FATCA: Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA) is US tax legislation which forms a part of the Hiring Incentives to Restore Employment (“HIRE”) Act signed into law in the US in March 2010.

FATCA forms a new chapter, chapter 4, of the Internal Revenue Code, which is focused on strengthening information reporting and withholding compliance with respect to US persons that invest through or in non-US entities. 

Why has FATCA been introduced?

With FATCA, the U.S. Internal Revenue Service ("IRS") will be able to identify and collect tax from "US persons" who invest in US assets through non-US entities.

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Who is impacted by FATCA?

Two broad categories of entities are impacted by FATCA:

  1. Foreign Financial Institutions (FFI)
  2. Passive Non-Financial Foreign Entities (NFFE) - generally any NFFE which either (a) earns more than 50% of its gross income from US sourced withholdable payments, or (b) greater than 50% of its assets produce or are held for the production of US sourced withholdable payments.

An FFI is a foreign entity that:

  • Accepts deposits in the ordinary course of a banking or similar business. Eg:
    • Banks
    • Savings and Loan Associations
    • Credit unions
    • Co-operative banking institutions
  • As a substantial portion of its business, holds financial assets for the account of others. Eg:
    • Broker Dealers
    • Clearing Organizations
    • Trust Companies
    • Custodial banks
    • Custodian of Employee Benefit Plan
  • Is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting or trading in securities , partnership interests, commodities, or any interest in such assets (including derivatives such as forwards, futures or options). Eg:
    • Mutual Funds
    • Funds of Funds
    • ETF
    • Hedge Funds
    • Private Equity Funds
    • Venture Capital Funds
    • Sovereign Wealth Funds
    • Commodity Pools
    • Managed Funds
    • Collective Investment Vehicles
    • Life Insurance companies

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What will FFIs need to do to comply with FATCA?

FATCA requires FFIs to identify, document and report on all US persons to the IRS. In addition, FFIs must withhold, and pay to the IRS, 30% of any payments relating to US-sourced income where the payment is made to either:

  1. A non-participating FFI
  2. Recalcitrant account holders i.e. those who have not provided sufficient information to determine whether or not they are US persons or substantially owned by US persons

Such “withholdable payments” include any sources of US income that is a fixed and determinable annual or periodical payment (FDAP), for example wages, dividends, interest, rents, royalties, or the gross proceeds from the sale of US property that is capable of producing interest or dividends.

The 30% withholding tax also applies to any withholdable payment paid to a passive NFFE unless the NFFE identifies each substantial US person that owns a direct or indirect interest (generally owners with more than 10% interest), or certifies that it has no such substantial US owners. Passive NFFEs are Non Financial Foregin Entities, which derive at least 50% of their income from passive income (e.g. interest, dividends, rents and royalties) or at least 50% of their assets are assets that are held to produce such income.

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What will NFFEs need to do to comply with FATCA?

In general, in order to avoid 30% FATCA withholding, a passive NFFE (other than an excepted NFFE) must provide the withholding agent with either:

  • A certification that the NFFE does not have any substantial US owners (generally owners with more than 10% interest); or
  • The name, address, and US Taxpayer Identification Number (TIN) of each substantial US owner.

Where the passive NFFE provides information in regard to substantial US owners, the withholding agent must report that information to the IRS.

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When does FATCA come into effect?

FATCA has a staggered implementation timetable, with some requirements commencing in 2013.

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