on close (MOC)) or may
require the use of a single interdealer broker, or the
circumstances may show that the parties are likely to
be in the market together upon a cross, particularly
where the volume is typically low and the number of
market participants is limited based upon a pattern of
dealing or other relevant facts.
The meaning of an MOC buy order or MOC sell
order should be determined by reference to the rules
of the relevant exchange on which the securities are
traded. For example, see the New York Stock Exchange
Rule 123C Relating to Market-on-Close Policy and
because the buyer and seller know that their respective
sales price and purchase price will be exactly the same.
Usually, MOC orders are guaranteed to be executed if
placed before a certain time for at least one exchange
and virtually certain of occurring for other exchanges.
Because MOC orders eliminate pricing risk, the use of
MOC to calculate the termination payment under the
TRS and to determine the purchase price of the U.S.
equity security reacquired by the foreign person is
equivalent to a “cross-out.” In addition to MOC, U.S.
financial institutions and foreign persons may have
used other strategies that eliminate price risk by using
the same price calculation method to determination
the final settlement of the swap and to determine the
purchase price of the stock sold in the cross-out. These
price calculation methods may be based on objective
benchmarks such as VWAP (Volume Weighted Average
Price) or MOO (Market on Open), which uses the first
price of the trade day.
Past examinations suggest that for the periods current-
ly under exam, relatively few TRS transactions involving
potential U.S. dividend withholding tax avoidance will
have been structured precisely as described above.
Nonetheless, audit teams should continue to pursue
examinations of these types of transactions. To facilitate
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New U.S. Withholding System for Foreign Account Tax Compliance
such investigations, the field is directed to issue Total
Return Swap Fact Pattern One Information Document
Request (“TRS IDR #1”) to help identify these abusive
transactions in an efficient manner.  existence of an arrangement on a case-by-case basis,
TRS IDR #1 will help audit teams identify those
transactions where the foreign person maintained
control over the equity securities that creates an
agency relationship between the Foreign Person
and the U.S. financial institution, where the foreign
person maintained elements of beneficial ownership
resembling a sale and repurchase agreement363 or
other similar arrangement, or where the transaction
may be treated in substance as a securities lending
transaction, loan, or other similar arrangement. TRS
IDR #1 attempts to collect all relevant facts, whether
obvious or not, such as:  securities. The foreign person has not divested its
whether any agreement or some other under-
standing or arrangement, written or not, (an
“Arrangement”) under which the U.S. financial
institution would return the stock to the foreign
person at the termination of the swap; and
whether the foreign person and the U.S. finan-
cial institution used a pricing mechanism that
eliminated the pricing risk with respect to the
U.S. equity security.  are directed to use TRS IDR #1, any other IDR
The field may also wish to consider the following
factors indicating that the foreign person remained the
beneficial owner of the U.S. equity securities during
the term of the TRS:
Voting rights maintained by foreign person—
Whether the foreign person maintained voting
rights in some fashion
Voting rights held by financial institution but
controlled by foreign person—Whether the U.S.
financial institution cast any votes with respect
to the U.S. equity securities held as a hedge of its
position under the TRS and whether such votes
were independent of the foreign person’s instruc-
tions or control
U.S. financial institution agreed to hedge its
position in a particular manner—Whether con-
tractual provisions or other formal or informal
arrangements, expressly written or not, existed
that required the U.S. financial institution coun-
terparty to hedge its position under the swap in
a particular manner (i.e., by holding the physical
underlying reference security)
Cost of hedge borne by foreign person—Whether
contractual provisions or other formal or informal
arrangements existed, expressly written or not,
that required the foreign person to bear the U.S.
108
financial institution’s cost of hedging its synthetic
issuer position
The examining agent is directed to determine the
with the assistance of counsel, depending on the facts
and circumstances. No one single fact or fact pattern
is considered a controlling fact or fact pattern, and
different facts will exist in different cases. The field
agents are also directed to gather all of the available
facts and then develop a conclusion with counsel.
Notwithstanding these factors and the specific in-
formation requested pursuant to the TRS IDR #1, the
field is directed to consider any other facts, including
the following:
Foreign person did not convey ownership in the
beneficial ownership interest in the U.S. equity
securities.
Form over substance. The form of a TRS does not
match the substance of the transaction.
Financial institution acted as agent of foreign
person. The U.S. financial institution acted as an
agent for the foreign person by holding the U.S.
equity securities.  In addition, the field agents
described herein, and interviews to examine trans-
actions that resemble the facts outlined in Situation
1 even when the transaction under examination
does not include every fact mentioned above.
The Greenberg & Traurig Tax Alert had the follow-
ing comments regarding the IRS characterization of
Situation#1:364
Many seasoned tax professionals would have
concerns that the substance of a transaction
structured in this manner would be taxed as
a disguised agency relationship. Although the
Swap Audit Guidelines are not entirely clear,
it appears that the IRS is also concerned about
equity swaps that do not entail actual cross-ins
and cross-outs but in which ostensible market
transactions contain mechanisms that result in
cross-ins and cross-outs.
For example, suppose the non-U.S. person
executes a market sale of the stock at the incep-
tion of the swap. At the same time, the financial
institution is in the market purchasing stock
to hold as a hedge of its obligations under the
swap. Notwithstanding the simultaneity of the
purchase and sale, if volume in the stock is robust

in comparison to the number of shares that are
referenced in the swap, it would be coincidence,
at best, if the non-U.S. person sold to the financial
institution (or vice versa at swap termination).
The Swap Audit Guidelines state that swap pricing
mechanisms that assist the parties in avoiding price
risk between the holding of the stock and the swap
can be viewed as evidence that “the parties are like-
ly to be in the market together upon a cross.” These
pricing mechanisms include referencing a single
interdealer broker price, market on close (MOC),
market on open (MOO) and volume weighted
average price (VWAP). This mandate is clearly a
case of “no good deed goes unpunished.” The IRS
rationale is that each of the pricing mechanisms,
if available for the stock purchase or sale, would
enable the parties to have certainty as to their
purchase and/or sale prices of the stock. Indeed,
the IDR for these transactions asks for the identity
of transactions in which the swap reference price
“and the prices at which the U.S, equity security
was sold or purchased in the cross-in or cross-out
are the same prices or are based on the same prices,
such as MOC or VWAP.” Accordingly, in the view
of the IRS, if the equity swaps references these
prices, there would not be any slippage in moving
between the stock and the swap.
It is interesting to note that many financial institu-
tions began using MOC, MOO and VWAP for swap
initiation and termination pricing for the specific
purpose of ensuring that there was economic risk
inherent for their swap counterparties in moving
from a physical stock position to a swap. Without
these mechanisms, the non-U.S. person could
simply have asked for swap pricing equal to the
price at which it sold the stock and the financial
institution would price the stock at swap termina-
tion at the price at which it disposed of its hedge.
The IDR to be provided to financial institutions
seeking to find cross-in/cross-out transactions asks
whether pricing mechanisms that eliminated price
risk were in place with respect to the equity swap.
Prior the promulgation of the Swap Audit Guide-
lines, the author’s own view was that the use of
MOC, MOO and VWAP swap pricing would not
have mandated a “yes” answer to this question.365
It is much more difficult to obtain a particular price
than it is to reference the price at which the parties
actually executed purchases and sales.
Taxes—The Tax Magazine®
September 2010
In addition to pricing, the IDR included in the
Swap Audit Guidelines asks about other factors
that could indicate an agency relationship. Spe-
cifically, it asks:
whether there was a written or oral agreement
for the financial institution to return stock to the
non-U.S. person at the swap termination,
whether the non-U.S. person had the right to
direct voting of any stock held by the financial
institution as a hedge of the swap,
if the financial institution did vote any shares
of stock held as a hedge of the swap, were
such votes independent of the counterparty’s
instructions, and
whether there a written or oral agreement by
the financial institution to hedge the swap in
a particular way.
Again, interestingly, the Swap Audit Guidelines
ask whether there was a written or oral agreement
for the counterparty to bear the cost of any hedg-
ing by the financial institution under the swap.
The answer here should always be, “Only if the
trader was doing his job correctly.” This question
misinterprets the role of financial institutions in
the swaps markets. Financial institutions do not
generally enter the swaps markets for the purpose
of taking any risk other than counterparty risk. The
institutions have a unique ability to execute and
hedge risks. If the costs of hedging increase, this
is a cost that is usually borne by the client, not
the financial institution. Accordingly, if a financial
institution is acting a dealer, it will price hedg-
ing into the swap and retain the ability to either
terminate the swap if hedging costs increase or
to pass along such costs to its clients.”
Situation 2 (cross-in/IDB out). The facts of Situa-
tion 2 are the same as Situation 1 except that when
the foreign person terminates the swap and crosses
out, the foreign person reacquires the U.S. equity
securities from a third-party who is not an affiliate of
the U.S. financial institution (an “Unaffiliated Third-
Party”) rather than from the U.S. financial institution
that was a counterparty to the swap.
In examining a transaction that resembles Situation
2, the field is directed to develop facts showing the
existence of an arrangement involving the foreign
person and the U.S. financial institution, the unaffili-
ated third party or both, with respect to the foreign
109
New U.S. Withholding System for Foreign Account Tax Compliance
person’s repurchase of the U.S. equity securities.
When the examination identifies a transaction where
the parties entered into such an arrangement, the field
is directed to complete the examination in the same
manner as described in Situation 1. If the field, after
examination, does not find such an arrangement, the
examination should be concluded.  the following:
In one variation of these transactions the U.S. fi-
nancial institution or the foreign person engages an
inter-dealer broker (an “IDB”) to act as an intermedi-
ary to facilitate the cross-out to the foreign person. At
the conclusion of the transaction, the U.S. financial
institution will sell the U.S. equity securities to an
IDB and the IDB will sell the U.S. equity securities
to the foreign person. The IDB usually receives some
type of small fee or spread for its participation, but
the economic impact of an IDB is the same as cross
trades that eliminate the pricing risk (the amount due
under the TRS will be exactly equal to the amounts
due from sale of the U.S. equity securities) for both
the foreign person and the U.S. financial institution.
The use of an IDB may provide prima facia evidence
of an arrangement because IDBs are in the business
of standing between two parties to a transaction.
Further, the use of an IDB may show a pattern of
dealing or course of conduct indicating that a U.S.
financial institution has used a third party to facilitate
the cross-outs with respect to other TRSs.
In developing the facts in the examination, the
audit teams should issue Total Return Swap Fact Pat-
tern Two IDR (“TRS IDR #2”), which seeks to target
information indicating that an Arrangement existed
whereby the U.S. financial institution coordinates
the foreign person’s reacquisition of the U.S. equity
securities through the unaffiliated third party.
TRS IDR #2 attempts to collect all relevant facts,
whether obvious or not, such as the following:
Small commission—Whether the U.S. financial
institution received an unusually small commis-
sion in connection with any trades
Lack of fees to unaffiliated third parties—Whether
the U.S. financial institution paid or received any
fees to the unaffiliated third party
Presence of repurchase agreement for securities—
Whether the foreign person and the U.S. financial
institution entered into any formal or informal
agreements, understandings, side letters, contracts,
or otherwise formulated an arrangement, written
or not, with respect to the foreign person reacquir-
ing the U.S. equity security upon the termination
of a TRS. If such an arrangement is demonstrated
110
through responses to TRS IDR #2 or interviews,
the audit team is directed to proceed with the
examination as directed under Situation 1.
Notwithstanding these factors and the specific in-
formation requested pursuant to the TRS IDR #2, the
field is directed to consider any other facts, including
No conveyance of underlying securities. The
foreign person has not divested its beneficial
ownership interest in the U.S. equity securities.
Form over substance. The form of a TRS does
not match the substance of the transaction. U.S.
financial institution is agent. The U.S. financial
institution acted as an agent for the foreign person
by holding the U.S. equity securities.
Agreement to repurchase securities by foreign
person. The foreign person, the U.S. financial in-
stitution and/or the unaffiliated third party had an
arrangement with respect to the reacquisition of
the U.S. equity securities by the foreign person. In
addition, the field is directed to use TRS IDR #2,
any other IDR described herein, and interviews
to examine transactions that resemble the facts
outlined in Situation 2 even when the transaction
under examination does not include every fact
mentioned above.
The Greenberg Traurig Tax Alert had the following
comment concerning Situation 2:366
The most important acknowledgement by the IRS
in its discussion of cross-in/IDB out equity swaps
is the direction that if an agent does not find an
arrangement in which the IDB was acting as the
proverbial “fig leaf” over the cross-out, “the ex-
amination should be concluded.” In other words,
this statement is an acknowledgement by the IRS
that a one-way cross, without more, should not be
viewed as a disguised agency relationship. This
implicit determination comports with the posi-
tion being advocated by most in-house financial
institution tax departments that in the absence of
a transfer and return of stock, no agency relation-
ship should be considered to exist.”
Situation 3 (cross-in/foreign affiliate out). The
facts of Situation 3 are the same as Situation 1 ex-
cept that the Foreign Person enters into a TRS with
a foreign affiliate of the U.S. financial institution
(“Foreign Affiliate”) as the swap counterparty. To
eliminate or substantially reduce its risk with respect
to its position under the TRS, the Foreign Affiliate

enters into a mirror swap with the U.S. financial
institution. Finally, when the foreign person termi-
nates the swap, the foreign person repurchases the
U.S. equity securities from the Foreign Affiliate or
the U.S. financial institution.
With respect to the facts discussed in Situation
3, the field is directed to follow Total Return Swap
Fact Pattern Three IDR (“TRS IDR #3”) to develop
facts related to these transactions in a manner that is
consistent with the guidance provided in Situation
1. Specifically, the field is instructed to develop facts
with respect to both the TRS entered in by (i) U.S.
financial institution and the Foreign Affiliate, and (ii)
the Foreign Affiliate and the foreign person.
Notwithstanding these factors and the specific in-
formation requested pursuant to the TRS IDR #3, the
field is directed to consider any other facts, including
the following:
No divestiture of securities by foreign person.
The foreign person has not divested its beneficial
ownership interest in the U.S. equity securities.
Form over substance. The form of a TRS does not
match the substance of the transaction.
U.S. financial institution is agent. U.S. financial
institution acted as an agent for the foreign person
by holding the U.S. equity securities.  sembling Situation 4 when certain facts indicate that
Reg. §1.1441-7(a)(1) defines a “withholding agent”
as “any person, U.S. or foreign, that has control,
receipt, custody, disposal, or payment of an item of
income of a foreign person subject to withholding ...
.” Both the U.S. financial institution and the Foreign
Affiliate may satisfy the definition of a withholding
agent with respect to the dividend payments. In ad-
dition to examining the U.S. financial institution, the
field may wish to consult the withholding on foreign
payments technical advisor for guidance with respect
to the examination of the Foreign Affiliate and the
foreign person.
In addition, the field is directed to use TRS IDR #3,
any other IDR described herein, and interviews to
examine transactions that resemble the facts outlined
in Situation 3 even when the transaction under exami-
nation does not include every fact mentioned above.
For example, in other variations of this Situation 3,
the foreign person repurchases the U.S. equity securi-
ties from the U.S. financial institution, another party
related to the U.S. financial institution or a third-party
seller of securities who act as an accommodation
party on behalf of U.S. financial institution. In the
event that the field discovers such transaction, the
field is directed to use TRS IDR #2.
Taxes—The Tax Magazine®
September 2010
Situation 4 (fully synthetic). The facts of Situation
4 are the same as Situation 1 except that the Foreign
Person has never owned the U.S. equity security
referenced by the TRS. To eliminate or substantially
reduce its risk with respect to its position under the
TRS, U.S. financial institution hedges its synthetic
issuer position under the swap. When the foreign
person terminates the swap, it does not purchase the
reference securities from the U.S. financial institution
or any other broker-dealer.
Absent additional exceptional facts as discussed
below, the field should not pursue such transactions.
Treasury regulations provide different tax consequenc-
es for different investment arrangements by providing
different source rules for dividends paid with respect
to physical long positions in an U.S. equity security
and for dividend equivalents paid pursuant to an
equity equivalent position held synthetically through
notional principal contracts that reference the same
U.S. equity security. The existing notional principal
contract rule, found in Reg. §1.863-7, is clear on its
face; taxpayers and withholding agents may rely on
that rule when their investment is in substance and
form a notional principal contract.
The field, however, should pursue transactions re-
the foreign person exercised control with respect to
the U.S. financial institution’s hedge and, therefore,
may have obtained beneficial ownership of the U.S.
equity securities as a result of entering into a TRS.
Size of reference stock so large as to compel
financial institution to hold hedge. In particu-
lar, when a foreign person holds a TRS position
that is so large or so illiquid that a U.S. finan-
cial institution acting as the swap counterparty
must acquire the underlying security itself to
hedge its synthetic issuer position under the
swap, the foreign person may be considered
the beneficial owner of the reference U.S.
equity securities.
Referenced stock is a hedge. Transactions in
which the U.S. financial institution hedged its
synthetic issuer position by retaining the physi-
cal underlying reference securities on its books.
Passage of voting rights to foreign person. Trans-
actions in which the foreign person maintained
voting rights with respect to the physical underly-
ing reference securities.
Foreign person must post collateral equal to at
least 50 percent of initial value of shares.367 The
foreign person was required to post collateral
111
New U.S. Withholding System for Foreign Account Tax Compliance
equal to at least 50 percent of the initial value of
the shares referenced by the equity swap.368
Transactions in which the U.S. financial institution
cast any votes with respect to the physical underlying
reference securities in a manner directed formally
or informally by the swap counterparty. The field is
directed to use Total Return Swap Fact Pattern Four
IDR (“TRS IDR #4”) and interviews to help identify
these abusive cases in an efficient manner. Finally, the
field should consider all the facts and circumstances
to determine whether a particular transaction that is
in form a notional principal contract constitutes a
legitimate swap agreement in substance.
The Greenberg and Traurig Tax Alert had the fol-
lowing comments related to Situation 4:369
A number of financial institutions have been
offering so-called “synthetic prime brokerage”
platforms. In a synthetic prime brokerage transac-
tion, the financial institution allows the non-U.S.
person to access its trading operations through
a computer and enter a position that it desires
to have economic exposure with respect to.
The agreement in place between the financial
institution and the non-U.S. person specifically
states that each position posted on the system
by the non-U.S. person will be treated as a swap
transaction. The Swap Audit Guidelines note
that synthetic prime brokerage transactions do
not pose any price risk to the financial institu-
tion. Although, in the author’s view, the taking
of market risk is inconsistent with the role that
financial institutions take in the equity derivative
markets, the IRS’s position is understandable
when the non-U.S. person is effectively executing
the hedge transaction for the financial institution,
on essentially one-to-one (delta one) basis. This
level of execution raises issues as to whether the
transaction should be treated as a notional prin-
cipal contract for federal income tax purposes.
The Swap Audit Guidance tells IRS agents to
consider whether this absence of involvement
by the financial institution causes the non-U.S.
person to be treated as the owner of the hedge.
In fact, the Swap Audit Guideline tells auditing
agents to consider subpoenaing prime brokerage
account statements for non-U.S. persons who
have used this technique.
In summary, the Swap Audit Guidelines evidence
a sophisticated approach to when swaps should
112
be taxed as custodial arrangements. Although the
IRS does have additional work to do, it clearly
has learned a lot about the over-the-counter
securities business through the audits that it has
conducted and through industry personnel who
have joined the IRS in recent years. The Swap Au-
dit Guidelines, however, are likely to substantially
increase the duration and complexity of financial
product audits.
Another commentator370 had the following caution-
ary language after the issuance of the IDD:
Foreign investors may begin to see increased audit
activity as a result of the Directives’s instruction
that agents coordinate the examinations of the
financial institutions with the examinations of
the foreign investors. Any such audits, however,
should potentially become more focused and
predictable as a result of the Directive. Notwith-
standing this greater clarity, financial institutions
and hedge funds should proceed with caution
when considering the types of swaps they execute
and when preparing or considering appropriate
guidelines for this activity. Although the Directive
only discusses TRSs on equity, the IRS could apply
the criteria set out in the Directive to non-equity
TRSs. As such, taxpayers might look to various
rules and safe harbors put forth in the Directive,
recently enacted legislation (the HIRE Act), and the
“red flags” that were highlighted in the September
2008 “Dividend Tax Abuse” report of the Senate
Permanent Subcommittee on Investigations.
TRSs referencing equity securities issued by pri-
vately held U.S. corporations. The field is instructed
to examine any transaction where the foreign person
entered into a TRS that references an equity security
issued by a privately held U.S. corporation371 (a “TRS
Referencing Private Securities”). The field should
pursue any TRS Referencing Private Securities where
the structure of the transaction resembles any of the
transactions described above in Situations 1 through
4. In addition, the field should pursue any other TRS
Referencing Private Securities structured in a man-
ner that is not specifically described in this IDD.
In a TRS Referencing Private Securities, the foreign
person likely maintains control with respect to the
reference private securities such that the foreign
person may be considered the beneficial owner of
reference securities. In the examination of a TRS

Referencing Private Securities, the field is directed
to develop facts necessary to support a challenge to
such transaction similar to the challenge described
above in Situation 4.  equity securities. The field should coordinate these
TRS executed using an automated program trading
offered by the U.S. financial institution. The field is
instructed to examine any transaction where the for-
eign person entered into a TRS using an automated
program trading offered by the U.S. financial institu-
tion. The automated program trading would allow
the foreign person to simultaneously and automati-
cally trigger the U.S. financial institution’s execution,
acquisition, and disposition of the TRS and the U.S.
equity securities. The use of such automated program
trading allows the foreign person to effectively control
when and how the U.S. equity securities’ acquisition
and disposition are executed, with the U.S. financial
institution assuming no risk with respect to the pricing.
In such a case, the foreign person may be considered
the beneficial owner of reference securities. The field
should examine these transactions in light of the four
situations discussed in this directive.
TRSs referencing a portfolio of U.S. equity securi-
ties. In the event that the field examines a transaction
in which the TRS references a basket or portfolio of
U.S. equity securities, the field should seek the assis-
tance of the industry counsel and technical advisor.
Audit techniques. The field always has the re-
sponsibility to monitor the statute of limitations on
assessment under Code Sec. 6501, whether for a
Form 1042 or any other income tax return. In the
examination of TRSs used to avoid withholding tax
with respect to dividends, the field is directed to is-
sue the four IDR templates specific to TRSs asking
the taxpayer and/or the withholding agent to identify
and provide information with respect to all transac-
tions that satisfy the criteria set forth in those IDRs. In
addition, the field is reminded to issue “Model IDR
for Withholding Strategy 1 and 2” with respect to
any new examination of TRS transactions. However,
the field should not be constrained by the five-day
period mentioned in Model IDR for Withholding
Strategy 1. In the examination of TRSs, the field must
make a referral to a financial products specialist, a
computer analyst specialist, and an international
examiner. Finally, the field should consider whether
relevant information may be obtained through other
applicable methods including, but not limited to, the
use of third-party summonses, such as the foreign
person’s prime brokerage account, and interviews
of all appropriate parties, including members of the
Taxes—The Tax Magazine®
September 2010
U.S. financial institution’s information technology
departments to identify the computer programs used
to execute TRSs and acquire and dispose of the U.S.
examinations with the teams that may be examining
the foreign persons who executed the TRSs with U.S.
financial institutions.
The field should analyze all possible transactions,
particularly those that use MOC pricing and those
transactions referencing a security that paid an ex-
traordinary dividend. Additionally, there are known
IDBs that facilitate these transactions. The examples
listed herein are not intended to be exhaustive; the
field should pursue other appropriate audit tech-
niques as determined on a case by case basis.372
Liability for Withholding Tax,
Interest, Penalties and Statute
of Limitations
Withholding Agent Liability for
Chapter 3 and Chapter 4 Tax
It is unclear under the new law if all or part of these
provisions will be applicable to withholding tax
imposed by Chapter 4 or whether the Treasury will
adopt any safe harbor presumptions from the FDAP
withholding tax rules which will ease the administra-
tive burden upon withholding agents. Presumably, the
Treasury will impose both strict rules and significant
liability on a Chapter 4 withholding agents who fails
to withhold regardless of whether any actual tax li-
ability exists to the payee to ensure compliance with
the new law given its legislative purpose to curb
offshore tax evasion by U.S. persons.
Liability for Interest
Under the FDAP withholding tax rules interest is
imposed on the amount that should have been with-
held under Code Sec. 1441. Interest generally begins
to accrue beginning on the last day for paying the
tax due under Code Sec. 1461, which is March 15,
the due date of the Form 1042 and ends on the date
that the appropriate documentation is provided to
the withholding agent to the extent withholding is
not required.373 For any remaining tax liability, the
interest continues to accrue until the tax liability is
satisfied. If the tax liability and interest on that tax
liability is satisfied by the beneficial owner of the pay-
ment, the interest charge imposed on the withholding
agent will be abated to the extent that interest is paid
113
New U.S. Withholding System for Foreign Account Tax Compliance
by the beneficial owner to avoid a double interest
charge.374 The withholding agent is not relieved of any
applicable penalties in such situation.375 Presumably,
the IRS will buckle these interest rules into the new
withholding tax and reporting regime.
New Six-Year Statute of
Limitations Applies to Chapter 4
Withholding Taxes
Under the present law, taxes are generally required
to be assessed within three-years after a taxpayer’s
return was filed.376 If an assessment is not made
with the required time period, additional tax liabili-
ties cannot be assessed or collected at any future
time. However, if there is a substantial omission of
income of an amount equal to or greater than 25
percent of the gross income reported on the return,
the three-year statute of limitations is extended to
six years.377
The new law authorizes a new six-year statute of
limitations for assessments of tax on understatements
of income attributable to foreign financial assets. This
new six-year statute of limitations differs from the
existing six-year statute of limitations which remains
unchanged. It should also be noted that the six-year
extension does not extend the period for filing a re-
fund claim for a tax return. Under Code Sec. 6511,
a taxpayer has three years from the date he files his
return or two years from the date he pays the tax,
whichever is later to file a claim for refund.
Under the new six-year statute of limitations, the
limitations period will be extended from three years
to six years if the taxpayer omits from gross income
an amount properly includible on his tax return,
and such amount is in excess of 25 percent of the
amount of the gross income stated in the return or
such amount is attributable to one or more assets
with respect to which information is required to be
reported under new Code Sec. 6038D (or would
have been required if this provision were applied
without regard to the $50,000 dollar or other dollar
threshold specified by the Secretary, or to any excep-
tion for nonresident aliens or any exceptions provide
by regulation) and the gross income is in excess of
more than $5,000.
If a domestic entity is formed or availed of to hold
foreign financial assets it is subject to the report-
ing requirements of Code Sec. 6038D in the same
manner as an individual and the six-year statute
of limitations period also applies to that entity.
114
The Secretary is permitted to assess the resulting
deficiency at any time within six years of the fil-
ing of the income tax return. By providing that the
Code Sec. 6038D information reporting require-
ments are to be determined without statutory or
regulatory exceptions, the new law ensures that
the longer limitation period applies to omissions
of income with respect to transactions involving
foreign financial assets owned by individuals. Thus,
a regulatory provision that alleviates duplicative
reporting obligations by providing that a report
that complies with another provision of the Code
may satisfy one’s obligations under new Code Sec.
6038D does not change the nature of the asset
subject to reporting. The asset remains one that is
subject to the requirements of Code Sec. 6038D for
purposes of determining whether the exception to
the three-year statute of limitations applies.378
The provision also suspends the limitations period
for assessment if a taxpayer fails to provide timely
information returns required with respect to pas-
sive foreign investment corporations379 and the new
self-reporting for foreign financial assets. Both the
three-year and new six-year limitations periods will
not begin to run until the information required by
those provisions has been furnished to the IRS.
The extended statute of limitations is effective for
returns filed after March 18, 2010, and if the statute
of limitations was still open for the return on March
18, 2010, for returns filed before March 18, 2010
(e.g., for any returns filed after the date of enactment
or for any other returns for which the assessment
period under Code Sec. 6501 has not yet expired as
of the date of enactment).380 This means that income
tax returns for calendar-year taxpayers for the 2006,
2007, 2008, 2009 and 2010 tax years are potentially
subject to the new six-year statute rather than the
traditional three-year statute unless the Treasury
provides guidance otherwise. See “Income tax return
reporting for foreign financial assets” and “Penalty
for failure to disclose foreign financial assets.”
Significant Changes to Three-Year
Statute of Limitations Under the
HIRE Act for Failure to Disclose
Foreign Transfers
Act Sec. 513(c) of the HIRE Act simply states,
“Paragraph (8) of [Code] Section 6501(c) is amend-
ed by striking “event” and inserting “tax return,
event.” The Joint Committee explanation states

that the provision “clarifies that the extension is
not limited to adjustments to income related to
the information required to be reported by one of
the enumerated sections.”381
One commentator382 has focused on the of addition
of the two words “tax return” to Code Sec. 6501(c)
(8) (which is entitled, statute on limitations on as-
sessments and collection-failure to notify Secretary
of certain foreign transfers) by stating:
This addition may have significant consequences
to the tolling of the assessment statute of limita-
tions for tax years of companies in the tax return
reporting of international operations.
Section 6501(c)(8) provides an exception to
the general rule that taxes are to be assessed
within three years after a taxpayer’s return is
filed. Prior to its recent amendment, [Code Sec.]
6501(c)(8) extended the assessment statute if a
taxpayer failed to provide information about
certain cross-border transactions until three
years after the required information is actually
provided to the Secretary. More specifically,
[Code Sec.] 501(c)(8) stated that “[i]n the case
of any information which is required to be re-
ported to the Secretary under [Code] Sec. 6038,
6038A, 6038B, 6046, 6046A, or 6048,383 the
time for assessment of any tax imposed by this
title with respect to any event or period to which
such information relates shall not expire before
the date which is three years after the date on
which the Secretary is furnished the information
required to be reported under such section.” In
other words, the assessment statute of limita-
tions is extended if a taxpayer fails to provide
any information required on Forms 5471, 5472,
926, 8621, 8865 and 3520,384 and the three-
year statute of limitations does not start until
all required information is provided.
Change to Code Sec. 6501(c)(8). The HIRE Act
added the words “tax return” such that the relevant
portion of the provision now reads as follows:
[T]he time for assessment of any tax imposed by this
title with respect to any tax return, event, or period
to which such information relates shall not expire
before the date which is three years after the date
on which the Secretary is furnished the information
required to be reported under such section.
Taxes—The Tax Magazine®
September 2010
What does this mean? The assessment statute of
limitations is extended if a taxpayer fails to provide
any information required on Forms 5471, 5472,
926, 8621, 8865 and 3520. The extension is not
limited to adjustments to income related to the in-
formation required to be reported on one of these
forms, but rather the Internal Revenue Service can
assess any additional tax that may be due on any tax
return (e.g., Form 1120 - U.S. Corporation Income
Tax Return). This change to [Code Sec.] 6501(c)(8)
is characterized in the Joint Committee’s technical
explanation of the HIRE Act as a clarification.385 This
contradicts the preamble to regulations issued in
2000 under [Code Secs.] 6038 and 6038B, which
stated that the extended statute of limitations
provided by [Code Sec.] 6501(c)(8) remains open
only with respect to “tax consequences related to
the information required to be reported under the
relevant reporting section and not to all transactions
with the U.S. person’s tax year at issue.386 [Code
Sec.] 6501(c)(8), as amended, if effective for returns
for which the assessment statute of limitations is
open after 18 March 2010 … .”
Technical Correction proposed. On July 28,
2010, House Ways and Means Committee Chair-
man Sander M. Levin (D-MI) introduced H.R. 5893,
the Investing in American Jobs and Closing Tax
Loopholes Act of 2010, which among other tax
proposals would make a technical correction to
the HIRE ACT that would clarify the circumstances
when the statute of limitations provision under
Code Sec. 6501(c) can be tolled if the failure to
comply with the filing requirements is due to rea-
sonable cause and is not willful. In cases in which
a taxpayer establishes reasonable cause the limita-
tions period will be suspended only for the item or
items related to the failure to disclose and not all
issues with respect to the income tax return.387 In
order to prove reasonable cause, it is anticipated
that a taxpayer must establish that the failure was
objectively reasonable (i.e., the existence of ad-
equate measures to ensure compliance with rules
and regulations) and in good faith.388 The Staff of
the Joint Committee on Taxation provided the fol-
lowing example389 to illustrate the application of the
provision in a prior proposal in the American Jobs
and Closing Tax Loopholes Act of 2010:
[T]he limitations period for assessing taxes with
respect to a tax return filed on March 31, 2011
115
New U.S. Withholding System for Foreign Account Tax Compliance
ordinarily expires on March 31, 2014. In order to
assess tax with respect to any issue on the return
after March 31, 2014, the IRS must be able to
establish that one of the exceptions applies. If the
taxpayer fails to attach to that return one of mul-
tiple information returns required, the limitations
period does not begin to run unless and until that
missing information return is supplied. Assuming
that the missing report is supplied to the IRS on
January 1, 2013, the limitations period for the
entire return begins and elapses no earlier than
three years later on January 1, 2016. All items
are subject to adjustment during that time, unless
the taxpayer can prove that reasonable cause
for the failure to file the information existed. If
the taxpayer establishes reasonable cause, the
only adjustments to tax permitted after March
31, 2014 are those related to the failure to file
the information return. For this purpose, related
items include (i) adjustments made to the tax
consequences claimed on the return with respect
to the transaction that was the subject of the in-
formation return (ii) adjustments to any item to
the extent the item is affected by the transaction
even if it is otherwise unrelated to the transaction
and (iii) interest and penalties that are related to
the transaction or the adjustments made to the
tax consequences.
Penalty for Failure to Disclose
Foreign Financial Assets
If an individual fails to furnish the Code Sec. 6038D
required information on his tax return (beginning
in his 2011 tax return) in the time and manner as
required such person will pay a penalty of $10,000
for the tax year.390 (See “Income tax return report-
ing for foreign financial assets.”) In addition, if the
failure continues for more than 90 days after the day
on which the IRS mails notice of such failure, such
individual will be subject to an additional penalty
of $10,000 for each 30-day period (or part thereof)
during which such failure continues with such pen-
alty not to exceed $50,000 for one taxable period.391
Thus, it would be prudent for taxpayers to determine
whether the new reporting requirements apply to
any investment or transaction in which a non-U.S.
person is a party.
The computation of the penalty is similar to that
applicable to failures to file reports with respect to
certain foreign corporations under Code Sec. 6038.
116
Thus, an individual who is notified of his failure to dis-
close with respect to a single tax year and who takes
remedial action on the 95th day after such notice is
mailed incurs a penalty of $20,000 comprising the
base amount of $10,000, plus $10,000 for the frac-
tion (i.e., the five days) of a 30-day period following
the lapse of 90 days after the notice of noncompliance
was mailed. An individual who postpones remedial
action until the 181st day is subject to the maximum
penalty of $50,000; the base amount of $10,000, plus
$30,000 for the three 30-day periods, plus $10,000
for the one fraction (i.e., the single day) of a 30-day
period following the lapse of 90 days after the notice
of noncompliance was mailed.
One commentator392 has suggested the 90-day
period and subsequent 30-day periods are too short
by stating:
Americans who reside abroad and have received
individual communications from the IRS have
complained that they receive IRS mailings months
after the date on the communication report and
often after the deadline indicated for compliance.
An automatic increase in the penalty can lead
to totally unjustified penalties if the individual
residing overseas does not receive the document
within a time frame to allow him/her to study the
issue, and if necessary, correct the reporting and
pay the initial penalty.
In addition, this commentator also questioned the
definition of “mailing” by stating:
What is the definition of “mailing” by the IRS
– the date on the IRS document or the actual
time that the document is put into U.S. postal
system for mailing? Or does the IRS assemble
mail and hold it for some time before actually
initiating the mailing to a foreign location for
further mail distribution? In some places in Af-
rica, Latin America and Asia, it may take two
months or more for a mailing from the United
States to arrive. The law presumes that all mail
sent to a foreign address will arrive within the
same delays as those for U.S. addresses; this
simply is not the case.393
If the IRS determines that an individual has an
interest in an SFFA and such individual does not
provide enough information to enable the Secretary
to determine the aggregate value of such assets,

then the aggregate value of such identified foreign
financial assets will be presumed to have exceeded
$50,000 or such higher amount as the IRS shall pre-
scribe for purposes of determining the penalty.394
Application to certain entities. The new law makes
clear Code Sec. 6038D return reporting will also ap-
ply to any domestic entity which is formed or availed
of for purposes of holding, directly or indirectly
SFFAs in the same manner as if such entity were an
individual as provided by the Secretary.395
Reasonable cause exception. However, no penalty
will be imposed on any failure that is shown to be
due to reasonable cause and not due to willful ne-
glect. Foreign law prohibitions such as the fact that a
foreign jurisdiction would impose a civil or criminal
penalty on the taxpayer for disclosing the required
information is not reasonable cause.396
Consequences of trying to avoid FATCA reporting
and withholding. At a recent tax reporting and with-
holding conference, a question was raised whether a
taxpayer can fly ‘under the radar’ for a foreign entity
he directly or indirectly controls by deciding not to
have the foreign entity enter into a Code Sec. 1471(b)
agreement with the IRS and thereby avoid filing an
annual report of its U.S. accounts with the IRS in
the case of a foreign financial institution, such as a
offshore investment fund comprising family members
and friends of family or deciding not to disclose the
substantial U.S. owners or otherwise certify that there
are no such owners for a non–financial foreign entity
he controls. Presumably, his nonparticipating foreign
financial institution and the non–financial foreign
entity will be subject to a 30-percent withholding
tax on any withholdable payments made to such
entities (e.g., U.S. source FDAP income and on the
gross proceeds from the sale of U.S. stock or securi-
ties by such entities)..
For this purpose, a question arises whether the
Treasury will treat an entity that is a disregarded entity
under the check-the-box rules as a separate foreign
entity subject to FATCA withholding and reporting.
Presumably these entities will also be included as
foreign entities under new Code Sec. 1474(5) to avoid
abuse by taxpayers by using such entities. However,
the Treasury may want to consider a kick-out rule for
those disregarded entities where duplicative reporting
and withholding may be required under new Codes
Sec. 1471 or 1472.
Since a “financial account” as defined under new
Code Sec. 1471(d)(4) will be included as a report-
able “specified foreign financial asset,” or SFFA, an
Taxes—The Tax Magazine®
September 2010
individual taxpayer will have to attach a statement
with his tax return for 2011 and forward under new
Code Sec. 6038D. Thus, an individual taxpayer must
report his interest in a foreign deposit or custodial
account or his interest in non–publicly traded equity
or debt of a foreign financial institution. Similarly, he
must report as an SFFA any other stock or security
issued by a non-U.S. person or his interest in any
financial instrument or contract held for investment
that has a foreign issuer as a counterparty and in any
interest he has in a foreign entity as defined in new
Code Sec. 1473.
This definition is broad enough to cover an indi-
vidual taxpayer’s interest in non–publicly traded debt
or equity of a non–financial foreign entity as well as
for his debt and equity interest in foreign publicly
traded entities, which would be excludable under
new Code Sec. 1472(c). Similarly, if an individual
taxpayer has an interest in a foreign entity that is ex-
empt as a foreign financial institution, the language of
new Code Sec. 6038(D) is broad enough to include
these interests as SFFAs unless the Treasury provides
guidance otherwise.
It is likely the IRS will take the position that if an
individual taxpayer fails to identify all his SFFAs, in-
cluding his interests in foreign financial institutions
or non–financial foreign entities, then he has failed
to file a complete tax return and therefore the statute
of limitations (which would otherwise now be six
years) remains open.
In cases where the failure to report was uninten-
tional, the taxpayer may be able abate the penalty
under new Code Sec. 6038D(d) and the new 40-
percent accuracy related penalty (see “New penalty
for underpayments attributable to undisclosed foreign
financial asset”) if he can establish the failure was due
to reasonable cause and not willful neglect.
In cases where the individual taxpayer intention-
ally tries to avoid reporting his interest in foreign
financial institution or non–financial foreign entity,
it is likely the IRS will seek not only to impose civil
fraud penalties, but the IRS (CI) or the DOJ may try to
impose criminal penalties especially if the taxpayer
has not reported the underlying income from these
investments. While it is too early to tell, it is not
too far of a reach to suggest that the new Code Sec.
6038D reporting statement may become the tool of
choice for the next decade (akin to the FBAR now)
to enforce criminal prosecutions against taxpayers
who fail to report and pay their U.S. income taxes
from their offshore accounts.
117
New U.S. Withholding System for Foreign Account Tax Compliance
Other Civil Penalties
In addition to liability for tax and interest a Chapter
4 withholding agent may be liable for significant
civil penalties:
Information return reporting penalties—Code
Secs. 6721 and 6722—Code Sec. 6721: Failure to file
timely, correct, and complete information returns. Un-
der Code Sec. 6721(a)(1), there is imposed a penalty
of $50 for each return for which such failure occurs
up total amount for all such failures during a calen-
dar year not to exceed $250,000. For this purpose,
a failure includes any failure to file an information
return or any failure to include all of the information
required on the return or the inclusion of incorrect
information. There are certain exceptions that may
mitigate this penalty, including (i) correction of fail-
ure, (ii) correction of failure under the small business
exception, and (iii) the de minimis exception.
Code Sec. 6721—Intentional failure to file. If there
is an intentional disregard of the filing requirement
the amount of the penalty will be the greater of $100
or 10 percent of the aggregate amount of the items
required to be reported correctly (without regard to
the $250,000 limitation) under Code Sec. 6045(a),
6041A(b), 6050H, 6050I, 6050J, 6050K or 6050L.
In the case of a return required to be filed under
Code Sec. 6045(a), 6050K or 6050L, five percent
of the aggregate amount of the items required to be
reported correctly. In the case of a return required
to be filed under Code Sec. 6050I(a) with respect to
any transaction (or related transactions) the greater of
$25,000 or the amount of cash (within the meaning
of Code Sec. 6050I(d)) received in such transaction
(or related transactions) to the extent the amount
of cash does not exceed $100,000. In the case of a
return required to be filed under Code Sec. 6050V,
10 percent of the value of the benefit of any contract
with respect to which information is required to be
included on the return.
Code Sec. 6722—Failure to furnish timely, correct
and complete payee statement. Under Code Sec.
6722, each failure by any person with respect to a
payee statement will be subject to a $50 penalty for
each statement with respect to which such failure
occurs. The total amount imposed on such person
for all such failures during a calendar year cannot
exceed $100,000 per year. For purposes of this
provision a failure includes (i) any failure to furnish
a payee statement, or (ii) any failure to include all
of the information required to be shown on a payee
statement or the inclusion of incorrect information.
118
Code Sec. 6722—Penalty in case of intentional disre-
gard. If one or more failures are due to the intentional
disregard of the requirement to furnish a payee state-
ment or the correct information reporting requirement,
then, with respect to each failure, the amount of the
penalty shall generally be the greater of $100 per state-
ment or 10 percent of the aggregate items required to
be reported and the $100,000 limitation will not apply.
In the case of a payee statement required under Code
Sec. 6045(b), 6050K(b) or 6050L(c), a lower penalty
equal to $100 per statement or five percent of the ag-
gregate items is required to be reported.
Code Secs. 6662 and 6663—Civil fraud penalties. A
withholding agent’s fraudulent failure to report to the
IRS income from one or more U.S. accounts, whether
in the form of interest, dividends, capital gains or other
income, may result in civil fraud penalties equal to 75
percent of the underpayment of tax that is attributable
to fraud. Acquittal in a criminal prosecution is not
decisive of the civil fraud issue. However, a criminal
conviction for income tax evasion does decide the
fraud issue and the subject are collaterally estopped
from raising it in the civil proceedings.397
When a withholding agent is required to file a tax
return and fraudulently fails to do so on or before the
due date of the return, Code Sec. 6651(f) imposes a
penalty of 15 percent of the net tax amount required
to be shown on the tax return for each month (or
fraction of a month) that the return is late.398 The
maximum penalty is 75 percent.399
Code Secs. 6651(a)(2) (late payment penalty)
and 6651(a)(3)—Civil penalty for failure to pay tax
penalties. When a withholding agent fails to timely
withhold and pay over the amount of tax shown on
the return on or before the due date prescribed for
payment, Code Sec. 6651(a)(2) imposes a late pay-
ment penalty equal to 0.5 percent of the amount
of the underpayment for the first month, with an
additional 0.5 percent for each additional month or
fraction thereof during which such failure continues.
The maximum amount of the penalty cannot exceed
an aggregate 25 percent.400 When a withholding
agent fails to withhold and pay over a tax that is
required (but was not) shown on a return within 21
days from the date of the IRS notice and demand for
that tax, Code Sec. 6651(a)(3) imposes a penalty of
0.5 percent for each month (or part thereof) that the
assessment remains unpaid. The maximum penalty
is 25 percent.401
Code Secs. 7203 and 6651(a)(1) (delinquency
penalty) for failure to file return—Criminal and civil

penalties. If the withholding agent fails to file his or
her income tax return, there may be a criminal penalty
of up to $25,000 ($100,000 in the case of a corpora-
tion), up to one year in prison or both.402 A delinquency
penalty of five percent a month may be imposed when
a tax return is filed delinquently without reasonable
cause, or when a taxpayer fails to file a return without
fraudulent intent. The penalty is limited to 25 percent
and is imposed on the net amount due.403
In applying the Code Sec. 6651(a)(1) penalty to a
withholding agent, the D.C. Circuit affirmed the Tax
Court’s decision in Del Commercial Properties, Inc.,404
stating that a taxpayer “bears the heavy burden of
proving that its deficiencies were due to reasonable
cause and not willful neglect.”
New penalty for underpayments attributable
to undisclosed foreign financial asset—Accuracy-
related (negligence) penalty. The new law adds a
new 40-percent accuracy-related penalty under
Code Sec. 6662. The 40-percent penalty is imposed
on any understatement of income attributable to an
“undisclosed foreign financial asset,” subject to the
same defenses as are otherwise applicable under
Code Sec. 6662.
Under the new law, an asset is an “undisclosed
foreign financial asset” if it is an asset subject to
certain information reporting requirements,405 and
the required information was not provided by the
taxpayer during the relevant tax year. The informa-
tion reporting requirements for this purpose, includes
information reporting related to the following:
The new law’s requirement for an individual to
furnish the “6038D required information” on his
tax return in the time and manner as required406
(See “Income tax return reporting for Foreign
Financial Assets.”)
Controlled foreign corporations and partnerships407
Transfers to foreign corporations and partner-
ships408
Certain organizations, reorganizations and acqui-
sitions of stock in foreign corporations409
Certain acquisitions, dispositions of and substan-
tial changes to interests in foreign partnerships410
Certain transactions involving foreign trusts411 (An
understatement is attributable to an undisclosed
foreign financial asset if it is attributable to any
transaction involving such asset.)
Thus, a U.S. person who fails to comply with the
various self-reporting requirements for a foreign
financial asset and engages in a transaction with
respect to that asset incurs a penalty on any resulting
Taxes—The Tax Magazine®
September 2010
underpayment that is double the otherwise applicable
penalty for substantial understatements or negligence.
For example, if a taxpayer fails to disclose amounts
held in a foreign financial account, any underpay-
ment of tax related to the transaction that gave rise
to the income would be subject to the new penalty
provision, as would any underpayment related to
interest, dividends or other returns accrued on such
undisclosed amounts. The effective date of the new
40-percent penalty is effective for tax years beginning
March 18, 2010, i.e., 2011 for individuals.
Code Sec. 6662 civil accuracy-related (neg-
ligence) penalty. Code Sec. 6662 continues to
impose a 20-percent accuracy-related penalty if the
underpayment is attributable to among other items,
negligence or disregard of the rules or regulations
or a substantial understatement of income tax or in
the case of any undisclosed asset understatement.412
Negligence includes any failure to make a reason-
able attempt to comply with the tax law and the
term disregard includes any careless, reckless or
intentional disregard.413 There is a substantial un-
derstatement of income tax for any tax year if the
amount of the understatement exceeds the greater
of 10 percent of the tax required to be shown on the
tax return for the tax year or $5,000.414 In the case
of a C corporation other than a personal holding
company or an S corporation, there is as substantial
understatement if the amount of the understatement
for the tax year exceeds the lesser of 10 percent
of the tax required to be shown on the tax return
for the tax year or $10 million.415 The negligence
penalty cannot be assessed against any portion of
the understatement against which the fraud penalty
is assessed.416
Code Sec. 6672 (100-percent penalty). A 100-
percent penalty equal to the total amount of tax
evaded may be imposed on a withholding agent
who is required to collect, truthfully account for
and pay over any tax; and willfully evades, fails to
collect, account for and/or pay over such tax or will-
fully attempts in any manner to evade or defeat any
such tax.417 No reported cases exist that apply the
100-percent penalty to a withholding agent under
the FDAP withholding tax rules.
Code Sec. 6694 understatement of taxpayer’s li-
ability. It is likely that some tax return preparers, as
well as the general public, may not fully understand
the new law and may not be fully compliant with
the withholding and reporting requirements for every
U.S. account. This raises the possibility that the tax
119
New U.S. Withholding System for Foreign Account Tax Compliance
return preparer penalty of Code Sec. 6694 may be
applied by the IRS as well.
Under Code Sec. 6694, any tax return preparer who
prepares a tax return or claim for refund with respect
to which any part of the understatement of liability
is due to a “unreasonable position” may have pay a
penalty equal to the greater of $1,000 or 50 percent
of the income derived by the tax return preparer.418
No penalty will be imposed if it shown that there is
reasonable cause for the understatement and the tax
return preparer acted in good faith.419
A position is treated as an unreasonable position
unless (i) there is or was substantial authority for the
position; or (ii) the position was properly disclosed
and had a reasonable basis.420 There is substantial
authority for a position if the taxpayer is subject of
a “written determination” as provided in Treasury
Regulation §1.6662-4(d)(3)(iv)(A).421
If a preparer of a tax return wants to take a posi-
tion that a U.S. person did not have an interest in
or a signature or other authority over a financial ac-
count in a foreign country, such as a bank account,
securities account or other financial account and
not disclose the position on the return, the preparer
must have “substantial authority” to avoid the Code
Sec. 6694 penalty. If the preparer discloses the is-
sue on the return, the preparer must also have a
reasonable basis for this position on the return to
avoid the penalty.
Penalty for Delinquent Deposits. The withholding
agent may be liable for underpayment of deposits or fail-
ure to make timely deposits.422 The penalty is two percent
for failure of not more than five days, up to 10 percent
for failure of more than 15 days, and could reach 15
percent if notice and demand is disregarded.423
Criminal Penalties
Code Sec. 7206 criminal fraud and making false
statements—Perjury penalty. If a withholding agent
provides false information in connection with a
return filing, the withholding person may be pros-
ecuted for willfully making a false tax return that
he does not believe to be true and correct as to
every material matter under penalties of perjury.
Filing a false return is a felony and is subject to a
fine of up to $100,000 ($500,000, in the case of a
corporation) and a prison term of up to three years
or both.424 Thus, a person who knowingly provides
false information regarding a U.S. account may
face possible criminal prosecution which from the
point of view of a prosecutor will be a relatively
120
simple case to prove when compared to trying to
establish tax evasion in complex fact situations
which are common in tax shelter schemes or other
abusive transactions.
Code Sec. 7202 criminal penalty for failure to col-
lect or account for and pay over tax. A withholding
agent may be liable for a criminal penalty of up to
$100,000 and/or five years imprisonment, plus the
costs of prosecution for willful failure to collect or
account for pay over tax.425
Code Sec. 7201 criminal attempt to evade or defeat
tax. Under Code Sec. 7201, if a withholding agent will-
fully attempts in any manner to defeat paying the U.S.
tax on the income from a foreign financial account, a
U.S. person may be guilty of a felony and may be fined
up to $100,000 ($500,000 in the case of a corporation),
imprisoned for up to five years or both.426
“U.S. Account” Exposures—
Prophylactic Planning, Corporate
Governance and Compliance to
Manage Global U.S. Account Risk
Banks and other financial service companies as
well as financial intermediaries may want to affir-
matively plan to have their corporate governance
and compliance shops in order before the govern-
ment comes knocking on their door asking about its
or its customers’ U.S. accounts or other accounts.
What can banks and other financial service com-
panies do now?
Conduct thorough due diligence and proactively
manage the global U.S. account risk. It is unlikely
that the UBS legal, compliance or tax groups knew
about the cross-border private banking initiative to
solicit American clients and set them up in offshore
accounts to conceal their assets and income from
the U.S. government. However, the behavior of
one or more business groups can be imputed to the
bank and to its directors and senior officers at the
bank with the potential for both civil and criminal
prosecution if the bank does not have robust compli-
ance programs in place to avoid misconduct.427 It is
necessary and prudent for banks and financial ser-
vice companies to undertake their own compliance
initiatives in 2010 to make sure they are compliant
with the HIRE Act on its effective date generally on
December 31, 2012.
The first step is for the legal, compliance or tax
groups who make the “key” compliance decisions for
investor compliance and recordkeeping and inves-

tor documentation and information reporting to do
a mock internal compliance health check to assess
the efficacy of the existing qualified intermediary and
investor documentation and information reporting
processes. (E.g., does the bank know its customers
under best-practice “KYC” principles, and has the
bank made reasonable inquiries to verify its clients’
documentation (e.g., Forms W-8s, W-8BENs,W-8-
IMYs or W-9s)428 and to assess the “quality” of the
repositories holding information about its custom-
ers global accounts and other proprietary debt and
equity investments?)
As part of an audit under Chapter 3 and presum-
ably Chapter 4, it is likely the IRS will review the
U.S. payors’ or withholding agents’ written processes
and procedures and will try to identify the accounts
which are held by foreign persons or vendors and
then look to the source of those payments. Existing
reporting systems should be reviewed to ensure that
the payments are sourced properly and that the in-
formation reporting documentation for the accounts
is proper. If there is conflicting information or files
or information arising from other reporting systems
or vendors, the processes and procedures for error
resolution should be reviewed.
If information is not timely obtained about ac-
counts, the processes and procedures to cure these
foot faults should also be reviewed. Importantly,
ascertaining whether the presumption rules and
certifications by customers are handled correctly
will also help in assessing the exposure for withhold-
ing or backup withholding and the possible failure
to identify payments subject to withholding. Also,
are the controlled foreign corporations compliant
with information reporting for their U.S. payees
and others? If a company has been relying upon
electronic signatures rather than getting a hard copy
of each investor certification (e.g., W-8), this will
likely create exposures. Lastly, the written internal
procedures addressing know-your-customer and
other information and reporting issues should be
reviewed and as necessary robust manuals should
be developed.429
As part of the evaluation it will be necessary
to assess the human and capital resource needs
to design and implement processes to satisfy the
new reporting, compliance and recordkeeping for
U.S. accounts on a global basis. For those foreign
financial institutions that are already qualified
intermediaries, every effort should be made to de-
velop foreign account compliance processes that
Taxes—The Tax Magazine®
September 2010
will be buckled into the existing processes thereby
generating synergies and cost savings. For those
foreign financial institutions that are not already
qualified intermediaries, new HIRE Act reporting
and compliance processes will have to be designed
and implemented which are in conformity with
the Code Sec. 1471(b) agreements that they will
likely enter into with the IRS by the effective date
of the new legislation, December 31, 2012, un-
less extended by the Treasury. Similarly, for those
institutions that are non–financial foreign entities,
processes will have to be developed to capture the
account information required to avoid withholding
under new Code Sec. 1472.
To give an idea of the scope of the undertaking, it
may be helpful to identify on a rough macro basis
the businesses which will likely be impacted by
FATCA for a medium-size financial institution. The
businesses will, include but not be limited to, bank-
ing, fixed income, loan origination and syndication,
equities, securitization, wealth management and
high–net worth, including discount and full service
brokerage, trustee and custodial services (personal
trusts, funds, employer-sponsored plans, etc.), estate
administration, investment management, custody,
and retail mutual funds, international banking, insur-
ance, which includes property, auto, travel, disability
and critical illness, term life, universal life, deferred
and life annuities, and segregated funds and capital
markets. Presumably, each of the existing front office
and back office systems, processes and procedures
in, for example, information reporting, accounts pay-
able, treasury, accounting , legal and compliance,
technology, etc.) will have to be identified and an
assessment made which systems, legal entities and
accounts are impacted by FATCA.
The optimal solution may, in many cases, be a sys-
tem that (i) automates the existing systems (e.g., QI or
existing 1441 and U.S. reporting, AML/KYC, accounts
payable, custodial reporting and documentation, etc.)
and new systems, as required for satisfaction of the
FATCA reporting and other requirements; and (ii) at
the same time identifies the key drivers which may
create substantial risk exposure for the firm and puts
appropriate human and other resources (in terms of
the appropriate number of people in the right loca-
tions, appropriate segregation of duties for internal
control and other purposes and level of experience
among other considerations) in place to manage the
risk process (e.g., timely identification of process and
non–process FATCA withholding and/or reporting
121
New U.S. Withholding System for Foreign Account Tax Compliance

errors, ongoing testing, follow-up on remediation pro-
cesses, privacy waiver issues and closing the accounts
as necessary, disclosure and confidentiality issues,
timely identification of material omissions and other
footfalls, real time financial statement reserve analyses
and documentation for reversals of such reserves and
the rollout of new business platforms and assets which
are FATCA compliant, etc.).
As part of this project, it will be a good idea to also
get an independent internal or external third-party
view and comments regarding best practices to imple-
ment the new reporting and withholding regime on
a global basis. The results of the due diligence for
the bank’s existing information reporting system and
recommendations by the bank’s advisors as to “best
practices” and as to how best to satisfy the require-
ments of the new law for the bank’s global accounts,
including documentation and information reporting
as well as the new required account verification and
“know-your-customer” processes should be reviewed
by the internal audit committee of the firm and recom-
mendations should be made to senior management
and to the Board of Directors as to how to how best
to develop, implement and manage the new law
requirements, information reporting and withhold-
ing as well as to remedy any internal control gaps as
quickly as possible.
Once a plan is fully developed, the working group
should put together a time line to show how each
step will be implemented to satisfy the new law’s
effective date requirement.
Continued and on-going testing. On an on-going
basis, a dedicated risk management group should be
assigned to continue to test and be able to answer two
questions on a continuing basis. First, if there were
to be an audit by an external monitor akin to what
UBS was required to recently undertake, would the
financial institution have the processes and docu-
mentation in place to support a favorable review?
Second, will the bank be able to support the conclu-
sion that the business groups both on- and off-balance
sheet, including the private equity, alternative funds
and structured product businesses are not setting up
foreign accounts or structures which need to have
FIN 48 or FAS 5 reserve exposures or which would
require footnote disclosure on the audited financial
statements or other SEC filings if all the facts are
known with 20/20 hindsight?
Future U.S. account reporting and enforce-
ment activity by the government. The reporting
and recordkeeping requirements are likely to be
expanded as the government moves forward in its
initiatives to close the perceived tax gap as part of
its international tax enforcement and anti–money
laundering efforts directed at among other areas
U.S. accounts which are owned by non-U.S. per-
sons. The government can be expected to employ
more resources into this area and to continue to
expand its own audit and enforcement strategies
which have garnered it so much good press. See
“Recent Senate AML probe into foreign persons
beneficial ownership of U.S. accounts.”

1
Deborah Fields and Carol Kulish Harvey,
New U.S. Law Imposes Withholding and
Reporting Requirements on Foreign Partner-
ships, Tax Analysts Special Report (May 24,
2010).
2
Kathleen Agbayani, Robert Albaral, Scott
Frewign, Robert F. Hudson, Jr., Robber
Kent, Jr., William J. Linklater, Richard M.
Lipton, Marnin J. Michaels, Sigurd So-
renson, Douglas M. Tween and A Duane
Webber, Experiences with the ‘New’ Vol-
untary Disclosure Program—Some Good,
Some Bad, http://checkpoint.riag.com/
app/servlet/com.tta.checkpoint.servlet.
CPJSPServlet?usid=25a...
3
Code Sec. 6159; IRA L Shafiroff, IRS Practice
& Procedure Deskbook, §5:15.1, Practising
Law Institute (3rd ed. 2008).
4
www.alvarezandmarsal.com/newsletters/
taw/taw2008-9.htm?camp=taw&div=tas&
date=Feb25&desc=issue9.
5
Code Sec. 1463.
Endnotes
6
Code Sec. 6901.
7
Jessica L. Everett Garcia, Dan Bagatell and
Thomas Johnson, Top 10 Issues to Consider
When You Are Sued: Issue #8: Disclosing
Litigation and Reserving for Litigation
Losses, Apr. 11, 2007.
8
IR-2010-088 (Aug. 4, 2010).
9
Tax Analyst Cod. 2007-10728 (Apr. 30,
2007) and Tax Analyst Doc. 2007-6222
(Mar. 2007); IRM §4.51.1 (“Rules of Engage-
ment”).
10
“Issue Tiering Fact Sheet,” issued by the
LMSB Division of the IRS (Mar. 18, 2009).
11
Id.
12
EMISC Tier I 1441, “U.S. Withholding
Agents—§1441: Reporting and Withholding
on U.S. Source FDAP Income” (undated);
Mark Leeds, New IRS Audit Guidelines
Target Equity Swaps with Non-U.S. Coun-
terparties, GreenbergTraurig Tax Alert, Jan.
2010 (hereinafter termed “Greenberg &
Traurig Comments”), at 2.
13
Paul D. DeNard, “Industry Directive on Ex-
aminations of Forms 1042,” Memorandum
for Industry Directors, Oct. 31, 2003.
14
Code Sec. 881(c)(3)(A).
15
IRM §4.10.21.8.7.7.
16
Code Sec. 1473(4); Reg. §1.1441-7(a)(1).
17
www.irs.gov/businesses/small/international/
article/0,,id=96404,00.html.
18
Rev. Rul. 2004-75, 2004-2 CB 109.
19
New Code Secs. 1471(d)(4), 1472(d),
1473(5).
20
www.irs.gov/businesses/small/international/
article/0,,id=105154,00.html.
21
Reg. §§1.1441-2(b); 1.306-3(h).
22
William Young, Rom P. Watson and Robert
Church, Securities Lending, Repos, and
Derivatives after FATCA, Executive Enter-
prise Institute 22nd Annual Forum on Inter-
national Tax Withholding and Information
Reporting, June 17–18, 2010 (New York,
New York).
23
New Code Sec. 1473(1)(A)(ii).

122
 September 2010

24
Reg. §1.6045-1(a)(1). 64
Code Sec. 1472(b). 94
It may be possible for a debt holder to
25
Laurie Hatten-Boyd, July 26, 2010, Web cast 65
The author added a refund section to the become a substantial U.S. owner if the IRS
sponsored by KMPG LLP. See also Marie Shawn McKenna’s chart. adopts related party rules similar to Code
Sapirie, Treasury Expected to Address FATCA 66
Chip Collins, Cyrus Daftary and Laurie Sec. 267(b), (C), 707(b) or 958(a), (b).
Definitions, TNT, July 26, 2010 (hereinafter Hatten-Boyd, FATCA Session III—Strategic 95
Code Sec. 1472(a).
cited as “KPMG Webcast”). Planning, Systems Implications, Things the 96
Id.
26
Act Sec. 501(d)(1) of the HIRE Act. Treasury Needs to Know, etc., Executive 97
Code Sec. 1471(d)(3).
27
Act Sec. 501(d)(2) of the HIRE Act. Enterprise Institute 22nd Annual Forum on 98
Code Sec. 1471(b)(3).
28
EBF/IBB Comments, at 9–14. International Tax Withholding and Informa- 99
There is no analog rule in new Code Sec.
29
Id. tion Reporting, June 17–18, 2010 (New York, 1474 similar to Code Sec. 1474(b)(2) for FFIs
30
Laura M Prendergast, “Field Directive on the New York). that explicitly permits an NFFE to obtain a
Use of Estimates from Probability Samples,” 67
John Staples, FATCA—Session I—Overview, refund or credit by reason of a U.S. treaty
Memorandum for Industry Directors, LMSB- Section 1471 and 1472, Executive Enterprise obligation.
4-0809-032, Nov. 3, 2009; Keith M. Jones, Institute 22nd Annual Forum on Interna- 100
Code Sec. 6038A(a).
“Field Directive on the Use of Estimates tional Tax Withholding and Information 101
Code Sec. 1471(d)(2). Any depository or cus-
from Probability Samples,” Memorandum Reporting, June 17–18, 2010 (New York, todial account or any non–publicly traded
for Industry Directors, Mar. 14, 2002. New York). equity or debt interest in a FFI.
31
Mary Batcher, Eric Falk, Wendy Rotz, New 68
RBC Comments, at 19–20. 102
Code Sec. 6038A(b).
IRS Guidance Makes Statistical Sampling 69
RBC Comments, at 22. 103
The new law has a grandfather rule for the
More Attractive than Ever for Federal Tax 70
Patricia Roth, Comments Regarding the For- treatment of outstanding obligations that
Purposes, 62 T ax E xecutive 1 (Jan.–Feb. eign Account Tax Compliance Act of 2009, provides that Chapter 4 shall not apply to
2010), at 37–39. Florida International Bankers Association any payments under any “obligation out-
32
Ann Noges, Foreign Account Tax Compli- (Apr. 30, 2010). standing” after March 18, 2012, or from the
ance Act Provisions in the Hiring Incen- 71
See, e.g., Reg. §§1.6042-3(b)(1)(iv) (treat- gross proceeds from any disposition of such
tives to Restore Employment Act of 2010 ing U.S. branches of foreign banks as U.S. obligation.
(“FATCA”) comments to the Treasury submit- payors or U.S. middlemen for purposes of 104
New Code Sec. 1474(c)(1); Staff of the Joint
ted on behalf of the RBC Financial Group interest payment reporting requirements), Committee Technical Explanation for the
(June 30, 2010), hereinafter cited as “RBC 1.6045-1(g)(3)(iii)(B)(1) (treating a sale ef- Extenders Act, at 137; Code Secs. 3406(f)
Comments,” at 19. fected by a broker at an office outside the and 6103.
33
Code Sec. 1471(d)(1)(A). United States as a sale effected by a broker 105
New Code Sec. 1474(c)(2); Staff of the Joint
34
KPMG Web cast, at 1. at an office inside the United States if the Committee Technical Explanation for the
35
Code Sec. 1473(3). customer has opened an account with a U.S. Extenders Act, at 137.
36
RBC Comments, at 6. office of that broker or a U.S. office of the 106
New Code Sec. 1474(e)(1); Code Secs.
37
Mary Richardson, Foreign Account Tax broker negotiates the sale with the customer 3406(f), 7431.
Compliance (“FATCA”), Alternative Invest- or receives instructions with respect to the 107
Notice 2009-93, IRB 2009-51, 863.
ment Management Association, June 29, 2010 sale from the customer), and 1.6049-5(c) 108
Comments on Notice 2009-93 Concerning
(hereinafter cited as “AIMA Comments”). (5)((i)(F) (treating U.S. branches of foreign the Pilot Program to Truncate Taxpayer Iden-
38
UCITS branded paper has been used in this banks as U.S. payors or U.S. middlemen tification Numbers on Certain Payee State-
scenario but privately placed debt would be for purposes of interest payment reporting ments, ABA Tax Section (July 22, 2010).
another example. requirements. 109
New Code Sec. 1474(d); Staff of the Joint
39
RBC Comments, at 11–13. 72
RBC Comments, at 15. Committee Technical Explanation for the
40
RBC Comments, at 8–11. 73
Code Sec. 1471(b)(1)(A) and (c). Extenders Act, at 137.
41
RBC Comments, at 20–22. 74
Code Sec. 1471(b)(1)(F). 110
Compare Act Sec. 101(b) of FATCA to Act
42
AIMA Comments. 75
Code Sec. 1471(a); Code Sec. 1471(d)(6). Sec. 501(d) of the Extenders Act.
43
Code Sec. 1471(c)(1). 76
Code Sec. 1471(b)(1)(F)(ii). 111
Staff of the Joint Committee Technical Expla-
44
Code Sec. 1471(d)(1)(A). 77
Code Sec. 1471(b)(3). nation for the Extenders Act, at 137.
45
Code Sec. 1471(d)(3). 78
Code Sec. 1471(b)(1)(D)(i), (d)(7). 112
SIFMA Comments, at 9.
46
Code Sec. 1473(2)(B). 79
Code Sec. 1471(b)(3)(C)(i), (ii). 113
New Code Sec. 1474(f); Staff of the Joint
47
Code Sec. 1473(2)(A). 80
Code Sec. 1471(b)(3)(C)(ii). Committee Technical Explanation for the
48
Code Sec. 1471(d)(1)(A). 81
Code Sec. 1471(d)(7). Extenders Act, at 137.
49
Code Sec. 1471(d)(1)(B)(ii). 82
Code Sec. 871(a)(1)(A). Reg. §1.861-2(a) 114
ABA Tax Section Comments, at 11.
50
Code Secs. 1471(d)(1)(A), (d)(3), 1473(2)(A) (1). 115
See Act Sec. 501(d)(1) of the Extenders
(i)–(iii). 83
Code Sec. 871(a)(1)(A). Reg. §1.861-3. Act; Staff of the Joint Committee Technical
51
Code Sec. 1473(2)(B). 84
Code Sec. 1471(b)(3). Explanation for the Extenders Act, at 138.
52
Code Sec. 1471(d)(2). 85
Code Sec. 1474(b)(1). 116
See Act Sec. 501(d)(2) of the Extenders
53
Code Sec. 1472(b). 86
Code Sec. 7701(b); (a)(30), (a)(4). Act; Staff of the Joint Committee Technical
54
Code Sec. 1471(c) 87
Code Sec. 1471(d)(3). An FFI has a zero- Explanation for the Extenders Act, at 138.
55
Code Sec. 1472(b). percent ownership threshold for a specified 117
Act Sec. 101(d)(2)(B) of FATCA.
56
Code Sec. 1471(b)(1)(B). U.S. person to be a substantial U.S. owner— 118
Sullivan & Cromwell Comments, at 7, foot-
57
Code Sec. 1472(b). Code Sec. 1473(2)(B). notes 12, 13.
58
Code Sec. 1471(b)(1)(E). 88
Code Sec. 1474(b)(2)(A). 119
Notice 97-34, 1997-1 CB 422.
59
Code Sec. 1471(b)(1)(F). 89
Code Sec. 1473(1). 120
Staff of the Joint Committee Technical Ex-
60
Code Sec. 1471(a), (b)(3). 90
Code Sec. 1471(d)(5). planation for the Extenders Act, at 138; JCT
61
Code Sec. 1472(a). 91
Code Sec. 1472(d). Explanation, at 49.
62
Code Sec. 1471(b). 92
Code Sec. 1472(b). 121
See Act Sec. 101(d)(1) of FATCA; Staff of the
63
Code Sec. 1471(e). 93
Code Sec. 1473(2)(A). Joint Committee Technical Explanation for

Taxes—The Tax Magazine® 123

New U.S. Withholding System for Foreign Account Tax Compliance
FATCA, at 23.
122
See Act Sec. 101(d)(2) of FATCA; Staff of the
Joint Committee Technical Explanation for
FATCA, at 23.
123
NYSBA Tax Section Comments, at 10–11.
124
EBF FATCA Comments.
125
ABA Tax Section Comments, at 11.
126
SIFMA Comments, at 3.
127
EBF/IIB Comments at 24–27.
128
31 CFR §103.27(c). The $10,000 threshold
is the aggregate value of all of foreign finan-
cial accounts in which a U.S. person has a
financial interest over which the U.S. person
has signature or other authority.
129
IRM §4.26.16.3.2(1)(A–D). For an expanded
explanation of the FBAR filing requirements,
see Dean Marsan, FBAR Reporting Obliga-
tions, Enforcement Exposures and Managing
the Risk: What Every Tax and Compliance
Advisor Needs to Know Now! Taxes, Nov.
2009, at 35.
130
New Code Sec. 6038D(a).
131
New Code Sec. 6038D(b).
132
New Code Sec. 6038D(c).
133
Marylouise Serrato and Jackie Bugnion,
Comments on Foreign Account Tax Compli-
ance Act (FATCA) Provisions incorporated in
the Hiring Incentives to Restore Employment
Act (HIRE), American Citizens Abroad, June
14, 2010 (hereinafter “ACA Comments”).
134
Id.
135
New Code Sec. 6038D(h).
136
Act Sec. 511(c) of the HIRE Act.
137
Code Sec. 1297.
138
Code Sec. 1291.
139
Code Secs. 1293–1295.
140
Code Sec. 1296.
141
See Instructions to IRS Form 8621. Accord-
ing to the Form, reportable elections include
the following: (i) an election to treat the PFIC
as a QEF; (ii) an election to recognize gain
on the deemed sale of a PFIC interest on the
first day of the PFIC’s tax year as a QEF; (iii)
an election to treat an amount equal to the
shareholder’s post-1986 earnings and profits
of a CFC as an excess distribution on the
first day of a PFIC’s tax year as a QEF that is
also a controlled foreign corporation under
Code Sec. 957(a); (iv) an election to extend
the time for payment of the shareholder’s
tax on the undistributed earnings and profits
of a QEF; and (v) an election to treat as an
excess distribution requirements for certain
PFIC shareholders, which is contingent upon
the issuance of regulations. See Code Sec.
1291(e) by reference to Code Sec. 1246(f).
Although the Treasury issued proposed
regulations in 1992 requiring U.S. persons
to file annually Form 8621 for each PFIC
of which the person is a shareholder dur-
ing the tax year, such regulations were not
finalized and current IRS Form 8621 requires
reporting only based on one of the triggering
events described above. See Proposed Reg.
§1.1291-1(i).
142
Notice 2010-34, IRB 2010-17, Apr. 6,
124
2010.
143
Code Secs. 871, 881, 1441, 1442.
144
Code Secs. 871, 881, 1441, 1442; Reg.
§1.1441-1(b). For purposes of the with-
holding tax rules applicable to payments to
nonresident alien individuals and foreign
corporations, a withholding agent is defined
broadly to include any U.S. or foreign per-
son that has the control, receipt, custody,
disposal or payment of an item of income
of a foreign person subject to withholding.
Reg. §1.1441-7(a).
145
Reg. §1.863-7(b)(1).
146
Reg. §1.861-3(a)(6).
147
Code Sec. 861(a)(2).
148
Reg. §1.863-7(b)(1). A notional principal
contract is a financial instrument that pro-
vides for the payment of amounts by one
party to another at specified intervals calcu-
lated by reference to a specified index upon
a notional principal amount in exchange for
specified consideration or a promise to pay
similar amounts. Reg. §1.446-3(c)(1).
149
Reg. §1.861-3(a)(6). This regulation de-
fines a “substitute dividend payment” as a
payment made to the transferor of a secu-
rity in a securities lending transaction or a
sale-repurchase transaction, of an amount
equivalent to a dividend distribution which
the owner of the transferred security is
entitled to receive during the term of the
transaction.
150
For purposes of the imposition of the 30-
percent withholding tax, substitute dividend
payments (and substitute interest payments)
received by a foreign person under a securi-
ties lending or sale-repurchase transaction
have the same character as dividend (and
interest) income received in respect of the
transferred security. Reg. §1.871-(7)(b)(2),
1.881-2(b)(2).
151
Notice 97-66, 1997-2 CB 328 (Dec. 1,
1997).
152
Department of the Treasury, General Expla-
nations of the Administration’s Fiscal Year
2010 Revenue Proposals, May 2009, at
37.
153
Proposed new Code Sec. 871(l)(2) of FATCA;
Staff of the Joint Committee Technical Expla-
nation for FATCA, at 61.
154
Id.
155
Securities Industry Financial Markets Asso-
ciation Comments on FATCA to the House
Ways and Means Committee and Senate
Finance Committee dated November 19,
2009 (hereinafter referred to as SIFMA Com-
ments on FATCA), at 3–4.
156
SIFMA Comments on FATCA, at 4.
157
SIFMA Comments on FATCA, at 4–5.
158
SIFMA Comments on FATCA, at 4, footnote
4, provides:
When the final regulations under
Code Sec. 1441 were issued in 1997,
the Treasury Department recognized
this difficulty and decided to limit
the withholding obligation where
the payor does not have custody or
control over property owned by the
recipient. In the Preamble to the final
regulations, the Treasury Department
explained that: “[s]everal comments
were received regarding the difficulty
for a withholding agent to withhold
on an amount of income that is not
represented by cash or property (i.e.,
deemed payments of income). The
final Treasury regulations in §1.1441-
2(d) provide relief in cases in which
the withholding agent does not have
custody of, or control over, property
...” T.D. 8734 (Oct. 6, 1997). Presum-
ably in response to such comments,
the final Treasury regulations §1.1441-
2(d)(1) provide that “[a] withhold-
ing agent who is not related to the
recipient or beneficial owner has an
obligation to withhold under Code
Sec. 1441 only to the extent that … it
has control over, or custody of money
or property owned by the recipient or
beneficial owner from which to with-
hold an amount …”
159
SIFMA Comments on FATCA, at 5, footnote
5 provides, “The 30 percent tax on FDAP
is imposed only upon a disposition of, or a
distribution on, an original issue discount
obligation.” Code Sec. 871(a)(1)(C), Reg.
§1.1441-2(b)(3).
160
SIFMA Comments on FATCA, at 5, footnote
6 provides, “When the regulations under
Code§1441 were finalized in October 1997,
their effective date was initially set for Janu-
ary 1, 1999.” T.D. 8734 (Oct. 6, 1997). The
Treasury Department later extended the ef-
fective date to January 1, 2000, explaining
that “[t]he Department of the Treasury and
the IRS believe it is in the best interest of tax
administration to extend the effective date of
the final withholding regulations to ensure
that both taxpayers and the government can
complete changes necessary to implement
the new withholding regime.” T.D. 8804
(Dec. 31, 1998). The effective date of these
regulations was then extended once again
to January 1, 2001, which is more than three
years after their original issue date. T.D. 8856
(Dec. 30, 1999).
161
SIFMA Comments on FATCA, at 5, footnote
7 provides:
More specifically, to build an equity
swap withholding system would pre-
sumably require at least the following:
(i) allocation of a significant amount
of information technology resources
which requires budgeting and man-
agement approval (ii) the creation of
a project plan (iii) implementation of
a project plan that would involve the
following human resources: techni-
cal tax, tax operations, information
technology, settlement operations,
business, legal, and controlling. (iv)

preparation of a business require-
ments document (v) creation of the
functional specifications (vi) infor-
mation technology programming
(vii) testing. In addition to creating
the withholding tax module for the
swap payment system, there needs
to be an integration of the swap
payment system with the front-office
systems, the general ledger for book-
ing and controlling the withholding
tax liabilities and the payments of the
withheld tax to the IRS, the creation
of a 1042-S reporting module, and a
reconciliation process between the
withheld taxes and the 1042-S report-
able amounts.
162
SIFMA Comments on FATCA, at 3.
163
Proposed Code Sec. 871(l)(2)(B)(i)–(vi) under
FATCA; Staff of the Joint Committee Techni-
cal Explanation for FATCA, at 61.
164
Staff of the Joint Committee Technical Expla-
nation for FATCA, at 61.
165
SIFMA Comments on FATCA, at 2–3 and
6–7.
166
Notice 97-66. Specifically, U.S. withhold-
ing tax on a substitute dividend payment is
limited to the amount of substitute dividend
multiplied by a rate equal to the excess, if
any, of the U.S. withholding tax rate that
would have been imposed on the recipient
of the substitute payment, if the recipient
had received the actual dividend payment
directly, over the same rate applicable to the
payor of the substitute payment. This amount
is further reduced by actual withholding
tax imposed on the underlying dividend or
substitute dividend payments (if any) earlier
in a chain of securities lending transactions.
Notice 97-66, §3.
167
On November 17, 2009, at the Wall Street
Tax Association Fall Tax Seminar, David
Miller, Esq. from Cadwalader Wickersham
& Taft compared the FATCA and Green Book
Proposals to avoid the withholding tax for
equity swaps.
168
New Code Sec. 871(l)(7).
169
Green Book 2011 Proposal, at 48.
170
Act Sec. 541(b) of the Extenders Act.
171
Act Sec. 841(b) of the HIRE Act.
172
William Young, Rom P. Watson and Robert
Church, Securities Lending, Repos, and
Derivatives after FATCA, Executive Enter-
prise Institute 22nd Annual Forum on Inter-
national Tax Withholding and Information
Reporting, June 17–18, 2010 (New York,
New York).
173
New Code Sec. 871(l)((3)(B) of the HIRE
Act.
174
New Code Sec. 871(l)(3)(B); Staff of the Joint
Committee Technical Explanation for the
Extenders Act, at 169.
175
New Code Sec. 871(l)(1);Staff of the Joint
Committee Technical Explanation for the
Extenders Act, at 168.
176
Staff of the Joint Committee Technical Expla-
Taxes—The Tax Magazine®
nation for the Extenders Act, at 168.
177
Id.
178
Id.
179
New Code Sec. 871(l)(3)(A)(i).
180
New Code Sec. 871(l)(3)(A)(ii).
181
New Code Sec. 871(l)(3)(A)(iii); Cadwalader
HIRE Act Memo at footnote 16: “For this
purpose, an index or fixed basket of securi-
ties will be treated as a single security. The
JCT Report provides such a security will be
treated as regularly traded on an established
securities market only if every component
of the index or fixed basket is a security
that is regularly tradable on an established
securities market. See JCT Report, p.79.”
182
New Code Sec. 871(l)(3)(A)(iv).
183
New Code Sec. 871(l)(3)(A)(v).
184
New Code Sec. 871(l)(4)(A); Staff of the Joint
Committee Technical Explanation for the
Extenders Act, at 169.
185
New Code Sec. 871(l)(4)(B); Staff of the Joint
Committee Technical Explanation for the
Extenders Act, at 169.
186
New Code Sec. 871(l)(4)(C); Staff of the Joint
Committee Technical Explanation for the
Extenders Act, at 169.
187
Id.
188
Staff of the Joint Committee Technical Expla-
nation for the Extenders Act, at 169.
189
New Code Sec. 871(l)(5); Staff of the Joint
Committee Technical Explanation for the
Extenders Act, at 169.
190
Staff of the Joint Committee Technical Expla-
nation for the Extenders Act, at 169.
191
Id.
192
New Code Sec. 871(l)(6).
193
Notice 97-66, 1972-2 CB 328.
194
Staff of the Joint Committee Technical Expla-
nation for the Extenders Act, at 169.
195
New Code Sec. 871(l)(7); Staff of the Joint
Committee Technical Explanation for the
Extenders Act. at 169–70.
196
Staff of the Joint Committee Technical Expla-
nation for the Extenders Act, at 170.
197
Cadwalader HIRE Act Memo, at 13–14.
198
Section 2(d)(i)(4) of the ISDA Master Agree-
ment.
199
Section 5(b)(ii) and 6(b)(iv) of the ISDA Mas-
ter Agreement generally provide a party the
right to terminate a swap if, as the result of a
change in law (which generally includes the
enactment or change of any law or change
in the application or official interpretation
of any law) after the date on which the
swap was entered into, there is a substantial
likelihood that the party will be required to
pay the other party a gross-up payment in
respect of taxes on the next scheduled pay-
ment date.
200
Section 6(b)(i) of the ISDA Master Agree-
ment.
201
Section 6(b)(ii) of the ISDA Master Agree-
ment.
202
Cadwalader HIRE Act Memo, at 13–14,
footnote 21 provides, “We do not believe
that a transfer will successfully mitigate the
September 2010
withholding imposed by the [HIRE] Act.”
203
Section 6(b)(ii) of the ISDA Master Agree-
ment.
204
Section 6(b)(iv) of the ISDA Master Agree-
ment.
205
T.D. 8735, 1997-2 CB 72, 62 FR 53498
(1997).
206
Reg. §§1.871-7(b) and 1.881-2(b)(2).
207
See JCT Report, at 78, footnote 317, which
provides, in part:
See United States Senate, Permanent
Subcommittee on Investigations,
Committee on Homeland Security
and Governmental Affairs, Dividend
Tax Abuse: How Offshore Entities
Dodge Taxes on U.S. Stock Divi-
dends, Staff Report (September 11,
2008), pages 18–20, 22–23, 40, 47,
52. In the Obama Administration’s
fiscal year 2010 budget, the Treasury
Department has announced that, to
address the avoidance of U.S. with-
holding tax through the use of secu-
rities lending transactions, it plans
to revoke Notice 97-66 and issue
guidance that eliminates the benefits
of those transactions but minimizes
over withholding. Department of the
Treasury, General Explanations of
the Administration’s Fiscal Year 2010
Revenue Proposals, 2009, p.37.
208
Code Sec. 871(l)(2)(A).
209
P.L. 111-152, 111 Cong. (Mar. 30, 2010).
210
These regulations will coordinate the tax
imposed on substitute payments under
Code Sec. 871(l) and Reg. §§1.871-7(b)(2)
and 1.881-2(b)(2) with the withholding and
reporting requirements under Code Secs.
1441, 1442 and 1461 and the regulations
there under to ensure that the appropriate
amount of tax is paid and reported.
211
Code Sec. 163(a).
212
An obligation is treated as in registered form
if (i) it is registered as to both principal and
interest with the issuer (or its agent) and
transfer of the obligation may be effected
only by surrender of the old instrument
and either the reissuance by the issuer of
the old instrument to the new holder or the
issuance by the issuer of a new instrument
to the new holder; (ii) the right to principal
and stated interest on the obligation may
be transferred only through a book entry
system maintained by the issuer or its agent;
or (iii) the obligation is registered as to both
principal and interest with the issuer or its
agent and may be transferred through both of
the foregoing methods. Reg. §5f.103-1(c).
213
Code Sec. 163(f)(2)(A). The registration
requirement is intended to preserve li-
quidity while reducing opportunities for
noncompliant taxpayers to conceal income
and property from the reach of the income,
estate and gift taxes. See Joint Committee
on Taxation, General Explanation of the
Revenue Provisions of the Tax Equity and
125
New U.S. Withholding System for Foreign Account Tax Compliance
Fiscal Responsibility Act of 1982 (JCS-38-
82), Dec. 31, 1982, at 190.
214
LTR 9343018 (July 29, 1993); LTR 9343019
(July 29, 1993); LTR 9613002 (Mar. 29,
1996). The IRS held that the registration
requirement may be satisfied by “demate-
rialized book-entry systems” developed in
some foreign countries, even if, under such
a system, a holder is entitled to receive a
physical certificate, tradable as a bearer
instrument, in the event the clearing orga-
nization maintaining the system goes out of
existence, because “cessation of operation
of the book-entry system would be an ex-
traordinary event.” Notice 2006-99, 2006-2
CB 907.
215
Code Sec. 163(f)(2)(B).
216
Code Sec. 4701.
217
Code Sec. 1287.
218
Code Sec. 1287.
219
Code Secs. 871, 881; Reg. §1.1441-1(b).
Generally, the determination by a withhold-
ing agent of the U.S. or foreign status of a
payee and of its other relevant characteristics
(e.g., as a beneficial owner or intermediary,
or as an individual, corporation or flow-
through entity) is made on the basis of a
withholding certificate that is a Form W-8
or a Form 8233 (indicating foreign status
of the payee or beneficial owner) or a Form
W-9 (indicating U.S. status of the payee).
220
Code Secs. 871(h) and 881(c). Congress
believed that the imposition of a withholding
tax on portfolio interest paid on debt obliga-
tions issued by U.S. persons might impair the
ability of U.S. corporations to raise capital
in the Eurobond market (i.e., the global
market for U.S. dollar-denominated debt
obligations). Congress also anticipated that
repeal of the withholding tax on portfolio
interest would allow the Treasury Depart-
ment direct access to the Eurobond market.
See Joint Committee on Taxation, General
Explanation of the Revenue Provisions of the
Deficit Reduction Act of 1984 (JCS-41-84),
Dec. 31, 1984, at 391–92.
221
In repealing the 30-percent tax on portfolio
interest, under the Deficit Reduction Act of
1984, Congress expressed concern about
potential compliance problems in connec-
tion with obligations issued in bearer form.
Given the foreign targeted exception to the
registration requirement under Code Sec.
163(f)(2)(A), U.S. persons intent on evading
U.S. tax on interest income might attempt to
buy U.S. bearer obligations overseas, claim-
ing to be foreign persons. These persons
might then claim the statutory exemption
from withholding tax for the interest paid
on the obligations and fail to declare the
interest income on their U.S. tax returns,
without concern that their ownership of the
obligations would come to the attention of
the IRS. Because of these concerns, Congress
expanded the Treasury’s authority to require
registration of obligations deigned to be
126
sold to foreign persons. See Joint Commit-
tee on Taxation, General Explanation of the
Revenue Provisions of the Deficit Reduction
Act of 1984 (JCS-41-84), Dec. 31, 1984, at
393.
222
Code Sec. 871(h)(3).
223
Code Sec. 871(h)(4).
224
Code Sec. 881(c)(3)(C)
225
Code Sec. 881(c)(3)(A).
226
31 USC §3121(g)(3). For purposes of Title 31
of the U.S. Code, “registration-required ob-
ligation” is defined as any obligation except
(i) an obligation not of a type offered to the
public; (ii) an obligation having a maturity
(at issue) of not more than one year; or (iii)
a foreign targeted obligation.
227
31 USC §3121(g)(2).
228
ABA Tax Section Comments, at 3–4.
229
ABA Tax Section Comments, at 17–20.
230
ABA Tax Section Comments, at 18, footnote
21 provides: “See PLR 9343018-9 (July 29,
1993); PLR 9613002 (March 29, 1996);
Notice 2006-99, 2006-2 CB 907.“ See Reg.
§1.163-5(c)(2)(i)(C) and (D).
231
ABA Tax Section Comments, at 18, footnote
22 provides, “Reg. §§1.163-5(c)(2)(i)(C) and
(D).”
232
ABA Tax Section Comments, at 18, footnote
23 provides:
Under applicable Treasury regula-
tions, an obligation is “in registered
form” if (1) it is registered with the
issuer or its agent as to principal and
stated interest, and transfer may be
effected only by surrender of the old
instrument and the issuance of a new
instrument or reissuance of the old
instrument to the new holder; (2) the
right to principal and stated interest
may be transferred only through a
book entry system maintained by the
issuer or its agent; or (3) it is registered
with the issuer or its agent as to prin-
cipal and stated interest, and transfer
may be effected through both of the
preceding methods.
233
ABA Tax Section Comments, at 19, footnote
24 provides, “For this purpose, a lower
ownership than provided in Code Sec. 957
might be appropriate.”
234
SIFMA Comments on FATCA, at 4.
235
SIFMA Comments on FATCA, at 4–5.
236
SIFMA Comments on FATCA, at 4, footnote
8 provides: “Section 102(d) and 101(d)(2)
(A) of the Bill.”
237
SIFMA Comments on FATCA, at 4, footnote 9
provides: “Section 101(d)(2)(B) of the Bill.”
238
Green Book 2011 Proposals, at 56–57.
239
New Foreign Account Tax Compliance Rules
Under the Hiring Incentives to Restore Em-
ployment (HIRE) Act, Shearman & Sterling
Client Publication, Tax, Mar. 26, 2010.
240
Such obligations would need to meet the
following requirements: (i) the obligation
would need to be issued under arrange-
ments “reasonably designed to ensure” that
the obligation will not be sold (or resold)
in connection with the original issue to a
U.S. person; (ii) interest on the obligation
would need to be payable only outside the
United States and its possessions; and (iii)
the obligation would need to be legended.
Currently, a bearer bond issued in compli-
ance with the TEFRA C rules is exempted
from the legending requirement.
241
See Sullivan and Cromwell, Revised FATCA
Plus Carried Interest Taxation Comments
dated December 11, 2009 (hereinafter
referred to as “Sullivan and Cromwell
Comments”), at 11, footnote 25 provides,
”It is unclear how these provisions will ap-
ply to foreign entities that apportion their
worldwide interest expense to their U.S.
branches or to entities that are controlled
foreign corporations or PFICs for purposes
of computing their earnings and profits and
their U.S. shareholders subpart F income.”
242
Under Code Sec. 163(f)(2(B), interest must
be payable outside the U.S. and its posses-
sions, a legend must appear on he obligation
stating that a U.S. person who holds the ob-
ligation will be subject to limitations under
U.S. income tax laws and “arrangements
reasonably designed to ensure that such
obligation will be sold (or resold in connec-
tion with the original issue) only to a person
who is not a U.S. person,” must be in place.
See also Code Secs. 871(h)(2) and 881(c)
(2)(A). This exemption, however, does not
eliminate all sanctions on holders of foreign-
targeted” bearer form obligations. In general,
any gain recognized by a U.S. holder of a
bearer form obligation that would have been
a “registration-required obligation” had it
not been issued in compliance with the
foreign-targeting rules is treated as ordinary
income (see Code Sec. 1287); and owners of
such of such foreign-targeted obligations are
not permitted to claim loss deductions on
the sale or exchange of the instrument. See
Code Sec. 165(j). See Sullivan and Cromwell
Comments, at 10.
243
HIRE Act’s Foreign Account Tax Compliance
Provisions, King & Spalding Alert—Tax Prac-
tice Group (Mar. 26, 2010).
244
By reason of cross references, this rule will
also apply to Code Secs. 165(j), 312(m),
871(h), 881(c), 1287 and 4701.
245
The issuance of physical certificates in
bearer form in the event that the book entry
system goes out of existence would be an
extraordinary event that is not in the ordinary
course of business. Notice 2006-99, 2006-2
CB 907. Sullivan & Cromwell Comments, at
11, footnote 26 provides, “We note, how-
ever, that dematerialized obligations issued
on or after January 1, 2007 are generally
considered to be in registered form under
current IRS practice. See Notice 2006-99,
2006-2 CB 907.“
246
Notice 2006-99, 2006-2 CB 907. The IRS
will generally treat dematerialized obliga-
 September 2010

tions issued after December 31, 2006, as or more U.S. persons have the authority to 287
Tax ID number with respect to a reportable
being in registered form. control all substantial decisions of the trust. payment. See Pub. 15 and Pub. 1281 for
247
Sullivan & Cromwell Comments, at 11. Code Sec. 7701(a)(30)(E). more information on Form 945.
248
NYSBA Tax Section Comments, at 13–15. 267
Code Sec. 679(a)(1). This rule does not ap- 288
See IRM §25.6.22 and IRS Publication 1035
249
NYSBA Tax Section Comments, at 14, foot- ply to transfers to trusts established to fund for more details.
note 5 provides: certain deferred compensation plans trusts 289
Rev. Proc. 2004-59, IRB 2004-42, 678.
In this regard, the use of the term “de- or to trusts exempt under Code Sec. 501(c) 290
IRM §4.10.21.7.
materialized obligation” may not be (3). 291
IRM §4.10.21.8.
technically correct. It is apparent from 268
Code Sec. 679(a)(2). 292
IRM §4.10.21.8.1.
the legislative history that the term 269
Code Sec. 679(c)(1). 293
IRM §4.10.21.8.1.1.
was meant to include obligations that 270
Code Sec. 6048(a). 294
IRM §4.10.21.8.1.2.
are in “global” bearer form, i.e., are 271
Code Sec. 6048(b)(1). 295
Id.; Form 1042-S instructions for Income,
represented by a single global note in 272
Code Secs. 7701(a)(30(E), (31)(B). In addi- Exemption and Recipient codes and other
bearer form that is held by a financial tion, for purposes of Code Sec. 6048, the application form requirements; Pub. 515 for
institution for the account of the obli- IRS can classify a trust as foreign if it “has tax rates.
gation’s various beneficial owners and substantial activities or holds substantial 296
IRM §4.10.21.8.2.
that trades through notations made in property outside the United States.” Code 297
IRM §4.10.21.8.2.1.
the records of the financial institution. Sec. 6048(d)(2). 298
Id.
As a technical matter, such global 273
Code Sec. 6048(a). 299
Reg. §1.1441-7(b)(1) defines the standards
securities are not usually covered by 274
Code Sec. 6048(c). the withholding agent must apply to deter-
the term “dematerialized”. Perhaps 275
Code Sec. 6048(b). mine the correct reporting under Code Secs.
another term, “book-entry” securities, 276
Code Sec. 6677(a). 1441–1443.
for example, could be used in the 277
Code Sec. 6677(c). 300
IRM §4.10.21.8.2.1.
statute, or the legislative history could 278
Code Sec. 6677(b). 301
IRM §4.10.21.8.3.
stat e that “global” securities would 279
Code Sec. 6677(a). 302
Reg. §1.1441-7(b).
be considered “dematerialized” for 280
Id. 303
IRM §4.10.21.8.3.2.
this purpose. 281
Rev. Proc 2000-12, 2000-1 CB 387. 304
IRM §4.10.21.8.3.3; see Reg. §1.1441-1(b)
250
Reg. §1.163-5(c)(1)(ii)(B). 282
Form 945, Annual Return of Withheld Fed- (3) and Code Sec. 1461 for further details.
251
Code Sec. 643(i)(2)(C). eral Income Tax, is used to report withheld 305
IRM §4.10.21.8.3.3.1.
252
Code Sec. 643(i)(2)(D). federal income tax from certain nonpayroll 306
Reg. §1.1441-1(b)(3)(iii).
253
Code Sec. 643(i)(3). payments, including gambling, IRAs and 307
Reg. §1.1441-1(b)(3)(iii)(A).
254
Code Sec. 643(i)(2)(B) treats a person as a pensions. Another type of nonpayroll pay- 308
See Reg. §1.1441-5(d) for more details
related person if the relationship between ment is backup withholding. Backup with- on partnerships’ presumption rules. If the
such person would result in a disallow- holding is required when a Form 1099 is partnership is presumed to be foreign, it is
ance of losses under Code Secs. 267 or missing a tax ID number. not the beneficial owner of the income paid
707(b) broadened to include the spouses 283
Form 1042—This is the income tax return for to it. If the partnership is presumed to be
of members of the family described in such reporting the liability for NRA withholding domestic, it is a U.S. nonexempt recipient
sections. tax, the amounts withheld, the reportable for backup withholding/Form 1099 report-
255
A trust is a foreign trust if it is not a U.S. amounts paid to foreign persons and any ing purposes. Also, a payment is generally
person under Code Sec. 7701(a)(31)(B). A credit claimed for amounts withheld by presumed made to a foreign payee if the
trust is a U.S. person if (i) a U.S. court is other withholding agents. This return is due payment is made outside the United States
able to exercise primary supervision over on March 15 (or the next business day if the to an off-shore account and the withhold-
the administration of the trust, and (ii) one 15th falls out on a nonbusiness day) of the ing agent does not have actual knowledge
or more U.S. persons have the authority to following year. All Forms 1042 are required that the payee is a U.S. person. See Reg.
control all substantial decisions of the trust. to be filed on a calendar-year basis, and §§1.1441-1(b)(3)(iii)(D) and 1.6049(d)(2)
Code Sec. 7701(a)(30)(E). consolidation of separate legal entities for and (3).
256
Code Sec. 679(a)(1). This rule does not ap- Form 1042 filing purposes is not permitted. 309
Reg. §1.1441-5(d)(3).
ply to transfers to trusts established to fund For Forms 1042 filed on or before April 15 310
Reg. §1.1441-1(b)(7)(i).
certain deferred compensation plans trusts following the end of the calendar year cov- 311
Code Sec. 1463.
or to trusts exempt under Code Sec. 501(c) ered by the form, Form 1042 is considered 312
IRM §4.10.21.8.3.4.
(3). filed on April 15 for purposes of determining 313
IRM §4.10.21.8.4.1; Reg. §1.1441-7(b)(4).
257
Code Sec. 679(a)(2). the statute of limitations on assessment. See 314
IRM §4.10.21.8.4.2.
258
Code Sec. 679(c)(1). Code Sec. 6501(b)(2). 315
IRM §4.10.21.8.4.3.
259
Reg. §1.679-2(a)(2)(i). 284
Form 1042-S—This is an information report- 316
IRM §4.10.21.8.4.4; Reg. §1.1441-7(b)(5).
260
Reg. §1.679-2(a)(2)(ii). ing form that a withholding agent files with 317
Reg. §1.1441-6(b).
261
Reg. §1.679-2(a)(4)(i). the IRS and issues to each foreign recipient 318
Reg. §1.1441-1(e)(2)(ii).
262
Reg. §1.679-2(a)(4)(ii). (NRA) of a reportable amount. It shows, 319
IRM §4.10.21.8.4.4.1 and 2; IRS Publication
263
“Undistributed net income” is defined in among other things, the amount and type 515.
Code Sec. 665(a). of income paid to the recipient, the tax 320
IRM §4.10.21.8.4.4.3.
264
Code Sec. 679(b). withheld, and any applicable withholding 321
IRM §4.10.21.8.4.5.
265
Reg. §1.679-2(c)(1). exemption. Form(s) 1042-S should have the 322
For a more thorough treatment of statisti-
266
A trust is a foreign trust if it is not a U.S. same due date as the Form 1042. cal sampling audit techniques, see IRM
person under Code Sec. 7701(a)(31)(B). A 285
For further guidance on backup withholding, §4.47.3.
trust is a U.S. person if (i) a U.S. court is see Code Sec. 3406 and IRS Publication 323
IRM §4.10.21.8.5.
able to exercise primary supervision over 1281. 324
IRM §4.10.21.8.6.
the administration of the trust, and (ii) one 286
IRM §4.10.21.5. 325
IRM §4.10.21.8.7.

Taxes—The Tax Magazine® 127

New U.S. Withholding System for Foreign Account Tax Compliance

326
Reg. §1.1441-3(c)(4)(i)(C). this question—Greenberg Traurig Comments, qualified electing fund; 8865—return of U.S.
327
Code Sec. 1445(e)(6) and Reg. §1.1445-8. at 6, footnote 24. Also see footnote 23, which persons with respect to certain foreign part-
328
IRM §4.10.21.8.7.1. provides for Situation 1; “The Model IDR for nerships; and 3520—annual return to report
329
IRM §4.10.21.8.7.2. Withholding Strategy 1” asks financial insti- transactions with foreign trusts and receipt of
330
IRM §4.10.21.8.7.3. tutions to identify transactions in which they certain foreign gifts.
331
IRM §4.10.21.8.7.4. acquired stock five business days prior to a 385
JCT Explanation, at 47.
332
IRM §4.10.21.8.7.5. dividend record date if the financial institu- 386
T.D. 8850, 2000-1 CB 265 (Jan. 10, 2000).
333
Code Sec. 881(c)(3)(A). tion entered into an equity swap within such 387
Technical Explanation of the Revenue
334
IRM §4.10.21.8.7.7. time frame. Provisions Contained in the ‘American Jobs
335
Rev. Proc. 2000-12, 2000-1 CB 387. 366
Greenberg Traurig Comments, at 4. and Closing Tax Loopholes Act of 2010, for
336
IRM §4.10.21.8.7.8; Rev. Proc. 2003-64, IRB 367
IDD Attachment 6. Consideration of the Floor of the House of
2003-32, 306. 368
Id.; Greenberg Traurig Comments, at 5. Representatives, prepared by the Staff of the
337
IRM §4.10.21.8.7.8.1. 369
Greenberg Traurig Comments at 5–6. Joint Committee on Taxation (JCX-29-10)
338
IRM §4.10.21.8.7.8.2. 370
KPMG Tax Advisory, at 4. (hereinafter referred to as “Tax Loopholes
339
IRM §4.10.21.8.7.8.3. 371
In the event that the field examines a trans- Act Explanation”), at 257.
340
IRM §4.10.21.8.7.8.4. action in which the equity security is an 388
Id.
341
IRM §4.10.21.8.8. equity interest in a privately held partner- 389
Id.
342
IRM §4.10.21.8.8.1; Code Sec. 163(f). ship the field should seek the assistance of 390
New Code Sec. 6038D(d).
343
Reg. §1.871-14(c)(3). counsel. 391
Id.
344
IRM §4.10.21.8.8.2; Reg. §1.871-14(e). 372
IDD—LMSB-4-1209-044, impacting IRM 392
ACA Comments, at 10.
345
IRM §4.10.21.8.8.3. §4.51.5 (Jan. 14, 2010). 393
Id., at 10.
346
IRM §4.10.21.8.9. 373
Tax Management Portfolio 915-2nd, at 394
New Code Sec. 6038D(e).
347
IRM §4.10.21.9. A-118. 395
New Code Sec. 6038D(f).
348
IRM §4.10.21.9.1. 374
Reg. §1.1441-1(b)(7)(iii). 396
New Code Sec. 6038D(g).
349
IRM §4.10.21.9.3. 375
Tax Management Portfolio 915-2nd, at 397
Code Sec. 6663(a). Code Sec. 6663(b)
350
IRM §4.10.21.9.3.1. A-118. provides that if the IRS establishes that any
351
IRM §4.10.21.9.3.2. 376
Code Sec. 6501(a). Returns that are filed portion of the underpayment is attributable
352
IRM §4.10.21.9.3.3. before the date they are due are deemed to fraud, the entire underpayment of tax shall
353
Reg. §1.1441-4(a)(3). filed on the due date; Code Sec. 6501(b)(1) be treated as attributable to fraud, except for
354
Reg. §1.1441-4(a). and (2). the portion of the underpayment that the
355
IRM §4.10.21.8.7.6. 377
Code Sec. 6501(e). taxpayer establishes by a preponderance of
356
LMSB Control No. LMBS-4-1209-044, im- 378
Id. the evidence is not attributable to fraud. IRM
pacting IRM 4.51.5 (Jan. 14, 2010). 379
Code Sec. 1295 (b), (f). §9.5.13.2.2.1(1) and (2).
357
Code Secs. 1461 and 6721(a); Greenberg & 380
Extenders Act §513; Staff of the Joint Com- 398
Code Sec. 6651(f).
Traurig Comments, at 2. mittee Technical Explanation for the Extend- 399
Id.
358
Denise Schwieger, Mark Price, Dale Col- ers Act, at 153–55. 400
Code Sec. 6651(a)(2); IRM §9.5.13.2.2.4(1).
linson and Daniel Mayo, The HIRE Act and 381
JCT Explanation, at 66; Act Sec. 513 of the 401
Code Sec. 6651(a)(3).
the IRS Address Dividend Equivalent Pay- Extenders Act; Staff of the Joint Committee 402
Code Sec. 7203.
ments on Equity Swaps, KPMG Audit Tax Technical Explanation for the Extenders Act, 403
Code Sec. 6651(a)(1); IRM §9.5.13.2.2.3(1).
Advisory, Apr. 5, 2010 (hereinafter referred at 153–55. 404
Del Commercial Properties, Inc., CA-DC,
to as “KPMG Tax Advisory”). 382
Tim Tuerff, John Keenan, Heather Jurek and 2001-2 ustc ¶50,474, 251 F3d 210 (2001),
359
Id. Mike Trujillo, Significant changes to statute cert. denied, 122 SCt 903 (2002).
360
Id., at 3. of limitations under the HIRE Act, Deloitte 405
The information reporting requirements
361
In the event the field examiner examines a United States Tax Alert, Apr. 16, 2010. identified under Code Secs. 6038, 6038A,
transaction in which the equity security is an 383
These Code sections address: Code Sec. 6038D, 6046A and 6048.
equity interest in a publicly traded partner- 6038—information reporting with respect 406
New Code Sec. 6038D(d).
ship as defined in Code Sec. 7704(c), the field to certain foreign corporations; Code 407
Code Sec. 6038.
should seek the assistance of counsel. Sec. 6038A—information with respect to 408
Code Sec. 6038B.
362
The record date is the “date on which a certain foreign-owned corporations; Code 409
Code Sec. 6046.
firm’s books are closed during the process Sec. 6038B—partnerships and notice of 410
Code Sec. 6046A.
of identifying the owners of a certain class certain transfers to foreign persons; Code 411
Code Sec. 6048.
of securities for purposes of transmitting divi- Sec. 6046—returns as to organization or 412
Code Sec. 6662, as amended by Section 512
dends … . For example, only the common reorganization of foreign corporations and of the new law.
stockholders who are listed on the record as to acquisitions of their stock; Code Sec. 413
Code Sec. 6662(c); IRM §9.5.13.2.2.2(2).
date will receive the dividends that re to be 6046A—returns as to interests in foreign 414
Code Sec. 6662(d)(1)(A).
mailed on the payment date.” David L. Scott, partnerships; and Code Sec. 6048—informa- 415
Code Sec. 6662(d)(1)(B).
Wall Street Words (3rd ed. 2003). tion with respect to certain foreign trusts. 416
IRM §9.5.13.2.2.2(1).
363
A repurchase agreement is a simultaneous 384
These forms address: 5471—information re- 417
Code Sec. 6672; IRM §9.13.2.2.5(1).
agreement (whether written or otherwise) (i) turn of U.S. persons with respect to certain for- 418
Code Sec. 6694(a)(1); Notice 2009-5, IRB
to “sell” an asset, and (ii) to repurchase the eign corporations; 5472—information return 2009-3, 309.
same (or substantially similar) asset at the of a 25-percent foreign-owned U.S. corpora- 419
Code Sec. 6694(a)(3).
end of a specified period for a set price. tion or a foreign corporation engaged in a U.S. 420
Code Sec. 6694(a)(2).
364
Greenberg Traurig Comments, at 3–4. trade or business; 926—filing requirement 421
Notice 2009-5. In the case of a tax return
365
The IDD, however, makes clear that the IRS is for U. S. transferors of property to a foreign preparer, however, a written determination
asking about formula pricing and the use of corporation; 8621—return by a shareholder with a misstatement or omission of material
this pricing should be disclosed in response to of a passive foreign investment company or fact is substantial authority unless the tax

128

return preparer knew or should have known
of the misstatement or omission of material
fact when the return or claim for refund was
filed. The applicability of court cases to the
taxpayer’s situation by reason of the taxpayer’s
residence in a particular jurisdiction is not
taken into account in determining whether
there is substantial authority for a position
in accordance with Reg. §1.6662-4(d)(3)(iv)
(B). Notwithstanding the preceding sentence,
there is substantial authority for a position if
the position is supported by controlling prec-
edent of a U.S. Court of Appeals to which the
taxpayer has a right of appeal with respect to
the position. Finally, there is substantial au-
thority for a position only if there is substantial
authority on the date the return or claim for
refund is deemed prepared, as prescribed
by Reg. §1.6694-1(a)(2), or there was sub-
stantial authority on the last day of the tax
year to which the return relates. Conclusions
reached in treatises, legal periodicals, legal
opinions or opinions rendered by tax profes-
sionals (including tax return preparers) are
not authority. The authorities underlying such
expressions of opinion, if applicable to the
facts of a particular case, however, may give
rise to substantial authority for the position.
Solely for purposes of Code Sec. 6694(a),
a tax return preparer nevertheless will be
considered to have met the standard in Code
Sec. 6694(a)(2)(A) if the tax return preparer
relies in good faith and without verification
on the advice of another advisor, another tax
return preparer or other party. Factors used in
evaluating a tax return preparer’s good faith
reliance on the advice of another are found
in Reg. §1.6694-2(e)(5).
422
Code Sec. 6656.
423
Id.; Rev. Proc. 90-58, 1990-2 CB 642, am-
plified and clarified by Rev. Proc. 91-52,
1991-2 CB 781, which provides guidance as
to how federal tax deposits will be credited
for purposes of Code Sec. 6656.
424
Code Sec. 7206(1).
425
Code Sec. 7202.
426
Code Sec. 7201. In addition, the defendant
may have to pay the costs of prosecution.
427
Corporations and other organizations can
be held liable for the criminal acts of their
directors, employees or agents. In June 1999,
the U.S. Department of Justice created an
additional incentive for corporations to
implement robust compliance programs
when it instructed federal prosecutors to
This article is reprinted with the publisher’s permission from the
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Copying or distribution without the publisher’s permission is prohibited.
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consider the existence of an organization’s
compliance programs in determining to
charge an organization for the misconduct of
its employees or agents. See U.S. Attorney’s
Manual, Principles of Federal Prosecution of
Business Organizations, §9-28.800 (2008).
The Sentencing Commission in response to
a directive in the Sarbanes-Oxley Act un-
dertook a major revision to the definition of
an effective compliance program and how it
would impact a corporation’s sentence under
the Sentencing Guidelines. These revisions
reflected the public’s reaction to the corporate
frauds that had dominated the news and now
require a corporation‘s board of directors to
be knowledgeable about the content and
operations of any compliance and ethics
program and to maintain reasonable over-
sight with respect to the implementation and
effectiveness of the program. In addition, the
person assigned day-to-day operations of a
compliance and ethics program was required
to report directly to the board or an appropri-
ate subcommittee of the board. In order for a
compliance program to qualify for a sentence
reduction, there must be an effective program
to prevent and detect violations. According
to the Sentencing Guidelines, an effective
compliance program “shall be reasonably
designed, implemented and enforced so
that the program is generally effective in
preventing and detecting criminal conduct.”
See USSG §8B2.1(a)(2). See also Jeffery M.
Cross and Marc H. Kallish, The Definition of
an Effective Compliance Program Under the
Sentencing Guidelines: A Template for Use
Beyond the Guidelines, Corporate Compli-
ance and Ethics Institute 2009, Practising Law
Institute Course Handbook Series Number
B-1731 (2009); and Rebecca Walker, The
Evolution of the Law of Corporate Compli-
ance in the United States: A Brief Overview,
Corporate Compliance and Ethics Institute
2009, Practising Law Institute Course Hand-
book Series Number B-1731 (2009); and
Corporate Compliance and Ethics Institute
2009, Practising Law Institute.
428
The Qualified Intermediary, or QI, program
was intended to put the burden of informa-
tion reporting and withholding tax returns
on the foreign financial institutions that
were presumably closer to their customers
under KYC principles. The theory being
that the foreign financial institutions would
not only be in the best position to collect the
September 2010
required documentation (e.g., Forms W-8s,
W-8BENs, W-8IMYs or W-9s), but would also
be able to verify that such information about
their clients was correct. The QI would agree
to assume responsibility for obtaining docu-
mentation from its customers covered by the
QI agreement with the IRS and to substanti-
ate the status of its customers as the benefi-
cial owners of such income. However, in a
telling exception, the QI rules under current
law continue to treat a foreign corporation
as such for U.S. tax purposes, even though
it was beneficially owned by U.S. persons
(absent actual knowledge that the beneficial
owners were U.S. persons). This would hold
true even though the foreign corporation was
located in a tax haven. Under the QI regu-
lations, the foreign financial institution or
clearing house (or foreign branch or office of
a U.S. financial institution or clearing house)
would enter into a contract with the IRS,
agree to verify the identities and beneficial
ownership of its customers (and generally not
look beyond the customers’ foreign entities
in which they had an ownership interest) and
be subject to an annual audit by an external
auditor. Unless the QI had agreed to assume
the U.S. withholding responsibilities, which
was atypical, it would certify to the U.S.
withholding agent or payor as to the amount
of withholding (or reduced treaty rate) by
providing withholding rate pool informa-
tion as to the portion of each payment that
qualifies for exemption or a reduced rate
of withholding. Thus, identifying customer
information was effectively shielded from
both the IRS, as well as the U.S. withhold-
ing agent with respect to foreign persons,
although the QI was generally required
to provide Form W-9s to the withholding
agent so that it could provide 1099s to
its U.S. customers. See Reg. §1.1441-1(e)
(5); Announcement 2000-48, 2000-1 CB
1243; Reg. §1.1441-1(e)(5)(ii); Rev. Proc,
2000-12, 2000-1 CB 387, supplemented
by Announcement 2000-50, 2000-1 CB
998, and modified by Rev. Proc. 2003-64,
2003-2 CB 306; Rev. Proc. 2005-77, 2005-2
CB 1176; Rev. Proc. 2002-55, IRB 2002-35,
435; Rev. Proc. 2000-55, IRB 2002-36, 481;
Rev. Proc. 2002-35, IRB 2002-2, 1187. T.D.
8881 (May 16, 2000).
429
Jaclyn Jaeger, IRS Spotlights Cross-Border
Withholding Tax, Compliance Week, Apr. 6,
2010.
129