What Canadian Business Owners Need to Know About FATCA

April 21, 2016

FATCA in a Nutshell
What Can You Expect?
Determining Your Company’s FATCA Status
Responding to FATCA Requests
Understanding Penalties and Withholding
Looking Forward

In the past few months, you may have seen the U.S. Foreign Account Tax Compliance Act (FATCA) in the news once more. September 2015 saw the first transfer of tax information about U.S. persons from the Canada Revenue Agency (CRA) to the Internal Revenue Service (IRS), heralded by court challenges that alleged such transfers violate Canadian privacy laws. While a federal judge ruled that the disclosure of personal information required by FATCA was not inconsistent with the Canada-U.S. tax treaty, controversy remains.

Though debate about FATCA continues, the current situation leaves Canadian business owners little room for error. FATCA legislation requires that all entities self-identify their FATCA status when requested, even if they have no connection to, income from, or investment in the United States. For those that don’t comply with these requests, stiff penalties may apply.

FATCA in a Nutshell

FATCA legislation was introduced in 2010 to prevent U.S. persons from evading taxes by hiding income and assets offshore. FATCA primarily targets two groups: U.S. citizens who live in other countries, and citizens and other residents who are hiding assets outside of the United States. However, given the broad definition of “U.S. person” under American tax law—a definition that includes U.S. citizens (even if living abroad), and U.S. non-citizens who are considered residents of the U.S. for tax purposes (even if they are also bona fide residents of Canada)— many Canadians are impacted.

Businesses, too, have a variety of FATCA-related obligations. While FATCA aims to increase the compliance of U.S. taxpayers, financial institutions worldwide now need to identify which accounts belong, in whole or in part, to U.S. persons. As a result, banks and other financial institutions are combing through existing accounts, seeking indications that a U.S. person may be a beneficial owner.

Canada, like many nations worldwide, has entered into an Intergovernmental Agreement (IGA) with the United States to help manage Canadian entities’ FATCA responsibilities. Canada has signed a Model 1 agreement, which stipulates that local institutions will send collected information to the CRA, which will subsequently send this information to the IRS under the data transfer provisions of the Canada-U.S. tax treaty, as happened this past September.

What Can You Expect?

It’s safe to assume that you may shortly receive a FATCA status request from your bank, another financial institution, or U.S.-based companies with which you work—if you haven’t already. While responding to these requests is voluntary, non-response or delaying your response will deem you or your company as “non-compliant” and could result in costly withholding and/or the closure of your accounts.

What can trigger these requests? There are a range of indicators that financial institutions look for, which may include payments to or from a U.S.-based account, a U.S. person granted signing authority, a U.S. birthplace, and/or a U.S. phone number or address associated with the account. However slight the indicator of a U.S. person’s involvement in the company, financial institutions will send a request to err on the side of caution, especially given the stiff financial penalties that result from non-compliance. Requesting FATCA status is also becoming a standard procedure for the creation of new financial accounts, and may also be required by other payors with which you work as part of their own due diligence.

Determining Your Company’s FATCA Status

Understanding your company’s FATCA status is critical to properly responding to information requests and avoiding the penalties.

Under the Canadian IGA, businesses are divided into two main classifications: Foreign Financial Institutions (FFIs) and Non-Financial Foreign Entities (NFFEs). FFIs are entities that accept deposits or hold financial assets for the account of others, or which are primarily in the business of investing, reinvesting, or trading in securities or commodities. Broadly, this includes banks, credit unions, investment firms, and pension funds. FFIs generally bear the greatest burden of responsibility with regard to FATCA rules.

A Non-Financial Foreign Entity, or NFFE, is defined as any entity that is not classified as a Foreign Financial Institution. Most Canadian businesses are NFFEs, including small businesses and start-ups. NFFEs are sub-classified into two groups:

  • Active NFFEs are publicly traded Canadian entities and other entities specifically identified in the IGA, such as registered charities. Privately owned Canadian entities also count as Active NFFEs so long as less than 50% of their gross income in the preceding year is passive income and less than 50% of the assets held during the preceding year produce or are held for passive income. Start-up entities also count as Active NFFEs if they are “investing in assets with the intent of operating a business,” so long as the entity was incorporated or otherwise formed in the 24 months prior to the status request.
  • Passive NFFEs are all non-financial foreign entities that do not count as Active NFFEs by the outlined criteria. Passive NFFEs have more disclosure requirements than Active NFFEs. Passive NFFEs must certify that they do not have any U.S. controlling persons, or must disclose the names, addresses, and U.S. tax identification numbers of all U.S. controlling persons. Under the Canadian IGA, a “controlling person” is generally defined as an individual who owns 25% or more of the business; however, if reporting to U.S. entities under the general FATCA rules, Passive NFFEs may need to disclose the information of all U.S. persons who are “substantial owners” of 10% or more of the business.

When determining whether your company is an Active or Passive NFFE, the best place to look for details is the Canadian IGA agreement.

Responding to FATCA Requests

By knowing your specific status and familiarizing yourself with the forms and information required, you can respond to status requests quickly and avoid withholding. As a best practice, we recommend designating a person at your organization who will be primarily responsible for responding to these requests, and that this individual keep records of all requests and copies of your responses.

Requestors will generally send FATCA status requests in one of two ways: using a custom questionnaire or a W-8BEN-E form. Custom questionnaires, which are assembled by the financial institution, are generally simpler and easier to complete. The W-8BEN-E, “Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)”, is a complex form that requests information regarding both your Chapter 4 (FATCA) status, as well as your Chapter 3 (income tax) status.

In some situations, requestors may send a form that does not fit your specific corporate status. For example, if you are a Canadian entity with a branch in the U.S., you will need form W-8ECI “Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States”; while a government organization or charity may require form W-8EXP, “Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding and Reporting”. Individuals may also be asked about their personal FATCA status and should use form W-8BEN.

Please note that all completed forms should be returned directly to the requesting entity, not sent to the IRS or CRA.

Understanding Penalties and Withholding

By responding quickly and with accurate information, you can avoid your business being deemed non-compliant. However, if your business is non-compliant, what can you expect?

As of July 1, 2014, FATCA imposes 30% withholding on U.S. source fixed, determinable, annual, or periodic (FDAP) income. This includes income sources such as interest, dividends, rents, salaries, wages, premiums, and annuities. 30% withholding is imposed on all non-participating foreign financial institutions, Passive NFFEs that fail to identify any substantial U.S. owners, and all entities that fail to comply with FATCA status requests, regardless of their classification.

As of January 1, 2019, 30% withholding will also apply on all gross proceeds payments, such as sale of stocks. This is in addition to the FDAP withholding.  Under the IGA, the U.S. and Canada have committed to develop a practical and effective approach to administer these withholding requirements in a way that minimizes the burden to taxpayers. 

At these rates, it’s easy to see how FATCA withholding can quickly create a significant financial impact for non-compliant companies.

Looking Forward

With court challenges continuing and further elements of this legislation coming into play, expect to see FATCA in the headlines for some time to come.

The good news for small business owners is that is that many organizations will count as Active NFFEs and thus have minimal FATCA obligations. For business owners who count as a U.S. person, or whose business is co-owned by a U.S. person, be aware that FATCA compliance will require more detailed reporting and/or filing a U.S. tax return. However, by following good business practices such as understanding your obligations, responding promptly to status requests, and keeping good records of all requests and responses, you should steer clear of costly penalties.

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For more information on this or other Canada-U.S. cross border tax issues facing your business, please contact your local BDO office or
the following U.S. Tax team members:

John McCrudden
partner, U.S. Tax
905 272 6235
jmccrudden@bdo.ca
Jason Ubeika
partner, U.S. Tax
905 272 7822
jubeika@bdo.ca
Gilbert Lederhos
partner, U.S. Tax
403 205 5761
glederhos@bdo.ca
Contributor:
Romana Fabicka
Senior Manager, U.S. Tax
905 272 7826
rfabicka@bdo.ca