US Tax Transparency regimes

Introduced in 2001, the QI regime has two primary objectives: First, the identification of US persons holding offshore investment accounts. Second, ensuring that the correct rate of withholding tax is applied to US source income paid to non-US recipients. Since FATCA now covers the reporting of US taxpayers, the QI regime is now primarily a withholding regime.

Non-US banks who hold US securities on behalf of their underlying clients act in an intermediary capacity. The QI program allows certain non-US intermediaries to enter into a contractual agreement with the US Internal Revenue Service (IRS) and assume tax responsibilities ordinarily reserved to US financial institutions. The QI agreement imposes the following key obligations on QIs:

• Requiring the appropriate tax documentation on behalf of clients looking to invest in US securities
• Ensuring the appropriate rate of withholding tax is applied taking into consideration tax treaty benefits or otherwise reduced withholding at source to recipients that are appropriately documented and
• Reporting the amount of US source income and the withholding tax applied, including identifying the type of recipients of the US source income.

Every QI is required to appoint an individual responsible for its compliance with the QI agreement. That person is designated as the QI responsible officer (RO) and needs to establish a compliance program that includes policies, procedures, processes and controls. Every third year, the RO is required to certify the QI’s compliance towards the IRS. To assist the RO with this certification, unless the QI is eligible for a waiver, an independent reviewer is required to perform a periodic review that covers one of the three years forming the certification period.

FATCA is a US tax law aimed at preventing the use of offshore accounts by US taxpayers to evade US fiscal obligations. FATCA came into force on 1 July 2014 and imposes additional obligations on foreign financial institutions (FFIs).

Switzerland, like most OECD countries, has entered into an intergovernmental agreement (IGA) with the US to facilitate the implementation of FATCA. The impact of FATCA differs depending on whether a Swiss financial institution (FI) is a reporting or non-reporting Swiss FI.

A reporting Swiss FI must register with the IRS and enter into an FFI agreement with the IRS. The main obligations of a reporting Swiss FI under the FFI agreement include:

• Performing due diligence on its entire account population
• Withholding 30 percent on US source income (e.g. dividends or interests) paid to non-compliant account holders and
• Reporting annually to the IRS information on its US accounts.

Further, a reporting Swiss FI is required to appoint a FATCA RO. The RO must establish a compliance program that includes policies, procedures, processes and controls. Every third year, the RO is required to certify the reporting Swiss FI’s compliance towards the IRS.

FATCA affects not only banks but also fiduciaries, trust companies, life insurance companies and asset managers. Even though these may be less impacted by FATCA as they may qualify for a non-reporting FI status, they are nevertheless required to ensure that they, as well as the trusts, underlying companies or funds they administer, comply with their respective FATCA obligations, including the necessary RO certifications, if needed.

Moreover, even a Non-Financial Entity (NFE) must be prepared to respond to FATCA queries from clients and counterparties, including requests to confirm its FATCA status when opening bank accounts or requesting financing.

On 1 January 2017, the US section 871(m) regulations entered into force. The 871(m) regime aims to regulate derivative instruments, for example, futures, forwards, total return swaps, equity securities lending and repurchase agreements, referencing US equities, regardless of the location of the issuer.

The goal of 871(m) is to ensure that such instruments are not being used by non-US persons to enjoy the benefits of holding the underlying US equity, while avoiding US withholding tax. In order to address this, 871(m) introduces the concept of a deemed dividend on behalf of these instruments whenever a dividend is paid on the referenced underlying US equity. These deemed dividend payments, so-called dividend equivalent payments, are treated by the IRS as US source income, subject to withholding and reporting that is consistent with treatment when holding US equities directly and receiving dividend payments. As the location of the issuer is not relevant under 871(m), a Swiss structured product referencing a US equity, held through a Swiss custodian and with a Swiss investor can fall within the scope of 871(m). Thus, such Swiss structured product could potentially pay dividend equivalents subject to US withholding tax and reporting.

To reduce the impact of 871(m), the IRS introduced a new status available to eligible financial institutions involved with the issuance of derivative instruments. Available as part of the QI regime, the qualified derivatives dealer (QDD) status simplifies the withholding process for affected instruments and in return imposes enhanced due diligence and reporting requirements on QDDs, similar to the ones imposed to QIs.

Due to its complexity, the 871(m) regime has not yet been fully implemented and is being phased in with the full scope not taking effect until 31 December 2022. During this phase-in period, various elements of the regulations are not yet applicable and the scope of impacted instruments is limited to delta-one instruments. Despite this phased-in implementation timeline and the current relief, a financial institution that issues or acts in an intermediary capacity with respect to derivative products, must still ensure compliance with the current regulations and prepare for what might be coming in the future.