Danger of Foreign Grantor Trust Becoming NPFFI

A popular form of U.S. trust for non-U.S. Persons is the Foreign Grantor Trust (FGT). However, if the professional trustee does not take on FATCA tasks through the role of Sponsoring Entity, the trustee runs the risk of the FGT becoming a Non-Participating Foreign Financial Institution (NPFFI).

What Is a Foreign Grantor Trust?

A trust is established in a U.S. jurisdiction such as South Dakota or Nevada and a trustee is appointed. How could this trust be considered a non-U.S. trust? The short answer is the U.S. Internal Revenue Service (IRS) allows trusts to be created with a U.S. situs which the IRS will then treat as a foreign trust. There is no magic wand to achieve the foreign trust status. Instead, it requires that the trust satisfy certain IRS requirements in addition to any local state trust laws.

A grantor trust is a flow-through entity for U.S. tax purposes and all assets of the trust and income earned on those assets are attributed to the grantor. To be considered a “foreign” grantor, the grantor must be a Non-Resident Alien (NRA) under U.S. income tax rules. [To read more on what makes a trust an FGT, click to read my 28Dec2017 post.]

Sponsoring Options

Assuming the FGT is professionally administered, it will be considered a Foreign Financial Institution (FFI) under the Foreign Account Tax Compliance Act (FATCA). Financial Institutions in the U.S. and in non-Intergovernmental Agreement (IGA) jurisdictions apply the FATCA regulations. Although Model 1 and Model 2 IGAs offer a classification of Trustee Documented Trust, this classification is not available in the FATCA regulations. Thus, the choice may come down to Participating FFI, Sponsored Entity, or Sponsored Closely Held Investment Vehicle (SCHIV). [To read more about SCHIVs click to read my 28Nov2022 post.]

Classifying a FGT as a Participating FFI would require that the FGT register in the IRS FATCA portal and receive a Global Intermediary Identification Number (GIIN). Through this registration, the FGT will enter into an agreement with the IRS to comply with FATCA by undertaking certain due diligence, withholding, and reporting requirements for U.S. account holders.

If the FGT is classified as a Sponsored Entity or as a SCHIV, the Sponsoring Entity (e.g., the professional trustee) would enter into an agreement with the IRS whereby it agrees to take on due diligence, withholding, reporting, and other requirements that the FGT would have been required to perform if it obtained its own GIIN. There would also be a Sponsoring Agreement between the Sponsoring Entity and the sponsored FGT establishing the roles and responsibilities associated with FATCA requirements. [To read more on Sponsoring Entity Agreements, click to read my 7Aug2018 post.]

Risk of NPFFI

If a Participating FFI does not satisfy its obligations, the FFI will be treated by the IRS as a NPFFI subject to FATCA withholding. FATCA requires Financial Institutions to withhold 30 percent on U.S. Source Withholdable Payments made to an NPFFI. The term “U.S. Source Withholdable Payment” means payments 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 U.S. This type of income is also known as FDAP income.

Failed obligations might include failure to submit FATCA reporting, Certification of Preexisting Accounts (COPA), or a Periodic Certification. If the COPA or Periodic Certification is not made, the FGT’s IRS FATCA account may turn from Approved to Terminated. A third party Financial Institution validating the FGT’s GIIN against the IRS FFI List will see the terminated status, treat the FGT as a NPFFI, and apply withholding. If the professional trustee is a withholding agent, then it too must apply appropriate withholding.

The professional trustee will have greater control over FATCA compliance if it takes on the role of Sponsoring Entity. For example, the trustee is aware if the FGT makes a payment to a U.S. Person and is able to calendar the COPA and Periodic Certification in its online system to ensure timely submission. If the grantor is not responsive to the trustee in the trustee’s efforts to achieve FATCA compliance for the FGT, the trustee has recourse through breach of contract (Sponsoring Entity Agreement).

In its role as a U.S. Financial Institution, the trustee has a FATCA obligation to report NPFFIs to the IRS. To ensure its own FATCA compliance, a trustee which chooses to not become the Sponsoring Entity or to take on FGTs whose grantors refuse to sign a Sponsoring Entity Agreement, should establish a schedule to check the IRS FFI List to ensure the FGT’s GIIN is still valid.

For assistance, please contact me via my contact page or at elizabeth@elizabethmcmorrowlaw.com.