How FATCA Applies to your Offshore Investment, Part 3

This article, the final in a three-part series, applies the FATCA rules discussed in the previous articles to non-U.S. trusts. This article discusses how non-U.S. trusts are treated for FATCA purposes and their options for FATCA compliance.

Written by Stewart Patton

The first part of this series discussed FATCA terminology and the basic operation of the FATCA rules. The second part applied these rules to a direct offshore investment and an investment through an offshore corporation. This article applies the FATCA rules to an investment through a non-U.S. trust.

FATCA Treatment of Non-U.S. Trusts

As described in the first part of this series, the term “FFI” applies not only to entities that are obviously financial institutions (like banks and brokers) but also to a class of entities called “investment entities.” One type of investment entity is an entity that (i) derives more than 50% of its income from investing in securities and (ii) is managed by another entity as part of the manager’s business.

A trust is not an entity for most legal purposes; rather, it is merely a contractual arrangement among the settlor, trustee, and beneficiary. However, consistent with its treatment for other U.S. tax reporting purposes, a trust is treated as an entity for FATCA purposes. And, if the trust’s income is predominantly from securities, then it will be an “investment entity” and therefore an FFI. If the trust’s income is not predominantly from securities, then the trust will simply be an NFFE.

What about a trust where no party involved (i.e., no settlor, trustee, protector, or beneficiary) is a U.S. person? The trust is still an FFI if it meets the income test discussed above. FATCA is a concern for non-U.S. trusts that have U.S. investments, even if there are no U.S. persons involved.

What about the common structure where a trust makes all investments through an underlying company (such as an IBC or LLC)? The FATCA treatment of this structure is unclear—the structure is not contemplated by the FATCA regulations or any other guidance. In certain cases, it may make sense to simply disregard the underlying company and treat the trust as the relevant entity for FATCA purposes. In other cases, someadditional reporting may need to be put in place for the underlying company. In any event, the trust itself must always insure that it is FATCA compliant.

FATCA Compliance Options for Non-U.S. Trusts that are FFIs

Non-U.S. trusts that are NFFEs (i.e., because their income is not predominantly from securities) have it pretty easy—they are treated in the same manner as are offshore corporations (as discussed in the second part of this series). However, trusts that are FFIs have a much more difficult time complying with FATCA. The remainder of this article addresses only trusts that are FFIs.

A trust that takes no action whatsoever would be a “non-participating FFI,” meaning that it would be subject to the 30% FATCA withholding tax. Therefore, a trust should take action to achieve a FATCA-compliant status before it receives any withholdable payments. A trust has several options to become FATCA compliant.

Option 1: Become a Participating FFI

First, the trust could become a participating FFI (just like a bank or broker). To become a participating FFI, the trust would need to comply with the complex FATCA regulations, which are written more with banks and brokers in mind and therefore do not always apply in a logical fashion to trusts. Thus, for example, becoming a participating FFI would involve the trust registering with the IRS through the IRS’s own proprietary online registration system, entering into an FFI agreement with the IRS, appointing a person to act as the “responsible officer” of the trust when it comes to FATCA matters, adopting a FATCA compliance policy, and filing annual FATCA reports with the IRS.

It is not clear exactly how certain of these rules apply to trusts—e.g., a trust doesn’t really have an “officer” that can be appointed as the “responsible officer,” and that is not a role that a settlor or beneficiary would ordinarily be willing to take on. The stakes are high: any failure to apply the FATCA rules correctly risks cancellation of the FFI agreement and, therefore, treatment as a non-participating FFI.

Option 2: Become an “Owner-Documented FFI”

Next, the trust could become an “owner-documented FFI.” An owner-documented FFI is an FFI that has an account with a U.S. financial institution or participating FFI that has, in turn, agreed to treat the trust as an owner-documented FFI. The advantage of this option over the first option is that the trust is not required to handle all of the FATCA matters described above on its own—all of these matters are taken care of by the U.S. financial institution or participating FFI in which the trust holds an account.

The disadvantage of this option is that the trust can only be treated as an owner-documented FFI with respect to one U.S. financial institution or participating FFI in which it holds an account. Therefore, if the trust has more than one account (for example, a bank account and a brokerage account), the trust would only be able to be treated as an owner-documented FFI with respect to one account (and would therefore be subject to FATCA withholding with respect to the other account(s)). Additionally, the trust would be limited in its selection of banks and brokers to only those that are willing to treat the trust as an owner-documented FFI—some banks and brokers do not offer this service.

Option 3: Become a “Sponsored Entity”

Finally, the trustee of the trust could act as the “sponsoring entity” for the trust, which allows the trust to be FATCA compliant as a “sponsored entity.” The trustee would first need to register with the IRS as a sponsoring entity—this registration is only be for purposes of acting as a sponsor and does not otherwise create FATCA compliance concerns for the trustee. The trustee would then do all the work to register each trust it sponsors with the IRS and cause each sponsored trust to comply with FATCA. The trustee would also file any required annual FATCA reports with the IRS.

This option combines the best of both of the previous options while avoiding their drawbacks. Like Option 1, the trust would be FATCA compliant with respect to all of its accounts and would be able to freely change banks or brokers without worrying about losing its FATCA-compliant status. Also, like Option 2, the trust would achieve FATCA compliance without having to comply with all of the FATCA rules that are written more for banks or brokers (such as the appointment of a FATCA responsible officer and adoption of a FATCA compliance policy).

Conclusion

We’ve reached the end of this series (at least for now—I may add an additional article or two in the future discussing the FATCA treatment of more exotic structures). I hope you have found it informative.

Over the next couple of years, the FATCA regulations and/or their application will very likely change, maybe in such a dramatic fashion that some of the discussion in these articles no longer applies. It’s a jungle out there—please be sure you have a guide and the latest map.

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Stewart Patton

I'm Stewart Patton, US tax attorney and expat entrepreneur based in beautiful Belize. Read more about me here, or email me at [email protected] to discuss how I can help.

U.S. Tax Services, P.O Box 2651 Belize City, Belize • Belize tel: (+501) 629-6007 • U.S. VOIP: (312) 675-8571 • Email: [email protected]