Part 3: What God Hath Wrought – The #FATCA Inquisition (Review, Identify and Report on “U.S. Persons”) – “Active or passive NFFE”?

In Part 2 of this series I concluded that:

The FATCA IGAs are now being used AROUND THE WORLD to hunt for people with “US indicica. The purpose of FATCA is clearly to:
Review non-U.S. “Entity Accounts”; to
Identify those beneficial owners who are “U.S. Persons”; to
Report those “U.S. owners” to the banks who will report them to the IRS
It’s the “RIR” principle! Understand that pursuant to the “RIR” principle, the United States is using FATCA to force disclosure of beneficial ownership of “Entity Accounts” in the whole wide world. The goal is to locate “U.S. Persons”. “U.S. Persons” are composed primarily of those with a U.S. place of birth.
When it comes to the hunt for those with a “U.S. place of birth”, FATCA is being used to “smoke em out“.

Part 1 of this series described how the FATCA inquisition has impacted impacted “entities” in general and a U.K. PTA in particular. A principal purpose of the inquisition is to identify what is called (in FATCASpeak) a “passive NFFE”. The search extends to the trust accounts maintained by lawyers. This includes lawyers in New Zealand.
Let’s let the New Zealand Law Society explain what a “NFFE” is and what makes a “NFFE” passive. Their description does NOT explain why the New Zealand Government “passively” acquiesced to FATCA. That said …

Understanding the importance of the Non-Financial Foreign Entity (“NFFE”)
In order to understand how the FATCA IGA applies to “non-DNA persons”, one must distinguish between:

  1. Financial Institutions (think your bank) – “FI”
  2. Non-Financial Foreign Entities (think active businesses, trusts, etc.) – “NFFE”

Furthermore, Non-Financial Foreign Entities” (“NFFE”) must be categorized as either “passive” or not passive. The following explanation from the New Zealand Law Society (how should laywers’ trust accounts be categorized?) is very interesting.
In June of 2014, the Government of New Zealand entered into an IGA with the United States
The “RIR” principle applies to all business bank accounts in every country that has signed a FATCA IGA. What follows is a fascinating discussion of how the New Zealand Law Society understands FATCA to apply to law firm trust accounts. (For an extensive discussion of how FATCA and FBAR apply to Canadian law firm trust accounts read here.)

Are you an FI or an NFFE?
Under FATCA your firm will either be a “financial institution” (FI) or a “non-financial foreign entity” (NFFE).
All non-US entitles are classified either as FIs or NFFEs. For the purposes of FATCA, entities include legal persons and legal arrangements such as joint ventures, associations, corporations, partnerships and trusts, but not natural persons.
A FI law firm will have greater obligations under FATCA (registration, due diligence and reporting) than a NFFE law firm.
Active and passive NFFEs
NFFEs are either active or passive. An NFFE is a passive NFFE if it is not an active NFFE. FATCA is concerned with passive NFFEs, not active NFFEs because active NFFEs do not give rise to US reportable accounts.
For present purposes, an active NFFE means an NFFE where less than 50% of the NFFE’s gross income for the preceding calendar year or other reporting period is passive income (under New Zealand tax law) and less than 50% of the assets held during such period produce or are held for the production of passive income.
Passive NFFEs are of interest to the IRS (and therefore the law firm’s bank and the IRD) if they have “controlling persons” who are US citizens or tax residents. Controlling persons would be the client if an individual or, for an entity, the natural persons exercising control over the entity.
For example, In the case of a trust client, the controlling persons would include a settlor, trustees, protector, beneficiaries or class of beneficiaries and any other natural person exercising ultimate effective control over the trust.
An NFFE law firm’s “trust account relationship entity” is likely to be a passive NFFE because none of the criteria for an active NFFE is likely to apply. This will be a question of fact in each case. If clients’ funds are held on interest bearing deposit, all income is likely to be passive income and it is likely that the clients’ funds would be assets that produce or are held for the production of passive income. Likewise if moneys are not placed on interest bearing deposit then it is likely that none of the criteria for an active NFFE would apply – with the
result that the trust account relationship entity will be a passive NFFE.
Bank requirements
When a law firm notifies its bank of an election it has made and that it is not an FI, but an NFFE, and that its trust account relationship entity is a passive NFFE, its bank will request the law firm to provide a self-certification. This is to be made by the law firm or controlling persons and must state whether the controlling persons of the passive NFFE “trust account relationship entity” are US citizens or US tax residents.
Effectively the information required is whether the client is a US citizen or US tax resident, or whether the client entity has any controlling person who is a US citizen or US tax resident.

Q. Why the hunt for U.S. citizens or tax residents associated with passive “NFFEs”?
Two answers:
A 1. To find U.S. citizens who are hiding taxable income behind “entities”.
A 2. To attribute the income of the passive “NFFE” to the individual U.S. citizen or tax resident. In the case of a corporation, this would mean that the individual would pay tax on income earned by the corporation even though that income was not paid to the individual. See SubPart F income.

2 thoughts on “Part 3: What God Hath Wrought – The #FATCA Inquisition (Review, Identify and Report on “U.S. Persons”) – “Active or passive NFFE”?

  1. badger Post author

    NZ IRD in talks re lawyers trust accounts:
    ‘IRD issues FATCA trusts guidance notes’
    10 March 2016
    “The Inland Revenue Department has issued Trusts Guidance Notes for the United States’ Foreign Account Tax Compliance Act (FATCA).
    The guidance sets out how IRD considers FATCA applies in New Zealand to trusts that maintain or hold financial accounts.
    A trust that is a Reporting New Zealand financial institution will be required to register with the US Internal Revenue Service (IRS) and will have FATCA due diligence and reporting obligations.
    The IRD guide outlines how FATCA applies to unit trusts, family trusts, trading trusts and charitable trusts.
    IRD says it will produce separate guidance on the application of FATCA to solicitors’ trust accounts.
    The New Zealand Law Society’s Practice Briefing FATCA and New Zealand Law Firms states that it will be updated when further information is received from IRD.
    The Law Society remains in discussion with IRD and the New Zealand Bankers Association. Several different approaches are being explored and as soon as accord is reached this will be communicated to all law firms running trust accounts.”

  2. badger Post author
    “Scott Michel Comments on Attorney Confidentiality FATCA Exemption
    March 1, 2016, Daily Tax Report
    Scott D. Michel spoke with Daily Tax Report concerning an agreement between Switzerland and the U.S. to exempt financial institutions from certain FATCA reporting requirements regarding confidential client accounts held by Swiss attorneys. The new exemption applies to client funds held in escrow accounts by Swiss attorneys and notaries in the ordinary course of business, e.g., prior to the distribution of an estate, after the settlement of a lawsuit and the like. For the full story, please visit Daily Tax Report’s website (subscription required).
    Excerpt taken from the article.
    “This is not about what we would consider in the U.S. to be matters protected under the attorney-client privilege,” said Scott Michel, a partner at Caplin & Drysdale Chartered in Washington. “It’s more about the fact that Swiss lawyers engage with their clients in perfectly legal but confidential transactions.”
    The new amendment to Annex II of FATCA specifies that Swiss banks don’t have to identify the clients of accounts held by lawyers or notaries as long as they provide written verification that the accounts fall under the scope of application of the exception clause……………”


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