Draft Instructions for Form 8966 (FATCA Report)

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August 14, 2017

The IRS recently posted draft instructions to the Form 8966 (FATCA Report) dated August 9, 2017, with some changes pertaining to participating foreign financial institutions (PFFIs) and others reflecting the final and temporary Chapter 4 regulations released in January of this year.  The Form 8966 reports information with respect to certain U.S. accounts, substantial U.S. owners of passive non-financial foreign entities (NFFEs), specified U.S. persons that own certain debt or equity interests in owner-documented FFIs, and certain other accounts as applicable based on the filer’s status under Chapter 4 of the Internal Revenue Code.  A Model 1 FFI files the Form 8966 (or its equivalent) with its host country’s tax authority which, pursuant to the Model 1 IGA, shares the information with the IRS.  A Model 2 FFI directly files a Form 8966 with the IRS pursuant to its FFI agreement (see prior coverage regarding deadline for renewal of FFI agreement).

The changes reflected in the draft instructions are summarized below.  The draft instructions are before the official release.

  • Reporting on accounts held by nonparticipating FFIs. For 2017, a PFFI (including a Reporting Model 2 FFI) does not need to report on accounts held by nonparticipating FFIs in Parts II and V of the Form 8966.  Specifically, PFFIs should not check the box for “nonparticipating FFI” on line 5 of Part II, should not check the pooled reporting type “nonparticipating FFI” on line 1 of Part V, and should not complete line 3 of Part V.  This reporting obligation only applied for 2015 and 2016.
  • Limited FFIs and limited branches. The statuses for limited FFIs and limited branches expired on December 31, 2016.  Accordingly, the references to limited FFI and limited branch statuses are removed for the 2017 Form 8966.
  • Reporting Model 2 FFI related entities or branches. The instructions for limited FFIs and limited branches are revised to apply to Reporting Model 2 FFIs with related entities and branches that are required by the applicable Model 2 IGA to report U.S. accounts to the IRS to the extent permitted.  Thus, a related entity or branch of a Reporting Model 2 FFI filing Form 8966 should select the filer category code for limited branch or limited FFI (code 03) on line 1b of Part I.
  • Reporting Model 2 FFIs reporting on non-consenting U.S. accounts. For a preexisting account that is a non-consenting U.S. account, the Reporting Model 2 FFI should use the pooled reporting category for either recalcitrant account holders that are U.S. persons or recalcitrant account holders that have U.S. indicia.  For a new individual account that has a change in circumstances that causes the Reporting Model 2 FFI to know or have reason to know that the original self-certification is incorrect or unreliable, and the Reporting Model 2 FFI is unable to obtain a valid self-certification establishing whether the account holder is a U.S. citizen or resident, the Reporting Model 2 FFI should use the pooled reporting category for recalcitrant account holders with U.S. indicia.
  • U.S. branches. The draft instructions under Special Rules for Certain Form 8966 Filers reflect the updated reporting requirements for U.S. branches in the final Chapter 4 regulations published in January 2017.  On line 1b of Part I, all U.S. branches of a FFI not treated as U.S. persons should select the filer category code for PFFIs (code 01), and U.S. branches that are treated as U.S. persons should select the code for withholding agents (code 10).
  • PFFIs (including Reporting Model 2 FFIs) that are partnerships. The draft instructions for line 4d of Part IV for PFFIs (including Reporting Model 2 FFIs) are updated to conform to temporary Chapter 4 regulations published in January 2017 with respect to the amounts required to be reported by a partnership-PFFI reporting a partner’s interest in the partnership.
  • Mergers and bulk acquisitions of accounts.  New instructions under Special Rules for Certain Form 8966 Filers are added for combined reporting after a merger or bulk acquisition of accounts.

Court Decision Underscores Need for Due Diligence When Using Payroll Service Providers

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August 24, 2016

A recent decision of the U.S. District Court for the Central District of California should remind employers to regularly verify the actions of payroll service providers regardless of the provider’s reputation and the longevity of the relationship.  In particular, employers should open an e-Services account with the IRS and verify that all deposits are in fact hitting their payroll accounts timely.  This check should be performed weekly.  If deposits are not timely reflected on accounts, it is incumbent on employers to promptly determine the nature of the problem.  The IRS does not police payroll service companies, and the Department of Justice has prosecuted a number of people for embezzlement of payroll taxes over the years.

In Kimdun Inc. et al. v. United States, four McDonald’s franchises (the “Employer”) under common ownership used an outside payroll company for 30 years to process all aspects of their payroll, including the remittance of payroll taxes to the U.S. Treasury and the California Employment Development Department.  However, during the last several years of the relationship (2008-2011), the payroll company or its related bank embezzled the Employer’s payroll taxes.  To make matters worse, the Employer learned of the failure to deposit its taxes in 2009 but neglected to take any action until mid-2011 and continued to use the payroll company through 2012.  The IRS subsequently assessed approximately $425,000 in failure-to-pay penalties under Section 6651(a), failure-to-deposit penalties under Section 6656, and related interest.  Note that the penalties and interest were in addition to the payroll taxes that the Employer had to pay to the U.S. Treasury above and beyond the funds that were embezzled.

The Employer filed refund claims with respect to the penalties and related interest, which were denied by the IRS.  The Employer then sued for a refund in U.S. District Court arguing that the penalties should be abated on the grounds that the failures occurred due to reasonable cause and not due to willful neglect.  The District Court granted the government’s motion to dismiss, holding that the Employer failed to show that it had acted with ordinary business care and prudence.  In its analysis, the court considered the typical authorities that arise in reasonable cause determinations and concluded that the Employer’s reliance on the payroll company, an agent, did not establish reasonable cause.  The fact that the Employer seemed to wait passively for such a protracted period of time was a particularly bad fact.  The result may well have been different if the Employer had identified the theft within a matter of weeks, made good on the late taxes, and pursued legal action against the payroll company.

The key takeaway from this case, however, is that employers will not simply be absolved of their tax obligations based upon illegal acts committed by third-party agents.  With the tools available from the IRS through e-Services, employers should independently verify that their payroll service providers perform the tasks they agree to perform.

IRS Pushes Bad Position in Penalty Case and Loses on Reasonable Cause Grounds

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August 17, 2016

The U.S. Tax Court recently held that an individual taxpayer was not liable for failure-to-file and failure-to-pay penalties under Code Sections 6651(a)(1) and 6651(a)(2), respectively, due to reasonable cause.  In Rogers v. Commissioner, a 2007 fire nearly destroyed Rogers’ home, resulting in losses exceeding $150,000 and essentially leaving her homeless.  Rogers did not deduct the losses on her 2007 or 2008 return, believing that she could claim the deduction only in the year the insurance company resolved her claim.  In 2009, the insurance company paid her $43,964, and she did not file an income tax return or pay the related taxes because she believed that her casualty losses (to the extent not compensated by insurance) fully offset her 2009 income.

The IRS disagreed with the timing of this deduction because a casualty loss is generally deductible in the year of the casualty.  Only if and to the extent a taxpayer has a reasonable prospect of insurance recovery, the deduction is deferred until it can be ascertained whether such reimbursement will be received.  Thus, Rogers should have deducted the casualty losses in 2007 or 2008, not in 2009.  Rogers and the IRS settled the deduction issue and litigated the penalties under Sections 6651(a)(1) and 6651(a)(2).

The Tax Court ruled that the taxpayer’s error was due to reasonable cause and not willful neglect for three key reasons.  First, Rogers had a significant compliance history hallmarked by timely filing and paying her federal income taxes, and “significant efforts to correctly prepare her income tax returns” by consulting tax books and articles and even the IRS.  Second, following the casualty, Rogers suffered personal hardships.  From 2007 through 2009, she suffered bouts of depression, experienced living conditions she found dehumanizing, and in 2009, fractured her skull after falling from a subway platform.  Third, Rogers’ error—deducting a loss in a year later than the correct year—was an error made in good faith and not a blatant tax avoidance technique.  Although the court did not explicitly mention the difficulty of applying the law as a factor, the court did highlight the murkiness of the issue: determining the year in which there was “no prospect of recovery from insurance.”

The reasonable cause exception exists because Congress recognized that even the most compliant taxpayers are not perfect.  Notwithstanding case law on penalties that is often viewed as unfavorable, taxpayers often prevail in penalty cases before IRS Appeals.  Although the taxpayer in Rogers was an individual, the case sheds light on why the IRS concedes penalty cases when businesses demonstrate a history of compliance and identify rational and understandable reasons for the errors at issue.  Reasonable cause exists when a taxpayer exercises “ordinary business care and prudence.”  Ordinary business care and prudence is determined based upon all the relevant facts and circumstances, and the burden of proof rests on the taxpayer.

Consistent with Rogers, taxpayers can elevate their chances for abatement by establishing a history of tax compliance.  Further, when things go awry, taxpayers should promptly take responsibility and correct the mistake, and then take steps to identify the cause of the failure and establish procedures to prevent a recurrence of the failure.  By taking swift action, the taxpayer increases the odds of overcoming its burden to show reasonable cause.

Proposed Regulations Impose Reporting Obligations on Foreign-Owned U.S. Entities

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May 10, 2016

Today, the IRS published proposed regulations that would impose reporting obligations upon a domestic disregarded entity wholly owned by a foreign person (foreign-owned DDE).  Specifically, the proposed regulations would amend Treasury Regulation § 301.7701-2(c) to treat a foreign-owned DDE as a domestic corporation separate from its owner for the limited purposes of the reporting, recordkeeping, and other compliance requirements that apply to 25 percent foreign-owned domestic corporations under Section 6038A of the Internal Revenue Code.  These changes broaden the IRS’s access to information that would help the IRS enforce tax laws under the Code and international treaties and agreements.

The proposed regulations would render foreign-owned DDEs reporting corporations under Section 6038A.  Accordingly, a transaction between a foreign-owned DDE and its foreign owner (or another disregarded entity of the same owner) would be considered a reportable transaction for purposes of the reporting and recordkeeping rules under Section 6038A, even though the transaction involves a disregarded entity and generally would not be considered a transaction for other purposes (e.g., adjustment under Section 482).  Thus, a foreign-owned DDE would be required to file Form 5472 for reportable transactions between the entity and its foreign owner or other foreign-related parties, and maintain supporting records.  Further, to file information returns, a foreign-owned DDE would have to obtain an Employer Identification Number by filing a Form SS-4 that includes responsible party information.

This rulemaking project is still in its infancy, and it remains to be seen if and how the IRS harmonizes the proposed regulations with existing rules.  For example, the proposed regulations impose a filing obligation on a foreign-owned DDE for reportable transactions even if its foreign owner already has an obligation to report the income resulting from those transactions (e.g., transactions resulting in income effectively connected with the conduct of a U.S. trade or business).  The Treasury Department and the IRS sought comments on possible alternative methods for reporting the disregarded entity’s transactions in these cases.  In the preambles, the IRS also stated that it is considering changing corporate, partnership, and other tax or information returns (or their instructions) to require foreign-owned DDEs to identify all the foreign and domestic disregarded entities it owns, consistent with the proposed regulations.

These proposed regulations will apply for tax years ending on or after May 10, 2017.  Comments and public hearing requests are due by August 8, 2016.

OECD Seeks Additional Proposals on Treaty Benefits for Non-CIV Funds

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March 25, 2016

On March 24, 2016, the Organization for Economic Co-operation and Development (OECD) issued a consultation document soliciting public comments regarding treaty entitlement of non-collective investment vehicle (non-CIV) funds. While collective investment vehicle funds are defined under the 2010 OECD Report and are entitled to treaty benefits subject to specific rules, commenters have sought treaty benefits for non-CIVs, which have yet to be defined.

The consultation document states that the OECD will continue to examine policy considerations regarding treaty entitlement of non-CIV funds. Further, the OECD plans to address two key concerns of OECD members about granting treaty benefits with respect to non-CIV funds. In particular, these concerns are that non-CIV funds should not be used to obtain treaty benefits for investors not otherwise entitled to such benefits and that investors should not be able to defer recognition of income on treaty benefits that have been granted.

The consultation document also asks commenters to clarify how non-CIV funds work, e.g., what types of vehicles would be defined as non-CIV funds; whether these funds are able to determine the identities and tax-residences of the beneficial owners; what is the intermediary-level tax; and at what point would taxation occur. In particular, the consultation document focuses on proposals concerning the impact on non-CIV funds of new limitation on benefits (LOB) rules, the principal purpose test, anti-conduit rules, and special tax regimes. Regarding the LOB rules, the document raised questions to commenters’ requests that: (a) treaty benefits be granted to regulated and/or widely-held non-CIV funds; (b) non-CIV funds be allowed to elect treatment as fiscally transparent entities for treaty purposes; (c) certain non-CIV funds be granted treaty benefits where a large proportion of the investors would be entitled to the same or better benefits; (d) the LOB rules not deny benefits to a non-CIV resident of a State with which the non-CIV has a sufficiently substantial connection; and (e) a “Global Streamed Fund” regime be adopted.

Fundamental objectives of the OECD include combating international tax avoidance and evasion by preventing multinationals from artificially shifting profits to low or no-tax jurisdictions and developing and encouraging the promulgation of clear guidance that identifies which country’s tax should apply under particular arrangements. The OECD’s analysis of how non-CIV funds should be taxed is part and parcel of this core mission.

Canada’s New Blanket Withholding Waiver for Non-Resident Employees

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March 1, 2016

A legislative amendment in Canada’s 2015 federal budget is providing some U.S. employers and employees much needed relief.  The amendment provides a blanket waiver for non-resident employers who otherwise would have to withhold from the wages of non-resident employees, including those ultimately entitled to full refunds.  The new waiver will eliminate a process by which many non-resident employees faced withholding and then had to file a return to claim a full refund.

Before 2016, a non-resident employer in Canada was required to withhold and remit taxes from compensation paid to an employee for work performed in Canada, even if the employee is a non-resident person exempt from Canadian income tax under a tax treaty. To get a refund, the non-resident employee was then required to file a Canadian income tax return and claim the treaty exemption.  Alternatively, a non-resident employee could have applied for a waiver from wage withholding—and point to the applicable treaty exemption—30 days before either the employment services began in Canada or when the initial payment was made for the services. But this per-employee waiver is administratively burdensome.

After 2015, however, a new blanket waiver valid for up to two years is available to qualifying non-resident employers paying qualifying non-resident employees.  To be certified as a qualified non-resident employer, an employer must file a Form RC473, Application for Non-Resident Employer Certification with the Canada Revenue Agency, 30 days before the first payment.  The employer must show that, at the time of the payment, it is resident in a country that Canada has a tax treaty with and it is certified by the Minister of National Revenue.  Additionally, an employer must agree that the employer will:

  1. Evaluate and document how its employee meets the definition of a qualifying non-resident employee at the time of any employment payment by (a) monitoring the employee’s qualification status on an ongoing basis; (b) obtaining documentation proving the employee’s country of residence; and (c) ensuring that the tax treaty between the employee’s resident country and Canada is applicable;
  2. Track and document the number of days the qualifying non-resident employee is working in Canada or is present in Canada, and the employment income that corresponds to these days;
  3. Keep a business number (or use Form RC1, Request for a Business Number, to get a business number if the employer does not yet have one) and register a program account number for payroll purposes if the employer expects to make remittances;
  4. Prepare and file a T4 slip and a T4 Summary for the non-resident employee who has provided employment services in Canada that are not excluded from reporting under proposed subsection 200(1.1) of the Income Tax Regulations;
  5. Complete and file Canadian income tax returns for calendar years covered by the certification period; and
  6. Render its books and records available for CRA inspection.

A qualifying non-resident employee is an employee that (a) is a resident in a country that Canada has a tax treaty with at the time of the payment; (b) owes no tax in Canada on the payment because of the tax treaty; and (c) works in Canada for less than 45 days in the calendar year that includes the time of the payment, or is present in Canada less than 90 days in any 12-month period that includes the time of the payment.

Although the new blanket waiver may lessen a non-resident employer’s administrative burdens, the employer must carefully comply with the conditions of certification.  The CRA may revoke a certification if the non-resident employer violates any of the conditions, rendering the employer liable for the whole amount that should have been withheld and remitted and subject to related penalties and interest.