The first part of this series discussed FATCA terminology and the basic operation of the FATCA rules. This article starts applying all of those technical rules, first to the simplest offshore structure—a direct offshore investment—and then to an investment through an offshore corporation.
The No-Structure Structure
The simplest way to invest offshore is to simply hold an account at a non-U.S. bank or non-U.S. brokerage in your own name. If the bank or brokerage is not a “participating FFI” (as defined in Part 1), and you hold U.S. securities through your account, then you will indirectly bear a 30% withholding tax on payments with respect to those securities. So, you will want to choose a non-U.S. bank or non-U.S. broker that is FATCA compliant. Make sure it is included in the IRS’s list of participating FFIs, available here.
FATCA requires participating FFIs to search their account records for information indicating that an accountholder may be a U.S. person; this information is called “U.S. indicia.” Next, FATCA requires a participating FFI to obtain additional specific information to cure any U.S. indicia found. If the accountholder does not provide the additional information, the participating FFI is required to close the account.
If a participating FFI determines that an accountholder is a U.S. person, then the participating FFI must file a report with the IRS each year with certain basic information about the accountholder and the account (i.e., account number, maximum value, income on the account, etc.). Many non-U.S. jurisdictions have bank secrecy laws that disallow banks from reporting this sort of information about their account holders; FATCA requires participating FFIs to obtain waivers of these laws from their U.S. accountholders.
Investment through a Non-U.S. Corporation
Next, let’s look at an investment through a non-U.S. corporation. But first (with my apologies), I need to drag you through a couple more technical rules before we dive in.
This section discusses the FATCA treatment of non-U.S. entities that are classified as corporations for U.S. tax purposes. Of course, U.S. tax law has its own rules for determining if an entity is a corporation for U.S. tax purposes. The U.S. tax rules provide for a default treatment and then allow certain entities to elect a different treatment.
First, the default treatment depends on whether the owners have limited liability. If all owners have limited liability, then the entity is a corporation for U.S. tax purposes. If at least one owner does not have limited liability, then the entity is either (i) disregarded as a separate entity from its owner if it only has one owner or (ii) a partnership if it has more than one owner.
Next, the IRS has published a list of entities that are always treated as corporations for U.S. tax purposes. If a non-U.S. entity is not one of the listed entity types, then it can elect its treatment for U.S. tax purposes (i.e., as either a corporation, disregarded entity (if it has one owner), or partnership (if it has more than one owner)). This election is made on IRS Form 8832, and it must be made within 75 days after formation of the entity to be effective as of its date of formation.
Application to Offshore Corporations—Active Business
Let’s apply these rules and the FATCA rules to an investment through a non-U.S. entity.
Joe (a U.S. citizen) forms and owns 100% of a Belize international business corporation (an “IBC”), which he uses as part of an active business (e.g., the manufacture and sale of physical goods). The IBC does not make an entity classification election on IRS Form 8832. How does FATCA apply to Joe and his IBC?
First, the IBC is a corporation for U.S. tax purposes because Joe has limited liability under Belize law and the IBC has not elected out of this default treatment.
Next, to determine its FATCA treatment, we must determine whether the IBC is an FFI or NFFE. The IBC is obviously not a bank or a broker, and it also is not an “investment entity” (as defined in Part 1) because its income is not predominantly from securities. Therefore, the IBC is not an FFI. All non-U.S. entities that are not FFIs are NFFEs, so Joe’s IBC is an NFFE.
Finally, because Joe’s IBC operates an active business, it can avoid withholding by certifying on its IRS Form W-8BEN-E that it is an “Active NFFE.” The IBC will not be required to provide information about Joe’s ownership on the IRS Form W-8BEN-E.
Application to Offshore Corporations—Passive Investments
Jane forms and owns 100% of an IBC, which she uses only to hold stock of U.S. companies through a brokerage account. Jane has not hired anyone else to manage the IBC.
First, the IBC is a corporation for US tax purposes for the same reason discussed above. Next, the IBC is obviously not a bank or brokerage, and it is also not an “investment entity” because no one manages the IBC’s assets. Therefore, Jane’s IBC is also an NFFE (just like Joe’s IBC).
However, Jane’s IBC cannot certify that it operates an active business. Rather, Jane’s IBC is a “Passive NFFE,” and Jane is a “substantial U.S. owner” (because she owns more than 10% of the IBC). So, to avoid FATCA withholding, the IBC must provide information about Jane to the broker on its IRS Form W-8BEN-E. The broker would then provide information about Jane’s indirect account ownership to the IRS.
Different Treatment, Same Ultimate Effect
It does not really matter in the grand scheme of things that Jane’s IBC must provide information about Jane while Joe’s IBC does not need to provide information about Joe. Both Jane and Joe are required to file an IRS Form 5471 with their U.S. tax return to report ownership of their IBC and to provide certain information about it (including financial information), and both are required to file an FBAR reporting the accounts held by the IBC. They also may both be required to file an IRS Form 8938 depending on the value of their IBCs and other non-U.S. assets. So, the fact that Joe’s IBC is an “Active NFFE” does not ultimately change his U.S. tax outcome.
Part 3 Preview
Part 3 of this series discusses trusts, which involve quite a bit more complication than offshore corporations.