Tax and legal issues can be difficult waters to navigate. For U.S. individuals and companies doing business in Latin America, however, it can be come even trickier. The introduction of the Foreign Account Tax Compliance Act (FATCA) is part of a broad initiative by the United States to combat offshore tax evasion by U.S. taxpayers, but it has implications for legitimate businesses operating in foreign markets, including Latin America and the Caribbean.
Joshua Ehrenfeld, counsel at Burr & Forman in Nashville, explained that FATCA poses two primary issues for US companies operating overseas, including in Latin America:
- FATCA has the potential to impact any “outbound” payment made to a foreign recipient by a US company.
- FATCA imposes specific and onerous reporting requirements on US companies that hold foreign financial accounts, as well as certain foreign entities that interact with those accounts.
“Other than simply foregoing offshore business opportunities, US companies have little choice but to work through the compliance regime that FATCA has installed,” Ehrenfeld said. “At a minimum, companies should be cognisant of these two issues and should thoroughly analyze their business activities to determine which (if any) appropriate actions are necessary to navigate FATCA’s rules.”
Outbound Payment Requirements
Ehrenfeld explained that in terms of outbound payments, US companies need to determine certain information up front relating to their foreign business partners and counterparties.
Brazil, Colombia, Costa Rica, Honduras and Chile have each signed IGAs and are locked in to specific reporting requirements with respect to financial institutions in their respective countries — Joshua Ehrenfeld
He added that, fortunately, not all outbound payments are subject to FATCA’s withholding regime. “The regulations provide a significant carve-out for outbound payments that relate to an active business. As a result, a US company needs to clarify information relating to the recipient of an outbound payment, as well as information about the payment itself,” he said.
Ehrenfeld used the example of a US firm outsourcing a project to a Brazilian service provider. In such a situation, the US firm needs to take steps to determine the status and nature of the Brazilian firm and the payment to that firm from a FATCA standpoint.
“Among the critical items to determine are a) whether the Brazilian firm runs and engages in an active business and b) whether the payment itself relates to an active business,” he said. “Payments such as interest on a loan from a Brazilian bank are subject to FATCA withholding, whereas payments to a Brazilian IT firm for software development are not.”
Ehrenfeld explained that to document FATCA compliance, US companies should request a certification from a foreign counterparty on a form such as IRS Form W-8BEN-E, that the counterparty is engaged in an active business.
Navigating Foreign Financial Accounts
The FATCA requirements have put a significant burden on foreign banks According to Ehrenfeld, FATCA forces a foreign bank to report the account activity of any financial account that is held by a US account holder. In other words, foreign banks are now forcibly deputized to report any activities of accounts they maintain for US citizens and businesses.
For example, he explained, an Argentinean bank must report to either the IRS or to the Argentinean administration of public revenue the existence and activity of a specific account held at the Argentinean bank on behalf of a U.S. company.
Payments to a Brazilian IT firm for software development are not subject to FATCA withholding — Joshua Ehrenfeld
“When viewed in this light, it is understandable why so many foreign financial institutions have simply closed US accounts and refused to take on business from US citizens and businesses,” he said. “Rather than trying to navigate the maze of FATCA’s regulations and rules, many foreign banks are instead simply foreclosing US clients out of the market.”
In such a situation, then, it is the responsibility of any US company acting overseas to confirm that their accounts will continue to be maintained by their current financial institutions, and to verify that a local financial institution is available to handle their business in the event their current account is shut down.
“Because some local vendors require payment through local financial institutions, a US company needs to confirm it will be able to facilitate payment through local channels prior to engaging in activities in a given jurisdiction,” Ehrenfeld warned.
Individuals are also required to comply with FATCA. Carlos Somoza, international tax principal with Kaufman Rossin in Miami, said that FATCA is currently only a reporting tool applicable for U.S. individual taxpayers holding certain foreign financial assets.
“The general recommendation is to report said foreign assets. It may even be advisable to err on the side of caution and over-report in a situation where it is unclear whether a certain foreign asset falls within the definition of specified foreign financial asset,” he said.
Somoza said that the reason for this is that the potential penalties for non-filing or for an incomplete filing can include a $10,000 penalty, and the extension of the normally applicable three year statute of limitations.
Differentiating Between Business and Contractors
Greg Freyman, CPA, CGMA, the managing partner of New York City & New Jersey based Freyman CPA, P.C., said that from a tax perspective, IT outsourcing services poses certain FATCA reporting issues related to understanding who is performing the work, how it is being performed, where the work is performed and which countries are involved in the transaction.
“Many companies do not properly document these details and as a result overlook some of the responsibilities associated with FATCA,” he sad.
Freyman explained that the tax reporting should reflect these business activities accurately to meet FATCA requirements. “For instance, the company controller and CFO should advise the Latin American individual or company on completing Form W-8BEN for individuals and Form W-8BEN-E for businesses,” he said, adding that it may be applicable to complete certain sections of these forms to obtain tax withholding exemption on the revenue generated as a result of a tax treaty for those performing services abroad.
He went on to explain that in cases where the services are performed only by an individual and not a business, non-resident alien employees or independent contractors should generally file a Form 8233 to be granted a tax withholding exemption.
Look For Inter-Government Agreements
FATCA is globally enacted, meaning that the requirements and regulations are the same whether you are transacting in Asia, Europe or Latin America. However, there can be differences.
“Any issues unique to Latin America will stem from individual reactions that particular countries in the region have to US companies transacting business,” Ehrenfeld explained.
Many companies do not properly document these details and as a result overlook some of the responsibilities associated with FATCA — Greg Freyman
This is when it is important to know whether the specific country has signed an inter-governmental agreement (an “IGA”) with the U.S. Thomson Reuters, which offers a FATCA software solution, noted that an IGA offers certain benefits to partner countries such as relaxation of deadlines, simplified due diligence, and increased clarity around due diligence with country specific provisions.
There are two models of IGA currently in existence. According to Thomson Reuters, the most notable differences between Model 1 and Model 2 IGAs, are that in Model 2 “financial institutions will report information directly to the IRS rather than their local jurisdictions; and there is no ‘reciprocal’ version of the Model 2 IGA.”
According to Ehrenfeld, Brazil, Colombia, Costa Rica, Honduras and Chile have each signed IGAs and are therefore locked in to specific reporting requirements with respect to financial institutions in their respective countries. According to Thomson Reuters, Nicaragua has agreed to a model 2 IGA “in substance.”
“Each of these countries will therefore have a more clear set of parameters for addressing how local financial institutions handle accounts held by US individuals or companies,” he said.
On the other hand, certain countries like Argentina do not currently have IGAs in place and thus financial institutions in Argentina are less likely to have uniform procedures for addressing US accounts, Ehrenfeld noted.
“Any US company doing business in Latin America should perform due diligence on the specific jurisdiction it seeks to transact business in and focus on whether that particular country has an IGA in place and what mechanics institutions in that country have implemented under FATCA,” he said.