FATCA: How to Achieve a Practical Understanding Without Getting Lost in the Weeds.
FATCA is a compliance program. It turns payors of U.S. source income into withholding agents. If a withholding agent receives written certification from a business in Canada that satisfies FATCA requirements no withholding occurs. If that certification is not forthcoming 30% of the amount due to the Canadian entity will be withheld.Why? U.S. citizens and residents are subject to U.S. income taxation on worldwide income regardless of the source from which it is derived. In order to avoid U.S. taxation, some U.S. citizens and residents invest outside the United States. FATCA is after those taxpayers. To find out about them and the income they receive FATCA turns the foreign financial institutions (“FFIs”) at which they bank and invest into withholding agents, as well.
Generally, FATCA withholding applies to any type of U.S. source income which is not effectively connected with the conduct of a U.S. trade or business. A variety of “nonfinancial payments” are excluded from withholding. These include
(1) wages and salaries,
(2) non-cash employee compensation including stock options,
(3) property rents,
(4) payments under office equipment leases,
(5) payments under software licenses,
(6) payments for transportation services,
(7) payments for shipping,
(8) awards, prizes, and scholarships, and
(9) proceeds from sale of property producing any of the kinds of income described above.
FATCA affects individuals but it does not apply to them. That is, individuals are not subject to any of the compliance obligations FATCA imposes. Instead, FATCA applies to entities, any kind of entity: corporations, partnerships, ULCs, even trusts. The entities that are characterized as FFIs are required to identify their depositors and investors who are “specified U.S. persons” and report information about the U.S. persons and payments made to them to CRA. CRA will, in turn, deliver the information it receives to the Internal Revenue Service. Nonfinancial foreign entities (“NFFEs”) are subject to little or no compliance, but all NFFEs must nevertheless certify their FATCA status to avoid withholding on U.S. source income. “Passive NFFEs” will also have to disclose the identity of any “substantial U.S. persons” who own equity or debt interests in the NFFE. Active NFFEs are not required to make any disclosures regarding their owners. The distinction between active NFFEs and passive NFFEs is based upon the character of the NFFE’s income. As long as at least half of the entity’s income is from the conduct of an active trade or business, the entity will not be characterized as a passive NFFE.
Whether a payor of U.S. source income will be required by FATCA to withhold on the payment depends upon the FATCA status of the payee. Canadian entities that receive U.S. source income will have to certify their FATCA status by providing the U.S. payor with a Form W-8BEN-E. A copy of this form is attached. The Canadian entity will have to choose one of 27 boxes to identify its FATCA status and verify its compliance with the requirements for the status it has claimed.