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  • Elizabeth A. McMorrow

FATCA Regs: Investment Entity Definition Clarified & Gross Proceeds Withholding Eliminated

Today the IRS released proposed FATCA regulations which clarify the definition of “Investment Entity,” and eliminate withholding on payments of gross proceeds.

Gross Proceeds Withholding Eliminated

A withholdable payment is:

  • Any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the United States; and

  • Any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States.

Withholding on gross proceeds was scheduled to commence on January 1, 2019. However, the IRS has determined that there are sufficient incentives in place for Foreign Financial Institutions (FFIs) to comply with FATCA without requiring withholding on gross proceeds.

Current Definition of Investment Entity

(i)In general. The term investment entity means any entity that is described in paragraph (e)(4)(i)(A), (B), or (C) of this section.

(A) The entity primarily conducts as a business one or more of the following activities or operations for or on behalf of a customer -

(1) Trading in money market instruments (checks, bills, certificates of deposit, derivatives, etc.); foreign currency; foreign exchange, interest rate, and index instruments; transferable securities; or commodity futures; (2) Individual or collective portfolio management; or (3) Otherwise investing, administering, or managing funds, money, or financial assets on behalf of other persons.

(B) The entity's gross income is primarily attributable to investing, reinvesting, or trading in financial assets (as defined in paragraph (e)(4)(ii) of this section) and the entity is managed by another entity that is described in paragraph (e)(1)(i), (ii), (iv), or (e)(4)(i)(A) of this section. For purposes of this paragraph (e)(4)(i)(B), an entity is managed by another entity if the managing entity performs, either directly or through another third-party service provider, any of the activities described in paragraph (e)(4)(i)(A) of this section on behalf of the managed entity.

(C) The entity functions or holds itself out as a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets.

More Restricted View of “Managed By”

The IRS provides several examples in the existing FATCA regulations to illustrate the definition of Investment Entity. In these examples, the IRS discusses that in some circumstances Entity 2 will be an Investment Entity if it is managed by Entity 1 which has discretionary management over Entity 2’s assets.

The proposed regulations clarify that Entity 1 is not “managed by” another entity solely because Entity 2 invests all or a portion of its assets in Entity 1 and Entity 1 is a mutual fund, an exchange traded fund, or a collective investment entity that is widely held and is subject to investor-protection regulation.

However, an investor in a discretionary mandate will be considered to be “managed by” the financial institution offering the discretionary mandate. (A “discretionary mandate” is an investment product or solution offered by a financial institution to certain clients where the financial institution manages and invests the client’s funds directly (rather than the client investing in a separate entity) in accordance with the client’s investment goals.)

The IRS indicated that the clarification in these proposed regulations is similar to the guidance published by the OECD interpreting the definition of a “managed by” investment entity under the Common Reporting Standard (CRS).

Additional Topics Covered by Proposed Regulations

The proposed regulations also:

  • Extend the time for withholding on foreign passthru payments

  • Eliminate withholding on certain insurance premiums

  • Include guidance regarding certain due diligence requirements of withholding agents and guidance on refunds and credits of amounts withheld.

Click to read the IRS’ proposed regulations.

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