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Foreign Financial Institutions Reporting and Withholding United States Taxes


Americans have become used to the idea that certain payments made to Foreign individuals, (Aliens) and Foreign Corporations require the American payor to withhold the U.S. taxes that must be paid by the foreign recipient of the U.S. income payment. This insures the taxes are paid. The law holds that if the American payor does not hold back, (withhold), the taxes due by the foreigner payee and pay these taxes to the U.S., the American payor is responsible to pay for the tax.

The United States has now passed a new law (the “New Law”) that is effective starting in 2014. This law that will require American payors to be responsible for a similar withholding tax on payments made by American Payors to American payees with accounts in certain Foreign Financial Institutions and Foreign Non Financial Entities that have substantial U.S. owners.1/

1/ Almost 50% of the New Law is used to provide definitions for all of the new “tax terms” that are used to describe the new tax concepts represented by the New Law.

The definitions have been provided to help better explain the overall pattern that the Treasury has tried to accomplish. Several of the definitions have been provided in the initial portion of this Article.

The New Law

The New Law generally requires Foreign Financial Institutions (FFIs) to provide information to the Internal Revenue Service (IRS) regarding the Foreign Financial Institutions’ United States accounts (U.S. accounts). It also requires certain Nonfinancial Foreign Entities (NFFEs) to provide information on their substantial United States owners (substantial U.S. owners).

The New Law requires that United States payors vs. Withholding Agent that make payments to Foreign Financial Institutions and Non Financial Foreign Entities to withhold the taxes payable by any U.S. persons who may be responsible for taxes to the United States on these payments.

The law takes a second step and imposes the same withholding tax on certain Foreign Financial Institutions for payments those institutions make to certain accounts that are owned by U.S. taxpayers or presumed to be owned by U.S. taxpayers.

The reasons for the new law are made quite plain in the preamble to the Regulations Governing the New Law. The United States is finally fully aware of the cost of offshore tax evasion and intends to stop it. The Preamble states:

As a result of recent improvements in international communications and the associated globalization of the world economy, U.S. taxpayers’ investments have become increasingly global in scope. Foreign Financial Institution (“FFI”) now provide a significant proportion of the investment opportunities for, and act as intermediaries with respect to the investments of, U.S. taxpayers. Like U.S. financial institutions, FFIs are generally in the best position to identify and report with respect to their U.S. customers. Absent such reporting by FFIS, some U.S. taxpayers may attempt to evade U.S. tax by hiding money in offshore accounts. To prevent this abuse of the voluntary compliance system and address the use of offshore accounts to facilitate tax evasion, it is essential in today’s global investment climate that reporting be available with respect to both the onshore and offshore accounts of U.S. taxpayers. This information reporting strengthens the integrity of the voluntary compliance system by placing U.S. taxpayers that have access to international investment opportunities on an equal footing with U.S. taxpayers that do not have such access or otherwise choose to invest within the United States.

[The New Law] extends the scope of the U.S. information reporting regime to include FFIs that maintain U.S. accounts. [It] also imposes increased disclosure obligations on certain Non Foreign Financial Institutions that present a high risk of U.S. tax avoidance. In addition, [it] provides for withholding on Foreign Financial and Non Financial Institutions that do not comply with the reporting and other requirements of [The New Law].

The New Law is codified in Internal Revenue Code Sections 1471 through 1474. This article will review each of those Code Sections.

Code Section 1471(a) of the Internal Revenue Code (“Section”) requires any person required to withhold taxes, (a “Withholding Agent”) to withhold 30 percent of any withholdable payment to a Foreign Financial Institution that does not meet certain requirements.

A withholdable payment is defined to mean

(i) any payment of interest, dividends rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income if such payment is from sources within the United States (Fixed Income) and

(ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States. (“Sale Income”).

The types of U.S. income that are identified as being subject to the 30% withholding tax, when that income is paid to Foreign Financial Institutions, is the type of income known as fixed or determinable income. Also included is gains from the sale of certain capital assets. This is different than the withholding tax on payments by Americans to non resident aliens and foreign corporations because gains from the sales of capital assets are not included in the existing withholding rules.

However, while the New Law requires withholding on certain items to any Foreign Financial Institution and Foreign Non Financial entities, the Foreign Institutions can avoid the responsibility to withhold these taxes. The withholding on payments to and by a Foreign Financial Institution or a Non Financial Foreign Entity can be avoided if the Foreign entities comply with new U.S. Treasury requirements. To comply, the U.S. now wants full disclosure of every U.S. account holder in that Foreign Institution and on every substantial shareholder in the Non Foreign Financial Enterprise.

The U.S. Treasury has now made foreign banks, brokers and companies similar to U.S. bankers and brokers, when it comes to supplying information about U.S. taxpayers.

In order to avoid the withholding tax a FFI must enter into an agreement (“FFI Agreement”) with the IRS to perform certain obligations and meet requirements prescribed by the Treasury Department and the IRS.

The best way to provide an understanding of the overall purpose of the new statute and what it is all about is to start off with a list of new terms that are now going to show up as a result of this new law. After the reader has mastered these few terms, the article provides a summary of the purpose of the statute, the mechanics of the statute and the practical ramifications of what international banking is going to look like starting in the year 2014.


U.S. Account:

A U.S. Account is any financial account maintained by a financial institution that is held by one or more specified U.S. persons or U.S. owned foreign entities. An account generally is considered to be held by the person listed or identified as the holder of such account with the financial institution that maintains the account, even if that person is a flow-through entity.

For accounts held by a grantor trust, the grantor is treated as the owner of the account or assets. For accounts held by agents, investment advisors, and similar persons, the person on whose behalf such person is acting is treated as the account holder. Each joint holder of a joint account will be treated as owning the account. Accounts that are insurance and annuity contracts consider the account holder is the person who can access the cash value of the contract or change the beneficiary, or, if there is no such person, the accountholder is the beneficiary.

Financial Account:

The term financial account means, with respect to any financial institution, any depository account maintained by such financial institution; any custodial account maintained by such financial institution; and any equity or debt interest in such financial institution (other than interests which are regularly trade on an established securities market). In addition, the Secretary may prescribe special rules addressing circumstances in which certain categories of companies, such as insurance companies, are financial institutions or the circumstances in which certain contracts of policies, for example annuity contracts or cash value life insurance contracts, are financial accounts

Depository Account:

A depository account is defined to include a commercial, checking, savings, time or thrift account, an account evidenced by a certificate of deposit or similar instruments, and any amount held by an insurance company under an agreement to pay interest. A custodial account is defined to include an account that holds any financial instrument or contract held for investment for the benefit of another person.


The proposed regulations also provide guidance on the treatment of debt or equity as a financial account. An equity interest includes a capital or profits interest in a partnership and beneficial interests in the case of a trust.

U.S. Owned Foreign Entity:

Any foreign entity that has one or more substantial U.S. owners. An owner-documented FFI will be treated as a U.S. owned foreign entity if it has one or more direct or indirect owners that are specified U.S. persons, whether or not it has a substantial U.S. owner.

Financial Institution (FFI)

FFI means any financial institution that is a foreign entity

The term financial institution means any entity that (i)accepts deposits in the ordinary course of a banking or similar business; (ii) holds as a substantial portion of its business financial assets by the account of others; or (iii) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interest, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interest or commodities.

The types of entities that constitute “financial institutions” lists the activities that constitute a “banking or similar business” for a deposit-taking institution, and clarifies that entities engaged in a banking or similar business include, but are not limited to, entities that would qualify as a “bank” under [I.R.S. Rules] The proposed regulations provide that the determination of whether an entity conducts a banking or similar business is based on the character of the business conducted, and the fact that the entity is subject to local regulation is relevant, but not necessarily determinative.

An entity is engaged primarily in the business of investing, reinvesting, or trading securities and other relevant assets if the entity’s gross income from those activities is at least 50 percent of the entity’s total gross income over the testing period.

An entity that is an insurance company and issues (or is obligated to make payments with respect to): a cash value insurance policy or an annuity contract is a financial institution.

Excluded Foreign Entities:

Many Foreign Entities are excluded from the definition of a financial institution or are treated as Non Financial Institutions that do not need to meet any of the withholding and/or reporting requirements. These entities include certain nonfinancial holding companies, certain startup companies, nonfinancial entities that are liquidating or emerging from reorganization or bankruptcy, hedging/financial centers of a nonfinancial group, and charitable entities.

Recalcitrant Account Holder:

A recalcitrant account holder is defined as any holder of an account maintained by a Participating FFI if the account holder is not an FFI and the account holder either (i) fails to comply with the Participating FFI’s request for documentation or information to establish whether the account is a U.S. account, (ii) fails to provide a valid Form W-9 upon the request of the Participating FFI, (iii) fails to provide a correct name and TIN upon request of the FFI after the Participating FFI receives notice from the IRS indicating a name/TIN mismatch or (iv) fails to provide a valid and effective waiver of foreign law if foreign law prevents reporting with respect to the account holder by the Participating FFI.

Pass thru Payments:

A pass thru payment is any withholdable payment and any foreign pass thru payment

Withholdable Payments to Non Financial Foreign Entities (NFFEs)

A withholding agent must withhold tax of 30 percent of any withholdable payment made to an NFFE, unless the beneficial owner is an NFFE that does not have any substantial U.S. owners or as an NFFE that has identified its substantial U.S. owners and the withholding agent reports the required information with respect to any substantial U.S. owners.

Substantial U.S. Owner:

Generally, the term substantial U.S. owner means any specified U.S. person that owns, directly or indirectly, more than ten percent of the stock of a corporation, or with respect to a partnership, more than ten percent of the profits interests or capital interests in such partnership. For trust, a substantial U.S. owner is any specified U.S. person that holds, directly or indirectly, more than ten percent by value of the beneficial interests in such trust, or with respect to a grantor trust, any specified U.S. person that is an owner of such grantor trust. There are attribution rules to determine indirect ownership of stock.

Specified U.S. Person:

There are several categories of U.S. payees whose payments are not subject to tax and therefore would not inure a withholding tax. This list includes a corporation the stock of which is regularly traded on an established securities market; corporations that are affiliates of such corporation; organization that are exempt from tax; individual retirement plans; real estate investment trust; regulated investment companies; common trust funds; regulated investment companies; common trust funds; dealers in securities; commodities or notional principal contracts; dealers in securities, commodities, or notional principal contracts and brokers. The United States and its wholly owned agencies or instrumentalities are also excluded, as are the States, the District of Columbia, the U.S. territories and any political subdivision or wholly owned agency or instrumentality of any of the foregoing.


The rules relating to the requirement to withhold U.S. tax on certain payments apply principally to U.S. and foreign financial institutions or withholding agents. The general rule is that with certain exceptions, a withholding agent must withhold on a withholdable payment made after December 31, 2013, to an FFI regardless of whether the FFI receives the withholdable payment as a beneficial owner or intermediary.

Under certain circumstances, a participating FFI will be permitted to make an election to be withheld upon rather than meet requirements to withhold on a pass thru payment.

As will be explored, the withholding requirement is met by an FFI Agreement. Furthermore, no withholding is required when the withholding agent lacks control, custody or knowledge of the payments.

The answer for the Foreign Financial Institutions on how to avoid the withholding tax is to do as the I.R.S. requires and (i) to collect all of the information necessary to determine the U.S. payees of the Institution’s accounts (ii) to report regularly in compliance with I.R.S. requirements on these U.S. accounts and (iii) withhold taxes on payment being made to a Nonparticipating FFI or a recalcitrant account.

The FFI Agreement:

An FFI is defined as any financial institution that is a foreign entity, other than a financial institution organized under the laws of a possession of the United States. A financial institution is defined generally as any entity that: (i) accepts deposits in the ordinary course of a banking or similar business: (ii) as a substantial portion of its business, holds financial assets for the account of others; or (iii) is engaged (or holding itself out to being engaged) primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities.

The FFI Agreement requires the FFI to identify its U.S. accounts and comply with verification and due diligence procedures prescribed by the Treasury. A “Participating FFI” is an FFI that has entered into an FFI Agreement.

A U.S. account is defined as any financial account held by one or more specified United States persons, or United States owned foreign entities (U.S. owned foreign entities) with certain exceptions. A financial account means generally any depository account, any custodial account and any equity or debt interest in an FFI, other than interests that are regularly traded on an established securities market. A U.S. owned foreign entity is any foreign entity that has one or more Substantial U.S. owners.

A Participating FFI that enters into the Agreement is required to report certain information on an annual basis to the IRS with respect to each U.S. account and to comply with requests for additional information with respect to any U.S. account. The information that must be reported with respect to each U.S. account includes: (i) the name, address and taxpayer identifying number (TIN) of each account holder who is a specified U.S. person (or, in the case of an account holder that is a U.S. owned foreign entity), the account number;(iii) the account balance or value; and (iv) the gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner a the Secretary may provide).

Furthermore, if the foreign law of the country where the FFI is located prevents the FFI from reporting the required information, the U.S. account holder must agree to waive any provision of foreign law within a reasonable period of time. If the information is not provided, the FFI is required to close the account.

Even if the Participating FFI has complied with all reporting requirements, there are still withholding requirements on payments to the FFI and from the FFI on two occasions.

(1) A participating FFI must withhold 30 percent of any pass thru payment to a recalcitrant account holder or

(2) to an FFI that is not a Participating FFI. A pass thru payment is defined as any withholdable payment or other payment to the extent attributable to a withholdable payment.

The FFI Agreement applies to the U.S. accounts of the participating FFI and to the U.S. accounts of other FFI’s that are a member of the same affiliated group.

Excluded Payments

Exempt Payments to Certain beneficial Owners

There are certain foreign beneficial owners of U.S. payments that are exempt and no withholding is required. The classes of persons treated as exempt beneficial owners are: foreign governments, political subdivisions of a foreign government, and wholly owned instrumentalities and agencies of a foreign government, international organizations and wholly owned agencies or instrumentalities of an international organization; foreign central banks of issue; governments of U.S. territories; and certain foreign retirement plans.

Certain foreign retirement funds will qualify as exempt beneficial owners. Specifically, a fund that is eligible for the benefits of an income tax treaty with the United States with respect to income that the fund derives from U.S. sources and that is generally exempt from income tax in that country is an exempt beneficial owner if it operates principally to administer or provide pension or retirement benefits.

Withholding on a Non Financial Foreign Entity

In order to gain full disclosure to U.S. holdings in other types of assets, the New Law also makes payments to and from Non Foreign Financial Entities (NFFE) potentially subject to withholding.

However, the manner in which an NFFE can avoid the withholding obligation is much less stringent than that of a Foreign Financial Institution.

The New Law requires a withholding agent to withhold 30 percent of any withholdable payment to Non Financial Foreign Entities (“NFFE”), if the payment is owned by the NFFE or another NFFE. An NFFE is any foreign entity that is not a financial institution.

However, there is no withholding requirement if the NFFE is: (i) the beneficial owner or payee provides the withholding agent with either a certification that such beneficial owner does not have any substantial U.S. owners, or the name, address and TIN of each substantial U.S. owner; (ii) and the withholding agent does not know or have reason to know that any information provided by the beneficial owners or payee is incorrect; and (iii) the withholding agent reports the information provided to the Secretary.

As with all withholding taxes, there is the ultimate penalty if the party who is supposed to withhold taxes for the United States does not do so; the New Law provides that every person required to withhold and deduct any tax is made liable for such tax and is indemnified against the claims and demands of any person for the amount of any payments made in accordance with the New Law.

The Verification Process

The FFI Agreement must comply with the IRS’s verification process for determining whether a participating FFI’s compliance with its FFI Agreement. A participating FFI must meet the following standards: (i) adopt written policies and procedures governing the participating FFI’s compliance with its responsibilities under the FFI agreement; (ii) conduct periodic internal reviews of its compliance (rather than periodic external audits, as is presently required for many [intermediates]; and (iii) periodically provide the IRS with a certification and certain other information that will allow the IRS to determine whether the participating FFI has met its obligations under the FFI agreement. The Treasury Department and the IRS intend to include the requirements to conduct these periodic reviews and to provide their certifications in the FFI agreement or in other guidance.

Withholding Requirements under the FFI Agreement

Even when the requirements of the FFI Agreement are met. Participating FFIs are required to withhold on any pass thru payment that is a withholdable payment made to a Recalcitrant Account Holder or a Nonparticipating FFI.

There is also a special withholding rule for dormant accounts, under which a participating FFI that withholds on pass thru payments (including withholdable payments) made to a recalcitrant account holder of a dormant account, may, in lieu of depositing the tax withheld, set aside the amount withhold in escrow until the are that the account cease to be a dormant account.

Identification of Account Holders under the FFI Agreement

There are general requirements with respect to the procedures to identify account U.S. holders that determine the status of an account holder and to associate an account with valid documentation and establish the standards of knowledge for reliance on documentation.

A participating FFI is required to review all information collected under its existing account opening procedures to determine whether the account holder has U.S. Indicia.

There are special identification requirements for high value accounts. A participating FFI must perform an additional enhanced review of high value accounts. A high value account is any account with a balance or value that exceeds $1,000,000 at the end of the calendar year. As part of the enhanced review, the participating FFI must identify all high value accounts for which a relationship manager has actual knowledge that the account holder is a U.S. person.

This does not apply to cause enhanced reviews of any high-value accounts for which the participating FFI has obtained documentary evidence to establish that the account is not held by a U.S. person but instead establishes the foreign status of the account holder.

Furthermore, the law requires a responsible officer of a participating FFI to make certain certifications to confirm that with respect to its preexisting accounts that are high value accounts, within one year of the effective date of the FFI agreement the participating FFI has completed the required review and to the best of the responsible officer’s knowledge, after conducting a reasonable inquiry.

Reporting Requirements of Participating FFIs

Under the FFI Agreement there are reporting responsibilities of Participating FFIs with respect to U.S. accounts and accounts held by recalcitrant account holders.

The participating FFI that maintains the account is generally responsible for reporting the account for each calendar year.

A participating FFI that maintains an account held by a financial institution that it has identified as an owner-documented FFI must report information with respect to each owner of the owner documented FFI that is a specified U.S. person.

Accounts held by specified U.S. persons and accounts held by U.S. owned foreign entities must be reported. These rules prescribe the information to be reported with respect to accounts required to be treated as U.S. accounts, the time and manner of filing the required form and procedures for requesting an extension to file such forms. There is guidance on the information required to be included in the U.S. account for determining the account balance or value

Accounts held by recalcitrant account holders are reported in aggregate but in separate categories. The separate categories of accounts held by recalcitrant account holders are accounts with U.S. indicia, or other recalcitrant account holders, and dormant accounts.

Expanded Affiliated Group Requirements

Today’s Foreign Financial Institutions can be found to have branches and subsidiaries all over the world; all of which may be opening U.S. accounts or accounts for foreign entities owned by U.S. shareholders.

The FFI Agreement makes provisions for this by allowing for “Affiliated Groups” to be covered by the FFI Agreement. The general rule is that, for any member of an expanded affiliated group to be a Participating FFI that is compliant with the Agreement, each FFI that is a member of the group must be either a Participating FFI or Registered Deemed Compliant FFI.

Each FFI that is a member of an expanded affiliated group must complete a registration form with the IRS and agree to all the requirements for the status for which it applies with respect to all of the accounts it maintains.

An FFI that is a member of an expanded affiliated group can obtain status as a Participating FFI notwithstanding that one or more members of the group cannot satisfy the requirements of the Agreement.

The Treasury Department and the IRS intend to require all Qualified Intermediaries that are FFIS to become Participating FFIs.

Adjustments for Over withholding and Under Withholding of Tax

There are certainly going to be situations in which there is over withholding as a result of the New Law requirements. Some U.S. Taxpayers are going to be claiming refunds.

The New Law provides for the potential that amounts may be over withheld by a withholding agent and if this is the case, tax refunds and credits should be available. This can result from a U.S. taxpayer whose tax rate is lower than the 30% withholding tax for many reasons. For example, a dividend from a U.S. company to a U.S. person’s foreign account that would normally be taxed at 15% may be withheld at 30%.

The New Law provides the procedures for adjustments for over withholding and under withholding of tax. If an overpayment of tax results from the withholding of tax under the New Law, the beneficial owner of an amount subject to withholding may claim a refund or credit for the overpayment of tax subject to certain requirements and limitations.

In order to obtain a reimbursement and/or set off for any over withheld amount, the withholding agent must obtain valid documentation from the beneficial owner or payee to identify its status and determine that withholding was not required.

The beneficial owner of the income or payment to which the withheld tax is attributable is allowed a credit against such beneficial owner’s income tax liability in the amount of tax actually withheld. If the tax required to be withheld is paid by the beneficial owner, payee, or withholding agent, the IRS may not collect from any other, regardless of the original liability for the tax.

To the extent the overpayment of tax was paid by a withholding agent out of its own funds, such amount may be credited or refunded to the withholding agent.

This is an updated video about the new IRS Streamlined Compliance Procedures announced by the IRS during the summer of 2014.

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