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On September 14, 2012, the US and the UK announced the signing of a bilateral agreement (the UK IGA) setting out the reporting and withholding requirements applicable to UK financial institutions under the Foreign Account Tax Compliance Act (FATCA). Hewing closely to the reciprocal version of the model intergovernmental agreement released in July (the model IGA), the UK IGA fleshes out points intentionally left open for negotiation by the model IGA and generally contains few surprises.

In connection with the announcement of the UK IGA, HM Revenue & Customs on September 18, 2012 issued a consultation document (the HMRC consultation document) discussing the projected implementation of the UK IGA and soliciting comments from interested parties.

Background

FATCA imposes a 30% US withholding tax on certain payments (generally, US-source payments and certain as-of-yet-undefined "foreign passthru payments") to foreign financial institutions (FFIs) that do not comply with FATCA (nonparticipating FFIs), with the goal of compelling FFIs to report US account information to the US government. The US and five European countries developed the model IGA as an alternative to compliance with FATCA's statutory requirements, since those requirements in many instances conflict with local bank secrecy, data protection, and other laws. A discussion of the model IGA framework can be found here. The remainder of this eAlert discusses the major instances in which the UK IGA expands upon or departs from the model IGA framework.

Key Elements of the UK IGA

FATCA-exempt Institutions and Products

As expected, the UK IGA contains an annex (the Annex) that carves specified entities and financial products with a low potential for US tax avoidance out of FATCA's reporting and withholding regime. Very generally, the Annex establishes that UK governmental organizations, certain international organizations operating in the UK, and certain pension and retirement funds will be treated as "exempt beneficial owners" for FATCA purposes, and therefore will not be subject to FATCA withholding. FATCA withholding similarly will not apply to UK financial institutions with local client bases (a category that is generally defined to include organizations that provide financial services only within the UK to UK or European Union residents) or certain UK non-profit organizations, as the Annex provides that these entities will be treated as "deemed-compliant FFIs". The Annex also excludes from the definition of "financial account" a list of retirement accounts and tax-advantaged financial products, all of which are already subject to some form of regulation in the UK. The effect of this exclusion is that such accounts will not be subject to the due diligence and reporting requirements imposed by FATCA or the UK IGA upon FFIs with respect to financial accounts.

The Annex is subject to revision by the mutual agreement of US and UK tax authorities, as necessary, to include or remove entities, accounts or products based on their potential for US tax avoidance. It is possible, for instance, that the US and the UK may at some future date include certain regulated investment fund vehicles within the list of deemed-compliant FFIs.

Withholding Penalty for Significant Non-Compliance

A UK-based FFI that does not qualify for one of the exceptions found in the Annex (a Reporting UK FFI) will still be eligible for an exemption from FATCA withholding, subject to reporting requirements that track closely the corresponding provisions of the model IGA. In a clarification of potentially ambiguous language in the model IGA, the UK IGA is explicit that a Reporting UK FFI that does not comply with its obligations will be subject to FATCA withholding only if its non-compliance is "significant" and has not been resolved within 18 months. It remains somewhat unclear where the threshold for significant non-compliance lies since neither the UK IGA nor the Model IGA define the concept. The HMRC consultation documentation suggests, however, that significant non-compliance would generally include intentional errors, deliberate or negligent omissions, repeated failure to timely supply accurate information, or ongoing failure to establish appropriate governance or due diligence processes. The precise contours of significant non-compliance will ultimately be determined by mutual agreement between the US and UK.

Most-favoured Nation Clause

The UK IGA ensures that the UK will receive the benefit of any more favorable terms afforded to any other jurisdiction that signs an intergovernmental agreement with the US, provided such other jurisdiction commits to the same obligations undertaken by the UK.

Effective Date

The UK IGA takes effect when the later of the US or the UK has completed the necessary internal procedures to carry out its respective obligations and notified the other party accordingly. A reference in the model IGA to January 1, 2013 as a potential outside effective date was stricken from the UK IGA, possibly in recognition that neither the US nor the UK will have their procedures in place by that date. On this score, the HMRC consultation document notes that a town hall meeting will be held in London on September 25, 2012 to solicit feedback from interested parties, with a view toward publishing draft legislation by the end of 2012 for the UK Finance Bill 2013.

Foreign Passthru Payment Withholding Still an Open Question

The UK IGA breaks no new ground on the important issue of withholding on foreign passthru payments, and instead merely reiterates the model IGA's commitment to devising a workable alternative. As under the model IGA, a Reporting UK FFI that complies with its obligations generally should not be subject to any form of FATCA withholding, including with respect to foreign passthru payments. It remains unclear, however, whether a Reporting UK FFI will ever be required to withhold on foreign passthru payments to FFIs in another jurisdiction. It is also unclear whether the penalty for significant non-compliance lasting greater than 18 months will require either withholding by or against the non-compliant FFI with respect to foreign passthru payments.

Circular 230

Circular 230 disclosure: To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that the US federal tax discussion contained herein (1) was not intended or written to be used, and cannot be used, for the purpose of avoiding US federal tax-related penalties under the Internal Revenue Code and (2) was not written to support the promotion or marketing of any transaction. Taxpayers should seek the advice of their own independent tax advisers based on their own particular circumstances.