Second IRS Notice on Implementation of the FATCA Reporting and Withholding Regime

On April 8, 2011, the U.S. Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) released Notice 2011-34, the second Notice addressing the implementation of the Foreign Account Tax Compliance provisions of the HIRE Act (“FATCA”).  FATCA is intended to prevent U.S. tax evasion by requiring foreign banks and investment funds to provide information to the IRS about U.S. customers and investors.  The Notice reflects a genuine attempt by the Treasury and IRS to be responsive to many of the concerns raised by banks, investment funds and foreign governments, for example by significantly revising the diligence that “foreign financial institutions” (“FFIs”) must undertake with respect to existing accounts of individual customers to focus on higher-risk accounts, and by establishing several new categories of FFIs that are exempt from the most onerous FATCA rules.  However, the Notice adopts a very broad set of rules requiring FFIs to withhold tax on foreign source payments made to customers that fail to cooperate with the information reporting process and financial institutions that do not satisfy reporting and withholding obligations.  For example, a bank may be required to withhold U.S. tax on interest that it pays on retail bank deposits or on commercial paper that it has issued.  Notice 2011-34 also adopts a new group rule that prohibits an FFI in an affiliated group from entering into an agreement with the IRS to comply with FATCA’s reporting and withholding obligations unless all members of the group that are non-exempt FFIs do so as well.  The new Notice thus creates several important issues and will continue to present significant challenges to financial institutions attempting to comply with FATCA.