New Individual Accounts Under FATCA IGAs

While many requirements of the Foreign Account Tax Compliance Act (FATCA) ¹For an overview of FATCA, see 6565 T.M., FATCA — Information Reporting and Withholding Under Chapter 4, I.B. have been serially postponed and aren’t yet effective, one in particular is: As of July 1, financial institutions (FIs) have been charged with opening accounts for new individual customers (“New Individual Accounts”) consistent with FATCA (or related) directives.

In essence, they must determine if the customer is a U.S. person for purposes of income taxation.

Depending on where the FI is located, one of three regimes will govern the process. U.S. FIs must continue to implement “know your customer” procedures (KYC) that have long been required, which have now been tweaked to accommodate FATCA. ²The tweaks are baked into recently revised Internal Revenue Service forms, which are (or will be) required. Foreign FIs (FFIs) in countries not subject to an intergovernmental agreement (IGA) ³For an overview of IGAs, see 6565 T.M., FATCA — Information Reporting and Withholding Under Chapter 4, IX. will follow the rules laid out in the FATCA regulations (the “FATCA Regs”). Finally, FFIs in countries subject to an IGA will follow procedures laid out in their IGA.

Uniquely, the last group is challenged to look beyond the plain meaning of the instruction they are provided. Otherwise they will find themselves collecting far more information, and analyzing it in a manner that is far more technical, than what was intended—provided that what was intended is consistent with the following analysis.

The Family of U.S. Persons–Big and Inclusive for Purposes Taxation

Individuals are taxed by the Internal Revenue Service on their worldwide income if they are U.S. citizens or resident aliens for tax purposes (collectively, “U.S. Individuals”). Consequently, the IRS is eager to know about every U.S. Individual that does or may earn income.

The IRS benefits from a robust set of reporting requirements that have long kept it informed of income U.S. Individuals earn domestically. FATCA is intended to help keep it similarly informed of income they earn abroad.

U.S. citizens are U.S. Individuals regardless of where they reside. Even a U.S. citizen that has never set foot in the Land of the Free (e.g., a person born abroad to U.S. expatriates) is fully subject to U.S. taxation on worldwide income. Resident aliens are taxed to the same extent. (In both cases, credits for taxes paid abroad may apply.) Note that an individual may be considered a resident alien for tax purposes even if he or she isn’t considered a U.S. resident for immigration law purposes.

Persons who are neither U.S. citizens nor U.S. residents for tax purposes are referred to as nonresident aliens (NRAs). They aren’t U.S. Individuals, and aren’t subject to U.S. taxation on their worldwide income.

What the IGAs Say

All model IGAs require FFIs to implement certain procedures when opening New Individual Accounts. ⁴Subject to certain de minimis exceptions. Nearly identical procedures apply across all IGAs (as per their Annex I). Among other things, FFIs are directed to:

… obtain a self-certification, which may be part of the account opening documentation, that allows the … Financial Institution to determine whether the Account Holder is resident in the United States for tax purposes ….

The IGA doesn’t elaborate on the content of the required self-certification, nor does it delimit the meaning of “determine.” It does, however, require that the meaning of U.S. Individual be “interpreted in accordance with the U.S. Internal Revenue Code” ⁵See the definition of “U.S. Person” in the various IGAs. (I.R.C.). Consequently, a diligent follower-of-instructions might be forgiven for thinking he or she must (1) obtain a self-certification, that (2) includes information sufficient to allow him or her to (3) determine whether the submitter is resident in the U.S. for tax purposes as defined by the I.R.C.

Accordingly, he or she might consult IRS Publication 519, U.S. Tax Guide for Aliens (Pub. 519). It directs non-U.S. citizens to “determine whether, for income tax purposes, you are a nonresident alien or a resident alien.” Sounds like the same inquiry, right? The analysis required by Pub. 519 is described in the better part of seven pages. Much of the discussion focuses on the “substantial presence test,” detailed as follows (as applied to the year 2013):

You will be considered a U.S. resident for tax purposes if you meet the substantial presence test for calendar year 2013. To meet this test, you must be physically present in the United States on at least:

1. 31 days during 2013, and

2. 183 days during the 3-year period that includes 2013, 2012, and 2011, counting:

a. All the days you were present in 2013, and

b. 1/3 of the days you were present in 2012, and

c. 1/6 of the days you were present in 2011.

Deeper and deeper our diligent follower-of-instructions dives through the guidance, quickly descending to the very seabed and subsoil of submarine areas. Physical presence in any of those, it turns out, must be counted for purposes of the substantial presence test if they are adjacent to U.S. waters. It says so explicitly in Pub. 519. He or she imagines an account application requesting a detailed disclosure of time spent underwater, and begins to feel queasy, like he or she might have the bends. ⁶Decompression sickness, also known as diver’s disease, characterized by the formation of gas bubbles within the body; effectively, the blood boils.

Surprisingly (maybe) U.S. FIs are indeed required to conduct this analysis. But the duty arises only in limited circumstances, as a “stage two” review. ⁷Reg. §1.1441-7T(b)(5)(i)(A)(1) and §1.1441-7T(b)(12)(ii). It is triggered when FIs receive information the IRS deems suspicious (e.g. a putative NRA lists a U.S. address). Notably U.S. FIs are fully responsible to understand and apply U.S. law, including this complex procedure.

Do IGAs really require FFIs to do the same—only at “stage one” and in every instance?

Probably Definitely Not

Like IGAs, the FATCA Regs also require FFIs to implement certain procedures when opening New Individual Accounts. Among other things, FFIs are directed to:

… determine if the account is a U.S. account or non-U.S. account by retaining a record of certain documentation …. Specifically, … a withholding certificate to establish an account holder’s status as a foreign … [or] U.S. person …. ⁸Reg. §1.1471-4(c)(4)(i). The quotation is heavily redacted for the present purpose.

For the present purpose, a “U.S. account” is one held by a U.S. Individual (also known as a U.S. person), and a “non-U.S. account” is one held by an NRA (aka a foreign person). “Withholding certificates” are a subset of self-certifications, comprised of official IRS Forms W-9, Request for Taxpayer Identification Number and Certification (which identifies U.S. Persons), and the suite of IRS Forms W-8 (which identify non-U.S. Persons). ⁹Acceptable substitutes are also part of the subset.

As distinct from the IGAs, here the rule does delimit the meaning of “determine.” How must the FFI determine whether a new account applicant is a U.S. Individual or an NRA? By obtaining from him or her a withholding certificate, which is essentially a signed statement declaring himself or herself to be one or the other. Thus the act of obtaining completes the task of determining—provided the withholding certificate is reliable.

Crucially the FFI may presume it to be so, in the absence of data suggesting otherwise. ¹⁰Reg. §1.1471-3(c)(1). But even if the withholding certificate is deemed unreliable (e.g. because it includes a U.S. address) the FFI will not be required to perform the substantial presence test. Rather, the FATCA Regs allow it to cure the defect simply by obtaining valid identification from the new account applicant that doesn’t contain a U.S. address. ¹¹Reg. §1.1471-3T(e)(4)(ii)(A) and §1.1441-7T(b)(5)(i)(A)(2).

Isn’t it clear that that is what is required from IGA FFIs too?

It May Depend on Who You Ask

Each IGA is construed by its local enforcer. Unfortunately an analogous FATCA Reg., like the one just discussed, may have no bearing on the analysis. For example, the Guidance Notes on the Implementation of FATCA Rules in Luxembourg state as follows:

In principle, the [Luxembourg-U.S. Intergovernmental] Agreement, as transposed into Luxembourg law, is a standalone piece of legislation. All applicable definitions and concepts for the implementation of FATCA by the Luxembourg tax authorities and Luxembourg Financial Institutions are available and described in the Agreement in such a way that reference to the Final [FATCA] Regulations is, as a general rule, not necessary. Three notable exceptions apply to this rule …. ¹²at Section 1 ¶ II. The Guidance Notes are published by the Luxembourg Bankers Association, and aren’t binding on any public authority in Luxembourg.

None of the “notable exceptions” are relevant to the current discussion. Consequently, our diligent follower-of-instructions may find little solace in the FATCA Regs, and feel compelled to turn back to the language of the IGA.

Unfortunately, even an aggressive, goal-oriented reading of the provision proves it resistant to reconciliation with the FATCA Regs. An IGA FFI must “obtain a self-certification … that allows … [it] to determine whether the Account Holder is” a U.S. Individual. The use of the word “that” is unhelpful. In standard English, “that” may never introduce a nonrestrictive relative clause. Conversely, “which” may introduce either a nonrestrictive relative clause or a restrictive relative clause. ¹³See http://www.oxforddictionaries.com/words/that-or-which. “I have a hat which I wear often” may mean you have only one hat, and you are remarking that you wear it often. “I have a hat that I wear often” must mean you have more than one hat, and are singling out the one you wear often.

If “which” were used in place of “that,” there would be some wiggle room. In that case, the rule might be read to mean this: “An IGA FFI must obtain a self-certification; doing so allows it to determine whether the Account Holder is a U.S. Individual.” A little tortured, this reading would be, but viable. And consistency with the FATCA Regs would make it seem sensible.

But the rule doesn’t say “which”; it says “that.” And that is something different altogether. “That” means the act of obtaining isn’t sufficient. To be acceptable, the self-certification must comply with a restriction; it must be one “that allows” the FFI to “determine” whether the account holder is a U.S. Individual. And, as discussed above, the meaning of “determine” isn’t delimited to mean something less than it does in Pub. 519.

Does the rule really mean what it says?

Clearly Not, but Not Explicitly Not

Our diligent follower-of-instructions is likely to be uncomfortable with what comes next: The answer is “no” chiefly because the answer can’t possibly be “yes.” Time spent under water is just the tip of the inverted iceberg. The substantial presence test would likewise necessitate extensive data collection on a broad range of activities occurring above sea level.

There is simply no way the IGAs mean for FFIs to engage in that exercise when the FATCA Regs require so much less from FFIs. (Remember, even U.S. FIs are required to do so only when something smells fishy, as a “stage two” review.)

So what is required? Maybe a clue can be found in other procedures the IGAs mandate. (Spoiler alert: This analysis just digs the hole deeper.)

We have thus far discussed the opening of New Individual Accounts. IGAs also require FFIs to review accounts held by individuals that were on the books as of June 30, 2014 (“Pre-Existing Accounts”). In that context, FFIs must search for clues (“U.S. Indicia”) that an account holder not classified as a U.S. Individual is in fact a U.S. Individual.

A short, finite list of U.S. Indicia is provided. It includes, for example, having a “U.S. mailing or residence address” or “[s]tanding instructions to transfer funds to an account maintained in the United States.” Some of the listed indicia suggest the account holder may be a U.S. citizen. The existence of any of the rest—the ones that implicate U.S. residency, not citizenship—can all be cured by either obtaining, or having previously reviewed and maintaining a record of:

(1) A self-certification that the Account Holder is neither a U.S. citizen nor a U.S. resident for tax purposes (which may be on an IRS Form W-8 or other similar agreed form) [and]

(2) … any valid identification issued by an authorized government body … that [establishes non-U.S. status,] includes the individual’s name and is typically used for identification purposes.

Similarly, IGA FFIs must monitor Pre-Existing Accounts for any change “that results in one or more U.S. indicia … being associated with the account.” Any such change that implicates U.S. tax residency may be cured in the same manner just described.

An analogous duty applies to New Individual Accounts, as follows:

If there is a change of circumstances with respect to a New Individual Account that causes the [FFI] … to know, or have reason to know, that the original self-certification is incorrect or unreliable, the [FFI] … cannot rely on the original self-certification and must obtain a valid self-certification that establishes whether the Account Holder is a U.S. citizen or resident for U.S. tax purposes.

Note that in this case the changes that trigger the duty aren’t limited to U.S. Indicia. To illustrate the distinction, assume an FFI receives a “hold mail” request effective from March through August of a given year from an account holder classified as a non-U.S. Individual. In it, the account holder states: “I will spend the entire period visiting the subsoil of submarine areas adjacent to U.S. waters.” That information wouldn’t meet the definition of U.S. Indicia. But if the account is a New Individual Account, that isn’t the applicable inquiry; the question is whether it impugns the account holder’s original self-certification. And that is, effectively, the question we keep bumping up against.

On nine occasions where the IGAs call for a self-certification, they specify that an IRS Form W-8 or W-9 would be acceptable. That delimits the information required to the information that appears on those forms. As noted, the rules that apply to New Individual Accounts pointedly don’t do the same; the omission might seem to be glaring.

Is our diligent follower-of-instructions supposed to ignore that entirely?

The Queen Weighs In

Her Majesty Queen Elizabeth II has been pleased to decree that within her domain the answer shall be yes. ¹⁴The U.K. tax system is administered by commissioners appointed by the monarch. The United Kingdom’s tax authority, Her Majesty’s Revenue and Customs (HMRC), has issued the following guidance on the U.K.-U.S. IGA:

A Financial Institution can choose the form of wording it uses to determine the tax residence of a New Individual Account holder. However the wording must be sufficient for an account holder to confirm the country or countries where they are tax resident and if they are a US citizen ….

The guidance proceeds to provide an example of an acceptable procedure for establishing a New Individual Account by telephone, stating:

The Financial Institution asks the account holder to state the countries in which they are tax resident and whether they are a US citizen. The individual provides this information on the phone and the Financial Institution records the confirmation on its system. Subsequent paperwork sent to the investor to confirm the account opening should include their response to these self certification questions and require them to contact the Financial Institution in the event that it is not correct. ¹⁵Presumably a valid non-U.S. I.D. will also be required from a non-U.S. Individual, at least if U.S. Indicia is present.

Clearly HMRC believes the IGA rule conforms to the FATCA Regs; its guidance provides that the act of obtaining a reliable self-certification completes the task of determining whether a New Individual Account holder is a U.S. Individual.

Which Came First,
The Mountain or the Molehill?

A casual observer may find it easy to presume that the same rule will apply in each of the remaining 100 jurisdictions currently treated as having an IGA in effect. And our diligent follower-of-instructions would seem to be left with no choice but to concur.

Nevertheless, in the event that our diligent follower-of-instructions was charged with developing IGA-compliant onboarding procedures for a slew of FIs across various continents—and pulling the trigger to implement them—concluding that IGA language means something different than what it plainly states may have made him or her somewhat trigger-unhappy. In that case, the best he or she could do is document the analysis, add it to the record and move on.