FATCA: The End of ‘Shadow Boxing’ in the Offshore Trust Industry

Not long after the U.S. Department of Justice’s Tax Division (“DOJ”) made international headlines in 2009 for its bombshell announcement that it had entered into a deferred prosecution agreement with the United Bank of Switzerland (UBS), lawmakers in Washington, D.C. began reviewing the testimony of hundreds of UBS’s U.S. clients who, along with their respective advisers, found themselves caught in the net of the Internal Revenue Service (IRS) reporting requirements that were part of the DOJ agreement. Indeed, the collective testimony of investors, bank professionals, trustees, investment advisers, and company directors provided the IRS, the DOJ and congressional subcommittees with information crucial for best understanding the business of offshore centers. Moreover, to encourage non-compliant U.S. clients of offshore companies other than UBS to come forward, the IRS successfully initiated numerous Offshore Voluntary Disclosure Initiatives and thus provided the U.S. tax authorities with ample useful information. The insights gleaned as a result of the DOJ’s and the IRS’s efforts, in turn, facilitated Congress’s passage of the Foreign Account Tax Compliance Act (FATCA) in 2010.

This article explores how the enactment of FATCA has had (and will continue to have) an adverse impact on offshore trust businesses, with one ensuing result being that those businesses are now far less willing to take on legitimate U.S. clients. The substantial burdens FATCA imposes on foreign financial institutions and on the decision-makers (e.g., the board of directors of corporations and the trustees of trusts) of other non-U.S. entities with respect to classification requirements, reporting requirements and, separately, withholding requirements prescribed under FATCA, are proving to be overwhelming in many instances, and particularly so with respect to smaller trust companies. In this sense, FATCA is, albeit by indirect means, having the effect that Congress intended when it passed that law: the prevention of illegal non-disclosure of taxable assets held in offshore accounts. That prevention, however, comes at great cost to legitimate U.S. clients and offshore providers alike: the former, despite their legitimate intentions, now must endure additional burdens complying with reporting requirements and choosing among service providers, while the latter are incurring enormous regulatory costs such that some trust companies are going out of business entirely.

INTRODUCTION

In general, the U.S. government taxes the worldwide income of its citizens and residents1 irrespective of where the individual lives or where the income arises.2 U.S. citizens and residents are required to voluntarily3 report their worldwide income, including income derived from offshore sources, to the IRS on an annual basis.4 In addition, U.S. citizens and residents face a plethora of mandatory information filing requirements for their assets held abroad.5

Under U.S. law, U.S. financial institutions are required to file with the IRS information returns that report income earned by U.S. account holders.6 Some U.S. citizens and residents evade taxes on passive income, such as interest, dividends, and capital gains, by not reporting the income to the IRS.7 The IRS estimates that $40-$70 billion is lost yearly due to offshore personal income tax evasion.8 The IRS uses that information to monitor the investment earnings of the account holders. Until the enactment of FATCA in 2010,9 there was no analogous reporting requirement for foreign financial institutions and non-U.S. foreign entities.10 This lack of reporting enabled U.S. taxpayers to avoid U.S. tax on their foreign-source income. FATCA was enacted largely as a result of a major tax enforcement victory for the IRS and the DOJ against UBS in 2009.11 The UBS settlement facilitated the provision of valuable information to U.S. tax authorities with respect to precisely how some U.S. citizens and residents (together “U.S. person(s)”)12 had been concealing their ownership of assets through the use of offshore structures (including, for example, trusts, foundations, companies, and other investment vehicles).13 The IRS, with the assistance of the DOJ, won similar high-profile tax enforcement cases in the wake of the UBS settlement.14 Since the enactment of FATCA, additional information obtained by the DOJ led to the landmark victory against Credit Suisse for a single count of conspiring to aid tax evasion over decades and to the largest criminal tax fine in U.S. history: $2.6 billion.15 Prior to the UBS case — and despite the agency’s best efforts to enforce compliance with the means it had at its disposal — the IRS lacked mechanisms by which it could monitor the use of offshore accounts for illicit purposes. It was well-known to the U.S. government that non-compliant U.S. taxpayers had for decades been using offshore accounts to shield taxable assets; the challenge for the government was to develop an enforceable system that would identify the specific assets held overseas in financial institutions.16 Thus, putting an end to the IRS’s decades-old, ever-continuing struggle to “shadow box” invisible enemies (perceived U.S. tax evaders and those who enabled them) was one of the main drivers behind Congress’s enactment of FATCA.17

FATCA has become a powerful international tax enforcement tool for the United States. In simple terms, it requires that all foreign financial institutions and non-financial foreign entities (defined to include, companies, trusts, foundations, and private trust companies as well as investment fund vehicles) verify and report to the United States the identity of their U.S. clients or become subject to withholding on certain payments. It is primarily intended to gather information about the identity of a U.S. person(s) with offshore assets by the threat of subjecting non-compliant foreign financial institutions to a simple but powerful withholding tax on certain types of passive income.18 It seeks to improve detection.19 It also encourages a government-to-government automated approach to collection of tax information on a global scale.20 Domestic courts view its purpose as an important tool to encourage international tax compliance.21 It was enacted to checkmate tax havens and offshore industries that provide clandestine financial services to U.S. clients who are not tax-compliant.

FATCA’s message to the foreign financial institutions, to their clients and to the larger international investment community is simple: participation in the U.S. capital markets requires compliance with U.S. tax laws. Therefore, foreign financial institutions are taking compliance with FATCA seriously.

Compliance with FATCA, however, requires enormous effort and resources. FATCA imposes a substantial burden on foreign financial institutions in terms of systems and controls.22 It also imposes domestic legal challenges for some foreign financial institutions (including foreign offshore trust companies) in cases where compliance with FATCA violates domestic privacy and bank secrecy laws (such as in Switzerland or Lichtenstein).23 For many offshore trust companies (in particular the smaller trust companies), the enormous cost of complying with FATCA outweighs the benefit of servicing U.S. clients. FATCA creates severe compliance burdens for the typical offshore trust company, as well as for its U.S. clients.24 A trust company’s potential FATCA withholding liability in the case of either non-compliance or a classification error remains a risk, and one easily removed by its decision not to take on U.S. clients. Foreign financial institutions faced with heavy compliance costs and potential liability may prefer to opt out entirely from assisting U.S. clients, if implementing FATCA proves to be too cumbersome.25 According to data released by the Boston Consulting Group, while offshore wealth is projected to rise modestly in the coming years, reaching $11.2 trillion by the end of 2017, “wealth is increasingly moving onshore due to the intense pressure that tax authorities are exerting on offshore centers.”26 It remains to be seen how much of the shift relates to U.S. clients moving assets onshore.

This article addresses FATCA’s impact on offshore trust businesses servicing U.S. clients. It provides a brief overview of FATCA, and discusses the application of those rules to the business of a typical offshore trust company. It discusses FATCA classification and reporting nuances and ambiguities vis-à-vis some of the services that offshore trust companies generally provide (for example, assistance with formation, as well as management and administration of private trust companies or family offices). Of particular interest is a sample survey of CEOs on FATCA application to the business case of a typical offshore trust company with U.S. clients and whether the profits generated outweigh the costs and risks.

It concludes that while it is too soon to fully appreciate FATCA’s impact on the trust industry globally, based on the data collected (including the testimonials that have been gathered from senior managers of large Swiss trust companies), FATCA will adversely impact the overall business of offshore trust companies for U.S. clients. Thus, Congress’s intent when enacting FATCA will have been met. The inability of Americans to open accounts offshore because of foreign financial institutions’ reluctance to service U.S. clients in the face of the strict compliance requirements they must endure may very well force the compliant internationally minded U.S. client to repatriate his or her funds onshore as revealed by the initial findings of the Boston Consulting Group.27 To that end, while the purpose of FATCA will have been met, it will have been achieved at the cost of imposing heavy burdens on the compliant. Future studies tracking this specific data will prove useful to more closely assess FATCA’s impact on the offshore trust industry.

BRIEF OVERVIEW OF FATCA

In 2010, FATCA was enacted in §1471-§1474 (“Chapter 4”) of the Code.28

In general, FATCA requires foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) to investigate, to document and to report the identity of any account(s) held by U.S. persons. More specifically, FATCA requires FFIs that hold U.S. accounts to: (1) enter into an agreement with the IRS (referred to as “participating FFIs” (or PFFIs)); (2) identify U.S. account holders (both direct and indirect); (3) report to the IRS on these taxpayers; and (4) withhold 30% on certain “withholdable payments”;29 unless the payee qualifies under for an exemption from withholding (such as a waiver or administrative relief available under FATCA).30

A withholding agent must also withhold 30% of any “withholdable payment” to an NFFE unless the NFFE either: (1) certifies that it has no substantial U.S. owners (generally, U.S. owners that hold an interest greater than 10%); or (2) gives the withholding agent information about each of the NFFE’s substantial U.S. owners.31

FFIs and NFFEs that do not comply with the FATCA requirements are subject to a 30% withholding tax on payments relating to certain categories of U.S.-source fixed or determinable annual or periodical (FDAP) income, as well as on gross proceeds from the sale or other disposition of debt or equity interests.32 In addition, withholding is imposed on “foreign payments” made by certain FFIs, referred to as “passthru payments.”33 FATCA’s passthru payment rule provides the U.S. tax authorities a mechanism that leverages the weight of the U.S. financial markets34 to ensure maximum compliance for cross-border information reporting.35 It broadens the definition of U.S.-source income to ensure that income that would otherwise not qualify as U.S.-source income for purposes of the withholding requirements now falls squarely within FATCA’s coverage and, therefore, remains subject to withholding. Indeed, according to FATCA’s former chief sponsor, Sen. Carl Levin (D-Mich.), FATCA was intended to authorize, in certain circumstances, Treasury to prohibit U.S. financial institutions from opening accounts for a designated foreign account, “thereby cutting off that foreign bank’s access to the U.S. financial system.”36

On January 17, 2013, Treasury released regulations clarifying withholding and reporting obligations (hereinafter, the “Treasury Regulations”). The Treasury Regulations provided for a phased implementation of FATCA’s requirements, commencing on January 1, 2014 and continuing through 2017.37 On February 20, 2014, Treasury issued temporary regulations that modified the Treasury Regulations38 by providing revised timelines for the implementation of the FATCA requirements that were adopted by the temporary regulations.39 FATCA is effective as of January 1, 2013.40 However, to alleviate the transition burden for withholding agents, FFIs, and NFFEs, the Treasury Regulations provide for a tapered implementation of Chapter 4. More specifically, Chapter 4 withholding on U.S.-source FDAP payments was delayed until July 1, 2014,41 and withholding on gross proceeds was delayed until January 1, 2017.42 In addition, the IRS designated calendar years 2014 and 2015 as a transitional period during which the enforcement and administration of FATCA will be limited.43 The Treasury Regulations are modified by intergovernmental agreements between the United States and foreign governments (referred to as “FATCA Partners”).44

Classification of Foreign Entities — FFIs and NFFEs

In general, FATCA classifies foreign entities into two reportable types: (1) FFIs; and (2) NFFEs. An FFI is defined as “any financial institution” that is a foreign entity.45 FFIs are further defined to include: depository institutions, custodial institutions, investment entities, specified insurance companies, and certain holding companies and treasury centers.46 An NFFE is a foreign entity that is not a financial institution.47

An NFFE is defined as any foreign entity that is not a “financial institution.”48 NFFEs are further classified as “passive” or “active,” depending on the underlying business activities (as further defined below). “Active” NFFEs are excepted from FATCA reporting.49 Entities that are classified as “passive” NFFEs are required to certify to withholding agents, or the IRS, whether they have any substantial U.S. owners and, if so, their identity and certain specific information.50

Model Intergovernmental Agreements (IGAs)

To promote compliance with FATCA in jurisdictions where local data protection and privacy laws make it illegal for an FFI or NFFE to comply with FATCA (Article 273 of the Swiss Penal Code, for example, makes it a crime for a person to divulge secret business information to a foreign government authority or its agent),51 the United States has entered into bilateral international agreements with foreign jurisdictions via intergovernmental agreements (IGAs).52 These IGAs provide an alternative means for FFIs and NFFEs in FATCA partner countries to comply with FATCA without violating local law.53 To encourage foreign governments to cooperate with the United States in terms of reporting, the U.S. has committed to providing reciprocity concerning accounts at U.S. financial institutions maintained by the residents of the FATCA partner.54

Treasury released two model IGAs.55 A Model 1 IGA requires the FFIs in the FATCA partner country to report information regarding U.S. accounts to the tax authorities of the FATCA partner, which then relay the information to the IRS. A reporting Model 1 FFI is treated as a registered deemed-compliant FFI and thus must register with the IRS.56 A Model 2 IGA requires the FFIs in the FATCA partner jurisdiction to comply with the Treasury Regulations, to register with the IRS, to enter into FFI agreements with the IRS, and to report directly to the IRS with respect to U.S. accounts. A reporting Model 2 FFI is treated as a participating FFI.57 In addition, several jurisdictions have agreed to a Model 1 or Model 2 IGA “in substance,” meaning that they will be treated as having an IGA in effect and FFIs in those jurisdictions will have additional time to register with the IRS.58

IGAs entered into between the United States and FATCA partners were intended to streamline and encourage FATCA implementation in those jurisdictions, as well as to reduce the compliance burdens for FFIs and NFFEs in those jurisdictions. The IGAs, to some extent, shifted FATCA’s reporting burden to local tax authorities by encouraging a reciprocal automatic information exchange between the tax authorities in the two countries. However, amid this benefit lies the complexity of multiple governing laws. FFIs and NFFEs resident in a country that has an IGA with the United States may choose to follow the FATCA reporting mechanism that is available under the IGA, rather than follow the requirements prescribed under the Treasury Regulations.59

In the context of IGAs, very generally, a U.S. person that beneficially owns 25% or more of the NFFE or exercises ultimate effective control over the NFFE is referred to as a “U.S. controlling person(s)” and the identity of the U.S. controlling person(s) must be reported. A “controlling person” is defined as any natural person who exercises control over an entity, including in the case of a trust, the settlor, the trustees, the protector, the beneficiaries, and any other person exercising ultimate control; or in the case of a legal arrangement other than a trust, a person in an equivalent or similar position. A controlling person is interpreted under the IGAs by reference to the Anti-Money Laundering (“AML”) due diligence rules. Recent guidance issued by the Financial Action Task Force (“FATF”) interpreting the meaning of “effective ultimate control” provides that legal ownership also applies to a natural person(s) at the end of a corporate chain who ultimately owns or controls the legal arrangement.60

FATCA Reporting Requirements

To ensure compliance with FATCA, an FFI must be treated as either a “PFFI” (i.e., an FFI that elects to enter into an agreement with the IRS and registers with the IRS to ensure due diligence, withholding, and reporting for U.S. account holders) or a “deemed-compliant FFI.”61 “Deemed-compliant FFIs” are divided into two general categories: (1) registered deemed-compliant FFIs (i.e., these FFIs are not required to enter an FFI agreement with the IRS; however, they must register with the IRS to obtain a global intermediary identification number (“GIIN”)); and (2) certified deemed-compliant FFIs (these FFIs are not required to register with the IRS).62 A correctly documented PFFI or deemed-compliant FFI is not subject to withholding on any withholdable payments it receives as a beneficial owner.63

In general, FFIs can choose to comply with FATCA as PFFIs or a reporting Model 1 FFI. According to the guidelines issued by the Treasury Regulations, an FFI can register with the IRS through a secure website, the FATCA Registration Portal.64 The Treasury Regulations require a Participating FFI to enter into an FFI Agreement with the IRS pursuant to which it must agree to implement internal controls to identify its “U.S. accounts” (i.e., accounts owned by U.S. persons), report certain information to the IRS with respect to those accounts, and withhold 30% of payments made to individuals or entities that fail to comply.65 In cases where foreign law prohibits the FFI from reporting the required information (absent a waiver from the account holder), and the account holder fails to provide a waiver within a reasonable period of time, the FFI is required to close the account.66 If an account holder fails to provide sufficient information to an FFI such that it cannot fulfill its reporting obligations, the account holder is deemed “recalcitrant”67 and is subject to a punitive withholding tax (see section below).

NFFEs are required to provide a withholding certificate that certifies their FATCA status, as well as whether there are any “substantial U.S. owners” (or “controlling U.S. persons” if reporting is under an IGA) to a requesting bank or withholding agent.68

FATCA CLASSIFICATION OF OFFSHORE TRUSTS AND TRUST COMPANIES

Brief Summary of the Offshore Trust Industry

Approximately $7.8 trillion, representing more than 6% of all global wealth, is managed through offshore accounts in jurisdictions where the investor has no legal residence or tax domicile.69 In some instances, investors fail — despite U.S. reporting requirements — to disclose income that derives from offshore accounts, that tax taxes go unpaid. Some have estimated the revenue losses associated with U.S. taxpayers failing to pay their fair share of the burden is around $100 billion per year.70 Some of the more popular locations for offshore trust planning are Anguilla, the Bahamas, Barbados, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Cook Islands, Cyprus, Gibraltar, the Isle of Man, Mauritius, Niue, Saint Kitts and Nevis, and the Turks and Caicos Islands, as well as Switzerland, Lichtenstein, and the UAE.71 All of these countries are tax havens, and some Americans use them to evade U.S. taxes.72 The offshore trust industry has been thriving for many years and is, according to recent reports, poised to continue to grow.73

An offshore trust is a trust that is formed under the laws of an offshore jurisdiction (i.e., a low-tax or zero-tax jurisdiction). In general, the purpose of settling a trust is to hold, protect, and conserve financial or other assets for the benefit of others. The use of offshore trusts for legitimate estate planning purposes has been common. A few examples include using offshore trusts to achieve: (1) asset protection (to shield assets from the hands of future creditors and to protect against a litigious environment);74 (2) diversification of wealth to another jurisdiction (for example, as a hedge against uncertainty surrounding political or economic concerns);75 (3) privacy (foreign trusts offer a high degree of confidentiality, and may help achieve legitimate anonymity with respect to wealth);76 (4) transfer of wealth in a tax-efficient manner; (5) avoidance of application of “forced heirship” civil laws;77 (6) consolidation of assets (i.e., in a family office or private trust company); and (7) estate tax optimization. In light of the legitimate advantages offered by offshore accounts — and, in some instances as a result of the illicit ones — a large number of Americans have established offshore trusts in foreign countries.78

Classification of a Trust for Purposes of FATCA: FFI or NFFE?

As discussed in previous sections of this Article, FATCA is resulting in an unprecedented effort to track and identify U.S. clients of offshore institutions (Know-Your-Customer rules) by virtue of broadly applicable disclosure and withholding obligations for nearly all FFIs and NFFEs that wish to access the U.S. capital markets. While Congress’s primary objective in enacting FATCA is the acquisition of information from foreign banks and similar foreign entities with respect to U.S. clients, FATCA’s coverage will, in fact, extend to and impact nearly all foreign trust companies, as well as many foreign family offices and foreign investment vehicles, including private trust companies.

The treatment of trusts under FATCA varies depending on whether a trust meets the definition of an FFI or an NFFE.79 Very generally, a trust that is professionally managed or that is managed by an entity that is itself treated as an FFI is classified as an FFI. A trust is considered “professionally managed” if the trustee is a trust company (and not an individual) that provides fiduciary services to customers or in the event that the trustee appoints a professional management company to manage the underlying assets (such as in the case of discretionary mandates).80 Furthermore, a trust is classified as an FFI if: (i) the trust itself; or (ii) the entity managing the trust; or (iii) the investment manager “invest[s], administer[s] and manage[s] funds as a business or on behalf of customers.81 The effect of these rules is to require an offshore trust company to review each trust currently in the trust company’s portfolio to assess whether, for purposes of FATCA, it should be classified as an FFI (and thus required to registers with the IRS) or an NFFE.82 In a sense, FATCA creates a genuine risk for any offshore trust company managing assets for U.S. clients given the statute’s 30% withholding “stick.”

FATCA defines an FFI as a financial institution that is a foreign entity.83 An entity is defined as “any person other than an individual.”84 A foreign entity is an entity that is not a U.S. person.85 A “U.S. person” is defined by cross-reference to the Code.86 Therefore, for purposes of FATCA’s classification rules, foreign entities, including banks, trust companies, and institutions that act as money managers (i.e., insurance companies, hedge funds, or private equity funds) meet the definition of an FFI.

In general, an offshore trust company does not “accept deposits.”87 Typically, an offshore trust company deposits its clients’ (beneficiaries) bankable assets and/or nonbankable assets (e.g., art, collectibles (automobiles, yachts, and planes), or real estate) with one or more institutions or, in the case of bank-owned trust companies, with the parent bank. The preference for the bank-owned trust company is to secure bankable assets giving higher yields, and in fact it often charges a surcharge for nonbankable assets. Thus, in this context, the bank itself is the entity that accepts the deposits, not the trust company. A custodial institution is defined for FATCA purposes as an institution that “holds, as a substantial portion of its business…financial assets for the benefit of one or more other persons.”88 Before the release of the Treasury Regulations, in Notice 2010-6089 the IRS maintained the position that corporate trustees should be treated as custodial financial institutions. However, the Treasury Regulations now provide a far more narrow definition using an objective standard which requires an entity to hold “financial assets for the account of others as a substantial portion of its business” only if the entity’s gross income “attributable to holding financial assets and related financial services” is 20% or more of its gross income over a stated period.90 The types of income derived from these “financial assets” are those typically derived from institutions in the business of financial services, namely, commissions and fees from executing and pricing securities transactions and income earned on bid-ask spread or financial assets.91

The typical offshore corporate trust company does not hold and manage assets with the fees attributed to these types of transactions. Quite to the contrary, most offshore trust companies delegate this function either to the parent bank (at preferred rates), to an external third party (at a surcharge rate given the preference for keeping assets under one consolidated group, or to an investment advisor of the client’s choice. Rather, most offshore trust companies derive their fees solely from fiduciary services, and those fees are directly related to the administration of financial assets.

The only other type of FFI, therefore, that fits the language of FATCA and resembles the business model of a typical offshore trust company under the Treasury Regulations (and the IGAs) is under the classification of an “investment entity.”92 The Treasury Regulations define an “investment entity” as: (1) an entity that “primarily conducts…on behalf of a customer”;93 (2) one whose gross income is “primarily attributable” to “investing, administering, or managing funds, money or financial assets [certain enumerated investment management activities]….on behalf of other persons”94 and that is “managed by” a depository institution, custodial institution, or a specified insurance company;95 and (3) a collective investment vehicle or any similar investment vehicle established with the view to strategize investing, reinvesting, or trading in financial assets (i.e., a fund).96 Trust companies derive their income from fiduciary services, including trust administration. An “investment entity” as defined under the Treasury Regulations would accurately include an offshore trust company whose business purpose is to “invest, administer, or manage funds, money, or financial assets on behalf of other persons.”97

However, while the language of the Treasury Regulations is sufficiently broad to include in its definition an offshore trust company to meet the definition of an FFI under FATCA, it reveals that the drafters of FATCA did not properly appreciate how an offshore trust company operates as a business. In practice, a typical offshore trust company holds “financial assets” (bankable as well as nonbankable assets) via the use of offshore trusts and underlying companies. The trust administration is often administered outside of the local jurisdiction where the trust company and the parent bank are incorporated (for example, in Singapore or in the Bahamas).98 It includes the day-to-day management of an offshore trust, chiefly involving executing the decisions of the investment advisor(s) and following up with ministerial matters. Thus, given the practice and business model of an offshore trust company, the Treasury Regulations’ classification of most offshore trust companies as FFIs within the meaning of FATCA is overly broad and subject to confusion.99

In the offshore trust business, the use of underlying entities is common. Because civil law countries, such as Switzerland and Lichtenstein, are not familiar with the use of common law trusts, many offshore trustees use underlying corporate entities, such as a company (typically incorporated offshore in the British Virgin Islands or the Bahamas) whose shares are held by an offshore trust as an estate planning tool. Offshore trustees use this structuring tool to permit trusts to own assets in jurisdictions that do not recognize trusts as well as to shelter the assets from estate, inheritance, or succession taxes, where appropriate.100 In addition, an underlying entity provided an additional shield for the trustee from liability associated with the underlying trust investments. For example, a settlor may wish to entrust a wide variety of assets to a trustee, including assets that may result in contractual debts or potential tort claims. If the liability arises in a jurisdiction that does not recognize trusts, the trustee may be liable for the underlying debt or tort claim. Shifting the situs of the assets to a jurisdiction that would provide redress for the trustee in such a case may be achieved through incorporation of an offshore company in a jurisdiction that recognizes trusts, the shares of which are held by the trust. For purposes of U.S. law, most of these underlying entities would be classified as Passive Foreign Investment Companies.101 The Treasury Regulations do not specifically address the classification of the underlying entities as described above, and for good reason: the United States is not familiar with the use of underlying companies as an estate planning tool. Therefore, FATCA’s drafters did not fully appreciate the business of offshore trust companies and instead merely created a large enough category to capture all foreign entities (including offshore corporate entities) that are managed by professional entities that are, in turn, classified as FFIs. The law is generously tilted in favor of the IRS.

In general, the Code defines a “foreign trust” as a trust that is not subject to the primary jurisdiction of a court in the United States or that allows a foreign person or persons to control any substantial decision.102 One of the main purposes of FATCA is to ensure that U.S. account holders (i.e., U.S. persons subject to taxation in the United States) do not escape taxation by sheltering assets offshore with foreign trustees.103 For purposes of FATCA, a foreign trust is treated as an FFI, if it is classified as an “investment entity.”104 For purposes of FATCA, as discussed above, most professional offshore trust companies will be classified as investment entities.105 The Treasury Regulations require an FFI to obtain information necessary to identify the “U.S. accounts”106 it maintains. A U.S. account is a financial account107 maintained by an FFI that is held by one or more “specified U.S. persons” (generally, any U.S. person other than a publicly traded corporation, a tax-exempt charity, the U.S. government or an agency thereof, or a bank)108 or U.S.-owned foreign entities.109 The term “U.S. owned foreign entity” means any foreign entity that has one or more “substantial U.S. owners,” including a foreign entity.110 A foreign trust will be classified as having one or more “substantial U.S. owners”111 and thus as being a U.S.-owned foreign entity, provided either: (1) the trust is a grantor trust deemed owned by a U.S. person; or (2) in the case of a nongrantor trust or a grantor trust deemed owned by a foreign person, the trust has U.S. beneficiaries that have the right to receive, or that actually receive, distributions, and the interest of such beneficiaries in the trust exceeds a pre-defined threshold.112 For an FFI that does not fall under the definition of an investment entity, the threshold is greater than 0% (the “0% Threshold).113 An equity interest in an FFI is treated as a financial account maintained by that FFI.114 In the case of a trust that is an FFI, equity interests are considered to be held by: (1) a person who is an owner of all or a portion of the trust under Code §671-§679 (i.e., grantor trust as the deemed owner of the assets); (2) a beneficiary who is entitled115 to a mandatory distribution from the trust (including through the exercise of a general power of appointment);116 or (3) a discretionary beneficiary who actually receives distributions in the prior calendar year.117 If the U.S. beneficiaries of a trust are discretionary beneficiaries who do not receive mandatory distributions and whose distributions are subject to trustee discretion, according to the Treasury Regulations that trust will not have a U.S. account holder and thus will not be required to report the distribution under FATCA unless it is a grantor trust deemed owned by a U.S. person. In such a case, a trust will be required to report certain information to the IRS.118 Where a trust company holds an account of a U.S. person in another FFI within its group (such as an underlying entity), the relevant threshold relates to the status of the underlying FFI. In such a case, the underlying entity would be required to assess whether it maintains a substantial U.S. owner by applying the 0% Threshold rule. The Treasury Regulations essentially broaden the scope of the U.S. domestic grantor trust rules to capture all foreign activities of U.S. individuals, including those activities that are contingent. If the trust is classified as an NFFE, only a specified U.S. person who is treated as the owner of a portion of the trust under the grantor trust rules or who owns more than 10% of the trust is considered to be a “substantial U.S. owner.”119 To determine the 10% threshold for NFFEs for purposes of direct and indirect ownership under the Treasury Regulations, persons are treated as having a more than 10% interest if: (1) in a particular year they receive distributions that exceed either 10% of the value of all distributions during the year or 10% of the value of the trust; (2) the value of their mandatory distributions rights exceeds 10% of the value of the trust; or (3) the sum of the distributions received and the value of the mandatory distribution rights exceeds either 10% of the value of distributions or 10% of the value of the trust.120 The statute provides for a de minimis rule such that a U.S. person will not be considered a “substantial U.S. owner” if he or she received $5,000 or less during the relevant year and the value of his or her mandatory distribution rights would, in total, be less than $50,000.121

FATCA triggers information reporting based on actual distributions. A discretionary beneficiary that does not actually receive any distributions should not be subject to reporting. An example in the Treasury Regulations provides the following illustration to determine the 10% threshold in the case of a beneficial interest of a foreign trust:

U, a U.S. citizen, holds an interest in FT1, a foreign trust, under which U may receive discretionary distributions from FT1. U also holds an interest in FT2, a foreign trust, and FT2, in turn, holds an interest in FT1 under which FT2 may receive discretionary distributions from FT1. U receives $25,000 from FT1 in Year 1. FT2 receives $120,000 from FT1 in Year 1 and distributes the entire amount to its beneficiaries in Year 1. The distribution from FT1 is FT2’s only source of income and FT2’s distributions in Year 1 total $120,000. U receives $40,000 from FT2 in Year 1. FT1’s distributions in Year 1 total $750,000. U’s discretionary interest in FT1 is valued at $65,000 at the end of Year 1 and therefore does not meet the 10% threshold as determined under paragraph (b)(3)(ii)(A). U’s discretionary interest in FT2, however, is valued at $40,000 at the end of Year 1 and therefore meets the 10% threshold as determined under paragraph (b)(3)(ii)(A).122 

In the case of ownership in a partnership or company, the trust beneficiaries are deemed indirect owners in proportion to their beneficial interest in the trust based on all relevant facts and circumstances.123 The ownership determination rules for a partnership or company are different from the bright-line test of ownership in shares of trust.124 A trust that is classified as an FFI has a 0% ownership threshold; therefore, it is conceivable for a U.S. person to be simultaneously subject to both the NFFE rules and the FFI rules (which creates double reporting and a heavy compliance burden for the trust company). An offshore trust company will, thus, require enormous resources to be compliant.

In addition to the FATCA classification nuances for offshore trusts, the Treasury Regulations do not address the FATCA classification treatment of private trust companies (“PTCs”), a company formed for the purpose of serving as the trustee of a large private family structure. Its board of directors include members of the family, as well as trusted advisors (such as lawyers). Such vehicles are attractive to international families of large wealth where the bankable and nonbankable assets could be pooled under one consolidated company (the PTC). Similarly, some offshore trust companies provide family office resources to large international families, leveraging the parent bank for all financial investments and utilizing the trust company to, again, administer and manage the decisions of the investment management committee (usually an external investment advisor or members of the settlor’s inner circle). These types of “products” (i.e., PTCs and family office capabilities) would be problematic to an offshore trust company given FATCA.125

The Heavy Burden of Compliance for Offshore Trust Companies

FATCA is burdensome, expensive, and demanding on offshore trust companies.126 Offshore trust companies will have to carefully review the current trusts and structures under management to determine each trust’s classification under FATCA (under either the Treasury Regulations or an IGA). A trust that is classified as an FFI can avoid withholding if: (1) it enters into an agreement with the IRS to become a participating FFI; or (2) it registers as a deemed-compliant FFI.127

A trust that is classified as an NFFE can avoid the 30% withholding by certifying either of two truths: (1) it has no “U.S. substantial owners”; or (2) it has “U.S. substantial owners.”128 An NFFE that is excepted from Chapter 4 withholding is known as an “excepted” NFFE.129 An “excepted” NFFE includes a publicly traded corporation and its affiliates, an NFFE engaged in an active operating business, and certain other specific types of entities.130

Extensive due diligence and cumbersome FATCA compliance requirements may ultimately tip the choice in favor of opting out of providing fiduciary services to U.S. clients entirely.131 One of the main reasons that some foreign banks will not comply with FATCA is that its compliance requires an extensive evaluation of computer and regulatory systems to ensure that U.S. customer accounts are properly reported to the IRS.132 Smaller trust companies would be required to review each trust under management manually.133 They simply may not have enough resources to comply with FATCA as a business.134

In general, FATCA has made it very difficult for many offshore trust companies to do business with U.S. clients. The cost of potential liabilities (mostly reputational) associated with failure to correctly classify an entity under FATCA, as well as the possibility that an incorrect classification will subject a foreign bank or trust company to exposure by those same clients for too much disclosure (or withholding by the IRS for too little reporting), outweighs the benefit of earning fees for the fiduciary services provided to those same U.S. clients.135 For large offshore trust companies classified as FFIs with underlying offshore trust companies, the actual cost of compliance may not be prohibitive.

Armed with a large enough purse to effectively manage the necessary costs to control the FATCA disclosure and reporting requirements, these FFIs have the ability to service U.S. clients with an array of services, including planning with PTCs and complex structures to hold a wide range of international assets. However, FATCA has diminished their appetite. The issue is a palpable risk of an unknown with which offshore trust company CEOs cannot get comfortable. One CEO of a large trust company in Switzerland expressed that, despite the willingness to adhere to all domestic and international tax laws, the risk is not merely successfully managing FATCA’s compliance requirements by expending the necessary costs to build an effective compliance infrastructure with the necessary internal checks and balances, as well as educating employees frequently about FATCA and international tax compliance. Rather, the risk is the inability to control with certainty the behavior of humans. In a large offshore trust company with more than 100 employees across the globe, it is nearly impossible to ensure that all employees are individually abiding by the rules of governance and international tax compliance.

In the context of relationship management,136 where private banks (and trust companies) leverage human connectivity to build business trust that translates into earnings, the emotional tie between the customer and the relationship manager (or trust officer) is critical. Typically a client entertains the idea of bringing assets to a financial institution (and settling a trust under the supervision of its affiliated trust company) because of the solidification of that human trust between the FFI officer and the customer. Thus, it is difficult to ensure that employees would abide by all internal tax compliance rules and regulations (e.g., know-your-customer rules) and reveal the (entire) identity of a customer to the FFI. In the case of dual citizens, there may be irregularities for a mutually beneficial result: assets secured in an FFI (structured in an offshore trust and planned for future generations) to the benefit of both the relationship manager (bigger bonuses at the end of the year because of achieving his or her net new asset targets) and the non-compliant U.S. client (achieving nefarious results) without the risk of being discovered as a U.S. person. There are no guarantees, therefore, that despite an offshore trust company’s best efforts to meet the FATCA compliance requirements, all risks can be contained. To that end, some of the smaller offshore companies simply do not have the necessary resources and funding required to manage a FATCA-compliant portfolio of trusts and are forced to get out of the business.137 Perhaps best explained by another Swiss trust company CEO, the requirement to abide with FATCA begins with the letter “f” for “foreign.” Any financial institution or entity that is not “foreign” within the meaning of FATCA is thus saved from the wrath of FATCA’s tedious and time-consuming reporting requirements.

Therefore, if the same foreign trust company’s operations are moved to Delaware, South Dakota or Nevada, for example, in the United States, it would remove the FATCA compliance burden entirely. Thus, senior managers may not want to “shadow box” in turn with a risk they cannot foresee, and thus forgo providing offshore fiduciary services to U.S. clients all together. It is that which they cannot control that concerns them. Furthermore, given the ample business currently available in emerging markets in Latin America and Asia, large trust companies are not dependent on the U.S. market per se. Compliant U.S. clients may thus struggle to achieve global asset diversification given the multiple layers of international compliance required from them (in addition, to each U.S. person(s) voluntary tax compliance requirements.138 Consequently, some will have no choice but to leave their assets back home. To that end, Congress’s intent with the enactment of FATCA has been achieved. However, at the cost of punishing compliant U.S. clients by creating a chilling effect for FFIs to want to do business with them.

CONCLUSION

To summarize, FATCA has changed the regulatory international enforcement platform to an unprecedented scale. It has created enormous compliance burdens for legitimate U.S. clients who choose to hold their assets abroad, as well as the trust companies and FFIs in the offshore industry that service them. It requires of financial institutions and other foreign entities total transparency of the identity of U.S. customers, or be subject to withholding tax. It has and will continue to put compliance duress on smaller trust companies that may prove fatal to them. It will be interesting to track the revenue benefits FATCA will yield to the United States Treasury over time given the massive global resources and expenditures it has required to date and continues to require from FFIs, NFFEs and their respective U.S. clients.

1 For U.S. tax purposes, a “citizen” is an individual who is either born or naturalized in the United States. Citizenship is determined under the Immigration and Nationality Act, 8 U.S.C. §1401-§1459 (1994). A U.S. citizen who possesses dual or multiple citizenship is treated as a U.S. citizen. SeeMatheson v. United States, 532 F.2d 809, 816 ( 2d Cir. 1976), cert. denied, 429 U.S. 823 ( 1976) (absent a specific intent to relinquish citizenship, a citizen with dual citizenship is still treated as a U.S. citizen for purposes of income and gift taxes); Rev. Rul. 75-82, 1975-1 C.B. 5. A “resident alien” is a non-U.S. citizen who: (1) is lawfully admitted for permanent residence at any time during the calendar year; (2) satisfies the substantial presence test; or (3) elects to be treated as a resident alien. §7701(b)(1)(A)(i)-§7701(b)(1)(A)(iii).

Unless the context indicates otherwise, all “§” references are to the U.S. Internal Revenue Code of 1986, as amended (the “Code”), and all “Reg. §” references are to the regulations issued thereunder (and set forth in 26 CFR).

2 §1, Reg. §1.1-1(b).

3Flora v. United States, 362 U.S. 145, 176 ( 1960) (“[o]ur system of taxation is based upon voluntary assessment and payment.”).

4 FinCen Form 114 (FBAR), formerly TD F 90-22.1 (disclosure of certain financial interest in or signature authority over foreign accounts held by trusts); IRS Form 8938 (Statement of Specified Foreign Financial Assets) and Instructions for Form 8938 (Jan. 5, 2014). See also Notice 2013-10, 2013-1 C.B. 503.

5Id. See, e.g., IRS Form 5471 (Information Report of U.S. Persons with Respect to Certain Foreign corporations), IRS Form 8865 (Return of U.S. Persons with Respect to Certain Foreign Partnerships), IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Elective Fund), IRS Form 926 (Filing Requirements by U.S. Transferors of Property to a Foreign Corporation), and IRS Forms 3520 and 3520-A (Information of Transactions and Ownership of Foreign Trusts) (these specific disclosures must be made in addition to FBARs and FATCA, discussed above).

6 §6049; Reg. §1.6049-8 (an information return is a return filed with the IRS by a person or other entity to report some economic information other than the tax liability of the filing person or entity).

7See Martin A. Sullivan, U.S. Citizens Hide Hundreds of Billions in Cayman Accounts, 103 Tax Notes 956, 957-59 (2004); Kim Dixon, Nearly 15,000 Americans Admit Offshore Tax Cheating, Reuters (Nov. 17, 2009), available at http://www.reuters.com/article/2009/11/17/us-ubs-tax-amnesty-idUSTRE5AG3IU20091117.

8 Jane G. Gravelle, Cong. Research Serv., R40623, Tax Havens: International Tax Avoidance and Evasion (Jan. 15, 2015), available at http://fas.org/sgp/crs/misc/R40623.pdf. See also Chad P. Ralston, Going It Alone: A Pragmatic Approach to Combating Foreign-Effected Tax Evasion, 24 Emory Int’l L. Rev. 873, 896-97 (2010) (describing strengths and weaknesses of the Qualified Intermediary program); Report of Foreign Bank and Financial Accounts (FBAR), IRS, http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR (last updated Sept. 26, 2014) (“[I]n response to a growing budget deficit and a growing problem with tax evasion, the IRS has been focusing on finding taxpayers with undeclared assets abroad thru such programs such as the Qualified Intermediary regime and FBAR (Report of Foreign Bank and Financial Accounts)”).

9 Hiring Incentives to Restore Employment Act of 2010 (HIRE Act), Pub. L. No. 111-147. The HIRE Act added §1471-§1474 to the Code (referred to as “Chapter 4”).

10 An entity for Chapter 4 purposes is any person other than an individual. Reg. §1.1471-1(b)(39). The term “entity” is also defined in Reg. §301.7701-1 and may include a contractual arrangement.

11DOJ Announces Deferred Prosecution Agreement with UBS, Tax Notes Today (Feb. 19, 2009), LEXIS 2009 TNT 31-32.

12 The term “U.S. person” is defined for FATCA purposes to mean a person described in §7701(a)(30), the U.S. government (including an agency or instrumentality thereof), a state (including any instrumentality thereof), the District of Columbia (including any instrumentality thereof), or a non-U.S. insurance company that has made an election under §953(d). Reg. §1.1471-1T(b)(141).

13See, e.g., Martin A. Sullivan, U.S. Citizens Hide Hundreds of Billions in Cayman Accounts, 103 Tax Notes 956, 957-59 (2004); Beckett G. Cantley, The UBS Case: The U.S. Attack on Swiss Banking Sovereignty, 7 BYU Int’l Mgmt. Rev. 1, 19-20 (2001); Michael G. & Oluyemi Ojutiku, An Overview of the Foreign Account Tax Compliance, A.B.A. Sec. Real Prop., Trust & Est. L. (Apr. 28-29, 2011), at 2, http://www.capdale.com/files/4106_An%20Overview%20of%20the%20Foreign%20Account%
20Tax%20Compliance%20Act.pdf; Steven A. Dean, More Cooperation, Less Uniformity: Tax Deharmonization and the Future of the International Tax Regime, 84 Tul. L. Rev. 125, 132 (2009) (citing Joseph Guttentag & Reuven Avi-Yonah, Closing the International Tax Gap, in Bridging the Tax Gap: Addressing the Crisis in Federal Tax Administration 99, 101 (Max B. Sawicky ed., 2005)).

14See, e.g., Lynnley Browning, Tentative Resolution Set in UBS Tax Evasion Case, N.Y. Times (Aug. 1, 2009), at B2; Deutsche Bank Agrees to Pay $553.6 mln to Settle U.S. Shelter Case, Int’l Bus. Times (Dec. 29. 2010), http://www.bloomberg.com/news/2010-12-21/deutsche-bank-agrees-to-pay-553-6-million-to-settle-u-s-tax-shelter-case.html; Clare Baldwin & Joe Rauch, HSBC Clients Scrutinized in U.S. Tax Evasion Probe, Reuters (July 6, 2010), available at http://www.reuters.com/article/2010/07/07/us-hsbc-idUSTRE66608720100707; Brent Kendall, Swiss Banker Pleads Guilty in U.S. Tax Case, Wall St. J. (Dec. 23, 2010), at C3 (for cases dealing with offshore tax evasion).

15Credit Suisse to Pay $1.8 Billion for Tax Charges, DOL Says, 2014 TNT 226-90 (Nov. 14, 2014) (Credit Suisse sentenced for conspiring to help U.S. taxpayers hide offshore accounts).

16See, e.g., Christian Aid, Death and Taxes: The True Toll of Tax Dodging, at 20-21 (2008), http://www.christianaid.org.uk/images/deathandtaxes.pdf; see also Scott A. Schumacher, Magnifying Deterrence by Prosecuting Professionals, 89 Ind. L. J. 511, 512 (2014).

17 Offshore Tax Evasion: The Effort to Collect Unpaid Taxes on Billions in Offshore Accounts, Permanent Subcommittee on Investigations, Committee on Homeland Security and Government Affairs (U.S. Senate), 113th Cong. 4-7 (2014) (statements of James M. Cole, Deputy Attorney General, and Kathryn Keneally, Assistant Attorney General, Tax Division).

18See Melissa A. Dizdarevic, The FATCA Provisions of the HIRE Act: Boldly Going Where No Withholding Has Gone Before, 70 Fordham L. Rev. 2967 (2011).

19See Vlad Frants, FATCA Provisions of the HIRE Act: Possible Effects on International Disclosure Norms, A.B.A. Sec. of Tax’n Newsquarterly (Summer 2010), at 12, 12-13.

20See Itai Grinberg, The Battle Over Taxing Offshore Accounts, 60 UCLA L. Rev. 304, 336 (2012). See also Marie Sapirie, Stacks Addresses IRS Budget Cuts, FATCA and BEPS, 2015 TNT 7-7 (Jan. 9, 2015) (stating the U.S. government’s commitment to reciprocity relating to FATCA).

21Fla. Bankers Ass’n v. U.S. Dep’t of Treasury, 2014 U.S. Dist. LEXIS 3521, 1 ( 2014) (“[B]ecause the Service reasonably concluded that the regulations [FATCA] will improve U.S. tax compliance, deter foreign burden on banks, and not cause any rational actor — other than a tax evader — to withdraw his funds from U.S. accounts, the Court upholds the regulations and grants the Government’s Cross-Motion for Summary Judgment.”).

22See Scott D. Michel and H. David Rosenbloom, FATCA and Foreign Bank Accounts: Has the U.S. Overreached? 62 Tax Notes Int’l 709, 713 (2011) (“it is becoming increasingly apparent that the backlash from FATCA, the burden on IRS regulations writers, and the enormous cost of compliance are not worth the tax revenue that FATCA is likely to produce or justify the other benefits of enhanced compliance.”).

23 Peter Nelson, Conflicts of Interest: Resolving Legal Barriers to the Implementation of the Foreign Account Tax Compliance Act, 32 Va. Tax Rev. 387 (2012).

24 Andrew F. Quinlan, President, Ctr. for Freedom & Prosperity, letter to Timothy Geithner, Sec’y, U.S. Dep’t of the Treasury (July 18, 2011), available at http://freedomandprosperity.org/files/fatca/FATCA-Geithner-ltr-07-18-2011.pdf.

25 Alison Bennett, Dozens of Stakeholders from Around Globe Raise Concerns on FATCA Regime, 29 Tax Mgmt. Wkly. Rep. 1535 (2010).

26 Bos. Consulting Grp., Global Wealth 2013: Maintaining Momentum in a Complex World (2013), https://www.bcgperspectives.com/content/articles/financial_institutions
_growth_global_wealth_2013_maintaining_momentum_complex
_world/. For purposes of this article, wealth managed through offshore accounts means “assets booked in a country where the investor has no legal residence or tax domicile.”

27Id.

28 §1471-§1474.

29 “[W]ithholdable payments” are defined to include any payment of fixed, determinable, annual, or periodical income, if such payments are from sources within the United States, and gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends from sources within the United States. §1473(1)(A); Reg. §1.1473-1(a)(1).

30 §1471(b)(1)(F).

31 Reg. §1.1472-1(b)(1).

32 §1471(a), §1472(a), §1473(l).

33 §1471(b)(1)(D)(i); §1471(d)(7). See also Reg. §1.1471-5(h)(2) (reserved); Reg. §1.1471-2(a).

34See Press Release, U.S. Cong., Baucus, Rangel, Kerry, Neal Improve Plan to Tackle Offshore Tax Abuse Through Increased Transparency, Enhanced Reporting and Stronger Penalties (Oct. 27, 2009) (“[B]ill offers a simple choice — if you wish to access our capital markets, you have to report on U.S. account holders.”).

35Id.

36 157 Cong. Rec. S. 4518, 4519 (July 12, 2011) (statement by Sen. Levin).

37 Treasury Regulations Relating to Information Reporting by Foreign Financial Institutions and Other Foreign Entities, T.D. 9610, 78 Fed. Reg. 5874 (Jan. 28, 2013).

38 Temporary and Treasury Regulations Regarding Information Reporting by FFIs, T.D. 9657, Fed. Reg. 12,811 (Mar. 6, 2014),https://federalregister.gov/a/2014-03967; Guidance with Respect to FATCA Coordination, T.D. 9658, 79 Fed. Reg. 12,725 (Mar. 6, 2014), https://federalregister.gov/a/2014-03991.

39 Notice 2013-43, 2013-2 C.B. 113. T.D. 9657, 78 Fed. Reg. 73,128 (Mar. 6, 2014).

40 Above n. 9, §501(d). Notice 2011-53, 2011-32 I.R.B. 124 (the statutory effective date was delayed by one year due to regulatory burden).

41 Reg. §1.1471-2T(a)(1), §1.1472-1T(b)(1).

42 Reg. §1.1473-1(a)(1)(ii).

43 Notice 2014-33, 2014-21 I.R.B. 1033. Notice 2014-33, released on May 5, 2014 announced that calendar years 2014 and 2015 will be regarded as a transition period for purposes of IRS enforcement and administration of FATCA, and that good faith efforts by withholding agents and other entities to comply with FATCA will be taken into consideration. See also Rev. Proc. 2015-7, 2015-1 I.R.B. 231, §4.01(27) (providing that the IRS will not issue advance letter rulings or determination letters as to whether a taxpayer, withholding agent, or intermediary has properly applied the requirements of Chapter 4 or applicable IGA).

44 A list of IGAs that Treasury treats as in effect is available on the Treasury website. Seehttp://www.treasury.gov/resource-center/tax-policy/treaties/pages/fatca-archive.aspx.

45 §1471(d)(5); Reg. §1.1471-5(d).

46 Reg. §1.1471-5(e). According to former Sen. Carl Levin, FATCA’s chief sponsor, the definition [of FFIs] is purposefully expansive in order to include “banks, securities firms, derivative dealers, and any other type of financial firm that holds, invests, or trades assets on behalf of itself or another person.” See Sen. Carl Levin, Senate Floor Statement on the Enactment of the HIRE Act (Mar. 18, 2010), available at http://www.levin.senate.gov/newsroom/speeches/speech/senate-floor-statement-on-the-enactment-of-the-hire-act/?section=alltypes. Furthermore, Levin commented, “the purpose of the provision is to have [FFIs] look past the nominal owners of their accounts to identify the true beneficial owners. That means accounts which are held in the name of a foreign legal representative, agent, or trustee on behalf of a U.S. person, or in the name of a foreign entity, such as an offshore corporation, partnership, or trust, for the benefit of a U.S. person, must be disclosed to the U.S. authorities.” Id.

47 Reg. §1.1471-1(b)(80). The term includes a foreign entity treated as an NFFE pursuant to a Model 1 or 2 IGA.

48 §1472(d).

49 Reg. §1.1472-1T(c)(1)(iv) An “active” NFFE is an entity where (i) less than 50% of its gross income for the preceding taxable year (calendar or fiscal) is passive income; and (ii) less than 50% of the weighted average percentage of assets (tested quarterly) held by it are assets that produce or are held for the production of passive income. Id. Reg. §1.1472-1(c)(1)(iv) (defines the categories of income that are treated as “passive income”).

50 Reg. §1.1471-1(b)(94). The Treasury Regulations require disclosure of specified U.S. persons who own directly or indirectly more than 10% of the NFFE, referred to as “substantial U.S. owners,” as measured by the last day of the accounting year or when the documentation is provided to the withholding agent. To calculate the 10% reporting threshold, interests owned by related parties are aggregated.

51 Schveizerichas Strafgesetzbuch [Criminal Code] Dec. 21, 1937, art. 273 (Switz.).

52See, e.g., “Joint Communiqué on the Occasion of the Publication of the Model Agreement,” available athttp://www.treasury.gov/resource-center/tax-policy/treaties/Documents/FATCA-Joint-Communique-Model-Agreement-to-Implement-FATCA-7-25-2012.pdf.

53See “Agreement Between the Government of the United States of America and the Government of [insert name of FATCA partner country] to Improve International Tax Compliance and to Implement FATCA,” as revised May 9, 2013 (hereinafter, “Model 1 IGA”) and “Agreement Between the Government of the United States of America and the Government of [FATCA Partner] for Cooperation to Facilitate the Implementation of FATCA,” revised May 9, 2013 (hereinafter “Model 2 IGA”).

54 The United States has entered into treaty negotiations with numerous foreign governments to provide for the exchange of tax information. See Rev. Proc. 2012-34, 2012-34 I.R.B. 280 (Aug. 20, 2012, §3; AR 6816 (Model Tax Convention on Income and on Capital, Commentary on Article 26, Exchange of Information (July 22, 2010).

55See Treasury News Release TG-1653 (July 26, 2012).

56 Reg. §1.1471-5(f)(1).

57 Reg. §1.1471-1T(b)(91).

58 Announcement 2014-38, 2014-51 I.R.B. 951; Announcement 2014-17, 2014-14 I.R.B. 1001.

59See Nils Cousin, The Current State of FATCA Readiness, Remaining Issues, and the Impetus Towards Global Information Reporting, 55 Tax Mgmt. Memo. 135 (2014), for an excellent discussion of FATCA governing law issues.

60 Model 1 IGA (reciprocal), art. 1(1)(mm); Model 1 IGA (nonreciprocal), art. 1(1)(hh). See also FATF, Guidance on Transparency and Beneficial Ownership at 9 (Oct. 2014), http://www.fatf-gafi.org/documents/news/transparency-and-beneficial-ownership.html. While there has been much discussion and debate as to whether “25%” is the correct ownership threshold for analyzing the “controlling U.S. person(s)” definition under the IGAs; it appears a reasonable interpretation of the FATF Recommendations would support this conclusion.

61 Reg. §1.1471-5(f).

62 Reg. §1.1471-5(f)(1), §1.1471-5T(f)(2).

63 Reg. §1.1471-2(a)(4)(iii), §1.1471-2(a)(4)(iv). In general, the PFFI or deemed-compliant FFI must furnish to the requesting withholding agent or bank a withholding certificate and/or documentary evidence, and in certain cases register with the IRS to obtain a global intermediary identification number (“GIIN”). A GIIN is the identification number assigned to a PFFI, a registered deemed-compliant FFI, a sponsoring entity (an entity that elects to sponsor an FFI and executes the necessary FATCA due diligence, reporting, and withholding requirements on behalf of the sponsored entity), or a registered Model 1 FFI that appears on the IRS FFI list. Reg. §1.1471-1(b)(57). In the context of offshore trusts, the “trustee-documented trust,” a sub-category of a deemed-compliant FFI, permits the trustees (rather than the trust itself), to report to the local tax authorities on behalf of the trust. See Model IGA Annex II.

64 The process of registering with the IRS and executing an FFI agreement may be achieved online via the FFI Registration Portal or by filing IRS Form 8957, Foreign Account Tax Compliance Act (FATCA) Registration. One a financial institution has registered, the IRS will issue upon approval a GIIN to each PFFI (including registered-deemed compliant FFIs). See IRS FATCA Information for Reporting Institutions and Entities, http://www.irs.gov/Businesses/Corporations/FATCA-Registration.

65 Above n. 29.

66 §1471(b)(1)(F). In some jurisdictions, such as Switzerland, local law prohibits an FFI from divulging client data to the IRS. To encourage those countries with strong banking secrecy laws to cooperate with FATCA (and thus the IRS), FFIs are encouraged to request “valid and effective” waivers from affected clients. In addition, the law requires the FFIs to close the accounts of clients who do not provide a waiver within a reasonable time (i.e., “recalcitrant account holders.” Reg. §1.1471-5(g)(2)).

67 §1471(d)(6); Reg. §1.1471-5(g)(2). For purposes of FATCA, a “recalcitrant” account holder refers to a U.S. account holder who fails to comply with the reasonable requests from local tax authorities for information by a participating FFI or that fails to provide a waiver in the case where foreign law would prohibit the reporting under domestic laws.

68 Above n. 31. In general, a bank or requesting withholding agent will request from the NFFE to provide either an IRS Form W-8BEN-E (Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) or IRS W-8BEN (Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals) (and, in the case of a U.S. person, an IRS Form W-9 (Request for Taxpayer Identification Number and Certification)). Careful review of FATCA entity classification issues will dictate the corresponding reporting requirements and the relevant FATCA IRS form (i.e., the W-8s) that must be completed, signed (under penalties of perjury by an individual authorized to sign on behalf of the beneficial owner) and provided to the requesting bank or withholding agent. An incorrect classification may lead to practical difficulties including experiencing delays with respect to liaising with the FFI where the account(s) is held in addition to potentially facing withholding. Even when classification of an NFFE is correctly analyzed, harmonizing the IRS forms given the two separate governing laws (namely, the Treasury Regulations and the IGAs) is confusing. It would be helpful if the IRS harmonized the reporting forms such that they would specifically match the IRS FATCA reporting requirements under either the Treasury Regulations, or an IGA, respectively. See e.g., Nathan Newman, Form W-8BEN and Alternative Certifications Under FATCA, BNA Insights, 163 DTR J-1 (Aug. 22, 2014).

69 Frederic Behrens, Using a Sledgehammer to Crack a Nut: Why FATCA Will Not Stand, 2013 Wis. L. Rev. 205, 211 (2013).

70Id.

71See OECD, Towards Global Tax Co-Operation: Report to the 2000 Ministerial Council Meeting and Recommendations by the Committee on Fiscal Affairs: Progress in Identifying and Eliminating Harmful Tax Practices, ¶17 (2000), http://www.oecd.org/tax/transparency/44430257.pdf (naming 35 countries on a tax-haven blacklist).

72 Above n. 17.

73 Above n. 26; see also James S. Henry, The Price of Offshore Revisited (2012) (excellent review of the offshore trust industry and secrecy).

74See Howard D. Rosen, The How’s and Why’s of Offshore Trusts in Asset Protection Planning, 21 Est. Gifts Tr. J. 115, 119-120 (1996); Jonathan L. Mezrich, It’s Better in the Bahamas: Asset Protection Trusts for the Pennsylvania Lawyer, 98 Dickinson L. Rev. 657 (1994); Robert Wills, Lawyers are Killing America 9 (1990) (stating that “anyone who watches television and reads newspapers realizes that America has a rising tide of litigation”); and U.S. Gov’t Accountability Office, GAO 13-318, Offshore Tax Evasion: IRS Has Collected Billions of Dollars, but May Be Missing Continued Evasion (2013) (stating, “some taxpayers reported opening bank accounts in Switzerland as a means of protecting family assets during periods of war or instability in their native country”).

75 Duncan Osborne, New Age Estate Planning: Offshore Trusts, Inst. on Est. Plan., 17-1, 17-11 (1993).

76Id. Other reasons cited by proponents of offshore trusts are “the avoidance of forced dispositions”; “the preservation of entitlements (e.g., Medicare and Medicaid)”; “marital property planning (e.g., partition of community property, spousal gifts, and QTIP trusts)”; and “tax planning.” Id.

77 The term “forced heirship,” commonly used in civil law countries, generally means that, upon a decedent’s death, assets are appropriated according to statute.

78 Stephen G. Gilles, The Judgment-Proof Society, 63 Wash. & Lee L. Rev. 603, 639 (2006).

79See Rachel J. Harris, Dina Kapur Sanna, and Jennifer Smithson, FATCA and Non-U.S. Trusts: An Overview, J. of Int’l Tax, Tr. and Corp. Plan., Vol. 21, No. 3 (2014), http://www.daypitney.com/news/docs/dp_5467.pdf; Ellen K. Harrison, The Foreign Account Tax Compliance Act, STEP J. (Mar. 2013), http://www.step.org/foreign-account-tax-compliance-act. See also Peter A. Cotorcenau, 1-9 Lexis Guide to FATCA, Chapter 9, FATCA and the Offshore Trust Industry.

80 Reg. §1.1471-5(e)(4)(v) Exs. 5 and 6.

81 Reg. §1.1471-5(e)(4)(i)(A)(3). Under an IGA, a trust should be treated as an FFI if it falls under the definition of a “financial institution,” which includes an “investment entity.” See, e.g., Article 1(g) of the Model 1A IGA Reciprocal, Preexisting TIEA or DTC (Nov. 30, 2014).

82 According to the CEO of a large Swiss trust company that was interviewed for this article, the company has budgeted US$1 million on an annual basis solely for FATCA compliance.

83 §1471(d)(5); Reg. §1.1471-5(d).

84 Above n. 10.

85 Reg. §1.1473-1(e).

86 Above n. 1.

87 The term “accept deposits” is not defined in the Treasury Regulations. A depository institution is one that “accepts deposits in the ordinary course of a banking or similar business.” It includes foreign entities that regularly provide trust or fiduciary services. Reg. §1.1471-5(e)(2)(i)(D).

88 Reg. §1.1471-5(e)(1)(ii); §1471(d)(5)(B) (a custodial FFI is one that “as a substantial portion of its business, holds financial assets for the account of others”). See also Notice 2010-60, 2010-37 I.R.B. 329 obsoleted by T.D. 9610, 78 Fed. Reg. 5873 (Jan. 28, 2013) (providing guidance regarding classification of foreign entities, the documentation of accounts, annual reporting requirements, and solicited comments from practitioners).

89Id.

90 Reg. §1.1471-5(e)(3)(i)(A). The relevant period is the shorter of: (1) the three-year period ending on December 31 of the year preceding the year of determination; or (2) the period during which the entity has been in existence before the determination is made. Id.

91Id. See also Reg. §1.1471-5(e)(4)(C)(ii) (a financial asset is defined as a security, partnership interest, insurance contract, or any interest in a derivative thereof).

92 Reg. §1.1471-5(e)(4). Under the IGAs, an “investment entity” is classified as a sub-category of a “financial institution” and thus classified as an FFI.

93 Reg. §1.1471-5(e)(4)(i)(A).

94 Reg. §1.1471-5(e)(4)(i)(B).

95Id.

96 Reg. §1.1471-5(e)(4)(i)(C).

97 Above n. 95.

98 In Switzerland, for example, trust administration is part of the cache of “Swissness.”

99 Above n. 93. An offshore professional trust company is classified ipso facto as an FFI.

100See, e.g., TAM 9507044 (May 31, 1994).

101 §1297, §1298(f).

102 §7701(a)(31)(B). To qualify as a U.S. trust, a trust must satisfy both the court test and the control test. Id. Many offshore trust companies suggest that the settlor appoint a “trust protector” to act as an advisor to the trustee and ensure that the trustee follows the settlor’s wishes. The trust protector is granted special nonfiduciary powers to control the administration of the trust, with respect to such matters as removal and replacement of trustees, as well as control over discretionary actions of the trustees; see also Stewart E. Sterk, Trust Protectors, Agency Costs, and Fiduciary Duty, 27 Cardozo L. Rev. 2761, 2764 (2006).

103 Above n. 46.

104 Above n. 80. See also definition of an “investment entity” under Model 1 and 2 IGAs.

105 Above n. 92.

106 Reg. §1.1471-1(b)(134).

107 Reg. §1.1471-5(a).

108 Reg. §1.1473-1(c).

109 Reg. §1.1471-5(a)(2).

110 Reg. §1.1471-5T(c).

111 Reg. §1.1473-1(b)(4).

112 Reg. §1.1473-1(b)(34), §1.1473-1(b)(1)(iii).

113 Reg. §1.1473-1(b)(5).

114See Reg. §1.1471-5(b)(1)(iii). An equity interest in an FFI that is not an “investment entity” is treated as a financial account only in certain circumstances. See Reg. §1.1471-5(b)(1)(iii)(c).

115 Above n. 112.

116Id.

117 Reg. §1.1471-5(b)(3)(iii).

118 The trust would be required to report the following information to the IRS: (1) the name, address, and tax identification number (TIN) of each U.S. account holder; (2) the account number; (3) the account balance or value of the account; (4) the payments made with respect to the account during the calendar year; and (5) any other information as required under IRS Form 8966 FATCA Report. §1471(c); Reg. §1.1471-4(d)(3).

119 Interests owned by related persons (defined to include a person or spouse of a person described in Reg. §1.267(c)-1(a)(d)) are aggregated. Reg. §1.1473-1(b)(2)(v).

120 Reg. §1.1473-1(b)(3)(ii).

121 Reg. §1.1473-1(b)(4).

122 Reg. §1.1473-1(b)(7) Ex. 3.

123 Reg. §1.1473-1(b)(2)(iv).

124 A substantial U.S. owner relating to an NFFE that is a corporation is any specified U.S. person that owns, directly or indirectly, more than 10% of the stock of the corporation, either by vote or by value. Reg. §1.1473-1(b)(1)(i). A substantial U.S. owner relating to an NFFE that is a partnership is any specified U.S. person that owns, directly or indirectly, more than 10% of the profits interests or capital interests in the partnership. Reg. §1.1473-1(b)(1)(ii).

125 In the context of IGAs, some jurisdictions have provided specific guidance with respect to the FATCA classification of PTCs depending on whether the board of directors are remunerated. See, e.g., Guidance Notes issued under the IGA with the British Virgin Islands (July 2014), available at http://www.finance.gov.vg/Portals/0/BVI%20-%20US%20and%20UK
%20FATCA%20DRAFT%20Guidance%20Notes%20document.pdf.

126 Above n. 22.

127 Reg. §1.1471-5(f).

128 Reg. §1.1472-1(b). In the context of IGAs, the trustees must certify that the trust does not have any individuals who exercise control over an entity and are U.S. person(s) (defined as “controlling person(s)”). Model 1 IGA (reciprocal), art. 1(1)(mm); Model 1 IGA (nonreciprocal), art. 1(1)(hh).

129 Reg. §1.1472-1(c), §1.1472-1T(c).

130Id.

131 Above n. 26.

132 Peter R. Altenburger, FATCA: U.S. Legislation with Broad Consequences for Many, Swiss-Am. Chamber Com. (Sept. 11, 2010), see also Frederic Behrens, Using a Sledgehammer to Crack a Nut: Why FATCA Will Not Stand, 2013 Wis. L. Rev. 205, 213 (2013).

133See e.g., Jonathan Lachowitz, FATCA Implications for Financial Institutions and US Persons in Switzerland, White Lighthouse Investment Management SARL (Feb. 17, 2013), at 8, available at https://www.americansabroad.org/files/9413/6354/4479/fatcaimplicationsforswitzerland.pdf.

134Id.

135 Lynnley Browning, Complying with U.S. Tax Evasion Law Is Vexing Foreign Banks, N.Y. Times (Sept. 17, 2013), at B6.

136 Above n. 133, at 7.

137See e.g., Swiss Trust Company for Sale, First Fidelity Trust AG, available at http://www.fidelitytrust.ch/standard-procedure.html; Swiss Financial Institutions for Sale, GlobalBX.com, available at http://www.globalbx.com/listing.asp?bId=150185; Swiss Trust Company for Sale, Corb7 International Inc., available at http://www.swisstrustcompanies.net/landing-page; 15 Year Old Swiss Trust Company, Lowest Price, MergerNetwork (Feb. 3, 2015), available athttp://www.mergernetwork.com/for-sale/year-old-swiss-trust-company-lowest-price/368978.htm; Financial Trust Company for Sale (Dec. 14, 2014), available at http://www.4321business.com/advert.asp?ad=44833; Swiss Private Bank for Sale (Jan. 19, 2011), available at http://www.businessreel.com/business/swiss-private-bank-business-for-sale/118564/.

138 Above nn. 4, 5.

* The views expressed in this article are those solely of the author and do not necessarily represent the views of Chadbourne & Parke LLP.