IRS announces two-year ‘transition’ for FATCA enforcement, easing pressure but raising questions

On May 2, compliance staff at more than 200,000 financial institutions worldwide likely breathed a collective sigh of relief as the US Internal Revenue Service announced a two-year “transition period” for enforcement of the Foreign Account Tax Compliance Act (FATCA).

The announcement came in the form of IRS Notice 2014-33, “Further Guidance on the Implementation of FATCA and Related Withholding Provisions,” issued last Friday. It provides the wide range of banks, broker-dealers, asset managers and other financial institutions subject to FATCA with latitude to get their compliance programs up and running. The announcement comes less than two months before the July 1 deadline, when many of FATCA’s key compliance and enforcement provisions were slated to come into effect.

“Calendar years 2014 and 2015 will be regarded as a transition period for purposes of IRS enforcement and administration of the due diligence, reporting, and withholding provisions,” the Notice states.

It stops short of being an actual delay to the implementation and enforcement of FATCA, which generally requires non-US institutions to identify their US account holders and report them to the IRS. Institutions and other entities will still be required to take “good faith efforts to comply” with the law’s far-reaching registration, customer due diligence, account review and reporting requirements over the next two years.

What constitutes “good faith efforts” is not entirely clear, which may have been an intentional move on the part of the IRS.

“The Notice is very vaguely worded,” says John Harrington, a tax attorney with Dentons in Washington, DC, and a former US Treasury official. “One way to read it is that the IRS didn’t want to spell out the minimum required for compliance.”

“It seems to indicate [institutions] are not going to be held to complete compliance, but it’s also unclear what’s ‘good enough,’” he continues. “That limits the amount of comfort you can take from [this Notice].”

Transition period eases pressure, but leaves unanswered questions

This “good faith” provision also applies to US institutions and other businesses responsible for implementing FATCA’s withholding tax, referred to as “US withholding agents.” As a mechanism to drive compliance, FATCA introduces a 30% withholding tax on many types of payments coming from US sources to non-US institutions or accounts that do not comply with the law.

Withholding is set to start on July 1, along with the requirement that non-US institutions (referred to as “foreign financial institutions” or FFIs in FATCA parlance) have onboarding procedures in place to identify and verify whether new customers are US persons. Those duties remain in effect, but the Notice indicates that institutions and withholding agents will not be expected to have flawless programs in place July 1, as long as they can demonstrate efforts to become compliant over the next two years.

“I would start with the premise that you have to comply starting July 1,” Harrington says. “You have to move forward, but do not need to have everything perfected on that date.”

The Notice does provide two very general examples what “good faith” steps may entail. The IRS will “take into account” whether a withholding agent has made “reasonable efforts during the transition period” to identify and document the FATCA status of its payment recipients for the purposes of implementing the 30% tax. The agency will also “consider the good faith efforts” of FFIs to identify all their affiliates and subsidiaries and register as part of one unit, or “expanded affiliated group,” with the IRS.

Along with the “transition period” announcement, the Notice introduces a number of other planned changes to final regulations related to due diligence and withholding duties. FFIs and withholding agents will be able to treat accounts opened by entities between July 1, 2014 and July 1, 2015 as “pre-existing,” which often require less due diligence than new accounts. The IRS also stated it will change rules on how “limited FFIs” can register, and revise certain standards of knowledge for withholding agents.

With elements of FATCA still missing, IRS skirts promise of ‘no delay’

Originally enacted in 2010 as part of the US HIRE Act, FATCA has long been critiqued by both US and non-US financial institutions as costly and overly complex to implement. As FATCA’s effective start date has loomed closer in recent months, the volume of criticism has intensified.

Some financial industry trade associations and institutions have penned comment letters to the IRS arguing that delays in the release of FATCA’s final regulations and key forms required for reporting and customer due diligence made it very difficult to become compliant by the July 1 date. Final regulations were issued January 2013, and final versions of FATCA-related forms like the W-8BEN-E and Form 8966 have only emerged in the past three months.

The IRS has pushed back the original start date for FATCA twice, once in 2011 and again in mid-2013. Since then, IRS officials have been adamant there will be no further push-back on FATCA implementation. In a press conference in January of this year, agency Commissioner John Koskinen stated directly that “we’re not going to have any delays.”

However, institutions are still waiting on some pieces of the FATCA compliance puzzle from the IRS, including instructions on how to use several forms and final regulations on certain withholding requirements.

“It wasn’t fair to demand full compliance from institutions, as the IRS hasn’t even gotten all the required information out itself,” says Harrington. “At the same time, from a credibility standpoint, the IRS didn’t want to let the deadline slip again.”