Financial Services Alert - May 13, 2014

On May 2, 2014, the Internal Revenue Service (“IRS”) issued Notice 2014-33 (the “Notice”) providing that calendar years 2014 and 2015 will be regarded as a transition period for purposes of IRS enforcement and administration of the due diligence, reporting and withholding provisions of the Foreign Account Tax Compliance Act (“FATCA”).  In addition, the Notice amends the existing regulations to provide other relief measures including the treatment of accounts opened after July 1, 2014 and before January 1, 2015 as preexisting accounts, revisions to the standards of knowledge and reasonable statements, and an alternative registration process for certain foreign financial institutions (“FFIs”).

Background

FATCA imposes a 30% withholding tax on “withholdable payments” made to FFIs and to “non-financial foreign entities” (“NFFEs”), unless certain certification, information reporting, withholding and other specified requirements are satisfied.  FFIs which agree to comply with such requirements  (“participating FFIs”) and certain other FFIs that register with the IRS and meet certain requirements (“registered deemed-compliant FFIs”) are not subject to FATCA withholding.  In addition, the Treasury has entered into several intergovernmental agreements (so called “Model 1 and “Model 2 IGAs”) intended to facilitate the implementation of FATCA in such partner jurisdictions, and FFIs that are organized or located in such jurisdictions are permitted to register with the IRS and also are treated as “registered deemed-compliant” FFIs. 

The term “withholdable payment” means (i) any payment of U.S. source interest, dividends, rents and other types of fixed or determinable annual or periodical income (to the extent treated as a withholdable payment in the Regulations, “U.S. FDAP”), and (ii) gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends payments that would be U.S. source FDAP income (“Gross Proceeds”).  The effective date of FATCA was extended by Notice 2013-43 to July 1, 2014 for withholding with respect to withholdable payments of U.S. FDAP (see IRS Notice 2013-43 discussed in the July 16, 2013 Financial Services Alert).  Withholding on withholdable payments of gross proceeds is scheduled to begin with respect to dispositions that occur on or after January 1, 2017.

On February 20, 2014, Treasury and the IRS released temporary regulations under FATCA (temporary chapter 4 regulations) that clarify and modify certain provisions of the final chapter 4 regulations issued on January 17, 2013, including incorporating the revised timeline for the implementation of FATCA set forth in Notice 2013-43.  At the same time, Treasury and the IRS also released temporary regulations under chapter 3, relating to withholding on nonresident aliens and foreign corporations, and under chapter 61 and section 3406, relating to information reporting and backup withholding (temporary coordination regulations), to coordinate those regulations with the requirements provided in the final and temporary chapter 4 regulations.  In addition, the IRS has published updated final versions of all forms in the Forms W-8 series and certain instructions to these forms to incorporate the documentation requirements of chapter 4. The IRS expects to publish all of the remaining instructions in this series in the near future.

Good-Faith Relief

In order to facilitate an orderly transition for withholding agents and FFIs that are working to get their systems in place to implement FATCA, the Notice provides that the IRS will treat calendar years 2014 and 2015 as a transition period for the purposes of IRS enforcement of the due diligence, reporting and withholding provisions under FATCA, as well as the provisions under chapters 3 and 61 that were modified by the temporary coordination regulations.  During the transition period, the IRS will take into account the extent to which a FFI, NFFE or withholding agent has made good faith efforts to comply with the requirements of FATCA and the temporary regulations thereunder.  For example, the IRS will take into account whether a withholding agent has made reasonable efforts during the transition period to modify its account opening practices and procedures to document the status of payees, apply the required standards of knowledge and the FATCA withholding presumption rules.  As a further example, the IRS will consider the good faith efforts of an FFI to identify and facilitate the registration of the other members of its expanded affiliated group (“EAG”).  The Notice provides, however, that an entity that has not made good faith efforts to comply will not be given any relief from IRS enforcement during the transition period.

Amendments to Existing Regulations

The Notice also announces certain relief measures that Treasury and the IRS intend to adopt as amendments to existing the final and temporary regulations.

Preexisting Account Treatment

Under the chapter 4 regulations, withholding agents and FFIs are generally required to implement new account opening procedures beginning on July 1, 2014.  Comments received after the publication of the temporary chapter 4 regulations indicated that the release dates of the final Forms W-8 and accompanying instructions present practical problems for both withholding agents and FFIs to implement new account opening procedures beginning on July 1, 2014.  In consideration of these comments, the Notice provides that withholding agents and FFIs are permitted to treat accounts held by an entity opened after July 1, 2014 and before January 1, 2015 as a preexisting account for the purposes of the due diligence and withholding requirements applicable to preexisting obligations (provided, however, that the exception in those requirements for accounts having a balance of $250,000 or less will not apply).  The effect of this change is to generally allow withholding agents and FFIs until June 30, 2016 to document such entity accounts.  The Notice emphasizes that this treatment will not apply to accounts held by individuals, as the procedures for documenting individual accounts are less complex than those for documenting entities.

Certain Technical Issues

The Notice also addresses certain technical compliance issues that commentators had raised.

Standards of Knowledge and Reasonable Statements.  The Notice provides certain relief with respect to the implementation of temporary regulations under chapters 3 and 61, which will allow a withholding agent to continue to treat an individual as foreign notwithstanding certain “indicia” of U.S. status, and allows withholding agents to rely on certain reasonable explanations contained in the chapter 3 regulations (but not listed in the temporary chapter 4 regulations) for purposes of establishing a person’s foreign status for chapter 4 purposes.

Alternative Registration Process for Limited FFIs and Limited Branches.  In general, in order for any FFI that is a member of an EAG to obtain status as a participating FFI or registered deemed-compliant FFI, each FFI member of the EAG must qualify for such status, be an exempt FFI or qualify as a “limited FFI.”  Similarly, any FFI or branch of a participating FFI must be registered with the IRS and agree to certain conditions in order to be treated as a limited FFI or limited branch.  The Notice addresses two issues related to obtaining limited FFI status:

• First, it allows a limited FFI or limited branch to open U.S. accounts for persons resident in the jurisdiction where it is located, and accounts for nonparticipating FFIs resident in that jurisdiction. 
• Second, it provides that, if an FFI is prohibited under local law from registering as a limited FFI but otherwise would be able to comply with the requirements of limited FFI status, the prohibition will not prevent the members of its EAG from obtaining statuses as participating FFIs or registered deemed-compliant FFIs if the FFI prohibited from registering is identified as a limited FFI on the FATCA registration website by another member of its EAG that is either a U.S. financial institution or an FFI seeking status as a participating FFI (including a reporting Model 2 FFI) or reporting Model 1 FFI.

The Financial Crimes Enforcement Network (“FinCEN”) published five administrative rulings (collectively, the “Rulings,” and each a “Ruling”) concerning the applicability of certain exemptions from money transmitter status to various business models.  The Rulings reflect modifications, adopted in 2011, to FinCEN’s regulations under the Bank Secrecy Act’s (“BSA”) definition of “money transmitter.”

FIN-2014-R008 (“Ruling 8”).  FinCEN responded to an inquiry as to whether:  (1) a company’s (“Company A”) armored car coin and currency exchange service (the “Service”) would make Company A a “money transmitter” for BSA purposes; and (2) if needed, whether the armored car service exemption to the definition of “money transmission” would apply to the Service.

Company A stated that the purpose of the Service is to provide retail customers (each a “Customer”) of Company A with smaller or higher denominations of cash or coins needed to meet the operational needs of the Customer.  Deliveries of cash or coins to the Customer are made at the location of the Customer by armored car.  The Customer then pays for the Service by giving the armored car driver the required amount of the payment, and the armored car returning the payment to Company A.  FinCEN characterizes the arrangement as Company A’s “armored cars effectively act[ing] as remote teller counters for its Service.”  FinCEN concludes that Company A is not a “money transmitter” because

“the transportation of currency and/or coin of certain denominations from [Company A’s] vault to the [C]ustomer’s location and the return transportation of currency and/or coin in the exact same amount of the change provided to [Company A’s] own vault does not constitute the acceptance of value from one person and the transportation of such value to another person or location…”

FinCEN also concluded in the Ruling that, had Company A been deemed a “money transmitter,” the armored car exemption would not have applied to the Service

“as the Service is not limited to the physical transportation of coin and/or currency…, but consists of the additional activity of changing larger denominations of currency for smaller denominations of currency for [C]ustomers.”

FIN-2014-R007 (“Ruling 7”).  FinCEN responded to an inquiry as to whether the rental of computer systems for mining virtual currency would make the company making the inquiry (“Company B”) an “administrator” of virtual currency or a “money transmitter” under the BSA.   Company B developed a computer system (the “System”) that mines cryptocurrencies.  Company B rents the System to third parties for rental periods of from 24 hours to 30 days in exchange for a payment based upon the length of the rental period.  Company B receives limited information about the third party.  All virtual currency mined by the third party remains the property of the third party, and Company B has no access to the third party’s wallet.  In Ruling 7, FinCEN concludes that, under these facts, Company B is not an “administrator” of virtual currency because Company B is not engaging as a business “in issuing (putting into circulation) a virtual currency, and [does not have] the authority to redeem (to withdraw from circulation) such virtual currency.”  Moreover, FinCEN concludes that Company B is not a “money transmitter” because it is only supplying rental services, and FinCEN’s regulations

“specifically exempt from money transmitter status a person that only provides the delivery, communication, or network data access services used by a money transmitter to supply money transmission services.”

FIN-2014-R006 (“Ruling 6”).  FinCEN responded to an inquiry from a company (“Company C”) that acknowledges that it is a money services business (“MSB”) and that has registered with FinCEN as a “money transmitter.”  Company C seeks confirmation from FinCEN that it is a money transmitter rather than a “provider of prepaid access” under FinCEN’s regulations.

Company C states that it operates a payments platform that enables consumers and businesses to send and receive online payments.  Company C’s platform is typically used for business real estate transactions, auction items, and other significant commercial purchases.  Each of a buyer and seller must open its own account with Company C, and a buyer can pay a seller directly using Company C’s platform “thus replacing the need for a traditional ‘escrow account’.”  A buyer can fund its account with Company C through Automated Clearing House transactions, credit and debit card transactions, checks or wire transfers.  Transactions are generally effected as follows:

1. The buyer transfers funds to its account at Company C;
2. The seller is notified by Company C that the transaction is ready for completion;
3. The seller agrees to the transaction;
4. A request for payment is sent to the buyer; and
5. The buyer releases the funds.

FinCEN notes in Ruling 6 that “[s]ettlements occur in real-time within [Company C’s] core processing system.”  Ruling 6 also is based on the facts that Company C “does not issue any credit, debit or prepaid cards and…the funds can only be transferred to one designated seller and not split among multiple sellers.”

FinCEN concludes that Company C is not a “provider of prepaid access” because, among other reasons, the funds that buyer places in its account with Company C may only be used to make a specific purchase from a specific seller, whereas prepaid access “operates more like a fungible payment instrument in traditional commerce, usable at any number of as-yet-unidentified merchants.”  FinCEN further concludes that Company C should remain registered as an MSB that is a “money transmitter” because: (1) Company C is not acting as a traditional escrow agent since Company C is not acting as an independent arbiter of whether the terms and conditions of a transaction have been satisfactorily completed by both parties; and (2) the services provided by Company C are not necessary or integral to any service other than money transmission.

FIN-2014-R005 (“Ruling 5”).  The representative of a company (“Company D”) asks FinCEN whether the secured transaction services that Company D offers to the buyer and the seller in a given sale of goods or services require Company D to register with FinCEN as a “money transmitter.”  Company D is an Internet-based facility that provides secure transaction management services (the “Services”) between buyers and sellers for goods and services.  The objective of the Services is to

“relieve the buyer of the risk of paying for an item or service that the buyer does not receive…[and to] relieve the seller of the risk of providing an item or service and not receiving valid payment for it.”

Key facts upon which Ruling 5 is based include the following:

1. Both the buyer and the seller in a specific transaction register on Company D’s website;
2. The website provides a platform for negotiation of the sale, including price, terms, freight, etc.;
3. Both parties are able to monitor each step of the transaction and each party is notified when it is required to take further action;
4. Both parties agree to the terms of the transaction;
5. The buyer pays the purchase price to Company D;
6. Company D instructs the seller to provide the goods or services;
7. The buyer certifies that it is satisfied with the goods or services received; and
8. Company D debits the buyer’s account for the purchase price and credits the seller’s account for an amount equal to the purchase price, less Company D’s transaction management fee.

FinCEN notes in Ruling 5 that Company D’s

“management services include assisting buyers and sellers in creating, negotiating, and managing their transactions; dispute resolution, including on-site visitations; item verification on merchandise shipped to [Company D’s] offices; and document handling.”

Under FinCEN’s regulations, a person is not deemed to be a money transmitter if the person “accepts and transmits funds ‘only integral to the sale of goods or the provision of services, other than money transmission services.’”  In Ruling 5, FinCEN concluded that Company D’s money transmission services are only integral to the provision of its transaction management services, and Company D’s “acceptance and transmission of funds do not constitute a separate and discrete service.”  Rather, said FinCEN, Company D’s acceptance and transmission of funds are a necessary and integral part of the transaction management (secured transaction) services.  Accordingly, FinCEN concluded in Ruling 5 that Company D is not a “money transmitter.”

FIN-2014-R004 (“Ruling 4”).  The representative of a company (“Company E”) asks FinCEN whether the escrow services that Company E offers to a buyer and a seller in a specific internet sale of goods or services requires Company E to register with FinCEN as a “money transmitter.”  The facts underlying Ruling 4 are that Company E provides escrow services to individuals and businesses.  Company E “receives funds from the buyer and holds the funds in escrow until releasing the funds to the seller, subject to the satisfaction of specified conditions precedent.”  The funds that Company E receives from the buyer are kept at a third-party depository institution and are segregated from Company E’s operating account.

After reviewing the facts, FinCEN found that the money transmission activities engaged in by Company E are necessary and integral to the provision of its escrow services and, accordingly, Company E need not register with FinCEN as a money transmitter.  FinCEN stated that Company E’s “acceptance and transmission of funds do not constitute a separate and discrete service provided in addition to the underlying service of transaction management [escrow services].”