This Alert is directed to Canadian businesses that are not in the financial services industry, as well as individuals.
In the coming months, all Canadian businesses and many individuals can expect to be contacted in some way or another about their status under the U.S. Foreign Account Tax Compliance Act, FATCA. Canadian financial institutions will be required to review your status because of the Intergovernmental Agreement, IGA, entered into between Canada and the U.S. You may also receive requests about your FATCA status from non-Canadian financial institutions and other businesses.
FATCA and the IGA in brief
In its efforts to combat tax evasion, the U.S. government enacted FATCA to help the U.S. Treasury identify U.S. residents and citizens who invest outside the U.S. With the information gathered under FATCA, the U.S. government will be in a much better position to enforce compliance with U.S. tax obligations. The legislation is far-reaching and would require foreign financial institutions, including those in Canada, to disclose their U.S. account holders' identities and account information to the Internal Revenue Service (IRS). We wrote about FATCA in the 2013-02 issue of the Tax Factor in the article titled “U.S. reporting requirements may affect Canadian financial institutions”.
Subsequently, and as noted in our February 2014 Tax Alert — Canada Announces Intergovernmental Agreement with the United States over FATCA, Canada entered into an IGA with the IRS in 2014. This agreement provides a way to administer the key elements of the FATCA rules within Canada. Under the IGA, Canadian financial institutions are required to report relevant information with respect to accounts held by U.S. persons to the Canada Revenue Agency (CRA), rather than to the IRS. The CRA will exchange the information with the IRS through the existing provisions and safeguards of the Canada-U.S. Tax Treaty.
FATCA status
Under the IGA, Canadian financial institutions are subject to extensive due diligence obligations for identifying and reporting on accounts held by and connected to U.S. citizens. In addition, payments to certain non-participating financial institutions must be identified and reported.
Canadian financial institutions will be asking their account holders and customers to complete various information requests. This information will assist the Canadian financial institution with their required compliance under the IGA. In addition, U.S. financial institutions or other organizations may ask you to complete U.S. Department of the Treasury Form W8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) in respect of your business. The W8 forms have been changed with the implementation of FATCA. The W8BEN-E requires a business or other organization to self-identify into one of approximately 30 categories of organization under FATCA. Note that these forms are returned to the person who requested them, not to the IRS. Many non-financial Canadian entities will be “non-financial foreign entities” or NFFEs. These categories are explained in further detail below.
Canadian non-financial entities
Active
Canadian businesses that are not in the financial services industry will generally fall into one of two categories of non-financial foreign entities — Active or Passive. Once identified as an Active NFFE, such businesses will generally not be significantly impacted by FATCA; their compliance will generally be limited to providing the business's status under FATCA when requested, and certifying that they meet the definition of an Active NFFE.
In general, a Canadian business will be an Active NFFE if less than 50% of its gross income is passive income, and less than 50% of the assets held during the preceding reporting period are assets that produce, or are held for the production of, passive income. Although the distinction between active and passive income is an important one for FATCA compliance, “passive income” is not a defined term in the IGA and the competent authorities have not agreed to a common meaning. However, the CRA states that passive income includes income from the mere holding of property, such as interest, dividends, rents, and royalties. In general, any active Canadian business that is not a financial institution and has limited passive assets or passive income will be an Active NFFE. Special rules apply where a company is in the start-up phase and therefore has a relatively large amount of passive assets that will be used in an active business.
Where the company is not a financial institution, an Active NFFE will also include a company whose stock is regularly traded on an established stock exchange, or a related company. Governments, including provincial and municipal governments, are not part of a separate classification, but are considered Active NFFEs. Your BDO advisor can assist in the determination of the FATCA classification of your organization.
Passive
The definition of a Passive NFFE is defined in the negative — any non-financial institution that is not an Active NFFE will be a Passive NFFE. A privately held Canadian investment holding company is likely to be a Passive NFFE.
Additional disclosure is required where a Canadian business meets the test to be a Passive NFFE. To start with, under the IGA, Passive NFFEs are required to certify to requesting financial institutions that they do not have any controlling persons that are U.S. persons. Where this is not the case, Passive NFFEs will need to provide certain information. Specifically, the information required if there are controlling U.S. persons is the U.S. person's full name, permanent residential address, and their U.S. tax identification number. Reporting Canadian financial institutions will need to report accounts held by Passive NFFEs that have controlling U.S. persons to the CRA as part of their annual filing under the IGA.
Controlling persons are defined as the people who exercise control over an entity. In the case of a trust, such term means the settlor, the trustees, the protector (if any), the beneficiaries (or class of beneficiaries), and any other person exercising ultimate effective control over the trust. Whether an individual is a controlling person is generally determined by reference to a 25% level of ownership, consistent with the "know your customer" and anti-money laundering policies used in the financial industry. However, whether any particular person exercises control over a particular entity is ultimately to be determined based on the particular situation in a manner consistent with how beneficial owners are identified for the purposes of Canada's Proceeds of Crime (Money Laundering) and Terrorist Financing Act.
Controlling persons vs. substantial U.S. owners
Under the IGA, Canadian financial institutions can create their own form to use to gather account information and required certifications. Alternately, they could ask their business account holders to complete IRS Form W-8BEN-E. However, it should be noted that this form may create some confusion regarding the information to be disclosed about U.S. shareholders. As discussed above, under the IGA, there is a threshold of 25% control where de facto control is not in the hands of U.S. persons. However, the IRS form is not specifically designed for compliance under the Canadian IGA; rather it is designed for compliance from all countries. Instead of “controlling person”, Form W-8BEN-E asks for the details regarding “substantial U.S. owners”. The “substantial U.S. owners” test requires only a 10% threshold of ownership. Your BDO advisor can help you to understand the information that you are required to provide to a requesting financial institution under FATCA or the IGA.
Individuals
Individuals may also be asked about their FATCA status by Canadian financial institutions, foreign financial institutions and U.S. payors. Canadian financial institutions may ask you to complete a questionnaire or form to assist them in their reporting obligations. Non-U.S. individuals may be asked to complete Form W8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals). If you are a U.S. person, you may instead be asked to complete IRS Form W-9, Request for Taxpayer Identification Number and Certification. These forms are sent to the person who requested them. They are not sent to the IRS unless specifically requested by the IRS. Your BDO advisor can assist you in the completion of these forms.
As noted earlier, the purpose of FATCA is to enable the U.S. Treasury to identify U.S. residents and citizens who invest offshore. This will then assist the IRS in determining if U.S. citizens living outside the U.S. are up-to-date on their personal income tax filings, and if U.S. citizens in general have been declaring income earned outside of the U.S. If you are a U.S. person and are not up-to-date on your tax filings, or your tax filings are not complete with respect to investments outside of the U.S., please contact your BDO advisor.
Key dates and other information
Although FATCA was enacted in 2010, the IGA was enacted in June of 2014 when the enabling Canadian legislation was passed. The effective date for the start of reporting under FATCA and the IGA was July 1, 2014. The first reporting date by Canadian financial institutions under this agreement is May 1, 2015. Reporting required under the IGA will be phased in over 2014, 2015 and 2016 such that limited disclosure will be required in the first two years.
The CRA recently issued IGA guidance directed at non-financial institutions and individuals. You can refer to “Information for entities with accounts with Canadian financial institutions” and “Information for individuals with accounts with Canadian financial institutions” on the CRA's website for more details on the administrative aspects of the IGA.
Summary
The FATCA and the IGA rules are complex. The guidance provided by the IRS regarding FATCA and by the CRA regarding the IGA has been issued in stages, and may not yet be complete. If your organization is not a financial institution, you should now have a better idea of the role of Canadian financial institutions regarding reporting accounts, and a better understanding behind the questions they will be asking you. If you are contacted regarding your or your organization's FATCA status, your BDO advisor would be pleased to discuss how FATCA may impact you or your business.
The information in this publication is current as of October 3, 2014.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.
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