Samantha Yardley discusses the far-reaching implications of the US Foreign Account Tax Compliance Act on lessors and lessees.
The United States Foreign Account Tax Compliance Act (FATCA), which was enacted in 2010, has potentially far-reaching implications for lessors and lessees across the globe and will be implemented by mutual agreement between the US, the UK and other countries.
Go deeper with GlobalData
FATCA is immensely complex and the implementing regulations have only just been finalised, so this article only deals with its broad themes.
The stated aim of FATCA is to improve tax compliance by requiring entities outside the US to report to the US Internal Revenue Service (IRS) or, in the UK under a joint agreement with the US, HMRC, information on assets held by US taxpayers.
The penalty on foreign entities for non-compliance is the imposition of a 30% withholding tax charge on US source payments made to it.
As the payer is liable to the IRS for its failure to withhold tax, both a lessor and a lessee could have a FATCA liability and so a leasing agreement should address the FATCA risk in relevant cases and allocate the liability among the parties.
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Thank you!
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form
By GlobalDataWho does it affect?
FATCA identifies two types of entities which may be subject to the withholding tax regime: Foreign Financial Institutions (FFIs) and Non-Financial Foreign Entities (NFFEs).
Essentially a FFI is a non-US entity that (i) accepts deposits in the ordinary course of a banking or similar business, (ii) holds financial assets for the account of others or a substantial portion of its business, or (iii) is engaged (or holds itself out as being engaged) primarily in the business of investing, reinvesting or trading in securities NFFEs are, effectively, every other non-US entity.
In order to be compliant with FATCA, each FFI is required to identify those of its account holders which may be US persons and to report the income of such persons to the IRS.
A NFFE has simplified reporting requirements which relate to direct or indirect ownership by US persons.
What is the penalty for non-compliance and are there exceptions?
The effect of FATCA is such that, when making almost any type of payment anywhere in the world, the paying party must know (and have been provided with sufficient evidence to prove) that the payee is FATCA-compliant, unless one of five exceptions applies. (There are two key exceptions which are potentially helpful to lessees and lessors – see below).
If an exception does not apply and the recipient is not or cannot prove that it is FATCA-compliant, then the payer (who for the purposes of FATCA is a ‘withholding agent’) may have to make a withholding of 30% (a ‘withholdable payment’) and pay the withheld amount to the IRS.
This could have serious implications for each party: a lessor may suffer a 30% withholding or, where a gross-up obligation is imposed on a lessee under the terms of a lease, the lessee may find itself having to pay a grossed-up amount each time a rental is due.
As mentioned above, there are exceptions:
– Debt and certain other limited obligations incurred before 1 January 2014, unless they are subsequently materially modified, and payments in respect of collateral under such agreements.
– Payments that are not US source – but note that the concept of ‘US source’ is a complicated one and the rules vary depending on the type of income.
– Payments to exempt recipients (essentially US persons and persons that demonstrate they are FATCA-compliant).
– Certain specified payments made for non-financial services and leases for the use of property.
– Payments in respect of which a FATCA withholding has already been made by another party.
Exceptions for leasing
For lessors and lessees in commercial leasing transactions, the key to determining the potential application of FATCA is the characterisation of the transaction.
A lease could be viewed as a financing transaction or an agreement for the use of property. If the transaction is properly characterised for US tax purposes as a lease for the use of tangible, personal property to be used solely outside the US, the source of the income is likely to be non-US source income, and therefore the rental payments would not be withholdable payments under FATCA.
Also, the FATCA rules exclude from the withholding requirement payments under leases that are not financing transactions, (specifically payments for "the use of property, office and equipment leases, software licences, transportation", and freight).
If the lease is a financing lease (including a ‘finance lease’ in UK terms), the lease may be treated as a loan under US tax principles, with the lessee as the borrower and the lessor as the lender.
Where a lessee in a financing lease is a non-US person who has no US business or US connections, the lease payments would generally be non-US source, but during the term of a transaction, the lessee’s circumstances in relation to the US could change, so a non-US lessor should have the obligation under the leasing documents to provide the lessee with evidence that it is exempt under FATCA.
The obligation to actually withhold in respect of withholdable payments does not start until 1 January 2014 (1 January 2017 in the case of ‘gross proceeds’ from the sale or disposition of property (other than a grandfathered obligation) that can produce US source interest or dividends).
However, as FATCA can apply to agreements entered into before 2014 if substantially modified after 2013, 2013 is the year in which lessors and lessees should consider and address FATCA, if they have not already done so, both as regards their documents and their reporting processes, before they risk getting caught out.
Samantha Yardley is a partner at Watson, Farley & Williams
