We in the information reporting community have come to expect guidance packages from the IRS in December, especially if the guidance is needed for implementation in the new year. We think of these as our little care packages. And on December 13, 2018, the IRS released one of these: a set of proposed regulations under Chapter 3 and FATCA issued under the auspices of “burden reduction.”
The big headline item is that, as indicated by IRS officials in public statements earlier this year, withholding on gross proceeds under FATCA is eliminated. But there are also a number of other tidbits to chew on. Among these, the “lag method” for partnership Form 1042-S reporting may finally be going away. What’s replacing it and what other gems are in these proposed regulations? Well, read on.
Here are some highlights from the burden reduction proposed regulations:
1. Bye, Bye FATCA Gross Proceeds Withholding. The elimination of FATCA withholding on gross proceeds is not unexpected since IRS officials had indicated as much in public comments earlier this year. Absent such guidance, FATCA withholding on gross proceeds was scheduled to begin as of January 1, 2019. Withholding agents can finally breathe a sigh of relief that now there is guidance in writing. This guidance can be relied on until final regulations are issued.
2. Passthru Payments: Deferred But Not Gone Away. FATCA “foreign passthru payments” would not be subject to withholding until two years after final regulations are issued defining the term. The concept of foreign passthru payments is intended to prevent an FFI such as an investment entity from resourcing U.S. source income to non-U.S. source when it makes distributions to FATCA non-compliant investors. For example, a FATCA-compliant offshore investment fund structured as a corporation receives U.S. source income (e.g., portfolio interest). When the fund makes dividend distributions to its investors, the distributions are treated as non-U.S. source and therefore would generally fall outside FATCA (irrespective of the compliant status of the investor). In such cases, the IRS wants the foreign dividend distribution to be brought back within the FATCA umbrella as a “foreign passthru payment” but has been unable to provide a workable mechanism as yet to do so. The IRS states that this remains an important compliance concept for FATCA and intends still to make this work
3. Non-Cash Insurance Premiums Out of Scope for FATCA. Premiums paid on insurance contracts are generally within scope for FATCA. The proposed regulations, however, provide that premiums paid on insurance contracts that do not have a cash value (non-cash value insurance premiums) would no longer be subject to FATCA withholding. Such payments would be considered nonfinancial payments that are outside the scope of FATCA. The IRS noted, in part, that a change to the passive foreign investment company (PFIC) provisions brought about by the Tax Cuts and Jobs Act reduced the likelihood of a noncompliance scenario that the IRS was previously concerned about.
4. Investment Entity Definition Clarified. Under FATCA provisions, an investment entity is treated as a financial institution if, in addition to having gross income primarily attributable to investing, reinvesting or trading financial assets, it is “managed by” another financial institution. The proposed regulations clarify that an entity (Entity K) is not “managed by” another entity solely because Entity K invests all or a portion of its assets in such other entity and such other entity is a mutual fund, an exchange traded fund, or a collective investment entity that is widely held and is subject to investor-protection regulation. In contrast, an investor in a “discretionary mandate” is considered “managed by” the financial institution.
5. Due Diligence Housekeeping. Certain due diligence rules for withholding agents under Chapter 3 and Chapter 4 are modified, including:
(a) time to obtain treaty statements containing the limitation on benefits (LOB) provision is extended for preexisting accounts until January 1, 2020 (from January 1, 2019);
(b) exceptions to the three-year validity period for treaty statements provided by tax exempt organizations (other than tax-exempt pension trusts or pension funds), governments, and publicly traded corporations;
(c) withholding agents can rely on an LOB claim on a treaty statement absent actual knowledge that such claim is unreliable or incorrect (the IRS noted that this was an inadvertent omission in the existing regulations and is the same standard applied to withholding certificates);
(d) documentary evidence (showing either foreign status or supporting the person’s residence in a treaty country) that a withholding agent may rely on in certain cases where there is a “hold mail” instruction is the documentary evidence described in the FATCA regulations (Reg. 1.1471-3(c)(5)(i)), without regard to the requirement that the documentation contain a permanent residence address;
(e) hold mail instruction does not include a request to receive all correspondence (including account statements) electronically.
6. Change to Partnership Lag Method 1042-S Reporting. Partnerships that report under the lag method currently report income and withholding on a Form 1042-S for prior-year (e.g., 2017) undistributed income allocable to a non-U.S. partner as if paid in the current year (e.g., 2018). The proposed regulations generally require a calendar-year partnership that withholds on income in the current year that is attributable to the prior year to report such income and withholding for the Form 1042-S for the prior year (the year the income is earned). There is an exception for fiscal year partnerships. The proposed regulations would also provide a revised due date for a partnership to file a Form 1042-S when it withholds tax after March 15 for income designated for the preceding year. The new due date would be September 15 (matching the extended due date for filing of a Form 1042 and Schedule K-1). Instructions to the 2019 Form 1042-S and Form 1042 would be updated to reflect the changes provided in the proposed regulations and taxpayers are to wait for the change in the forms prior to implementing the new guidance.
7. Overwithholding Reimbursements and Offsets. The proposed regulations would provide additional time for withholding agents that have over-withheld on an accountholder to utilize reimbursement and set-off procedures. The rule had been that such procedures had to be completed by the due date of Form 1042-S (without extensions) and a claim made on the withholding agent’s timely filed Form 1042 (again without extensions). The proposed regulations would essentially extend the time for utilizing the procedures to the extended due date of Form 1042-S and for a claim to be made on a Form 1042 filed on extension.
8. NQI Form 1042-S Reporting. Finally, a nonqualified intermediary that is a participating FFI or a registered deemed-compliant FFI would obtain more flexibility when they are required to issue Form 1042-S to their account holders in certain cases. Where an NQI has not provided information on one or more underlying beneficial owners, a U.S. withholding agent may withhold on payments to the NQI and issue a Form 1042-S reporting withholding under Chapter 4. The proposed regulations would allow the NQI that then issues a Form 1042-S to its account holders (if such payees are indeed FATCA-compliant) to treat the tax withheld as withheld under Chapter 3 and report the withholding as Chapter 3 withholding on the Form 1042-S it issues. This is intended to assist underlying account holders to claim foreign tax credits in their jurisdictions of residence.
According to the preamble to the proposed regulations, taxpayers may generally rely on the proposed regulations until final regulations are issued. The elimination of withholding on non-cash value insurance premiums, the clarification of the definition of “managed by” for investment entities and the revised allowance for a permanent residence address subject to a hold mail instruction provisions may be applied to all open tax years until final regulations are issued. For revisions relating to credits and refunds of withheld tax (e.g., lag method change and application of reimbursement and set-off procedures), taxpayers may not rely on these proposed regulations until Form 1042 and Form 1042-S are updated for the 2019 calendar year.